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EX-32.1 - SECTION 350 CERTIFICATIONS - CITIZENS FINANCIAL SERVICES INCcertification.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - CITIZENS FINANCIAL SERVICES INCcfocert.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - CITIZENS FINANCIAL SERVICES INCceocert.htm
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 March 31, 2016
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 April 26, 2016, was 3,319,958.


Citizens Financial Services, Inc.
Form 10-Q

INDEX

   
PAGE
Part I
FINANCIAL INFORMATION
 
Item 1.
Financial Statements (unaudited):
 
 
Consolidated Balance Sheet as of March 31,2016 and December 31, 2015
1
 
Consolidated Statement of Income for the Three months Ended March 31, 2016 and 2015
2
 
Consolidated Statement of Comprehensive Income for the Three Months ended March 31, 2016 and 2015
3
 
Consolidated Statement of Cash Flows for the Three Months ended March 31, 2016 and 2015
4
 
Notes to Consolidated Financial Statements
5-31
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
22-52
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
52
Item 4.
Controls and Procedures
52
     
Part II
OTHER INFORMATION
 
Item 1.
Legal Proceedings
52-53
Item 1A.
Risk Factors
53
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
53
Item 3.
Defaults Upon Senior Securities
53
Item 4.
Mine Safety Disclosures
53
Item 5.
Other Information
53
Item 6.
Exhibits
53-54
 
Signatures
55



CITIZENS FINANCIAL SERVICES, INC.
           
CONSOLIDATED BALANCE SHEET
           
(UNAUDITED)
           
 
           
 
 
March 31
   
December 31
 
(in thousands except share data)
 
2016
   
2015
 
ASSETS:
           
Cash and due from banks:
           
  Noninterest-bearing
 
$
14,746
   
$
14,088
 
  Interest-bearing
   
22,633
     
10,296
 
Total cash and cash equivalents
   
37,379
     
24,384
 
Interest bearing time deposits with other banks
   
7,697
     
7,696
 
Available-for-sale securities
   
371,925
     
359,737
 
Loans held for sale
   
1,557
     
603
 
                 
Loans (net of allowance for loan losses:
               
  2016, $7,275 and 2015, $7,106)
   
692,428
     
687,925
 
                 
Premises and equipment
   
17,249
     
17,263
 
Accrued interest receivable
   
4,096
     
4,211
 
Goodwill
   
21,089
     
21,089
 
Bank owned life insurance
   
25,705
     
25,535
 
Other intangibles
   
2,309
     
2,437
 
Other assets
   
11,130
     
12,104
 
 
               
TOTAL ASSETS
 
$
1,192,564
   
$
1,162,984
 
 
               
LIABILITIES:
               
Deposits:
               
  Noninterest-bearing
 
$
147,897
   
$
150,960
 
  Interest-bearing
   
869,914
     
837,071
 
Total deposits
   
1,017,811
     
988,031
 
Borrowed funds
   
39,996
     
41,631
 
Accrued interest payable
   
660
     
734
 
Other liabilities
   
12,126
     
12,828
 
TOTAL LIABILITIES
   
1,070,593
     
1,043,224
 
STOCKHOLDERS' EQUITY:
               
Preferred Stock
               
  $1.00 par value; authorized 3,000,000 shares March 31, 2016 and December 31, 2015;
               
   none issued in 2016 or 2015
   
-
     
-
 
Common stock
               
  $1.00 par value; authorized 15,000,000 shares;  issued 3,671,751 at March 31, 2016 and
               
  December 31, 2015
   
3,672
     
3,672
 
Additional paid-in capital
   
40,722
     
40,715
 
Retained earnings
   
87,696
     
85,790
 
Accumulated other comprehensive income (loss)
   
903
     
(236
)
Treasury stock, at cost:  353,400 shares at March 31, 2016
               
  and 335,876 shares at December 31, 2015
   
(11,022
)
   
