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EX-32.1 - SECTION 350 CERTIFICATIONS - CITIZENS FINANCIAL SERVICES INCcertification.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - CITIZENS FINANCIAL SERVICES INCcfocert.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - CITIZENS FINANCIAL SERVICES INCceocert.htm

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10‑Q


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

For the quarterly period ended September 30, 2016
Or

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

For the transition period from_____________________ to ___________________

Commission file number 0‑13222

CITIZENS FINANCIAL SERVICES, INC.
(Exact name of registrant as specified in its charter)

            PENNSYLVANIA                               23‑2265045
   (State or other jurisdiction of incorporation or organization)  (I.R.S. Employer Identification No.)


15 South Main Street
Mansfield, Pennsylvania 16933
(Address of principal executive offices)(Zip Code)

Registrant's telephone number, including area code: (570) 662‑2121

N/A
(Former Name, former address and former fiscal year, if changed since last report)

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer ____                                                                                                                                 Accelerated filer _X__

Non-accelerated filer ____                                                                                                                                 Smaller reporting company ____
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes____ No __X__

The number of outstanding shares of the Registrant's Common Stock, as of October 25, 2016, was 3,349,841.


Citizens Financial Services, Inc.
Form 10-Q

INDEX

   
PAGE
Part I
FINANCIAL INFORMATION
 
Item 1.
Financial Statements (unaudited):
 
 
Consolidated Balance Sheet as of September 30,2016 and December 31, 2015
1
 
Consolidated Statement of Income for the Three and Nine Months Ended September 30, 2016 and 2015
2
 
Consolidated Statement of Comprehensive Income for the Three and Nine months ended September 30, 2016 and 2015
3
 
Consolidated Statement of Cash Flows for the Nine Months ended September 30, 2016 and 2015
4
 
Notes to Consolidated Financial Statements
5-32
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
33-55
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
55
Item 4.
Controls and Procedures
55-56
     
Part II
OTHER INFORMATION
 
Item 1.
Legal Proceedings
56
Item 1A.
Risk Factors
56
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
56
Item 3.
Defaults Upon Senior Securities
56
Item 4.
Mine Safety Disclosures
56-57
Item 5.
Other Information
57
Item 6.
Exhibits
57
 
Signatures
58
 


CITIZENS FINANCIAL SERVICES, INC.
           
CONSOLIDATED BALANCE SHEET
           
(UNAUDITED)
           
 
           
 
 
September 30
   
December 31
 
(in thousands except share data)
 
2016
   
2015
 
ASSETS:
           
Cash and due from banks:
           
  Noninterest-bearing
 
$
15,459
   
$
14,088
 
  Interest-bearing
   
912
     
10,296
 
Total cash and cash equivalents
   
16,371
     
24,384
 
Interest bearing time deposits with other banks
   
6,955
     
7,696
 
Available-for-sale securities
   
349,154
     
359,737
 
Loans held for sale
   
576
     
603
 
                 
Loans (net of allowance for loan losses:
               
  2016, $8,194 and 2015, $7,106)
   
743,099
     
687,925
 
                 
Premises and equipment
   
17,143
     
17,263
 
Accrued interest receivable
   
3,988
     
4,211
 
Goodwill
   
21,089
     
21,089
 
Bank owned life insurance
   
26,050
     
25,535
 
Other intangibles
   
2,059
     
2,437
 
Other assets
   
11,170
     
12,104
 
 
               
TOTAL ASSETS
 
$
1,197,654
   
$
1,162,984
 
 
               
LIABILITIES:
               
Deposits:
               
  Noninterest-bearing
 
$
149,848
   
$
150,960
 
  Interest-bearing
   
858,899
     
837,071
 
Total deposits
   
1,008,747
     
988,031
 
Borrowed funds
   
51,859
     
41,631
 
Accrued interest payable
   
636
     
734
 
Other liabilities
   
10,862
     
12,828
 
TOTAL LIABILITIES
   
1,072,104
     
1,043,224
 
STOCKHOLDERS' EQUITY:
               
Preferred Stock
               
  $1.00 par value; authorized 3,000,000 shares September 30, 2016 and December 31, 2015;
               
   none issued in 2016 or 2015
   
-
     
-
 
Common stock
               
$1.00 par value; authorized 15,000,000 shares; issued 3,704,375 at September 30, 2016 and
         
   3,671,751 at December 31, 2015
   
3,704
     
3,672
 
Additional paid-in capital
   
42,241
     
40,715
 
Retained earnings
   
89,501
     
85,790
 
Accumulated other comprehensive income (loss)
   
1,390
     
(236
)
Treasury stock, at cost:  358,811 shares at September 30, 2016
               
  and 335,876 shares at December 31, 2015
   
(11,286
)
   
(10,181
)
TOTAL STOCKHOLDERS' EQUITY
   
125,550
     
119,760
 
TOTAL LIABILITIES AND
               
   STOCKHOLDERS' EQUITY
 
$
1,197,654
   
$
1,162,984
 
 
               
The accompanying notes are an integral part of these unaudited consolidated financial statements.
         
