Attached files

file filename
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 September 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 October 26, 2015, was 3,001,071.

 
 

 
 
Citizens Financial Services, Inc.
Form 10-Q

INDEX
 
 
   
PAGE
Part I
FINANCIAL INFORMATION
 
Item 1.
Financial Statements (unaudited):
 
 
Consolidated Balance Sheet as of September 30,2015 and December 31, 2014
1
 
Consolidated Statement of Income for the Three and Nine months Ended September 30,2015 and 2014
2
 
Consolidated Statement of Comprehensive Income for the Three and Nine months ended September 30, 2015 and 2014
3
 
Consolidated Statement of Cash Flows for the Nine Months ended September 30, 2015 and 2014
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)
   
     
 
September 30,
December 31,
(in thousands except share data)
2015
2014
ASSETS:
   
Cash and due from banks:
   
  Noninterest-bearing
 $               9,437
 $          10,091
  Interest-bearing
                     877
               1,332
Total cash and cash equivalents
                10,314
             11,423
Interest bearing time deposits with other banks
                  6,460
               5,960
Available-for-sale securities
              300,630
           306,146
Loans held for sale
                  1,248
                  497
 
   
Loans (net of allowance for loan losses:
   
  2015, $7,045 and 2014, $6,815)
              575,964
           547,290
 
   
Premises and equipment
                12,544
             12,357
Accrued interest receivable
                  3,566
               3,644
Goodwill
                10,256
             10,256
Bank owned life insurance
                20,773
             20,309
Other assets
                12,222
               7,166
 
 
 
TOTAL ASSETS
 $           953,977
 $        925,048
 
 
 
LIABILITIES:
   
Deposits:
   
  Noninterest-bearing
 $           106,957
 $          95,526
  Interest-bearing
              690,891
           678,407
Total deposits
              797,848
           773,933
Borrowed funds
                44,657
             41,799
Accrued interest payable
                     693
                  756
Other liabilities
                  6,875
               8,032
TOTAL LIABILITIES
              850,073
           824,520
STOCKHOLDERS' EQUITY:
   
Preferred Stock
   
  $1.00 par value; authorized 3,000,000 shares September 30, 2015 and December 31, 2014;
   
   none issued in 2015 or 2014
                          -
                      -
Common stock
   
  $1.00 par value; authorized 15,000,000 shares;  issued 3,335,236 at September 30, 2015 and
   
  December 31, 2014
                  3,335
               3,335
Additional paid-in capital
                25,131
             25,150
Retained earnings
                84,698
             79,512
Accumulated other comprehensive income
                     842
                  767
Treasury stock, at cost: 334,165 shares at September 30, 2015
   
  and 296,280 shares at December 31, 2014
               (10,102)
             (8,236)
TOTAL STOCKHOLDERS' EQUITY
              103,904
           100,528
TOTAL LIABILITIES AND
   
   STOCKHOLDERS' EQUITY
 $           953,977
 $        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
Nine Months Ended
 
September30,
September30,
(in thousands, except share and per share data)
2015
2014
2015
2014
INTEREST INCOME:
       
Interest and fees on loans
 $        7,248
 $      7,094
 $       21,416
 $     21,200
Interest-bearing deposits with banks
                 33
               25
                103
               51
Investment securities:
       
    Taxable
               798
             805
             2,317
          2,542
    Nontaxable
               749
             844
             2,398
          2,526
    Dividends
                 35
               40
                168
             159
TOTAL INTEREST INCOME
           8,863
         8,808
          26,402
        26,478
INTEREST EXPENSE:
       
Deposits
           1,044
         1,092
             3,088
          3,291
Borrowed funds
               174
             142
                521
             451
TOTAL INTEREST EXPENSE
           1,218
         1,234
             3,609
          3,742
NET INTEREST INCOME
           7,645
         7,574
          22,793
        22,736
Provision for loan losses
               120
             150
                360
             480
NET INTEREST INCOME AFTER
       
    PROVISION FOR LOAN LOSSES
           7,525
         7,424
          22,433
        22,256
NON-INTEREST INCOME:
       
Service charges
           1,054
         1,098
             3,058
          3,239
Trust
               149
             151
                523
             528
Brokerage and insurance
               181
             141
                563
             398
Gains on loans sold
                 85
               40
                183
             110
Investment securities gains, net
               129
             242
                430
             488
Earnings on bank owned life insurance
               158
             124
                464
             366
Other
               109
             128
                327
             337
TOTAL NON-INTEREST INCOME
           1,865
         1,924
             5,548
          5,466
NON-INTEREST EXPENSES:
       