(10,181
)
TOTAL STOCKHOLDERS' EQUITY
   
121,971
     
119,760
 
TOTAL LIABILITIES AND
               
   STOCKHOLDERS' EQUITY
 
$
1,192,564
   
$
1,162,984
 
 
               
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
 
   
March 31
 
(in thousands, except share and per share data)
 
2016
   
2015
 
INTEREST INCOME:
           
Interest and fees on loans
 
$
8,596
   
$
7,039
 
Interest-bearing deposits with banks
   
71
     
31
 
Investment securities:
               
    Taxable
   
944
     
754
 
    Nontaxable
   
771
     
848
 
    Dividends
   
80
     
99
 
TOTAL INTEREST INCOME
   
10,462
     
8,771
 
INTEREST EXPENSE:
               
Deposits
   
1,074
     
1,009
 
Borrowed funds
   
183
     
175
 
TOTAL INTEREST EXPENSE
   
1,257
     
1,184
 
NET INTEREST INCOME
   
9,205
     
7,587
 
Provision for loan losses
   
135
     
120
 
NET INTEREST INCOME AFTER
               
    PROVISION FOR LOAN LOSSES
   
9,070
     
7,467
 
NON-INTEREST INCOME:
               
Service charges
   
1,102
     
976
 
Trust
   
196
     
194
 
Brokerage and insurance
   
209
     
127
 
Gains on loans sold
   
46
     
38
 
Investment securities gains, net
   
27
     
126
 
Earnings on bank owned life insurance
   
170
     
152
 
Other
   
166
     
115
 
TOTAL NON-INTEREST INCOME
   
1,916
     
1,728
 
NON-INTEREST EXPENSES:
               
Salaries and employee benefits
   
3,882
     
3,056
 
Occupancy
   
445
     
369
 
Furniture and equipment
   
157
     
128
 
Professional fees
   
287
     
232
 
FDIC insurance
   
157
     
116
 
Pennsylvania shares tax
   
150
     
201
 
Amortization of intangibles
   
82
     
-
 
ORE expenses
   
92
     
117
 
Other
   
1,660
     
1,116
 
TOTAL NON-INTEREST EXPENSES
   
6,912
     
5,335
 
Income before provision for income taxes
   
4,074
     
3,860
 
Provision for income taxes
   
791
     
740
 
NET INCOME
 
$
3,283
   
$
3,120
 
                 
PER COMMON SHARE DATA:
               
Net Income – Basic
 
$
0.99
   
$
1.03
 
Net Income – Diluted
 
$
0.99
   
$
1.03
 
Cash Dividends Paid
 
$
0.415
   
$
0.405
 
 
               
Number of shares used in computation - basic
   
3,323,949
     
3,026,265
 
Number of shares used in computation - diluted
   
3,323,949
     
3,026,265
 
 
               
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
 
 
 
March 31,
 
(in thousands)
       
2016
         
2015
 
Net income
       
$
3,283
         
$
3,120
 
Other comprehensive income:
                           
      Unrealized gains on available for sale securities
   
1,694
             
1,345
         
      Income tax effect
   
(577
)
           
(458
)
       
      Change in unrecognized pension cost
   
61
             
48
         
      Income tax effect
   
(21
)
           
(16
)
       
      Less:  Reclassification adjustment for investment security gains included in net income
   
(27
)
           
(126
)
       
      Income tax effect
   
9
             
43
         
Other comprehensive income, net of tax
           
1,139
             
836
 
Comprehensive income
         
$
4,422
           
$
3,956
 
 
                               
The accompanying notes are an integral part of these unaudited consolidated financial statements.
                 

3

CITIZENS FINANCIAL SERVICES, INC.
           