 
1

 
CITIZENS FINANCIAL SERVICES, INC.
                       
CONSOLIDATED STATEMENT OF INCOME
                       
(UNAUDITED)
                       
 
 
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
(in thousands, except share and per share data)
 
2016
   
2015
   
2016
   
2015
 
INTEREST INCOME:
                       
Interest and fees on loans
 
$
9,204
   
$
7,248
   
$
26,387
   
$
21,416
 
Interest-bearing deposits with banks
   
50
     
33
     
185
     
103
 
Investment securities:
                               
    Taxable
   
897
     
798
     
2,800
     
2,317
 
    Nontaxable
   
733
     
749
     
2,259
     
2,398
 
    Dividends
   
64
     
35
     
205
     
168
 
TOTAL INTEREST INCOME
   
10,948
     
8,863
     
31,836
     
26,402
 
INTEREST EXPENSE:
                               
Deposits
   
1,048
     
1,044
     
3,194
     
3,088
 
Borrowed funds
   
188
     
174
     
554
     
521
 
TOTAL INTEREST EXPENSE
   
1,236
     
1,218
     
3,748
     
3,609
 
NET INTEREST INCOME
   
9,712
     
7,645
     
28,088
     
22,793
 
Provision for loan losses
   
500
     
120
     
770
     
360
 
NET INTEREST INCOME AFTER
                               
    PROVISION FOR LOAN LOSSES
   
9,212
     
7,525
     
27,318
     
22,433
 
NON-INTEREST INCOME:
                               
Service charges
   
1,115
     
1,054
     
3,345
     
3,058
 
Trust
   
161
     
149
     
539
     
523
 
Brokerage and insurance
   
211
     
181
     
578
     
563
 
Gains on loans sold
   
109
     
85
     
225
     
183
 
Investment securities gains, net
   
-
     
129
     
155
     
430
 
Earnings on bank owned life insurance
   
174
     
158
     
515
     
464
 
Other
   
138
     
109
     
450
     
327
 
TOTAL NON-INTEREST INCOME
   
1,908
     
1,865
     
5,807
     
5,548
 
NON-INTEREST EXPENSES:
                               
Salaries and employee benefits
   
4,285
     
3,069
     
12,067
     
9,118
 
Occupancy
   
485
     
347
     
1,385
     
1,064
 
Furniture and equipment
   
164
     
108
     
492
     
323
 
Professional fees
   
283
     
202
     
836
     
614
 
FDIC insurance
   
175
     
116
     
492
     
348
 
Pennsylvania shares tax
   
240
     
201
     
630
     
602
 
Amortization of intangibles
   
82
     
-
     
246
     
-
 
Merger and acquisition
   
-
     
282
     
-
     
405
 
ORE expenses (recovery)
   
(71
)
   
328
     
234
     
686
 
Other
   
1,557
     
1,199
     
5,031
     
3,455
 
TOTAL NON-INTEREST EXPENSES
   
7,200
     
5,852
     
21,413
     
16,615
 
Income before provision for income taxes
   
3,920
     
3,538
     
11,712
     
11,366
 
Provision for income taxes
   
767
     
681
     
2,245
     
2,200
 
NET INCOME
 
$
3,153
   
$
2,857
   
$
9,467
   
$
9,166
 
PER COMMON SHARE DATA:
                               
Net Income - Basic
 
$
0.94
   
$
0.94
   
$
2.83
   
$
3.00
 
Net Income - Diluted
 
$
0.94
   
$
0.94
   
$
2.83
   
$
3.00
 
Cash Dividends Paid
 
$
0.421
   
$
0.503
   
$
1.250
   
$
1.304
 
Number of shares used in computation - basic
   
3,339,962
     
3,044,311
     
3,346,623
     
3,051,826
 
Number of shares used in computation - diluted
   
3,341,656
     
3,045,775
     
3,348,321
     
3,053,294
 
The accompanying notes are an integral part of these unaudited consolidated financial statements.
                 
 
2

 
CITIZENS FINANCIAL SERVICES, INC.
                                               
CONSOLIDATED STATEMENT OF
                                               
       COMPREHENSIVE INCOME
       
`
                                     
(UNAUDITED)
                                               
 
 
Three Months Ended
   
Nine months Ended
 
 
 
September 30,
   
September 30,
 
(in thousands)
       
2016
         
2015
         
2016
         
2015
 
Net income
       
$
3,153
         
$
2,857
         
$
9,467
         
$
9,166
 
Other comprehensive income (loss):
                                                       
      Unrealized gain (loss) on available for sale securities
   
(1,049
)
           
1,094
             
2,439
             
390
         
      Income tax effect
   
357
             
(372
)
           
(830
)
           
(132
)
       
      Change in unrecognized pension cost
   
61
             
51
             
181
             
153
         
      Income tax effect
   
(21
)
           
(17
)
           
(62
)
           
(52
)
       
      Less:  Reclassification adjustment for investment
                                                               
                 security gains included in net income
   
-
             
(129
)
           
(155
)
           
(430
)
       
      Income tax effect
   
-
             
44
             
53
             
146
         
Other comprehensive income (loss), net of tax
           
(652
)
           
671
             
1,626
             
75
 
Comprehensive income
         
$
2,501
           
$
3,528
           
$
11,093
           
$
9,241
 
 
                                                               
The accompanying notes are an integral part of these unaudited consolidated financial statements.
 