Salaries and employee benefits
           3,069
         2,790
             9,118
          8,600
Occupancy
               347
             313
             1,064
             967
Furniture and equipment
               108
               86
                323
             280
Professional fees
               202
207
                614
649
FDIC insurance
               116
             116
                348
             345
Pennsylvania shares tax
               201
             101
                602
             485
Merger and acquisition
282
187
                405
237
ORE expenses
               328
             106
                686
             243
Other
           1,199
         1,161
             3,455
          3,352
TOTAL NON-INTEREST EXPENSES
           5,852
         5,067
          16,615
        15,158
Income before provision for income taxes
           3,538
         4,281
          11,366
        12,564
Provision for income taxes
               681
             913
             2,200
          2,655
NET INCOME
 $        2,857
 $      3,368
 $         9,166
 $       9,909
PER COMMON SHARE DATA:
       
Net Income - Basic
 $          0.95
 $        1.11
 $            3.04
 $         3.26
Net Income - Diluted
 $          0.95
 $        1.11
 $            3.03
 $         3.26
Cash Dividends Paid
 $        0.510
 $      1.000
 $         1.320
 $       1.772
         
Number of shares used in computation - basic
   3,011,687
  3,035,214
     3,019,202
  3,038,973
Number of shares used in computation - diluted
   3,013,151
  3,036,700
     3,020,670
  3,040,400
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
Nine Months Ended
 
September30,
September30,
(in thousands)
 
2015
 
2014
 
2015
 
2014
Net income
 
 $     2,857
 
 $   3,368
 
 $  9,166
 
 $  9,909
Other comprehensive income (loss):
               
      Change in unrealized gains on available
               
                 for sale securities
1,094
 
855
 
   390
 
4,598
 
      Income tax effect
 (372)
 
 (291)
 
(132)
 
(1,563)
 
      Change in unrecognized pension cost
51
 
13
 
   153
 
38
 
      Income tax effect
 (17)
 
 (4)
 
 (52)
 
 (13)
 
      Less:  Reclassification adjustment for investment
               
                 security gains included in net income
 (129)
 
 (242)
 
(430)
 
 (488)
 
      Income tax effect
44
 
82
 
   146
 
166
 
Other comprehensive income, net of tax
 
671
 
413
 
    75
 
2,738
Comprehensive income
 
 $     3,528
 
 $   3,781
 
 $  9,241
 
 $ 12,647
                 
The accompanying notes are an integral part of these unaudited consolidated financial statements. 
   

 
3

 

 
CITIZENS FINANCIAL SERVICES, INC.
   
CONSOLIDATED STATEMENT OF CASH FLOWS
   
(UNAUDITED)
Nine Months Ended
 
September 30,
(in thousands)
2015
2014
CASH FLOWS FROM OPERATING ACTIVITIES:
   
  Net income
 $          9,166
 $          9,909
  Adjustments to reconcile net income to net
   
   cash provided by operating activities:
   
    Provision for loan losses
                360
                480
    Depreciation and amortization
                370
                358
    Amortization and accretion of investment securities
             1,521
             1,632
    Deferred income taxes
                (39)
                562
    Investment securities gains, net
              (430)
              (488)
    Earnings on bank owned life insurance
              (464)
              (366)
    Originations of loans held for sale
         (13,510)
           (8,055)
    Proceeds from sales of loans held for sale
           12,942
             7,690
    Realized gains on loans sold
              (183)
              (110)
    Decrease in accrued interest receivable
                  78
                  39
    Decrease in accrued interest payable
                (63)
              (142)
    Other, net
              (842)
              (222)
      Net cash provided by operating activities
             8,906
           11,287
CASH FLOWS FROM INVESTING ACTIVITIES:
   
  Available-for-sale securities:
   
    Proceeds from sales
           18,393
           17,338
    Proceeds from maturity and principal repayments
           39,472
           39,416
    Purchase of securities
         (58,667)
         (44,769)
  Purchase of interest bearing time deposits with other banks
              (500)
           (3,232)
  Proceeds from redemption of regulatory stock
             2,150
             2,891
  Purchase of regulatory stock
           (2,097)
           (1,895)
  Net increase in loans
         (29,148)
           (4,680)
  Purchase of premises and equipment
              (633)
              (555)
  Proceeds from sale of foreclosed assets held for sale
                340
                647
      Net cash (used) provide by investing activities
         (30,690)
             5,161
CASH FLOWS FROM FINANCING ACTIVITIES:
   
