Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
⌧ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2023
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: 000-16084
CITIZENS & NORTHERN CORPORATION
(Exact name of Registrant as specified in its charter)
PENNSYLVANIA
23-2451943
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
90-92 MAIN STREET, WELLSBORO, PA 16901
(Address of principal executive offices) (Zip code)
570-724-3411
(Registrant’s telephone number including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Trading Symbol
Name of Each Exchange on Which Registered
Common Stock Par Value $1.00
CZNC
NASDAQ Capital Market
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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes ⌧ No ◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definition of “large accelerated filer,” accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ◻ Accelerated filer ⌧ Non-accelerated filer ◻ Smaller reporting company ☐ Emerging growth company ◻
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No ⌧
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.
Common Stock ($1.00 par value)
15,274,766 Shares Outstanding on November 2, 2023
CITIZENS & NORTHERN CORPORATION – FORM 10-Q
Index
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets (Unaudited) –September 30, 2023 and December 31, 2022
Page 3
Consolidated Statements of Income (Unaudited) – Three-month and Nine-month Periods Ended September 30, 2023 and 2022
Page 4
Consolidated Statements of Comprehensive Income (Loss) (Unaudited) – Three-month and Nine-month Periods Ended September 30, 2023 and 2022
Page 5
Consolidated Statements of Cash Flows (Unaudited) – Nine-month Periods Ended September 30, 2023 and 2022
Page 6
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) – Three-month and Nine-month Periods Ended September 30, 2023 and 2022
Page 7
Notes to Unaudited Consolidated Financial Statements
Pages 8 – 39
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Pages 40 – 65
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Pages 66 – 68
Item 4. Controls and Procedures
Page 68
Part II. Other Information
Pages 69 – 71
Signatures
Page 72
2
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share and Per Share Data) (Unaudited)
September 30,
December 31,
2023
2022
ASSETS
Cash and due from banks:
Noninterest-bearing
$
25,775
25,811
Interest-bearing
26,883
29,237
Total cash and due from banks
52,658
55,048
Available-for-sale debt securities, at fair value
429,138
498,033
Loans receivable
1,830,670
1,740,040
Allowance for credit losses on loans
(18,085)
(16,615)
Loans, net
1,812,585
1,723,425
Bank-owned life insurance
31,557
31,214
Accrued interest receivable
9,311
8,653
Bank premises and equipment, net
21,267
21,574
Foreclosed assets held for sale
633
275
Deferred tax asset, net
23,731
20,884
Goodwill
52,505
Core deposit intangibles, net
2,571
2,877
Other assets
47,993
39,819
TOTAL ASSETS
2,483,949
2,454,307
LIABILITIES
Deposits:
495,829
563,843
1,529,168
1,433,750
Total deposits
2,024,997
1,997,593
Short-term borrowings
23,253
80,062
Long-term borrowings - FHLB advances
125,276
62,347
Senior notes, net
14,814
14,765
Subordinated debt, net
24,689
24,607
Accrued interest and other liabilities
30,715
25,608
TOTAL LIABILITIES
2,243,744
2,204,982
STOCKHOLDERS' EQUITY
Preferred stock, $1,000 par value; authorized 30,000 shares; $1,000 liquidation
preference per share; no shares issued
0
Common stock, par value $1.00 per share; authorized 30,000,000 shares;
issued 16,030,172 and outstanding 15,275,686 at September 30, 2023;
issued 16,030,172 and outstanding 15,518,819 at December 31, 2022
16,030
Paid-in capital
143,972
143,950
Retained earnings
157,044
151,743
Treasury stock, at cost; 754,486 shares at September 30, 2023 and 511,353
shares at December 31, 2022
(17,015)
(12,520)
Accumulated other comprehensive loss
(59,826)
(49,878)
TOTAL STOCKHOLDERS' EQUITY
240,205
249,325
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY
The accompanying notes are an integral part of these unaudited consolidated financial statements.
3
Consolidated Statements of Income
(In Thousands Except Per Share Data) (Unaudited)
Three Months Ended
Nine Months Ended
INTEREST INCOME
Interest and fees on loans:
Taxable
25,529
20,085
72,322
56,561
Tax-exempt
552
505
1,687
1,426
Income from available-for-sale debt securities:
2,077
2,138
6,440
6,143
597
768
1,847
2,258
Other interest and dividend income
363
214
972
404
Total interest and dividend income
29,118
23,710
83,268
66,792
INTEREST EXPENSE
Interest on deposits
7,264
1,972
15,593
4,012
Interest on short-term borrowings
677
179
2,918
302
Interest on long-term borrowings - FHLB advances
1,164
332
2,901
436
Interest on senior notes, net
120
119
359
357
Interest on subordinated debt, net
230
229
691
849
Total interest expense
9,455
2,831
22,462
5,956
Net interest income
19,663
20,879
60,806
60,836
(Credit) provision for credit losses
(1,225)
3,794
(765)
4,993
Net interest income after (credit) provision for credit losses
20,888
17,085
61,571
55,843
NONINTEREST INCOME
Trust revenue
1,919
1,744
5,500
5,245
Brokerage and insurance revenue
394
696
1,189
1,784
Service charges on deposit accounts
1,443
1,105
4,121
3,662
Interchange revenue from debit card transactions
1,098
1,031
3,115
3,050
Net gains from sale of loans
237
131
450
733
Loan servicing fees, net
154
189
466
757
Increase in cash surrender value of life insurance
160
133
405
Other noninterest income
1,084
622
3,442
2,666
Realized gains on available-for-sale debt securities, net
20
6
21
Total noninterest income
6,489
5,671
18,739
18,323
NONINTEREST EXPENSE
Salaries and employee benefits
10,878
10,826
33,082
31,698
Net occupancy and equipment expense
1,268
1,498
3,993
4,217
Data processing and telecommunications expense
1,823
1,719
5,659
5,062
Automated teller machine and interchange expense
504
397
1,374
1,128
Pennsylvania shares tax
403
487
1,210
1,463
Professional fees
521
1,988
1,490
Other noninterest expense
2,577
1,995
8,443
6,310
Total noninterest expense
17,940
17,443
55,749
51,368
Income before income tax provision
9,437
5,313
24,561
22,798
Income tax provision
1,846
858
4,674
3,959
NET INCOME
7,591
4,455
19,887
18,839
EARNINGS PER COMMON SHARE - BASIC
0.50
0.29
1.29
1.21
EARNINGS PER COMMON SHARE - DILUTED
4
Consolidated Statements of Comprehensive Income (Loss)
(In Thousands) (Unaudited)
Net income
Available-for-sale debt securities:
Unrealized holding losses on available-for-sale debt securities
(14,865)
(25,880)
(12,535)
(77,923)
Reclassification adjustment for gains realized in income
(20)
(6)
(21)
Other comprehensive loss on available-for-sale debt securities
(25,900)
(12,541)
(77,944)
Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses
(8)
Amortization of prior service cost and net actuarial loss included in net periodic benefit cost
(14)
(9)
(42)
(31)
Other comprehensive (loss) income on pension and postretirement obligations
(50)
102
Other comprehensive loss before income tax
(14,879)
(25,909)
(12,591)
(77,842)
Income tax related to other comprehensive loss
3,126
5,442
2,643
16,347
Net other comprehensive loss
(11,753)
(20,467)
(9,948)
(61,495)
Comprehensive (loss) income
(4,162)
(16,012)
9,939
(42,656)
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES:
Adjustments to reconcile net income to net cash provided by operating activities:
Net amortization of securities
1,556
2,174
(450)
(405)
Depreciation and amortization of bank premises and equipment
1,633
1,780
Net accretion of purchase accounting adjustments
(198)
(1,017)
Stock-based compensation
1,015
1,169
Deferred income taxes
235
(93)
Decrease (increase) in fair value of servicing rights
136
(128)
Gains on sales of loans, net
(733)
Origination of loans held for sale
(14,568)
(25,003)
Proceeds from sales of loans held for sale
14,341
26,752
Increase in accrued interest receivable and other assets
(1,175)
(1,562)
Increase (decrease) in accrued interest payable and other liabilities
4,588
(352)
Other
22
148
Net Cash Provided by Operating Activities
25,801
26,541
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of certificates of deposit
(250)
Proceeds from maturities of certificates of deposit
3,000
750
Proceeds from sales of available-for-sale debt securities
18,357
4,100
Proceeds from calls and maturities of available-for-sale debt securities
44,208
50,263
Purchase of available-for-sale debt securities
(8,215)
(104,601)
Redemption of Federal Home Loan Bank of Pittsburgh stock
19,503
10,765
Purchase of Federal Home Loan Bank of Pittsburgh stock
(19,905)
(12,009)
Purchase of Federal Reserve Bank stock
(6,243)
Net increase in loans
(89,998)
(126,792)
Proceeds from bank owned life insurance
147
Purchase of premises and equipment
(1,381)
(2,986)
Proceeds from sale of foreclosed assets
62
351
109
161
Net Cash Used in Investing Activities
(40,356)
(180,248)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits
27,425
114,667
Net (decrease) increase in short-term borrowings
(56,809)
654
Proceeds from long-term borrowings - FHLB advances
70,049
39,041
Repayments of long-term borrowings - FHLB advances
(7,078)
(11,430)
Redemption of subordinated debt
(8,500)
Sale of treasury stock
141
Purchases of treasury stock
(6,719)
(9,349)
Common dividends paid
(11,703)
(11,921)
Net Cash Provided by Financing Activities
15,165
113,303
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
610
(40,404)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
47,698
95,848
CASH AND CASH EQUIVALENTS, END OF PERIOD
48,308
55,444
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
(Decrease) increase in accrued purchase of available-for-sale debt securities
(454)
Assets acquired through foreclosure of real estate loans
390
51
Leased assets obtained in exchange for new operating lease liabilities
904
Interest paid
21,392
5,729
Income taxes paid
4,667
3,835
Consolidated Statements of Changes in Stockholders’ Equity
(In Thousands Except Share and Per Share Data) (Unaudited)
Accumulated
Common
Treasury
Paid-in
Retained
Comprehensive
Three Months Ended September 30, 2023
Shares
Stock
Capital
Earnings
Loss
Total
Balance, June 30, 2023
16,030,172
762,076
143,661
153,725
(48,073)
(17,226)
248,117
Other comprehensive loss, net
Cash dividends declared on common stock, $.28 per share
(4,272)
Shares issued for dividend reinvestment plan
(20,184)
(36)
457
421
Forfeiture of restricted stock
1,073
27
(27)
Stock-based compensation expense
320
Purchase of restricted stock for tax withholding
838
(16)
Treasury stock purchases
10,683
(203)
Balance, September 30, 2023
754,486
Three Months Ended September 30, 2022
Balance, June 30, 2022
530,958
143,417
148,187
(36,002)
(13,013)
258,619
(4,338)
(16,019)
8
392
400
3,638
81
(81)
388
910
(22)
10,269
(246)
Balance, September 30, 2022
529,756
143,894
148,304
(56,469)
(12,970)
238,789
Nine Months Ended September 30, 2023
(Loss) Income
Balance, December 31, 2022
511,353
Adoption of ASU 2016-13 (CECL)
(1,652)
Cash dividends declared on common stock, $.84 per share
(12,934)
(60,871)
(182)
1,413
1,231
Restricted stock granted
(53,788)
(1,314)
1,314
23,039
503
(503)
9,453
(219)
325,300
(6,500)
Nine Months Ended September 30, 2022
Balance, December 31, 2021
271,082
144,453
142,612
5,026
(6,716)
301,405
(13,147)
(49,221)
10
1,216
1,226
Shares issued from treasury related to exercise of stock options
(7,024)
(34)
175
(78,243)
(1,932)
1,932
10,782
228
(228)
6,964
(175)
375,416
(9,174)
7
1. BASIS OF INTERIM PRESENTATION AND STATUS OF RECENT ACCOUNTING PRONOUNCEMENTS
The consolidated financial statements include the accounts of Citizens & Northern Corporation and its subsidiaries, Citizens & Northern Bank (“C&N Bank”), Bucktail Life Insurance Company and Citizens & Northern Investment Corporation (collectively, “Corporation”). The consolidated financial statements also include C&N Bank’s wholly-owned subsidiaries, C&N Financial Services, LLC and Northern Tier Holding LLC. C&N Bank is the sole member of C&N Financial Services, LLC and Northern Tier Holding LLC. All material intercompany balances and transactions have been eliminated in consolidation.
The consolidated financial information included herein, except the consolidated balance sheet dated December 31, 2022, is unaudited. Such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations, comprehensive income, cash flows and changes in stockholders’ equity for the interim periods; however, the information does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for a complete set of financial statements. Certain 2022 information has been reclassified for consistency with the 2023 presentation.
Operating results reported for the nine-month period ended September 30, 2023 might not be indicative of the results for the year ending December 31, 2023. The Corporation evaluates subsequent events through the date of filing with the Securities and Exchange Commission.
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board (FASB) issues Accounting Standards Updates (ASUs) to the FASB Accounting Standards Codification (ASC). This section provides a summary description of recent ASUs that have significant implications (elected or required) within the consolidated financial statements, or that management expects may have a significant impact on the consolidated financial statements issued in the near future.
Recent Accounting Pronouncements - Adopted
On January 1, 2023, the Corporation adopted ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (ASC 326). This standard replaced the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (“CECL”) methodology. CECL requires an estimate of credit losses for the remaining estimated life of the financial asset using historical experience, current conditions, and reasonable and supportable forecasts and generally applies to financial assets measured at amortized cost, including loan receivables and held-to-maturity debt securities, and some off-balance sheet credit exposures such as unfunded commitments to extend credit. Financial assets measured at amortized cost will be presented at the net amount expected to be collected by using an allowance for credit losses. Purchased credit deteriorated (“PCD”) loans will receive an initial allowance at the acquisition date that represents an adjustment to the amortized cost basis of the loan, with no impact to earnings.
In addition, CECL made changes to the accounting for available for sale debt securities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available for sale debt securities if management does not intend to sell and does not believe that it is more likely than not, they will be required to sell. The Corporation adopted ASC 326 using the prospective transition approach for debt securities for which other-than-temporary impairment had been recognized prior to January 1, 2023. As of December 31, 2022, the Company did not have any other-than-temporarily impaired investment securities. Therefore, upon adoption of ASC 326, the Company determined that an allowance for credit losses on available for sale debt securities was not necessary.
Effective January 1, 2023, the Corporation adopted ASC 326 using the modified retrospective approach for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2023 are presented under CECL while prior period amounts continue to be reported in accordance with previously applicable accounting standards (“Incurred Loss”). The following table illustrates the impact from the adoption of ASC 326:
As Reported
Under
Pre-ASC 326
Impact of
ASC 326
Adoption
(In Thousands)
January 1, 2023
December 31, 2022
1,740,846
806
18,719
16,615
2,104
Allowance for credit losses on off-balance sheet exposures (included in accrued interest and other liabilities)
1,218
425
793
21,323
439
150,091
The Corporation adopted ASC 326 using the prospective transition approach for PCD assets that were previously classified as purchased credit impaired (“PCI”) under ASC 310-30. In accordance with the standard, management did not reassess whether PCI assets met the criteria of PCD assets as of the date of adoption. On January 1, 2023, the amortized cost basis of PCD assets was adjusted to establish the allowance for credit losses. Essentially all of the PCD loans were reported as nonaccrual loans at January 1, 2023 and September 30, 2023.
ASU 2022-02, Financial Instruments-Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. This update reduces the complexity of accounting for Troubled Debt Restructurings (“TDRs”) by eliminating certain accounting guidance, enhancing disclosures and improving the consistency of vintage disclosures. The Corporation adopted ASU 2022-02 on January 1, 2023. Changes in disclosure requirements in accordance with ASU 2022-02 are reflected in Note 6. The adoption of ASU 2022-02 did not have a material impact on the consolidated financial statements.