CONSOLIDATED STATEMENT OF CASH FLOWS
           
(UNAUDITED)
 
Three Months Ended
 
 
 
March 31,
 
(in thousands)
 
2016
   
2015
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
  Net income
 
$
3,283
   
$
3,120
 
  Adjustments to reconcile net income to net
               
   cash provided by operating activities:
               
    Provision for loan losses
   
135
     
120
 
    Depreciation and amortization
   
76
     
125
 
    Amortization and accretion of investment securities
   
567
     
516
 
    Deferred income taxes
   
(115
)
   
(128
)
    Investment securities gains, net
   
(27
)
   
(126
)
    Earnings on bank owned life insurance
   
(170
)
   
(152
)
    Originations of loans held for sale
   
(3,913
)
   
(3,155
)
    Proceeds from sales of loans held for sale
   
3,005
     
2,661
 
    Realized gains on loans sold
   
(46
)
   
(38
)
    Increase in accrued interest receivable
   
115
     
8
 
    Decrease in accrued interest payable
   
(74
)
   
(65
)
    Other, net
   
(467
)
   
207
 
      Net cash provided by operating activities
   
2,369
     
3,093
 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
  Available-for-sale securities:
               
    Proceeds from sales
   
5,020
     
14,623
 
    Proceeds from maturity and principal repayments
   
9,757
     
13,521
 
    Purchase of securities
   
(25,840
)
   
(13,074
)
  Proceeds from redemption of regulatory stock
   
112
     
1,271
 
  Purchase of regulatory stock
   
-
     
(864
)
  Net increase in loans
   
(4,454
)
   
(11,054
)
  Purchase of premises and equipment
   
(166
)
   
(403
)
  Proceeds from sale of foreclosed assets held for sale
   
289
     
17
 
      Net cash (used in) provided by investing activities
   
(15,282
)
   
4,037
 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
  Net increase in deposits
   
29,780
     
14,843
 
  Proceeds from long-term borrowings
   
2
     
4,730
 
  Net decrease in short-term borrowed funds
   
(1,637
)
   
(17,141
)
  Purchase of treasury and restricted stock
   
(860
)
   
(979
)
  Dividends paid
   
(1,377
)
   
(1,223
)
      Net cash provided by financing activities
   
25,908
     
230
 
          Net increase in cash and cash equivalents
   
12,995
     
7,360
 
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
   
24,384
     
11,423
 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
 
$
37,379
   
$
18,783
 
 
               
Supplemental Disclosures of Cash Flow Information:
               
    Interest paid
 
$
1,331
   
$
1,249
 
    Income taxes paid
 
$
450
   
$
600
 
    Loans transferred to foreclosed property
 
$
64
   
$
-
 
 
               
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"). On December 11, 2015, the Company completed its acquisition of The First National Bank of Fredericksburg (FNB) by merging FNB into the Bank.
 
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 March 31, 2016 and for the three month periods ended March 31, 2016 and 2015 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 periods.  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 three month period ended March 31, 2016 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, 2015.

Note 2 - Earnings per Share
 
The following table sets forth the computation of earnings per share.

   
Three months ended
 
   
March 31,
 
   
2016
   
2015
 
Net income applicable to common stock
 
$
3,283,000
   
$
3,120,000
 
 
               
Basic earnings per share computation
               
Weighted average common shares outstanding
   
3,323,949
     
3,026,265
 
Earnings per share - basic
 
$
0.99
   
$
1.03
 
 
               
Diluted earnings per share computation
               
Weighted average common shares outstanding for basic earnings per share
   
3,323,949
     
3,026,265
 
Add: Dilutive effects of restricted stock
   
-
     
-
 
Weighted average common shares outstanding for dilutive earnings per share
   
3,323,949
     
3,026,265
 
Earnings per share - diluted
 
$
0.99
   
$
1.03
 
 
For the three months ended March 31, 2016 and 2015, there were 5,325 and 4,082 shares, respectively, related to the restricted stock program that were excluded from the diluted earnings per share calculations since they were anti-dilutive. These anti-dilutive shares had prices ranging from $46.69 to $53.15 for the three month period ended March 31, 2016 and prices ranging from $37.10 to $53.50 for the three month period ended March 31, 2015.