  Net increase in deposits
           23,915
           19,726
  Proceeds from long-term borrowings
             5,288
             6,815
  Repayments of long-term borrowings
              (700)
           (4,200)
  Net increase in short-term borrowed funds
           (1,730)
         (31,818)
  Purchase of treasury and restricted stock
           (2,315)
              (733)
  Dividends paid
           (3,783)
           (4,998)
      Net cash (used) provided by financing activities
           20,675
         (15,208)
          Net (decrease) increase in cash and cash equivalents
           (1,109)
             1,240
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
           11,423
           10,083
CASH AND CASH EQUIVALENTS AT END OF PERIOD
 $        10,314
 $        11,323
     
Supplemental Disclosures of Cash Flow Information:
   
    Interest paid
 $          3,672
 $          3,884
    Income taxes paid
 $          2,425
 $          2,085
    Loans transferred to foreclosed property
 $             241
 $             867
    Premises and equipment transferred from other assets
 $                  -
 $             549
    Investments sold and not settled
 $          5,187
 $                 -
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 September 30, 2015 and for the periods ended September 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 nine month period ended September 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
Nine months ended
 
September30,
September30,
 
2015
2014
2015
2014
Net income applicable to common stock
$2,857,000
$3,368,000
$9,166,000
$9,909,000
         
Basic earnings per share computation
       
Weighted average common shares outstanding
   3,011,687
   3,035,214
     3,019,202
   3,038,973
Earnings per share - basic
$0.95
$1.11
$3.04
$3.26
         
Diluted earnings per share computation
       
Weighted average common shares outstanding for basic earnings per share
   3,011,687
   3,035,214
     3,019,202
   3,038,973
Add: Dilutive effects of restricted stock
          1,464
          1,486
            1,468
          1,427
Weighted average common shares outstanding for dilutive earnings per share
   3,013,151
   3,036,700
     3,020,670
   3,040,400
Earnings per share - diluted
$0.95
$1.11
$3.03
$3.26
 
For the three months ended September 30, 2015 and 2014, there were 2,696 and 1,938 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 September 30, 2015 and prices ranging from $34.70-$50.50 for the three month period ended September 30, 2014. For the nine months ended September 30, 2015 and 2014, 2,696 and 2,913 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 nine month period ended September 30, 2015 and prices ranging from $34.70-$50.50 for the nine month period ended September 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 affordable housing tax credits.

Investments in Qualified Affordable Housing Projects
 
As of September 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 $1,024,000 and $1,218,000 as of September 30, 2015 and December 31, 2014, respectively. Investments purchased prior to January 1, 2015, are accounted for utilizing the effective yield method. As of September 30, 2015, the Company has $1,094,000 of tax credits remaining that will be recognized over seven years. Tax credits of $50,000 and $149,000 were recognized as a reduction of tax expense during the three and nine months ended September 30, 2015, respectively.

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

   
Gross
Gross
 
 
Amortized
Unrealized
Unrealized
Fair
September 30, 2015
Cost
Gains
Losses
Value
Available-for-sale securities:
       
  U.S. agency securities
 $    163,012
 $               1,113
 $              (23)
 $       164,102
  Obligations of state and political subdivisions
         95,374
                  2,946
               (155)
            98,165
  Corporate obligations
         12,643
                     103
                 (39)
            12,707
  Mortgage-backed securities in
       
    government sponsored entities
         23,635
                     305
                 (41)
            23,899
  Equity securities in financial institutions
           1,319
                     448
                 (10)
              1,757
Total available-for-sale securities
 $    295,983
 $               4,915
 $            (268)
 $       300,630
         
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 September 30, 2015 and December 31, 2014 (in thousands). As of September 30, 2015, the Company owned 46 securities whose fair value was less than their cost basis.