Accounting Policies
The Corporation’s significant accounting policies followed in the preparation of the unaudited consolidated financial statements are disclosed in Note 1 of the audited consolidated financial statements and notes for the year ended December 31, 2022 and are contained in the Corporation’s Annual Report on Form 10-K. There have been no significant changes to the application of significant accounting policies since December 31, 2022, except for the following:
Allowance for Credit Losses – Available-for-Sale Debt Securities
For available-for-sale debt securities, management evaluates all investments in an unrealized loss position on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. If the Corporation has the intent to sell the security or it is more likely than not that the Corporation will be required to sell the security, the security is written down to fair value and the entire loss is recorded in earnings.
If either of the above criteria is not met, the Corporation evaluates whether the decline in fair value is the result of credit losses or other factors. The Corporation has elected the practical expedient of zero credit loss estimates for securities issued or guaranteed by U.S. Government entities or agencies. In making the credit loss assessment of securities not issued or guaranteed by U.S. Government entities or agencies, the Corporation may consider various factors including the extent to which fair value is less than amortized cost, performance on any underlying collateral, downgrades in the ratings of the security by a rating agency, the failure of the issuer to make scheduled interest or principal payments and adverse conditions specifically related to the security. If the assessment indicates that a credit loss exists, the present value of cash flows expected to be collected are compared to the amortized cost basis of the security and any excess is recorded as an allowance for credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any amount of unrealized loss that has not been recorded through an allowance for credit loss is recognized in other comprehensive income (loss).
9
Changes in the allowance for credit losses are recorded as provision for (or reversal of) credit loss expense. Losses are charged against the allowance for credit losses when management believes an available-for-sale debt security is confirmed to be uncollectible or when either of the criteria regarding intent or requirement to sell is met. At September 30, 2023, there was no allowance for credit losses related to the available-for-sale portfolio.
Accrued interest receivable on available-for-sale debt securities totaled $2,688,000 at September 30, 2023 and was excluded from the estimate of credit losses.
Allowance for Credit Losses on Loans
The allowance for credit losses is a valuation account that is deducted from the loans' amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when management believes the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off.
The allowance for credit losses represents management’s estimate of lifetime credit losses inherent in loans as of the balance sheet date. The allowance for credit losses is estimated by management using relevant available information, from both internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts.
Accrued interest receivable on loans totaled $6,590,000 at September 30, 2023 and was excluded from the estimate of credit losses.
The allowance for credit losses (“ACL”) includes two primary components: (i) an allowance established on loans which share similar risk characteristics collectively evaluated for credit losses (collective basis), and (ii) an allowance established on loans which do not share similar risk characteristics with any loan segment and which are individually evaluated for credit losses (individual basis).
Evaluation of Expected Losses on Individual Loans
Loans evaluated on an individual basis are identified based on a detailed assessment of certain larger loan relationships, and their related credit risk ratings, by a management committee referred to as the Watch List Committee. The allowance will be determined on an individual basis using the present value of expected cash flows or, for collateral-dependent loans, the fair value of the collateral as of the reporting date, less estimated selling costs, as applicable. If the fair value of the collateral is less than the amortized cost basis of the loan, the Corporation will charge off the difference between the fair value of the collateral, less costs to sell at the reporting date and the amortized cost basis of the loan.
The scope of loans reviewed individually for credit loss each quarter includes all commercial loan relationships greater than $200,000 and any residential mortgage or consumer loans of $400,000 or more for which there is at least one extension of credit graded Special Mention, Substandard or Doubtful. Additionally, all PCD loans are evaluated individually for credit loss.
Collective Evaluation of Expected Losses – Pool Basis
The Corporation measures expected credit losses for loans on a pooled basis when similar risk characteristics exist. The Corporation has identified the following portfolio segments and calculates the allowance for credit losses for each using the weighted-average remaining maturity (“WARM”) method:
Commercial real estate - nonowner occupied, further broken down into the following classes:
Nonowner occupied
Multi-family (5 or more) residential
1-4 Family - commercial purpose
Commercial real estate - owner occupied
All other commercial loans, further broken down into the following classes:
Commercial and industrial
Commercial lines of credit
Political subdivisions
Commercial construction and land
Other commercial loans
Residential mortgage loans, further broken down into the following classes:
1-4 Family – residential
1-4 Family residential construction and land
Consumer loans, further broken down into the following classes:
Consumer lines of credit (including HELOCs)
All other consumer
In determining the pools for collective evaluation, management uses a combination of loan purpose, collateral and payment type (for example, lines of credit vs. amortizing). The pools identified are similar to the loan classes used in the Corporation’s financial reporting for several years, with several exceptions including the following which are of the most significance:
Each of these changes was made to better sort loans into pools with similar risk and cash flow characteristics.
Estimation Method - WARM (Weighted-Average Remaining Maturity Method)
In applying the WARM method, for each pool identified above, the Corporation determined the annual net charge-offs as a percentage of average total loan balances (net charge-off percentage). In the January 1, 2023 calculation, the Corporation used the annualized net charge-off percentage over the prior 5 calendar years. In the September 30, 2023 calculation, the Corporation used the net charge-off percentage for the 5.75-year period ended September 30, 2023. For each loan pool, the average annualized net charge-off percentage was multiplied by the estimated weighted-average remaining average life of the loans to calculate the loss rate.
The calculation of the estimated weighted-average remaining life of each loan pool was based on instrument-level data, with contractual principal payments adjusted for the estimated impact of prepayments. Commercial lines of credit and other revolving credit facilities were generally assumed to be repaid after 1 year. The estimated weighted-average remaining life of the entire portfolio was calculated to be 4.16 years at September 30, 2023 and 4.36 years at January 1, 2023. Management determined that use of the Corporation’s net charge-off experience over a 5.75-year period at September 30, 2023 and 5-year period at January 1, 2023 would provide a reasonable time period to include in the WARM expected loss rate calculations in relationship to the weighted-average life of the portfolio overall and to each of the pools.
11
Qualitative Factors
The allowance for credit losses calculation includes subjective adjustments for qualitative risk factors that are deemed likely to cause estimated credit losses to differ from historical experience. These qualitative adjustments generally increase allowance levels and include adjustments for factors deemed relevant, including: the nature and volume of portfolio changes, including loan portfolio growth; concentrations of credit based on loan type (such as non-owner occupied commercial real estate) or industry; the volume and severity of past due, nonaccrual or adversely classified loans; trends in real estate or other collateral values; lending policies and procedures, including changes in underwriting and collections practices; credit review function; lending, credit and other relevant management experience and risk tolerance; external factors and economic conditions not already captured.
Economic Forecast
ASC Topic 326 requires management to consider forward-looking information that is both reasonable and supportable and relevant to the collectability of cash flows. Reasonable and supportable forecasts may extend over the entire contractual term of a financial asset or a period shorter than the contractual term. In that regard, management has selected a forecast period of 2 years, which is shorter than the estimated weighted-average remaining life of the loan portfolio.
The Corporation calculated an additional expected credit loss based on establishing a correlation between past loss experience and an economic statistic. This additional credit loss is added to the allowance calculation, conceptually for the first 2 years of the weighted-average remaining life of the portfolio after which time the credit loss for each pool is determined based on the WARM historical loss rate as adjusted for qualitative factors.
Allowance for Credit Losses on Off-Balance Sheet Exposures
Financial instruments include off-balance sheet credit instruments, such as commitments to make loans, commercial letters of credit and credit enhancement obligations related to residential mortgage loans sold with recourse. The Corporation’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the contractual amount of those instruments. Such financial instruments are recorded when they are funded.
The Corporation records an allowance for credit losses on off-balance sheet credit exposures, unless the commitments to extend credit are unconditionally cancelable, through a charge to provision for unfunded commitments in the Corporation’s statements of income. The allowance for credit losses on off-balance sheet credit exposures is estimated by loan segment at each balance sheet date under the current expected credit loss model using the same methodologies as portfolio loans, taking into consideration the likelihood that funding will occur as well as any third-party guarantees. The allowance for off-balance sheet exposures is included in accrued interest and other liabilities in the Corporation’s unaudited consolidated balance sheets and the related credit expense is recorded in the provision for credit losses in the unaudited consolidated statements of income.
12
2. PER SHARE DATA
Basic earnings per common share are calculated using the two-class method to determine income attributable to common shareholders. Unvested restricted stock awards that contain nonforfeitable rights to dividends are considered participating securities under the two-class method. Distributed dividends and an allocation of undistributed net income to participating securities reduce the amount of income attributable to common shareholders. Income attributable to common shareholders is then divided by weighted-average common shares outstanding for the period to determine basic earnings per common share.
Diluted earnings per common share are calculated under the more dilutive of either the treasury method or the two-class method. Diluted earnings per common share is computed using weighted-average common shares outstanding, plus weighted-average common shares available from the exercise of all dilutive stock options, less the number of shares that could be repurchased with the proceeds of stock option exercises based on the average share price of the Corporation’s common stock during the period.
(In Thousands, Except Share and Per Share Data)
Basic
Less: Dividends and undistributed earnings allocated to participating securities
(57)
(39)
(156)
(169)
Net income attributable to common shares
7,534
4,416
19,731
18,670
Basic weighted-average common shares outstanding
15,154,797
15,364,075
15,264,391
15,482,672
Basic earnings per common share (a)
Diluted
Dilutive effect of potential common stock arising from stock options
3,114
3,276
Diluted weighted-average common shares outstanding
15,367,189
15,264,395
15,485,948
Diluted earnings per common share (a)
Weighted-average nonvested restricted shares outstanding
113,328
136,040
120,632
139,761
Anti-dilutive stock options are excluded from earnings per share calculations. The weighted-average number of anti-dilutive instruments outstanding was 8,934 in the three-month period ended September 30, 2023 and 0 in the nine-month period ended September 30, 2023. There were no anti-dilutive instruments outstanding in the three-month and nine-month periods ended September 30, 2022.
13
3. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is the total of (1) net income, and (2) all other changes in equity from non-stockholder sources, which are referred to as other comprehensive income (loss). The components of other comprehensive income (loss), and the related tax effects, are as follows:
Before-Tax
Income Tax
Net-of-Tax
Amount
Effect
3,123
(11,742)
Other comprehensive loss from available-for-sale debt securities
(11)
Other comprehensive loss on unfunded retirement obligations
Total other comprehensive loss
5,437
(20,443)
Reclassification adjustment for (gains) realized in income
5,441
(20,459)
1
2,632
(9,903)
(5)
2,633
(9,908)
(7)
(33)
(40)
16,365
(61,558)
(17)
16,369
(61,575)
106
(26)
Other comprehensive income on unfunded retirement obligations
80
14
The amounts shown in the table immediately above are included in the following line items in the consolidated statements of income:
Affected Line Item in the
Description
Reclassification adjustment for (gains) realized in income (before-tax)
Amortization of prior service cost and net actuarial loss included in net periodic benefit cost (before-tax)
Income tax effect
Changes in the components of accumulated other comprehensive (loss) income are as follows and are presented net of tax:
Unrealized
(Losses)
Unfunded
Gains
Retirement
on Securities
Obligations
Balance, beginning of period
(48,536)
463
Other comprehensive loss during three months ended September 30, 2023
Balance, end of period
(60,278)
452
(36,307)
305
Other comprehensive loss during three months ended September 30, 2022
(56,766)
297
(50,370)
492
Other comprehensive loss during nine months ended September 30, 2023
4,809
217
Other comprehensive loss during nine months ended September 30, 2022
4. CASH AND DUE FROM BANKS
Cash and due from banks at September 30, 2023 and December 31, 2022 include the following:
Cash and cash equivalents
Certificates of deposit
4,350
7,350
15
Certificates of deposit are issues by U.S. banks with original maturities greater than three months. Each certificate of deposit is fully FDIC-insured. The Corporation maintains cash and cash equivalents with certain financial institutions in excess of the FDIC insurance limit.
5. SECURITIES
Amortized cost and fair value of available-for-sale debt securities at September 30, 2023 and December 31, 2022 are summarized as follows:
September 30, 2023
Gross
Amortized
Holding
Fair
Cost
Losses
Value
Obligations of the U.S. Treasury
33,938
(3,381)
30,557
Obligations of U.S. Government agencies
21,372
(2,576)
18,796
Bank holding company debt securities
28,950
(6,639)
22,311
Obligations of states and political subdivisions:
123,598
114
(19,259)
104,453
65,408
(11,951)
53,457
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities
109,102
(14,633)
94,469
Residential collateralized mortgage obligations
38,267
(4,870)
33,397
Commercial mortgage-backed securities
76,627
(12,955)
63,672
Private label commercial mortgage-backed securities
8,178
(152)
8,026
Total available-for-sale debt securities
505,440
(76,416)
35,166
(3,330)
31,836
25,938
(2,508)
23,430
28,945
(3,559)
25,386
146,149
319
(13,845)
132,623
68,488
(11,676)
56,812
112,782
(12,841)
99,941
44,868
(4,572)
40,296
91,388
(11,702)
79,686
8,070
(49)
8,023
561,794
321
(64,082)
The following table presents gross unrealized losses and fair value of available-for-sale debt securities with unrealized loss positions aggregated by length of time that individual securities have been in a continuous unrealized loss position at September 30, 2023 and December 31, 2022:
16
Less Than 12 Months
12 Months or More
1,850
16,946
(2,568)
4,172
(268)
96,600
(18,991)
100,772
9,304
(412)
83,619
(14,221)
92,923
2,662
(130)
30,735
(4,740)
2,211
61,461
(12,825)
Total temporarily impaired available-for-sale debt securities
28,225
(1,100)
395,686
(75,316)
423,911
17
20,192
(1,939)
11,644
(1,391)
8,509
(430)
12,921
(2,078)
21,430
14,248
(1,697)
11,138
(1,862)
106,204
(11,023)
15,153
(2,822)
121,357
28,901
(4,739)
27,761
(6,937)
56,662
45,410
(4,226)
54,531
(8,615)
28,670
(2,042)
11,626
(2,530)
40,408
(2,585)
39,278
(9,117)
4,762
297,304
(28,730)
184,052
(35,352)
481,356
Gross realized gains and losses from available-for-sale debt securities were as follows:
Gross realized gains from sales
44
89
48
Gross realized losses from sales
(24)
(83)
Net realized gains
The amortized cost and fair value of available-for-sale debt securities by contractual maturity are shown in the following table as of September 30, 2023. Actual maturities may differ from contractual maturities because counterparties may have the right to call or prepay obligations with or without call or prepayment penalties.
Due in one year or less
10,899
10,672
Due from one year through five years
70,095
64,235
Due from five years through ten years
80,423
66,554
Due after ten years
111,849
88,113
Sub-total
273,266
229,574
The Corporation’s mortgage-backed securities and collateralized mortgage obligations have stated maturities that may differ from actual maturities due to borrowers’ ability to prepay obligations. Cash flows from such investments are dependent upon the performance of the underlying mortgage loans and are generally influenced by the level of interest rates. In the table above, mortgage-backed securities and collateralized mortgage obligations are shown in one period.
18
Investment securities carried at $242,190,000 at September 30, 2023 and $277,302,000 at December 31, 2022 were pledged as collateral for public deposits, trusts and certain other deposits as provided by law. See Note 8 for information concerning securities pledged to secure borrowing arrangements and Note 11 for information related to securities pledged against interest rate swap obligations.
A summary of information management considered in evaluating debt and equity securities for credit losses at September 30, 2023 and December 31, 2022 is provided below.
