CODORUS VALLEY BANCORP INC - FORM 10-Q

Attached files

file	filename
EX-31.1 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER PURSUANT TO SECTION 302 OF SARBANES-OXLEY - CODORUS VALLEY BANCORP INC	codorus163740_ex31-1.htm
EX-32 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER AND PRINCIPAL FINANCIAL OFFICER PURSUANT TO SECTION 906 OF SARBANES-OXLEY - CODORUS VALLEY BANCORP INC	codorus163740_ex32.htm
EX-31.2 - CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER PURSUANT TO SECTION 302 OF SARBANES-OXLEY - CODORUS VALLEY BANCORP INC	codorus163740_ex31-2.htm

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2016

☐ 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: 0-15536

CODORUS VALLEY BANCORP, INC.

(Exact name of registrant as specified in its charter)

	Pennsylvania		23-2428543
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

	105 Leader Heights Road, P.O. Box 2887, York, Pennsylvania 17405
	(Address of principal executive offices) (Zip code)

	717-747-1519
(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year,

if changed since the last report.)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its 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 ☒ 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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

	Large accelerated filer ☐	Accelerated filer ☒
	Non-accelerated filer ☐	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 ☒

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. On October 27, 2016, 8,380,855 shares of common stock, par value $2.50, were outstanding, which includes the effect of the 5 percent common stock dividend declared October 11, 2016.

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Codorus Valley Bancorp, Inc.

Form 10-Q Index


PART I – FINANCIAL INFORMATION		Page #

Item 1.	Financial statements (unaudited):
	Consolidated balance sheets	3
	Consolidated statements of income	4
	Consolidated statements of comprehensive income	5
	Consolidated statements of cash flows	6
	Consolidated statements of changes in shareholders’ equity	7
	Notes to consolidated financial statements	8

Item 2.	Management’s discussion and analysis of financial condition and results of operations	40

Item 3.	Quantitative and qualitative disclosures about market risk	65

Item 4.	Controls and procedures	66

PART II – OTHER INFORMATION

Item 1.	Legal proceedings	66

Item 1A.	Risk factors	66

Item 2.	Unregistered sales of equity securities and use of proceeds	66

Item 3.	Defaults upon senior securities	66

Item 4.	Mine safety disclosures	66

Item 5.	Other information	66

Item 6.	Exhibits	67

SIGNATURES		68

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Codorus Valley Bancorp, Inc.

Consolidated Balance Sheets


	(Unaudited)
	September 30,			December 31,
(dollars in thousands, except per share data)	2016			2015
Assets
Interest bearing deposits with banks	$	32,945		$	44,496
Cash and due from banks		13,190			12,989
Total cash and cash equivalents		46,135			57,485
Securities, available-for-sale		200,373			213,470
Restricted investment in bank stocks, at cost		4,526			5,028
Loans held for sale		3,318			564
Loans (net of deferred fees of $3,261 - 2016 and $2,701 - 2015)		1,207,842			1,123,211
Less-allowance for loan losses		(14,225	)		(12,704	)
Net loans		1,193,617			1,110,507
Premises and equipment, net		24,616			24,606
Goodwill		2,301			2,301
Other assets		48,095			42,373
Total assets	$	1,522,981		$	1,456,334

Liabilities
Deposits
Noninterest bearing	$	187,455		$	162,982
Interest bearing		1,034,640			931,167
Total deposits		1,222,095			1,094,149
Short-term borrowings		31,061			74,510
Long-term debt		105,310			120,310
Other liabilities		9,198			8,224
Total liabilities		1,367,664			1,297,193

Shareholders’ equity
Preferred stock, par value $2.50 per share; $1,000 liquidation preference,
1,000,000 shares authorized; Series B shares issued and outstanding:
0 at September 30, 2016 and 12,000 at December 31, 2015		0			12,000
Common stock, par value $2.50 per share; 15,000,000 shares authorized; shares issued:
8,382,573 at September 30, 2016 and 7,957,145 at December 31, 2015; and shares		20,957			19,893
outstanding: 8,380,855 at September 30, 2016 and 7,957,145 at December 31, 2015
Additional paid-in capital		105,745			97,338
Retained earnings		26,104			28,539
Accumulated other comprehensive income		2,515			1,371
Treasury stock, at cost; 1,718 shares at September 30, 2016		(4	)		0
Total shareholders’ equity		155,317			159,141
Total liabilities and shareholders’ equity	$	1,522,981		$	1,456,334

See accompanying notes.

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Codorus Valley Bancorp, Inc.

Consolidated Statements of Income

Unaudited


	Three months ended					Nine months ended
	September 30,					September 30,
(dollars in thousands, except per share data)	2016			2015		2016		2015
Interest income
Loans, including fees	$	14,540		$	12,868	$	42,572	$	37,735
Investment securities:
Taxable		579			738		1,883		2,280
Tax-exempt		383			412		1,228		1,256
Dividends		61			64		183		270
Other		97			35		131		68
Total interest income		15,660			14,117		45,997		41,609

Interest expense
Deposits		1,757			1,564		4,875		4,755
Federal funds purchased and other short-term borrowings		34			47		116		126
Long-term debt		454			484		1,427		1,199
Total interest expense		2,245			2,095		6,418		6,080
Net interest income		13,415			12,022		39,579		35,529
Provision for loan losses		800			500		2,400		2,300
Net interest income after provision for loan losses		12,615			11,522		37,179		33,229

Noninterest income
Trust and investment services fees		654			604		1,892		1,809
Income from mutual fund, annuity and insurance sales		240			265		735		580
Service charges on deposit accounts		957			882		2,695		2,514
Income from bank owned life insurance		233			179		631		523
Other income		224			110		642		426
Gain on sales of loans held for sale		262			181		612		489
Gain on sales of securities		0			121		194		492
Total noninterest income		2,570			2,342		7,401		6,833

Noninterest expense
Personnel		5,990			5,367		17,988		15,520
Occupancy of premises, net		780			811		2,501		2,395
Furniture and equipment		728			664		2,160		2,014
Postage, stationery and supplies		147			153		524		505
Professional and legal		185			198		515		618
Marketing		437			242		1,275		931
FDIC insurance		121			177		467		526
Debit card processing		291			235		853		657
Charitable donations		116			21		884		763
Telephone		187			208		513		527
External data processing		385			306		1,067		850
Merger related		0			0		0		474
Foreclosed real estate including (recovery of) provision for losses		(13	)		66		122		215
Other		868			1,062		2,224		2,072
Total noninterest expense		10,222			9,510		31,093		28,067
Income before income taxes		4,963			4,354		13,487		11,995
Provision for income taxes		1,560			1,343		4,227		3,630
Net income		3,403			3,011		9,260		8,365
Preferred stock dividends		0			30		16		90
Net income available to common shareholders	$	3,403		$	2,981	$	9,244	$	8,275
Net income per common share, basic	$	0.41		$	0.46	$	1.10	$	1.28
Net income per common share, diluted	$	0.40		$	0.45	$	1.09	$	1.27

See accompanying notes.

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Codorus Valley Bancorp, Inc.

Consolidated Statements of Comprehensive Income

Unaudited


	Three months ended
	September 30,
(dollars in thousands)	2016			2015
Net income	$	3,403		$	3,011
Other comprehensive income (loss):
Securities available for sale:
Net unrealized holding (losses) gains arising during the period (net of tax (benefit) expense of ($179) and $268, respectively)		(347	)		521
Reclassification adjustment for (gains) included in net income (net of tax expense of $0 and $41, respectively) (a) (b)		0			(80	)
Net unrealized (losses) gains		(347	)		441
Comprehensive income	$	3,056		$	3,452


	Nine months ended
	September 30,
(dollars in thousands)	2016			2015
Net income	$	9,260		$	8,365
Other comprehensive income (loss):
Securities available for sale:
Net unrealized holding gains arising during the period (net of tax expense of $655 and $43, respectively)		1,272			84
Reclassification adjustment for (gains) included in net income (net of tax expense of $66 and $167, respectively) (a) (b)		(128	)		(325	)
Net unrealized gains (losses)		1,144			(241	)
Comprehensive income	$	10,404		$	8,124

(a)

Amounts are included in net gain on sales of securities on the Consolidated Statements of Income within noninterest income.

(b)

Income tax amounts are included in provision for income taxes on the Consolidated Statements of Income.

See accompanying notes.

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Codorus Valley Bancorp, Inc.

Consolidated Statements of Cash Flows

Unaudited


	Nine months ended
	September 30,
(dollars in thousands)	2016			2015
Cash flows from operating activities
Net income	$	9,260		$	8,365
Adjustments to reconcile net income to net cash provided by operations:
Depreciation/amortization		1,762			1,693
Net amortization of premiums on securities		685			784
Amortization of deferred loan origination fees and costs		(771	)		(630	)
Provision for loan losses		2,400			2,300
(Reversal of) provision for losses on foreclosed real estate		(31	)		57
Increase in bank owned life insurance		(631	)		(523	)
Originations of loans held for sale		(31,369	)		(23,508	)
Proceeds from sales of loans held for sale		29,010			23,853
Gain on sales of loans held for sale		(612	)		(489	)
(Gain) loss on disposal of premises and equipment		(2	)		60
Gain on sales of securities, available-for-sale		(194	)		(492	)
(Gain) loss on sales of foreclosed real estate		(19	)		19
Stock-based compensation		391			229
Decrease in interest receivable		389			0
Increase in other assets		888			249
Increase in interest payable		0			9
Increase (decrease) in other liabilities		1,018			(1,311	)
Net cash provided by operating activities		12,174			10,665
Cash flows from investing activities
Purchases of securities, available-for-sale		(37,901	)		(40,613	)
Maturities, repayments and calls of securities, available-for-sale		39,337			35,390
Sales of securities, available-for-sale		12,903			9,615
Net decrease (increase) in restricted investment in bank stock		502			(1,229	)
Net proceeds from acquisition		0			21,091
Proceeds from acquired receivables of sold investment settlements		0			15,256
Net increase in loans made to customers		(84,989	)		(58,824	)
Purchases of premises and equipment		(1,770	)		(3,544	)
Investment in bank owned life insurance		(6,994	)		(7	)
Proceeds from sale of fixed assets		0			51
Proceeds from sales of foreclosed real estate		540			238
Net cash used in investing activities		(78,372	)		(22,576	)
Cash flows from financing activities
Net increase in demand and savings deposits		102,379			74,993
Net increase (decrease) in time deposits		25,567			(55,868	)
Net (decrease) increase in short-term borrowings		(43,449	)		5,145
Proceeds from issuance of long-term debt		0			35,000
Repayment of long-term debt		(15,000	)		(5,071	)
Cash dividends paid to preferred shareholder		(46	)		(90	)
Cash dividends paid to common shareholders		(3,106	)		(2,225	)
Redemption of preferred stock		(12,000	)		0
Issuance of common stock		503			966
Net cash provided by financing activities		54,848			52,850
Net (decrease) increase in cash and cash equivalents		(11,350	)		40,939
Cash and cash equivalents at beginning of year		57,485			31,094
Cash and cash equivalents at end of period	$	46,135		$	72,033

See accompanying notes.

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Codorus Valley Bancorp, Inc.

Consolidated Statements of Changes in Shareholders’ Equity
Unaudited


*(dollars in thousands, except per share data)*	Preferred Stock			Common Stock		Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Income			Treasury Stock			Total

Balance, January 1, 2016	$	12,000		$	19,893	$	97,338		$	28,539		$	1,371		$	0		$	159,141
Net income										9,260									9,260
Other comprehensive income, net of tax													1,144						1,144
Common stock cash dividends ($0.371 per share, adjusted)										(3,106	)								(3,106	)
5% common stock dividend, 399,088 shares at fair value					998		7,575			(8,573	)								0
Preferred stock cash dividends										(16	)								(16	)
Redemption of preferred stock		(12,000	)																(12,000	)
Stock-based compensation including related tax benefit							391												391
Forfeiture of restricted stock							8									(8	)		0
Issuance and reissuance of common stock including related tax benefit:
15,425 shares under the dividend reinvestment and stock purchase plan					37		282									2			321
5,621 shares under the stock option plan					12		90									2			104
2,421 shares of stock-based compensation awards					6		(6	)											0
4,447 shares under employee stock purchase plan					11		67												78

Balance, September 30, 2016	$	0		$	20,957	$	105,745		$	26,104		$	2,515		$	(4	)	$	155,317

Balance, January 1, 2015	$	12,000		$	14,577	$	62,713		$	26,483		$	2,667		$	0		$	118,440
Net income										8,365									8,365
Other comprehensive loss, net of tax													(241	)					(241	)
Common stock cash dividends ($0.345 per share, adjusted)										(2,225	)								(2,225	)
5% common stock dividend, 294,507 shares at fair value					736		5,228			(5,964	)								0
Preferred stock cash dividends										(90	)								(90	)
Stock-based compensation including related tax benefit							229												229
Forfeiture of restricted stock							8									(8	)		0
Issuance and reissuance of common stock including related tax benefit:
14,756 shares under the dividend reinvestment and stock purchase plan					37		499												536
41,207 shares under the stock option plan					103		264									8			375
3,361 shares under employee stock purchase plan					8		47												55

Balance, September 30, 2015	$	12,000		$	15,461	$	68,988		$	26,569		$	2,426		$	0		$	125,444

See accompanying notes.

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Note 1—Summary of Significant Accounting Policies

Nature of Operations and Basis of Presentation

The accompanying consolidated balance sheet at December 31, 2015 has been derived from audited financial statements, and the unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, the instructions to Form 10-Q, and FASB Accounting Standards Codification (ASC) 270. Accordingly, the interim financial statements do not include all of the financial information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the interim consolidated financial statements include all adjustments necessary to present fairly the financial condition and results of operations for the reported periods, and all such adjustments are of a normal and recurring nature.

Codorus Valley Bancorp, Inc. (“Corporation” or “Codorus Valley”) is a one-bank holding company headquartered in York, Pennsylvania that provides a full range of banking services through its subsidiary, PeoplesBank, A Codorus Valley Company (“PeoplesBank” or “Bank”). PeoplesBank operates two wholly-owned subsidiaries, Codorus Valley Financial Advisors, Inc., which sells nondeposit investment products, and SYC Settlement Services, Inc., which provides real estate settlement services. In addition, PeoplesBank may periodically create nonbank subsidiaries for the purpose of temporarily holding foreclosed properties pending the liquidation of these properties. PeoplesBank operates under a state charter and is subject to regulation by the Pennsylvania Department of Banking and Securities, and the Federal Deposit Insurance Corporation. The Corporation is subject to regulation by the Federal Reserve Board and the Pennsylvania Department of Banking and Securities.

The consolidated financial statements include the accounts of Codorus Valley and its wholly-owned bank subsidiary, PeoplesBank, and two wholly-owned nonbank subsidiaries, SYC Realty Company, Inc. and CVLY Corp. SYC Realty is primarily used to hold foreclosed properties obtained by PeoplesBank and was inactive during the period ended September 30, 2016. CVLY Corp. was formed to facilitate the acquisition of Madison Bancorp, Inc. (“Madison”) and may be used, as needed, for the financial and legal management of future acquisition transactions. The accounts of CVB Statutory Trust No. 1 and No. 2 are not included in the consolidated financial statements as discussed in Note 8—Short-Term Borrowings and Long-Term Debt. All significant intercompany account balances and transactions have been eliminated in consolidation. The accounting and reporting policies of Codorus Valley and subsidiaries conform to accounting principles generally accepted in the United States of America and have been followed on a consistent basis.

These consolidated statements should be read in conjunction with the notes to the audited consolidated financial statements contained in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2015.

The results of operations for the three and nine months ended September 30, 2016 are not necessarily indicative of the results to be expected for the full year.

In accordance with FASB ASC 855, the Corporation evaluated the events and transactions that occurred after the balance sheet date of September 30, 2016 and through the date these consolidated financial statements were issued, for items of potential recognition or disclosure.

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Loans

Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at their outstanding unpaid principal balances less amounts charged off, net of an allowance for loan losses and any deferred fees or costs. Interest income is accrued on the unpaid principal balance. Generally, loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (interest income) over the contractual life of the loan. The loans receivable portfolio is segmented into commercial and consumer loans. Commercial loans consist of the following industry classes: builder & developer, commercial real estate investor, residential real estate investor, hotel/motel, wholesale & retail, agriculture, manufacturing and all other. Consumer loans consist of the following classes: residential mortgage, home equity and all other.

For all classes of loans receivable, the accrual of interest is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan may be currently performing. A past due loan may remain on accrual status if it is in the process of collection and well secured. When a loan is placed on nonaccrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against the allowance for loan losses. Interest received on nonaccrual loans, including impaired loans, generally is either applied against principal or reported as interest income, according to the Corporation’s judgment as to the collectability of principal. Generally, nonaccrual loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time, generally six months, and the ultimate collectability of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans receivable is determined based on contractual due dates for loan payments.

Acquired Loans

Acquired loans are initially recorded at their acquisition date fair values. The carryover of allowance for loan losses is prohibited as any credit losses in the loans are included in the determination of the fair value of the loans at the acquisition date. Fair values for acquired loans are based on a discounted cash flow methodology that involves assumptions and judgments as to credit risk, prepayment risk, liquidity risk, default rates, loss severity, payment speeds, collateral values and discount rate.

For acquired loans that are not deemed impaired at acquisition, credit discounts representing principal losses expected over the life of the loan are a component of the initial fair value and amortized over the life of the asset. Subsequent to the acquisition date, the methods used to estimate the required allowance for loan losses on these loans is similar to originated loans. However, the Corporation records a provision for loan losses only when the required allowance for loan losses exceeds any remaining credit discount. The remaining differences between the acquisition date fair value and the unpaid principal balance at the date of acquisition are recorded in interest income over the life of the loan.

Acquired loans that have evidence of deterioration in credit quality since origination and for which it is probable, at acquisition, that the Corporation will be unable to collect all contractually required payments are accounted for as impaired loans under ASC 310-30. The excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized into interest income over the remaining life of the loans. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the non-accretable discount. The non-accretable discount represents estimated future credit losses expected to be incurred over the life of the loan. Subsequent decreases to the expected cash flows require the Corporation to evaluate the need for an allowance for loan losses on these loans. Subsequent improvements in expected cash flows result in the reversal of a corresponding amount of the non-accretable discount which the Corporation then reclassifies as an accretable discount that is recognized into interest income over the remaining life of the loans using the interest method.