 
6

 
 

September 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
 $        10,067
 $          (16)
 $        10,986
 $            (7)
 $        21,053
 $             (23)
Obligations of state and political subdivisions
17,133
(104)
             4,747
             (51)
21,880
(155)
Corporate obligations
             5,399
              (23)
             2,167
             (16)
7,566
(39)
Mortgage-backed securities in
           
   government sponsored entities
4,317
(31)
                250
             (10)
4,567
(41)
Equity securities in financial institutions
590
(10)
                     -
                  -
590
(10)
    Total securities
 $        37,506
 $        (184)
 $        18,150
 $          (84)
 $        55,656
 $           (268)
               
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 state 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 September 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, mortgage backed securities issued by 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 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 nine months ended September 30, 2015 and 2014 were $18,393,000 and $17,338,000, respectively.  For the three months ended September 30, 2015 and 2014, sales of available-for-sale securities were $5,187,000 for each period. The gross gains and losses were as follows (in thousands):
 
 
Three Months Ended
Nine Months Ended
 
 September 30,
 September 30,
 
2015
2014
2015
2014
Gross gains
 $           129
 $                    242
 $              441
 $              488
Gross losses
                   -
                          -
                 (11)
                      -
Net gains
 $           129
 $                    242
 $              430
 $             488
 
Investment securities with an approximate carrying value of $182.7 million and $186.4 million at September 30, 2015 and December 31, 2014, respectively, were pledged to secure public funds and certain other deposits.

 
7

 
 
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 September 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
 $        6,593
 $               6,606
  Due after one year through five years
       161,984
              163,761
  Due after five years through ten years
         44,998
                46,018
  Due after ten years
         81,089
                82,488
Total
 $    294,664
 $           298,873

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 September 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 September 30, 2015 and December 31, 2014 (in thousands):

September 30, 2015
 
Total Loans
Individually
 evaluated for
impairment
Collectively
evaluated for
impairment
Real estate loans:
       
     Residential
 
 $                 178,280
 $                        330
 $                 177,950
     Commercial and agricultural
 
                    233,931
                        5,583
                    228,348
     Construction
 
                      10,159
                                -
                      10,159
Consumer
 
                        8,473
                                -
                        8,473
Other commercial and agricultural loans
                      64,712
                        2,237
                      62,475
State and political subdivision loans
 
                      87,454
                                -
                      87,454
Total
 
                    583,009
 $                     8,150
 $                 574,859
Allowance for loan losses
 
                        7,045
   
Net loans
 
 $                 575,964
   

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 consist 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 with terms of 15 years or less secured by a mortgage which is often a second lien on residential real estate. 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
September 30, 2015
Balance
Allowance
Allowance
Investment
Allowance
Real estate loans:
         
     Mortgages
 $       304
 $          119
 $          149
 $          268
 $          27
     Home Equity
            62
                  -
               62
               62
             12
     Commercial
       7,965
          5,314
               99
          5,413
             34
     Agricultural
170
             170
                  -
             170
                -
     Construction
               -
                  -
                  -
                  -
                -
Consumer
               -
                  -
                  -
                  -
                -
Other commercial loans
       2,238
          1,125
             999
          2,124
           123
Other agricultural loans
113
             113
                  -
             113
                -
State and political subdivision loans
               -
                  -
                  -
                  -
                -
Total
 $  10,852
 $       6,841
 $       1,309
 $       8,150
 $        196
           
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 nine month periods ended September 30, 2015 and 2014(in thousands):

 
 For the Nine Months ended
 
September 30, 2015
September 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
 $       239
 $              8
 $              5
 $          201
 $            7
 $               -
     Home Equity
            97
                 3
                  -
             131
               3
                  -
     Commercial
       5,728
               46
                  -
          7,616
             66
                  -
     Agricultural
               19
                 1
                  -
                  -
                -
                  -
     Construction
               -
                  -
                  -
                  -
                -
                  -
Consumer
               -
                  -
                  -
               13
                -
                  -
Other commercial loans
       2,488
               64
                 4
          1,982
             61
                  -
Other agricultural loans
               13
                 1
                  -
                  -
                -
                  -
State and political subdivision loans
               -
                  -
                  -
                  -
                -
                  -
Total
 $    8,584
 $          123
 $              9
 $       9,943
 $        137
 $               -
             
 
 For the Three Months Ended
 
September 30, 2015
September 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
 $       269
 $              4
 $               -
 $          197
 $            3
 $               -
     Home Equity
            62
                 1
                  -
             130
               1
                  -
     Commercial
       5,462
               14
                  -
          6,770
             22
                  -
     Agricultural
            57
                 1
                  -
                  -
                -
                  -
     Construction
               -
                  -
                  -
                  -
                -
                  -
Consumer
               -
                  -
                  -
               10
                -
                  -
Other commercial loans
       2,107
               15
                 1
          1,943
             15
                  -
Other agricultural loans
               38
                 1
                  -
                  -
                -
                  -
State and political subdivision loans
               -
                  -
                  -
                  -
                -
                  -
Total
 $    7,995
 $            36
 $              1
 $       9,050
 $          41
 $               -

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.
 
