EDGAR 10-K Filing

Company CIK: 810958
Filing Year: 2021
Filename: 810958_10-K_2021_0001558370-21-002437.json

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ITEM 1. BUSINESS
ITEM 1. BUSINESS
Citizens & Northern Corporation (“Corporation”) is a holding company whose principal activity is community banking. The Corporation’s principal office is located in Wellsboro, Pennsylvania. The largest subsidiary is Citizens & Northern Bank (“C&N Bank” or the “Bank”). The Corporation’s other wholly-owned subsidiaries are Citizens & Northern Investment Corporation and Bucktail Life Insurance Company (“Bucktail”). Citizens & Northern Investment Corporation was formed in 1999 to engage in investment activities. Bucktail reinsures credit and mortgage life and accident and health insurance on behalf of C&N Bank.
The Corporation’s acquisition of Covenant Financial, Inc. (“Covenant”) was completed July 1, 2020. Covenant was the parent company of Covenant Bank, a commercial bank which operated a community bank office in Bucks County, Pennsylvania and another in Chester County, Pennsylvania. Pursuant to the transaction, Covenant merged with and into the Corporation and Covenant Bank merged with and into C&N Bank. Total purchase consideration was $63.3 million, including common stock with a fair value of $41.6 million and cash of $21.7 million. Holders of Covenant common stock prior to the consummation of the merger held approximately 12.9% of the Corporation’s common stock outstanding immediately following the merger.
Over the past few years, the Corporation has been employing a growth strategy. Presently, a majority of C&N Bank’s operations are conducted in its legacy markets in the northern tier/north central region of Pennsylvania and southern tier of New York. In 2020, with the acquisition of Covenant, the Bank expanded its presence in Southeastern Pennsylvania. The Covenant acquisition follows the acquisition of Monument Bancorp, Inc. (“Monument”) in 2019, as well as the opening of a lending office in York, Pennsylvania which is located in southcentral Pennsylvania. Mainly as a result of the acquisitions, the Corporation’s consolidated total assets at December 31, 2020 of $2.2 billion were up 73% from the corresponding total at December 31, 2018. Similarly, gross loans of $1.6 billion at December 31, 2020 were up 99% from December 31, 2018 and total deposits of $1.8 billion were up 76% from December 31, 2018.
C&N Bank is a Pennsylvania banking institution that was formed by the consolidation of Northern National Bank of Wellsboro and Citizens National Bank of Towanda in 1971. C&N Bank has held its current name since May 6, 1975, at which time C&N Bank changed its charter from a national bank to a Pennsylvania bank. The Bank has expanded its presence over the past several decades through a series of mergers as well as by opening new branch and lending offices and providing access to banking services via the internet and through ATMs. At December 31, 2020, the Bank had 29 branch offices, including 23 in the northern tier/north central region of Pennsylvania, 4 in Southeastern Pennsylvania (3 in Bucks County and 1 in Chester County) and 2 in the southern tier of New York State. In addition to its branch locations, the Bank had lending offices in York, Pennsylvania and Elmira, New York.
C&N Bank provides an extensive range of banking services, including deposit and loan products for personal and commercial customers. The Bank also maintains a trust department that provides a wide range of financial services, such as 401(k) plans, retirement planning, estate planning, estate settlements and asset management. C&N Financial Services Corporation (“C&NFSC”), a wholly-owned subsidiary of the Bank, is a licensed insurance agency that provides insurance products to individuals and businesses and through its broker-dealer division, offers mutual funds, annuities, educational savings accounts and other investment products through registered agents. C&NFSC’s operations are not significant in relation to the total operations of the Corporation.
In 2017, C&N Bank established Northern Tier Holding LLC, to acquire, hold and dispose of real property acquired by the Bank. C&N Bank is the sole member of Northern Tier Holding LLC.
All phases of the Bank’s business are competitive. The Bank competes with online financial institutions, local commercial banks headquartered in our market areas and other commercial banks with branches in our market area. Many of the online financial institutions and some of the banks that have branches in our market areas are larger in overall size. With respect to lending activities and attracting deposits, the Bank also competes with savings banks, savings and loan associations, insurance companies, regulated small loan companies and credit unions. Also, the Bank competes with mutual funds, exchange-traded funds and other investment vehicles for deposits. C&N Bank competes with insurance companies, investment counseling firms, mutual funds and other business firms and individuals for trust, investment management, brokerage and insurance services. The Bank is generally competitive with all financial institutions in our service areas with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans. The Bank serves a diverse customer base and is not economically dependent on any small group of customers or on any individual industry.
At December 31, 2020, C&N Bank had total assets of $2,222,478,000, total deposits of $1,827,881,000 and net loans outstanding of $1,632,824,000.
Most activities of the Corporation and its subsidiaries are regulated by federal or state agencies. The primary regulatory relationships are described as follows:
● The Corporation is a bank holding company formed under the provisions of Section 3 of the Federal Reserve Act. The Corporation is under the direct supervision of the Federal Reserve and must comply with the reporting requirements of the Federal Bank Holding Company Act.
● C&N Bank is a state-chartered, nonmember bank, supervised by the Federal Deposit Insurance Corporation and the Pennsylvania Department of Banking and Securities.
● C&NFSC is a Pennsylvania corporation. The Pennsylvania Department of Insurance regulates C&NFSC’s insurance activities. Brokerage products are offered through third party networking agreements.
● Bucktail is incorporated in the state of Arizona and supervised by the Arizona Department of Insurance.
A copy of the Corporation’s annual report on Form 10-K, quarterly reports on Form 10-Q, current events reports on Form 8-K, and amendments to these reports, will be furnished without charge upon written request to the Corporation’s Treasurer at P.O. Box 58, Wellsboro, PA 16901. Copies of these reports will be furnished as soon as reasonably possible after they are filed electronically with the Securities and Exchange Commission. The information is also available through the Corporation’s web site at www.cnbankpa.com
Human Capital
The Corporation’s Board of Directors and executive leadership team have established the following mission, vision and values:
Mission: Creating value through lifelong relationships with our customers, teammates, shareholders and communities.
Vision: Every customer says “C&N is the ONLY bank I need.”
Values: Teamwork, Respect, Responsibility and Accountability, Excellence, Integrity, Client Focus, Have Fun.
We recognize that our ability to create value on a consistent basis is highly dependent upon the effectiveness of our team.
The Corporation‘s key human capital management objectives are to attract and retain diverse raw and seasoned talent that fits our values and culture. Our talent strategy focuses on acquiring new employees through branding and outreach programs, developing employees though a robust onboarding program, ongoing training, and performance management, and retaining employees through recognition, engagement, and an attractive total rewards package.
Diversity and Inclusion
At C&N Bank, we are committed to creating value through relationships. At the heart of this mission is a promise of excellence in service to all people, as demonstrated by our commitment to equity of opportunity, inclusion and our fostering of a spirit of belonging. We live our values of respect, integrity and excellence by creating access and providing support to help our diverse constituents of customers, teammates, shareholders and communities in achieving their financial goals. We embrace inclusion of all of our stakeholders as an important component of our vision to be the ONLY bank our customers need.
Compensation and Benefits
The Corporation offers competitive compensation to attract and retain talent. Our generous total rewards package includes market-competitive salary, bonuses or sales commissions, short-term and long-term equity incentives, healthcare and retirement benefits, and paid time off. Employees have regular performance reviews and salary raises commensurate with performance. Employees have access to a holistic suite of items within our employee assistance program that caters to physical, emotional, and mental wellbeing for the employee and their family. Additionally, we have conducted discretionary bonus payouts - the most recent grant program took place in 2020 and was in recognition of our employees’ special efforts during the COVID-19 pandemic.
Training and Development
The Corporation provides a robust training and development program that supports our culture, prepares employees for their immediate role, develops them for long term success at the bank and supports personal enrichment. We offer functional training, culture building exercises, personal development, C&N Bank history, C&N Bank integration and ongoing technical training throughout each year. Employees also have access to additional educational and development opportunities including tuition reimbursement and certification programs.
Communication and Engagement
At C&N, we believe in the importance of employee communication and engagement. We utilize several methods to foster engagement, including activities such as Employee Recognition programs, Service Anniversary Awards, Bank wide monthly calls, semi-annual Bank wide events, annual employee surveys, focus groups, daily huddles, and the Giving Back, Giving Together community service program. We believe keeping our team well informed, connected, and appreciated adds to the success of our organization.

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ITEM 1A. RISK FACTORS
ITEM 1A. RISK FACTORS
The Corporation is subject to the many risks and uncertainties applicable to all banking companies, as well as risks specific to the Corporation’s geographic locations. Although the Corporation seeks to effectively manage risks, and maintains a level of equity that exceeds the banking regulatory agencies’ thresholds for being considered “well capitalized” (see Note 18 to the consolidated financial statements), management cannot predict the future and cannot eliminate the possibility of credit, operational or other losses. Accordingly, actual results may differ materially from management’s expectations. Some of the Corporation’s significant risks and uncertainties are discussed below.
Coronavirus Outbreak - In December 2019, a coronavirus (COVID-19) was reported in China, and, in March 2020, the World Health Organization declared it a pandemic. Since first being reported in China, the coronavirus has spread to additional countries including the United States.
In response, many state and local governments, including the Commonwealth of Pennsylvania, have instituted emergency restrictions that have substantially limited the operation of non-essential businesses and the activities of individuals. It has been widely reported that these restrictions have resulted in significant adverse effects for many different types of businesses, particularly those in the travel, hospitality and food and beverage industries, among many others, and has resulted in a significant number of layoffs and furloughs of employees nationwide and in the regions in which the Corporation operates. The ultimate effect of COVID-19 on the local or broader economy is not known nor is the ultimate length of the restrictions described and any accompanying effects. Moreover, the Federal Reserve has taken action to lower the Federal Funds rate, which may negatively affect interest income and, therefore, earnings. Given the ongoing and dynamic nature of the circumstances, it is difficult to predict the impact of the coronavirus outbreak, and there is no guarantee that the Corporation’s efforts to address the adverse impacts of the coronavirus will be effective. The extent of such impact will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of the coronavirus and actions taken to contain the coronavirus or its impact, among others.
The effect of COVID-19 and related events, including those described above and those not yet known or knowable, could have a negative effect on the Corporation’s business prospects, financial condition and results of operations, as a result of quarantines; market volatility; market downturns; changes in consumer behavior; business closures; deterioration in the credit quality of borrowers or the inability of borrowers to satisfy their obligations (and any related forbearances or restructurings that may be implemented); changes in the value of
collateral securing outstanding loans; changes in the value of the investment securities portfolio; effects on key employees, including operational management personnel and those charged with preparing, monitoring and evaluating the Corporation’s financial reporting and internal controls; declines in the demand for loans and other banking services and products; declines in demand resulting from adverse impacts of the disease on businesses deemed to be “non-essential” by governments; branch or office closures and business interruptions; and efforts to integrate the businesses of the Corporation and Covenant.
Risk Related to Acquisition Activity - As described in Item 1, the Corporation has completed two acquisitions of banking companies over the past two years (Covenant and Monument) and expanded its geographic footprint to Southeastern and southcentral Pennsylvania. Further, management intends to continue to pursue additional acquisition opportunities. Potential acquisitions may disrupt the Corporation’s business and dilute shareholder value. We regularly evaluate merger and acquisition opportunities and conduct due diligence activities related to possible transactions with other financial institutions and financial service companies. Acquiring other banks, businesses, or branches involves various risks commonly associated with acquisitions, including: potential exposure to unknown or contingent liabilities of the target company, exposure to potential asset quality issues of the target company, difficulty and expense of integrating the operations and personnel of the target company, potential disruption to the Corporation’s business, potential diversion of management’s time and attention, the possible loss of key employees and customers of the target company, difficulty in estimating the value of the target company and potential changes in banking or tax laws or regulations that may affect the target company. Acquisitions may involve the payment of a premium over book and market values, and, therefore, some dilution of the Corporation’s tangible book value and net income per share of common stock may occur in connection with any future transaction. Furthermore, failure to realize the expected revenue projections, cost savings, increases in geographic or product presence, and/or other projected benefits from recent or future acquisitions could have a material adverse effect on the Corporation’s financial condition or results of operations.