 

3

CITIZENS FINANCIAL SERVICES, INC.
           
CONSOLIDATED STATEMENT OF CASH FLOWS
           
(UNAUDITED)
 
Nine Months Ended
 
 
 
September 30,
 
(in thousands)
 
2016
   
2015
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
  Net income
 
$
9,467
   
$
9,166
 
  Adjustments to reconcile net income to net
               
   cash provided by operating activities:
               
    Provision for loan losses
   
770
     
360
 
    Provision for off-balance sheet items
   
30
     
-
 
    Depreciation and amortization
   
265
     
370
 
    Amortization and accretion of investment securities
   
1,750
     
1,521
 
    Deferred income taxes
   
141
     
(39
)
    Investment securities gains, net
   
(155
)
   
(430
)
    Earnings on bank owned life insurance
   
(515
)
   
(464
)
    Originations of loans held for sale
   
(15,698
)
   
(13,510
)
    Proceeds from sales of loans held for sale
   
15,950
     
12,942
 
    Realized gains on loans sold
   
(225
)
   
(183
)
    Decrease in accrued interest receivable
   
223
     
78
 
    Decrease in accrued interest payable
   
(98
)
   
(63
)
    Other, net
   
(1,137
)
   
(842
)
      Net cash provided by operating activities
   
10,768
     
8,906
 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
  Available-for-sale securities:
               
    Proceeds from sales
   
12,077
     
18,393
 
    Proceeds from maturity and principal repayments
   
43,759
     
39,472
 
    Purchase of securities
   
(44,567
)
   
(58,667
)
  Purchase of interest bearing time deposits with other banks
   
-
     
(500
)
  Proceeds from matured interest bearing time deposits with other banks
   
744
     
-
 
  Proceeds from redemption of regulatory stock
   
459
     
2,150
 
  Purchase of regulatory stock
   
(1,138
)
   
(2,097
)
  Net increase in loans
   
(55,846
)
   
(29,148
)
  Purchase of premises and equipment
   
(500
)
   
(633
)
  Proceeds from sale of foreclosed assets held for sale
   
900
     
340
 
      Net cash used in investing activities
   
(44,112
)
   
(30,690
)
CASH FLOWS FROM FINANCING ACTIVITIES:
               
  Net increase in deposits
   
20,716
     
23,915
 
  Proceeds from long-term borrowings
   
541
     
5,288
 
  Repayments of long-term borrowings
   
(534
)
   
(700
)
  Net increase (decrease) in short-term borrowed funds
   
10,221
     
(1,730
)
  Purchase of treasury and restricted stock
   
(1,713
)
   
(2,315
)
  Dividends paid
   
(3,900
)
   
(3,783
)
      Net cash provided by financing activities
   
25,331
     
20,675
 
          Net decrease in cash and cash equivalents
   
(8,013
)
   
(1,109
)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
   
24,384
     
11,423
 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
 
$
16,371
   
$
10,314
 
Supplemental Disclosures of Cash Flow Information:
               
    Interest paid
 
$
3,846
   
$
3,672
 
    Income taxes paid
 
$
1,700
   
$
2,425
 
    Loans transferred to foreclosed property
 
$
633
   
$
241
 
    Investments sold and not settled
 
$
-
   
$
5,187
 
 
               
The accompanying notes are an integral part of these unaudited consolidated financial statements.
 

4

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

Note 1 - Basis of Presentation

 
Citizens Financial Services, Inc. (individually and collectively with its direct and indirect subsidiaries, the "Company") is a Pennsylvania corporation organized as the holding company of its wholly owned subsidiary, First Citizens Community Bank (the "Bank"), and the Bank's wholly owned subsidiary, First Citizens Insurance Agency, Inc. ("First Citizens Insurance"). On December 11, 2015, the Company completed its acquisition of The First National Bank of Fredericksburg (FNB) by merging FNB into the Bank.

The accompanying consolidated financial statements have been prepared pursuant to rules and regulations of the Securities and Exchange Commission ("SEC") and in conformity with U.S. generally accepted accounting principles.  Because this report is based on an interim period, certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted.  Certain of the prior year amounts have been reclassified to conform with the current year presentation.  Such reclassifications had no effect on net income or stockholders' equity.  All material inter‑company balances and transactions have been eliminated in consolidation.