 
10

 
 
·  
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 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 September 30, 2015 and December 31, 2014 (in thousands):

September 30, 2015
Pass
Special Mention
Substandard
Doubtful
Loss
Ending Balance
Real estate loans:
           
     Commercial
 $          181,306
 $           3,860
 $                  12,575
 $                34
 $              -
 $          197,775
     Agricultural
               32,326
              3,302
                          528
                      -
                 -
               36,156
     Construction
               10,123
                   36
                              -
                      -
                 -
               10,159
Other commercial loans
               46,435
                 480
                       5,140
                 140
                 -
               52,195
Other agricultural loans
               11,756
                 648
                          113
                      -
                 -
               12,517
State and political
           
   subdivision loans
               87,454
                      -
                              -
                      -
                 -
               87,454
Total
 $          369,400
 $           8,326
 $                  18,356
 $              174
 $              -
 $          396,256
             
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 September 30, 2015 and December 31, 2014 (in thousands):

 
11

 
 
September 30, 2015
Performing
Non-performing
Total
Real estate loans:
     
     Mortgages
 $          117,363
 $           1,032
 $                118,395
     Home Equity
               59,714
                 171
                     59,885
Consumer
                 8,421
                   52
                       8,473
Total
 $          185,498
 $           1,255
 $                186,753
       
December 31, 2014
Performing
Non-performing
Total
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 September 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
September 30, 2015
Past Due
Past Due
Or Greater
Due
Current
Receivables
Accruing
Real estate loans:
             
     Mortgages
 $        388
 $        133
 $        663
 $     1,184
 $   117,211
 $           118,395
 $            303
     Home Equity
           521
             21
           158
           700
        59,185
                59,885
               106
     Commercial
           302
           130
        4,138
        4,570
      193,205
              197,775
                 60
     Agricultural
             38
           170
                -
           208
        35,948
                36,156
                   -
     Construction
                -
                -
                -
                -
        10,159
                10,159
                   -
Consumer
             41
             29
             24
             94
          8,379
                  8,473
                   -
Other commercial loans
           528
             30
           756
        1,314
        50,881
                52,195
               199
Other agricultural loans
             30
           168
                -
           198
        12,319
                12,517
                   -
State and political subdivision loans
                -
                -
                -
                -
        87,454
                87,454
                   -
 
Total
 $     1,848
 $        681
 $     5,739
 $     8,268
 $   574,741
 $           583,009
 $            668
Loans considered non-accrual
 $        319
 $        204
 $     5,071
 $     5,594
 $          725
 $               6,319
 
Loans still accruing
        1,529
           477
           668
        2,674
      574,016
              576,690
 
 
Total
 $     1,848
 $        681
 $     5,739
 $     8,268
 $   574,741
 $           583,009
 

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 September 30, 2015 and December 31, 2014, respectively. The balances are presented by class of financing receivable (in thousands):

   
September 30, 2015
 
December 31, 2014
Real estate loans:
     
     Mortgages
 $                         729
 
 $                   676
     Home Equity
                              65
 
                      152
     Commercial
                         4,441
 
                   5,010
     Agricultural
                              -
 
                        -
     Construction
                              -
 
                        -
Consumer
                              52
 
                        47
Other commercial loans
                         1,032
 
                      714
Other agricultural loans
                              -
 
                        -
State and political subdivision loans
                              -
 
                        -
   
 $                      6,319
 
 $                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 September 30, 2015 and December 31, 2014, included within the allowance for loan losses are reserves of $39,000 and $26,000 respectively, that are associated with loans modified as TDRs.
 