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 March 31, 2016 and December 31, 2015, 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 $894,000 and $959,000 as of March 31, 2016 and December 31, 2015, respectively. Investments purchased prior to January 1, 2015, are accounted for utilizing the effective yield method. As of March 31, 2016, the Company has $995,000 of tax credits remaining that will be recognized over 6.7 years. Tax credits of $50,000 were recognized as a reduction of tax expense during the three months ended March 31, 2016 and 2015.

Note 4 – Investments
 
The amortized cost, gross unrealized gains and losses, and fair value of investment securities at March 31, 2016 and December 31, 2015 were as follows (in thousands):

         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
March 31, 2016
 
Cost
   
Gains
   
Losses
   
Value
 
Available-for-sale securities:
                       
  U.S. agency securities
 
$
212,978
   
$
1,377
   
$
(36
)
 
$
214,319
 
  U.S. treasury securities
   
5,078
     
4
     
-
     
5,082
 
  Obligations of state and
                               
    political subdivisions
   
101,685
     
3,089
     
(116
)
   
104,658
 
  Corporate obligations
   
12,503
     
52
     
(19
)
   
12,536
 
  Mortgage-backed securities in
                               
    government sponsored entities
   
32,675
     
351
     
(37
)
   
32,989
 
  Equity securities in financial
                               
     institutions
   
2,001
     
364
     
(24
)
   
2,341
 
Total available-for-sale securities
 
$
366,920
   
$
5,237
   
$
(232
)
 
$
371,925
 
                                 
December 31, 2015
                               
Available-for-sale securities:
                               
  U.S. agency securities
 
$
199,749
   
$
369
   
$
(527
)
 
$
199,591
 
  U.S. treasury securities
   
10,103
     
-
     
(21
)
   
10,082
 
  Obligations of state and
                               
    political subdivisions
   
99,856
     
3,080
     
(73
)
   
102,863
 
  Corporate obligations
   
14,583
     
68
     
(86
)
   
14,565
 
  Mortgage-backed securities in
                               
    government sponsored entities
   
30,107
     
186
     
(89
)
   
30,204
 
  Equity securities in financial institutions
   
2,001
     
436
     
(5
)
   
2,432
 
Total available-for-sale securities
 
$
356,399
   
$
4,139
   
$
(801
)
 
$
359,737
 
 
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 March 31, 2016 and December 31, 2015 (in thousands). As of March 31, 2016, the Company owned 44 securities whose fair value was less than their cost basis.

6



March 31, 2016
 
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
 
$
34,231
   
$
(36
)
 
$
-
   
$
-
   
$
34,231
   
$
(36
)
Obligations of state and
                                               
    political subdivisions
   
12,058
     
(96
)
   
2,197
     
(20
)
   
14,255
     
(116
)
Corporate obligations
   
4,257
     
(14
)
   
2,140
     
(5
)
   
6,397
     
(19
)
Mortgage-backed securities in
                                               
   government sponsored entities
   
6,174
     
(21
)
   
929
     
(16
)
   
7,103
     
(37
)
Equity securities in financial institutions
   
985
     
(24
)
   
-
     
-
     
985
     
(24
)
    Total securities
 
$
57,705
   
$
(191
)
 
$
5,266
   
$
(41
)
 
$
62,971
   
$
(232
)
                                                 
December 31, 2015
                                               
U.S. agency securities
 
$
123,591
   
$
(527
)
 
$
-
   
$
-
   
$
123,591
   
$
(527
)
U.S. treasury securities
   
10,082
     
(21
)
   
-
     
-
     
10,082
     
(21
)
Obligations of states and
                                               
     political subdivisions
   
7,023
     
(57
)
   
2,914
     
(16
)
   
9,937
     
(73
)
Corporate obligations
   
5,822
     
(61
)
   
2,138
     
(25
)
   
7,960
     
(86
)
Mortgage-backed securities in
                                               
   government sponsored entities
   
9,830
     
(77
)
   
227
     
(12
)
   
10,057
     
(89
)
Equity securities in financial institutions
   
106
     
(5
)
   
-
     
-
     
106
     
(5
)
    Total securities
 
$
156,454
   
$
(748
)
 