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The following is a summary of acquired impaired loans from the merger, as discussed in Note 2-Merger with Madison Bancorp, Inc.:


*(dollars in thousands)*		January 16, 2015
Contractually required principal and interest at acquisition	$	1,961
Contractual cash flows not expected to be collected		1,185
Expected cash flows at acquisition		776
Interest component of expected cash flows		160
Basis in acquired loans at acquisition - estimated fair value	$	616

Allowance for Loan Losses

The allowance for loan losses represents the Corporation’s estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectable are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. While the Corporation attributes a portion of the allowance to individual loans and groups of loans that it evaluates and determines to be impaired, the allowance is available to cover all charge-offs that arise from the loan portfolio.

The allowance for loan losses is maintained at a level considered by management to be adequate to provide for losses that can be reasonably anticipated. The Corporation performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Corporation’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available.

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The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as impaired, generally substandard and nonaccrual loans. For loans that are classified as impaired, an allowance is established when the collateral value (or discounted cash flows or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers pools of loans by loan class, including commercial loans not considered impaired, as well as smaller balance homogeneous loans such as residential real estate, home equity and other consumer loans. These pools of loans are evaluated for loss exposure based upon historical loss rates for each of these classes of loans, adjusted for qualitative (environmental) risk factors. Historical loss rates are based on a two year rolling average of net charge-offs. Qualitative risk factors that supplement historical losses in the evaluation of loan pools are shown below. Each factor is assigned a value to reflect improving, stable or declining conditions based on the Corporation’s best judgment using relevant information available at the time of the evaluation.

Changes in national and local economies and business conditions

Changes in the value of collateral for collateral dependent loans

Changes in the level of concentrations of credit

Changes in the volume and severity of classified and past due loans

Changes in the nature and volume of the portfolio

Changes in collection, charge-off, and recovery procedures

Changes in underwriting standards and loan terms

Changes in the quality of the loan review system

Changes in the experience/ability of lending management and key lending staff

Regulatory and legal regulations that could affect the level of credit losses

Other pertinent environmental factors

The unallocated component is maintained to cover uncertainties that could affect the Corporation’s estimate of probable losses. For example, increasing credit risks and uncertainties, not yet reflected in current leading indicators, associated with prolonged low economic growth, or recessionary business conditions for certain industries or the broad economy, or the erosion of real estate values, represent risk factors, the occurrence of any or all of which can adversely affect a borrowers’ ability to service their loans. The unallocated component of the allowance also reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the loan portfolio, including the unpredictable timing and amounts of charge-offs and related historical loss averages, and specific-credit or broader portfolio future cash flow value and collateral valuation uncertainties which could negatively impact unimpaired portfolio loss factors.

As disclosed in Note 5—Loans, the Corporation engages in commercial and consumer lending. Loans are made within the Corporation’s primary market area and surrounding areas, and include the purchase of whole loan or participation interests in loans from other financial institutions or private equity companies. Commercial loans, which pose the greatest risk of loss to the Corporation, whether originated or purchased, are generally secured by real estate. Within the broad commercial loan segment, the builder & developer and commercial real estate investor loan classes generally present a higher level of risk than other commercial loan classifications. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effect of general economic conditions on income producing properties, unstable real estate prices and the dependency upon successful construction and sale or operation of the real estate project. Within the consumer loan segment, junior (i.e., second) liens present a higher risk to the Corporation because economic and housing market conditions can adversely affect the underlying value of the collateral, which could render the Corporation under-secured or unsecured. In addition, economic and housing market conditions can adversely affect the ability of borrowers to service their debt.

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A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered in determining impairment include payment status and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. The Corporation determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Loans that are deemed impaired are evaluated for impairment loss based on the net realizable value of the collateral, as applicable. Loans that are not collateral dependent will rely on the present value of expected future cash flows discounted at the loan’s effective interest rate to determine impairment loss. Large groups of smaller balance homogeneous loans such as residential mortgage loans, home equity loans and other consumer loans are collectively evaluated for impairment, unless they are classified as impaired.

An allowance for loan losses is established for an impaired commercial loan if its carrying value exceeds its estimated fair value. For commercial loans secured by real estate, estimated fair values are determined primarily through third-party appraisals of the underlying collateral. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the most recent appraisal and the condition of the property. Appraisals are generally discounted to provide for selling costs and other factors to determine an estimate of the net realizable value of the property. For commercial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets. In instances when specific consumer related loans become impaired, they may be partially or fully charged off, which obviates the need for a specific allowance.

Loans whose terms are modified are classified as troubled debt restructurings if the Corporation grants borrowers experiencing financial difficulties concessions that it would not otherwise consider. Concessions granted under a troubled debt restructuring may involve an interest rate that is below the market rate given the associated credit risk of the loan or an extension of a loan’s stated maturity date. Loans classified as troubled debt restructurings are designated as impaired. Non-accrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for a reasonable period of time, generally six consecutive months after modification and future payments are reasonably assured.

Banking regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses and may require the Corporation to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to the Corporation. Based on an analysis of the loan portfolio, the Corporation believes that the level of the allowance for loan losses at September 30, 2016 is adequate.

Foreclosed Real Estate

Foreclosed real estate, included in other assets, is comprised of property acquired through a foreclosure proceeding or property that is acquired through in-substance foreclosure. Foreclosed real estate is initially recorded at fair value minus estimated costs to sell at the date of foreclosure, establishing a new cost basis. Any difference between the carrying value and the new cost basis is charged against the allowance for loan losses. Appraisals, obtained from an independent third party, are generally used to determine fair value. After foreclosure, management reviews valuations at least quarterly and adjusts the asset to the lower of cost or fair value minus estimated costs to sell through a valuation allowance or a write-down. Costs related to the improvement of foreclosed real estate are generally capitalized until the real estate reaches a saleable condition subject to fair value limitations. Revenue and expense from operations and changes in the valuation allowance are included in noninterest expense. When a foreclosed real estate asset is ultimately sold, any gain or loss on the sale is included in the income statement as a component of noninterest expense. At September 30, 2016, foreclosed real estate, net of allowance, was $2,674,000, compared to $2,913,000 at December 31, 2015. Included within loans receivable as of September 30, 2016 was a recorded investment of $230,000 of consumer mortgage loans secured by residential real estate, for which formal foreclosure proceedings were in process according to local requirements of the applicable jurisdiction.

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Mortgage Servicing Rights

PeoplesBank retained servicing of sold mortgage loans beginning in 2016. The mortgage servicing rights (MSRs) associated with the sold loans are included in other assets on the consolidated balance sheets at an amount equal to the estimated fair value of the contractual rights to service the mortgage loans. The MSR asset is amortized as a reduction to servicing income. The MSR asset is evaluated periodically for impairment and carried at the lower of amortized cost or fair value. A third party calculates fair value by discounting the estimated cash flows from servicing income using a rate consistent with the risk associated with these assets and an expected life commensurate with the expected life of the underlying loans. In the event that the amortized cost of the MSR asset exceeds the fair value of the asset, a valuation allowance would be established through a charge against servicing income. Subsequent fair value evaluations may determine that impairment has been reduced or eliminated, in which case the valuation allowance would be reduced through a credit to earnings. At September 30, 2016, the MSR asset was $209,000, net of a valuation allowance of $3,000. There were no mortgage servicing assets as of December 31, 2015.

Goodwill and Core Deposit Intangible Assets

Goodwill arising from acquisitions is not amortized, but is subject to an annual impairment test. This test consists of a qualitative analysis. If the Corporation determines events or circumstances indicate that it is more likely than not that goodwill is impaired, a quantitative analysis must be completed. Analyses may also be performed between annual tests. Significant judgment is applied when goodwill is assessed for impairment. This judgment includes developing cash flow projections, selecting appropriate discount rates, identifying relevant market comparables, incorporating general economic and market conditions, and selecting an appropriate control premium. The Corporation completes its annual goodwill impairment test on October 1^st of each year. Based upon a qualitative analysis of goodwill, the Corporation concluded that the amount of recorded goodwill was not impaired as of October 1, 2016.

Core deposit intangibles represent the value assigned to demand, interest checking, money market, and savings accounts acquired as part of an acquisition. The core deposit intangible value represents the future economic benefit of potential cost savings from acquiring core deposits as part of an acquisition compared to the cost of alternative funding sources and the alternative cost to grow a similar core deposit base. The core deposit intangible asset resulting from the merger with Madison Bancorp, Inc. was determined to have a definite life and is being amortized using the sum of the years’ digits method over ten years. All intangible assets must be evaluated for impairment if certain events or changes in circumstances occur. Any impairment write-downs would be recognized as expense on the consolidated statements of income.

At September 30, 2016, the Corporation does not have any indicators of potential impairment of either goodwill or core deposit intangibles.

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Per Common Share Data

All per share computations include the effect of stock dividends declared, including a 5 percent common stock dividend declared October 11, 2016. The computation of net income per common share is provided in the table below.

	Three months ended September 30,				Nine months ended September 30,
(in thousands, except per share data)	2016		2015		2016		2015
Net income available to common shareholders	$	3,403	$	2,981	$	9,244	$	8,275

Weighted average shares outstanding (basic)		8,378		6,491		8,367		6,464
Effect of dilutive stock options		70		63		68		72
Weighted average shares outstanding (diluted)		8,448		6,554		8,435		6,536

Basic earnings per common share	$	0.41	$	0.46	$	1.10	$	1.28
Diluted earnings per common share	$	0.40	$	0.45	$	1.09	$	1.27

Anti-dilutive stock options excluded from the computation of earnings per share		57		32		69		33

Comprehensive Income

Accounting principles generally accepted in the United States require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the shareholders’ equity section of the balance sheet, such items, along with net income, are components of comprehensive income.

Cash Flow Information

For purposes of the statements of cash flows, the Corporation considers interest bearing deposits with banks, cash and due from banks, and federal funds sold to be cash and cash equivalents.

Supplemental cash flow information is provided in the table below.

	Nine months ended September 30,
(dollars in thousands)	2016		2015
Cash paid during the period for:
Income taxes	$	2,729	$	4,100
Interest	$	6,418	$	6,071

Noncash investing activities:
Transfer of loans to foreclosed real estate	$	251	$	41
Increase in other liabilities for purchase of securities settling after quarter end	$	0	$	1,157

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Recent Accounting Pronouncements

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments. This standard clarifies how certain cash receipts and cash payments are presented and classified in the statement of cash flows to reduce diversity in practice. This standard contains guidance clarifying when an entity should separate cash receipts and cash payments and classify them into more than one class of cash flows (including when reasonable judgment is required to estimate and allocate cash flows) versus when an entity should classify the aggregate amount into one class of cash flows on the basis of predominance. The new standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The Corporation is currently evaluating the impact of the adoption of this guidance on its consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326). This standard adds a new Topic 326 which requires companies to measure and record impairment on financial instruments at the time of origination using the expected credit loss (CECL) model. The CECL model calculates impairment based on historical experience, current conditions, and reasonable and supportable forecasts, and reflects the organization’s current estimate of all expected credit losses over the contractual term of its financial assets. The new standard is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2018. The Corporation is currently evaluating the impact of the adoption of this guidance on its consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718). This standard introduces amendments intended to simplify the accounting for stock compensation. Specifically, the ASU requires all excess tax benefits and tax deficiencies (including tax benefits of dividends on share-based payment awards) to be recognized as income tax expense or benefit in the income statement. The new standard is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption is permitted. The Corporation is currently evaluating the impact of the adoption of this guidance on its consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases. From the lessee’s perspective, the new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for lessees. From the lessor’s perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating. A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing lease. If the lessor does not convey risks and rewards or control, an operating lease results. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. A modified retrospective transition approach is required for lessors for sales-type, direct financing, and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Corporation is currently evaluating the impact of the adoption of this guidance on its consolidated financial statements.

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In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). This standards update provides a framework that replaces most existing revenue recognition guidance. The guidance requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. ASU 2014-09 is effective for interim and annual reporting periods beginning after December 15, 2017, with earlier adoption permitted. The Corporation is currently evaluating the impact of the adoption of this guidance on its consolidated financial statements.

Note 2-Merger with Madison Bancorp, Inc.

On July 22, 2014, the Corporation entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Madison Bancorp, Inc., a Maryland corporation (“Madison”), and CVLY Corp., a Pennsylvania corporation and wholly-owned subsidiary of the Corporation (“Acquisition Subsidiary”). Pursuant to the Merger Agreement, Madison agreed to cause its wholly-owned subsidiary, Madison Square Federal Savings Bank (“MSFSB”), to merge with and into the Corporation’s wholly-owned bank subsidiary, PeoplesBank, with PeoplesBank being the surviving bank in the Bank Merger.

The acquisition of Madison and MSFSB was completed on January 16, 2015, as reported on a Form 8-K filed on the same date. Pursuant to the Merger Agreement, each share of Madison common stock was converted into the right to receive $22.90 in cash, without interest, and each outstanding option to purchase Madison common stock was converted into the right to receive cash based on a formula set forth in the Merger Agreement. Total consideration paid was $14,425,000, which included the purchase of 608,116 shares of Madison common stock as well as the cash out of 41,270 options to purchase Madison common stock with an average exercise price of $10.81 per share.

The merger was accounted for using acquisition accounting, which requires the Corporation to allocate total consideration transferred to the assets acquired and liabilities assumed, based on their respective fair value at the merger date, with any remaining excess consideration being recorded as goodwill. The table below presents the detail of the total acquisition cost as well as a summary of the assets acquired and liabilities assumed recorded at their estimated fair value, as of the January 16, 2015 acquisition date.

*(in thousands, except per share data)*		January 16, 2015
Cash paid for outstanding shares of Madison common stock and outstanding options			$	14,425

Assets Acquired:
Cash and due from banks	$	35,516
Securities, available for sale		1,396
Loans		77,228
Premises and equipment		2,601
Other assets		17,567
Total assets acquired				134,308
Liabilities Assumed:
Deposits		120,545
Other liabilities		1,639
Total liabilities assumed				122,184

Net goodwill resulting from merger			$	2,301

The fair value of total assets acquired as a result of the merger totaled $134,308,000, which included $1,396,000 of securities which were subsequently sold in the first quarter of 2015. Additionally, other assets of $17,567,000 included $15,256,000 of receivables related to investment securities sold prior to the merger, pending receipt of sales proceeds, which were subsequently collected. The transaction also resulted in a core deposit intangible of $39,000 and goodwill of $2,301,000. Goodwill arising from the acquisition consists largely of synergies and the cost savings expected to result from the combining of operations and is not expected to be deductible for income tax purposes.

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The following table presents unaudited pro forma information as if the merger between PeoplesBank and MSFSB had been completed on January 1, 2014. The pro forma information does not necessarily reflect the results of operations that would have occurred had MSFSB merged with PeoplesBank at the beginning of 2014. The pro forma financial information does not include the impact of possible business model changes, nor does it consider any potential impacts of current market conditions or revenues, cost savings, or other factors.

(in thousands, except per share data)	Pro forma for the year ended December 31, 2014
Net interest income	$	44,598
Noninterest income		8,246
Net income available to common shareholders		10,972

Pro forma earnings per share, adjusted:
Basic	$	1.78
Diluted	$	1.74

Note 3-Securities

A summary of securities available-for-sale at September 30, 2016 and December 31, 2015 is provided below. The securities available-for-sale portfolio is generally comprised of high quality debt instruments, principally obligations of the United States government or agencies thereof and investments in the obligations of states and municipalities. The majority of municipal bonds in the portfolio are general obligation bonds, which can draw upon multiple sources of revenue, including taxes, for payment. Only a few bonds are revenue bonds, which are dependent upon a single revenue stream for payment, but they are for critical services such as water and sewer. In many cases, municipal debt issues are insured or, in the case of school districts of selected states, backed by specific loss reserves. At September 30, 2016, the fair value of the municipal bond portfolio was concentrated in the state of Pennsylvania at 71 percent.

	Amortized		Gross Unrealized					Fair
(dollars in thousands)	Cost		Gains		Losses			Value
September 30, 2016
Debt securities:
U.S. Treasury notes	$	9,960	$	25	$	(48	)	$	9,937
U.S. agency		21,054		10		(32	)	$	21,032
U.S. agency mortgage-backed, residential		97,368		2,785		0			100,153
State and municipal		68,181		1,077		(7	)		69,251
Total debt securities	$	196,563	$	3,897	$	(87	)	$	200,373
December 31, 2015
Debt securities:
U.S. agency	$	17,554	$	0	$	(140	)	$	17,414
U.S. agency mortgage-backed, residential		119,266		1,472		(157	)		120,581
State and municipal		74,573		937		(35	)		75,475
Total debt securities	$	211,393	$	2,409	$	(332	)	$	213,470

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The amortized cost and estimated fair value of debt securities at September 30, 2016 by contractual maturity are shown below. Actual maturities may differ from contractual maturities if call options on select debt issues are exercised in the future. Mortgage-backed securities are included in the maturity categories based on average expected life.

	Available-for-sale
	Amortized		Fair
(dollars in thousands)	Cost		Value
Due in one year or less	$	19,341	$	19,412
Due after one year through five years		126,514		129,658
Due after five years through ten years		44,364		44,749
Due after ten years		6,344		6,554
Total debt securities	$	196,563	$	200,373

Gross realized gains and losses on sales of securities available-for-sale are shown below. Realized gains and losses are computed on the basis of specific identification of the adjusted cost of each security and are shown net as a separate line item in the income statement.

	Three months ended				Nine months ended
	September 30,				September 30,
(dollars in thousands)	2016		2015		2016		2015
Realized gains	$	0	$	121	$	194	$	492
Realized losses		0		0		0		0
Net gains	$	0	$	121	$	194	$	492

Securities, issued by agencies of the federal government, with a carrying value of $162,501,000 and $186,097,000 on September 30, 2016 and December 31, 2015, respectively, were pledged to secure public and trust deposits, repurchase agreements and other short-term borrowings.

The table below shows gross unrealized losses and fair value, aggregated by investment category and length of time, for securities that have been in a continuous unrealized loss position, at September 30, 2016 and December 31, 2015.