Debt Securities
As reflected in the table above, gross unrealized holding losses on available-for-sale debt securities totaled $76,416,000 at September 30, 2023 and $64,082,000 at December 31, 2022. At September 30, 2023, the Corporation does not have the intent to sell, nor is it more likely than not it will be required to sell, these securities before it is able to recover the amortized cost basis. The unrealized holding losses were consistent with significant increases in market interest rates that occurred in 2022 and 2023.
At September 30, 2023 and December 31, 2022, management performed an assessment for possible credit losses of the Corporation’s debt securities on an issue-by-issue basis, relying on information obtained from various sources, including publicly available financial data, ratings by external agencies, brokers and other sources. At September 30, 2023 and December 31, 2022, all of the Corporation’s holdings of bank holding company debt securities, obligations of states and political subdivisions and private label commercial mortgage-backed securities were investment grade and there have been no payment defaults.
Based on the results of the assessment, there was no ACL required on available-for-sale debt securities in an unrealized loss position at September 30, 2023 and December 31, 2022.
Equity Securities
C&N Bank is a member of the Federal Home Loan Bank of Pittsburgh (FHLB-Pittsburgh), which is one of 11 regional Federal Home Loan Banks. As a member, C&N Bank is required to purchase and maintain stock in FHLB-Pittsburgh. There is no active market for FHLB-Pittsburgh stock, and it must ordinarily be redeemed by FHLB-Pittsburgh in order to be liquidated. C&N Bank’s investment in FHLB-Pittsburgh stock, included in other assets in the consolidated balance sheets, was $14,570,000 at September 30, 2023 and $14,168,000 at December 31, 2022. The Corporation evaluated its holding of FHLB-Pittsburgh stock for impairment and deemed the stock to not be impaired at September 30, 2023 and December 31, 2022. In making this determination, management concluded that recovery of total outstanding par value, which equals the carrying value, is expected. The decision was based on review of financial information that FHLB-Pittsburgh has made publicly available.
In July 2023, C&N Bank became a member of the Federal Reserve System. As a member, C&N Bank is required to purchase and maintain stock in the Federal Reserve Bank of Philadelphia. There is no active market for Federal Reserve Bank stock, and it must ordinarily be redeemed by the Federal Reserve Bank of Philadelphia in order to be liquidated. C&N Bank’s investment in Federal Reserve Bank stock, included in other assets in the consolidated balance sheets, was $6,243,000 at September 30, 2023.
The Corporation has a marketable equity security included in other assets in the consolidated balance sheets with a carrying value of $832,000 at September 30, 2023 and $859,000 December 31, 2022, consisting exclusively of one mutual fund. There was an unrealized loss on the mutual fund of $168,000 at September 30, 2023 and $141,000 at December 31, 2022. Changes in the unrealized gains or losses on this security, which are included in other noninterest income in the consolidated statements of income, were a loss of $27,000 in the third quarter 2023 and for the nine-month period ended September 30, 2023, a loss of $38,000 in the third quarter 2022 and a loss of $114,000 in the nine-month period ended September 30, 2022.
19
6. LOANS AND ALLOWANCE FOR CREDIT LOSSES
Loans receivable at September 30, 2023 and December 31, 2022 are summarized as follows:
Summary of Loans by Type
2022 (1)
Commercial real estate - non-owner occupied
737,287
675,597
231,112
205,910
All other commercial loans
395,703
410,077
Residential mortgage loans
410,013
393,582
Consumer loans
56,555
54,874
Less: allowance for credit losses on loans
(1) Total loans at December 31, 2022 include purchased credit impaired loans of $1,027,000.
In the table above, outstanding loan balances are presented net of deferred loan origination fees, net, of $4,456,000 at September 30, 2023 and $4,725,000 at December 31, 2022.
The Corporation grants loans to individuals as well as commercial and tax-exempt entities. Commercial, residential and personal loans are made to customers geographically concentrated in Northcentral Pennsylvania, the Southern tier of New York State, Southeastern Pennsylvania and Southcentral Pennsylvania. Although the Corporation has a diversified loan portfolio, a significant portion of its debtors’ ability to honor their contracts is dependent on the local economic conditions within the region.
Acquired loans were initially recorded at fair value, with adjustments made to gross amortized cost based on movements in interest rates (market rate adjustment) and based on credit fair value adjustments on non-impaired loans and impaired loans. Subsequently, the Corporation has recognized amortization and accretion of a portion of the market rate adjustments and credit adjustments on performing loans. For the three-month and nine-month periods ended September 30, 2023 and 2022, adjustments to the initial market rate and credit fair value adjustments of performing loans were recognized as follows:
Market Rate Adjustment
Adjustments to gross amortized cost of loans at beginning of period
(1,000)
(866)
(916)
(637)
(Amortization) accretion recognized in interest income
(100)
(224)
Adjustments to gross amortized cost of loans at end of period
(1,016)
(861)
Credit Adjustment on Non-impaired Loans
(1,446)
(2,403)
(1,840)
(3,335)
Accretion recognized in interest income
308
541
1,240
(1,299)
(2,095)
The following table presents an analysis of past due loans as of September 30, 2023:
As of September 30, 2023
Past Due
30-89
90+
Nonaccrual
Current
Days
Loans
132
9,031
728,120
151
1,586
229,375
1,438
162
1,390
392,713
1,569
892
3,244
404,308
513
250
55,686
3,675
1,292
15,501
1,810,202
The following table presents an analysis of past due loans as of December 31, 2022:
As of December 31, 2022
644
947
6,350
667,656
723
204,099
204,982
537
11,528
397,762
409,978
4,540
866
3,974
384,202
635
187
53,920
Purchased credit impaired
1,027
7,079
2,237
23,085
1,707,639
In determining the larger loan relationships for detailed assessment under the specific allowance component, the Corporation uses an internal risk rating system. Under the risk rating system, the Corporation classifies problem or potential problem loans as “Special Mention,” “Substandard,” or “Doubtful” on the basis of currently existing facts, conditions and values. Substandard loans include those characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected. Loans classified as Doubtful have all the weaknesses inherent in those classified as Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans that do not currently expose the Corporation to sufficient risk to warrant classification as Substandard or Doubtful, but possess weaknesses that deserve management’s close attention, are deemed to be Special Mention. Risk ratings are updated any time that conditions or the situation warrants. Loans not classified are included in the “Pass” rows in the table that follows.
The following table presents the recorded investment in loans by credit quality indicators by year of origination as of September 30, 2023:
Term Loans by Year of Origination
2021
2020
2019
Prior
Revolving
Pass
83,002
188,426
91,246
55,618
80,858
211,778
710,928
Special Mention
2,475
8,147
10,741
Substandard
12,431
15,618
Doubtful
Total commercial real estate - non-owner occupied
93,721
58,195
81,587
232,356
Year-to-date gross charge-offs
28,058
37,306
52,680
13,245
17,722
75,113
224,124
2,617
1,301
3,918
3,070
Total commercial real estate - owner occupied
55,297
79,484
39,638
94,942
53,556
29,097
17,364
25,489
112,698
372,784
4,642
805
5,847
3,091
1,250
435
2,151
1,121
9,024
17,072
Total all other commercial loans
98,033
59,448
29,532
19,515
27,415
122,122
44,449
88,378
57,166
40,943
33,257
140,684
404,877
289
369
4,478
5,136
Total residential mortgage loans
41,232
33,626
145,162
33
5,216
5,070
2,227
1,372
238
991
40,512
55,626
78
833
929
Total consumer loans
2,228
1,384
243
1,069
41,345
134
96
254
The following table presents the recorded investment in loans by credit quality indicators as of December 31, 2022:
Special
Mention
654,430
9,486
11,681
202,702
1,909
371
383,846
2,516
23,616
387,944
5,638
54,353
1,683,275
13,911
42,854
The following table is a summary of the Corporation’s nonaccrual loans by major categories for the periods indicated.
Nonaccrual Loans with
Nonaccrual Loans
Total Nonaccrual
No Allowance
with an Allowance
1,669
7,362
1,283
303
1,194
196
7,640
7,861
The Corporation recognized $317,000 and $744,000 of interest income on nonaccrual loans during the three months and nine months ended September 30, 2023, respectively.
The following table represents the accrued interest receivable written off by reversing interest income during the three-month and nine-month periods ended September 30, 2023:
67
23
The Corporation has certain loans for which repayment is dependent upon the operation or sale of collateral, as the borrower is experiencing financial difficulty. The underlying collateral can vary based upon the type of loan. The following provides more detail about the types of collateral that secure collateral dependent loans:
The following table details the amortized cost of collateral dependent loans, which are individually evaluated to determine expected credit losses, and the related allowance for credit losses on loans allocated to these loans:
Allowance
664
61
95
12,007
820
The following table summarizes the activity related to the ACL for the three and nine months ended September 30, 2023 under the CECL methodology.
Commercial
All
real estate -
other
Residential
nonowner
owner
commercial
mortgage
Consumer
occupied
loans
Unallocated
10,603
2,025
3,686
2,464
278
19,056
Charge-offs
(91)
(98)
Recoveries
34
60
(Credit) provision for credit losses on loans
(161)
(479)
(933)
10,335
1,864
3,552
1,993
341
18,085
6,305
1,942
4,142
2,751
475
1,000
3,763
(88)
(344)
(234)
(12)
(254)
(299)
30
74
267
(85)
(524)
(391)
324
(409)
24
Prior to the adoption of ASC 326 on January 1, 2023, the Corporation calculated the allowance for loan losses under the incurred loss methodology. The following tables are disclosed related to the allowance for loan losses in prior periods.
June 30, 2022
September 30, 2022
Balance
Provision (Credit)
Allowance for Loan Losses:
Commercial:
Commercial loans secured by real estate
4,982
(2,160)
3,225
6,047
2,792
31
2,823
515
169
684
Loans secured by farmland
112
113
339
88
427
Agricultural loans
(1)
122
Total commercial
8,894
3,504
10,238
Residential mortgage:
Residential mortgage loans - first liens
3,689
3,919
Residential mortgage loans - junior liens
180
194
Home equity lines of credit
25
333
1-4 Family residential construction
215
36
251
Total residential mortgage
4,392
304
4,697
261
Total Allowance for Loan Losses
14,547
(2,196)
16,170
December 31, 2021
4,405
3,802
2,723
(150)
637
47
115
(2)
212
(3)
173
(51)
8,293
(2,310)
4,255
3,650
266
184
202
49
4,338
(107)
39
68
671
329
13,537
(2,417)
57
The following tables present a summary of loan balances and the related allowance for loan losses summarized by portfolio segment and class for each impairment method used as of December 31, 2022.
Loans:
Individually
Collectively
Evaluated
Totals
7,154
675,095
682,249
6,647
7,074
11,223
167,048
178,271
26
2,883
2,909
Paycheck Protection Program - 1st Draw
Paycheck Protection Program - 2nd Draw
163
90,719
244
73,719
73,963
647
76
12,874
12,950
55,886
411
2,378
2,435
14,857
124
18,754
1,092,744
1,111,498
453
10,845
11,298
506
509,276
509,782
3,413
24,919
24,949
167
43,730
43,798
282
30,577
211
604
608,502
609,106
4,073
19,436
19,358
1,720,682
15,162
Prior to the adoption of ASU 2016-13, loans were classified as impaired when, based on current information and events, it was probable that the Corporation would be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment included payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experienced insignificant payment delays and payment shortfalls generally were not classified as impaired. Management determined 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 shortfall in relation to the principal and interest owed. Impairment was measured on a loan-by-loan basis for commercial loans by the fair value of the collateral (if the loan is collateral dependent), by future cash flows discounted at the loan’s effective rate or by the loan’s observable market price.
The scope of loans reviewed individually each quarter to determine if they were impaired included all commercial loan relationships greater than $200,000 and any residential mortgage or consumer loans of $400,000 or more for which there was at least one extension of credit graded Special Mention, Substandard or Doubtful. All loans classified as troubled debt restructurings and all commercial loan relationships less than $200,000 or other loan relationships less than $400,000 in the aggregate, but with an estimated loss of $100,000 or more, were individually evaluated for impairment.
Summary information related to impaired loans at December 31, 2022 is provided in the table immediately below.
Unpaid
Principal
Recorded
Related
Investment
With no related allowance recorded:
8,563
3,754
12,926
11,163
Construction and other land loans
Total with no related allowance recorded
22,508
15,898
With a related allowance recorded:
3,400
Total with a related allowance recorded
3,460
25,968
The average balance of impaired loans and interest income recognized on these impaired loans is as follows:
Interest Income Recognized on
Average Investment in Impaired Loans
Impaired Loans on a Cash Basis
9,710
9,804
143
483
839
207
79
263
1,156
59
10,266
11,095
1,849
Residential mortgage loans - first lien
612
587
Residential mortgage loans - junior lien
711
10,977
11,749
153
1,875
The allowance for credit losses incorporates an estimate of lifetime expected credit losses and is recorded on each asset upon asset origination or acquisition. The starting point for the estimate of the allowance for credit losses is historical loss information, which includes losses from modifications of receivables to borrowers experiencing financial difficulty. An assessment of whether a borrower is experiencing financial difficulty is made on the date of a modification.
Because the effect of most modifications made to borrowers experiencing financial difficulty, such as extensions of terms, insignificant payment delays and interest rate reductions, is already included in the allowance for credit losses because of the measurement methodologies used to estimate the allowance, a change to the allowance for credit losses is generally not recorded upon modification.
Occasionally, the Corporation modifies loans by providing principal forgiveness on certain of its real estate loans. When principal forgiveness is provided, the amortized cost basis of the asset is written off against the allowance for credit losses. The amount of the principal forgiveness is deemed to be uncollectible; therefore, that portion of the loan is written off, resulting in a reduction of the amortized cost basis and a corresponding adjustment to the allowance for credit losses.
There were no loans modified to borrowers experiencing financial difficulty in the three-month and nine-month periods ended September 30, 2023.
The carrying amount of foreclosed residential real estate properties held as a result of obtaining physical possession (included in foreclosed assets held for sale in the unaudited consolidated balance sheets) is as follows:
Foreclosed residential real estate
The recorded investment of consumer mortgage loans secured by residential real properties for which formal foreclosure proceedings were in process is as follows:
Residential real estate in process of foreclosure
1,049
1,229
The Corporation maintains an allowance for off-balance sheet credit exposures such as unfunded balances for existing lines of credit, commitments to extend future credit, commercial letters of credit and credit enhancement obligations related to residential mortgage loans sold with recourse, when there is a contractual obligation to extend credit and when this extension of credit is not unconditionally cancellable (i.e. commitment cannot be canceled at any time). The allowance for off-balance sheet credit exposures is adjusted as a provision for credit loss expense. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over their estimated lives. The allowance for credit losses for off-balance sheet exposures of $900,000 at September 30, 2023 and $425,000 at December 31, 2022, is included in accrued interest and other liabilities on the unaudited consolidated balance sheets.
The following table presents the balance and activity in the allowance for credit losses for off-balance sheet exposures for the three and nine months ended September 30, 2023.
Three Months
Nine Months
Ended
Beginning Balance
1,154
Adjustment to allowance for off-balance sheet exposures for adoption of ASU 2016-13
38
Credit for unfunded commitments
(292)
(356)
900
28
7. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill represents the excess of the cost of acquisitions over the fair value of the net assets acquired. At September 30, 2023 and December 31, 2022, the net carrying value of goodwill was $52,505,000.
Information related to core deposit intangibles is as follows:
Gross amount
6,639
Accumulated amortization
(4,068)
(3,762)
Net
Amortization expense related to core deposit intangibles is included in other noninterest expense in the consolidated statements of income, as follows:
Amortization expense
110
306
8. BORROWED FUNDS
SHORT-TERM BORROWINGS
Short-term borrowings (initial maturity within one year) include the following:
FHLB-Pittsburgh borrowings
21,500
77,000
Customer repurchase agreements
1,753
3,062
Total short-term borrowings
The Corporation had available credit with other correspondent banks totaling $95,000,000 at September 30, 2023 and December 31, 2022. These lines of credit are primarily unsecured. No amounts were outstanding at September 30, 2023 or December 31, 2022.