In the opinion of management of the Company, the accompanying interim financial statements at September 30, 2016 and for the periods ended September 30, 2016 and 2015 include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the financial condition and the results of operations for the periods. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. The financial performance reported for the Company for the nine month period ended September 30, 2016 is not necessarily indicative of the results to be expected for the full year.  This information should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2015.

Note 2 - Earnings per Share

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

   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
Net income applicable to common stock
 
$
3,153,000
   
$
2,857,000
   
$
9,467,000
   
$
9,166,000
 
 
                               
Basic earnings per share computation
                               
Weighted average common shares outstanding
   
3,339,962
     
3,044,311
     
3,346,623
     
3,051,826
 
Earnings per share - basic
 
$
0.94
   
$
0.94
   
$
2.83
   
$
3.00
 
 
                               
Diluted earnings per share computation
                               
Weighted average common shares outstanding for basic earnings per share
   
3,339,962
     
3,044,311
     
3,346,623
     
3,051,826
 
Add: Dilutive effects of restricted stock
   
1,694
     
1,464
     
1,698
     
1,468
 
Weighted average common shares outstanding for dilutive earnings per share
   
3,341,656
     
3,045,775
     
3,348,321
     
3,053,294
 
Earnings per share - diluted
 
$
0.94
   
$
0.94
   
$
2.83
   
$
3.00
 

For the three months ended September 30, 2016 and 2015, there were 3,804 and 2,696 shares, respectively, related to the restricted stock plan that were excluded from the diluted earnings per share calculations since they were anti-dilutive. These anti-dilutive shares had per share prices ranging from $46.69-$53.15 for the three month period ended September 30, 2016 and per share prices ranging from $44.50-$53.15 for the three month period ended September 30, 2015. For the nine months ended September 30, 2016 and 2015, 3,804 and 2,696 shares, respectively, related to the restricted stock plan were excluded from the diluted earnings per share calculations since they were anti-dilutive. These anti-dilutive shares had per share prices ranging from $46.69-$53.15 for the nine month period ended September 30, 2016 and per share prices ranging from $44.50-$53.15 for the nine month period ended September 30, 2015.

5

Note 3 - Income Tax Expense

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

Investments in Qualified Affordable Housing Projects

As of September 30, 2016 and December 31, 2015, the Company was invested in four partnerships that provide affordable housing. The balance of the investments, which is included within other assets in the Consolidated Balance Sheet, was $765,000 and $959,000 as of September 30, 2016 and December 31, 2015, respectively. Investments purchased prior to January 1, 2015, are accounted for utilizing the effective yield method. As of September 30, 2016, the Company had $895,000 of tax credits remaining that will be recognized over 6.25 years. Tax credits of $50,000 were recognized as a reduction of tax expense during the three months ended September 30, 2016 and 2015. Tax credits of $149,000 were recognized as a reduction of tax expense during the nine months ended September 30, 2016 and 2015.

Note 4 – Investments

The amortized cost, gross unrealized gains and losses, and fair value of investment securities at September 30, 2016 and December 31, 2015 were as follows (in thousands):

 
       
Gross
   
Gross
       
 
 
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
September 30, 2016
 
Cost
   
Gains
   
Losses
   
Value
 
Available-for-sale securities:
                       
  U.S. agency securities
 
$
188,936
   
$
1,839
   
$
(9
)
 
$
190,766
 
  U.S. treasury securities
   
5,013
     
7
     
-
     
5,020
 
  Obligations of state and
                               
    political subdivisions
   
99,557
     
2,702
     
(37
)
   
102,222
 
  Corporate obligations
   
14,359
     
17
     
-
     
14,376
 
  Mortgage-backed securities in
                               
    government sponsored entities
   
33,665
     
420
     
(33
)
   
34,052
 
  Equity securities in financial
                               
     institutions
   
2,002
     
716
     
-
     
2,718
 
Total available-for-sale securities
 
$
343,532
   
$
5,701
   
$
(79
)
 
$
349,154
 
 
                               
December 31, 2015
                               
Available-for-sale securities:
                               
  U.S. agency securities
 
$
199,749
   
$
369
   
$
(527
)
 
$
199,591
 
  U.S. treasury securities
   
10,103
     
-
     
(21
)
   
10,082
 
  Obligations of state and
                               
    political subdivisions
   
99,856
     
3,080
     
(73
)
   
102,863
 
  Corporate obligations
   
14,583
     
68
     
(86
)
   
14,565
 
  Mortgage-backed securities in
                               
    government sponsored entities
   
30,107
     
186
     
(89
)
   
30,204
 
  Equity securities in financial institutions
   
2,001
     
436
     
(5
)
   
2,432
 
Total available-for-sale securities
 
$
356,399
   
$
4,139
   
$
(801
)
 
$
359,737
 

The following table shows the Company's gross unrealized losses and fair value of the Company's investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time, which individual securities have been in a continuous unrealized loss position, at September 30, 2016 and December 31, 2015 (in thousands). As of September 30, 2016, the Company owned 24 securities whose fair value was less than their cost basis.