$
5,279
   
$
(53
)
 
$
161,733
   
$
(801
)
 
As of March 31, 2016, 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 three months ended March 31, 2016 and 2015 were $5,020,000 and $14,623,000, respectively. The gross gains and losses were as follows (in thousands):
 
   
Three Months Ended
 
   
March 31,
 
 
 
2016
   
2015
 
Gross gains
 
$
27
   
$
137
 
Gross losses
   
-
     
(11
)
Net gains
 
$
27
   
$
126
 
 
7

Investment securities with an approximate carrying value of $221.9 million and $203.8 million at March 31, 2016 and December 31, 2015, 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 March 31, 2016, by contractual maturity, are shown below (in thousands):

   
Amortized
       
 
 
Cost
   
Fair Value
 
Available-for-sale debt securities:
           
  Due in one year or less
 
$
37,238
   
$
37,445
 
  Due after one year through five years
   
198,445
     
200,491
 
  Due after five years through ten years
   
43,004
     
43,960
 
  Due after ten years
   
86,232
     
87,688
 
Total
 
$
364,919
   
$
369,584
 

Note 5 – Loans
 
The Company grants loans primarily to customers throughout north central and south central Pennsylvania and the southern tier New York.  Although the Company had a diversified loan portfolio at March 31, 2016 and December 31, 2015, 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 March 31, 2016 and December 31, 2015 (in thousands):

March 31, 2016
 
Total Loans
   
Individually evaluated for impairment
   
Loans acquired with deteriorated credit quality
   
Collectively evaluated for impairment
 
Real estate loans:
                       
     Residential
 
$
201,988
   
$
523
   
$
33
   
$
201,432
 
     Commercial and agricultural
   
299,633
     
6,438
     
2,761
     
290,434
 
     Construction
   
8,699
     
-
     
-
     
8,699
 
Consumer
   
11,125
     
-
     
8
     
11,117
 
Other commercial and agricultural loans
   
69,197
     
6,277
     
681
     
62,239
 
State and political subdivision loans
   
109,061
     
-
     
-
     
109,061
 
Total
   
699,703
     
13,238
     
3,483
     
682,982
 
Allowance for loan losses
   
7,275
     
475
     
-
     
6,800
 
Net loans
 
$
692,428
   
$
12,763
   
$
3,483
   
$
676,182
 
 
                               
December 31, 2015
                               
Real estate loans:
                               
     Residential
 
$
203,407
   
$
304
   
$
35
   
$
203,068
 
     Commercial and agricultural
   
295,364
     
6,235
     
2,908
     
286,221
 
     Construction
   
15,011
     
-
     
-
     
15,011
 
Consumer
   
11,543
     
-
     
9
     
11,534
 
Other commercial and agricultural loans
   
71,206
     
5,745
     
866
     
64,595
 
State and political subdivision loans
   
98,500
     
-
     
-
     
98,500
 
Total
   
695,031
     
12,284
     
3,818
     
678,929
 
Allowance for loan losses
   
7,106
     
355
     
-
     
6,751
 
Net loans
 
$
687,925
   
$
11,929
   
$
3,818
   
$
672,178
 
 
Purchased loans acquired in the FNB acquisition are recorded at fair value on their purchase date without a carryover of the related allowance for loan losses.
 
8

 
Upon acquisition, the Company evaluated whether an acquired loan was within the scope of ASC 310-30, Receivables-Loans and Debt Securities Acquired with Deteriorated Credit Quality. Purchased credit-impaired loans (PCI) are loans that have evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. There were no material increases or decreases in the expected cash flows of these loans between December 11, 2015 (the "acquisition date") and March 31, 2016. The fair value of purchased credit-impaired loans, on the acquisition date, was determined, primarily based on the fair value of loan collateral. The carrying value of purchased loans acquired with deteriorated credit quality was $3,483,000 and $3,818,000 at March 31, 2016 and December 31, 2015, respectively.