The Corporation has a line of credit with the Federal Reserve Bank of Philadelphia’s Discount Window. At September 30, 2023, the Corporation had available credit in the amount of $20,766,000 on this line with no outstanding advances. At December 31, 2022, the Corporation had available credit in the amount of $23,107,000 on this line with no outstanding advances. As collateral for this line, the Corporation has pledged available-for-sale securities with a carrying value of $21,731,000 at September 30, 2023 and $24,113,000 at December 31, 2022.
The Corporation engages in repurchase agreements with certain commercial customers. These agreements provide that the Corporation sells specified investment securities to the customers on an overnight basis and repurchases them on the following business day. The weighted average rate paid by the Corporation on customer repurchase agreements was 0.10% at September 30, 2023 and December 31, 2022. The carrying value of the underlying securities was $1,770,000 at September 30, 2023 and $3,080,000 at December 31, 2022.
The FHLB-Pittsburgh loan facility is collateralized by qualifying loans secured by real estate with a book value totaling $1,321,417,000 at September 30, 2023 and $1,209,179,000 at December 31, 2022. Also, the FHLB-Pittsburgh loan facility requires the Corporation to invest in established amounts of FHLB-Pittsburgh stock. The carrying values of the Corporation’s holdings of FHLB-Pittsburgh stock (included in other assets in the consolidated balance sheets) were $14,570,000 at September 30, 2023 and $14,168,000 at December 31, 2022. The Corporation’s total credit facility with FHLB-Pittsburgh was $918,798,000 at September 30, 2023, including an unused
29
(available) amount of $752,847,000. At December 31, 2022, the Corporation’s total credit facility with FHLB-Pittsburgh was $839,378,000, including an unused (available) amount of $689,279,000.
At September 30, 2023, short-term borrowings included an overnight borrowing from FHLB-Pittsburgh of $6,500,000 at an interest rate of 5.68% and an advance of $15,000,000 maturing in October 2023 with an interest rate of 5.61%. At December 31, 2022, the overnight borrowing from FHLB-Pittsburgh was $77,000,000 at an interest rate of 4.45% with no other short-term advances.
LONG-TERM BORROWINGS – FHLB ADVANCES
Long-term borrowings from FHLB-Pittsburgh are as follows:
Loan maturing in 2023 with a rate of 3.25%
2,290
9,303
Loans maturing in 2024 with a weighted-average rate of 2.89%
29,784
29,813
Loans maturing in 2025 with a weighted-average rate of 4.12%
35,653
23,231
Loans maturing in 2026 with a weighted-average rate of 4.44%
31,518
Loans maturing in 2027 with a weighted-average rate of 4.00%
24,031
Loan maturing in 2028 with a rate of 3.72%
2,000
Total long-term FHLB-Pittsburgh borrowings
Note: Weighted-average rates are presented as of September 30, 2023.
SENIOR NOTES
In 2021, the Corporation issued and sold $15.0 million in aggregate principal amount of 2.75% Fixed Rate Senior Unsecured Notes due 2026 (the "Senior Notes"). The Senior Notes mature on June 1, 2026 and bear interest at a fixed annual rate of 2.75%. The Corporation is not entitled to redeem the Senior Notes, in whole or in part, at any time prior to maturity and the Senior Notes are not subject to redemption by the holders. The Senior Notes are unsecured and unsubordinated obligations of the Corporation only and are not obligations of, and are not guaranteed by, any subsidiary of the Corporation.
The Senior Notes were recorded, net of debt issuance costs of $337,000, at an initial carrying amount of $14,663,000. Debt issuance costs are amortized over the term of the Senior Notes as an adjustment of the effective interest rate. Amortization of debt issuance costs associated with the Senior Notes totaling $16,000 in the third quarter 2023 and $49,000 in the nine-month period ended September 30, 2023, and $16,000 in the third quarter 2022 and $48,000 in the nine month-period ended September 30, 2022, was included in interest expense in the unaudited consolidated statements of income.
At September 30, 2023 and December 31, 2022, outstanding Senior Notes are as follows:
Senior Notes with an aggregate par value of $15,000,000; bearing interest at 2.75% with an effective interest rate of 3.23%; maturing in June 2026
Total carrying value
SUBORDINATED DEBT
In 2021, the Corporation issued and sold $25.0 million in aggregate principal amount of 3.25% Fixed-to-Floating Rate Subordinated Notes due 2031 (the "Subordinated Notes"). The Subordinated Notes mature on June 1, 2031 and bear interest at a fixed annual rate of 3.25%, to June 1, 2026. From June 1, 2026 to maturity or early redemption, the interest rate will reset quarterly to an interest rate per annum equal to the three-month Secured Overnight Financing Rate provided by the Federal Reserve Bank of New York plus 259 basis points. The Corporation is entitled to redeem the Subordinated Notes, in whole or in part, at any time on or after June 1, 2026, and to redeem the Subordinated Notes at any time in whole upon certain other events. Any redemption of the Subordinated Notes will be subject to prior regulatory approval to the extent required.
The Subordinated Notes are not subject to redemption at the option of the holders. The Subordinated Notes are unsecured, subordinated obligations of the Corporation only and are not obligations of, and are not guaranteed by, any subsidiary of the Corporation. The Subordinated Notes rank junior in right to payment to the Corporation's current and future senior indebtedness, including the Senior Notes (described above). The Subordinated Notes are intended to qualify as Tier 2 capital for regulatory capital purposes.
The Subordinated Notes were recorded, net of debt issuance costs of $563,000, at an initial carrying amount of $24,437,000. Debt issuance costs are amortized through June 1, 2026 as an adjustment of the effective interest rate. Amortization of debt issuance costs associated with the Subordinated Notes totaling $28,000 in the third quarter 2023 and $82,000 in the nine-month period ended September 30, 2023, and $27,000 in the third quarter 2022 and $79,000 in the nine-month period ended September 30, 2022, was included in interest expense in the unaudited consolidated statements of income.
At September 30, 2023 and December 31, 2022, the carrying amounts of subordinated debt agreements are as follows:
Agreements with a par value of $25,000,000; bearing interest at 3.25% with an effective interest rate of 3.74%; maturing in June 2031 and redeemable at par in June 2026
9. STOCK-BASED COMPENSATION PLANS
The Corporation had a Stock Incentive Plan for a selected group of officers and an Independent Directors Stock Incentive Plan. The 2023 restricted stock awards under the Stock Incentive Plan vest ratably over three years, and the 2023 restricted stock issued under the Independent Directors Stock Incentive Plan vests over one year. There were no restricted stock awards granted in the three-month periods ended September 30, 2023 and June 30, 2023. Following is a summary of restricted stock awards granted in the three-month period ended March 31, 2023:
(Dollars in Thousands)
Aggregate
Grant
Date
Number of
1st quarter 2023 awards:
Time-based awards to independent directors
11,000
257
Time-based awards to employees
31,684
740
Performance-based awards to employees
11,104
259
53,788
1,256
Effective April 20, 2023, the Corporation’s shareholders approved a new plan, the Citizens & Northern Corporation 2023 Equity Incentive Plan (the “2023 Equity Incentive Plan”). New awards to employees and independent directors will be governed under the 2023 Equity Incentive Plan, while outstanding awards under the prior plans (including the awards made in the first quarter 2023) will be governed under the prior plans.
Compensation cost related to restricted stock is recognized based on the fair value of the stock at the grant date over the vesting period, adjusted for estimated and actual forfeitures. Total annual stock-based compensation for the year ending December 31, 2023 is estimated to total $1,340,000. Total stock-based compensation expense attributable to restricted stock awards amounted to $320,000 in the third quarter 2023 and $388,000 in the third quarter 2022. Total stock-based compensation expense attributable to restricted stock awards amount to $1,015,000 in the nine-month period ended September 30, 2023 and $1,169,000 in the nine-month period ended September 30, 2022.
10. CONTINGENCIES
In the normal course of business, the Corporation is subject to pending and threatened litigation in which claims for monetary damages are asserted. In management’s opinion, the Corporation’s financial position and results of operations would not be materially affected by the outcome of these legal proceedings.
11. DERIVATIVE FINANCIAL INSTRUMENTS
The Corporation is a party to derivative financial instruments. These financial instruments consist of interest rate swap agreements and risk participation agreements (RPAs) which contain master netting and collateral provisions designed to protect the party at risk.
Interest rate swaps with commercial loan banking customers were executed to facilitate their respective risk management strategies. Under the terms of these arrangements, the commercial banking customers effectively exchanged their floating interest rate exposures on loans into fixed interest rate exposures. Those interest rate swaps have been simultaneously economically hedged by offsetting interest rate swaps with a third party, such that the Corporation has effectively exchanged its fixed interest rate exposures for floating rate exposures. These derivatives are not designated as hedges and are not speculative. Rather, these derivatives result from a service provided to certain customers. As the interest rate swaps associated with this program do not meet the hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings.
The aggregate notional amount of interest rate swaps was $152,536,000 at September 30, 2023 and $155,214,000 at December 31, 2022. There were no interest rate swaps originated in the three or nine-month periods ended September 30, 2023 and 2022. There were no gross amounts of interest rate swap-related assets and liabilities not offset in the consolidated balance sheets at September 30, 2023. The net impact on the consolidated statements of income from interest rate swaps was an increase in interest income on loans of $502,000 in the third quarter 2023 and $1,286,000 in the nine-month period ended September 30, 2023 as compared to a reduction in interest income on loans of $4,000 in third quarter 2022 and $541,000 in the nine months ended September 30, 2022.
The Corporation has entered into an RPA with another institution as a means to assume a portion of the credit risk associated with a loan structure which includes a derivative instrument, in exchange for fee income commensurate with the risk assumed. This type of derivative is referred to as an “RPA In.” In addition, in an effort to reduce the credit risk associated with an interest rate swap agreement with a borrower for whom the Corporation has provided a loan structured with a derivative, the Corporation purchased an RPA from an institution participating in the facility in exchange for a fee commensurate with the risk shared. This type of derivative is referred to as an “RPA Out.” The net impact on the consolidated statements of income from RPAs was an increase in other noninterest income of $1,000 in the third quarter 2023 and $19,000 in the nine-month period ended September 30, 2023 with no comparable amount in the third quarter 2022 and in the nine months ended September 30, 2022.
The table below presents the fair value of the Corporation’s derivative financial instruments as well as their classification on the consolidated balance sheets at September 30, 2023 and December 31, 2022:
At September 30, 2023
At December 31, 2022
Asset Derivatives
Liability Derivatives
Notional
Value (1)
Value (2)
Interest rate swap agreements
76,268
4,545
77,607
RPA Out
7,111
7,200
RPA In
10,000
32
The Corporation’s agreements with its derivative counterparties provide that if the Corporation defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Corporation could also be declared in default on its derivative obligations. Further, if the Corporation were to fail to maintain its status as a well or adequately capitalized institution, then the counterparties could terminate the derivative positions and the Corporation would be required to settle its obligations under the agreements. Available-for-sale securities with a carrying value of $2,251,000 were pledged as collateral against the Corporation’s obligations related to the interest rate swaps at September 30, 2023.
12. FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS
The Corporation measures certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FASB topic 820, “Fair Value Measurements and Disclosures” establishes a framework for measuring fair value that includes a hierarchy used to classify the inputs used in measuring fair value. The hierarchy prioritizes the inputs used in determining valuations into three levels. The level in the fair value hierarchy within which the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement. The levels of the fair value hierarchy are as follows:
Level 1 – Fair value is based on unadjusted quoted prices in active markets that are accessible to the Corporation for identical assets or liabilities. These generally provide the most reliable evidence and are used to measure fair value whenever available.
Level 2 – Fair value is based on significant inputs, other than Level 1 inputs, that are observable either directly or indirectly for substantially the full term of the asset or liability through corroboration with observable market data. Level 2 inputs include quoted market prices in active markets for similar assets or liabilities, quoted market prices in markets that are not active for identical or similar assets or liabilities and other observable inputs.
Level 3 – Fair value is based on significant unobservable inputs. Examples of valuation methodologies that would result in Level 3 classification include option pricing models, discounted cash flows and other similar techniques.
The Corporation monitors and evaluates available data relating to fair value measurements on an ongoing basis and recognizes transfers among the levels of the fair value hierarchy as of the date of an event or change in circumstances that affects the valuation method chosen. Examples of such changes may include the market for a particular asset or liability becoming active or inactive, changes in the availability of quoted prices, or changes in the availability of other market data.
At September 30, 2023 and December 31, 2022, assets and liabilities measured at fair value and the valuation methods used are as follows:
Quoted
Prices
in Active
Observable
Unobservable
Markets
Inputs
(Level 1)
(Level 2)
(Level 3)
Recurring fair value measurements, assets:
AVAILABLE-FOR-SALE DEBT SECURITIES:
398,581
Marketable equity security
832
Servicing rights
2,630
Interest rate swap agreements, assets
Total recurring fair value measurements, assets
31,389
403,132
437,151
Recurring fair value measurements, liabilities,
Interest rate swap agreements, liabilities
Nonrecurring fair value measurements, assets:
Loans individually evaluated for credit loss, net
7,041
Total nonrecurring fair value measurements, assets
7,674
466,197
859
2,653
32,695
469,835
505,183
Impaired loans, net
3,007
3,282
Management’s evaluation and selection of valuation techniques and the unobservable inputs used in determining the fair values of assets valued using Level 3 methodologies include sensitive assumptions. Other market participants might use substantially different assumptions, which could result in calculations of fair values that would be substantially different than the amount calculated by management.
35
At September 30, 2023 and December 31, 2022, quantitative information regarding valuation techniques and the significant unobservable inputs used for assets measured on a recurring basis using unobservable inputs (Level 3 methodologies) are as follows:
Fair Value at
9/30/2023
Valuation
Method or Value As of
Asset
Technique
Input(s)
Discounted cash flow
Discount rate
13.00
%
Rate used through modeling period
Loan prepayment speeds
129.00
Weighted-average PSA
Servicing fees
0.25
of loan balances
4.00
of payments are late
5.00
late fees assessed
1.94
Miscellaneous fees per account per month
Servicing costs
6.00
Monthly servicing cost per account
24.00
Additional monthly servicing cost per loan on loans more than 30 days delinquent
1.50
of loans more than 30 days delinquent
3.00
annual increase in servicing costs
12/31/2022
133.00
The fair value of servicing rights is affected by expected future interest rates. Increases (decreases) in future expected interest rates tend to increase (decrease) the fair value of the Corporation’s servicing rights because of changes in expected prepayment behavior by the borrowers on the underlying loans. Unrealized gains (losses) in fair value of servicing rights are included in Loan servicing fees, net, in the unaudited consolidated statements of income.
Following is a reconciliation of activity for Level 3 assets measured at fair value on a recurring basis:
Servicing rights balance, beginning of period
2,607
2,640
2,329
Originations of servicing rights
64
192
Unrealized (loss) gain included in earnings
(41)
(136)
128
Servicing rights balance, end of period
2,649
Loans are individually evaluated for credit loss 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. Foreclosed assets held for sale consist of real estate acquired by foreclosure. For individually evaluated commercial loans secured by real estate and foreclosed assets held for sale, estimated fair values are determined primarily using values from third-party appraisals. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.