Credit Risk from Lending Activities - A significant source of risk is the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loan agreements. Most of the Corporation’s loans are secured, but some loans are unsecured. With respect to secured loans, the collateral securing the repayment of these loans may be insufficient to cover the obligations owed under such loans. Collateral values may be adversely affected by changes in economic, environmental and other conditions, including declines in the value of real estate, changes in interest rates, changes in monetary and fiscal policies of the federal government, wide-spread disease, terrorist activity, environmental contamination and other external events. In addition, collateral appraisals that are out of date or that do not meet industry recognized standards may create the impression that a loan is adequately collateralized when it is not. The Corporation has adopted underwriting and credit monitoring procedures and policies, including regular reviews of appraisals and borrower financial statements, that management believes are appropriate to mitigate the risk of loss. Also, as discussed further in the “Provision and Allowance for Loan Losses” section of Management’s Discussion and Analysis, the Corporation attempts to estimate the amount of losses that may be inherent in the portfolio through a quarterly evaluation process that includes several members of management and that addresses specifically identified problem loans, as well as other quantitative data and qualitative factors. Such risk management and accounting policies and procedures, however, may not prevent unexpected losses that could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.
Interest Rate Risk - Business risk arising from changes in interest rates is an inherent factor in operating a banking organization. The Corporation’s assets are predominantly long-term, fixed-rate loans and debt securities. Funding for these assets comes principally from shorter-term deposits and borrowed funds. Accordingly, there is an inherent risk of lower future earnings or decline in fair value of the Corporation’s financial instruments when interest rates change. Significant fluctuations in interest rates could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.
Limited Geographic Diversification - The Corporation grants commercial, residential and personal loans to customers primarily in the Corporation’s legacy markets of the northern tier/north central regions of Pennsylvania and southern tier of New York and in Southeastern 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 these regions. Deterioration in economic conditions could adversely affect the quality of the Corporation’s loan portfolio and the demand for its products and services, and accordingly, could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.
Competition - All phases of the Corporation’s business are competitive. Some competitors are much larger in total assets and capitalization than the Corporation, have greater access to capital markets and can offer a broader array of financial services. There can be no assurance that the Corporation will be able to compete effectively in its markets. Furthermore, developments increasing the nature or level of competition could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.
Inability to Attract and Develop Qualified Personnel - The Corporation believes that our future success will depend in large part on our ability to attract, develop and retain highly qualified management, lending, financial, technical, marketing, sales, and support personnel. Competition for qualified personnel is intense and we cannot ensure success in attracting or retaining qualified personnel. There may be only a limited number of persons with the requisite skills to serve in these positions, and it may be increasingly difficult for us to hire personnel over time. Our ability to retain key officers and employees may be further impacted by legislation and regulation affecting the financial services industry. For example, legislation and bank regulatory action that places restrictions on executive compensation at, and the pay practices of, financial institutions may further impact our ability to compete for talent with other industries that are not subject to the same limitations as financial institutions. Any inability to attract, develop and retain significant numbers of qualified management and other personnel would have a material adverse effect on our business, results of operations and financial condition.
Breach of Information Security and Technology Dependence - The Corporation relies on software, communication, and information exchange on a variety of computing platforms and networks and over the Internet. Despite numerous safeguards, the Corporation cannot be certain that its systems are entirely free from vulnerability to attack or other technological difficulties or failures. The Corporation relies on the services of a variety of vendors to meet its data processing and communication needs. If information security is breached or other technology difficulties or failures occur, information may be lost or misappropriated, services and operations may be interrupted, and the Corporation could be exposed to claims from customers. Any of these results could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.
Government Regulation and Monetary Policy - The Corporation and the banking industry are subject to extensive regulation and supervision under federal and state laws and regulations. The requirements and limitations imposed by such laws and regulations limit the way the Corporation conducts its business, undertakes new investments and activities and obtains financing. These regulations are designed primarily for the protection of the deposit insurance funds and consumers and not to benefit the Corporation’s shareholders. Financial institution regulation has been the subject of significant legislation in recent years and may be the subject of further significant legislation in the future, none of which is in the control of the Corporation. Significant new laws or changes in, or repeals of, existing laws could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects short-term interest rates and credit conditions, and any unfavorable change in these conditions could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.
Bank Secrecy Act and Related Laws and Regulations - These laws and regulations have significant implications for all financial institutions. In recent years, they have increased due diligence requirements and reporting obligations for financial institutions, created new crimes and penalties, and required the federal banking agencies, in reviewing merger and other acquisition transactions, to consider the effectiveness of the parties to such transactions in combating money laundering activities. Even innocent noncompliance and inconsequential failure to follow the regulations could result in significant fines or other penalties, which could have a material adverse impact on the Corporation’s financial condition, results of operations or liquidity.
The Federal Home Loan Bank of Pittsburgh - Through its subsidiary (C&N Bank), the Corporation is a member of the Federal Home Loan Bank of Pittsburgh (FHLB-Pittsburgh), which is one of 11 regional Federal Home Loan Banks. The Corporation has a line of credit with the FHLB-Pittsburgh that is secured by a blanket lien on its loan portfolio. Access to this line of credit is critical if a funding need arises. However, there can be no assurance that the FHLB-Pittsburgh will be able to provide funding when needed, nor can there be assurance that the FHLB-Pittsburgh will provide funds specifically to the Corporation should its financial condition deteriorate and/or regulators prevent that access. The inability to access this source of funds could have a materially adverse effect on the Corporation’s financial flexibility if alternate financing is not available at acceptable interest rates. The failure of the FHLB-Pittsburgh or the FHLB system in general, may materially impair the Corporation’s ability to meet short- and long-term liquidity needs or to meet growth plans.
The Corporation owns common stock of the FHLB-Pittsburgh to qualify for membership in the FHLB system and access services from the FHLB-Pittsburgh. The FHLB-Pittsburgh faces a variety of risks in its operations including interest rate risk, counterparty credit risk,
and adverse changes in its regulatory framework. In addition, the 11 Federal Home Loan Banks are jointly liable for the consolidated obligations of the FHLB system. To the extent that one FHLB cannot meet its obligations, other FHLBs can be called upon to make required payments. Such risks affecting the FHLB-Pittsburgh could adversely impact the value of the Corporation’s investment in the common stock of the FHLB-Pittsburgh and/or affect its access to credit.
Soundness of Other Financial Institutions - In addition to the FHLB-Pittsburgh, the Corporation maintains other credit facilities that provide it with additional liquidity. These facilities include secured and unsecured borrowings from the Federal Reserve Bank and third-party commercial banks. The Corporation believes that it maintains a strong liquidity position and that it is well positioned to withstand foreseeable market conditions. However, legal agreements with counterparties typically include provisions allowing them to restrict or terminate the Corporation’s access to these credit facilities with or without advance notice and at their sole discretion.
Financial institutions are interconnected because of trading, clearing, counterparty, and other relationships. Financial market conditions have been negatively impacted in the past and such disruptions or adverse changes in the Corporation’s results of operations or financial condition could, in the future, have a negative impact on available sources of liquidity. Such a situation may arise due to circumstances that are outside the Corporation’s control, such as general market disruptions or operational problems affecting the Corporation or third parties. The Corporation’s efforts to monitor and manage liquidity risk may not be successful or sufficient to deal with dramatic or unanticipated reductions in available liquidity. In such events, the Corporation’s cost of funds may increase, thereby reducing net interest income, or the Corporation may need to sell a portion of its securities and/or loan portfolio, which, depending upon market conditions, could necessitate realizing a loss.
Securities Markets - The fair value of the Corporation’s available-for-sale debt securities, as well as the revenues the Corporation earns from its Trust and Financial Management and brokerage services, are sensitive to price fluctuations and market events.
Declines in the values of the Corporation’s securities holdings, combined with adverse changes in the expected cash flows from these investments, could result in other-than-temporary impairment charges. For additional information regarding debt securities, see the “Securities” section of Management’s Discussion and Analysis and Note 7 to the consolidated financial statements.
The Corporation’s Trust and Financial Management revenue is determined, in part, from the value of the underlying investment portfolios. Accordingly, if the values of those investment portfolios decrease, whether due to factors influencing U.S. or international securities markets, in general, or otherwise, the Corporation’s revenue could be negatively impacted. In addition, the Corporation’s ability to sell its brokerage services is dependent, in part, upon consumers’ level of confidence in securities markets.
Mortgage Banking - Since 2009, the Corporation has originated and sold residential mortgage loans to the secondary market through the MPF Xtra program. Since 2014, the Corporation has also originated and sold residential mortgage loans to the secondary market through the MPF Original program. Both of these programs are administered by the Federal Home Loan Banks of Pittsburgh and Chicago. At December 31, 2020, the total outstanding balance of residential mortgages sold and serviced through the two programs amounted to $278,857,000. The Corporation must strictly adhere to the MPF Xtra and MPF Original program guidelines for origination, underwriting and servicing loans, and failure to do so may result in the Corporation being forced to repurchase loans or being dropped from the program. As of December 31, 2020, the total outstanding balance of residential mortgage loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $1,714,000. If the volume of such forced repurchases of loans were to increase significantly, or if the Corporation were to be dropped from the programs, it could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.

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ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.

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ITEM 2. PROPERTIES
ITEM 2. PROPERTIES
The Corporation’s full-service banking branch properties as of December 31, 2020 totaled 29 branches located in Bradford, Bucks, Cameron, Chester, Lycoming, McKean, Potter, Sullivan and Tioga Counties in Pennsylvania and Steuben County in New York. Of those branches, 25 were owned and 4 were leased. The Corporation operates loan production offices in Elmira, New York and York, Pennsylvania and operates 4 administrative offices in Wellsboro and Doylestown, Pennsylvania. Of the 35 total properties, 29 were owned and 6 were leased. The Corporation’s headquarters is located in Wellsboro, Pennsylvania.

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ITEM 3. LEGAL PROCEEDINGS
ITEM 3. LEGAL PROCEEDINGS
The Corporation and the 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.

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ITEM 4. MINE SAFETY DISCLOSURE
ITEM 4. MINE SAFETY DISCLOSURE
Not applicable.
PART II

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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
QUARTERLY SHARE DATA
Trades of the Corporation’s stock are executed through various brokers who maintain a market in the Corporation’s stock. The Corporation’s stock is listed on the NASDAQ Capital Market with the trading symbol CZNC. As of December 31, 2020, there were 2,147 shareholders of record of the Corporation’s common stock.
The following table sets forth the high and low sales prices of the common stock and dividends declared per quarter during 2020 and 2019.
Dividend
Dividend
Declared
Declared
per
per
High
Low
Quarter
High
Low
Quarter
First quarter
$
29.06
$
15.69
$
0.27
$
27.07
$
23.60
$
0.37
Second quarter
22.89
16.20
0.27
29.25
25.02
0.27
Third quarter
20.76
14.92
0.27
27.00
22.52
0.27
Fourth quarter
20.84
16.05
0.27
28.58
24.23
0.27
Future dividend payments will depend upon maintenance of a strong financial condition, future earnings and capital and regulatory requirements. Also, 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. These restrictions are described in Note 18 to the consolidated financial statements.
Effective April 21, 2016, the Corporation’s Board of Directors approved a treasury stock repurchase program. Under this program, the Corporation is authorized to repurchase up to 600,000 shares of the Corporation’s common stock. The Board of Directors’ April 21, 2016 authorization provides that: (1) the treasury stock repurchase program shall be effective when publicly announced and shall continue thereafter until suspended or terminated by the Board of Directors, in its sole discretion; and (2) 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 Plan and its equity compensation program. To date, no purchases have been made under this repurchase program.
The following table sets forth a summary of purchases by the Corporation, in the open market, of its equity securities during the fourth quarter 2020:
Total Number of
Maximum
Shares
Number of
Purchased
Shares that May
as Part of
Yet
Publicly
be Purchased
Total Number
Average
Announced
Under
of Shares
Price Paid
Plans
the Plans or
Period
Purchased
per Share
or Programs
Programs
October 1 - 31, 2020
$
600,000
November 1 - 30, 2020
$
600,000
December 1 - 31, 2020
$
600,000
PERFORMANCE GRAPH
Set forth below is a chart comparing the Corporation’s cumulative return to stockholders against the cumulative return of the Russell 2000 and a Peer Group Index of similar banking organizations selected by the Corporation for the five-year period commencing December 31, 2015 and ended December 31, 2020. The index values are market-weighted dividend-reinvestment numbers, which measure the total return for investing $100.00 five years ago. This meets Securities & Exchange Commission requirements for showing dividend reinvestment share performance over a five-year period and measures the return to an investor for placing $100.00 into a group of bank stocks and reinvesting any and all dividends into the purchase of more of the same stock for which dividends were paid.