	Less than 12 months							12 months or more							Total
	Number of		Fair		Unrealized			Number of		Fair		Unrealized			Number of		Fair		Unrealized
(dollars in thousands)	Securities		Value		Losses			Securities		Value		Losses			Securities		Value		Losses
September 30, 2016
Debt securities:
U.S. Treasury notes		1	$	4,952	$	(48	)		0	$	0	$	0			1	$	4,952	$	(48	)
U.S. agency		2		9,968		(32	)		0		0		0			2		9,968	$	(32	)
State and municipal		13		5,903		(4	)		1		503		(3	)		14		6,406	$	(7	)
Total temporarily impaired debt securities, available-for-sale		16	$	20,823	$	(84	)		1	$	503	$	(3	)		17	$	21,326	$	(87	)
December 31, 2015
Debt securities:
U.S. agency		6	$	17,414	$	(140	)		0	$	0	$	0			6	$	17,414	$	(140	)
U.S. agency mortgage-backed, residential		8		18,991		(157	)		0		0		0			8		18,991		(157	)
State and municipal		27		11,272		(26	)		4		1,886		(9	)		31		13,158		(35	)
Total temporarily impaired debt securities, available-for-sale		41	$	47,677	$	(323	)		4	$	1,886	$	(9	)		45	$	49,563	$	(332	)

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Securities available-for-sale are analyzed quarterly for possible other-than-temporary impairment. The analysis considers, among other factors: 1) whether the Corporation has the intent to sell its securities prior to market recovery or maturity; 2) whether it is more likely than not that the Corporation will be required to sell its securities prior to market recovery or maturity; 3) default rates/history by security type; 4) third-party securities ratings; 5) third-party guarantees; 6) subordination; 7) payment delinquencies; 8) nature of the issuer; and 9) current financial news.

The Corporation believes that unrealized losses at September 30, 2016 were primarily the result of changes in market interest rates and that the Corporation has the ability to hold these investments for a time necessary to recover the amortized cost. Through September 30, 2016 the Corporation has collected all interest and principal on its investment securities as scheduled. The Corporation believes that collection of the contractual principal and interest is probable and, therefore, all impairment is considered to be temporary.

Note 4—Restricted Investment in Bank Stocks

Restricted stock, which represents required investments in the common stock of correspondent banks, is carried at cost and, as of September 30, 2016 and December 31, 2015, consisted primarily of the common stock of the Federal Home Loan Bank of Pittsburgh (FHLBP) and, to a lesser degree, Atlantic Community Bankers Bank (ACBB). Under the FHLBP’s Capital Plan, PeoplesBank is required to maintain a minimum member stock investment, as a condition of becoming and remaining a member and as a condition of obtaining borrowings from the FHLBP. The FHLBP uses a formula to determine the minimum stock investment, which is based on the volume of loans outstanding, unused borrowing capacity and other factors.

The FHLBP paid dividends during the periods ended September 30, 2016 and 2015. The FHLBP restricts the repurchase of the excess capital stock of member banks. The amount of excess capital stock that can be repurchased from any member is currently the lesser of five percent of the member’s total capital stock outstanding or its excess capital stock outstanding.

Management evaluates the restricted stock for impairment in accordance with FASB ASC Topic 942. Management’s determination of whether these investments are impaired is based on their a ssessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. Using the FHLBP as an example, the determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as: (1) the significance of the decline in net assets of the FHLBP as compared to the capital stock amount for the FHLBP and the length of time this situation has persisted; (2) commitments by the FHLBP to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLBP; and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the FHLBP. Management believes no impairment charge was necessary related to the restricted stock during the periods ended September 30, 2016 and 2015.

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Note 5—Loans

Loan Portfolio Composition

The table below provides the composition of the loan portfolio at September 30, 2016 and December 31, 2015. The portfolio is comprised of two segments, commercial and consumer loans. The commercial loan segment is disaggregated by industry class which allows the Corporation to monitor risk and performance. Those industries representing the largest dollar investment and most risk are listed separately. The “Other” commercial loans category is comprised of various industries. The consumer related segment is comprised of residential mortgages, home equity and other consumer loans. The Corporation has not engaged in sub-prime residential mortgage originations.

	September 30,		% Total		December 31,		% Total
(dollars in thousands)	2016		Loans		2015		Loans
Builder & developer	$	128,996		10.7	$	133,978		11.9
Commercial real estate investor		229,619		19.0		191,994		17.1
Residential real estate investor		175,768		14.6		161,144		14.3
Hotel/Motel		82,714		6.8		84,171		7.5
Wholesale & retail		88,422		7.3		77,694		6.9
Manufacturing		39,327		3.3		30,325		2.7
Agriculture		48,105		4.0		41,217		3.7
Other		223,954		18.5		215,891		19.2
Total commercial related loans		1,016,905		84.2		936,414		83.4
Residential mortgages		69,845		5.8		70,094		6.2
Home equity		91,468		7.6		86,408		7.7
Other		29,624		2.4		30,295		2.7
Total consumer related loans		190,937		15.8		186,797		16.6
Total loans	$	1,207,842		100.0	$	1,123,211		100.0

Loan Risk Ratings

The Corporation’s internal risk rating system follows regulatory guidance as to risk classifications and definitions. Every approved loan is assigned a risk rating. Generally, risk ratings for commercial related loans and residential mortgages held for investment are determined by a formal evaluation of risk factors performed by the Corporation’s underwriting staff. For consumer loans, and commercial loans up to $500,000, the Corporation uses third-party credit scoring software models for risk rating purposes. The loan portfolio is monitored on a continuous basis by loan officers, loan review personnel and senior management. Adjustments of loan risk ratings are generally performed by the Special Asset Committee, which includes senior management. The Committee, which meets monthly, makes changes, as appropriate, to risk ratings when it becomes aware of credit events such as payment delinquency, cessation of a business or project, bankruptcy or death of the borrower, or changes in collateral value.

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The Corporation uses ten risk ratings to grade loans. The first seven ratings, representing the lowest risk, are combined and given a “pass” rating. A pass rating is a satisfactory credit rating, which applies to a loan that is expected to perform in accordance with the loan agreement and has a low probability of loss. A loan rated “special mention” has a potential weakness which may, if not corrected, weaken the loan or inadequately protect the Corporation’s position at some future date. A loan rated “substandard” is inadequately protected by the current net worth or paying capacity of the borrower or of the collateral pledged. A substandard loan has a well-defined weakness or weaknesses that could jeopardize liquidation of the loan, which exposes the Corporation to loss if the deficiencies are not corrected. A loan classified “doubtful” has all the weaknesses inherent in one classified substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and value highly improbable and the possibility of loss extremely high. When circumstances indicate that collection of the loan is doubtful, the loan is risk rated “nonaccrual,” the accrual of interest income is discontinued, and any unpaid interest previously credited to income is reversed. The table below does not include the regulatory classification of “doubtful,” which is subsumed within the nonaccrual risk rating category, nor does it include the regulatory classification of “loss” because the Corporation promptly charges off known loan losses.

The table below presents a summary of loan risk ratings by loan class at September 30, 2016 and December 31, 2015.

			Special
(dollars in thousands)	Pass		Mention		Substandard		Nonaccrual		Total
September 30, 2016
Builder & developer	$	118,625	$	6,445	$	3,542	$	384	$	128,996
Commercial real estate investor		222,173		1,494		5,952		0		229,619
Residential real estate investor		169,863		4,192		1,710		3		175,768
Hotel/Motel		82,353		0		0		361		82,714
Wholesale & retail		79,769		8,653		0		0		88,422
Manufacturing		33,946		4,763		618		0		39,327
Agriculture		46,295		802		0		1,008		48,105
Other		216,411		6,404		876		263		223,954
Total commercial related loans		969,435		32,753		12,698		2,019		1,016,905
Residential mortgage		69,625		0		99		121		69,845
Home equity		91,085		71		0		312		91,468
Other		29,361		72		129		62		29,624
Total consumer related loans		190,071		143		228		495		190,937
Total loans	$	1,159,506	$	32,896	$	12,926	$	2,514	$	1,207,842

December 31, 2015
Builder & developer	$	122,919	$	6,775	$	3,873	$	411	$	133,978
Commercial real estate investor		185,621		396		5,957		20		191,994
Residential real estate investor		153,072		6,601		874		597		161,144
Hotel/Motel		83,751		0		0		420		84,171
Wholesale & retail		69,973		7,678		0		43		77,694
Manufacturing		26,705		2,990		630		0		30,325
Agriculture		40,795		0		0		422		41,217
Other		212,971		1,131		855		934		215,891
Total commercial related loans		895,807		25,571		12,189		2,847		936,414
Residential mortgage		69,930		0		97		67		70,094
Home equity		85,690		516		0		202		86,408
Other		29,973		75		130		117		30,295
Total consumer related loans		185,593		591		227		386		186,797
Total loans	$	1,081,400	$	26,162	$	12,416	$	3,233	$	1,123,211

- 21 -

Impaired Loans

The table below presents a summary of impaired loans at September 30, 2016 and December 31, 2015. Generally, impaired loans are loans risk rated substandard and nonaccrual. An allowance is established for individual commercial loans where the Corporation has doubt as to full recovery of the outstanding principal balance. The recorded investment represents outstanding unpaid principal loan balances adjusted for charge-offs.


	With No Allowance				With A Related Allowance						Total
	Recorded		Unpaid		Recorded		Unpaid		Related		Recorded		Unpaid
(dollars in thousands)	Investment		Principal		Investment		Principal		Allowance		Investment		Principal
September 30, 2016
Builder & developer	$	3,542	$	3,678	$	384	$	384	$	200	$	3,926	$	4,062
Commercial real estate investor		5,952		5,967		0		0		0		5,952		5,967
Residential real estate investor		1,713		2,438		0		0		0		1,713		2,438
Hotel/Motel		361		361		0		0		0		361		361
Wholesale & retail		262		262		0		0		0		262		262
Manufacturing		618		618		0		0		0		618		618
Agriculture		636		636		372		372		263		1,008		1,008
Other commercial		956		956		183		298		31		1,139		1,254
Total impaired commercial related loans		14,040		14,916		939		1,054		494		14,979		15,970
Residential mortgage		220		289		0		0		0		220		289
Home equity		312		312		0		0		0		312		312
Other consumer		191		191		0		0		0		191		191
Total impaired consumer related loans		723		792		0		0		0		723		792
Total impaired loans	$	14,763	$	15,708	$	939	$	1,054	$	494	$	15,702	$	16,762

December 31, 2015
Builder & developer	$	4,284	$	4,917	$	0	$	0	$	0	$	4,284	$	4,917
Commercial real estate investor		5,977		5,991		0		0		0		5,977		5,991
Residential real estate investor		649		1,199		822		864		142		1,471		2,063
Hotel/Motel		420		420		0		0		0		420		420
Wholesale & retail		309		309		0		0		0		309		309
Manufacturing		630		630		0		0		0		630		630
Agriculture		0		0		422		422		263		422		422
Other commercial		1,789		1,904		0		0		0		1,789		1,904
Total impaired commercial related loans		14,058		15,370		1,244		1,286		405		15,302		16,656
Residential mortgage		164		188		0		0		0		164		188
Home equity		202		242		0		0		0		202		242
Other consumer		247		265		0		0		0		247		265
Total impaired consumer related loans		613		695		0		0		0		613		695
Total impaired loans	$	14,671	$	16,065	$	1,244	$	1,286	$	405	$	15,915	$	17,351

- 22 -

The table below presents a summary of average impaired loans and related interest income that was included in net income for the three and nine months ended September 30, 2016 and 2015.


	With No Related Allowance						With A Related Allowance						Total
	Average		Total		Cash Basis		Average		Total		Cash Basis		Average		Total		Cash Basis
	Recorded		Interest		Interest		Recorded		Interest		Interest		Recorded		Interest		Interest
(dollars in thousands)	Investment		Income		Income		Investment		Income		Income		Investment		Income		Income
Three months ended September 30, 2016
Builder & developer	$	3,722	$	56	$	0	$	192	$	0	$	0	$	3,914	$	56	$	0
Commercial real estate investor		5,854		74		0		0		0		0		5,854		74		0
Residential real estate investor		1,086		14		0		255		0		0		1,341		14		0
Hotel/Motel		371		0		0		0		0		0		371		0		0
Wholesale & retail		269		3		0		0		0		0		269		3		0
Manufacturing		620		10		0		0		0		0		620		10		0
Agriculture		636		16		16		376		0		0		1,012		16		16
Other commercial		954		14		0		183		0		0		1,137		14		0
Total impaired commercial related loans		13,512		187		16		1,006		0		0		14,518		187		16
Residential mortgage		253		1		1		0		0		0		253		1		1
Home equity		312		1		1		0		0		0		312		1		1
Other consumer		192		3		1		0		0		0		192		3		1
Total impaired consumer related loans		757		5		3		0		0		0		757		5		3
Total impaired loans	$	14,269	$	192	$	19	$	1,006	$	0	$	0	$	15,275	$	192	$	19

Three months ended September 30, 2015
Builder & developer	$	4,128	$	93	$	30	$	1,445	$	0	$	0	$	5,573	$	93	$	30
Commercial real estate investor		4,935		83		33		1,106		0		0		6,041		83		33
Residential real estate investor		776		5		0		998		7		0		1,774		12		0
Hotel/Motel		470		6		6		0		0		0		470		6		6
Wholesale & retail		385		4		0		0		0		0		385		4		0
Manufacturing		638		10		0		0		0		0		638		10		0
Agriculture		0		0		0		422		0		0		422		0		0
Other commercial		1,935		14		0		0		0		0		1,935		14		0
Total impaired commercial related loans		13,267		215		69		3,971		7		0		17,238		222		69
Residential mortgage		159		1		0		0		0		0		159		1		0
Home equity		172		0		0		0		0		0		172		0		0
Other consumer		343		4		1		0		0		0		343		4		1
Total impaired consumer related loans		674		5		1		0		0		0		674		5		1
Total impaired loans	$	13,941	$	220	$	70	$	3,971	$	7	$	0	$	17,912	$	227	$	70

- 23 -


	With No Related Allowance						With A Related Allowance						Total
	Average		Total		Cash Basis		Average		Total		Cash Basis		Average		Total		Cash Basis
	Recorded		Interest		Interest		Recorded		Interest		Interest		Recorded		Interest		Interest
(dollars in thousands)	Investment		Income		Income		Investment		Income		Income		Investment		Income		Income
Nine months ended September 30, 2016
Builder & developer	$	3,917	$	174	$	0	$	96	$	0	$	0	$	4,013	$	174	$	0
Commercial real estate investor		5,876		224		0		0		0		0		5,876		224		0
Residential real estate investor		821		38		0		536		0		0		1,357		38		0
Hotel/Motel		393		2		2		0		0		0		393		2		2
Wholesale & retail		285		8		0		0		0		0		285		8		0
Manufacturing		624		29		0		0		0		0		624		29		0
Agriculture		318		17		17		391		0		0		709		17		17
Other commercial		1,332		62		20		91		0		0		1,423		62		20
Total impaired commercial related loans		13,566		554		39		1,114		0		0		14,680		554		39
Residential mortgage		246		1		1		0		0		0		246		1		1
Home equity		295		3		2		0		0		0		295		3		2
Other consumer		226		9		4		0		0		0		226		9		4
Total impaired consumer related loans		767		13		7		0		0		0		767		13		7
Total impaired loans	$	14,333	$	567	$	46	$	1,114	$	0	$	0	$	15,447	$	567	$	46

Nine months ended September 30, 2015
Builder & developer	$	4,037	$	214	$	32	$	1,745	$	0	$	0	$	5,782	$	214	$	32
Commercial real estate investor		4,704		562		416		1,491		0		0		6,195		562		416
Residential real estate investor		926		19		1		897		19		0		1,823		38		1
Hotel/Motel		492		11		11		0		0		0		492		11		11
Wholesale & retail		389		14		2		0		0		0		389		14		2
Manufacturing		645		30		0		0		0		0		645		30		0
Agriculture		0		0		0		425		13		13		425		13		13
Other commercial		1,617		81		31		118		0		0		1,735		81		31
Total impaired commercial related loans		12,810		931		493		4,676		32		13		17,486		963		506
Residential mortgage		167		4		0		0		0		0		167		4		0
Home equity		149		0		0		0		0		0		149		0		0
Other consumer		367		13		6		0		0		0		367		13		6
Total impaired consumer related loans		683		17		6		0		0		0		683		17		6
Total impaired loans	$	13,493	$	948	$	499	$	4,676	$	32	$	13	$	18,169	$	980	$	512

- 24 -

Past Due and Nonaccrual

The performance and credit quality of the loan portfolio is also monitored by using an aging schedule that shows the length of time a loan is past due. The table below presents a summary of past due loans, nonaccrual loans and current loans by loan segment and class at September 30, 2016 and December 31, 2015.


					≥ 90 Days
	30-59		60-89		Past Due				Total Past
	Days		Days		and				Due and				Total
(dollars in thousands)	Past Due		Past Due		Accruing		Nonaccrual		Nonaccrual		Current		Loans
September 30, 2016
Builder & developer	$	0	$	0	$	0	$	384	$	384	$	128,612	$	128,996
Commercial real estate investor		211		0		0		0		211		229,408		229,619
Residential real estate investor		132		203		93		3		431		175,337		175,768
Hotel/Motel		0		0		0		361		361		82,353		82,714
Wholesale & retail		134		0		0		0		134		88,288		88,422
Manufacturing		0		0		0		0		0		39,327		39,327
Agriculture		0		0		0		1,008		1,008		47,097		48,105
Other		0		0		0		263		263		223,691		223,954
Total commercial related loans		477		203		93		2,019		2,792		1,014,113		1,016,905
Residential mortgage		0		433		68		121		622		69,223		69,845
Home equity		235		40		0		312		587		90,881		91,468
Other		67		132		12		62		273		29,351		29,624
Total consumer related loans		302		605		80		495		1,482		189,455		190,937
Total loans	$	779	$	808	$	173	$	2,514	$	4,274	$	1,203,568	$	1,207,842

December 31, 2015
Builder & developer	$	398	$	308	$	0	$	411	$	1,117	$	132,861	$	133,978
Commercial real estate investor		216		396		0		20		632		191,362		191,994
Residential real estate investor		0		304		0		597		901		160,243		161,144
Hotel/Motel		0		0		0		420		420		83,751		84,171
Wholesale & retail		0		119		0		43		162		77,532		77,694
Manufacturing		0		0		0		0		0		30,325		30,325
Agriculture		0		0		0		422		422		40,795		41,217
Other		324		0		198		934		1,456		214,435		215,891
Total commercial related loans		938		1,127		198		2,847		5,110		931,304		936,414
Residential mortgage		0		0		249		67		316		69,778		70,094
Home equity		485		71		0		202		758		85,650		86,408
Other		171		163		37		117		488		29,807		30,295
Total consumer related loans		656		234		286		386		1,562		185,235		186,797
Total loans	$	1,594	$	1,361	$	484	$	3,233	$	6,672	$	1,116,539	$	1,123,211

- 25 -

Troubled Debt Restructurings

Loans classified as troubled debt restructurings (TDRs) are designated impaired and arise when the Corporation grants borrowers experiencing financial difficulties concessions that it would not otherwise consider. Concessions granted with respect to these loans generally involve an extension of the maturity date or a below market interest rate relative to new debt with similar credit risk. Generally, these loans are secured by real estate. If repayment of the loan is determined to be collateral dependent, the loan is evaluated for impairment loss based on the fair value of the collateral. For loans that are not collateral dependent, the present value of expected future cash flows, discounted at the loan’s original effective interest rate, is used to determine any impairment loss.