37
At September 30, 2023 and December 31, 2022, quantitative information regarding valuation techniques and the significant unobservable inputs used for nonrecurring fair value measurements using Level 3 methodologies are as follows:
(Dollars In Thousands)
Weighted
Average
Balance at
Allowance at
Discount at
Loans individually evaluated for credit loss:
Commercial real estate - nonowner occupied
6,698
Sales comparison
Discount to appraised value
242
Sales comparison & SBA guaranty
101
Liquidation & SBA guaranty
Total loans individually evaluated for credit loss
Foreclosed assets held for sale - real estate:
Residential (1-4 family)
Commercial real estate
431
45
Total foreclosed assets held for sale
Impaired loans:
2,973
Liquidation of assets
Total impaired loans
50
Certain of the Corporation’s financial instruments are not measured at fair value in the consolidated financial statements. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from disclosure requirements. Therefore, the aggregate fair value amounts presented may not represent the underlying fair value of the Corporation.
The estimated fair values, and related carrying amounts, of the Corporation’s financial instruments that are not recorded at fair value are as follows:
Fair Value
Hierarchy
Carrying
Level
Financial assets:
Level 1
Level 2
4,033
6,956
Restricted equity securities (included in other assets)
21,062
14,418
Level 3
1,732,232
1,674,002
Financial liabilities:
Deposits with no stated maturity
1,603,033
1,702,404
Time deposits
421,964
419,686
295,189
293,814
Long-term borrowings
123,056
60,944
Senior debt
12,870
9,712
Subordinated debt
20,184
16,186
Accrued interest payable
1,464
461
The Corporation has commitments to extend credit and has issued standby letters of credit. Standby letters of credit are conditional guarantees of performance by a customer to a third party. Estimates of the fair value of these off-balance sheet items were not made because of the short-term nature of these arrangements and the credit standing of the counterparties.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements in this section and elsewhere in this quarterly report on Form 10-Q are forward-looking statements. Citizens & Northern Corporation and its wholly-owned subsidiaries (collectively, the Corporation) intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995. Forward-looking statements, which are not historical facts, are based on certain assumptions and describe future plans, business objectives and expectations, and are generally identifiable by the use of words such as, "should", “likely”, "expect", “plan”, "anticipate", “target”, “forecast”, and “goal”. These forward-looking statements are subject to risks and uncertainties that are difficult to predict, may be beyond management’s control and could cause results to differ materially from those expressed or implied by such forward-looking statements. Factors which could have a material, adverse impact on the operations and future prospects of the Corporation include, but are not limited to, the following:
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
EARNINGS OVERVIEW
Third Quarter 2023 as Compared to Third Quarter 2022
Third quarter 2023 net income was $7,591,000, or $0.50 per diluted share, as compared to $4,455,000, or $0.29 per diluted share, in the third quarter 2022. Significant variances were as follows:
40
41
Nine Months Ended September 30, 2023 as Compared to Nine Months Ended September 30, 2022
Net income for the nine-month period ended September 30, 2023 was $19,887,000, or $1.29 per diluted share, as compared to $18,839,000, or $1.21 per diluted share, for the first nine months of 2022. Significant variances were as follows:
42
43
TABLE I – QUARTERLY FINANCIAL DATA
(Dollars In Thousands,
For the Three Months Ended :
Except Per Share Data)
June 30,
March 31,
(Unaudited)
Interest income
28,011
26,139
25,855
Interest expense
7,649
5,358
3,563
20,362
20,781
22,292
812
2,262
19,550
21,133
20,030
Noninterest income
6,634
5,616
6,109
Noninterest expense
18,722
19,087
16,587
7,462
7,662
9,552
1,419
1,409
1,773
6,043
6,253
7,779
5,996
6,201
7,711
Basic earnings per common share
0.39
0.40
Diluted earnings per common share
TABLE II – COMPARISON OF NONINTEREST INCOME
Change
10.0
(302)
(43.4)
338
30.6
6.5
Net gains from sales of loans
80.9
(35)
(18.5)
20.3
462
74.3
(100.0)
818
14.4
255
4.9
(595)
(33.4)
459
12.5
65
2.1
(283)
(38.6)
(291)
(38.4)
11.1
776
29.1
(15)
(71.4)
416
2.3
TABLE III - COMPARISON OF NONINTEREST EXPENSE
52
0.5
(230)
(15.4)
104
6.1
107
27.0
(84)
(17.2)
(6.5)
582
29.2
497
2.8
4.4
(5.3)
11.8
246
21.8
(253)
(17.3)
498
33.4
2,133
33.8
4,381
8.5
Additional detailed information concerning fluctuations in the Corporation’s earnings results and other financial information are provided in other sections of Management’s Discussion and Analysis.
CRITICAL ACCOUNTING POLICIES
The presentation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect many of the reported amounts and disclosures. Actual results could differ from these estimates.
Allowance for Credit Losses on Loans – A material estimate that is particularly susceptible to significant change is the determination of the allowance for credit losses (ACL) on loans. The Corporation maintains an ACL on loans which represents management’s estimate of expected net charge-offs over the life of the loans. The ACL includes two primary components: (i) an allowance established on loans which share similar risk characteristics collectively evaluated for credit losses (collective basis), and (ii) an allowance established on loans which do not share similar risk characteristics with any loan segment and which are individually evaluated for credit losses (individual basis). Management considers the determination of the ACL on loans to be critical because it requires significant judgment regarding estimates of expected credit losses based on the Corporation’s historical loss experience, current conditions and economic forecasts. Management’s evaluation is based upon a continuous review of the Corporation’s loans, with consideration given to evaluations resulting from examinations performed by regulatory authorities. Note 6 to the unaudited consolidated financial statements provides an overview of the process management uses for determining the ACL, and additional discussion of the ACL is provided in a separate section of Management’s Discussion and Analysis.
The ACL may increase or decrease due to changes in economic conditions affecting borrowers and macroeconomic variables, including new information regarding existing problem loans, identification of additional problem loans, changes in the fair value of underlying collateral, unforeseen events such as natural disasters and pandemics, and other factors. Because current economic conditions and
46
forecasts can change and future events are inherently difficult to predict, the anticipated amount of estimated credit losses on loans, and therefore the appropriateness of the ACL, could change significantly.
Fair Value of Available-For-Sale Debt Securities – Another material estimate is the calculation of fair values of the Corporation’s debt securities. For most of the Corporation’s debt securities, the Corporation receives estimated fair values of debt securities from an independent valuation service, or from brokers. In developing fair values, the valuation service and the brokers use estimates of cash flows, based on historical performance of similar instruments in similar interest rate environments. Based on experience, management is aware that estimated fair values of debt securities tend to vary among brokers and other valuation services.
NET INTEREST INCOME
The Corporation’s primary source of operating income is net interest income, which is equal to the difference between the amounts of interest income and interest expense. Tables IV, V and VI include information regarding the Corporation’s net interest income for the three-month and nine-month periods ended September 30, 2023 and 2022. In each of these tables, the amounts of interest income earned on tax-exempt securities and loans have been adjusted to a fully taxable-equivalent basis. The Corporation believes presentation of net interest income on a fully taxable-equivalent basis provides investors with meaningful information for purposes of comparing returns on tax-exempt securities and loans with returns on taxable securities and loans. Accordingly, the net interest income amounts reflected in these tables exceed the amounts presented in the consolidated financial statements. The discussion that follows is based on amounts in the related Tables.
Three-Month Periods Ended September 30, 2023 and 2022
For the three-month periods, fully taxable equivalent net interest income (a non-GAAP measure) of $19,875,000 in 2023 was $1,313,000 (6.2%) lower than in 2022. The decrease in net interest income reflected an increase in interest expense of $6,624,000 (includes $5,292,000 interest on deposits and $1,332,000 in interest on borrowings) and an increase of $5,311,000 in total interest income. As presented in Table VI, the net impact of changes in volume of earning assets and interest-bearing liabilities increased net interest income in the third quarter 2023 as compared to third quarter 2022 by $255,000, while the net impact of changes in interest rates (primarily increases) decreased net interest income by $1,568,000. As presented in Table V, the Net Interest Margin was 3.35% in the third quarter 2023 as compared to 3.69% in the third quarter 2022, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) decreased to 2.73% in 2023 from 3.46% in 2022. The average yield on earning assets of 4.94% was 0.76% higher in 2023 as compared to 2022, and the average rate on interest-bearing liabilities of 2.21% in 2023 was 1.49% higher.
INTEREST INCOME AND EARNING ASSETS
Interest income totaled $29,330,000 in 2023, an increase of $5,311,000, or 22.1% from 2022.
Interest and fees from loans receivable increased $5,489,000 in 2023 as compared to 2022. The fully taxable equivalent yield on loans in 2023 increased to 5.72% from 4.91% in 2022, reflecting the effects of rising interest rates on the loan portfolio. Average outstanding loans receivable increased $142,728,000 (8.5%) to $1,816,998,000 in 2023 from $1,674,270,000 in 2022. The Corporation has experienced growth in commercial real estate and residential mortgage loans over the last three quarters of 2022 and first nine months of 2023.
Income from interest-bearing due from banks totaled $345,000 in 2023, an increase of $169,000 from the total for 2022. The average yield on interest-bearing due from banks was 4.31% in 2023, up from 2.03% in 2022. The average balance of interest-bearing due from banks was $31,729,000 in 2023, down from $34,465,000 in 2022. Within this category, the largest asset balance in 2023 and 2022 has been interest-bearing deposits held with the Federal Reserve.
Interest income from available-for-sale debt securities, on a fully taxable-equivalent basis, totaled $2,758,000 in 2023, down $327,000 from 2022, as the average balance (at amortized cost) of available-for-sale debt securities decreased $60,776,000. The average yield on available-for-sale debt securities was 2.17% in 2023 and 2022.
INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES
Interest expense increased $6,624,000 to $9,455,000 in 2023 from $2,831,000 in 2022.
Interest expense on deposits increased $5,292,000, as the average rate on interest-bearing deposits increased to 1.93% in 2023 from 0.54% in 2022. Average total deposits (interest-bearing and noninterest-bearing) amounted to $1,990,092,000 for the third quarter 2023, down $8,491,000 (0.4%) from the third quarter 2022. Within average total deposits, average brokered deposits (primarily time and money market) were $60,829,000 with an average interest rate of 4.98% in the third quarter 2023, up from $39,074,000 with an average interest rate of 2.51% in the third quarter 2022. The deposit mix has changed significantly over the past several months as businesses and consumers have become more interest-rate sensitive in light of higher market rates. Average time deposits increased $107,808,000 and average interest checking deposits increased $69,427,000, while the average total balance of money market accounts decreased $98,152,000, average noninterest-bearing demand deposits decreased $58,392,000 and average savings deposits decreased $29,182,000.
Interest expense on borrowed funds increased $1,332,000 in 2023 as compared to 2022, as the Corporation utilized higher levels of short-term and long-term FHLB borrowings to help provide funding for loan growth. Interest expense on short-term borrowings was $677,000 in 2023, up from $179,000 in 2022. The average balance of short-term borrowings increased to $49,157,000 in 2023 from $33,970,000 in 2022. The average rate on short-term borrowings was 5.46% in 2023 compared to 2.09% in 2022. Interest expense on long-term borrowings (FHLB advances) increased $832,000 to $1,164,000 in 2023 from $332,000 in 2022. The average balance of long-term borrowings was $119,395,000 at an average rate of 3.87% in 2023, up from an average balance of $51,628,000 at an average rate of 2.55% in 2022. Borrowings are classified as long-term within the Tables based on their term at origination or assumption in business combinations. The average rate on total borrowed funds was 4.18% in 2023 compared to 2.73% in 2022.
Nine-Month Periods Ended September 30, 2023 and 2022
For the nine-month periods, fully taxable equivalent net interest income was $61,526,000 in 2023, which was $233,000 (0.4%) lower than in 2022. Similar to the discussion for the third quarter 2023, the decrease in net interest income reflected an increase in interest expense of $16,506,000 (includes $11,581,000 interest on deposits and $4,925,000 in interest on borrowings) and an increase of $16,273,000 in total interest income. As presented in Table VI, the net impact of changes in volume of earning assets and interest-bearing liabilities increased net interest income for the nine months ended September 30, 2023 over the nine months ended September 30, 2022 by $2,482,000, while the net impact of changes in interest rates (primarily increases) decreased net interest income by $2,715,000. As presented in Table V, the Net Interest Margin was 3.53% in the first nine months of 2023 as compared to 3.72% in the first nine months of 2022, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) decreased to 2.99% in 2023 from 3.55% in 2022. The average yield on earning assets of 4.81% was 0.73% higher in 2023 as compared to 2022, while the average rate on interest-bearing liabilities of 1.82% in 2023 was 1.29% higher as compared to 2022.
Interest income totaled $83,988,000 in 2023, an increase of $16,273,000 from 2022.
Interest and fees from loans receivable increased $16,058,000 in 2023 as compared to 2022. In the nine-month period ended September 30, 2023, the fully taxable equivalent yield on loans was 5.60%, up from 4.86% in the first nine months of 2022, reflecting the effects of rising interest rates on the loan portfolio. Average outstanding loans receivable increased $173,103,000 (10.8%) to $1,777,238,000 in 2023 from $1,604,135,000 in 2022. As noted above, the Corporation has experienced growth in outstanding commercial real estate and residential mortgage loans over the last three quarters of 2022 and first nine months of 2023.
Income from interest-bearing due from banks was $932,000 in 2023, an increase of $597,000 from 2022. The average yield on interest-bearing due from banks was 4.01% in 2023, up from 0.81% in 2022. The average balance of interest-bearing due from banks was $31,076,000 in 2023, down from $55,154,000 in 2022. The reduction in interest-bearing due from bank balances reflects the use of funds to help support loan growth. Within this category, the largest asset balance in 2023 and 2022 has been interest-bearing deposits held with the Federal Reserve.
Interest income from available-for-sale debt securities decreased $353,000 in 2023 from 2022. The average balance of available-for-sale debt securities (at amortized cost) decreased to $522,600,000 in 2023 from $557,155,000 in 2022, as net proceeds from maturities and sales of securities have been used to help fund loan growth. The average yield on available-for-sale debt securities was 2.20% for 2023 as compared to 2.15% in 2022.
For the nine-month periods, interest expense increased $16,506,000 to $22,462,000 in 2023 from $5,956,000 in 2022.
Interest expense on deposits increased $11,581,000, as the average rate on interest-bearing deposits increased to 1.45% in 2023 from 0.38% in 2022. Average total deposits (interest-bearing and noninterest-bearing) amounted to $1,956,757,000 for the first nine months of 2023, down $7,906,000 (0.4%) from the first nine months of 2022. Within average deposits, average brokered deposits were $40,910,000 at an average rate of 4.56% for the first nine months of 2023 as compared to $35,423,000 at an average rate of 1.36% in the first nine months of 2022. As noted above, the deposit mix has changed significantly over the last several months. Average time deposits increased $83,501,000 and average interest checking deposits increased $46,407,000, while the average total balance of money market accounts decreased $103,850,000, the average balances of noninterest bearing demand deposits decreased $24,014,000 and average savings deposits decreased $9,950,000.
Interest expense on borrowed funds increased $4,925,000 in 2023 as compared to 2022. Interest expense on short-term borrowings of $2,918,000 in 2023 was up from $302,000 in 2022 as the average balance of short-term borrowings increased to $75,978,000 in 2023 from $24,306,000 in 2022. The average rate on short-term borrowings was 5.13% in 2023 compared to 1.66% in 2022. Interest expense on long-term borrowings (FHLB advances) increased $2,465,000 to $2,901,000 in 2023 from $436,000 in 2022. The average balance of long-term borrowings was $103,817,000 in 2023, up from an average balance of $32,509,000 in 2022. Borrowings are classified as long-term within the Tables based on their term at origination or assumption in business combinations. The average rate on long-term borrowings was 3.74% in 2023 compared to 1.79% in 2022. Interest expense on subordinated debt decreased $158,000 to $691,000 in 2023 from $849,000 in 2022. The average balance of subordinated debt decreased to $24,648,000 in 2023 from $27,966,000 in 2022, and the average rate on subordinated debt decreased to 3.75% in 2023 from 4.06% in 2022.