Period Ending
Index
12/31/15
12/31/16
12/31/17
12/31/18
12/31/19
12/31/20
Citizens & Northern Corporation
100.00
131.18
125.40
144.14
161.19
119.65
Russell 2000 Index
100.00
121.31
139.08
123.76
155.35
186.36
Peer Group
100.00
135.91
161.32
145.48
175.14
138.85
Peer Group includes all publicly traded SEC filing Commercial Banks & Thrifts within NJ, NY, OH, PA, MD, and WV with assets between $1.1B and $4.6B as of 9/30/2020
Source: S&P Global Market Intelligence
© 2021
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth information concerning the Stock Incentive Plan and Independent Directors Stock Incentive Plan, both of which have been approved by the Corporation’s shareholders. The figures shown in the table below are as of December 31, 2020.
Number of
Number of
Weighted-
Securities
Securities to be
average
Remaining
Issued Upon
Exercise
for Future
Exercise of
Price of
Issuance Under
Outstanding
Outstanding
Equity Compen-
Options
Options
sation Plans
Equity compensation plans approved by shareholders
57,111
$
18.92
269,746
Equity compensation plans not approved by shareholders
N/A
More details related to the Corporation’s equity compensation plans are provided in Notes 1 and 13 to the consolidated financial statements.

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ITEM 6. SELECTED FINANCIAL DATA
ITEM 6. SELECTED FINANCIAL DATA
Not applicable.

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements in this section and elsewhere in this Annual Report on Form 10-K 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:
● the effect of the novel coronavirus (COVID-19) and related events
● changes in monetary and fiscal policies of the Federal Reserve Board and the U.S. Government, particularly related to changes in interest rates
●changes in general economic conditions
●legislative or regulatory changes
●downturn in demand for loan, deposit and other financial services in the Corporation’s market area
●increased competition from other banks and non-bank providers of financial services
● technological changes and increased technology-related costs
●changes in accounting principles, or the application of generally accepted accounting principles
● failure to achieve merger-related synergies and difficulties in integrating the business and operations of acquired institutions
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
CORONAVIRUS (COVID-19) OUTBREAK
The Corporation’s Pandemic Committee has been very active since March 2020, providing frequent communication with employees and clients by telephone, video conference, email and digital tools, while substantially limiting business travel. Since the pandemic
began, the Committee instituted measures to protect the health of employees and clients, including temporarily operating branch locations on a drive-through only basis and transitioning a significant portion of the Corporation’s employees to remote work. Currently all branches have limited operations to drive-up and appointment-only services. No furloughs or layoffs of employees have been made to date.
Emergency restrictions on the activities of businesses and individuals have resulted in significant adverse economic effects and a significant number of layoffs and furloughs of employees nationwide and in the regions in which the Corporation operates. The ultimate effect of COVID-19 on the local or broader economy is not known nor is the ultimate length of the restrictions described and any accompanying effects. In 2020, the Corporation increased the allowance for loan losses $785,000 based on an increase in qualitative factors related to potential deterioration in economic conditions. Because of the significant uncertainties related to the ultimate duration of the COVID-19 pandemic and its economic impact, the total impact on the Corporation’s loan portfolio is not determinable.
Section 4013 of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) provides that, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 pandemic declared by the President of the United States under the National Emergencies Act terminates (the “applicable period”), the Corporation may elect to suspend U.S. GAAP for loan modifications related to the pandemic that would otherwise be categorized as troubled debt restructurings (TDRs) and suspend any determination of a loan modified as a result of the effects of the pandemic as being a TDR, including impairment for accounting purposes. The suspension is applicable for the term of the loan modification that occurs during the applicable period for a loan that was not more than 30 days past due as of December 31, 2019. The suspension is not applicable to any adverse impact on the credit of a borrower that is not related to the pandemic.
On December 27, 2020, the President of the United States signed into law the Consolidated Appropriations Act, 2021 (the “CAA Act”), which both funds the federal government until September 30, 2021 and broadly addresses additional COVID-19 responses and relief. Among the additional relief measures included are certain extensions to elements of the CARES Act, including extension of temporary relief from troubled debt restructurings established under Section 4013 of the CARES Act to the earlier of a) January 1, 2022, or b) the date that is 60 days after the date on which the national COVID-19 emergency terminates.
In addition, the banking regulators and other financial regulators, on March 22, 2020 and revised April 7, 2020, issued a joint interagency statement titled the “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of the COVID-19 pandemic. Pursuant to the interagency statement, loan modifications that do not meet the conditions of Section 4013 of the CARES Act may still qualify as a modification that does not need to be accounted for as a TDR. Specifically, the agencies confirmed with the Financial Accounting Standards Board (“FASB”) staff that short-term modifications made in good faith in response to the pandemic to borrowers who were current prior to any relief are not TDRs under U.S. GAAP. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. Appropriate allowances for loan and lease losses are expected to be maintained. With regard to loans not otherwise reportable as past due, financial institutions are not expected to designate loans with deferrals granted due to the pandemic as past due because of the deferral. The interagency statement also states that during short-term pandemic-related loan modifications, these loans generally should not be reported as nonaccrual.
To work with clients impacted by COVID-19, the Corporation is offering short-term loan modifications on a case-by-case basis to borrowers who were current in their payments at the inception of the loan modification program. Prior to merging with the Corporation on July 1, 2020, Covenant Financial Inc. (“Covenant”) had a similar program in place, and these modified loans have been incorporated into the Corporation’s program. These efforts have been designed to assist borrowers as they deal with the current crisis and help the Corporation mitigate credit risk. For loans subject to the program, each borrower is required to resume making regularly scheduled loan payments at the end of the modification period and the deferred amounts will be moved to the end of the loan term. Consistent with Section 4013 of the CARES Act and guidance from the joint interagency statement described in the preceding paragraphs, the modified loans have not been reported as past due, nonaccrual or as TDRs at December 31, 2020. Most of the modifications under the program became effective in March or the second quarter 2020 and provided a deferral of interest or principal and interest for 90-to-180 days. Accordingly, most of the loans for which deferrals were granted returned to full payment status prior to December 31, 2020. At December 31, 2020, there were 45 loans in deferral status with a total recorded investment of $37,397,000, including 27 commercial loans with a total recorded investment of $35,002,000. A breakdown of these commercial loans by industry is as follows:
Deferrals Remaining
As of December 31, 2020
(Dollars In Thousands)
Number
of
Recorded
Commercial Loans Modified - Summary
Loans
Investment
Accommodation and food services - hotels
$
25,090
Lessors of residential buildings & dwellings
3,108
Lessors of nonresidential buildings (except miniwarehouses)
2,471
Accommodation and food services - other
1,102
Transportation and warehousing
Real estate rental and leasing - other
Religious organizations
Golf courses and country clubs
Breweries
Personal care services
$
35,002
The Corporation began accepting and processing applications for loans under the Paycheck Protection Program (“PPP”) through the Small Business Administration (“SBA”) and Treasury Department on April 3, 2020. Covenant also engaged in PPP lending starting in early April 2020. Under the PPP, the Corporation provides SBA-guaranteed loans to small businesses to pay their employees, rent, mortgage interest, and utilities. PPP loans will be forgiven subject to clients providing documentation evidencing their compliant use of funds and otherwise complying with the terms of the program.
The maximum term of PPP loans is five years, though most of the Corporation’s PPP loans have two-year terms, and the Corporation will be repaid sooner to the extent the loans are forgiven. The interest rate on PPP loans is 1%, and the Corporation has received fees from the SBA ranging between 1% and 5% per loan, depending on the size of the loan. Fees on PPP loans, net of origination costs and a market rate adjustment on PPP loans acquired from Covenant, will be recognized in interest income as a yield adjustment over the term of the loans.
As of December 31, 2020, the recorded investment in PPP loans was $132,269,000, including contractual principal balances of $134,802,000, increased by a market rate adjustment on PPP loans acquired from Covenant of $504,000 and reduced by net deferred origination fees of $3,037,000. Accretion of fees received on PPP loans, net of amortization of the market rate adjustment on PPP loans acquired from Covenant, was $1,945,000 for the year ended December 31, 2020.
Capital Strength
While it is difficult to estimate the future impact of COVID-19, the Corporation, including the principal subsidiary, Citizens & Northern Bank (“C&N Bank”), entered the crisis from a position of strength. This is especially apparent in the capital ratios, which are at levels that demonstrate the capacity to absorb significant losses if they arise while continuing to meet the requirements to be considered well capitalized.
C&N Bank’s leverage ratio (Tier 1 capital to average assets) at December 31, 2020 of 10.12% is significantly higher than the well-capitalized threshold of 5%, an excess capital amount of $113.9 million. Similarly, the total capital to risk-weighted assets ratio at December 31, 2020 is 15.98%, which exceeds the well-capitalized threshold of 10%, an excess capital amount of $88.7 million.
Additional details regarding the Corporation’s and C&N Bank’s regulatory capital position are provided in the “Stockholders’ Equity and Capital Adequacy” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”).
ACQUISITIONS OF COVENANT FINANCIAL, INC. AND MONUMENT BANCORP, INC
The Corporation’s acquisition of Covenant was completed July 1, 2020. Covenant was the parent company of Covenant Bank, a commercial bank which operated a community bank office in Bucks County, Pennsylvania and another in Chester County, Pennsylvania. Pursuant to the transaction, Covenant merged with and into the Corporation and Covenant Bank merged with and into C&N Bank. Total purchase consideration was $63.3 million, including common stock with a fair value of $41.6 million and cash of $21.7 million. Holders of Covenant common stock prior to the consummation of the merger held approximately 12.9% of the Corporation’s common stock outstanding immediately following the merger.
In connection with the acquisition, effective July 1, 2020, the Corporation recorded goodwill of $24.1 million and a core deposit intangible asset of $3.1 million. Assets acquired included loans valued at $464.2 million, cash and due from banks of $97.8 million, bank-owned life insurance valued at $11.2 million and securities valued at $10.8 million. Liabilities assumed included deposits valued at $481.8 million, borrowings valued at $64.0 million and subordinated debt valued at $10.1 million. The assets purchased and liabilities assumed in the acquisition were recorded at their preliminary estimated fair values at the time of closing and may be adjusted for up to one year subsequent to the acquisition.
The acquisition of Covenant follows the acquisition of Monument Bancorp, Inc. (“Monument”) on April 1, 2019. Monument was the parent company of Monument Bank, with two community banking offices and a lending office in Bucks County, Pennsylvania. Monument merged with and into the Corporation and Monument Bank merged with and into C&N Bank. The total transaction value of the Monument acquisition was $42.7 million.
In 2020, the Corporation incurred pre-tax merger-related expenses related to the Covenant transaction of $7.7 million. Merger-related expenses include severance and similar expenses as well as expenses related to conversion of Covenant’s core customer system data into the Corporation’s core system and legal and other professional expenses. Management expects additional merger-related expenses associated with the Covenant acquisition will be insignificant.
Merger-related expenses associated with the Monument transaction totaled $3.8 million for the year ended December 31, 2019.
EARNINGS OVERVIEW
Net income for the year ended December 31, 2020 was $19,222,000, or $1.30 per diluted share as compared to 2019 net income of $19,504,000 or $1.46 per share. Earnings for the year ended December 31, 2020 were significantly impacted by the Covenant acquisition, including the effects of merger-related expenses described earlier. Earnings for the year ended December 31, 2020 included a pre-tax loss of $1.6 million on prepayment of long-term borrowings (Federal Home Loan Bank of Pittsburgh advances) with outstanding balances totaling $48.0 million. The borrowings included several advances maturing in 2022 through 2024 with a weighted-average interest rate of 1.77% and a weighted-average duration of 2.3 years. Management estimated the use of excess cash to prepay borrowings would generate an improvement in the net interest margin of approximately 0.11% in 2021 over previous internal projections, and that the loss would be recovered through higher future earnings in approximately two years. Excluding the impact of merger-related expenses, loss on prepayment of borrowings and net securities gains, adjusted (non-U.S. GAAP) earnings for 2020 would be $26,514,000 or $1.79 per share as compared to similarly adjusted (non-GAAP) earnings of $22,756,000 or $1.70 per share for 2019.