A nonaccrual TDR represents a nonaccrual loan, as previously defined, which includes an economic concession. Nonaccrual TDRs are restored to accrual status if principal and interest payments, under the modified terms, are current for six consecutive payments after the modification and future principal and interest payments are reasonably assured. In contrast, an accruing TDR represents a loan that, at the time of the modification, has a demonstrated history of payments and management believes that future loan payments are reasonably assured under the modified terms.

There were no loans whose terms have been modified under TDRs during the three and nine months ended September 30, 2016 and 2015. There were no defaults during the three and nine months ended September 30, 2016 for TDRs entered into during the previous 12 month period.

- 26 -

NOTE 6 – Allowance for Loan Losses

The table below shows the activity in and the composition of the allowance for loan losses by loan segment and class detail as of and for the three and nine months ended September 30, 2016 and 2015.


	Allowance for Loan Losses
	July 1, 2016										September 30, 2016
(dollars in thousands)	Balance		Charge-offs			Recoveries		Provision			Balance
Builder & developer	$	2,033	$	(85	)	$	0	$	141		$	2,089
Commercial real estate investor		2,586		0			0		125			2,711
Residential real estate investor		2,415		0			0		2			2,417
Hotel/Motel		844		0			0		(20	)		824
Wholesale & retail		697		0			0		112			809
Manufacturing		309		0			0		63			372
Agriculture		568		0			0		24			592
Other commercial		2,107		0			1		134			2,242
Total commercial related loans		11,559		(85	)		1		581			12,056
Residential mortgage		65		(45	)		0		57			77
Home equity		167		0			0		5			172
Other consumer		209		(8	)		4		(11	)		194
Total consumer related loans		441		(53	)		4		51			443
Unallocated		1,558		0			0		168			1,726
Total	$	13,558	$	(138	)	$	5	$	800		$	14,225


	Allowance for Loan Losses
	July 1, 2015										September 30, 2015
(dollars in thousands)	Balance		Charge-offs			Recoveries		Provision			Balance
Builder & developer	$	1,906	$	0		$	0	$	234		$	2,140
Commercial real estate investor		2,630		0			0		(530	)		2,100
Residential real estate investor		1,384		(42	)		0		225			1,567
Hotel/Motel		702		0			0		183			885
Wholesale & retail		586		0			2		105			693
Manufacturing		192		0			0		52			244
Agriculture		509		0			0		18			527
Other commercial		1,523		0			0		372			1,895
Total commercial related loans		9,432		(42	)		2		659			10,051
Residential mortgage		66		0			0		3			69
Home equity		158		0			0		1			159
Other consumer		153		(49	)		3		70			177
Total consumer related loans		377		(49	)		3		74			405
Unallocated		2,157		0			0		(233	)		1,924
Total	$	11,966	$	(91	)	$	5	$	500		$	12,380

- 27 -


	Allowance for Loan Losses
	January 1, 2016										September 30, 2016
(dollars in thousands)	Balance		Charge-offs			Recoveries		Provision			Balance
Builder & developer	$	1,934	$	(85	)	$	0	$	240		$	2,089
Commercial real estate investor		2,337		0			0		374			2,711
Residential real estate investor		2,101		(487	)		2		801			2,417
Hotel/Motel		837		0			0		(13	)		824
Wholesale & retail		701		0			2		106			809
Manufacturing		223		(140	)		0		289			372
Agriculture		548		0			0		44			592
Other commercial		2,054		(59	)		1		246			2,242
Total commercial related loans		10,735		(771	)		5		2,087			12,056
Residential mortgage		67		(69	)		0		79			77
Home equity		161		0			0		11			172
Other consumer		261		(101	)		57		(23	)		194
Total consumer related loans		489		(170	)		57		67			443
Unallocated		1,480		0			0		246			1,726
Total	$	12,704	$	(941	)	$	62	$	2,400		$	14,225


	Allowance for Loan Losses
	January 1, 2015										September 30, 2015
(dollars in thousands)	Balance		Charge-offs			Recoveries		Provision			Balance
Builder & developer	$	2,236	$	0		$	0	$	(96	)	$	2,140
Commercial real estate investor		2,204		0			0		(104	)		2,100
Residential real estate investor		1,484		(585	)		2		666			1,567
Hotel/Motel		671		0			0		214			885
Wholesale & retail		691		0			19		(17	)		693
Manufacturing		201		0			0		43			244
Agriculture		329		0			0		198			527
Other commercial		1,554		(400	)		0		741			1,895
Total commercial related loans		9,370		(985	)		21		1,645			10,051
Residential mortgage		64		(40	)		21		24			69
Home equity		176		(40	)		0		23			159
Other consumer		216		(81	)		22		20			177
Total consumer related loans		456		(161	)		43		67			405
Unallocated		1,336		0			0		588			1,924
Total	$	11,162	$	(1,146	)	$	64	$	2,300		$	12,380

- 28 -

The table below shows the allowance amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment at September 30, 2016 and 2015 and December 31, 2015.


	Allowance for Loan Losses						Loans
	Individually		Collectively				Individually		Collectively
	Evaluated For		Evaluated For				Evaluated For		Evaluated For
(dollars in thousands)	Impairment		Impairment		Balance		Impairment		Impairment		Balance
September 30, 2016
Builder & developer	$	200	$	1,889	$	2,089	$	3,926	$	125,070	$	128,996
Commercial real estate investor		0		2,711		2,711		5,952		223,667		229,619
Residential real estate investor		0		2,417		2,417		1,713		174,055		175,768
Hotel/Motel		0		824		824		361		82,353		82,714
Wholesale & retail		0		809		809		262		88,160		88,422
Manufacturing		0		372		372		618		38,709		39,327
Agriculture		263		329		592		1,008		47,097		48,105
Other commercial		31		2,211		2,242		1,139		222,815		223,954
Total commercial related		494		11,562		12,056		14,979		1,001,926		1,016,905
Residential mortgage		0		77		77		220		69,625		69,845
Home equity		0		172		172		312		91,156		91,468
Other consumer		0		194		194		191		29,433		29,624
Total consumer related		0		443		443		723		190,214		190,937
Unallocated		0		1,726		1,726		-		-		-
Total	$	494	$	13,731	$	14,225	$	15,702	$	1,192,140	$	1,207,842

December 31, 2015
Builder & developer	$	0	$	1,934	$	1,934	$	4,284	$	129,694	$	133,978
Commercial real estate investor		0		2,337		2,337		5,977		186,017		191,994
Residential real estate investor		142		1,959		2,101		1,471		159,673		161,144
Hotel/Motel		0		837		837		420		83,751		84,171
Wholesale & retail		0		701		701		309		77,385		77,694
Manufacturing		0		223		223		630		29,695		30,325
Agriculture		263		285		548		422		40,795		41,217
Other commercial		0		2,054		2,054		1,789		214,102		215,891
Total commercial related		405		10,330		10,735		15,302		921,112		936,414
Residential mortgage		0		67		67		164		69,930		70,094
Home equity		0		161		161		202		86,206		86,408
Other consumer		0		261		261		247		30,048		30,295
Total consumer related		0		489		489		613		186,184		186,797
Unallocated		0		1,480		1,480		-		-		-
Total	$	405	$	12,299	$	12,704	$	15,915	$	1,107,296	$	1,123,211

September 30, 2015
Builder & developer	$	495	$	1,645	$	2,140	$	5,461	$	128,356	$	133,817
Commercial real estate investor		0		2,100		2,100		6,032		166,773		172,805
Residential real estate investor		142		1,425		1,567		1,602		121,080		122,682
Hotel/Motel		0		885		885		446		84,298		84,744
Wholesale & retail		0		693		693		383		76,448		76,831
Manufacturing		0		244		244		636		32,469		33,105
Agriculture		263		264		527		422		37,868		38,290
Other commercial		0		1,895		1,895		1,937		201,713		203,650
Total commercial related		900		9,151		10,051		16,919		849,005		865,924
Residential mortgage		0		69		69		165		72,914		73,079
Home equity		0		159		159		203		84,714		84,917
Other consumer		0		177		177		306		31,423		31,729
Total consumer related		0		405		405		674		189,051		189,725
Unallocated		0		1,924		1,924		-		-		-
Total	$	900	$	11,480	$	12,380	$	17,593	$	1,038,056	$	1,055,649

- 29 -

Note 7—Deposits

The composition of deposits as of September 30, 2016 and December 31, 2015 is shown below.


	September 30,		December 31,
(dollars in thousands)	2016		2015
Noninterest bearing demand	$	187,455	$	162,982
NOW		123,845		102,943
Money market		410,806		360,983
Savings		76,827		69,646
Time deposits less than $100,000		245,560		238,392
Time deposits $100,000 to $250,000		129,963		122,730
Time deposits $250,000 or more		47,639		36,473
Total deposits	$	1,222,095	$	1,094,149

Note 8—Short-Term Borrowings and Long-Term Debt

Short-term borrowings consist of securities sold under agreements to repurchase, federal funds purchased and other borrowings. At September 30, 2016, the balance of securities sold under agreements to repurchase was $31,061,000 compared to $74,510,000 at December 31, 2015. There were no other short-term borrowings at September 30, 2016 or December 31, 2015.

The following table presents a summary of long-term debt as of September 30, 2016 and December 31, 2015. PeoplesBank’s long-term debt obligations to the FHLBP are fixed rate instruments. Under terms of a blanket collateral agreement with the FHLBP, the obligations are secured by FHLBP stock and PeoplesBank qualifying loan receivables, principally real estate secured loans.


	September 30,		December 31,
(dollars in thousands)	2016		2015
PeoplesBank’s obligations:
Federal Home Loan Bank of Pittsburgh (FHLBP)
Due July 2016, 2.35%		0		5,000
Due September 2016, 1.18%		0		10,000
Due October 2016, 1.06%		10,000		10,000
Due October 2016, 1.10%		10,000		10,000
Due April 2017, 0.97%		10,000		10,000
Due November 2017, 1.19%		5,000		5,000
Due March 2018, 1.17%		10,000		10,000
Due June 2018, 1.87%		5,000		5,000
Due November 2018, 1.62%		5,000		5,000
Due June 2019, 2.10%		5,000		5,000
Due June 2019, 1.64%		5,000		5,000
Due June 2020, 1.87%		15,000		15,000
Due June 2021, 2.14%		15,000		15,000
Total FHLBP		95,000		110,000
Codorus Valley Bancorp, Inc. obligations:
Junior subordinated debt
Due 2034, 2.87%, floating rate based on 3 month
LIBOR plus 2.02%, callable quarterly		3,093		3,093
Due 2036, 2.22% floating rate based on 3 month
LIBOR plus 1.54%, callable quarterly		7,217		7,217
Total long-term debt	$	105,310	$	120,310

- 30 -

In June 2006, Codorus Valley formed CVB Statutory Trust No. 2, a wholly-owned special purpose subsidiary whose sole purpose was to facilitate a pooled trust preferred debt issuance of $7,217,000. In November 2004, Codorus Valley formed CVB Statutory Trust No. 1 to facilitate a pooled trust preferred debt issuance of $3,093,000. The Corporation owns all of the common stock of these nonbank subsidiaries, and the debentures are the sole assets of the Trusts. The accounts of both Trusts are not consolidated for financial reporting purposes in accordance with FASB ASC 810. For regulatory capital purposes, all of the Corporation’s trust preferred securities qualified as Tier 1 capital for all reported periods. Trust preferred securities are subject to capital limitations under the FDIC’s risk-based capital guidelines. The Corporation used the net proceeds from these offerings to fund its operations.

Note 9—Regulatory Matters

Codorus Valley and PeoplesBank are subject to various regulatory capital requirements. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if imposed, could have a material adverse effect on Codorus Valley’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Codorus Valley and PeoplesBank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators.

On July 2, 2013, the Board of Governors of the Federal Reserve System finalized its rule implementing the Basel III regulatory capital framework, which the FDIC adopted on July 9, 2013. Under the rule, minimum requirements increased both the quantity and quality of capital held by banking organizations. Consistent with the Basel III framework, the rule included a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5 percent, and a common equity Tier 1 conservation buffer of 2.5 percent of risk-weighted assets, that applies to all supervised financial institutions, which is to be phased in over a four year period beginning January 1, 2016, with the full 2.5 percent required as of January 1, 2019. The rule also raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4 percent to 6 percent, and includes a minimum leverage ratio of 4 percent for all banking organizations. The new rule also increased the risk weights for past-due loans, certain commercial real estate loans, and some equity exposures, and makes selected other changes in risk weights and credit conversion factors. The rule for smaller, less complex institutions, including the Corporation, took effect January 1, 2015.

- 31 -

As of September 30, 2016, Codorus Valley and PeoplesBank met the minimum requirements of the Basel III framework, and PeoplesBank’s capital ratios exceeded the amount to be considered “well capitalized” as defined in the regulations. The table below provides a comparison of the Corporation’s and PeoplesBank’s risk-based capital ratios and leverage ratios to the minimum regulatory requirement for the periods indicated.

						Minimum for					Well Capitalized
	Actual					Capital Adequacy (1)					Minimum (2)
(dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
*Codorus Valley Bancorp, Inc. (consolidated)*
at September 30, 2016
Capital ratios:
Common equity Tier 1	$	150,485		12.18	%	$	63,324		5.125	%		n/a		n/a
Tier 1 risk based		160,485		12.99			81,858		6.625			n/a		n/a
Total risk based		174,710		14.14			106,569		8.625			n/a		n/a
Leverage		160,485		10.53			60,967		4.00			n/a		n/a

at December 31, 2015
Capital ratios:
Common equity Tier 1	$	143,456		12.56	%	$	51,395		4.50	%		n/a		n/a
Tier 1 risk based		165,456		14.49			68,527		6.00			n/a		n/a
Total risk based		178,160		15.60			91,370		8.00			n/a		n/a
Leverage		165,456		11.73			56,398		4.00			n/a		n/a

PeoplesBank, A Codorus Valley Company
at September 30, 2016
Capital ratios:
Common equity Tier 1	$	156,897		12.73	%	$	63,151		5.125	%	$	80,094		6.50	%
Tier 1 risk based		156,897		12.73			81,634		6.625			98,577		8.00
Total risk based		171,122		13.89			106,279		8.625			123,222		10.00
Leverage		156,897		10.32			60,828		4.00			76,035		5.00

at December 31, 2015
Capital ratios:
Common equity Tier 1	$	149,073		13.10	%	$	51,227		4.50	%	$	73,994		6.50	%
Tier 1 risk based		149,073		13.10			68,302		6.00			91,070		8.00
Total risk based		161,777		14.21			91,070		8.00			113,837		10.00
Leverage		149,073		10.60			56,248		4.00			70,310		5.00

(1) Minimum amounts and ratios as of September 30, 2016 include the first year phase in of the capital conservation buffer of 0.625 percent required by the Basel III framework. The conservation buffer is to be phased in over a four year period beginning January 1, 2016, with the full 2.5 percent required as of January 1, 2019.

(2) To be “well capitalized” under the prompt corrective action provisions in the Basel III framework. “Well capitalized” applies to PeoplesBank only.

- 32 -

Note 10—Shareholders’ Equity

Public Offering of Common Stock

On December 15, 2015, the Corporation completed a public offering of 1,519,000 shares of common stock at a price of $19.75 per share. On December 23, 2015, the Corporation announced that the underwriters of the previously closed public offering had exercised in full their option to purchase an additional 227,850 shares of the Corporation’s common stock at a public offering price of $19.75 per share.

The Corporation raised net proceeds of approximately $32,500,000, resulting from the gross amount of the public offering transaction and the exercise of the purchase options of $34,500,000, less related underwriting discounts, commissions and offering expense of approximately $2,000,000. Approximately $19,800,000 of the net proceeds from the public offering was invested in the Corporation’s Bank subsidiary, PeoplesBank. A portion of the proceeds were used to redeem the remaining $12,000,000 of Series B preferred held by the United States Department of Treasury on February 18, 2016. The remaining proceeds were used for general corporate purposes.

Preferred Stock Issued under the US Treasury’s Small Business Lending Fund Program

The U.S. Department of the Treasury (“Treasury”) had a capital investment in the Corporation pursuant to the Corporation’s participation in the Treasury’s Small Business Lending Funding Program (“SBLF Program”). In August 2011, the Corporation sold to the Treasury, for an aggregate purchase price of $25,000,000, 25,000 shares of non-cumulative, perpetual preferred stock, Series B, $1,000 liquidation value, $2.50 par value. On May 30, 2014, the Corporation redeemed 13,000 of the 25,000 outstanding shares of the Corporation’s preferred stock that had been issued to the Treasury, leaving 12,000 outstanding shares representing $12,000,000 of preferred stock. On February 18, 2016, the Corporation redeemed the remaining $12,000,000 of Series B preferred stock issued to the Treasury as reported on Form 8-K filed on February 19, 2016.

The annualized dividend rate on the preferred stock issued under the SBLF Program was 1 percent for the nine months ended September 30, 2015 and through the redemption date of February 18, 2016.

Common Stock Dividend

Periodically, the Corporation distributes stock dividends on its common stock. On October 11, 2016, the Corporation declared a 5 percent common stock dividend payable on December 13, 2016, to shareholders of record at the close of business on October 25, 2016. Distribution of this stock dividend will result in the issuance of approximately 399,088 additional common shares. The Corporation distributed a 5 percent stock dividend on December 8, 2015 which resulted in the issuance of 294,161 additional common shares.

Note 11—Contingent Liabilities

There are no legal proceedings pending against Codorus Valley Bancorp, Inc. or any of its subsidiaries which are expected to have a material impact upon the consolidated financial position and/or operating results of the Corporation, other than routine litigation incidental to the business. Management is not aware of any proceedings known or contemplated by government authorities.