TABLE IV - ANALYSIS OF INTEREST INCOME AND EXPENSE
Increase/
.
(Decrease)
Interest-bearing due from banks
345
176
932
335
(61)
681
(266)
2,161
2,811
(650)
2,758
3,085
(327)
8,601
8,954
(353)
Loans receivable:
25,526
19,967
5,559
72,314
55,662
16,652
Paycheck Protection Program
118
(115)
899
(891)
680
2,093
1,796
Total loans receivable
26,209
20,720
5,489
74,415
58,357
16,058
Other earning assets
69
(29)
Total Interest Income
29,330
24,019
5,311
83,988
67,715
16,273
Interest-bearing deposits:
Interest checking
2,360
1,873
4,859
989
3,870
Money market
639
1,030
3,654
1,270
2,384
Savings
66
186
191
3,175
780
2,395
6,894
1,562
5,332
Total interest-bearing deposits
5,292
11,581
Borrowed funds:
Short-term
2,616
Long-term - FHLB advances
2,465
(158)
Total borrowed funds
2,191
1,332
6,869
1,944
4,925
Total Interest Expense
6,624
16,506
Net Interest Income
19,875
21,188
(1,313)
61,526
61,759
(233)
Note: Interest income from tax-exempt securities and loans has been adjusted to a fully taxable-equivalent basis (a non-GAAP measure), using the Corporation’s marginal federal income tax rate of 21%. The following table is a reconciliation of net interest income under U.S. GAAP as compared to net interest income as adjusted to a fully taxable-equivalent basis.
Net Interest Income Under U.S. GAAP
(1,216)
(30)
Add: fully taxable-equivalent interest income adjustment from tax-exempt securities
84
(95)
314
553
(239)
Add: fully taxable-equivalent interest income adjustment from tax-exempt loans
130
406
370
Net Interest Income as adjusted to a fully taxable-equivalent basis
TABLE V - Analysis of Average Daily Balances and Rates
Rate of
Return/
9/30/2022
Cost of
Funds %
EARNING ASSETS
31,729
4.31
34,465
2.03
31,076
4.01
55,154
0.81
Available-for-sale debt securities, at amortized cost:
379,709
2.17
414,147
2.05
395,070
2.18
408,178
2.01
124,435
150,773
2.49
127,530
2.27
148,977
2.52
504,144
564,920
522,600
2.20
557,155
2.15
1,729,835
5.85
1,582,245
5.01
1,687,444
5.73
1,507,756
4.94
137
8.69
4,695
9.97
149
7.18
10,887
11.04
87,026
3.10
87,330
2.88
89,645
3.12
85,492
2.81
1,816,998
5.72
1,674,270
4.91
1,777,238
5.60
1,604,135
4.86
1,468
3,925
3.84
4.02
2,750
3.35
Total Earning Assets
2,354,339
2,277,580
4.18
2,332,246
4.81
2,219,194
4.08
Cash
22,068
22,475
22,527
Unrealized loss on securities
(63,110)
(44,559)
(59,921)
(28,068)
Allowance for credit losses
(19,540)
(14,914)
(18,472)
(14,406)
31,559
30,991
31,413
30,857
Bank premises and equipment
21,132
21,874
21,262
21,494
Intangible assets
55,125
55,547
55,227
55,655
74,483
57,012
70,369
52,610
Total Assets
2,476,056
2,407,262
2,454,599
2,359,863
INTEREST-BEARING LIABILITIES
512,074
1.83
442,647
0.44
477,751
1.36
431,344
0.31
340,618
438,770
0.58
344,527
1.42
448,377
0.38
232,240
0.10
261,422
245,483
255,433
406,436
298,628
1.04
365,174
281,673
0.74
1,491,368
1.93
1,441,467
0.54
1,432,935
1.45
1,416,827
49,157
5.46
33,970
2.09
75,978
5.13
24,306
1.66
119,395
3.87
51,628
2.55
103,817
3.74
32,509
1.79
14,808
3.22
14,741
3.20
14,790
3.25
14,725
3.24
24,676
3.70
24,566
24,648
3.75
27,966
4.06
208,036
124,905
2.73
219,233
4.19
99,506
2.61
Total Interest-bearing Liabilities
1,699,404
2.21
1,566,372
0.72
1,652,168
1.82
1,516,333
0.53
Demand deposits
498,724
557,116
523,822
547,836
Other liabilities
30,749
23,588
28,091
22,565
Total Liabilities
2,228,877
2,147,076
2,204,081
2,086,734
Stockholders' equity, excluding accumulated other comprehensive loss
296,577
295,086
297,386
295,019
(49,398)
(34,900)
(46,868)
(21,890)
Total Stockholders' Equity
247,179
260,186
250,518
273,129
Total Liabilities and Stockholders' Equity
Interest Rate Spread
3.46
2.99
3.55
Net Interest Income/Earning Assets
3.69
3.53
3.72
Total Deposits (Interest-bearing and Demand)
1,990,092
1,998,583
1,956,757
1,964,663
TABLE VI - ANALYSIS OF VOLUME AND RATE CHANGES
Three Months Ended 9/30/2023 vs. 9/30/2022
Nine Months Ended 9/30/2023 vs. 9/30/2022
Change in
Volume
Rate
(76)
245
800
(180)
(202)
499
(154)
(112)
(380)
(270)
(334)
(582)
1,985
3,574
7,088
9,564
(113)
(658)
90
1,870
3,619
6,520
9,538
1,434
3,877
5,694
10,579
73
1,800
117
3,753
1,205
(357)
2,741
2,063
585
4,747
222
337
11,244
347
1,319
1,297
802
1,650
815
(96)
(62)
957
375
2,875
2,050
1,179
5,445
3,212
13,294
(1,568)
2,482
(2,715)
INCOME TAXES
The income tax provision in interim periods is based on the Corporation’s estimate of the effective tax rate expected to be applicable for the full year. Due to higher levels of pre-tax income in 2023, the income tax provision for the third quarter 2023 of $1,846,000 was $988,000 higher than the provision for the third quarter 2022 and the provision for the nine months ended September 30, 2023 of $4,674,000 was $715,000 higher than the amount for the first nine months of 2022. The effective tax rate (tax provision as a percentage of pre-tax income) was 19.6% in the third quarter 2023 compared to 16.1% in the third quarter 2022 and 19.0% for the first nine months of 2023 as compared to 17.4% for the first nine months of 2022. The Corporation’s effective tax rates differ from the statutory rate of 21% principally because of the effects of tax-exempt interest income, nondeductible interest expense, state income taxes and other permanent differences.
The Corporation recognizes deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax basis of assets and liabilities. The net deferred tax asset at September 30, 2023 and December 31, 2022 represents the following temporary difference components:
Deferred tax assets:
Unrealized holding losses on securities
16,024
13,391
3,982
3,648
Purchase accounting adjustments on loans
510
938
Deferred compensation
1,300
1,149
Operating leases liability
907
Deferred loan origination fees
715
779
Net operating loss carryforward
571
659
Accrued incentive compensation
354
Other deferred tax assets
1,308
1,115
Total deferred tax assets
25,618
22,940
Deferred tax liabilities:
Defined benefit plans - ASC 835
129
280
298
Core deposit intangibles
566
Right-of-use assets from operating leases
Other deferred tax liabilities
Total deferred tax liabilities
1,887
2,056
The Corporation regularly reviews deferred tax assets for recoverability based on history of earnings, expectations for future earnings and expected timing of reversals of temporary differences. Realization of deferred tax assets ultimately depends on the existence of sufficient taxable income.
Management believes the recorded net deferred tax asset at September 30, 2023 is fully realizable; however, if management determines the Corporation will be unable to realize all or part of the net deferred tax asset, the Corporation would adjust the deferred tax asset, which would negatively impact earnings.
SECURITIES
Management continually evaluates several objectives in determining the size, securities mix and other characteristics of the available-for-sale debt securities (investment) portfolio. Key objectives include supporting liquidity needs and maximizing return on earning assets within reasonable risk parameters.
53
The composition of the available-for-sale debt securities portfolio at September 30, 2023, December 31, 2022 and December 31, 2021 is as follows:
25,058
24,912
23,936
24,091
18,000
17,987
143,427
148,028
72,182
72,765
98,048
98,181
44,015
44,247
86,926
87,468
Total Available-for-Sale Debt Securities
511,592
517,679
Aggregate Unrealized (Loss) Gain
(76,302)
(63,761)
6,087
Aggregate Unrealized (Loss) Gain as a % of Amortized Cost
(15.1)
(11.3)
1.2
Market Yield on 5-Year U.S. Treasury Obligations (a)
4.60
3.99
1.26
(a) Source: Treasury.gov (Daily Treasury Par Yield Curve Rates)
As reflected in the table above, the fair value of available-for-sale securities was lower than the amortized cost basis by $76,302,000, or 15.1% at September 30, 2023 and $63,761,000 (11.3%) at December 31, 2022. In comparison, the aggregate unrealized gain position was $6,087,000 (1.2%) at December 31, 2021. The volatility in the fair value of the portfolio, including the significant reduction in fair value, resulted from changes in interest rates. As shown above, the market yield on the 5-year U.S. Treasury Note was 0.61% higher at September 30, 2023 in comparison to December 31, 2022, and 3.34% higher than at December 31, 2021.
Additional information regarding the potential impact of interest rate changes on all of the Corporation’s financial instruments is provided in Item 3, Quantitative and Qualitative Disclosures about Market Risk.
As described in Note 5 to the unaudited consolidated financial statements, management determined the Corporation does not have the intent to sell, nor is it more likely than not that it will be required to sell, available-for-sale debt securities in an unrealized loss position at September 30, 2023 before it is able to recover the amortized cost basis. Further, management reviewed the Corporation’s holdings as of September 30, 2023 and concluded there were no credit-related declines in fair value. Additional information related to the types of securities held at September 30, 2023, other than securities issued or guaranteed by U.S. Government entities or agencies, is as follows:
54
Based on the results of management’s assessment, there was no ACL required on available-for-sale debt securities in an unrealized loss position at September 30, 2023.
FINANCIAL CONDITION
This section includes information regarding the Corporation’s lending activities or other significant changes or exposures that are not otherwise addressed in Management’s Discussion and Analysis. Significant changes in the average balances of the Corporation’s earning assets and interest-bearing liabilities are described in the Net Interest Income section of Management’s Discussion and Analysis. Other significant balance sheet items, including securities, the allowance for credit losses and stockholders’ equity, are discussed in separate sections of Management’s Discussion and Analysis. Management does not expect the amount of purchases of bank premises and equipment to have a material, detrimental effect on the Corporation’s financial condition in 2023.
Table VII shows the composition of the loan portfolio at September 30, 2023 and at year-end from 2018 through 2022. The segments presented in Table VII have been revised from those used in prior year disclosures to be consistent with the pools used in determining the collectively evaluated portion of the allowance for credit losses based on the CECL methodology in 2023.
As presented in Table VII, total loans outstanding at September 30, 2023 of $1,830,670,000 was more than double the corresponding total at December 31, 2018. The increase in loans outstanding includes the impact of acquisitions of banks located in Southeastern Pennsylvania in 2019 and 2020. Primarily as a result of the acquisitions, as well as expansion by opening two offices in Southcentral Pennsylvania, the mix of the loan portfolio has changed to become predominantly commercial in nature. At September 30, 2023, commercial loans represented 75% of the portfolio while residential loans totaled 22% of the portfolio; in comparison, commercial loans totaled 48% and residential loans totaled 47% of the portfolio at December 31, 2018.
Table VII shows an increase in commercial and industrial loans to $222,923,000 at December 31, 2020 followed by reductions in 2021, 2022 and the first nine months of 2023. The elevated balance of commercial and industrial loans at December 31, 2020 included Paycheck Protection Program (PPP) loans of $132,269,000, a substantial portion of which were subsequently repaid. The outstanding balance of PPP loans was $130,000 at September 30, 2023.
At September 30, 2023, gross loans outstanding increased $90,630,000 from December 31, 2022. Gross loans outstanding at December 31, 2022 increased $175,191,000, or 11.2%, from the total at December 31, 2021. The pace of loan growth in the fourth quarter of 2023 and in future periods will depend on the impact of the increases in interest rates that have occurred in 2022 and 2023, potential further increases in interest rates, potential deterioration in economic conditions and other factors.
While the Corporation’s lending activities are primarily concentrated in its market areas, a portion of the Corporation’s commercial loan segment consists of participation loans. Participation loans represent portions of larger commercial transactions for which other institutions are the “lead banks”. Although not the lead bank, the Corporation conducts detailed underwriting and monitoring of participation loan opportunities. Total participation loans outstanding amounted to $38,995,000 at September 30, 2023, down from $44,723,000 at December 31, 2022.
55
At September 30, 2023, the total recorded investment in non-owner occupied commercial real estate loans for which the primary purpose is utilization of office space by third parties was $94,729,000, or 5.2% of total gross loans receivable. Within this segment, at September 30, 2023, there were two loans with a recorded investment of $3,963,000 risk rated as substandard and nonaccrual with specific allowance for credit losses totaling $540,000. The remainder of the non-owner occupied commercial real estate loans for the primary purpose of office space utilization totaling $90,766,000 were accruing interest and risk rated Pass at September 30, 2023.
The Corporation originates and sells residential mortgage loans to the secondary market through the MPF Xtra program administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Residential mortgages originated and sold through the MPF Xtra program consist primarily of conforming, prime loans sold to the Federal National Mortgage Association (Fannie Mae), a quasi-government entity. The Corporation also originates and sells residential mortgage loans to the secondary market through the MPF Original program, administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Residential mortgages originated and sold through the MPF Original program consist primarily of conforming, prime loans sold to the Federal Home Loan Bank of Pittsburgh. In late 2019, the Corporation began to originate and sell larger-balance, nonconforming mortgages under the MPF Direct Program, which is also administered by the Federal Home Loan Banks of Pittsburgh and Chicago. The Corporation does not retain servicing rights for loans sold under the MPF Direct Program. Through September 30, 2023, the Corporation’s activity under the MPF Direct Program has been minimal.
For loan sales originated under the MPF programs, the Corporation provides customary representations and warranties to investors that specify, among other things, that the loans have been underwritten to the standards established by the investor. The Corporation may be required to repurchase a loan and reimburse a portion of fees received or reimburse the investor for a credit loss incurred on a loan, if it is determined that the representations and warranties have not been met. Such repurchases or reimbursements generally result from an underwriting or documentation deficiency. At September 30, 2023, the total outstanding balance of loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $1,472,000, and the corresponding total outstanding balance of repurchased loans at December 31, 2022 was $1,515,000.
At September 30, 2023, outstanding balances of loans sold and serviced through the MPF Xtra and Original programs totaled $318,526,000, including loans sold through the MPF Xtra program of $151,094,000 and loans sold through the Original program of $167,432,000. At December 31, 2022, outstanding balances of loans sold and serviced through the two programs totaled $325,677,000, including loans sold through the MPF Xtra program of $155,506,000 and loans sold through the Original Program of $170,171,000. Based on the fairly limited volume of required repurchases to date, no allowance has been established for representation and warranty exposures as of September 30, 2023 and December 31, 2022.