6


September 30, 2016
 
Less than Twelve Months
   
Twelve Months or Greater
   
Total
 
         
Gross
         
Gross
         
Gross
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
 
 
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
U.S. agency securities
 
$
6,998
   
$
(9
)
 
$
-
   
$
-
   
$
6,998
   
$
(9
)
Obligations of state and
                                               
    political subdivisions
   
9,244
     
(37
)
   
-
     
-
     
9,244
     
(37
)
Mortgage-backed securities in
                                               
   government sponsored entities
   
3,568
     
(18
)
   
1,855
     
(15
)
   
5,423
     
(33
)
    Total securities
 
$
19,810
   
$
(64
)
 
$
1,855
   
$
(15
)
 
$
21,665
   
$
(79
)
                                                 
December 31, 2015
                                               
U.S. agency securities
 
$
123,591
   
$
(527
)
 
$
-
   
$
-
   
$
123,591
   
$
(527
)
U.S. treasury securities
   
10,082
     
(21
)
   
-
     
-
     
10,082
     
(21
)
Obligations of states and
                                               
     political subdivisions
   
7,023
     
(57
)
   
2,914
     
(16
)
   
9,937
     
(73
)
Corporate obligations
   
5,822
     
(61
)
   
2,138
     
(25
)
   
7,960
     
(86
)
Mortgage-backed securities in
                                               
   government sponsored entities
   
9,830
     
(77
)
   
227
     
(12
)
   
10,057
     
(89
)
Equity securities in financial institutions
   
106
     
(5
)
   
-
     
-
     
106
     
(5
)
    Total securities
 
$
156,454
   
$
(748
)
 
$
5,279
   
$
(53
)
 
$
161,733
   
$
(801
)

As of September 30, 2016, the Company's investment securities portfolio contained unrealized losses on agency securities issued or backed by the full faith and credit of the United States government or are generally viewed as having the implied guarantee of the U.S. government, obligations of states and political subdivisions and mortgage backed securities issued by government sponsored entities. For fixed maturity investments management considers whether the present value of cash flows expected to be collected are less than the security's amortized cost basis (the difference defined as the credit loss), the magnitude and duration of the decline, the reasons underlying the decline and the Company's intent to sell the security or whether it is more likely than not that the Company would be required to sell the security before its anticipated recovery in market value, to determine whether the loss in value is other than temporary. Once a decline in value is determined to be other than temporary, if the Company does not intend to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of the security's amortized cost basis, the charge to earnings is limited to the amount of credit loss. Any remaining difference between fair value and amortized cost (the difference defined as the non-credit portion) is recognized in other comprehensive income, net of applicable taxes. Otherwise, the entire difference between fair value and amortized cost is charged to earnings. For equity securities where the fair value has been significantly below cost for one year, the Company's policy is to recognize an impairment loss unless sufficient evidence is available that the decline is not other than temporary and a recovery period can be predicted.  The Company has concluded that any impairment of its investment securities portfolio outlined in the above table is not other than temporary and is the result of interest rate changes, sector credit rating changes, or issuer-specific rating changes that are not expected to result in the non-collection of principal and interest during the period.

Proceeds from sales of securities available-for-sale for the nine months ended September 30, 2016 and 2015 were $12,077,000 and $18,393,000, respectively. There were no sales of available for sale securities during the three months ended September 30, 2016.  For the three months ended September 30, 2015 there were sales of $5,187,000 of available-for-sale securities. The gross gains and losses were as follows (in thousands):

 
 
Three Months Ended
   
Nine Months Ended
 
 
 
September 30,
   
September 30,
 
 
 
2016
   
2015
   
2016
   
2015
 
Gross gains
 
$
-
   
$
129
   
$
155
   
$
441
 
Gross losses
   
-
     
-
     
-
     
(11
)
Net gains
 
$
-
   
$
129
   
$
155
   
$
430
 

7

Investment securities with an approximate carrying value of $224.9 million and $203.8 million at September 30, 2016 and December 31, 2015, respectively, were pledged to secure public funds and certain other deposits.

Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.   The amortized cost and fair value of debt securities at September 30, 2016, by contractual maturity, are shown below (in thousands):

 
 
Amortized
       
 
 
Cost
   
Fair Value
 
Available-for-sale debt securities:
           
  Due in one year or less
 
$
49,510
   
$
49,724
 
  Due after one year through five years
   
173,075
     
175,690
 
  Due after five years through ten years
   
41,247
     
42,129
 
  Due after ten years
   
77,698
     
78,893
 
Total
 
$
341,530
   
$
346,436
 

Note 5 – Loans

The Company grants loans primarily to customers throughout north central, central and south central Pennsylvania and the southern tier of New York.  Although the Company had a diversified loan portfolio at September 30, 2016 and December 31, 2015, a substantial portion of its debtors' ability to honor their contracts is dependent on the economic conditions within these regions. The following table summarizes the primary segments of the loan portfolio and how those segments are analyzed within the allowance for loan losses as of September 30, 2016 and December 31, 2015 (in thousands):