The following table provides a reconciliation of the Corporation’s 2020 earnings results under U.S. generally accepted accounting principles (U.S. GAAP) to comparative non-U.S. GAAP results excluding merger-related expenses, loss on prepayment of borrowings and net securities gains. Management believes disclosure of 2020 and 2019 earnings results, adjusted to exclude the impact of these items, provides useful information to investors for comparative purposes.
RECONCILIATION OF NET INCOME AND
DILUTED EARNINGS PER SHARE TO NON-U.S.
GAAP MEASURE
(Dollars In Thousands, Except Per Share Data)
Year Ended December 31, 2020
Year Ended December 31, 2019
Income
Diluted
Income
Diluted
Before
Earnings
Before
Earnings
Income
Income
per
Income
Income
per
Tax
Tax
Net
Common
Tax
Tax
Net
Common
Provision
Provision
Income
Share
Provision
Provision
Income
Share
Results as Presented Under U.S. GAAP
$
23,212
$
3,990
$
19,222
$
1.30
$
23,409
$
3,905
$
19,504
$
1.46
Add: Merger-Related Expenses (1)
7,708
1,574
6,134
4,099
3,270
Add: Loss on Prepayment of Borrowings (1)
1,636
1,292
Net Gains on Available-for-Sale Debt Securities (1)
(169)
(35)
(134)
(23)
(5)
(18)
Adjusted Earnings (Non-U.S. GAAP)
$
32,387
$
5,873
$
26,514
$
1.79
$
27,485
$
4,729
$
22,756
$
1.70
(1) Income tax has been allocated based on a marginal income tax rate of 21%. The effect on the income tax provision of merger-related expenses is adjusted for the estimated nondeductible portion of the expenses.
In 2020, interest income on loans acquired from Covenant, partially offset by interest expense on deposits, borrowings and subordinated debt assumed, contributed to growth in net interest income, while costs associated with the expansion contributed to an increase in noninterest expenses. Results for 2019 were significantly impacted by the Monument acquisition.
Other significant variances were as follows:
● Net interest income was up $13,077,000 (24.0%) in 2020 over 2019, reflecting the benefits of growth, particularly from the mid-year Covenant acquisition as well as the impact of former Monument activity for the full year as compared to the final nine months of 2019. In 2020, annual average outstanding loans totaled $1.445 billion, an increase of $387.5 million over 2019, and annual average total deposits of $1.586 billion were up $372.7 million. The net interest margin was 3.69% for 2020, down from 3.86% in 2019. The average yield on earning assets in 2020 was down 0.37% from 2019, while the average rate on interest-bearing liabilities was down 0.30% between periods. Accretion and amortization of purchase accounting adjustments had a net positive impact on net interest income of $3,272,000 for 2020 as compared to a net positive impact of $558,000 in 2019.
● The provision for loan losses of $3,913,000 for 2020 was higher than the 2019 provision by $3,064,000. The provision included the impact of a charge-off of $2,219,000 on a commercial loan of $3,500,000. In total, the 2020 provision included a net charge of $2,238,000 related to specific loans (net decrease in specific allowances on loans of $126,000 and net charge-offs of $2,364,000) and a $1,675,000 increase in the collectively determined portion of the allowance for loan losses. The increase in the collectively determined portion of the allowance includes the impact of an increase in the net charge-off experience factor for commercial loans and an increase in qualitative factors. In comparison, the 2019 provision of $849,000 included a net reduction in expense of $232,000 related to specific loans (net decrease in specific allowances on loans of $554,000 and net charge-offs of $322,000), a net $1,193,000 charge attributable to loan growth and a net reduction in expense of $112,000 related to changes in historical loss and qualitative factors and the unallocated portion of the allowance.
● Noninterest income increased $5,060,000, or 26.2% in 2020 over 2019. Significant variances include the following:
Ø Net gains from sales of loans totaled $5,403,000 in 2020, an increase of $4,479,000 over 2019, reflecting an increase in volume of mortgage loans sold, resulting mainly from the impact of lower interest rates on the housing market and refinancing activity. Total proceeds from sales of residential mortgage loans amounted to $163.1 million in 2020 as compared to $30.1 million in 2019.
Ø Other noninterest income totaled $3,010,000, an increase of $1,135,000 over 2019. Income from realization of tax credits of $504,000 was $349,000 higher in 2020 as compared to 2019. In 2020, income from a life insurance arrangement in which benefits were split between C&N and heirs of a former employee was $279,000. Dividend income from Federal Home Loan Bank stock of $654,000 was up $167,000, reflecting a higher average balance of stock held due to increased borrowings and
credit card interchange income totaled $289,000 in 2020, an increase of $76,000 over 2019. Fee income from credit enhancement provided on residential mortgage loans sold totaled $227,000 in 2020, an increase of $137,000 over 2019.
Ø Service charges on deposit accounts were down $1,127,000, or 21.0% in 2020 over 2019 as the volume of consumer and business overdraft activity fell.
● Noninterest expense, excluding merger-related expenses and loss on prepayment of borrowings, increased $10,171,000 in 2020 over 2019. Significant variances included the following:
Ø Salaries and wages and benefits expense increased $6,581,000, reflecting: inclusion of Covenant for six months in 2020 and the former Monument operations for all of 2020 as compared to nine months in 2019; an increase in incentive compensation mainly attributable to increases in earnings performance as compared to peers and an increase in residential mortgage origination volume; annual merit-based salary adjustments; an increase in overtime pay related mainly to mortgage lending activity; a reduction in expense due to a higher proportion of payroll costs capitalized (added to the carrying value of loans) due to the high volume of PPP loans originated; and an increase in health care expense due to higher claims on the Corporation’s partially self-insured plan.
Ø Data processing expenses increased $1,050,000, including the impact of increases in software licensing and maintenance costs associated with core banking, lending, trust and other functions as well as professional fees associated with analysis of the Corporation’s online delivery channel.
Ø Other noninterest expense increased $761,000. Within this category, significant variances included the following:
● Other operational losses increased $554,000, including estimated accruals of $340,000 for penalties related to certain information returns and an estimated accrual of $200,000 related to a state tax reporting matter.
● Donations expense increased $460,000, mainly due to an increase in donations associated with the Pennsylvania Educational Improvement Tax Credit program.
● Amortization of core deposit intangibles increased $318,000, mainly resulting from the Covenant acquisition.
● Expenses related to other real estate properties decreased $340,000. The reduction resulted from the completion in the first quarter 2020 of a complex commercial workout situation for which a significant amount of expenses were incurred in 2019.
● Consulting expenses related to the overdraft privilege program decreased $201,000 consistent with the decrease in overdraft fees collected.
Ø Professional fee expense increased $623,000, including costs associated with a change in certain trust administrative activities to handle them on an outsourced basis.
Ø Occupancy expense increased $381,000, primarily reflecting an increase due to the Covenant acquisition.
Ø Pennsylvania shares tax expense increased $309,000 reflecting the impact of an increase in C&N Bank’s stockholder’s equity.
● The income tax provision was $3,990,000 for the year ended December 31, 2020, up from $3,905,000 for the year ended December 31, 2019. Pre-tax income was $197,000 lower for the year ended December 31, 2020 as compared to the year ended December 31, 2019. The effective tax rate was 17.2% for the year ended December 31, 2020, slightly higher than the 16.7% effective tax rate for the year ended December 31, 2019.
More detailed information concerning the Corporation’s earnings results 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 Loan Losses - A material estimate that is particularly susceptible to significant change is the determination of the allowance for loan losses. The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and recorded as a reduction of the investment in loans. Management believes the allowance for loan losses is adequate and reasonable. Notes 1 and 8 to the consolidated financial statements provide an overview of the process management uses for evaluating and determining the allowance for loan losses, and additional discussion of the allowance for loan losses is provided in a separate section later in Management’s Discussion and Analysis. Given the very subjective nature of identifying and valuing loan losses, it is likely that well-informed individuals could make materially different assumptions, and could, therefore calculate a materially different allowance value. While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.
Business Combinations - We account for business combinations under the purchase method of accounting. The application of this method of accounting requires the use of significant estimates and assumptions in the determination of the fair value of assets acquired and liabilities assumed in order to properly allocate purchase price consideration between assets that are amortized, accreted or depreciated from those that are recorded as goodwill. Our estimates of the fair values of assets acquired and liabilities assumed are based upon assumptions that we believe to be reasonable.
Goodwill - Goodwill is tested at least annually at December 31 for impairment, or more often if events or circumstances indicate there may be impairment. In 2020, the COVID-19 pandemic led to government-imposed emergency restrictions that have had significant adverse effects on macroeconomic conditions. The ultimate effect of COVID-19 on the local or broader economy is not known nor is the ultimate length of the restrictions described and any accompanying effects.
In testing goodwill for impairment at December 31, 2020, the Corporation by-passed performing a qualitative assessment and performed a quantitative assessment based on comparison of the Corporation’s market capitalization to its stockholders’ equity, resulting in the determination that the fair value of its reporting unit, its community banking operation, exceeded its carrying amount. Accordingly, there was no goodwill impairment at December 31, 2020.
Fair Value of 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 I, II and III include information regarding the Corporation’s net interest income in 2020 and 2019. 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. 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 tables.
Fully taxable equivalent net interest income was $68,545,000 in 2020, $13,013,000 (23.4%) higher than in 2019. Interest income was $12,325,000 higher in 2020 as compared to 2019; interest expense was lower by $688,000 in comparing the same periods. As presented in Table II, the Net Interest Margin was 3.69% in 2020 as compared to 3.86% in 2019, 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 3.49% in 2020 from 3.56% in 2019.
Income from purchase accounting-related adjustments in 2020 had a positive effect on net interest income of $3,272,000, including an increase in income on loans of $1,888,000 and reductions in interest expense on time deposits of $928,000 and on borrowed funds of $456,000. The positive impact to the net interest margin from purchase accounting adjustments was 0.18% in 2020 and 0.04% in 2019.
INTEREST INCOME AND EARNING ASSETS
Interest income totaled $78,140,000 in 2020, an increase of 18.7% from 2019. Interest and fees on loans receivable increased $13,881,000, or 24.9%, to $69,606,000 in 2020 from $55,725,000 in 2019. Table III shows the increase in interest on loans includes $17,713,000 attributable to an increase in volume and a decrease of $3,832,000 related to a decrease in average yield. The average balance of loans receivable increased $387,539,000 (36.6%) to $1,445,098,000 in 2020 from $1,057,559,000 in 2019. The increase in average balance reflects the Corporation’s purchase of Covenant on July 1, 2020. The average balance of loans outstanding in 2020 attributable to the former Covenant operations totaled $234,062,000, including PPP loans of $32,279,000. Excluding Covenant, average loans outstanding increased $153,477,000, including PPP loans of $66,187,000. The increase in average loans outstanding includes the effect of loans acquired from Monument, effective April 1, 2019, as well as subsequent loan growth over the last three quarters of 2019. The average yield on loans in 2020 was 4.82% compared to 5.27% in 2019.
Interest income on available-for-sale debt securities totaled $8,203,000 in 2020, a reduction of $1,328,000 from the total for 2019. As indicated in Table II, average available-for-sale debt securities (at amortized cost) totaled $328,445,000 in 2020, a decrease of $28,839,000 (8.1%) from 2019. The average yield on available-for-sale debt securities decreased to 2.50% in 2020 from 2.67% in 2019.
Interest income from interest-bearing deposits in banks totaled $251,000 in 2020, a decrease of $263,000 from the total for 2019. The most significant categories of assets within this category include interest-bearing balances held with the Federal Reserve and investments in certificates of deposit issued by other banks. The average balance increased $58,876,000, partly due to cash received in the Covenant transaction that was not fully deployed. The average yield on interest-bearing deposits with banks fell to 0.31% in 2020 from 2.37% in 2019, which is a result of the decreases to the rates paid on balances held at the Federal Reserve.
INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES
Interest expense decreased $688,000, or 6.7%, to $9,595,000 in 2020 from $10,283,000 in 2019. Table II shows that the overall cost of funds on interest-bearing liabilities decreased to 0.72% in 2020 from 1.02% in 2019.
Total average deposit balances (interest-bearing and noninterest-bearing) increased $372,722,000 to $1,586,409,000 in 2020 from $1,213,687,000 in 2019. The average balance of deposits from the former Covenant operations totaled $225,541,000. Excluding Covenant average deposits for 2020, deposits increased $147,181,000 over the comparative amount for 2019, reflecting the inclusion of deposits assumed from Monument for all of 2020 as compared to nine months in 2019 as well as increases in deposits related to PPP and other government stimulus programs.
Interest expense on deposits decreased $959,000 in 2020 over 2019. The average rate on interest-bearing deposits decreased to 0.60% in 2020 from 0.89% in 2019, consistent with the reduction in market rates in 2020.
Interest expense on borrowed funds increased $271,000 in 2020 as compared to 2019. Total average borrowed funds increased $46,553,000 to $129,265,000 in 2020 from $82,712,000 in 2019. The increase in average borrowed funds includes the impact of borrowings originated to fund loan growth in the last three quarters of 2019 and borrowings assumed from Covenant. The average rate on total borrowed funds was 1.83% in 2020 compared to 2.53% in 2019. The decrease in the average rate on borrowed funds in 2020 reflects the impact of a reduction in market rates.
TABLE I - ANALYSIS OF INTEREST INCOME AND EXPENSE
Year Ended
December 31,
Increase/
(In Thousands)
(Decrease)
INTEREST INCOME
Interest-bearing due from banks
$
$
$
(263)
Available-for-sale debt securities:
Taxable
5,534
7,008
(1,474)
Tax-exempt
2,669
2,523
Total available-for-sale debt securities
8,203
9,531
(1,328)
Loans receivable:
Taxable
64,460
53,086
11,374
Paycheck Protection Program (Taxable)
2,924
2,924
Tax-exempt
2,222
2,639
(417)
Total loans receivable
69,606
55,725
13,881
Other earning assets
Total Interest Income
78,140
65,815
12,325
INTEREST EXPENSE
Interest-bearing deposits:
Interest checking
1,155
(207)
Money market
1,172
Savings
(16)
Time deposits
4,881
5,827
(946)
Total interest-bearing deposits
7,231
8,190
(959)
Borrowed funds:
Short-term
(366)
Long-term
1,291
1,013
Subordinated debt
Total borrowed funds
2,364
2,093
Total Interest Expense
9,595
10,283
(688)
Net Interest Income
$
68,545
$
55,532
$
13,013
(1) Interest income from tax-exempt securities and loans has been adjusted to a fully taxable-equivalent basis, using the Corporation’s marginal federal income tax rate of 21%.
(2) Fees on loans are included with interest on loans and amounted to $4,134,000 in 2020 and $919,000 in 2019.
TABLE II - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES
(Dollars In Thousands)
Year
Year
Ended
Rate of
Ended
Rate of
12/31/2020
Return/
12/31/2019
Return/
Average
Cost of
Average
Cost of
Balance
Funds%
Balance
Funds%
EARNING ASSETS
Interest-bearing due from banks
$
80,587
0.31
%
$
21,711
2.37
%
Available-for-sale securities,
at amortized cost:
Taxable
238,407
2.32
%
284,072
2.47
%
Tax-exempt
90,038
2.96
%
73,212
3.45
%
Total available-for-sale debt securities
328,445
2.50
%
357,284
2.67
%
Loans receivable:
Taxable
1,285,383
5.01
%
988,560
5.37
%
Paycheck Protection Program (Taxable)
98,466
2.97
%
0.00
%
Tax-exempt
61,249
3.63
%
68,999
3.82
%
Total loans receivable
1,445,098
4.82
%
1,057,559
5.27
%
Other earning assets
2,357
3.39
%
1,439
3.13
%
Total Earning Assets
1,856,487
4.21
%
1,437,993
4.58
%
Cash
25,439
19,906
Unrealized gain/loss on securities
12,487
1,347
Allowance for loan losses
(11,018)
(8,876)
Bank-owned life insurance
24,415
18,543
Bank premises and equipment
19,826
15,914
Intangible assets
43,330
25,531
Other assets
38,859
30,111
Total Assets
$
2,009,825
$
1,540,469
INTEREST-BEARING LIABILITIES
Interest-bearing deposits:
Interest checking
$
310,782
0.31
%
$
217,910
0.53
%
Money market
298,736
0.39
%
194,849
0.49
%
Savings
189,316
0.12
%
167,677
0.15
%
Time deposits
397,974
1.23
%
344,446
1.69
%
Total interest-bearing deposits
1,196,808
0.60
%
924,882
0.89
%
Borrowed funds:
Short-term
34,212
1.07
%
33,521
2.19
%
Long-term
83,500
1.55
%
43,917
2.31
%
Subordinated debt
11,553
6.11
%
5,274
6.58
%
Total borrowed funds
129,265
1.83
%
82,712
2.53
%
Total Interest-bearing Liabilities.
1,326,073
0.72
%
1,007,594
1.02
%
Demand deposits
389,601
288,805
Other liabilities
20,800
14,624
Total Liabilities
1,736,474
1,311,023
Stockholders' equity, excluding accumulated
other comprehensive income/loss
263,253
228,103
Accumulated other comprehensive income/loss
10,098
1,343
Total Stockholders' Equity
273,351
229,446
Total Liabilities and Stockholders' Equity
$
2,009,825
$
1,540,469
Interest Rate Spread
3.49
%
3.56
%
Net Interest Income/Earning Assets
3.69
%
3.86
%
Total Deposits (Interest-bearing
and Demand)
$
1,586,409
$
1,213,687
(1) Rates of return on tax-exempt securities and loans are presented on a fully taxable-equivalent basis, using the Corporation’s marginal federal income tax rate of 21%.
(2) Nonaccrual loans have been included with loans for the purpose of analyzing net interest earnings.
TABLE III - ANALYSIS OF VOLUME AND RATE CHANGES
(In Thousands)
Year Ended 12/31/2020 vs. 12/31/2019
Change in
Change in
Total
Volume
Rate
Change
EARNING ASSETS
Interest-bearing due from banks
$
$
(740)
$
(263)
Available-for-sale debt securities:
Taxable
(1,078)
(396)
(1,474)
Tax-exempt
(384)
Total available-for-sale debt securities
(548)
(780)
(1,328)
Loans receivable:
Taxable
15,075
(3,701)
11,374
Paycheck Protection Program (Taxable)
2,924
2,924
Tax-exempt
(286)
(131)
(417)
Total loans receivable
17,713
(3,832)
13,881
Other earning assets
Total Interest Income
17,673
(5,348)
12,325
INTEREST-BEARING LIABILITIES
Interest-bearing deposits:
Interest checking
(594)
(207)
Money market
(227)
Savings
(45)
(16)
Time deposits
(1,762)
(946)
Total interest-bearing deposits
1,669
(2,628)
(959)
Borrowed funds:
Short-term
(381)
(366)
Long-term
(415)
Subordinated debt
(27)
Total borrowed funds
1,094
(823)
Total Interest Expense
2,763
(3,451)
(688)
Net Interest Income
$
14,910
$
(1,897)
$
13,013
(1) Changes in income on tax-exempt securities and loans are presented on a fully taxable-equivalent basis, using the Corporation’s marginal federal income tax rate of 21%.
(2) The change in interest due to both volume and rates has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
NONINTEREST INCOME
TABLE IV - COMPARISON OF NONINTEREST INCOME
(Dollars in Thousands)
Years Ended
December 31,
$
%
Change
Change
Trust and financial management revenue
$
6,321
$
6,106
$
3.5
%
Brokerage revenue
1,343
1,266
6.1
%
Insurance commissions, fees and premiums
10.2
%
Service charges on deposit accounts
4,231
5,358
(1,127)
(21.0)
%
Service charges and fees
(28)
(8.4)
%
Interchange revenue from debit card transactions
3,094
2,754
12.3
%
Net gains from sales of loans
5,403
4,479
484.7
%
Loan servicing fees, net
(61)
(161)
(161.0)
%
Increase in cash surrender value of life insurance
28.1
%
Other noninterest income
3,010
1,875
1,135
60.5
%
Total noninterest income, excluding realized gains on securities, net
24,344
19,284
5,060
26.2
%
Realized gains on available-for-sale debt securities, net
634.8
%
Total noninterest income
$
24,513
$
19,307
$
5,206
27.0
%
Total noninterest income, excluding realized gains and losses on securities, increased $5,060,000 (26.2%) in 2020 compared to 2019. Changes of significance are discussed in the Earnings Overview section of Management’s Discussion and Analysis.
NONINTEREST EXPENSE
TABLE V - COMPARISON OF NONINTEREST EXPENSE
(Dollars in Thousands)
Year Ended
December 31,
$
%
Change
Change
Salaries and wages
$
25,599
$
20,644
$
4,955
24.0
%
Pensions and other employee benefits
7,463
5,837
1,626
27.9
%
Occupancy expense, net
3,010
2,629
14.5
%
Furniture and equipment expense
1,451
1,289
12.6
%
Data processing expenses
4,453
3,403
1,050
30.9
%
Automated teller machine and interchange expense
1,231
1,103
11.6
%
Pennsylvania shares tax
1,689
1,380
22.4
%
Professional fees
1,692
1,069
58.3
%
Telecommunications
16.0
%
Directors' fees
8.5
%
Other noninterest expense
7,428
6,667
11.4
%
Total noninterest expense, excluding merger-related expenses and loss on prepayment of borrowings
55,609
45,438
10,171
22.4
%
Merger-related expenses
7,708
4,099
3,609
88.0
%
Loss on prepayment of borrowings
1,636
1,636
Total noninterest expense
$
64,953
$
49,537
$
15,416
31.1
%
Total noninterest expenses increased $15,416,000 (31.1%) in 2020 as compared to 2019. Total noninterest expenses excluding merger-related expenses and loss on prepayment of borrowings increased $10,171,000 (22.4%) in 2020 as compared to 2019. Merger-related expenses are discussed in the Acquisitions of Covenant Financial Inc. and Monument Bancorp, Inc. section of Management’s Discussion
and Analysis. Loss on prepayment of borrowings and other changes of significance are discussed in the Earnings Overview section of Management’s Discussion and Analysis.
INCOME TAXES
The effective income tax rate was 17.2% of pre-tax income in 2020, up from 16.7% in 2019. The Corporation’s effective tax rates differed from the statutory rate of 21% mainly because of the effects of tax-exempt interest income. The higher effective income tax rate in 2020 as compared to 2019 resulted mainly from a reduction in tax-exempt interest income and an increase in nondeductible penalties.
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. At December 31, 2020, the net deferred tax asset was $2,705,000, up from the balance at December 31, 2019 of $2,618,000. The most significant changes in temporary difference components included a net increase of $2,170,000 in the deferred tax liability resulting from appreciation in available-for-sale debt securities attributable to lower interest rates as well as Covenant acquisition-related adjustments to loans, a net operating loss carryforward, core deposit intangibles, bank premises and equipment and operating leases.
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, including taxable income in prior carryback years, as well as future taxable income. Further, the value of the benefit from realization of deferred tax assets would be impacted if income tax rates were changed from currently enacted levels.
Management believes the recorded net deferred tax asset at December 31, 2020 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.
Additional information related to income taxes is presented in Note 14 to the consolidated financial statements.
SECURITIES
The objectives of the Corporation’s available-for-sale debt securities (investment) portfolio are to maintain high credit quality, achieve good portfolio balance, support liquidity needs, maximize return on earning assets within reasonable risk parameters, provide an adequate amount of pledgeable securities, support local communities by purchasing securities they issue for public projects and programs, provide a means to hedge the Corporation’s interest rate risk exposure, and minimize taxes. Management continually evaluates the size and mix of securities held in the available-for-sale debt securities portfolio while considering these objectives.