56
TABLE VII - SUMMARY OF LOANS BY TYPE
2018
Commercial real estate - non-owner occupied:
Non-owner occupied
503,434
454,386
358,352
328,662
208,579
115,128
61,061
55,406
49,054
54,893
30,474
7,104
172,792
165,805
175,027
198,918
147,121
35,176
582,433
582,473
386,174
157,408
196,083
191,075
78,729
38,478
All other commercial loans:
80,960
95,368
118,488
222,923
67,288
49,947
122,189
141,444
106,338
105,802
92,509
65,492
80,415
86,663
75,401
46,295
46,054
49,037
91,014
60,892
59,505
41,000
32,717
11,126
21,125
25,710
26,498
29,310
28,735
23,130
386,230
445,330
267,303
198,732
Residential mortgage loans:
1-4 Family - residential
385,777
363,005
327,593
356,532
388,415
360,195
24,236
23,151
18,736
14,640
24,698
350,744
375,268
403,055
384,893
Consumer loans:
37,736
36,650
33,522
34,566
30,810
31,955
18,819
18,224
15,837
15,497
16,151
16,097
Total consumer
49,359
50,063
46,961
48,052
1,564,849
1,644,209
1,182,222
827,563
(13,537)
(11,385)
(9,836)
(9,309)
1,551,312
1,632,824
1,172,386
818,254
Additional details regarding the composition of the non-owner occupied commercial real estate loan portfolio at September 30, 2023 is as follows:
NON-OWNER OCCUPIED COMMERCIAL REAL ESTATE
% of Non-owner
% of
Occupied CRE
Total Loans
Industrial
107,268
21.3
5.9
Office
94,729
18.8
5.2
Retail
94,542
Hotels
73,511
14.6
4.0
Mixed Use
59,702
11.9
3.3
73,682
Total Non-owner Occupied CRE Loans
Total Gross Loans
PROVISION AND ALLOWANCE FOR CREDIT LOSSES
On January 1, 2023, the Corporation adopted ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (ASC 326). This standard replaced the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (CECL) methodology. CECL requires an estimate of credit losses for the remaining estimated life of the financial asset using historical experience, current conditions, and reasonable and supportable forecasts. Note 1 to the unaudited consolidated financial statements provides a detailed explanation of the Corporation’s adopted accounting policies related to the application of CECL.
Effective January 1, 2023, the Corporation adopted ASC 326 using the modified retrospective approach for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2023 are presented under CECL while prior period amounts continue to be reported in accordance with previously applicable accounting standards (“Incurred Loss”). At January 1, 2023, the impact of adopting CECL included an increase in gross loans receivable of $806,000 as compared to December 31, 2022 and an increase in the allowance for credit losses of $2,104,000 as compared to the allowance for loan losses determined under the Incurred Loss method at December 31, 2022.
A summary of the credit for credit losses for the third quarter 2023 and for the nine-month period ended September 30, 2023 is as follows:
3 Months
9 Months
(Credit) for credit losses:
Off-balance sheet exposures (1)
Total (credit) for credit losses
In the third quarter 2023, the credit for credit losses included the impact of reductions in the ACL from a reduction in estimated future net charge-offs related to an economic forecast, qualitative adjustments in concentrations of credit based on loan type, lending policies and procedures and changes in external indexes, and a reduction in the Corporation’s average net charge-off experience. Similarly, the credit for credit losses for the first nine months of 2023 included the impact of reductions in the ACL related to the qualitative adjustments described above and a reduction in the Corporation’s average net charge-off experience; however, the net impact of changes in the economic forecast was not significant. The ACL as a percentage of gross loans receivable was 0.99% at September 30, 2023 and 1.05% at June 30, 2023 as compared to 1.08% at January 1, 2023 upon initial adoption of CECL. Within the credit for
58
credit losses on loans in the first nine months of 2023, the net provision related to specific loans was $294,000, including net charge-offs of $225,000 and a net increase in specific allowances on loans of $69,000. In comparison, the provision for loan losses in the first nine months of 2022 included $2,047,000 related to specific loans (net decrease in specific allowances on loans of $313,000 and net charge-offs of $2,360,000), an increase of $2,617,000 in the collectively determined portion of the allowance and a $329,000 increase in the unallocated portion.
Table X shows that total nonperforming assets as a percentage of total assets was 0.70% at September 30, 2023, down from 1.04% at December 31, 2022 and lower than that at year-end 2018 through 2021. Total nonperforming assets were $17.4 million at September 30, 2023, down from $25.6 million at December 31, 2022. Similarly, total loans individually evaluated for credit loss decreased to $12.0 million at September 30, 2023 from $19.4 million at December 31, 2022. The net decrease in nonperforming assets at September 30, 2023 compared to December 31, 2022 included the impact of a $10.0 million payoff in the first quarter 2023 on a commercial loan relationship that was classified as nonaccrual at December 31, 2022. The reduction also included paydowns totaling $2,262,000 in the first nine months of 2023 on a commercial loan for which partial charge-offs totaling $3,942,000 were recorded in 2022. The remaining carrying value of this loan was $392,000 at September 30, 2023. These reductions were partially offset by the addition to nonaccrual of two commercial loan relationships totaling $4,512,000, including two commercial real estate loans with a primary purpose of office space utilization totaling $3,963,000, at September 30, 2023.
In the first nine months of 2023, net charge-offs were low by historical standards, totaling $225,000, or 0.01% of average outstanding loans. Table VIII shows annual average net charge-off rates ranging from a high of 0.26% in 2022 to a low of 0.02% in 2018.
Over the period 2018-2022 and the first nine months of 2023, each period includes a few large commercial relationships that have required significant monitoring and workout efforts. As a result, a limited number of relationships may significantly impact the total amount of allowance required on individual loans and may significantly impact the provision for credit losses and the amount of total charge-offs reported in any one period.
Management believes it has been conservative in its decisions concerning identification of loans requiring individual evaluation for credit loss, estimates of loss, and nonaccrual status; however, the actual losses realized from these relationships could vary materially from the allowances calculated as of September 30, 2023. Management continues to closely monitor its commercial loan relationships for possible credit losses and will adjust its estimates of loss and decisions concerning nonaccrual status, if appropriate.
Tables VIII through X present historical data related to loans and the allowance for credit losses.
TABLE VIII - ANALYSIS OF THE ALLOWANCE FOR CREDIT LOSSES
Years Ended December 31,
Balance, beginning of year
11,385
9,836
9,309
8,856
Increase due to adoption of CECL
(4,245)
(1,575)
(2,465)
(379)
(497)
366
Net charge-offs
(225)
(2,360)
(4,177)
(1,509)
(2,364)
(322)
(131)
7,255
3,661
3,913
584
Net charge-offs as a % of average loans
0.01
0.15
0.26
0.09
0.16
0.03
0.02
TABLE IX - COMPONENTS OF THE ALLOWANCE FOR CREDIT LOSSES
UPON ADOPTION OF CECL
January 1,
Loans individually evaluated
751
Loans collectively evaluated:
9,671
9,641
1,803
1,765
3,457
3,914
Residential mortgage
2,407
241
Total Allowance
PRIOR TO CECL ADOPTION
As of December 31,
ASC 310 - Impaired loans - individually evaluated
925
1,051
1,605
ASC 450 - Collectively evaluated:
7,553
5,545
3,102
4,091
4,006
239
281
233
TABLE X - PAST DUE LOANS AND NONPERFORMING ASSETS
Loans individually evaluated with a valuation allowance
6,540
8,082
3,375
4,851
Loans individually evaluated without a valuation allowance
4,146
14,871
2,636
2,895
1,670
4,923
Purchased credit impaired loans
6,558
6,841
441
Total individually evaluated loans
15,734
17,818
5,486
9,774
Total loans past due 30-89 days and still accruing
5,106
5,918
8,889
7,142
Nonperforming assets:
Other nonaccrual loans
22,058
12,441
14,575
8,777
13,113
Total nonaccrual loans
18,999
21,416
9,218
Total loans past due 90 days or more and still accruing
2,219
1,975
1,207
2,906
Total nonperforming loans
16,793
25,322
21,218
23,391
10,425
16,019
Foreclosed assets held for sale (real estate)
1,338
2,886
1,703
Total nonperforming assets
17,426
25,597
21,902
24,729
13,311
Total nonperforming loans as a % of loans
0.92
1.46
0.88
Total nonperforming assets as a % of assets
0.70
0.94
1.10
0.80
1.37
Allowance for credit losses as a % of total loans
0.99
0.95
0.87
0.69
0.83
1.12
LIQUIDITY
Liquidity is the ability to quickly raise cash at a reasonable cost. An adequate liquidity position permits the Corporation to pay creditors, compensate for unforeseen deposit fluctuations and fund unexpected loan demand.
The Corporation maintains overnight borrowing facilities with several correspondent banks that provide a source of day-to-day liquidity. Also, the Corporation maintains borrowing facilities with the Federal Home Loan Bank of Pittsburgh, secured by various mortgage loans.
The Corporation has a line of credit with the Federal Reserve Bank of Philadelphia’s Discount Window. Management intends to use this line of credit as a contingency funding source. As collateral for the line, the Corporation has pledged available-for-sale debt securities with a carrying value of $21,731,000 at September 30, 2023.
The Corporation’s outstanding, available, and total credit facilities at September 30, 2023 and December 31, 2022 are as follows:
Outstanding
Available
Total Credit
Federal Home Loan Bank of Pittsburgh
165,951
150,099
752,847
689,279
918,798
839,378
Federal Reserve Bank Discount Window
20,766
23,107
Other correspondent banks
95,000
Total credit facilities
868,613
807,386
1,034,564
957,485
At September 30, 2023, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight and short-term advances of $21,500,000, long-term borrowings of $125,243,000 and letters of credit totaling $19,208,000. At December 31, 2022, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowing of $77,000,000, long-term borrowings of $62,272,000 and letters of credit totaling $10,827,000. Additional information regarding borrowed funds is included in Note 8 to the unaudited consolidated financial statements.
Additionally, the Corporation uses “RepoSweep” arrangements to borrow funds from commercial banking customers on an overnight basis. If required to raise cash in an emergency situation, the Corporation could sell available-for-sale securities to meet its obligations or use repurchase agreements placed with brokers to borrow funds secured by investment assets. In light of the unrealized loss at September 30, 2023 resulting from increases in interest rates, as described in more detail in the Securities section of Management’s Discussion and Analysis, management would be more likely in the near term to utilize securities as collateral for borrowings than to sell securities in such an emergency situation. At September 30, 2023, the carrying value of available-for-sale securities in excess of amounts required to meet pledging or repurchase agreement obligations was $227,667,000.
Deposits totaled $2,024,997,000 at September 30, 2023, up $27,404,000 (1.4%) from $1,997,593,000 at December 31, 2022. Excluding brokered deposits, adjusted total deposits at September 30, 2023 were lower by $14,125,000 (0.7%) as compared to December 31, 2022. Brokered deposits, consisting mainly of short-term certificates of deposit, totaled $62,512,000 at September 30, 2023, an increase of $41,529,000 from December 31, 2022. The reduction in total deposits, excluding brokered deposits, included a reduction in the estimated amount of deposits in excess of FDIC insurance levels (uninsured deposit balances) of $86.4 million as compared to December 31, 2022. The net reduction in uninsured deposits resulted from several factors, including the impact of customer funds transferred to higher-yielding investment alternatives and increased use of reciprocal deposits that allow C&N Bank to place customer funds in excess of the FDIC insurance limit with other financial institutions through a deposit placement network in exchange for a matching amount of deposits from other network financial institutions. Reciprocal deposits totaled $220.6 million at September 30, 2023, up $120.8 million from December 31, 2022.
As shown in the table below, at September 30, 2023, estimated uninsured deposits totaled $603.0 million, or 29.5% of total deposits, down from $689.4 million or 34.2% of total deposits at December 31, 2022. Included in uninsured deposits are deposits collateralized by securities (almost exclusively municipal deposits) totaling $188.9 million at September 30, 2023. As shown in the table below, total
uninsured and uncollateralized deposits amounted to 20.3% of total deposits at September 30, 2023, down from 24.0% at December 31, 2022.
As summarized in the table that immediately follows, the Corporation’s highly liquid sources of available funds described above, including unused borrowing capacity with the Federal Home Loan Bank of Pittsburgh, unused availability on the Federal Reserve Bank of Philadelphia’s discount window, available federal funds lines with other banks and unencumbered available-for-sale debt securities totaled $1.1 billion at September 30, 2023. Available funding from these sources totaled 181.8% of uninsured deposits and 264.8% of total uninsured and uncollateralized deposits at September 30, 2023.
Uninsured Deposits Information
Total Deposits - C&N Bank
2,040,506
2,016,666
Estimated Total Uninsured Deposits
602,957
689,435
Portion of Uninsured Deposits that are
Collateralized
188,927
205,886
Uninsured and Uncollateralized Deposits
414,030
483,549
Uninsured and Uncollateralized Deposits as
a % of Total Deposits
24.0
Available Funding from Credit Facilities
Fair Value of Available-for-sale Debt
Securities in Excess of Pledging Obligations
227,667
272,475
Highly Liquid Available Funding
1,096,280
1,079,861
Highly Liquid Available Funding as a % of
Uninsured Deposits
181.8
156.6
264.8
223.3
Despite the reduction in deposits, excluding brokered deposits, in the first nine months of 2023, based on the ample sources of highly liquid funds as described above, management believes the Corporation is well-positioned to meet its short-term and long-term funding obligations.
STOCKHOLDERS’ EQUITY AND CAPITAL ADEQUACY
In August 2018, the Federal Reserve Board issued an interim final rule that expanded applicability of the Board’s small bank holding company policy statement. The interim final rule raised the policy statement’s asset threshold from $1 billion to $3 billion in total consolidated assets for a bank holding company or savings and loan holding company that: (1) is not engaged in significant nonbanking activities; (2) does not conduct significant off-balance sheet activities; and (3) does not have a material amount of debt or equity securities, other than trust-preferred securities, outstanding. The interim final rule provides that, if warranted for supervisory purposes, the Federal Reserve may exclude a company from the threshold increase. Management believes the Corporation meets the conditions of the Federal Reserve’s small bank holding company policy statement and is therefore excluded from consolidated capital requirements at September 30, 2023; however, C&N Bank remains subject to regulatory capital requirements administered by the federal banking agencies.
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Details concerning capital ratios at September 30, 2023 and December 31, 2022 are presented below. Management believes, as of September 30, 2023, that C&N Bank meets all capital adequacy requirements to which it is subject and maintains a capital conservation buffer (described in more detail below) that allows the Bank to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. Further, as reflected in the table below, the Corporation’s and C&N Bank’s capital ratios at September 30, 2023 and December 31, 2022 exceed the Corporation’s Board policy threshold levels.
Minimum To Be
Minimum To Maintain
Well
Minimum
Capital Conservation
Capitalized Under
Minimum To Meet
Buffer at Reporting
Prompt Corrective
the Corporation's
Actual
Requirement
Action Provisions
Policy Thresholds
Ratio
September 30, 2023:
Total capital to risk-weighted assets:
Consolidated
288,587
15.81
N/A
200,756
≥11
C&N Bank
274,474
15.07
145,695
≥8
191,225
≥10.5
182,119
≥10
200,331
Tier 1 capital to risk-weighted assets:
244,913
13.42
164,255
≥9
255,489
14.03
109,271
≥6
154,801
≥8.5
163,907
Common equity tier 1 capital to risk-weighted assets:
136,879
≥7.5
81,954
≥4.5
127,483
≥7.0
118,377
≥6.5
136,589
Tier 1 capital to average assets:
9.91
197,691
10.40
98,244
≥4
122,805
≥5
196,488
December 31, 2022:
285,397
15.72
190,590
265,784
14.68
144,873
190,145
181,091
243,750
13.43
154,287
248,744
13.74
108,654
153,927
127,060
≥7
81,491
126,764
117,709
10.11
192,941
10.38
95,826
119,783
191,652
In February 2021, the Corporation amended its treasury stock repurchase program. Under the amended program, the Corporation was authorized to repurchase up to 1,000,000 shares of its common stock. On July 11, 2023, C&N announced that it had completed the treasury stock repurchase program that began in February 2021. Cumulatively, C&N repurchased 1,000,000 shares of common stock for a total cost of $23,086,000, at an average price of $23.09 per share. For the three months ended September 30, 2023, 10,683 shares were repurchased for a total cost of $203,000, at an average price of $19.01 per share. For the nine months ended September 30, 2023, 325,300 shares were repurchased for a total cost of $6,500,000, at an average price of $19.98 per share.