On the acquisition date, the preliminary estimate of the unpaid principal balance for all loans evidencing credit impairment acquired in the FNB acquisition was $6,969,000 and the estimated fair value of the loans was $3,809,000. Total contractually required payments on these loans, including interest, at the acquisition date was $9,913,000. However, the Company's preliminary estimate of expected cash flows was $4,474,000. At such date, the Company established a credit risk related non-accretable discount (a discount representing amounts which are not expected to be collected from the customer nor liquidation of collateral) of $5,439,000 relating to these impaired loans, reflected in the recorded net fair value. Such amount is reflected as a non-accretable fair value adjustment to loans. The Company further estimated the timing and amount of expected cash flows in excess of the estimated fair value and established an accretable discount of $665,000 on the acquisition date relating to these impaired loans.

The carrying value of the loans acquired in the FNB acquisition with specific evidence of deterioration in credit quality was determined by projected discounted contractual cash flows.

Changes in the accretable yield for purchased credit-impaired loans were as follows for the three months ended March 31, 2016:
 

(In Thousands)
 
March 31, 2016
Balance at beginning of period
 
 $                             637
Accretion
 
 (86)
Balance at end of period
 
 $                             551
 
The following table presents additional information regarding loans acquired with specific evidence of deterioration in credit quality under ASC 310-30:

(In Thousands)
 
March 31, 2016
   
December 31, 2015
 
Outstanding balance
 
$
6,516
   
$
6,950
 
Carrying amount
   
3,483
     
3,818
 
 
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.
 
9

 
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
 
March 31, 2016
 
Balance
   
Allowance
   
Allowance
   
Investment
   
Allowance
 
Real estate loans:
                             
     Mortgages
 
$
504
   
$
115
   
$
348
   
$
463
   
$
38
 
     Home Equity
   
60
     
-
     
60
     
60
     
11
 
     Commercial
   
8,922
     
6,064
     
209
     
6,273
     
103
 
     Agricultural
   
165
     
165
     
-
     
165
     
-
 
     Construction
   
-
     
-
     
-
     
-
     
-
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other commercial loans
   
6,295
     
5,122
     
1,051
     
6,173
     
323
 
Other agricultural loans
   
104
     
104
     
-
     
104
     
-
 
State and political
                                       
   subdivision loans
   
-
     
-
     
-
     
-
     
-
 
Total
 
$
16,050
   
$
11,570
   
$
1,668
   
$
13,238
   
$
475
 
 
                                       
December 31, 2015
                                       
Real estate loans:
                                       
     Mortgages
 
$
281
   
$
114
   
$
129
   
$
243
   
$
26
 
     Home Equity
   
61
     
-
     
61
     
61
     
11
 
     Commercial
   
8,654
     
5,843
     
225
     
6,068
     
62
 
     Agricultural
   
167
     
167
     
-
     
167
     
-
 
     Construction
   
-
     
-
     
-
     
-
     
-
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other commercial loans
   
5,535
     
4,653
     
987
     
5,640
     
256
 
Other agricultural loans
   
105
     
105
     
-
     
105
     
-
 
State and political
                                       
   subdivision loans
   
-
     
-
     
-
     
-
     
-
 
Total
 
$
14,803
   
$
10,882
   
$
1,402
   
$
12,284
   
$
355
 
 
The following table includes the average balance of impaired financing receivables by class and the income recognized on impaired loans for the three month periods ended March 31, 2016 and 2015(in thousands):

10

 
 
 
For the Three Months Ended
 
 
 
March 31, 2016
   
March 31, 2015
 
 
             
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
 
$
391
   
$
4
   
$
-
   
$
188
   
$
2
   
$
-
 
     Home Equity
   
60
     
1
     
-
     
124
     
1
     
-
 
     Commercial
   
6,179
     
26
     
-
     
6,023
     
13
     
-
 
     Agricultural
   
165
     
2
     
-
     
-
     
-
     
-
 
     Construction
   
-
     
-
     
-
     
-
     
-
     
-
 
Consumer
   
-
     
-
     
-
     
-
     
-
     
-
 
Other commercial loans
   
5,952
     
66
     
1
     
2,729
     
25
     
1
 
Other agricultural loans
   
105
     
1
     
-
     
-
     
-
     
-
 
State and political subdivision loans
   
-
     
-
     
-
     
-
     
-
     
-
 
Total
 
$
12,852
   
$
100
   
$
1
   
$
9,064
   
$
41
   
$
1
 

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.
·
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 or classified Special Mention, Substandard, Doubtful, or Loss, and 5) such other loans which management or the consultant deems appropriate.
 