Table VI shows the composition of the available-for-sale debt securities portfolio at December 31, 2020 and 2019. The amortized cost of available-for-sale debt securities was $334,552,000 at December 31, 2020 and $342,278,000 at December 31, 2019. Within the securities portfolio, mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies decreased to 40.5% of the amortized cost basis of the portfolio at December 31, 2020 from 64.8% at December 31, 2019. Investments in tax-exempt and taxable municipal bonds increased to 48.3% of the portfolio at December 31, 2020 from 30.5% at December 31, 2019. These changes in portfolio mix were based on changes in liquidity and interest rate risk management needs and current market yields for various categories of securities.
As reflected in Table VI, the fair value of available-for-sale securities as of December 31, 2020 was $14,780,000, or 4.4%, greater than the total amortized cost basis. In comparison, the aggregate unrealized gain position at December 31, 2019 was $4,445,000, or 1.3% of the total amortized cost basis. The unrealized appreciation in the portfolio in 2020 resulted mainly from a decrease in interest rates.
Management has reviewed the Corporation’s holdings as of December 31, 2020 and concluded that unrealized losses on all of the securities in an unrealized loss position are considered temporary. Note 7 to the consolidated financial statements provides more detail concerning the Corporation’s processes for evaluating securities for other-than-temporary impairment.
TABLE VI - INVESTMENT SECURITIES
Amortized
Fair
Amortized
Fair
(In Thousands)
Cost
Value
Cost
Value
AVAILABLE-FOR-SALE DEBT SECURITIES:
Obligations of the U.S. Treasury
$
12,184
$
12,182
$
$
Obligations of U.S. Government agencies
25,349
26,344
16,380
17,000
Obligations of states and political subdivisions:
Tax-exempt
116,427
122,401
68,787
70,760
Taxable
45,230
47,452
35,446
36,303
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities
36,853
38,176
58,875
59,210
Residential collateralized mortgage obligations
56,048
57,467
115,025
114,723
Commercial mortgage-backed securities
42,461
45,310
47,765
48,727
Total Available-for-Sale Debt Securities
$
334,552
$
349,332
$
342,278
$
346,723
The following table presents the contractual maturities and the weighted-average yields (calculated based on amortized cost) of investment securities as of December 31, 2020. Yields on tax-exempt securities are presented on a fully taxable-equivalent basis. For callable securities, yields on securities purchased at a discount are based on yield-to-maturity, while yields on securities purchased at a premium are based on yield to the first call date. Yields on mortgage-backed securities are estimated and include the effects of prepayment assumptions. 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.
Within
One-
Five-
After
One
Five
Ten
Ten
(Dollars In Thousands)
Year
Yield
Years
Yield
Years
Yield
Years
Yield
Total
Yield
AVAILABLE-FOR-SALE DEBT SECURITIES:
Obligations of the U.S. Treasury
$
6,027
0.11
%
$
6,157
0.12
%
$
0.00
%
$
0.00
%
$
12,184
0.11
%
Obligations of U.S. Government agencies
0.00
%
4,999
0.35
%
12,509
1.54
%
7,841
3.42
%
25,349
1.89
%
Obligations of states and political subdivisions:
Tax-exempt
3,408
3.71
%
20,160
2.87
%
28,037
2.82
%
64,822
2.64
%
116,427
2.76
%
Taxable
3,974
2.63
%
14,856
2.83
%
6,989
2.86
%
19,411
2.64
%
45,230
2.73
%
Sub-total
$
13,409
1.78
%
$
46,172
2.23
%
$
47,535
2.50
%
$
92,074
2.73
%
$
199,190
2.48
%
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities
36,853
1.93
%
Residential collateralized mortgage obligations
56,048
1.73
%
Commercial mortgage-backed securities
42,461
2.45
%
Total
$
334,552
2.29
%
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. As rates increase, cash flows generally decrease as prepayments on the underlying mortgage loans decrease. As rates decrease, cash flows generally increase as prepayments increase due to increased refinance activity and other factors. In the table above, the entire balances and weighted-average rates for mortgage-backed securities and collateralized mortgage obligations are shown in one period.
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 loan losses and stockholders’ equity, are discussed in separate sections of Management’s Discussion and Analysis. There are no significant concerns that have arisen related to the Corporation’s off-balance sheet loan commitments or outstanding letters of credit at December 31, 2020, and 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 2021.
Table VII shows the composition of the loan portfolio as of the end of the years 2016 through 2020. From December 31, 2016 through December 31, 2018, total loans outstanding increased $75.7 million (10.1%) and the overall mix by segment remained fairly constant, with residential mortgage loans of approximately 55% to 56% of the portfolio at each year-end, and commercial loans of 42% to 43% of the portfolio. At December 31, 2019, gross loans outstanding totaled $1,182,222,000, an increase of $354.7 million (42.9%) from December 31, 2018. At December 31, 2020, gross loans outstanding totaled $1,644,209,000, an increase of $462.0 million (39.1%) from December 31, 2019. A significant portion of the Corporation’s loan growth in 2019 was attributable to the Monument acquisition, while, similarly, growth in 2020 is attributable to the Covenant acquisition as well as due to new loans originated in the southeastern and southcentral Pennsylvania markets. At December 31, 2020, commercial loans represented approximately 61% of the portfolio while residential mortgage loans totaled 38% of the portfolio.
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. Participation loans are included in the “Commercial and industrial,” “Commercial loans secured by real estate”, “Political subdivisions” and “Other commercial” classes in the loan tables presented in this Form 10-K. Total participation loans outstanding amounted to $65,741,000 at December 31, 2020, up slightly from $64,633,000 at December 31, 2019. At December 31, 2020, the balance of participation loans outstanding includes a total of $40,009,000 to businesses located outside of the Corporation’s market areas. Also, included within participation loans are “leveraged loans,” meaning loans to businesses with minimal tangible book equity and for which the extent of collateral available is limited, though typically at the time of origination the businesses have demonstrated strong cash flow performance in their recent histories. Leveraged participation loans totaled $8,437,000 at December 31, 2020 and $9,947,000 at December 31, 2019.
Table VIII presents loan maturity data as of December 31, 2020. Fixed-rate loans are shown in Table VIII based on their contractually scheduled principal repayments, and variable-rate loans are shown based on the date of the next change in rate. Table VIII shows that fixed-rate loans are approximately 43% of the loan portfolio and approximately 34% of the portfolio are variable-rate loans that re-price after more than one year. Variable-rate loans re-pricing after more than one year include residential and commercial real estate secured loans. The Corporation’s substantial investment in long-term, fixed-rate loans and variable-rate loans with extended periods until re-pricing is one of the concerns management attempts to address through interest rate risk management practices.
Since 2009, the Corporation has originated and sold 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. In 2014, the Corporation began to originate and sell residential mortgage loans to the secondary market through the MPF Original program, which is also 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. In 2020, the Corporation’s activity under the MPF Direct Program was 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 December 31, 2020, the total outstanding balance of loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $1,714,000, and the corresponding total outstanding balance of repurchased loans at December 31, 2019 was $1,770,000.
At December 31, 2020, outstanding balances of loans sold and serviced through the MPF Xtra and Original programs totaled $278,857,000, including loans sold through the MPF Xtra program of $149,463,000 and loans sold through the Original program of $129,394,000. At December 31, 2019, outstanding balances of loans sold and serviced through the two programs totaled $178,446,000, including loans sold through the MPF Xtra program of $104,707,000 and loans sold through the Original Program of $73,739,000. Based on the fairly limited volume of required repurchases to date, no allowance has been established for representation and warranty exposures as of December 31, 2020 and December 31, 2019.
For loans sold under the Original program, the Corporation provides a credit enhancement whereby the Corporation would assume credit losses in excess of a defined First Loss Account (“FLA”) balance, up to specified amounts. The FLA is funded by the Federal Home Loan Bank of Pittsburgh based on a percentage of the outstanding balance of loans sold. At December 31, 2020, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $6,766,000, and the Corporation has recorded a related allowance for credit losses in the amount of $500,000 which is included in accrued interest and other liabilities in the accompanying consolidated balance sheets. At December 31, 2019, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $4,618,000, and the related allowance for credit losses was $333,000. Income related to providing the credit enhancement (included in other noninterest income in the consolidated statements of income) totaled $227,000 in 2020 and $90,000 in 2019. A provision for losses related to the credit enhancement obligation (included in other noninterest expense in the consolidated statements of income) of $167,000 was recorded in 2020 with no corresponding charge in 2019. The Corporation does not provide a credit enhancement for loans sold through the Xtra program.
The Corporation is a participating SBA lender. Under the terms of its arrangements with the SBA, the Corporation may originate loans to commercial borrowers, with full-or-partial guarantees by the SBA, subject to the SBA’s underwriting and documentation requirements. Covenant had also been a participating SBA lender. Pursuant to the Covenant acquisition, the Corporation acquired loans with partial SBA guarantees, or in some cases, loans where the SBA-guaranteed portion of the loans had been sold back to the SBA subject to ongoing compliance with SBA underwriting and documentation requirements. As part of its due diligence, the Corporation reviewed all the loans originated through the various SBA loan programs acquired from Covenant as of July 1, 2020 and recorded an allowance for SBA claim adjustments of $800,000. Determination of the allowance was subjective in nature and was based on the Corporation’s assessment of the credit quality of the loans and the quality of the documentation supporting compliance with SBA requirements. The Corporation’s total exposure related to SBA guarantees on loans originated by Covenant was $17,041,000 at December 31, 2020. In the fourth quarter 2020, the Corporation recorded a reduction in other noninterest expense of $70,000 resulting from better collection experience on certain claims than had been estimated in determining the allowance at July 1, 2020. At December 31, 2020, the allowance for SBA claim adjustments (included in accrued interest and other liabilities in the consolidated balance sheets) had a balance of $730,000.
TABLE VII - Five-year Summary of Loans by Type
(Dollars In Thousands)
%
%
%
%
%
Residential mortgage:
Residential mortgage loans - first liens
$
532,947
32.4
$
510,641
43.2
$
372,339
45.0
$
359,987
44.1
$
334,102
44.4
Residential mortgage loans - junior liens
27,311
1.7
27,503
2.3
25,450
3.1
25,325
3.1
23,706
3.2
Home equity lines of credit
39,301
2.4
33,638
2.8
34,319
4.1
35,758
4.4
38,057
5.1
1-4 Family residential construction
20,613
1.3
14,798
1.3
24,698
3.0
26,216
3.2
24,908
3.3
Total residential mortgage
620,172
37.8
586,580
49.6
456,806
55.2
447,286
54.8
420,773
56.0
Commercial:
Commercial loans secured by real estate
531,810
32.3
301,227
25.5
162,611
19.6
159,266
19.5
150,468
20.0
Commercial and industrial
159,577
9.7
126,374
10.7
91,856
11.1
88,276
10.8
83,854
11.2
Small business administration - paycheck protection program
132,269
8.0
0.0
0.0
0.0
0.0
Political subdivisions
53,221
3.2
53,570
4.5
53,263
6.4
59,287
7.3
38,068
5.1
Commercial construction and land
42,874
2.6
33,555
2.8
11,962
1.4
14,527
1.8
14,287
1.9
Loans secured by farmland
11,736
0.7
12,251
1.0
7,146
0.9
7,255
0.9
7,294
1.0
Multi-family (5 or more) residential
55,811
3.4
31,070
2.6
7,180
0.9
7,713
0.9
7,896
1.1
Agricultural loans
3,164
0.2
4,319
0.4
5,659
0.7
6,178
0.8
3,998
0.5
Other commercial loans
17,289
1.1
16,535
1.4
13,950
1.7
10,986
1.3
11,475
1.5
Total commercial
1,007,751
61.2
578,901
49.0
353,627
42.7
353,488
43.3
317,340
42.2
Consumer
16,286
1.0
16,741
1.4
17,130
2.1
14,939
1.8
13,722
1.8
Total
1,644,209
100.0
1,182,222
100.0
827,563
100.0
815,713
100.0
751,835
100.0
Less: allowance for loan losses
(11,385)
(9,836)
(9,309)
(8,856)
(8,473)
Loans, net
$
1,632,824
$
1,172,386
$
818,254
$
806,857
$
743,362
TABLE VIII - LOAN MATURITY DISTRIBUTION
As of December 31, 2020
Fixed-Rate Loans
Variable- or Adjustable-Rate Loans
1 Year
1-5
>5
1 Year
1-5
>5
(In Thousands)
or Less
Years
Years
Total
or Less
Years
Years
Total
Real Estate
$
29,159
$
192,348
$
231,459
$
452,966
$
288,368
$
343,930
$
177,140
$
809,438
Commercial
23,149
173,492
35,275
231,916
93,529
30,579
9,495
133,603
Consumer
3,585
9,494
2,988
16,067
Total
$
55,893
$
375,334
$
269,722
$
700,949
$
382,116
$
374,509
$
186,635
$
943,260
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and recorded as a reduction of the investment in loans. Notes 1 and 8 to the consolidated financial statements provide an overview of the process management uses for evaluating and determining the allowance for loan losses.