September 30, 2016
 
Total Loans
   
Individually
evaluated for impairment
   
Loans acquired
with deteriorated
credit quality
   
Collectively
evaluated for impairment
 
Real estate loans:
                       
     Residential
 
$
205,092
   
$
969
   
$
35
   
$
204,088
 
     Commercial and agricultural
   
339,704
     
5,567
     
2,748
     
331,389
 
     Construction
   
18,774
     
-
     
-
     
18,774
 
Consumer
   
11,226
     
-
     
4
     
11,222
 
Other commercial and agricultural loans
   
78,258
     
5,428
     
778
     
72,052
 
State and political subdivision loans
   
98,239
     
-
     
-
     
98,239
 
Total
   
751,293
     
11,964
     
3,565
     
735,764
 
Allowance for loan losses
   
8,194
     
482
     
-
     
7,712
 
Net loans
 
$
743,099
   
$
11,482
   
$
3,565
   
$
728,052
 
 
                               
December 31, 2015
                               
Real estate loans:
                               
     Residential
 
$
203,407
   
$
304
   
$
35
   
$
203,068
 
     Commercial and agricultural
   
295,364
     
6,235
     
2,908
     
286,221
 
     Construction
   
15,011
     
-
     
-
     
15,011
 
Consumer
   
11,543
     
-
     
9
     
11,534
 
Other commercial and agricultural loans
   
71,206
     
5,745
     
866
     
64,595
 
State and political subdivision loans
   
98,500
     
-
     
-
     
98,500
 
Total
   
695,031
     
12,284
     
3,818
     
678,929
 
Allowance for loan losses
   
7,106
     
355
     
-
     
6,751
 
Net loans
 
$
687,925
   
$
11,929
   
$
3,818
   
$
672,178
 

Purchased loans acquired in the FNB acquisition were recorded at fair value on their purchase date without a carryover of the related allowance for loan losses.

Upon acquisition, the Company evaluated whether an acquired loan was within the scope of ASC 310-30, Receivables-Loans and Debt Securities Acquired with Deteriorated Credit Quality. Purchased credit-impaired ("PCI") loans are loans that have evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. Based upon management's review, there were no material increases or decreases in the expected cash flows of these loans between December 11, 2015 (the "acquisition date") and September 30, 2016. The fair value of PCI loans, on the acquisition date, was determined, primarily based on the fair value of the loans' collateral. The carrying value of PCI loans was $3,565,000 and $3,818,000 at September 30, 2016 and December 31, 2015, respectively.

8

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

The carrying value of the PCI loans was determined by projected discounted contractual cash flows.

Changes in the accretable yield for PCI loans were as follows for the three and nine months ended September 30, 2016 (in thousands):

 
 
Three Months Ended
   
Nine months
Ended
 
Balance at beginning of period
 
$
464
   
$
637
 
Accretion
   
(88
)
   
(261
)
Balance at end of period
 
$
376
   
$
376
 

The following table presents additional information regarding loans acquired with specific evidence of deterioration in credit quality under ASC 310-30 (in thousands):

   
September 30, 2016
   
December 31, 2015
 
Outstanding balance
 
$
6,774
   
$
6,950
 
Carrying amount
   
3,565
     
3,818
 

The segments of the Company's loan portfolio are disaggregated into classes to a level that allows management to monitor risk and performance. Residential real estate mortgages consist primarily of 15 to 30 year first mortgages on residential real estate, while residential real estate home equity loans are consumer purpose installment loans or lines of credit with terms of 15 years or less secured by a mortgage which is often a second lien on residential real estate. Commercial real estate loans are business purpose loans secured by a mortgage on commercial real estate. Agricultural real estate loans are loans secured by a mortgage on real estate used in agriculture production. Construction real estate loans are loans secured by residential or commercial real estate used during the construction phase of residential and commercial projects. Consumer loans are typically unsecured or primarily secured by assets other than real estate and overdraft lines of credit are typically secured by customer deposit accounts. Other commercial loans are loans for commercial purposes primarily secured by non-real estate collateral. Other agricultural loans are loans for agricultural purposes primarily secured by non-real estate collateral. State and political subdivision loans are loans to state and local municipalities for capital and operating expenses or tax free loans used to finance commercial development.

Management considers commercial loans, other agricultural loans, state and political subdivision loans, commercial real estate loans and agricultural real estate loans which are 90 days or more past due to be impaired. Management will also consider a loan impaired based on other factors it becomes aware of, including the customer's results of operations and cash flows or if the loan is modified in a troubled debt restructuring. In addition, certain residential mortgages, home equity and consumer loans that are cross collateralized with commercial relationships that are determined to be impaired may also be classified as impaired. Impaired loans are analyzed to determine if it is probable that all amounts will not be collected according to the contractual terms of the loan agreement. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allocation of the allowance for loan losses or a charge-off to the allowance for loan losses.