There were no loan modifications that were considered TDRs during the three months ended September 30, 2015 or 2014. Loan modifications that are considered TDRs completed during the nine months ended September 30, 2015 and 2014 were as follows (dollars in thousands):

 
13

 

 
 
For the Nine Months Ended September 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 Nine Months Ended September 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 (nine month periods) and July 1, 2015 and 2014 (3 month periods), respectively, and that subsequently defaulted during these reporting periods (dollars in thousands):

 
For the Three Months Ended
For the Nine Months Ended
 
September 30, 2015
September 30, 2014
September 30, 2015
September 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 September 30, 2015 and December 31, 2014, respectively (in thousands):
 
 
14

 
 
 
September 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
 $           39
 $         874
 $         913
 
 $           25
 $           853
 $             878
     Commercial and agricultural
              34
         3,769
3,803
 
              72
           3,798
             3,870
     Construction
                 -
              17
17
 
                 -
                26
                  26
Consumer
                 -
              91
91
 
                 -
                84
                  84
Other commercial and agricultural loans
            123
         1,322
1,445
 
                1
           1,223
             1,224
State and political subdivision loans
                 -
            586
586
 
                 -
              545
                545
Unallocated
                 -
            190
190
 
                 -
              188
                188
Total
 $         196
 $      6,849
 $      7,045
 
 $           98
 $        6,717
 $          6,815
 
The following tables roll forward the balance of the ALLL by portfolio segment for the three and nine month periods ended September 30, 2015 and 2014, respectively (in thousands):
 
 
Balance at
June 30, 2015
Charge-offs
Recoveries
Provision
Balance at
 September 30, 2015
Real estate loans:
         
     Residential
 $         931
 $              -
 $              -
 $       (18)
 $         913
     Commercial and agricultural
         3,679
                 -
                4
          120
         3,803
     Construction
              14
                 -
                 -
              3
              17
Consumer
              89
             (11)
              13
               -
              91
Other commercial and agricultural loans
         1,502
             (40)
                 -
          (17)
         1,445
 State and political subdivision loans
            568
                 -
                 -
            18
            586
Unallocated
            176
                 -
                 -
            14
            190
Total
 $      6,959
 $          (51)
 $           17
 $       120
 $      7,045
           
 
Balance at
December 31, 2014
Charge-offs
Recoveries
Provision
Balance at
September 30, 2015
Real estate loans:
         
     Residential
 $         878
 $          (34)
 $              -
 $         69
 $         913
     Commercial and agricultural
         3,870
             (56)
              11
          (22)
         3,803
     Construction
              26
                 -
                 -
            (9)
              17
Consumer
              84
             (35)
              25
            17
              91
Other commercial and agricultural loans
         1,224
             (41)
                 -
          262
         1,445
State and political subdivision loans
            545
                 -
                 -
            41
            586
Unallocated
            188
                 -
                 -
              2
            190
Total
 $      6,815
 $        (166)
 $           36
 $       360
 $      7,045
           
 
Balance at
June 30, 2014
Charge-offs
Recoveries
Provision
Balance at
September 30, 2014
Real estate loans:
         
     Residential
 $         879
 $              -
 $              -
 $           7
 $         886
     Commercial and agricultural
         3,809
             (11)
                4
          (99)
         3,703
     Construction
              13
                 -
                 -
            10
              23
Consumer
              86
             (26)
                6
            20
              86
Commercial and other loans
         1,151
             (58)
                 -
            70
         1,163
State and political subdivision loans
            455
                 -
                 -
            (5)
            450
Unallocated
            358
                 -
                 -
          147
            505
Total
 $      6,751
 $          (95)
 $           10
 $       150
 $      6,816
 
 
15

 
 
 
Balance at December 31, 2013
Charge-offs
Recoveries
Provision
Balance at
September 30, 2014
Real estate loans:
         
     Residential
 $         946
 $          (45)
 $              -
 $       (15)
 $         886
     Commercial and agricultural
         4,558
           (486)
                9
        (378)
         3,703
     Construction
              50
                 -
                 -
          (27)
              23
Consumer
            105
             (40)
              21
               -
              86
Commercial and other loans
            942
           (221)
                 -
          442
         1,163
State and political subdivision loans
            330
                 -
                 -
          120
            450
Unallocated
            167
                 -
                 -
          338
            505
Total
 $      7,098
 $        (792)
 $           30
 $       480
 $      6,816
 
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 and 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;
·  
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 nine 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 nine months of 2015.
 
 
16

 
 
·  
The qualitative factors for changes in levels of and trends in delinquencies and impaired/classified loans were decreased for commercial and agricultural real estate due to the decrease in the amount of loans classified as substandard. While there has been an increase in delinquencies of commercial and agricultural real estate loans, the qualitative factor was not increased. The increase in delinquencies is attributable to one relationship, which is classified as impaired and management does not believe that this delinquency is a reflection of a further decrease in the credit quality of the commercial and agricultural real estate loan portfolio.
·  
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 norms 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 and impaired/classified loans was increased for residential mortgages due to increases in the amount of non-performing loans.
 