While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.
The allowance for loan losses was $11,385,000 at December 31, 2020, up from $9,836,000 at December 31, 2019. Table X shows that the collectively determined portion of the allowance increased $1,675,000 across all loan classes, including an increase in the collectively determined portion of the allowance related to commercial loans of $1,632,000. This increase was primarily due to increases in qualitative factors related to economic conditions in 2020 and an increase in the historical loss factor on commercial loans.
Table X shows total specific allowances on impaired loans decreased $126,000 to $925,000 at December 31, 2020 from $1,051,000 at December 31, 2019. This net decrease included the impact of the elimination of a specific allowance of $678,000 at December 31, 2019 on a commercial loan that was repaid for less than the full principal balance resulting in a charge-off of $107,000 in the second quarter of 2020 as well as the elimination of $125,000 in specific allowances on loans no longer considered impaired at December 31, 2020.
This reduction in specific allowances on impaired loans was partially offset by allowances totaling $701,000 at December 31, 2020 related to three commercial loan relationships with an aggregate recorded investment of $7,312,000 that management identified as impaired in the second quarter 2020 and that were still considered impaired at December 31, 2020.
Loans acquired from Covenant that were identified as having a deterioration in credit quality (purchased credit impaired, or PCI), were valued at $6,648,000 at July 1, 2020 and $6,537,000 at December 31, 2020. The remainder of the portfolio was deemed to be the performing component of the portfolio. The calculation of the fair value of performing loans included a discount for credit losses of $7,219,000 reduced by accretion of $1,857,000 in the third and fourth quarters of 2020 to $5,362,000 at December 31, 2020. The discount recorded in the acquisition represented an estimate of the present value of credit losses based on market expectations at the date of acquisition.
Loans acquired from Monument that were identified as having a deterioration in credit quality (PCI) were valued at $441,000 at April 1, 2019 and $304,000 at December 31, 2020. The remainder of the portfolio was deemed to be the performing component of the portfolio. Performing loans acquired from Monument are presented net of a discount for credit losses of $617,000 at December 31, 2020 and $1,216,000 at December 31, 2019. This discount reflects an estimate of the present value of credit losses based on market expectations at the date of acquisition of $1,914,000, subsequently reduced as accretion has been recognized based on estimated and actual principal pay-downs.
Table XI shows the allowance for loan losses totaled 0.69% of gross loans outstanding at December 31, 2020, down from 0.83% at December 31, 2019 and down from levels in excess of 1.00% from 2016 to 2018. Table XI also shows that the total of the allowance and the credit adjustment on purchased non-impaired loans, as a percentage of total loans plus the credit adjustment, was 1.05% at December 31, 2020, in line with ratios from the previous years.
The provision for loan losses by segment for 2020 and 2019 is as follows:
(In Thousands)
Residential mortgage
$
$
Commercial
3,847
Consumer
Unallocated
Total
$
3,913
$
The provision for loan losses is further detailed as follows:
Residential mortgage segment
(In Thousands)
(Decrease) increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs
$
(58)
$
(Decrease) increase in collectively determined portion of the allowance attributable to:
Loan (reduction) growth
(240)
Changes in historical loss experience factors
(88)
Changes in qualitative factors
(82)
Total provision for loan losses - Residential mortgage segment
$
$
Commercial segment
(In Thousands)
Increase (decrease) in total specific allowance on impaired loans, adjusted for the effect of net charge-offs
$
2,215
$
(614)
Increase (decrease) in collectively determined portion of the allowance attributable to:
Loan growth
1,025
Changes in historical loss experience factors
(371)
Changes in qualitative factors
Total provision for loan losses - Commercial segment
$
3,847
$
Consumer segment
(In Thousands)
Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs
$
$
(Decrease) increase in collectively determined portion of the allowance attributable to:
Loan reduction
(30)
(3)
Changes in historical loss experience factors
(15)
Changes in qualitative factors
Total provision for loan losses - Consumer segment
$
$
Total - All segments
(In Thousands)
Increase (decrease) increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs
$
2,238
$
(232)
Increase (decrease) in collectively determined portion of the allowance attributable to:
Loan growth
1,193
Changes in historical loss experience factors
(293)
Changes in qualitative factors
Sub-total
3,913
Unallocated
Total provision for loan losses - All segments
$
3,913
$
For the periods shown in the tables immediately above, the provision related to increases or decreases in specific allowances on impaired loans was affected by changes in the results of management’s assessment of the amount of probable or actual (charged-off) losses associated with a small number of larger, individual loans. This line item also includes net charge-offs or recoveries from smaller loans that had not been individually evaluated for impairment prior to charge-off.
In the tables immediately above, the portion of the net change in the collectively determined allowance attributable to loan growth was determined by applying the historical loss experience and qualitative factors used in the allowance calculation at the end of the preceding period to the net increase in loans outstanding (excluding purchased loans and loans specifically evaluated for impairment) for the period.
The effect on the provision of changes in historical loss experience and qualitative factors, as shown in the tables above, was determined by: (1) calculating the net change in each factor used in determining the allowance at the end of the period as compared to the preceding period, and (2) applying the net change in each factor to the outstanding balance of loans at the end of the preceding period (excluding loans specifically evaluated for impairment).
In 2020, net charge-offs were $2,364,000, including charge-offs of $2,465,000 and recoveries of $101,000. The Corporation’s overall net charge-off experience in 2020 was elevated compared to results over the past several years due to the impact of a charge-off of $2,219,000 on a commercial loan with an outstanding balance of $3,500,000 in the third quarter 2020. Table XII shows the average rate of net charge-offs as a percentage of loans was 0.16% in 2020, with an annual average over the five-year period ended December 31, 2020 of 0.08%, and annual average rates ranging from a high of 0.16% in 2020 to a low of 0.02% in 2018.
Table XI presents information related to past due and impaired loans, and loans that have been modified under terms that are considered troubled debt restructurings (TDRs). Total nonperforming loans as a percentage of outstanding loans was 1.42% at December 31, 2020, up from 0.88% at December 31, 2019, and nonperforming assets as a percentage of total assets was 1.10% at December 31, 2020, up from 0.80% at December 31, 2019. Table XI presents data at the end of each of the years ended December 31, 2016 through 2020. Table XI shows that total nonperforming loans as a percentage of loans of 1.42% at December 31, 2020, though up from December 31, 2019, was lower than the corresponding year-end ratio from 2016 through 2018. Similarly, the December 31, 2020 ratio of total nonperforming assets as a percentage of assets of 1.10% was lower than the corresponding ratio from 2016 through 2018.
Total impaired loans of $17,818,000 at December 31, 2020 are up $12,332,000 from the corresponding amount at December 31, 2019 of $5,486,000. The increase in impaired loans includes the net impact of classification as impaired of the commercial loans referred to above in the discussion of specific allowances and the loans purchased with credit impairment from Covenant. Table XI shows that the
total balance of impaired loans at December 31, 2020 was higher than the year-end amounts over the period 2016-2019, which ranged from a low of $9,511,000 in 2017 to the high of $17,818,000 at December 31, 2020.
Total nonperforming assets of $24,729,000 at December 31, 2020 are $11,418,000 higher than the corresponding amount at December 31, 2019, summarized as follows:
● Total nonaccrual loans at December 31, 2020 of $21,416,000 was $12,198,000 higher than the corresponding December 31, 2019 total of $9,218,000. Similar to the discussions above related to impaired loans and nonperforming assets, this increase reflects the impact of net changes in classification as impaired of the commercial loans subject to specific allowances and the loans purchased from Covenant with credit impairment described above.
● Total loans past due 90 days or more and still accruing interest amounted to $1,975,000 at December 31, 2020, an increase of $768,000 from the total at December 31, 2019. The increase includes $631,000 from loans secured by commercial real estate and $121,000 increase on residential. Management has evaluated the loans within this category and determined they are well secured and in the process of collection at December 31, 2020.
● Foreclosed assets held for sale consisted of real estate, and totaled $1,338,000 at December 31, 2020, a decrease of $1,548,000 from $2,886,000 at December 31, 2019. Within this decrease, there was a reduction of $1,134,000 related to the sale of a commercial real estate property in the first quarter of 2020. At December 31, 2020, the Corporation held six such properties for sale, with total carrying values of $80,000 related to residential real estate and $1,258,000 related to commercial real estate. At December 31, 2019, the Corporation held ten such properties for sale, with total carrying values of $292,000 related to residential real estate, $70,000 of land and $2,524,000 related to commercial real estate. The Corporation evaluates the carrying values of foreclosed assets each quarter based on the most recent market activity or appraisals for each property.
As reflected in Table XI, total loans past due 30-89 days and still accruing interest amounted to $5,918,000 at December 31, 2020, down from $8,889,000 at December 31, 2019. This variance includes the effect of fluctuations in 30-89 day past due residential mortgage loans, which totaled $5,084,000 at December 31, 2020, down from $7,816,000 at December 31, 2019. Management monitors the status of delinquent residential mortgage loans on an ongoing basis and has considered delinquency trends, which were generally favorable throughout most of 2020, in evaluating the allowance for loan losses at December 31, 2020.
Over the period 2016-2020, 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 impaired loans, and may significantly impact the amount of total charge-offs reported in any one period.
Management believes it has been conservative in its decisions concerning identification of impaired loans, estimates of loss, and nonaccrual status; however, the actual losses realized from these relationships could vary materially from the allowances calculated as of December 31, 2020. 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 IX through XII present historical data related to the allowance for loan losses.