11

 
The following tables represent credit exposures by internally assigned grades as of March 31, 2016 and December 31, 2015 (in thousands):

March 31, 2016
 
Pass
   
Special Mention
   
Substandard
   
Doubtful
   
Loss
   
Ending Balance
 
Real estate loans:
                                   
     Commercial
 
$
220,649
   
$
4,258
   
$
16,097
   
$
30
   
$
-
   
$
241,034
 
     Agricultural
   
53,867
     
3,844
     
888
     
-
     
-
     
58,599
 
     Construction
   
8,699
     
-
     
-
     
-
     
-
     
8,699
 
Other commercial loans
   
49,353
     
594
     
5,524
     
134
     
-
     
55,605
 
Other agricultural loans
   
13,093
     
395
     
104
     
-
     
-
     
13,592
 
State and political
                                               
   subdivision loans
   
109,061
     
-
     
-
     
-
     
-
     
109,061
 
Total
 
$
454,722
   
$
9,091
   
$
22,613
   
$
164
   
$
-
   
$
486,590
 
 
                                               
December 31, 2015
                                               
Real estate loans:
                                               
     Commercial
 
$
217,544
   
$
4,150
   
$
15,816
   
$
32
   
$
-
   
$
237,542
 
     Agricultural
   
53,695
     
2,865
     
1,262
     
-
     
-
     
57,822
 
     Construction
   
14,422
     
589
     
-
     
-
     
-
     
15,011
 
Other commercial loans
   
51,297
     
446
     
5,669
     
137
     
-
     
57,549
 
Other agricultural loans
   
13,318
     
234
     
105
     
-
     
-
     
13,657
 
State and political
                                               
   subdivision loans
   
98,500
     
-
     
-
     
-
     
-
     
98,500
 
Total
 
$
448,776
   
$
8,284
   
$
22,852
   
$
169
   
$
-
   
$
480,081
 
 
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 March 31, 2016 and December 31, 2015 (in thousands):

March 31, 2016
 
Performing
   
Non-performing
   
PCI
   
Total
 
Real estate loans:
                       
     Mortgages
 
$
140,106
   
$
1,568
   
$
33
   
$
141,707
 
     Home Equity
   
60,049
     
232
     
-
     
60,281
 
Consumer
   
11,055
     
62
     
8
     
11,125
 
Total
 
$
211,210
   
$
1,862
   
$
41
   
$
213,113
 
 
                               
 
                               
December 31, 2015
 
Performing
   
Non-performing
   
PCI
   
Total
 
Real estate loans:
                               
     Mortgages
 
$
139,734
   
$
1,270
   
$
35
   
$
141,039
 
     Home Equity
   
62,236
     
132
     
-
   
$
62,368
 
Consumer
   
11,470
     
64
     
9
   
$
11,543
 
Total
 
$
213,440
   
$
1,466
   
$
44
   
$
214,950
 

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 March 31, 2016 and December 31, 2015 (in thousands):
12


 
                                     
Total
   
90 Days or
 
 
 
30-59 Days
   
60-89 Days
   
90 Days
   
Total Past
               
Financing
   
Greater and
 
March 31, 2016
 
Past Due
   
Past Due
   
Or Greater
   
Due
   
Current
   
PCI
   
Receivables
   
Accruing
 
Real estate loans:
                                               