9

The following table includes the recorded investment and unpaid principal balances for impaired financing receivables by class, excluding PCI loans, with the associated allowance amount, if applicable (in thousands):

 
       
Recorded
   
Recorded
             
 
 
Unpaid
   
Investment
   
Investment
   
Total
       
 
 
Principal
   
With No
   
With
   
Recorded
   
Related
 
September 30, 2016
 
Balance
   
Allowance
   
Allowance
   
Investment
   
Allowance
 
Real estate loans:
                             
     Mortgages
 
$
959
   
$
574
   
$
337
   
$
911
   
$
28
 
     Home Equity
   
58
     
-
     
58
     
58
     
11
 
     Commercial
   
7,722
     
5,437
     
130
     
5,567
     
46
 
     Agricultural
   
-
     
-
     
-
     
-
     
-
 
     Construction
   
-
     
-
     
-
     
-
     
-
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other commercial loans
   
5,591
     
4,494
     
934
     
5,428
     
397
 
Other agricultural loans
   
-
     
-
     
-
     
-
     
-
 
State and political
                                       
   subdivision loans
   
-
     
-
     
-
     
-
     
-
 
Total
 
$
14,330
   
$
10,505
   
$
1,459
   
$
11,964
   
$
482
 
 
                                       
December 31, 2015
                                       
Real estate loans:
                                       
     Mortgages
 
$
281
   
$
114
   
$
129
   
$
243
   
$
26
 
     Home Equity
   
61
     
-
     
61
     
61
     
11
 
     Commercial
   
8,654
     
5,843
     
225
     
6,068
     
62
 
     Agricultural
   
167
     
167
     
-
     
167
     
-
 
     Construction
   
-
     
-
     
-
     
-
     
-
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other commercial loans
   
5,535
     
4,653
     
987
     
5,640
     
256
 
Other agricultural loans
   
105
     
105
     
-
     
105
     
-
 
State and political
                                       
   subdivision loans
   
-
     
-
     
-
     
-
     
-
 
Total
 
$
14,803
   
$
10,882
   
$
1,402
   
$
12,284
   
$
355
 

The following tables includes the average balance of impaired financing receivables by class and the income recognized on these receivables for the three and nine month periods ended September 30, 2016 and 2015(in thousands):
 
10


 
 
For the Nine Months ended
 
 
 
September 30, 2016
   
September 30, 2015
 
 
             
Interest
               
Interest
 
 
 
Average
   
Interest
   
Income
   
Average
   
Interest
   
Income
 
 
 
Recorded
   
Income
   
Recognized
   
Recorded
   
Income
   
Recognized
 
 
 
Investment
   
Recognized
   
Cash Basis
   
Investment
   
Recognized
   
Cash Basis
 
Real estate loans:
                                   
     Mortgages
 
$
486
   
$
10
   
$
-
   
$
239
   
$
8
   
$
5
 
     Home Equity
   
59
     
3
     
-
     
97
     
3
     
-
 
     Commercial
   
6,088
     
87
     
-
     
5,728
     
46
     
-
 
     Agricultural
   
110
     
7
     
-
     
19
     
1
     
-
 
     Construction
   
-
     
-
     
-
     
-
     
-
     
-
 
Consumer
   
-
     
-
     
-
     
-
     
-
     
-
 
Other commercial loans
   
5,743
     
187
     
5
     
2,488
     
64
     
4
 
Other agricultural loans
   
70
     
3
     
-
     
13
     
1
     
-
 
State and political
                                               
   subdivision loans
   
-
     
-
     
-
     
-
     
-
     
-
 
Total
 
$
12,556
   
$
297
   
$
5
   
$
8,584
   
$
123
   
$
9
 
 
                                               
 
 
For the Three Months Ended
 
 
 
September 30, 2016
   
September 30, 2015
 
Real estate loans:
                                               