The following qualitative factors experienced changes during the three months ended September 30, 2015:
·  
The qualitative factors for changes in levels of and trends in delinquencies and impaired/classified loans were increased for other agricultural loans due to an increase in the amount of classified loans.
·  
The qualitative factor for levels of and trends in charge-offs and recoveries was increased for other commercial loans due to the increase in charge-offs during the quarter.
 
The primary factor that resulted in negative provision for commercial and agricultural loans for the nine month period ended September 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 nine 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 and state economy.
·  
The qualitative factors for changes in levels of and trends in delinquencies and 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 and a decrease in the amount of loans past due.
·  
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 2014.
·  
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 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 decreased for agricultural related loans due to the improvement in the agricultural economy during 2014.

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

·  
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 factors for changes in levels of and trends in delinquencies, impaired/classified loans were decreased for other commercial loans real estate due to the decrease in the amount of loans past due as of September 30, 2014.
·  
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 decreased for agricultural related loans due to the improvement in the agricultural economy during 2014.
 
The primary factor that resulted in negative provisions for certain portfolio segments for the three and nine month periods in 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.

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 September 30, 2015 and December 31, 2014 included with other assets are $1,429,000 and $1,792,000, respectively, of foreclosed assets. As of September 30, 2015, included within the foreclosed assets is $305,000 of consumer residential mortgages that were foreclosed on or received via a deed in lieu transaction prior to the period end. As of September 30, 2015, the Company has initiated formal foreclosure proceedings on $1,256,000 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 September 30, 2015 and December 31, 2014, the Bank’s investment in FHLB stock was $1,708,000 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 – Repurchase Agreements
 
We utilize securities sold under agreements to repurchase to facilitate the needs of our customers and to facilitate secured short-term funding needs. Securities sold under agreements to repurchase are stated at the amount of cash received in connection with the transaction. We monitor collateral levels on a continuous basis. We may be required to provide additional collateral based on the fair value of the underlying securities. Securities pledged as collateral under repurchase agreements are maintained with our safekeeping agents.

 
18

 
 
The remaining contractual maturity of repurchase agreements in the Consolidated Balance Sheets as of September 30, 2015 and December 31, 2014 is presented in the following tables.
 
     
Remaining Contractual Maturity of the Agreements
     
Overnight and
Up to
 
Greater than
 
September 30, 2015
 
Continuous
30 Days
30 - 90 Days
90 days
 Total
Repurchase Agreements:
         
U.S. agency securities
 
 $         6,112,000
 $                  -
 $                  -
 $        2,070,000
$                      -
Total carrying value of collateral pledged
 $         6,112,000
 $                  -
 $                  -
 $        2,070,000
 $       8,182,000
               
Total liability recognized for repurchase agreements
       
 $       5,728,000
               
       
     
Remaining Contractual Maturity of the Agreements
     
Overnight and
Up to
 
Greater than
 
December 31, 2014
 
Continuous
30 Days
30 - 90 Days
90 days
 Total
Repurchase Agreements:
           
U.S. agency securities
 
 $       10,368,000
 $      1,015,000
$                  -
 $        2,940,000
$                       -
Total carrying value of collateral pledged
 $       10,368,000
 $      1,015,000
 $                  -
 $        2,940,000
 $      14,323,000
               
Total liability recognized for repurchase agreements
       
 $       5,906,000

Note 8 - 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 nine months ended September 30, 2015 and 2014, respectively (in thousands):
 
 
19

 
 
 
Three Months Ended
Nine Months Ended
 
 September 30,
 September 30,
 
2015
2014
2015
2014
Service cost
 $             110
 $          77
 $             242
 $                  230
Interest cost
                128
    104
                281
                     311
Expected return on plan assets
              (243)
  (197)
              (533)
                    (590)
Net amortization and deferral
                   65
      13
                141
                       38
Net periodic benefit cost
 $               60
 $          (3)
 $             131
 $                   (11)
 