- 33 -

Note 12—Guarantees

Codorus Valley does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Standby letters of credit are written conditional commitments issued by PeoplesBank to guarantee the performance of a customer to a third party. Generally, all letters of credit, when issued, have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers. The Corporation generally holds collateral and/or personal guarantees supporting these commitments. The Corporation had $20,505,000 of standby letters of credit outstanding on September 30, 2016, compared to $19,037,000 on December 31, 2015. Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payments required under the corresponding letters of credit. The amount of the liability as of September 30, 2016 and December 31, 2015, for guarantees under standby letters of credit issued, was not material. Many of the commitments are expected to expire without being drawn upon and, therefore, generally do not present significant liquidity risk to the Corporation or PeoplesBank.

Note 13—Fair Value of Assets and Liabilities

The Corporation uses its best judgment in estimating the fair value of the Corporation’s assets and liabilities; however, there are inherent weaknesses in any estimation technique. Therefore, the fair value estimates herein are not necessarily indicative of the amounts that could be realized in sales transactions on the dates indicated. The estimated fair value amounts have been measured as of their respective period-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values subsequent to the respective reporting dates may be different than the amounts reported at each period end.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date. GAAP establishes a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following three levels:

Level 1: Inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

Level 2: Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets; inputs to the valuation methodology include quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs to the valuation methodology that utilize model-based techniques for which all significant assumptions are observable in the market.

Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement; inputs to the valuation methodology that utilize model-based techniques for which significant assumptions are not observable in the market; or inputs to the valuation methodology that require significant management judgment or estimation, some of which may be internally developed.

Since management maximizes the use of observable inputs and minimizes the use of unobservable inputs when determining fair value, an asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Management reviews and updates the fair value hierarchy classifications on a quarterly basis.

- 34 -

Assets Measured at Fair Value on a Recurring Basis

Securities available-for-sale

The fair values of investment securities were measured using information from a third-party pricing service. The pricing service uses quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique, used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities, but rather, by relying on the securities’ relationship to other benchmark quoted prices. At least annually, the Corporation reviews a random sample of the pricing information received from the third-party pricing service by comparing it to price quotes from third-party brokers. Historically, price deviations have been immaterial.

			Fair Value Measurements
(dollars in thousands)		Total		(Level 1) Quoted Prices in Active Markets for Identical Assets		(Level 2) Significant Other Observable Inputs		(Level 3) Significant Other Unobservable Inputs
September 30, 2016
Securities available-for-sale:
U.S. Treasury notes	$	9,937	$	9,937	$	0	$	0
U.S. agency		21,032		0		21,032		0
U.S. agency mortgage-backed, residential		100,153		0		100,153		0
State and municipal		69,251		0		69,251		0

December 31, 2015
Securities available-for-sale:
U.S. agency	$	17,414	$	0	$	17,414	$	0
U.S. agency mortgage-backed, residential		120,581		0		120,581		0
State and municipal		75,475		0		75,475		0

Assets Measured at Fair Value on a Nonrecurring Basis

Impaired loans

Impaired loans are those that are accounted for under FASB ASC Topic 310, in which the Corporation has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These loans are included as Level 3 fair values, based on the lowest level of input that is significant to the fair value measurements. At September 30, 2016, the fair value of impaired loans with a valuation allowance or charge-off was $570,000, net of valuation allowances of $494,000 and charge-offs of $870,000. At December 31, 2015 the fair value of impaired loans with a valuation allowance or charge-off was $1,846,000, net of valuation allowances of $405,000 and charge-offs of $1,262,000.

Foreclosed Real Estate

Other real estate property acquired through foreclosure is initially recorded at fair value of the property at the transfer date less estimated selling cost. Subsequently, other real estate owned is carried at the lower of its carrying value or the fair value less estimated selling cost. Fair value is usually determined based on an independent third-party appraisal of the property or occasionally on a recent sales offer. At September 30, 2016, the fair value of foreclosed real estate with a valuation allowance or write-down was $1,630,000, net of valuation allowances of $891,000. At December 31, 2015, the fair value of foreclosed real estate with a valuation allowance or write-down was $2,003,000, net of valuation allowances of $981,000 and write-downs of $34,000.

- 35 -

Mortgage Servicing Rights

Mortgage servicing rights are initially recorded at fair value upon the sale of residential mortgage loans to secondary market investors. The fair value of servicing rights is based on the present value of estimated future cash flows on pools of mortgages stratified by rate and original time to maturity. Mortgage servicing rights are subsequently evaluated for impairment on a quarterly basis. Significant inputs to the valuation include expected cash flow, expected net servicing income, a cash flow discount rate and the expected life of the underlying loans. At September 30, 2016, the fair value of the mortgage servicing rights asset was $209,000, net of a valuation allowance of $3,000. There were no mortgage servicing assets as of December 31, 2015.


			Fair Value Measurements
				(Level 1)		(Level 2)		(Level 3)
				Quoted Prices in		Significant Other		Significant Other
				Active Markets for		Observable		Unobservable
(dollars in thousands)		Total		Identical Assets		Inputs		Inputs
September 30, 2016
Impaired loans	$	570	$	0	$	0	$	570
Foreclosed real estate		1,630		0		0		1,630
Mortgage servicing rights		209		0		0		209

December 31, 2015
Impaired loans	$	1,846	$	0	$	0	$	1,846
Foreclosed real estate		2,003		0		0		2,003

The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which the Corporation has utilized Level 3 inputs to determine fair value:

Quantitative Information about Level 3 Fair Value Measurements

Fair Value

Valuation

Unobservable

Weighted

(dollars in thousands)

Estimate

Techniques

Input

Range

Average

September 30, 2016

Impaired loans

570

Appraisal ⁽¹⁾

Appraisal adjustments ⁽²⁾

15% - 25%

24%

Foreclosed real estate

1,630

Appraisal ⁽¹⁾

Appraisal adjustments ⁽²⁾

9% - 19%

19%

Mortgage servicing rights

209

Multiple of annual service fee

Estimated prepayment speed based on rate and term

231% - 405%

378%

December 31, 2015

Impaired loans

1,846

Appraisal ⁽¹⁾

Appraisal adjustments ⁽²⁾

15% - 25%

16%

Foreclosed real estate

2,003

Appraisal ⁽¹⁾

Appraisal adjustments ⁽²⁾

7% - 38%

34%

(1)

Fair value is generally determined through independent appraisals, which generally include various level 3 inputs that are not identifiable.

(2)

Appraisals may be adjusted downward by the Corporation’s management for qualitative factors such as economic conditions and estimated liquidation expenses. The range of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

- 36 -

Disclosures about Fair Value of Financial Instruments

The following methods and assumptions were used to estimate the fair value of the Corporation’s financial instruments as of September 30, 2016 and December 31, 2015:

Cash and cash equivalents

The carrying amount is a reasonable estimate of fair value.

Securities available for sale

The fair value of securities available for sale is determined in accordance with the methods described under FASB ASC Topic 820 as described above.

Restricted investment in bank stocks

The carrying amount of restricted investment in bank stocks is a reasonable estimate of fair value. The Corporation is required to maintain minimum investment balances in these stocks. These stocks are not actively traded and, therefore, have no readily determinable market value.

Loans held for sale

The fair value of loans held for sale is determined, when possible, using quoted secondary-market prices. If no such quoted prices exist, the fair value of a loan is determined using quoted prices for a similar loan or loans, adjusted for the specific attributes of that loan.

Loans, net

The fair value of loans, excluding all impaired loans, is estimated using discounted cash flow analyses using the current interest rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Loans were first segregated by type such as commercial, real estate, and consumer, and were further segmented into fixed and variable rate. Projected future cash flows are calculated based on contractual maturity or call dates. For variable rate loans that reprice frequently and have no significant change in credit risk, fair value is based on carrying value.

Interest receivable

The carrying value of interest receivable is a reasonable estimate of fair value.

Deposits

The fair value of demand deposits, savings accounts and money market deposits is the amount payable on demand at the reporting date. The fair values of time deposits are estimated using a discounted cash flow analyses. The discount rates used are based on rates currently offered for deposits with similar remaining maturities. The fair values of variable rate time deposits that reprice frequently are based on carrying value. The fair values of time deposit liabilities do not take into consideration the value of the Corporation’s long-term relationships with depositors, which may have significant value.

Short-term borrowings

For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

Long-term debt

Long-term debt includes FHLBP advances (Level 2) and junior subordinated debt (Level 3). The fair value of FHLBP advances is estimated using discounted cash flow analysis, based on quoted prices for new FHLBP advances with similar credit risk characteristics, terms and remaining maturity. These prices are obtained from this active market and represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party. The fair value of junior subordinated debt is estimated using discounted cash flow analysis, based on market rates and spread characteristics of similar debt with similar credit risk characteristics, terms and remaining maturity.

- 37 -

Interest payable

The carrying value of interest payable is a reasonable estimate of fair value.

Off-balance sheet instruments

Off-balance sheet instruments consist of lending commitments and letters of credit and are based on fees currently charged in the market to enter into similar arrangements, taking into account the remaining terms of the agreements and counterparties’ credit standing. These amounts were not considered material.

The following presents the carrying amounts and estimated fair values of the Corporation’s financial instruments as of September 30, 2016 and December 31, 2015.


					Fair Value Estimates
						(Level 1)		(Level 2)		(Level 3)
						Quoted Prices		Significant		Significant
						in Active		Other		Other
		Carrying		Estimated		Markets for		Observable		Unobservable
(dollars in thousands)		Amount		Fair Value		Identical Assets		Inputs		Inputs
September 30, 2016
Financial assets
Cash and cash equivalents	$	46,135	$	46,135	$	46,135	$	0	$	0
Securities available-for-sale		200,373		200,373		9,937		190,436		0
Restricted investment in bank stocks		4,526		4,526		0		4,526		0
Loans held for sale		3,318		3,422		0		3,422		0
Loans, net		1,193,617		1,202,404		0		0		1,202,404
Interest receivable		3,614		3,614		0		3,614		0
Mortgage servicing rights		209		209		0		0		209

Financial liabilities
Deposits	$	1,222,095	$	1,223,310	$	0	$	1,223,310	$	0
Short-term borrowings		31,061		31,061		0		31,061		0
Long-term debt		105,310		103,213		0		95,995		7,218
Interest payable		468		468		0		468		0

Off-balance sheet instruments		0		0		0		0		0

December 31, 2015
Financial assets
Cash and cash equivalents	$	57,485	$	57,485	$	57,485	$	0	$	0
Securities available-for-sale		213,470		213,470		0		213,470		0
Restricted investment in bank stocks		5,028		5,028		0		5,028		0
Loans held for sale		564		574		0		574		0
Loans, net		1,110,507		1,119,758		0		0		1,119,758
Interest receivable		4,003		4,003		0		4,003		0

Financial liabilities
Deposits	$	1,094,149	$	1,092,819	$	0	$	1,092,819	$	0
Short-term borrowings		74,510		74,510		0		74,510		0
Long-term debt		120,310		117,041		0		110,195		6,846
Interest payable		468		468		0		468		0

Off-balance sheet instruments		0		0		0		0		0

- 38 -

Note 14—Assets and Liabilities Subject to Offsetting

Securities Sold Under Agreements to Repurchase

PeoplesBank enters into agreements with customers in which it sells securities subject to an obligation to repurchase the same securities (“repurchase agreements”). The contractual maturity of the repurchase agreement is overnight and continues until either party terminates the agreement. These repurchase agreements are accounted for as a collateralized financing arrangement (i.e., secured borrowings) and not as a sale and subsequent repurchase of securities. The obligation to repurchase the securities is reflected as a liability (short-term borrowings) in the Corporation’s consolidated financial statements of condition, while the securities underlying the repurchase agreements are appropriately segregated for safekeeping purposes and remain in the respective securities asset accounts. Thus, there is no offsetting or netting of the securities with the repurchase agreement liabilities.


						Gross amounts Not Offset in
			Gross		Net Amounts	the Statements of Condition
	Gross		Amounts		of Liabilities	Financial Instruments
	Amounts of		Offset in the		Presented in	U.S. agency			Cash
		Recognized		Statements	the Statements	mortgage-backed,				Collateral		Net
(dollars in thousands)		Liabilities		of Condition	of Condition	residential	U.S. agency			Pledged		Amount
September 30, 2016
Repurchase Agreements	$	31,061	$	0	$31,061	$(25,837)	(5,224	)	$	0	$	0

December 31, 2015
Repurchase Agreements	$	74,510	$	0	$74,510	(63,162)	(11,348	)	$	0	$	0

As of September 30, 2016 and December 31, 2015, the fair value of securities pledged in connection with repurchase agreements was $34,859,000 and $75,094,000, respectively.

- 39 -

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s discussion and analysis of the significant changes in the results of operations, capital resources and liquidity presented in the accompanying consolidated financial statements for Codorus Valley Bancorp, Inc. (Codorus Valley or the Corporation), a bank holding company, and its wholly-owned subsidiary, PeoplesBank, A Codorus Valley Company (PeoplesBank), are provided below. Codorus Valley’s consolidated financial condition and results of operations consist almost entirely of PeoplesBank’s financial condition and results of operations. Current performance does not guarantee, and may not be indicative of, similar performance in the future.

Forward-looking Statements

Management of the Corporation has made forward-looking statements in this Form 10-Q. These forward-looking statements may be subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of operations of the Corporation and its subsidiaries. When words such as “believes,” “expects,” “anticipates” or similar expressions occur in the Form 10-Q, management is making forward-looking statements.

Note that many factors, some of which are discussed elsewhere in this report and in the documents that are incorporated by reference, could affect the future financial results of the Corporation and its subsidiaries, both individually and collectively, and could cause those results to differ materially from those expressed in the forward-looking statements contained or incorporated by reference in this Form 10-Q. These factors include, but are not limited to, the following:

Operating, legal and regulatory risks;

Credit risk, including an increase in nonperforming assets requiring loss provisions and the incurrence of carrying costs related to nonperforming assets;

Interest rate fluctuations which could increase our cost of funds or decrease our yield on earning assets and therefore reduce our net interest income;

Declines in the market value of investment securities considered to be other-than-temporary;

Unavailability of capital when needed, or availability at less than favorable terms;

Unauthorized disclosure of sensitive or confidential client or customer information, whether through a breach of our computer systems or otherwise, which may adversely affect the Corporation’s operations, net income or reputation;

Inability to achieve merger-related synergies, and difficulties in integrating the business and operations of acquired institutions;

A prolonged economic downturn;

Political and competitive forces affecting banking, securities, asset management and credit services businesses;

The effects of and changes in the rate of FDIC premiums, including special assessments;

Enacted financial reform legislation, e.g., Dodd-Frank Wall Street Reform and Consumer Protection Act, may have a significant impact on the Corporation’s business and results of operations; and

The risk that management’s analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.

The Corporation undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this report.

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Critical Accounting Policies

The Corporation’s critical accounting policies, as summarized in Note 1—Summary of Significant Accounting Policies, include those related to the allowance for loan losses, valuation of foreclosed real estate, evaluation of other-than-temporary impairment of securities, and determination of acquisition-related goodwill and fair value adjustments, which require management to make significant judgments, estimates and assumptions that have a material impact on the carrying value of the respective assets and liabilities. For this Form 10-Q, there were no material changes made to the Corporation’s critical accounting policies, which are more fully disclosed in Item 7 of the Corporation’s previously filed Annual Report on Form 10-K for the year ended December 31, 2015.

Three Months Ended September 30, 2016 vs. Three Months Ended September 30, 2015

Financial Highlights

The Corporation’s net income available to common shareholders (earnings) was $3,403,000 for the quarter ended September 30, 2016, as compared to $2,981,000 for the quarter ended September 30, 2015, an increase of $422,000 or 14 percent.

Net interest income for the third quarter of 2016 increased $1,393,000 or 12 percent above the same period in 2015, primarily due to increased interest income from a higher volume of commercial loans in the third quarter of 2016 as compared to the third quarter of 2015.

The Corporation’s net interest margin (tax-equivalent basis) for the third quarter of 2016 was 3.75 percent, compared to 3.71 percent for the third quarter of 2015. PeoplesBank continues to have success in growing low cost core deposits, while maintaining reasonable yields on new loan growth in a highly competitive, low interest rate environment.

The provision for loan losses was $800,000 for the third quarter 2016, a $300,000 increase as compared to a provision of $500,000 for the third quarter of 2015. The increased provision supported adequate allowance for loan loss coverage considering several factors, including the Corporation’s continued commercial loan growth. The allowance as a percentage of total loans was 1.18 percent at September 30, 2016, as compared to 1.13 percent at December 31, 2015, and 1.17 percent at September 30, 2015.

Noninterest income for the third quarter of 2016 increased $228,000 or 10 percent ($349,000 or 16 percent excluding gain on sale of securities) compared to the third quarter of 2015. Several sources contributed to the rise in noninterest revenues, including trust and investment service fees, increased deposit service fees, income from bank owned life insurance, gains on sale of mortgage loans and other income.

Noninterest expenses in the third quarter of 2016 were $712,000 or 7 percent higher than the third quarter of 2015. Personnel costs accounted for the majority of the increase, reflecting additional compensation and benefits due primarily to the addition of new employees to support normal business growth in our existing and newly expanded markets. In the prior twelve months, PeoplesBank added a limited services facility, a full service branch and an administrative services center.

The provision for income taxes for the third quarter of 2016 increased by $217,000 or 16 percent as compared to the third quarter of 2015. The increase is primarily a result of $609,000 or 14 percent more pre-tax income in the third quarter of 2016 compared to the same period in 2015.

- 41 -

The schedule below presents selected performance metrics for the third quarter of both 2016 and 2015. Per share computations include the effect of stock dividends, including the 5 percent common stock dividend declared on October 11, 2016.

	Three months ended
	September 30,
	2016			2015
Basic earnings per common share	$	0.41		$	0.46
Diluted earnings per common share	$	0.40		$	0.45
Cash dividend payout ratio		30.46	%		25.67	%
Return on average assets		0.89	%		0.87	%
Return on average equity		8.79	%		9.68	%
Net interest margin (tax equivalent basis)		3.75	%		3.71	%
Net overhead ratio		2.00	%		2.10	%
Efficiency ratio		62.44	%		65.00	%
Average equity to average assets		10.12	%		8.98	%

A more detailed analysis of the factors and trends affecting the Corporation’s earnings and financial position follows.

Income Statement Analysis

Net Interest Income

Net interest income for the quarter ended September 30, 2016 was $13,415,000, an increase of $1,393,000 or 12 percent compared to net interest income of $12,022,000 for the third quarter of 2015. The increase was primarily attributable to higher loan interest income. The Corporation’s net interest margin, computed as interest income (tax-equivalent basis) annualized as a percentage of average interest earning assets, was 3.75 percent for the third quarter of 2016, which compared favorably to the 3.71 percent net interest margin for the third quarter of 2015.