     Mortgages
 
$
607
   
$
1
   
$
-
   
$
269
   
$
4
   
$
-
 
     Home Equity
   
58
     
1
     
-
     
62
     
1
     
-
 
     Commercial
   
5,980
     
35
     
-
     
5,462
     
14
     
-
 
     Agricultural
   
-
     
2
     
-
     
57
     
1
     
-
 
     Construction
   
-
     
-
     
-
     
-
     
-
     
-
 
Consumer
   
-
     
-
     
-
     
-
     
-
     
-
 
Other commercial loans
   
5,298
     
53
     
2
     
2,107
     
15
     
1
 
Other agricultural loans
   
-
     
-
     
-
     
38
     
1
     
-
 
State and political
                                               
   subdivision loans
   
-
     
-
     
-
     
-
     
-
     
-
 
Total
 
$
11,943
   
$
92
   
$
2
   
$
7,995
   
$
36
   
$
1
 

Credit Quality Information

For commercial real estate, agricultural real estate, construction, other commercial, other agricultural and state and political subdivision loans, management uses a nine grade internal risk rating system to monitor credit quality. The first five categories are considered not criticized and are aggregated as "Pass" rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The definitions of each rating are defined below:
·
Pass (Grades 1-5) – These loans are to customers with credit quality ranging from an acceptable to very high quality and are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral.
·
Special Mention (Grade 6) – This loan grade is in accordance with regulatory guidance and includes loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected.
·
Substandard (Grade 7) – This loan grade is in accordance with regulatory guidance and includes loans that have a well-defined weakness based on objective evidence and be characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
·
Doubtful (Grade 8) – This loan grade is in accordance with regulatory guidance and includes loans that have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, based on existing circumstances.
 
11

·
Loss (Grade 9) – This loan grade is in accordance with regulatory guidance and includes loans that are considered uncollectible, or of such value that continuance as an asset is not warranted.
 
To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay the loan as agreed, the Company's loan rating process includes several layers of internal and external oversight. The Company's loan officers are responsible for the timely and accurate risk rating of the loans in each of their portfolios at origination and on an ongoing basis under the supervision of management.  All commercial and agricultural loans are reviewed annually to ensure the appropriateness of the loan grade. In addition, the Company engages an external consultant on at least an annual basis to 1) review a minimum of 55% of the dollar volume of the commercial loan portfolio on an annual basis, 2) review new loans originated for over $1.0 million in the last year, 3) review a majority of borrowers with commitments greater than or equal to $1.0 million,  4) review selected loan relationships over $750,000 which are over 30 days past due or classified Special Mention, Substandard, Doubtful, or Loss, and 5) such other loans which management or the consultant deems appropriate.

The following tables represent credit exposures by internally assigned grades as of September 30, 2016 and December 31, 2015 (in thousands):

September 30, 2016
 
Pass
   
Special Mention
   
Substandard
   
Doubtful
   
Loss
   
Ending Balance
 
Real estate loans:
                                   
     Commercial
 
$
221,715
   
$
13,935
   
$
15,471
   
$
28
   
$
-
   
$
251,149
 
     Agricultural
   
76,500
     
8,969
     
3,086
     
-
     
-
     
88,555
 
     Construction
   
18,774
     
-
     
-
     
-
     
-
     
18,774
 
Other commercial loans
   
49,987
     
1,964
     
4,980
     
131
     
-
     
57,062
 
Other agricultural loans
   
17,383
     
2,350
     
1,463
     
-
     
-
     
21,196
 
State and political
                                               
   subdivision loans
   
84,541
     
13,698
     
-
     
-
     
-
     
98,239
 
Total
 
$
468,900
   
$
40,916
   
$
25,000
   
$
159
   
$
-
   
$
534,975
 
 
                                               
December 31, 2015
                                               
Real estate loans:
                                               
     Commercial
 
$
217,544
   
$
4,150
   
$
15,816
   
$
32
   
$
-
   
$
237,542
 
     Agricultural
   
53,695
     
2,865
     
1,262
     
-
     
-
     
57,822
 
     Construction
   
14,422
     
589
     
-
     
-
     
-
     
15,011
 
Other commercial loans
   
51,297
     
446
     
5,669
     
137
     
-
     
57,549
 
Other agricultural loans
   
13,318
     
234
     
105
     
-
     
-
     
13,657
 
State and political
                                               
   subdivision loans
   
98,500
     
-
     
-
     
-
     
-
     
98,500
 
Total
 
$
448,776
   
$
8,284
   
$
22,852
   
$
169
   
$
-
   
$
480,081
 

For residential real estate mortgages, home equity and consumer loans, credit quality is monitored based on whether the loan is performing or non-performing, which is typically based on the aging status of the loan and payment activity, unless a specific action, such as bankruptcy, repossession, death or significant delay in payment occurs to raise awareness of a possible credit event. Non-performing loans include those loans that are considered nonaccrual, described in more detail below, and all loans past due 90 or more days and still accruing. The following table presents the recorded investment in those loan classes based on payment activity as of September 30, 2016 and December 31, 2015 (in thousands):

September 30, 2016
 
Performing
   
Non-performing
   
PCI
   
Total
 
Real estate loans:
                       
     Mortgages
 
$
144,249
   
$
1,846
   
$
35
   
$
146,130
 
     Home Equity
   
58,845
     
117
     
-
     
58,962
 
Consumer
   
11,146
     
76
     
4
     
11,226
 
Total
 
$
214,240
   
$
2,039
   
$
39
   
$
216,318
 
 
12


December 31, 2015
 
Performing
   
Non-performing
   
PCI
   
Total
 
Real estate loans:
                       
     Mortgages
 
$
139,734
   
$
1,270
   
$
35
   
$
141,039
 
     Home Equity
   
62,236
     
132
     
-
   
$
62,368
 
Consumer
   
11,470
     
64
     
9