On September 25, 2023, the Corporation announced a new treasury stock repurchase program. Under the newly approved program, the Corporation is authorized to repurchase up to 750,000 shares of the Corporation’s common stock, or slightly less than 5% of the Corporation’s issued and outstanding shares at August 4, 2023. The new program was effective when publicly announced and will continue thereafter until suspended or terminated by the Board of Directors, in its sole discretion. All shares of common stock repurchased pursuant to the new program shall be held as treasury shares and be available for use and reissuance for purposes as and when determined by the Board of Directors including, without limitation, pursuant to the Corporation’s Dividend Reinvestment and Stock Purchase Plans and its equity compensation program. Through September 30, 2023, no shares were repurchased under the new program.
Future dividend payments and repurchases of common stock will depend upon maintenance of a strong financial condition, future earnings and capital and regulatory requirements. In addition, the Corporation and C&N Bank are subject to restrictions on the amount of dividends that may be paid without approval of banking regulatory authorities. Further, although the Corporation is no longer subject to the specific consolidated capital requirements described herein, the Corporation’s ability to pay dividends, repurchase stock or engage in other activities may be limited by the Federal Reserve if the Corporation fails to hold capital commensurate with its overall risk profile.
To avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization subject to the rule must hold a capital conservation buffer composed of common equity tier 1 capital above its minimum risk-based capital requirements. The buffer is measured relative to risk-weighted assets. At September 30, 2023, the minimum risk-based capital ratios, and the capital ratios including the capital conservation buffer, are as follows:
Minimum common equity tier 1 capital ratio
4.5
Minimum common equity tier 1 capital ratio plus capital conservation buffer
7.0
Minimum tier 1 capital ratio
6.0
Minimum tier 1 capital ratio plus capital conservation buffer
Minimum total capital ratio
8.0
Minimum total capital ratio plus capital conservation buffer
10.5
A banking organization with a buffer greater than 2.5% over the minimum risk-based capital ratios would not be subject to additional 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. Also, a banking organization is prohibited from making dividend payments or discretionary bonus payments if its eligible retained 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
Maximum Payout
(as a % of risk-weighted assets)
(as a % of eligible retained income)
Greater than 2.5%
No payout limitation applies
≤2.5% and >1.875%
≤1.875% and >1.25%
≤1.25% and >0.625%
≤0.625%
At September 30, 2023, C&N Bank’s Capital Conservation Buffer, determined based on the minimum total capital ratio, was 7.07%.
The Corporation’s total stockholders’ equity is affected by fluctuations in the fair values of available-for-sale debt securities. The difference between amortized cost and fair value of available-for-sale debt securities, net of deferred income tax, is included in accumulated other comprehensive (loss) income within stockholders’ equity. Accumulated other comprehensive (loss) income is excluded from the Bank’s and Corporation’s regulatory capital ratios. The balance in accumulated other comprehensive loss related to unrealized losses on available-for-sale debt securities, net of deferred income tax, amounted to $60,278,000 at September 30, 2023 and $50,370,000 at December 31, 2022. The decrease in stockholders’ equity in the first nine months of 2023 from the change in accumulated other comprehensive loss resulted from an increase in interest rates. Changes in accumulated other comprehensive loss are excluded from earnings and directly increase or decrease stockholders’ equity. To the extent unrealized losses on available-for-sale debt securities result from credit losses, unrealized losses are recorded as a charge against earnings. The securities section of Management’s Discussion and Analysis and Notes 1 and 5 to the unaudited consolidated financial statements provide additional information concerning management’s evaluation of available-for-sale debt securities for credit losses at September 30, 2023.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
Market risk is the risk of loss arising from adverse changes in market rates and prices of the Corporation’s financial instruments. In addition to the effects of interest rates, the market prices of the Corporation’s available-for-sale debt securities are affected by fluctuations in the risk premiums (amounts of spread over risk-free rates) demanded by investors. Management attempts to limit the risk that economic conditions would force the Corporation to sell securities for realized losses by maintaining a strong capital position (discussed in the “Stockholders’ Equity and Capital Adequacy” section of Management’s Discussion and Analysis) and ample sources of liquidity (discussed in the “Liquidity” section of Management’s Discussion and Analysis).
The Corporation’s major category of market risk, interest rate risk, is discussed in the following section.
INTEREST RATE RISK
The Corporation uses a simulation model to calculate the potential effects of interest rate fluctuations on net interest income and the economic value of equity. For purposes of these calculations, the economic value of equity includes the discounted present values of financial instruments, such as securities, loans, deposits and borrowed funds, and the book values of nonfinancial assets and liabilities, such as premises and equipment and accrued expenses. The model measures and projects the amount of potential changes in net interest income, and calculates the discounted present value of anticipated cash flows of financial instruments, assuming an immediate increase or decrease in interest rates. Management ordinarily runs a variety of scenarios within a range of plus or minus 100-400 basis points of current rates.
The projected results based on the model includes the impact of estimates, at each level of interest rate change, regarding cash flows from principal repayments on loans and mortgage-backed securities and call activity on other investment securities. Further, the projected results are impacted by assumptions regarding the run-off and the extent of sensitivity to interest rate changes of deposits with no stated maturity (checking, savings and money market accounts). Actual results could vary significantly from these estimates, which could result in significant differences in the calculations of projected changes in net interest income and economic value of equity. Also, the model does not make estimates related to changes in the composition of the deposit portfolio that could occur due to rate competition, and the table does not necessarily reflect changes that management would make to realign the portfolio as a result of changes in interest rates.
The Corporation’s Board of Directors has established policy guidelines for acceptable levels of interest rate risk, based on an immediate increase or decrease in interest rates. The policy limits acceptable fluctuations in net interest income from the baseline (flat rates) one-year scenario and variances in the economic value of equity from the baseline values based on current rates.
Table XI, which follows this discussion, is based on the results of calculations performed using the simulation model as of September 30, 2023 and December 31, 2022. In the analysis based on September 30, 2023 data, the amounts of net interest income decrease, as compared to the amounts based on current interest rates, in both the upward and downward rate scenarios. Further, the economic value of equity is modeled to decrease in the rising rate scenarios and in all of the falling rate scenarios except -200 basis points for which the economic value of equity is modeled to increase 0.2%. The results based on September 30, 2023 data as presented in Table XI are significantly different from the results based on the modeling performed using December 31, 2022 data which showed the net interest income profile to be asset-sensitive. In the analysis based on September 30, 2023 data, management assumed that, in rising rate scenarios, the average rate to be paid on interest checking, savings and money market accounts would increase by a higher percentage of the baseline scenario as compared to the assumptions used in the December 31, 2022 analysis. This change reflects management’s assessment that, in light of significant increases in short-term interest rates that have occurred over the course of 2022 and year-to-date in 2023, the Corporation’s deposit rates would increase to a greater extent if such scenarios would occur. The change in results also reflects changes in deposit mix, as the carrying amount of total deposits without stated maturities was $99.4 million lower at September 30, 2023 as compared to December 31, 2022, while time deposits were higher by $126.8 million. Further, results in the downward rate scenarios reflect limitations on the benefit of falling rates on some deposit types due to a 0% assumed floor. The Table also shows that as of the respective dates, despite the impact of the modeling changes and changes in deposit mix, the changes in net interest income and changes in economic value were within the policy limits in all scenarios.
Under U.S. generally accepted accounting principles, available-for-sale debt securities are carried at fair value as of each balance sheet date. The difference between amortized cost and fair value of available-for-sale debt securities, net of deferred income tax, is included in accumulated other comprehensive income (loss) within stockholders’ equity. Increases in interest rates have caused the fair value of the Corporation’s available-for-sale debt securities to decrease, resulting in an accumulated other comprehensive loss of $60.3 million at September 30, 2023. In contrast, most of the Corporation’s other financial instruments, including loans receivable (held for investment), deposits and borrowed funds are carried on the balance sheet at historical cost without adjustment for the impact of changes in interest rates.
TABLE XI – THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES
September 30, 2023 Data
Period Ending September 30, 2024
Basis Point
Interest
Net Interest
NII
Change in Rates
Income
Expense
Income (NII)
% Change
Risk Limit
+400
145,051
78,526
66,525
(21.1)
25.0
+300
140,116
67,183
72,933
(13.5)
20.0
+200
135,219
57,108
78,111
(7.4)
15.0
+100
130,286
48,302
81,984
(2.8)
125,123
40,771
84,352
0.0
-100
119,799
35,837
83,962
(0.5)
-200
114,410
30,942
83,468
(1.0)
-300
108,555
26,543
82,012
-400
102,316
22,255
80,061
(5.1)
Economic Value of Equity at September 30, 2023
Present
Equity
346,292
(23.8)
50.0
379,784
(16.5)
45.0
410,450
(9.7)
35.0
436,196
(4.1)
454,742
453,578
(0.3)
455,691
0.2
443,816
(2.4)
428,885
(5.7)
December 31, 2022 Data
Period Ending December 31, 2023
131,145
34,767
96,378
8.9
125,127
30,816
94,311
6.6
119,561
26,864
92,697
4.8
113,703
22,912
90,791
2.6
107,451
18,961
88,490
101,048
15,516
85,532
(3.3)
94,854
13,240
81,614
(7.8)
89,405
11,325
78,080
(11.8)
85,076
9,439
75,637
(14.5)
Economic Value of Equity at December 31, 2022
498,368
0.3
496,186
(0.1)
501,422
1.0
501,991
1.1
496,650
485,332
(2.3)
468,195
445,129
(10.4)
417,505
(15.9)
ITEM 4. CONTROLS AND PROCEDURES
The Corporation’s management, under the supervision of and with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, has carried out an evaluation of the design and effectiveness of the Corporation’s disclosure controls and procedures as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Securities Exchange Act of 1934 as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Corporation’s disclosure controls and procedures are effective to ensure that all material information required to be disclosed in reports the Corporation files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.
There were no significant changes made to the Corporation’s internal control over financial reporting that occurred during the period covered by this report that have materially affected, or that are reasonably likely to affect, our internal control over financial reporting.
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
The Corporation and C&N Bank are involved in various legal proceedings incidental to their business. Management believes the aggregate liability, if any, resulting from such pending and threatened legal proceedings will not have a material, adverse effect on the Corporation’s financial condition or results of operations.
Item 1A. Risk Factors
There have been no material changes from the risk factors previously disclosed in Item 1A of the Corporation’s Form 10-K filed March 16, 2023 except for the following:
Risks Related to Recent Banking Industry Turmoil
The Corporation is exposed to the risk that when a bank or other financial institution experiences financial difficulties, there could be an adverse “contagion” impact on other banking institutions. The recent failures of Silicon Valley Bank in California, Signature Bank in New York and First Republic Bank in California during the first and second quarters of 2023 have caused an element of panic and uncertainty in the investor community and among bank customers generally, including, specifically, deposit customers. While the Corporation does not believe that the circumstances of these three failures are necessarily indicators of broader issues for concern with all other banks or with the banking system itself, the failures are likely to reduce customer confidence, affect sources of funding and liquidity, increase regulatory requirements and costs, adversely affect financial markets and/or have negative reputational ramifications for institutions in the banking industry, including, possibly, the Corporation. The Corporation will continue to closely monitor the ongoing events and volatility in the financial services industry, together with any responsive measures taken by the banking regulators to mitigate or manage the turmoil.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
Effective February 18, 2021, the Corporation amended its treasury stock repurchase program. Under the amended program, the Corporation was authorized to repurchase up to 1,000,000 shares of the Corporation’s common stock, or 6.25% of the Corporation’s issued and outstanding shares at February 18, 2021. On July 11, 2023, the Corporation announced that 1,000,000 shares had been repurchased and that it had completed the treasury stock repurchase program.
On September 25, 2023, the Corporation announced a new treasury stock repurchase program. Under the newly approved program, the Corporation is authorized to repurchase up to 750,000 shares of the Corporation’s common stock, or slightly less than 5% of the Corporation’s issued and outstanding shares at August 4, 2023. The new program was effective when publicly announced and will continue thereafter until suspended or terminated by the Board of Directors, in its sole discretion. All shares of common stock repurchased pursuant to the new program shall be held as treasury shares and be available for use and reissuance for purposes as and when determined by the Board of Directors including, without limitation, pursuant to the Corporation’s Dividend Reinvestment and Stock Purchase Plans and its equity compensation program. As of September 30, 2023, no shares had been repurchased under this repurchase program.
The following table sets forth a summary of the purchases by the Corporation of its common stock during the third quarter 2023.
Total Number of
Maximum
Purchased
Shares that May
as Part of
Yet
Publicly
be Purchased
Total Number
Announced
of Shares
Price Paid
Plans
the Plans or
Period
per Share
or Programs
Programs
July 1 - 31, 2023
19.01
1,000,000
August 1 - 31, 2023
0.00
September 1 - 30, 2023
750,000
Item 3. Defaults Upon Senior Securities
None
Item 4. Mine Safety Disclosures
Not applicable
Item 5. Other Information
During the three months ended September 30, 2023, no director or officer of the Corporation adopted or terminated a “Rule 10b5-1 trading arrangement” or “non-Rule 10b5-1 trading arrangement”, as each term is defined in Item 408(a) of Regulation S-K.
On September 25, 2023, the Corporation entered into Rule 10b5-1 Issuer Repurchase Plan with a registered broker to effect repurchases of the Corporation’s common stock under the Corporation’s treasury stock repurchase program, which was announced on September 25, 2023 and which is described under Item 2 of this Form 10-Q. The 10b5-1 issuer repurchase plan will terminate upon the earlier of all 750,000 shares of common stock authorized for repurchase having been repurchased or September 22, 2026.
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Item 6. Exhibits
3.1
Articles of Incorporation
Incorporated by reference to Exhibit 3.1 of The Corporation’s Form 10-Q filed May 6, 2022
3.2
By-laws
Incorporated by reference to Exhibit 3.1 of The Corporation’s Form 8-K filed February 18, 2022
4.
Instruments defining the rights of Security holders, including Indentures
4.1
Indenture, dated May 19, 2021 between Citizens & Northern Corporation and UMB Bank, National Association, as trustee
Incorporated by reference to Exhibit 4.1 of the Corporation’s Form 8-K filed May 19, 2021
4.2
Form of Subordinated Note
Incorporated by reference to Exhibit A-2 to Exhibit 4.1 of the Corporation’s Form 8-K filed May 19, 2021
4.3
Form of Senior Note
Incorporated by reference to Exhibit 4.3 of the Corporation’s Form 8-K filed May 19, 2021
31.
Rule 13a-14(a)/15d-14(a) certifications:
31.1
Certification of Chief Executive Officer
Filed herewith
31.2
Certification of Chief Financial Officer
32.
Section 1350 certifications
101.INS
Inline XBRL Instance Document.
101.SCH
Inline XBRL Schema Document.
101.CAL
Inline XBRL Calculation Linkbase Document.
101.DEF
Inline XBRL Definition Linkbase Document.
101.LAB
Inline XBRL Label Linkbase Document.
101.PRE
Inline XBRL Presentation Linkbase Document.
The cover page of the Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2023, formatted in Inline XBRL (contained in Exhibit 101).
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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, thereunto duly authorized.
November 6, 2023
By: /s/ J. Bradley Scovill
President and Chief Executive Officer
By: /s/ Mark A. Hughes
Treasurer and Chief Financial Officer
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