Total interest income for the third quarter of 2016 totaled $15,660,000, an increase of $1,543,000 or 11 percent above the amount of total interest income for the third quarter of 2015. The change was primarily a result of a significant increase in loan income, partially offset by a decline in investment income.

Interest income on loans increased $1,672,000 or 13 percent in the third quarter of 2016 compared to the same period in 2015. The average balance of outstanding loans, primarily commercial loans, increased approximately $133,690,000 or 13 percent comparing the third quarter of 2016 to the same period in 2015. In addition, the tax equivalent yield on loans for the third quarter of 2016 increased by 2 basis points compared to the third quarter of 2015.

Interest income on investments decreased $191,000 or 16 percent in the third quarter of 2016 compared to the same period in 2015. The average balance of the investment securities portfolio decreased 10 percent when comparing the third quarter of 2016 to the same period in 2015, as some funds from investment maturities, repayments and calls were not reinvested, but were used for other purposes, including providing funds to support loan growth. The tax-equivalent yield on investments for the third quarter of 2016 was 2.51 percent or 14 basis points lower than the 2.65 percent experienced in the third quarter of 2015, which also contributed to the decrease in interest income on investments.

- 42 -

Total interest expense for the third quarter of 2016 totaled $2,245,000, an increase of $150,000 or 7 percent as compared to total interest expense of $2,095,000 for the third quarter of 2015. An increase in both the average volume and cost of deposits, used to fund commercial loans, more than offset the decrease in the average volume of short-term borrowings and long-term debt.

Interest expense on deposits increased $193,000 or 12 percent in the third quarter of 2016 compared to the same period in 2015. The change in expense on deposits was primarily volume driven, as the average rate paid on interest-bearing deposits was 0.68 percent in the third quarter of 2016 which was slightly higher than the average rate paid of 0.66 percent in the third quarter of 2015. The average balance of interest-bearing deposits for the third quarter of 2016 increased by $87,899,000 or 9 percent compared to the third quarter of 2015. Also, the Corporation experienced favorable growth in noninterest-bearing deposits, with the average volume for the third quarter of 2016 increasing to $192,950,000 as compared to $149,204,000 for the third quarter of 2015.

Interest expense on borrowings for the third quarter of 2016 decreased by $43,000 compared to the third quarter of 2015, due primarily to a lower average balance of borrowings. Short-term borrowings consisting of repurchase agreements averaged $26,355,000 for the third quarter of 2016, compared to an average balance $37,413,000 for the third quarter of 2015. The rate on average short-term borrowings for the third quarter of 2016 was 0.51 percent, a slight increase as compared to a rate of 0.50 percent for the third quarter of 2015. Long-term debt from the Federal Home Loan Bank of Pittsburgh (FHLB) averaged $101,739,000 for the third quarter of 2016, compared to an average balance of approximately $110,039,000 for the third quarter of 2015. The decrease in the average balance of long-term debt resulted from repayment of maturing FHLB advances totaling $15,000,000 during the third quarter of 2016. The rate on average long-term debt for the third quarter of 2016 was 1.61 percent, a slight increase as compared to the rate of 1.60 percent for the third quarter of 2015.

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Table 1-Average Balances and Interest Rates (tax equivalent basis)

	Three months ended September 30,
	2016								2015
	Average					Yield/			Average					Yield/
(dollars in thousands)	Balance		Interest			Rate			Balance		Interest			Rate

Assets
Interest bearing deposits with banks	$	75,410	$	97			0.51	%	$	55,258	$	35			0.25	%
Investment securities:
Taxable		121,935		640			2.09			145,609		802			2.19
Tax-exempt		69,785		570			3.25			66,855		615			3.65
Total investment securities		191,720		1,210			2.51			212,464		1,417			2.65

Loans:
Taxable (1)		1,162,124		14,407			4.93			1,026,039		12,706			4.91
Tax-exempt		18,926		199			4.18			21,321		241			4.48
Total loans		1,181,050		14,606			4.92			1,047,360		12,947			4.90
Total earning assets		1,448,180		15,913			4.37			1,315,082		14,399			4.34
Other assets (2)		81,232								70,821
Total assets	$	1,529,412							$	1,385,903
Liabilities and Shareholders’ Equity
Deposits:
Interest bearing demand	$	533,350	$	531			0.40	%	$	459,921	$	412			0.36	%
Savings		78,638		19			0.10			71,580		18			0.10
Time		422,086		1,207			1.14			414,674		1,134			1.08
Total interest bearing deposits		1,034,074		1,757			0.68			946,175		1,564			0.66
Short-term borrowings		26,355		34			0.51			37,413		47			0.50
Long-term debt		112,049		454			1.61			120,349		484			1.60
Total interest bearing liabilities		1,172,478		2,245			0.76			1,103,937		2,095			0.75

Noninterest bearing deposits		192,950								149,204
Other liabilities		9,204								8,339
Shareholders’ equity		154,780								124,423

Total liabilities and shareholders’ equity	$	1,529,412							$	1,385,903
Net interest income (tax equivalent basis)			$	13,668							$	12,304
Net interest margin (3)							3.75	%							3.71	%
Tax equivalent adjustment				(253	)							(282	)
Net interest income			$	13,415							$	12,022

(1)

Average balance includes average nonaccrual loans of $2,373,000 for 2016 and $7,210,000 for 2015.

Interest includes net loan fees of $843,000 for 2016 and $511,000 for 2015.

(2)

Average balance includes average bank owned life insurance, foreclosed real estate and unrealized holding gains (losses) on investment securities.

(3)

Net interest income (tax equivalent basis) annualized as a percentage of average earning assets.

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Table 2-Rate/Volume Analysis of Changes in Net Interest Income (tax equivalent basis)

	Three months ended
	September 30,
	2016 vs. 2015
	Increase (decrease) due to change in*
(dollars in thousands)	Volume			Rate			Net

Interest Income
Interest bearing deposits with banks	$	13		$	49		$	62
Investment securities:
Taxable		(143	)		(19	)		(162	)
Tax-exempt		28			(73	)		(45	)
Loans:
Taxable		2,055			(354	)		1,701
Tax-exempt		(27	)		(15	)		(42	)
Total interest income		1,926			(412	)		1,514
Interest Expense
Deposits:
Interest bearing demand		58			61			119
Savings		2			(1	)		1
Time		20			53			73
Short-term borrowings		(14	)		1			(13	)
Long-term debt		(33	)		3			(30	)
Total interest expense		33			117			150
Net interest income	$	1,893		$	(529	)	$	1,364

*Changes which are due to both volume and rate are allocated in proportion to their relationship to the amount of change attributed directly to volume or rate.

Provision for Loan Losses

The provision for loan losses is an expense charged to earnings to cover the estimated losses attributable to uncollected loans. The provision reflects management’s judgment of an appropriate level for the allowance for loan losses. The provision for loan losses was $800,000 for the third quarter of 2016, a $300,000 increase as compared to a provision of $500,000 for the third quarter of 2015. The increased provision was provided to maintain the adequacy of the allowance for loan losses, particularly given the substantial growth in the loan portfolio during the twelve months ended September 30, 2016. The third quarter provisions for each period were impacted by net charge-offs of $133,000 in 2016 and $86,000 in 2015. The allowance as a percentage of total loans was 1.18 percent at September 30, 2016, as compared to 1.13 percent at December 31, 2015, and 1.17 percent at September 30, 2015.

More information about the allowance for loan losses can be found in this report under the caption Allowance for Loan Losses on page 62.

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Noninterest Income

The following table presents the components of total noninterest income for the third quarter of 2016, compared to the third quarter of 2015.


Table 3 - Noninterest income

	Three months ended				Change
	September 30,				Increase (Decrease)
(dollars in thousands)	2016		2015		$			%

Trust and investment services fees	$	654	$	604	$	50			8	%
Income from mutual fund, annuity and insurance sales		240		265		(25	)		(9	)
Service charges on deposit accounts		957		882		75			9
Income from bank owned life insurance		233		179		54			30
Other income		224		110		114			104
Net gain on sales of loans held for sale		262		181		81			45
Gain on sales of securities		0		121		(121	)		(100	)
Total noninterest income	$	2,570	$	2,342	$	228			10	%

The discussion that follows addresses changes in selected categories of noninterest income.

Income from bank owned life insurance—The $54,000 or 30 percent increase in income from bank owned life insurance was due to additional investments totaling $6,987,000 in 2016.

Other income— The $114,000 or 104 percent increase in other income was due to higher miscellaneous client based service charges, such as wire transfer, gift card, and credit card merchant fees and loan related income, such as mortgage loan servicing and FHA mortgage loan origination fees. Also contributing to the increase was higher revenue provided by SYC Settlement Services, Inc., a subsidiary of PeoplesBank, due to an upturn in the volume of real estate settlement services.

Net gain on sales of loans held for sale—The $81,000 or 45 percent increase in gains from the sale of residential mortgage loans held for sale was due to a higher volume of mortgage originations and sales during the third quarter of 2016 compared to 2015.

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Noninterest Expense

The following table presents the components of total noninterest expense for the third quarter of 2016, compared to the third quarter of 2015.


Table 4 - Noninterest expense

	Three months ended					Change
	September 30,					Increase (Decrease)
(dollars in thousands)	2016			2015		$			%

Personnel	$	5,990		$	5,367	$	623			12	%
Occupancy of premises, net		780			811		(31	)		(4	)
Furniture and equipment		728			664		64			10
Postage, stationery and supplies		147			153		(6	)		(4	)
Professional and legal		185			198		(13	)		(7	)
Marketing		437			242		195			81
FDIC insurance		121			177		(56	)		(32	)
Debit card processing		291			235		56			24
Charitable donations		116			21		95			452
Telephone		187			208		(21	)		(10	)
External data processing		385			306		79			26
Foreclosed real estate including (recovery of) provision for losses		(13	)		66		(79	)		(120	)
Other		868			1,062		(194	)		(18	)
Total noninterest expense	$	10,222		$	9,510	$	712			7	%

The discussion that follows addresses changes in selected categories of noninterest expense.

Personnel—The $623,000 or 12 percent increase in personnel expense was due largely to the addition of new employees to support the Corporation’s business and consumer banking services in our Maryland market and expanded Pennsylvania market.

Furniture and equipment – The $64,000 or 10 percent increase in furniture and equipment costs was due to increased computer hardware and software costs related to enhanced technology to support business growth.

Marketing—The $195,000 or 81 percent increase in marketing expenses was due to incentives paid for new deposit accounts, timing in sponsorships of community events and costs associated with naming rights to PeoplesBank Park, the facility that houses the York, Pennsylvania-based York Revolution independent league baseball team.

FDIC Insurance—The $56,000 or 32 percent decrease in FDIC insurance is due to the change in the assessment methodology effective with the third quarter of 2016.

Debit card processing—The $56,000 or 24 percent increase in debit card processing reflects year over year higher debit card transaction volume, due primarily to the increased number of demand deposit accounts and debit cards.

Charitable donations—The $95,000 or 452 percent increase in charitable donations was primarily due to timing in payment of donations.

- 47 -

External data processing—The $79,000 or 26 percent increase in external data processing expenses reflects increased outsourcing of transaction processing to specialized vendors, which is typically performed on such vendors’ hosted and secure websites. The Corporation continues to expand and enhance electronic banking services provided to our clients and has outsourced statement printing and mailing services, resulting in higher external data processing costs.

Foreclosed real estate—The $79,000 or 120 percent decrease in foreclosed real estate expenses was primarily attributable to the recovery of real estate taxes, insurance premiums and the reversal of provision expense on a property that was sold during the third quarter of 2016.

Other—The $194,000 or 18 percent decrease in other expenses is primarily a result of a reduction in the costs associated with a corporate-wide training program, deposit account charge-offs from debit card fraud and impaired loan expenses.

Provision for Income Taxes

The provision for income taxes for the third quarter of 2016 was $1,560,000, an increase of $217,000 or 16 percent as compared to the third quarter of 2015. The increase is primarily a result of a higher level of pre-tax income for the third quarter of 2016 versus the same period in 2015. For both the third quarter of 2016 and 2015, the Corporation’s statutory federal income tax rate was 35 percent and the effective income tax rate was 31 percent. The effective tax rate differs from the statutory tax rate due to the impact of certain elements with specific tax benefits, including tax-exempt income, such as income from tax-exempt investments, tax-exempt loans, and bank-owned life insurance.

Preferred Stock Dividends

No preferred stock dividends were paid in the third quarter of 2016 compared to $30,000 for the same period in 2015. On February 18, 2016, the Corporation completed the redemption of all 12,000 remaining shares of the Corporation’s Series B preferred stock issued in connection with the Small Business Lending Fund Program. This transaction was reported on a Form 8-K filed on February 19, 2016. The Information about the SBLF Program is provided in this report at Note 10-Shareholders’ Equity.

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Nine Months Ended September 30, 2016 vs. Nine Months Ended September 30, 2015

Financial Highlights

The Corporation’s net income available to common shareholders (earnings) was $9,244,000 for the first nine months of 2016 compared to $8,275,000 for the first nine months of 2015, an increase of $969,000 or 12 percent.

Net interest income for the first nine months of 2016 increased $4,050,000 or 11 percent above the first nine months of 2015, primarily due to increased interest income from a higher volume of commercial loan growth over the previous twelve months.

The Corporation’s net interest margin (tax-equivalent basis) for the nine months ended September 30, 2016 was 3.88 percent, compared to 3.82 percent for the first nine months of 2015. PeoplesBank continues to have success in growing low cost core deposits, while maintaining reasonable yields on new loan growth in a highly competitive, low interest rate environment.

The provision for loan losses for the first nine months of 2016 was $2,400,000 or a $100,000 increase as compared to a provision of $2,300,000 for the first nine months of 2015. The provision for both periods supported adequate allowance for loan loss coverage including the Corporation’s substantial growth in commercial loans. The allowance as a percentage of total loans was 1.18 percent at September 30, 2016, as compared to 1.13 percent at December 31, 2015, and 1.17 percent at September 30, 2015.

Noninterest income for the first nine months of 2016 increased $568,000 or 8 percent ($866,000 or 14 percent excluding gain on sales of securities) compared to the first nine months of 2015. All sources contributed to the rise in noninterest revenues, including trust and investment services fees, income from mutual fund, annuity and insurance sales, service charges on deposits, income from bank owned life insurance and other income.

Noninterest expenses for the first nine months of 2016 were $3,026,000 or 11 percent higher than the first nine months of 2015. Growth in our existing and newly expanded markets resulted in higher personnel, occupancy and furniture and equipment, marketing, debit card processing and external data processing costs. In the prior twelve months, PeoplesBank added a limited services facility, a full service branch and an administrative services center.

The provision for income taxes for the first nine months of 2016 increased by $597,000 or 16 percent as compared to the first nine months of 2015. The increase was primarily a result of higher pre-tax income for the first nine months of 2016 compared to the same period in 2015.

On September 30, 2016, the Corporation’s total assets were over $1.52 billion, an increase of 5 percent since December 31, 2015. The increase was attributed to loan growth, primarily in commercial loans.

The Corporation’s capital level remained sound as evidenced by regulatory capital ratios that exceed current regulatory requirements for well capitalized institutions. As of September 30, 2016, the Corporation’s capital calculations and ratios reflect full compliance with the Basel III regulatory capital framework, which became effective on January 1, 2015.

- 49 -

The schedule below presents selected performance metrics for the first nine months of both 2016 and 2015. Per share computations include the effect of stock dividends, including the 5 percent common stock dividend declared on October 11, 2016.


	Nine months ended
	September 30,
	2016			2015
Basic earnings per common share	$	1.10		$	1.28
Diluted earnings per common share	$	1.09		$	1.27
Cash dividend payout ratio		33.60	%		26.89	%
Return on average assets		0.84	%		0.83	%
Return on average equity		8.00	%		9.15	%
Net interest margin (tax equivalent basis)		3.88	%		3.82	%
Net overhead ratio		2.17	%		2.16	%
Efficiency ratio		64.84	%		65.19	%
Average equity to average assets		10.51	%		9.08	%

A more detailed analysis of the factors and trends affecting the Corporation’s earnings and financial position follows.

Income Statement Analysis

Net Interest Income

Net interest income for the nine months ending September 30, 2016 was $39,579,000, an increase of $4,050,000 or 11 percent compared to net interest income of $35,529,000 for the first nine months of 2015. The increase was primarily attributable to higher loan interest income. The Corporation’s net interest margin, computed as interest income (tax-equivalent basis) annualized as a percentage of average interest earning assets, was 3.88 percent for the first nine months of 2016, representing a slight increase compared to the 3.82 percent net interest margin for the first nine months of 2015.

Total interest income for the first nine months of 2016 totaled $45,997,000, an increase of $4,388,000 or 11 percent above the amount of total interest income for the first nine months of 2015. The change was primarily a result of a significant increase in loan income, partially offset by a decline in investment income.

Interest income on loans increased $4,837,000 or 13 percent in the first nine months of 2016 compared to the same period in 2015. The average balance of outstanding loans increased approximately $132,929,000 or 13 percent in the first nine months of 2016 compared to the first nine months of 2015, reflecting commercial loan growth over the past year.

Investment income for the first nine months of 2016 decreased $512,000 or 13 percent compared to the first nine months of 2015. The average balance of the investment securities portfolio decreased 7 percent when comparing the first nine months of 2016 to the same period in 2015, which contributed to the decline in investment income. Some proceeds from investment maturities and sales were not fully reinvested, but were used for other purposes, including providing funds to support loan growth. Also, the tax-equivalent yield on investments for the first nine months of 2016 was 2.62 percent or 15 basis points lower than the 2.77 percent experienced during the first nine months of 2015, as the yields on maturing investments (primarily tax-exempt municipal securities) were generally higher than those on investments purchased in the current lower interest rate environment.

- 50 -

Total interest expense for the first nine months of 2016 totaled $6,418,000, an increase of $338,000 or 6 percent as compared to total interest expense of $6,080,000 for the first nine months of 2015. The change in interest expense was primarily a result of an increase in the average volume and cost of deposits and long-term borrowings.