     Mortgages
 
$
551
   
$
96
   
$
728
   
$
1,375
   
$
140,299
   
$
33
   
$
141,707
   
$
173
 
     Home Equity
   
370
     
64
     
176
     
610
     
59,671
     
-
     
60,281
     
71
 
     Commercial
   
1,550
     
204
     
4,289
     
6,043
     
232,953
     
2,038
     
241,034
     
222
 
     Agricultural
   
36
     
164
     
-
     
200
     
57,676
     
723
     
58,599
     
-
 
     Construction
   
-
     
-
     
-
     
-
     
8,699
     
-
     
8,699
     
-
 
Consumer
   
180
     
51
     
51
     
282
     
10,835
     
8
     
11,125
     
11
 
Other commercial loans
   
77
     
209
     
1,053
     
1,339
     
53,585
     
681
     
55,605
     
143
 
Other agricultural loans
   
496
     
84
     
-
     
580
     
13,012
     
-
     
13,592
     
-
 
State and political
                                                               
   subdivision loans
   
-
     
-
     
-
     
-
     
109,061
     
-
     
109,061
     
-
 
Total
 
$
3,260
   
$
872
   
$
6,297
   
$
10,429
   
$
685,791
   
$
3,483
   
$
699,703
   
$
620
 
 
                                                               
Loans considered non-accrual
 
$
140
   
$
-
   
$
5,677
   
$
5,817
   
$
1,166
   
$
-
   
$
6,983
         
Loans still accruing
   
3,120
     
872
     
620
     
4,612
     
684,625
     
3,483
     
692,720
         
Total
 
$
3,260
   
$
872
   
$
6,297
   
$
10,429
   
$
685,791
   
$
3,483
   
$
699,703
         
 
                                                               
December 31, 2015
                                                               
Real estate loans:
                                                               
     Mortgages
 
$
487
   
$
283
   
$
687
   
$
1,457
   
$
139,547
   
$
35
   
$
141,039
   
$
321
 
     Home Equity
   
630
     
15
     
121
     
766
     
61,602
     
-
     
62,368
     
73
 
     Commercial
   
824
     
57
     
4,139
     
5,020
     
230,352
     
2,170
     
237,542
     
60
 
     Agricultural
   
177
     
167
     
-
     
344
     
56,740
     
738
     
57,822
     
-
 
     Construction
   
-
     
-
     
-
     
-
     
15,011
     
-
     
15,011
     
-
 
Consumer
   
239
     
37
     
49
     
325
     
11,209
     
9
     
11,543
     
9
 
Other commercial loans
   
143
     
214
     
1,010
     
1,367
     
55,316
     
866
     
57,549
     
160
 
Other agricultural loans
   
9
     
-
     
-
     
9
     
13,648
     
-
     
13,657
     
-
 
State and political
                                                               
   subdivision loans
   
-
     
-
     
-
     
-
     
98,500
     
-
     
98,500
     
-
 
Total
 
$
2,509
   
$
773
   
$
6,006
   
$
9,288
   
$
681,925
   
$
3,818
   
$
695,031
   
$
623
 
 
                                                               
Loans considered non-accrual
 
$
54
   
$
171
   
$
5,383
   
$
5,608
   
$
923
   
$
-
   
$
6,531
         
Loans still accruing
   
2,455
     
602
     
623
     
3,680
     
681,002
     
3,818
     
688,500
         
Total
 
$
2,509
   
$
773
   
$
6,006
   
$
9,288
   
$
681,925
   
$
3,818
   
$
695,031
         

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 March 31, 2016 and December 31, 2015, respectively. The balances are presented by class of financing receivable (in thousands):

13





 
 
March 31, 2016
   
December 31, 2015
 
Real estate loans:
           
     Mortgages
 
$
1,395
   
$
949
 
     Home Equity
   
161
     
59
 
     Commercial
   
4,265
     
4,422
 
     Agricultural
   
32
     
34
 
Consumer
   
51
     
55
 
Other commercial loans
   
1,079
     
1,012
 
 
 
$
6,983
   
$
6,531
 

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 structure more a