The Company has contributed $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 $215,000 and $201,000 for the nine months ended September 30, 2015 and 2014, respectively. For the three months ended September 30, 2015 and 2014, contributions by the Company totaled $60,000 and $55,000, 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 September 30, 2015 and December 31, 2014, an obligation of $952,000 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 $4,000 for each of the three months ended September 30, 2015 and 2014. For the nine months ended September 30, 2015 and 2014, amounts included in interest expense on the deferred amounts totaled $17,000 and $15,000, 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 September 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 September 30,
Nine months ended September 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
         7,018
 $          50.63
   7,187
 $     48.28
               6,971
 $          48.55
   7,172
 $      42.02
Granted
                 -
                     -
           -
-
               3,496
             50.02
   3,598
52.82
Forfeited
           (139)
             51.49
         (7)
37.10
                (139)
             51.49
         (7)
         37.10
Vested
                 -
                     -
           -
-
             (3,449)
             45.80
  (3,583)
40.30
Outstanding, end of period
         6,879
 $          50.61
   7,180
 $     48.29
               6,879
 $          50.61
   7,180
 $      48.29
 
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 $129,000 and $115,000 for the nine months ended September 30, 2015 and 2014, respectively. For the three months ended September 30, 2015 and 2014, compensation expense totaled $44,000 and $42,000, respectively. At September 30, 2015 the total compensation cost related to nonvested awards that has not yet been recognized was $349,000, which is expected to be recognized over the next 2.58 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 September 30, 2015 and December 31, 2014, an obligation of $1,304,000 and $1,198,000, respectively, was included in other liabilities for this plan in the Consolidated Balance Sheet. Expenses related to this plan totaled $106,000 and $114,000 for the nine months ended September 30, 2015 and 2014, respectively. For the three months ended September 30, 2015 and 2014, expenses totaled $35,000 and $38,000, respectively.

Note 9 – Accumulated Comprehensive Income
 
The following tables present the changes in accumulated other comprehensive income by component net of tax for the three and nine months ended September 30, 2015 and 2014 (in thousands):

 
Three months ended September 30, 2015
 
Unrealized gain
(loss) on available
for sale securities (a)
Defined Benefit
Pension Items (a)
Total
Balance as of June 30, 2015
 $                     2,430
 $     (2,259)
 $         171
Other comprehensive income (loss) before reclassifications, net of tax
                           722
               -
            722
Amounts reclassified from accumulated other
     
     comprehensive income (loss), net of tax
                           (85)
              34
             (51)
Net current period other comprehensive income
                           637
              34
            671
Balance as of September 30, 2015
 $                     3,067
 $     (2,225)
 $         842
       
 
Nine months ended September 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
                           258
               -
            258
Amounts reclassified from accumulated other
     
     comprehensive income (loss), net of tax
                         (284)
            101
           (183)
Net current period other comprehensive income (loss)
                           (26)
            101
              75
Balance as of September 30, 2015
 $                     3,067
 $     (2,225)
 $         842

 
Three months ended September 30, 2014
 
Unrealized gain (loss)
on available for sale
securities (a)
Defined Benefit
Pension Items (a)
Total
Balance as of June 30, 2014
 $                     2,201
 $     (1,101)
 $      1,100
Other comprehensive income (loss) before reclassifications, net of tax
                           564
               -
            564
Amounts reclassified from accumulated other
     
     comprehensive income (loss), net of tax
                         (160)
                9
           (151)
Net current period other comprehensive income
                           404
                9
            413
Balance as of September  30, 2014
 $                     2,605
 $     (1,092)
 $      1,513
 
 
21

 
 
       
 
Nine months ended September 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
                        3,035
               -
         3,035
Amounts reclassified from accumulated other
     
     comprehensive income (loss), net of tax
                         (322)
              25
           (297)
Net current period other comprehensive income
                        2,713
              25
         2,738
Balance as of September  30, 2014
 $                     2,605
 $     (1,092)
 $      1,513
       
(a) Amounts in parentheses indicate debits to the Consolidated Balance Sheet
   
 
The following table presents the significant amounts reclassified out of each component of accumulated other comprehensive income for the three and nine months ended September 30, 2015 and 2014 (in thousands):

Details about accumulated other comprehensive income (loss)
Amount reclassified from accumulated comprehensive income (loss) (a)
 
Affected line item in the income statement where net Income is presented
 
Three Months Ended  September 30,
   
 
2015
2014
   
Unrealized gains and losses on available for sale securities
       
 
 $                          129
 $                    242
 
Investment securities gains, net
 
                             (44)
                       (82)
 
Provision for income taxes