Interest expense on deposits increased by $120,000 or 3 percent in the first nine months of 2016 compared to the same period in 2015. The increase was primarily due to the growth in the volume of deposits. The average balance of interest-bearing deposits for the first nine months of 2016, primarily in lower cost core deposits, increased by $44,585,000 or 5 percent compared to the average for the first nine months of 2015. The average rate paid on interest-bearing deposits in the first nine months of 2016 was 0.66 percent, a decrease from the average rate of 0.68 percent paid on interest-bearing deposits during the first nine months of 2015. Also, the Corporation experienced favorable growth in noninterest-bearing deposits, with the average volume for the first nine months of 2016 increasing to $177,805,000, as compared to $138,939,000 for the first nine months of 2015.

Interest expense on borrowings for the first nine months of 2016 increased by $218,000 or 16 percent compared to the first nine months of 2015, due primarily to a higher average balance and cost of long-term debt. Outstanding long-term borrowings, consisting primarily of Federal Home Loan Bank of Pittsburgh (FHLB) advances, averaged $107,226,000 for the first nine months of 2016, compared to an average balance of approximately $94,019,000 for the same period of 2015. The increase in the average balance related primarily to FHLB advances totaling $35,000,000 obtained in June 2015, offset by the repayment of maturing FHLB advances totaling $15,000,000 during the third quarter of 2016. The rate on average long-term borrowings for the first half of 2016 was 1.62 percent, a slight increase as compared to the rate of 1.54 percent for the same period of 2015.

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Table 5-Average Balances and Interest Rates (tax equivalent basis)

	Nine months ended September 30,
			2016								2015
	Average					Yield/			Average					Yield/
(dollars in thousands)	Balance		Interest			Rate			Balance		Interest			Rate

Assets
Interest bearing deposits with banks	$	33,718	$	131			0.52	%	$	35,765	$	68			0.25	%
Investment securities:
Taxable		125,984		2,066			2.19			146,998		2,550			2.32
Tax-exempt		72,579		1,829			3.37			66,309		1,873			3.78
Total investment securities		198,563		3,895			2.62			213,307		4,423			2.77

Loans:
Taxable (1)		1,138,129		42,171			4.95			1,002,312		37,219			4.96
Tax-exempt		18,952		599			4.22			21,840		771			4.72
Total loans		1,157,081		42,770			4.94			1,024,152		37,990			4.96
Total earning assets		1,389,362		46,796			4.50			1,273,224		42,481			4.46
Other assets (2)		77,983								69,773
Total assets	$	1,467,345							$	1,342,997
Liabilities and Shareholders’ Equity
Deposits:
Interest bearing demand	$	493,704	$	1,389			0.38	%	$	434,801	$	1,095			0.34	%
Savings		75,101		55			0.10			68,253		51			0.10
Time		410,793		3,431			1.12			431,959		3,609			1.12
Total interest bearing deposits		979,598		4,875			0.66			935,013		4,755			0.68
Short-term borrowings		29,601		116			0.52			33,824		126			0.50
Long-term debt		117,536		1,427			1.62			104,329		1,199			1.54
Total interest bearing liabilities		1,126,735		6,418			0.76			1,073,166		6,080			0.76

Noninterest bearing deposits		177,805								138,939
Other liabilities		8,558								8,941
Shareholders’ equity		154,247								121,951

Total liabilities and shareholders’ equity	$	1,467,345							$	1,342,997
Net interest income (tax equivalent basis)			$	40,378							$	36,401
Net interest margin (3)							3.88	%							3.82	%
Tax equivalent adjustment				(799	)							(872	)
Net interest income			$	39,579							$	35,529

(1)

Average balance includes average nonaccrual loans of $2,674,000 for 2016 and $7,935,000 for 2015.

Interest includes net loan fees of $2,411,000 for 2016 and $1,531,000 for 2015.

(2)

Average balance includes average bank owned life insurance, foreclosed real estate and unrealized holding gains (losses) on investment securities.

(3)

Net interest income (tax equivalent basis) annualized as a percentage of average interest earning assets.

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Table 6-Rate/Volume Analysis of Changes in Net Interest Income (tax equivalent basis)

	Nine months ended
	September 30,
	2016 vs. 2015
	Increase (decrease) due to change in*
(dollars in thousands)		Volume			Rate			Net

Interest Income
Interest bearing deposits with banks	$	(4	)	$	67		$	63
Investment securities:
Taxable		(309	)		(175	)		(484	)
Tax-exempt		178			(222	)		(44	)
Loans:
Taxable		6,077			(1,125	)		4,952
Tax-exempt		(102	)		(70	)		(172	)
Total interest income		5,840			(1,525	)		4,315
Interest Expense
Deposits:
Interest bearing demand		182			112			294
Savings		5			(1	)		4
Time		(177	)		(1	)		(178	)
Short-term borrowings		(19	)		9			(10	)
Long-term debt		147			81			228
Total interest expense		138			200			338
Net interest income	$	5,702		$	(1,725	)	$	3,977

*Changes which are due to both volume and rate are allocated in proportion to their relationship to the amount of change attributed directly to volume or rate.

Provision for Loan Losses

For the first nine months of 2016, the provision for loan losses was $2,400,000, as compared to a provision of $2,300,000 for the first nine months of 2015. The provision for both periods supported adequate allowance for loan loss coverage, including the Corporation’s substantial growth in commercial loans. For the first nine months of 2016, net charge-offs were $879,000, as compared to $1,082,000 in the first nine months of 2015. The allowance as a percentage of total loans was 1.18 percent at September 30, 2016, as compared to 1.13 percent at December 31, 2015, and 1.17 percent at September 30, 2015.

More information about the allowance for loan losses can be found in this report under the caption Allowance for Loan Losses on page 62.

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Noninterest Income

The following table presents the components of total noninterest income for the first nine months of 2016, compared to the first nine months of 2015.


Table 7 - Noninterest income

	Nine months ended				Change
	September 30,				Increase (Decrease)
(dollars in thousands)	2016		2015		$			%

Trust and investment services fees	$	1,892	$	1,809	$	83			5	%
Income from mutual fund, annuity and insurance sales		735		580		155			27
Service charges on deposit accounts		2,695		2,514		181			7
Income from bank owned life insurance		631		523		108			21
Other income		642		426		216			51
Net gain on sales of loans held for sale		612		489		123			25
Gain on sales of securities		194		492		(298	)		(61	)
Total noninterest income	$	7,401	$	6,833	$	568			8	%

The discussion that follows addresses changes in selected categories of noninterest income.

Income from mutual fund, annuity and insurance sales—The $155,000 or 27 percent increase in income from the sale of mutual fund, annuity and insurance products by CVFA was due to the higher volume of assets under management during the first nine months of 2016.

Service charges on deposit accounts—The $181,000 or 7 percent increase in service charge income on deposit accounts was due to an increase in the volume of deposit accounts subject to fees, as well as fee schedule increases implemented during the first quarter of 2015. The increased fees were in effect during the entire first nine months of 2016.

Income on bank owned life insurance—The $108,000 or 21 percent increase in income from bank owned life insurance was due to additional investments totaling $6,987,000 in 2016.

Other income—The $216,000 or 51 percent increase in other income was due to higher miscellaneous client based service charges, such as wire transfer, gift card, and credit card merchant fees and loan related income, such as mortgage loan servicing and FHA loan origination fees. Also contributing to the increase was higher revenue provided by SYC Settlement Services, Inc., a subsidiary of PeoplesBank, due to an upturn in the volume of real estate settlement services.

Net gain on sales of loans held for sale—The $123,000 or 25 percent increase in net gains from the sale of residential mortgage loans held for sale was due to a higher volume of mortgage originations and sales during 2016 compared to 2015.

Gain on sales of securities— The Corporation realized $194,000 in gains from the sales of four securities. This represents a $298,000 or 61 percent decrease from the $492,000 recognized in 2015. Securities sold included those where market pricing provided a favorable return at the time of sale, versus holding the respective securities to maturity. In addition, sales in 2016 provided cash to meet short-term liquidity needs.

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Noninterest Expense

The following table presents the components of total noninterest expense for the first nine months of 2016, compared to the first nine months of 2015.


Table 8 - Noninterest expense

	Nine months ended				Change
	September 30,				Increase (Decrease)
(dollars in thousands)	2016		2015		$			%

Personnel	$	17,988	$	15,520	$	2,468			16	%
Occupancy of premises, net		2,501		2,395		106			4
Furniture and equipment		2,160		2,014		146			7
Postage, stationery and supplies		524		505		19			4
Professional and legal		515		618		(103	)		(17	)
Marketing		1,275		931		344			37
FDIC insurance		467		526		(59	)		(11	)
Debit card processing		853		657		196			30
Charitable donations		884		763		121			16
Telephone		513		527		(14	)		(3	)
External data processing		1,067		850		217			26
Merger related		0		474		(474	)		(100	)
Foreclosed real estate including (recovery of) provision for losses		122		215		(93	)		(43	)
Other		2,224		2,072		152			7
Total noninterest expense	$	31,093	$	28,067	$	3,026			11	%

The discussion that follows addresses changes in selected categories of noninterest expense.

Personnel—The $2,468,000 or 16 percent increase in personnel expense was due largely to the addition of new employees to support the Corporation’s business growth, which included our entry into Lancaster County, Pennsylvania and the hiring of employees to support our business and consumer banking services in our Maryland market. Also contributing to the increase was the timing of expense recognition for the annual employee performance bonuses, as well as the higher cost of health insurance. Additionally, personnel expense as of September 30, 2016 included the full nine month impact of the Corporation’s January 2015 acquisition of Madison Bancorp, Inc.

Occupancy—The $106,000 or 4 percent increase in occupancy expense was due primarily to two new branches opened over the previous twelve months. The two branches included one limited services facility, which opened in January of 2016, and a full service branch, which opened in our Maryland market in April of 2016. Additionally, in December of 2015, PeoplesBank relocated the South Hanover Branch into a newly constructed facility and completed the renovations of, and subsequently opened, the administrative services center.

Furniture and equipment—The $146,000 or 7 percent increase in furniture and equipment expense was due primarily to the opening of new branches and an administrative services center noted above, and computer hardware and software costs related to enhanced technology to support business growth.

Professional and legal—The $103,000 or 17 percent decrease in professional and legal expense is attributed to a reduction in legal and consulting fees related to corporate strategic initiatives.

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Marketing—The $344,000 or 37 percent increase in marketing expenses was due to planned initiatives related to the continued expansion of our franchise, along with the initial expenses associated with the acquisition of the naming rights to PeoplesBank Park, the facility that houses the York, Pennsylvania-based York Revolution independent league baseball team.

FDIC Insurance—The $59,000 or 11 percent decrease in FDIC insurance is due to the change in the assessment methodology effective with the third quarter of 2016.

Debit card processing—The $196,000 or 30 percent increase in debit card processing reflects higher debit card transaction volumes and the reissuance costs associated with upgrading PeoplesBank’s debit cards to EMV chip card technology.

Charitable donations—The $121,000 or 16 percent increase in charitable donations was primarily due to timing in payment of donations. Some donations to Pennsylvania nonprofit organizations qualify for related state tax credits that typically range from 55 to 90 percent of the donated amount, effectively lowering the cost of the donation. PeoplesBank uses state tax credits from donations to reduce its Pennsylvania shares tax expense, which is included in other expenses.

External data processing—The $217,000 or 26 percent increase in external data processing expenses reflects increased reliance on outsourcing transaction processing to specialized vendors, which is typically performed on such vendors’ hosted and secure websites. Transaction volumes have increased year over year due to business expansion. The Corporation continues to expand and enhance electronic banking services provided to our clients and has outsourced statement printing and mailing services, resulting in higher external data processing costs.

Merger related—The Corporation incurred $474,000 of merger related expenses during the first nine months of 2015 related to the acquisition of Madison Bancorp, Inc. in January 2015. Merger-related integration activities were completed in the first half of 2015.

Foreclosed real estate —The $93,000 or 43 percent decrease in foreclosed real estate expenses is primarily attributable to the recovery of real estate taxes, insurance premiums and the reversal of provision expense on a property that was sold during the third quarter of 2016.

Other —The $152,000 or 7 percent increase in other expenses, which is comprised of many underlying expenses, is primarily due to increases in the Pennsylvania Department of Banking’s annual assessment, annual shareholder meeting costs, Pennsylvania bank shares tax, and impaired loan expenses.

Provision for Income Taxes

The provision for income taxes for the first nine months of 2016 was $4,227,000, an increase of $597,000 or 16 percent as compared to the first nine months of 2015. The increase is primarily a result of a higher level of pre-tax income for the first nine months of 2016 versus the same period in 2015. For both the first nine months of 2016 and 2015, the Corporation’s statutory federal income tax rate was 35 percent. However, the effective income tax rate was 31 percent for the first nine months of 2016, compared to 30 percent for the same period in 2015. The effective tax rate differs from the statutory tax rate due to the impact of certain elements with specific tax benefits, including tax-exempt income, such as income from tax-exempt investments, tax-exempt loans, and bank-owned life insurance.

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Preferred Stock Dividends

Preferred stock dividends for the first nine months of 2016 totaled $16,000 compared to $90,000 for the first nine months of 2015. Though an annualized dividend rate of 1 percent applied to both periods, the amount of preferred stock dividends for the first nine months of 2016 decreased compared to the same period in 2015 because, on February 18, 2016, the Corporation completed the redemption of all 12,000 remaining shares of the Corporation’s Series B preferred stock issued in connection with the Small Business Lending Fund Program. This transaction was reported on a Form 8-K filed on February 19, 2016. The Information about the SBLF Program is provided in this report at Note 10-Shareholders’ Equity.

Balance Sheet Review

Interest Bearing Deposits with Banks

On September 30, 2016, interest bearing deposits with banks totaled $32,945,000, compared to $44,496,000 at year-end 2015. The reduction was primarily the result of funding of loan growth and long-term debt principal repayments, offset by an increase in deposits.

Investment Securities (Available-for-Sale)

The Corporation’s entire investment securities portfolio is classified available-for-sale, and is comprised primarily of interest-earning debt securities. The overall composition of the Corporation’s investment securities portfolio is provided in Note 3—Securities. On September 30, 2016, the fair value of investment securities available-for-sale totaled $200,373,000, which represented a decrease of $13,097,000 as compared to the fair value of investment securities at year-end 2015. Principal reductions from investment sales and maturities and mortgage-backed security payments exceeded new investments during the first nine months of 2016.

Loans

On September 30, 2016, total loans, net of deferred fees, were $1.21 billion, which was $84,631,000 or 8 percent higher than the level at year-end 2015. This change in volume was due primarily to an increase in commercial loans, particularly within the commercial real estate investor and residential real estate investor sectors. Commercial loans within the builder & developer, commercial real estate investor and residential real estate investor sectors each represented more than 10 percent of the total portfolio. The composition of the Corporation’s loan portfolio is provided in Note 5—Loans.

Deposits

Deposits are the Corporation’s principal source of funding for earning assets. On September 30, 2016, deposits totaled $1.22 billion, which reflected a $127,946,000 or 12 percent increase compared to the level at year-end 2015. Of the increase in total deposits, $24,473,000 was attributable to growth in noninterest bearing deposits, with an additional $77,906,000 related to growth in both interest bearing demand and savings deposits. Time deposits increased $25,567,000 compared to the level at year-end 2015. Growth in deposits, particularly money market and time deposits, reflects several rate promotions during the first nine months of 2016. The composition of the Corporation’s total deposit portfolio is provided in Note 7—Deposits.

Short-term Borrowings

Short-term borrowings, which consist of securities sold under agreements to repurchase (repurchase agreements), federal funds purchased, and other short-term borrowings, totaled $31,061,000 at September 30, 2016, which reflected a $43,449,000 or 58 percent decrease compared to the level at year-end 2015. The entire balance of short-term borrowings at September 30, 2016 and December 31, 2015 was comprised of repurchase agreements, which decreased primarily due to the loss of a significant account relationship.

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Long-term Debt

The Corporation uses long-term borrowings as a secondary funding source for asset growth. On September 30, 2016 long-term debt totaled $105,310,000 compared to $120,310,000 at year-end 2015. The decrease reflects the repayment of $15,000,000 of long-term debt obligations which matured during the third quarter of 2016. A listing of outstanding long-term debt obligations is provided in Note 8—Short-Term Borrowings and Long-Term Debt.

Shareholders’ Equity and Capital Adequacy

Shareholders’ equity, or capital, enables Codorus Valley to maintain asset growth and absorb losses. Capital adequacy can be affected by a multitude of factors, including profitability, new stock issuances, corporate expansion and acquisitions, dividend policy and distributions, and regulatory mandates. The Corporation’s total shareholders’ equity was approximately $155,317,000 on September 30, 2016, a decrease of approximately $3,824,000 or 2 percent, compared to the level at year-end 2015. The decrease was primarily the result of the redemption of all 12,000 remaining shares of the Corporation’s Series B preferred stock issued in connection with the Small Business Lending Fund Program, as discussed below.

Redemption of Preferred Stock and Preferred Stock Dividends

As previously announced on the Form 8-K filed on February 19, 2016, the Corporation redeemed the remaining $12,000,000 of the Corporation’s Preferred Stock, Series B that had been issued to the United States Treasury under its Small Business Lending Fund Program. The annualized dividend rate on the preferred stock issued under the SBLF Program was 1 percent for the nine months ended September 30, 2015 and through the redemption date of February 18, 2016.

Cash Dividends on Common Stock

The Corporation has historically paid cash dividends on its common stock on a quarterly basis. The Board of Directors determines the dividend rate after considering the Corporation’s capital requirements, current and projected net income, and other relevant factors. As recently announced, the Board of Directors declared a quarterly cash dividend of $0.13 per common share on October 11, 2016, payable on November 8, 2016, to common shareholders of record at the close of business on October 25, 2016. This cash dividend follows the $0.13 common stock cash dividend distributed in August 2016.

Capital Adequacy

The Corporation and PeoplesBank are subject to various regulatory capital requirements administered by banking regulators that involve quantitative guidelines and qualitative judgments. The regulatory capital measures for the Corporation and PeoplesBank as of September 30, 2016 and the minimum capital ratios established by regulators are set forth in Note 9—Regulatory Matters to the financial statements. We believe that both Codorus Valley and PeoplesBank were well capitalized on September 30, 2016.

Our capital adequacy as of September 30, 2016, reflects updated regulatory capital guidelines from the Board of Governors of the Federal Reserve System finalized rule which implemented the Basel III regulatory capital framework, and which became effective for the Corporation and PeoplesBank on January 1, 2015. Under the revised regulatory capital framework, minimum requirements increased both the quantity and quality of capital held by banking organizations. Additionally, a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5 percent and a common equity Tier 1 conservation buffer of risk-weighted assets applies to all supervised financial institutions. The rule also raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4 percent to 6 percent and includes a minimum leverage ratio of 4 percent for all banks. The new rule also increases the risk weights for past-due loans, certain commercial real estate loans and some equity exposures, and makes selected other changes in risk weights and credit conversion factors.

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The new rule further provides that, in order to avoid restrictions on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold the 2.5 percent capital conservation buffer, which is to be phased in over a four year period beginning January 1, 2016, with the full 2.5 percent required as of January 1, 2019.

The transition schedule for new ratios, including the capital conservation buffer, is as follows:


	As of January 1:
	2015			2016			2017			2018			2019
Minimum common equity Tier 1 capital ratio		4.5	%		4.5	%		4.5	%		4.5	%		4.5	%
Common equity Tier 1 capital conservation buffer		N/A			0.625	%		1.25	%		1.875	%		2.5	%
Minimum common equity Tier 1 capital ratio plus capital conservation buffer		4.5	%		5.125	%		5.75	%		6.375	%		7.0	%
Phase-in of most deductions from common equity Tier 1 capital		40	%		60	%		80	%		100	%		100	%
Minimum Tier 1 capital ratio		6.0	%		6.0	%		6.0	%		6.0	%		6.0	%
Minimum Tier 1 capital ratio plus capital conservation buffer		N/A			6.625	%		7.25	%		7.875	%		8.5	%
Minimum total capital ratio		8.0	%		8.0	%		8.0	%		8.0	%		8.0	%
Minimum total capital ratio plus capital conservation buffer		N/A			8.625	%		9.25	%		9.875	%		10.5	%

As fully phased in, a banking organization with a buffer greater than 2.5% would not be subject to limits on dividend payments or discretionary bonus payments; however, a banking organization with a buffer less than 2.5% would be subject to increasingly stringent limitations as the buffer approaches zero. The new rule also prohibits a banking organization from paying dividends or discretionary bonuses if its eligible net income is negative in that quarter and its capital conservation buffer ratio was less than 2.5% as of the beginning of that quarter. Eligible net income is defined as net income for the four calendar quarters preceding the current calendar quarter, net of any distributions and associated tax effects not already reflected in net income.

A summary of payout restrictions based on the capital conservation buffer is as follows:


Capital Conservation Buffer (as a % of risk-weighted assets)		Maximum Payout (as a % of eligible net income)
Greater than 2.5%		No payout limitation applies
≤2.5% and >1.875%		60%
≤1.875% and >1.25%		40%
≤1.25% and >0.625%		20%
≤0.625%		0%

Under the new rule as effective through the nine months ending September 30, 2016, the Corporation and PeoplesBank had no regulatory dividend restrictions and remained well capitalized by all regulatory capital measures (see Note 9—Regulatory Matters to the financial statements). The Corporation plans to manage its capital adequacy to ensure continued compliance with the new capital rules.

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Risk Management

Credit Risk Management

Credit risk represents the possibility that a loan client, counterparty or issuer may not perform in accordance with contractual terms, posing one of the most significant risks of loss to the Corporation. Accordingly, the Corporation emphasizes the management of credit risk, and has established a lending policy which management believes is sound given the nature and scope of our operations. The Credit Risk Management section included in Item 7 of the Corporation’s previously filed Annual Report on Form 10-K for the year ended December 31, 2015, provides a more detailed overview of the Corporation’s credit risk management process.

Nonperforming Assets

Nonperforming assets, as shown in the table below, are asset categories that pose the greatest risk of loss. The level of nonperforming assets as of September 30, 2016, has decreased by approximately $1,270,000 or 19 percent when compared to year-end 2015. The decrease was primarily the result of a reduction in nonaccrual loans.

The Corporation regularly monitors large and criticized assets in its commercial loan portfolio recognizing that prolonged low economic growth, or a weakening economy, could have negative effects on these commercial borrowers. Nonperforming assets are under the purview of in-house counsel, who continuously monitors and manages the collection of these accounts. Collection efforts, including modification of contractual terms for individual accounts based on prevailing market conditions and liquidation of collateral assets, are employed to maximize recovery. A special assets committee meets monthly to review nonperforming assets. We generally rely on appraisals performed by independent licensed appraisers to determine the value of real estate collateral for impaired collateral-dependent loans. Generally, an appraisal is performed when: an account reaches 90 days past due, unless a certified appraisal was completed within the past twelve months; market values have changed significantly; the condition of the property has changed significantly; or the existing appraisal is outdated based upon regulatory or policy requirements. In instances where the value of the collateral, net of costs to sell, is less than the net carrying amount for impaired commercial related loans, a specific loss allowance is established for the difference. Further provisions for loan losses may be required for nonaccrual loans as additional information becomes available or conditions change. When it is probable that some portion or an entire loan balance will not be collected, that amount is charged off as loss against the allowance.

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The paragraphs and table below address significant changes in the nonperforming asset categories as of September 30, 2016, compared to December 31, 2015.

Table 9 - Nonperforming Assets

(dollars in thousands)		September 30, 2016			December 31, 2015

Nonaccrual loans	$	2,514		$	3,045
Nonaccrual loans, troubled debt restructurings		0			188
Accruing loans 90 days or more past due		172			484
Total nonperforming loans		2,686			3,717
Foreclosed real estate, net of allowance		2,674			2,913
Total nonperforming assets	$	5,360		$	6,630
Accruing troubled debt restructurings	$	3,713		$	3,903

Total period-end loans, net of deferred fees	$	1,207,842		$	1,123,211
Allowance for loan losses (ALL)	$	14,225		$	12,704
ALL as a % of total period-end loans		1.18	%		1.13	%
Annualized net charge-offs as a % of average total loans		0.10	%		0.19	%
ALL as a % of nonperforming loans		529.56	%		341.78	%
Nonperforming loans as a % of total period-end loans		0.22	%		0.33	%
Nonperforming assets as a % of total period-end loans and net foreclosed real estate		0.44	%		0.59	%
Nonperforming assets as a % of total period-end assets		0.35	%		0.46	%
Nonperforming assets as a % of total period-end shareholders’ equity		3.45	%		4.17	%

Nonperforming loans consist of nonaccrual loans and accruing loans 90 days or more past due. We generally place a loan on nonaccrual status and cease accruing interest income (i.e., recognize interest income on a cash basis, as long as the loan is sufficiently collateralized) when loan payment performance is unsatisfactory and the loan is past due 90 days or more. A loan is returned to interest accruing status when we determine that circumstances have improved to the extent that all of the principal and interest amounts contractually due are current for at least six consecutive payments and future payments are reasonably assured. Loans past due 90 days or more and still accruing interest represent loans that are contractually past due, but are well collateralized and in the process of collection. As of September 30, 2016, the nonperforming loan portfolio balance totaled $2,686,000, compared to $3,717,000 at year-end 2015. The decrease was primarily the result of principal repayments and charge-offs of nonaccrual commercial loans totaling $1,736,000, which was partially offset by commercial loans placed on nonaccrual status totaling $1,170,000. For both periods, the nonperforming portfolio balance was comprised primarily of collateralized commercial loans.

Foreclosed real estate represents real estate acquired to satisfy debts owed to PeoplesBank and is included in the Other Assets category on the Corporation’s balance sheet. The carrying amount of foreclosed real estate as of September 30, 2016, net of allowance, totaled $2,674,000 compared to $2,913,000 at year-end 2015. Total foreclosed real estate decreased by $239,000 or 8 percent from December 31, 2015 to September 30, 2016. The decrease is attributable to the sales of certain smaller properties and was partially offset by the transfer of two properties to foreclosed real estate during the first nine months of 2016.

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Troubled debt restructurings pertain to loans whose terms have been modified to include a concession that we would not ordinarily consider due to the debtor’s financial difficulties. Concessions granted under a troubled debt restructuring typically involve a reduction of interest rate lower than the current market rate for new debt with similar risk, the deferral of payments or extension of the stated maturity date. Troubled debt restructurings are evaluated for impairment if they have been restructured during the most recent calendar year, or if they cease to perform in accordance with the modified terms. As of September 30, 2016, the accruing troubled debt restructuring portfolio balance totaled $3,713,000, compared to $3,903,000 at year-end 2015. The decrease was the result of principal payments made on loans within the troubled debt restructuring portfolio.

Allowance for Loan Losses

Although the Corporation believes that it maintains sound credit policies, certain loans deteriorate and must be charged off as losses. The allowance for loan losses is maintained to absorb losses inherent in the portfolio. The allowance is increased by provisions charged to expense and is reduced by loan charge-offs, net of recoveries. The allowance is based upon management’s continuous evaluation of the loan portfolio coupled with a formal review of adequacy on a quarterly basis, which is subject to review and approval by the Board.

The allowance for loan losses consists primarily of three components: specific allowances for individually impaired commercial loans; allowances calculated for pools of loans; and an unallocated component, which reflects the margin of imprecision inherent in the assumptions that underlie the evaluation of the adequacy of the allowance. The Corporation uses an internal risk rating system to evaluate individual loans. Loans are segmented into industry groups or pools with similar characteristics, and an allowance for loan losses is allocated to each segment based on quantitative factors such as recent loss history (two-year rolling average of net charge-offs) and qualitative factors, such as the results of internal and external credit reviews, changes in the size and composition of the loan portfolio, adequacy of collateral, and general economic conditions. Determining the level of the allowance for probable loan losses at any given period is subjective, particularly during deteriorating or uncertain economic periods, and requires that we make estimates using assumptions. There is also the potential for adjustment to the allowance as a result of regulatory examinations.

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The following table presents an analysis of the activity in the allowance for loan losses for the three and nine months ended September 30, 2016 and 2015:

Table 10 - Analysis of Allowance for Loan Losses

(dollars in thousands)		2016			2015
Balance-January 1,	$	12,704		$	11,162

Provision charged to operating expense		2,400			2,300

Loans charged off:
Commercial, financial and agricultural		771			985
Real estate - residential mortgages		69			40
Consumer and home equity		101			121
Total loans charged off		941			1,146
Recoveries:
Commercial, financial and agricultural		5			21
Real estate - residential mortgages		0			21
Consumer and home equity		57			22
Total recoveries		62			64
Net charge-offs		879			1,082
Balance-September 30,	$	14,225		$	12,380

Ratios:
Allowance for loan losses as a % of total period-end loans		1.18	%		1.17	%
Annualized net charge-offs as a % of average total loans		0.10	%		0.14	%
Allowance for loan losses as a % of nonperforming loans		529.56	%		212.54	%

The allowance for loan losses increased $1,845,000 or 15 percent from September 30, 2015 to September 30, 2016. The increase in the allowance was primarily attributable to the $152,193,000 or 14 percent increase in loans, net of deferred fees, over the same 12 month period.

Net charge-offs for the first nine months of 2016 were $879,000 compared to $1,082,000 of net charge-offs for the same period of 2015. During the first nine months of 2015, charge-offs were higher in both volume and amount than the same period of 2016. The risks and uncertainties associated with prolonged sluggish growth, weak economic and business conditions, or the erosion of real estate values can adversely affect our borrowers’ ability to service their loans, causing significant fluctuations in the level of charge-offs and provision expense from one period to another. The provision for loan losses for the first nine months of 2016 was $2,400,000, compared to $2,300,000 for the same period of 2015. The allowance as a percentage of total loans at September 30, 2016 was 1.18 percent, compared to 1.13 percent at December 31, 2015 and 1.17 percent as of September 30, 2015. The unallocated portion of the allowance was $1,726,000 or 12 percent of the total allowance as of September 30, 2016, as compared to $1,480,000 or 12 percent of the total allowance as of December 31, 2015.

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Liquidity Risk Management

Maintaining adequate liquidity provides the Corporation with the ability to meet financial obligations to depositors, loan customers, employees, and shareholders on a timely and cost effective basis in the normal course of business. Additionally, adequate liquidity provides funds for growth and business opportunities as they arise. Liquidity is generated from transactions relating to both the Corporation’s assets and liabilities. The primary sources of asset liquidity are funds received from customer loan payments, investment maturities and cash inflows from mortgage-backed securities, and the net proceeds of asset sales. The primary sources of liability liquidity are deposit growth, and funds obtained from short-term borrowings and long-term debt. The Consolidated Statements of Cash Flows, included in this report, present the changes in cash from operating, investing and financing activities. At September 30, 2016, we believe that liquidity was adequate based upon the potential liquidation of unpledged available-for-sale securities with a fair value totaling approximately $37,511,000 and available credit from the Federal Home Loan Bank of Pittsburgh totaling approximately $326,756,000. The Corporation’s loan-to-deposit ratio was 99 percent as of September 30, 2016, as compared to a 103 percent loan-to-deposit ratio as of December 31, 2015, and a 96 percent loan-to-deposit ratio as of September 30, 2015.

Off-Balance Sheet Arrangements

The Corporation’s financial statements do not reflect various commitments that are made in the normal course of business, which may involve some liquidity risk. These commitments consist primarily of commitments to grant new loans, unfunded commitments under existing loan facilities, and letters of credit issued under the same standards as on-balance sheet instruments. Unused commitments on September 30, 2016, totaled $410,082,000 and consisted of $279,459,000 in unfunded commitments under existing loan facilities, $110,118,000 to grant new loans and $20,505,000 in letters of credit. Generally these commitments have fixed expiration dates or termination clauses and are for specific purposes. Accordingly, many of the commitments are expected to expire without being drawn upon and, therefore, generally do not present significant liquidity risk to the Corporation or PeoplesBank.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

The most significant market risk to which the Corporation is exposed is interest rate risk. The primary business of the Corporation and the composition of its balance sheet consist of investments in interest earning assets (primarily loans and securities), which are funded by interest bearing liabilities (deposits and borrowings), all of which have varying levels of sensitivity to changes in market interest rates. Changes in rates also have an impact on the Corporation’s liquidity position and could affect its ability to meet obligations and continue to grow.

The Corporation employs various management techniques to minimize its exposure to interest rate risk. An Asset Liability Management Committee, consisting of key financial and senior management personnel, meets on a regular basis. The Committee is responsible for reviewing the interest rate sensitivity and liquidity positions of the Corporation, reviewing projected sources and uses of funds, approving asset and liability management policies, monitoring economic conditions, and overseeing the formulation and implementation of strategies regarding balance sheet positions.

Simulation of net interest income is performed for the next twelve-month period. A variety of interest rate scenarios are used to measure the effects of sudden and gradual movements upward and downward in the yield curve. These results are compared to the results obtained in a flat or unchanged interest rate scenario. Simulation of net interest income is used primarily to measure the Corporation’s short-term earnings exposure to rate movements. A “shock” is an immediate upward or downward movement of interest rates. The shocks do not take into account changes in customer behavior that could result in changes to mix and/or volumes in the balance sheet, nor do they account for competitive pricing over the forward 12-month period. The Corporation applies these interest rate “shocks” to its financial instruments up and down 100, 200, 300, and 400 basis points. A 300 and 400 basis point decrease in interest rates cannot be simulated at this time due to the historically low interest rate environment.

The following table summarizes the expected impact of interest rate shocks on net interest income as well as the Corporation’s policy limits at each level. All scenarios were within policy limits at September 30, 2016.

Change in Interest Rates	Annual Change in Net			% Change in Net		% Change
(basis points)	Interest Income (in thousands)			Interest Income		Policy Limit
+100	$	1,986		3.74	%	(5.00	)%
-100	$	(477	)	(0.90	)%	(5.00	)%

+200	$	3,846		7.24	%	(15.00	)%
-200	$	(1,416	)	(2.67	)%	(15.00	)%

+300	$	5,563		10.48	%	(25.00	)%

+400	$	7,407		13.95	%	(35.00	)%

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Item 4. Controls and Procedures

The Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Interim Treasurer, of the effectiveness of its disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon the evaluation, the Corporation’s Chief Executive Officer and Interim Treasurer concluded that, as of September 30, 2016, the Corporation’s disclosure controls and procedures were effective. The Corporation’s disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that information required to be disclosed in the Corporation’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. A control system, no matter how well conceived and operated, must reflect the fact that there are resource constraints and that the benefits of controls must be considered relative to their costs, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

There has been no change in the Corporation’s internal control over financial reporting that occurred during the nine months ended September 30, 2016, that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

Part II—OTHER INFORMATION

Item 1. Legal Proceedings

The Corporation and PeoplesBank are involved in routine litigation incidental to their business. In the opinion of management, there are no legal proceedings pending against the Corporation or any of its subsidiaries which are expected to have a material impact upon the consolidated financial position and/or operating results of the Corporation. Management is not aware of any adverse proceedings known or contemplated by government authorities.

Item 1A. Risk Factors

There have been no material changes to the risk factors as previously disclosed in Item 1A – Risk Factors – in our Annual Report on Form 10-K for the year ended December 31, 2015.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The Corporation relies on its subsidiary PeoplesBank, A Codorus Valley Company, for dividend distributions, which are subject to restrictions as reported in Note 9—Regulatory Matters of the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2015.

The Corporation has a Share Repurchase Program (Program), which was authorized in 1995, and has been periodically amended, to permit the purchase of up to a maximum of 4.9 percent of the outstanding shares of the Corporation’s common stock at a price per share no greater than 200 percent of the latest quarterly published book value. For the nine month period ended September 30, 2016 and the year ended December 31, 2015, the Corporation had not acquired any of its common stock under the Program.

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

This Item 4 is not applicable to the Corporation.

Item 5. Other Information

None

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Item 6. Exhibits

Exhibit

Number

Description of Exhibit

3.1

Amended Articles of Incorporation (Incorporated by reference to Exhibit 3.1 of the Registrant’s Quarterly Report on Form 10-Q for June 30, 2016 filed with the Commission on August 8, 2016)

3.2

Amended By-laws (Incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 12, 2016)

31.1

Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Certification of Principal Executive Officer and Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101

Financial statements from the Quarterly Report on Form 10-Q of Codorus Valley Bancorp, Inc. for the quarter ended September 30, 2016, formatted in XBRL: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income (iii) the Consolidated Statements of Comprehensive Income (iv) the Consolidated Statements of Cash Flows, (v) the Consolidated Statements of Changes in Shareholder’s Equity, and (vi) the Notes to Consolidated Financial Statements – filed herewith.

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Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned there unto duly authorized.

			Codorus Valley Bancorp, Inc.
			(Registrant)

November 3, 2016			/s/ Larry J. Miller
Date			Larry J. Miller
			Chairman, President
			and Chief Executive Officer
			(Principal Executive Officer)

November 3, 2016			/s/ Diane E. Baker
Date			Diane E. Baker, CPA
			Interim Treasurer
			(Principal Financial and Accounting Officer)

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