TABLE IX - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
(Dollars In Thousands)
Years Ended December 31,
Balance, beginning of year
$
9,836
$
9,309
$
8,856
$
8,473
$
7,889
Charge-offs:
Residential mortgage
(190)
(158)
(197)
(73)
Commercial
(2,343)
(6)
(165)
(132)
(597)
Consumer
(122)
(183)
(174)
(150)
(87)
Total charge-offs
(2,465)
(379)
(497)
(479)
(757)
Recoveries:
Residential mortgage
Commercial
Consumer
Total recoveries
Net charge-offs
(2,364)
(322)
(131)
(418)
(637)
Provision for loan losses
3,913
1,221
Balance, end of period
$
11,385
$
9,836
$
9,309
$
8,856
$
8,473
Net charge-offs as a % of average loans
0.16
%
0.03
%
0.02
%
0.05
%
0.09
%
TABLE X - COMPONENTS OF THE ALLOWANCE FOR LOAN LOSSES
(In Thousands)
As of December 31,
ASC 310 - Impaired loans
$
$
1,051
$
1,605
$
1,279
$
ASC 450 - Collective segments:
Commercial
5,545
3,913
3,102
3,078
3,373
Residential mortgage
4,091
4,006
3,870
3,841
3,890
Consumer
Unallocated
Total Allowance
$
11,385
$
9,836
$
9,309
$
8,856
$
8,473
TABLE XI - PAST DUE AND IMPAIRED LOANS, NONPERFORMING ASSETS AND TROUBLED DEBT RESTRUCTURINGS (TDRs)
(Dollars In Thousands)
As of December 31,
Impaired loans with a valuation allowance
$
8,082
$
3,375
$
4,851
$
4,100
$
3,372
Impaired loans without a valuation allowance
2,895
1,670
4,923
5,411
7,488
Purchased credit impaired loans
6,841
Total impaired loans
$
17,818
$
5,486
$
9,774
$
9,511
$
10,860
Total loans past due 30-89 days and still accruing
$
5,918
$
8,889
$
7,142
$
9,449
$
7,735
Nonperforming assets:
Purchased credit impaired loans
$
6,841
$
$
$
$
Other nonaccrual loans
14,575
8,777
13,113
13,404
8,736
Total nonaccrual loans
21,416
9,218
13,113
13,404
8,736
Total loans past due 90 days or more and still accruing
1,975
1,207
2,906
3,724
6,838
Total nonperforming loans
23,391
10,425
16,019
17,128
15,574
Foreclosed assets held for sale (real estate)
1,338
2,886
1,703
1,598
2,180
Total nonperforming assets
$
24,729
$
13,311
$
17,722
$
18,726
$
17,754
Loans subject to troubled debt restructurings (TDRs):
Performing
$
$
$
$
$
5,803
Nonperforming
7,285
1,737
2,884
3,027
2,874
Total TDRs
$
7,451
$
2,626
$
3,539
$
3,663
$
8,677
Total nonperforming loans as a % of loans
1.42
%
0.88
%
1.94
%
2.10
%
2.07
%
Total nonperforming assets as a % of assets
1.10
%
0.80
%
1.37
%
1.47
%
1.43
%
Allowance for loan losses as a % of total loans
0.69
%
0.83
%
1.12
%
1.09
%
1.13
%
Credit adjustment on purchased non-impaired loans and allowance for loan losses
as a % of total loans and the credit adjustment (a)
1.05
%
0.93
%
1.12
%
1.09
%
1.13
%
Allowance for loan losses as a % of nonperforming loans
48.67
%
94.35
%
58.11
%
51.70
%
54.40
%
(a) Credit adjustment on purchased non-impaired loans at end of period
$
5,979
$
1,216
$
$
$
Allowance for loan losses
11,385
9,836
9,309
8,856
8,473
Total credit adjustment on purchased non-impaired loans at end of period and allowance for loan losses (1)
$
17,364
$
11,052
$
9,309
$
8,856
$
8,473
Total loans receivable
$
1,644,209
$
1,182,222
$
827,563
$
815,713
$
751,835
Credit adjustment on purchased non-impaired loans at end of period
5,979
1,216
Total (2)
$
1,650,188
$
1,183,438
$
827,563
$
815,713
$
751,835
Credit adjustment on purchased non-impaired loans and allowance for loan losses as a % of total loans and the credit adjustment (1)/(2)
1.05
%
0.93
%
1.12
%
1.09
%
1.13
%
TABLE XII - FIVE-YEAR HISTORY OF LOAN LOSSES
(Dollars In Thousands)
Average
Average gross loans
$
1,445,098
$
1,057,559
$
822,346
$
780,640
$
723,076
$
965,744
Year-end gross loans
1,644,209
1,182,222
827,563
815,713
751,835
$
1,044,308
Year-end allowance for loan losses
11,385
9,836
9,309
8,856
8,473
$
9,572
Year-end nonaccrual loans
21,416
9,218
13,113
13,404
8,736
$
13,177
Year-end loans 90 days or more past due and still accruing
1,975
1,207
2,906
3,724
6,838
3,330
Net charge-offs
2,364
Provision for loan losses
3,913
1,221
1,474
Earnings coverage of charge-offs
x
x
x
x
x
x
Allowance coverage of charge-offs
x
x
x
x
x
x
Net charge-offs as a % of provision for loan losses
60.41
%
37.93
%
22.43
%
52.18
%
52.17
%
52.51
%
Net charge-offs as a % of average gross loans
0.16
%
0.03
%
0.02
%
0.05
%
0.09
%
0.08
%
Income before income taxes on a fully taxable equivalent basis
24,192
24,453
27,564
23,350
23,861
24,684
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
The Corporation’s significant fixed and determinable contractual obligations as of December 31, 2020 include repayment obligations related to time deposits and borrowed funds. Information related to maturities of time deposits is provided in Note 11 to the consolidated financial statements. Information related to maturities of borrowed funds is provided in Note 12 to the consolidated financial statements. The Corporation’s operating lease commitments with terms of one year or less and other commitments at December 31, 2020 are immaterial. Information concerning operating lease commitments with terms greater than one year is provided in Note 17 to the consolidated financial statements. The Corporation’s significant off-balance sheet arrangements include commitments to extend credit and standby letters of credit. Off-balance sheet arrangements are described in Note 16 to the consolidated financial statements.
As described in more detail in the Financial Condition section of Management’s Discussion and Analysis, the Corporation sells residential mortgage loans for which 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. At December 31, 2020, outstanding balances of such loans sold totaled $278,857,000.
Also, for loans sold under the MPF Original program, the Corporation provides a credit enhancement. At December 31, 2020, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $6,766,000, and the Corporation has recorded a related allowance for credit losses in the amount of $500,000 which is included in “Accrued interest and other liabilities” in the accompanying consolidated balance sheets.
As discussed in the Financial Condition section of Management’s Discussion and Analysis, the Corporation is a participating SBA lender and may originate loans to commercial borrowers, with full-or-partial guarantees by the SBA, subject to the SBA’s underwriting and documentation requirements. In some cases, the Corporation may sell the SBA-guaranteed portion of the loan back to the SBA subject to ongoing compliance with SBA underwriting and documentation requirements. If it is determined that the ongoing compliance requirements are not met, the Corporation could be subject to claim adjustments on SBA guaranteed loans. At December 31, 2020, the Corporation’s total exposure to SBA guarantees was $17,041,000 with a recorded claims adjustment allowance of $730,000, included in accrued interest and other liabilities in the consolidated balance sheets.
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. At December 31, 2020, the Corporation maintained overnight interest-bearing deposits with the Federal Reserve Bank of Philadelphia and other correspondent banks totaling $71,237,000.
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 securities with a carrying value of $15,126,000 at December 31, 2020.
The Corporation’s outstanding, available, and total credit facilities at December 31, 2020 and 2019 are as follows:
Outstanding
Available
Total Credit
(In Thousands)
December 31,
December 31,
December 31,
December 31,
December 31,
December 31,
Federal Home Loan Bank of Pittsburgh
$
72,222
$
136,424
$
698,977
$
416,122
$
771,199
$
552,546
Federal Reserve Bank Discount Window
14,654
14,244
14,654
14,244
Other correspondent banks
45,000
45,000
45,000
45,000
Total credit facilities
$
72,222
$
136,424
$
758,631
$
475,366
$
830,853
$
611,790
The significant increase in credit available from the Federal Home Loan Bank of Pittsburgh in 2020 resulted from an increase in the borrowing base created by the acquisition of real estate secured loans from Covenant. At December 31, 2020, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of short-term borrowings of $18,000,000, long-term borrowings of $53,822,000 and a $400,000 letter of credit. At December 31, 2019, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowings of $64,000,000, short-term borrowings of $20,297,000 and long-term borrowings with a total amount of $52,127,000.
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 debt securities to meet its obligations. At December 31, 2019, the carrying value of available-for-sale debt securities in excess of amounts required to meet pledging or repurchase agreement obligations was $124,510,000.
Management believes the Corporation is well-positioned to meet its short-term and long-term obligations.
STOCKHOLDERS’ EQUITY AND CAPITAL ADEQUACY
Details concerning capital ratios at December 31, 2020 and December 31, 2019 are presented in Note 18 to the consolidated financial statements. Management believes, as of December 31, 2020, 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, the Corporation’s and C&N Bank’s capital ratios at December 31, 2020 and December 31, 2019 exceed the Corporation’s Board policy threshold levels. Management expects C&N Bank to maintain capital levels that exceed the regulatory standards for well-capitalized institutions for the next 12 months and for the foreseeable future.
Future dividend payments 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. These restrictions are described in Note 18 to the consolidated financial statements. 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 sufficient 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 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 December 31, 2020, 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
8.5
%
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% 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. The rule also prohibits a banking organization 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%
60%
≤1.875% and >1.25%
40%
≤1.25% and >0.625%
20%
≤0.625%
0%
At December 31, 2020, C&N Bank’s Capital Conservation Buffer (determined based on the minimum total capital ratio) was 7.98%.
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 Income within stockholders’ equity. The balance in Accumulated Other Comprehensive Income related to unrealized gains (losses) on available-for-sale debt securities, net of deferred income tax, amounted to $11,676,000 at December 31, 2020 and $3,511,000 at December 31, 2019. Changes in accumulated other comprehensive income (loss) are excluded from earnings and directly increase or decrease stockholders’ equity. If available-for-sale debt securities are deemed to be other-than-temporarily impaired, unrealized losses are recorded as a charge against earnings, and amortized cost for the affected securities is reduced. Note 7 to the consolidated financial statements provides additional information concerning management’s evaluation of available-for-sale debt securities for other-than-temporary impairment at December 31, 2020.
Stockholders’ equity is also affected by the underfunded or overfunded status of defined benefit pension and postretirement plans. The balance in Accumulated Other Comprehensive Income related to defined benefit plans, net of deferred income tax, was $119,000 at December 31, 2020 and $180,000 at December 31, 2019.

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 8. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
December 31,
December 31,
(In Thousands, Except Share and Per Share Data)
ASSETS
Cash and due from banks:
Noninterest-bearing
$
24,780
$
17,667
Interest-bearing
77,077
17,535
Total cash and due from banks
101,857
35,202
Available-for-sale debt securities, at fair value
349,332
346,723
Marketable equity security
1,000
Loans held for sale
Loans receivable
1,644,209
1,182,222
Allowance for loan losses
(11,385)
(9,836)
Loans, net
1,632,824
1,172,386
Bank-owned life insurance
30,096
18,641
Accrued interest receivable
8,293
5,001
Bank premises and equipment, net
21,526
17,170
Foreclosed assets held for sale
1,338
2,886
Deferred tax asset, net
2,705
2,618
Goodwill
52,505
28,388
Core deposit intangibles, net
3,851
1,247
Other assets
32,831
22,137
TOTAL ASSETS
$
2,239,100
$
1,654,145
LIABILITIES
Deposits:
Noninterest-bearing
$
465,332
$
285,904
Interest-bearing
1,355,137
966,756
Total deposits
1,820,469
1,252,660
Short-term borrowings
20,022
86,220
Long-term borrowings
54,608
52,127
Subordinated debt
16,553
6,500
Accrued interest and other liabilities
27,692
12,186
TOTAL LIABILITIES
1,939,344
1,409,693
STOCKHOLDERS' EQUITY
Preferred stock, $1,000 par value; authorized 30,000 shares; $1,000 liquidation
preference per share; no shares issued
Common stock, par value $1.00 per share; authorized 20,000,000 shares;
issued 15,982,815 and outstanding 15,911,984 at December 31, 2020;
issued 13,934,996 and outstanding 13,716,445 at December 31, 2019
15,983
13,935
Paid-in capital
143,644
104,519
Retained earnings
129,703
126,480
Treasury stock, at cost; 70,831 shares at December 31, 2020 and 218,551
shares at December 31, 2019
(1,369)
(4,173)
Accumulated other comprehensive income
11,795
3,691
TOTAL STOCKHOLDERS' EQUITY
299,756
244,452
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY
$
2,239,100
$
1,654,145
The accompanying notes are an integral part of the consolidated financial statements.
Consolidated Statements of Income
Years Ended December 31,
(In Thousands Except Per Share Data)
INTEREST INCOME
Interest and fees on loans:
Taxable
$
67,384
$
53,086
Tax-exempt
1,768
2,104
Interest on mortgages held for sale
Interest on balances with depository institutions
Income from available-for-sale debt securities:
Taxable
5,534
7,008
Tax-exempt
2,143
2,014
Dividends on marketable equity security
Total interest and dividend income
77,160
64,771
INTEREST EXPENSE
Interest on deposits
7,231
8,190
Interest on short-term borrowings
Interest on long-term borrowings
1,291
1,013
Interest on subordinated debt
Total interest expense
9,595
10,283
Net interest income
67,565
54,488
Provision for loan losses
3,913
Net interest income after provision for loan losses
63,652
53,639
NONINTEREST INCOME
Trust and financial management revenue
6,321
6,106
Brokerage revenue
1,343
1,266
Insurance commissions, fees and premiums
Service charges on deposit accounts
4,231
5,358
Service charges and fees
Interchange revenue from debit card transactions
3,094
2,754
Net gains from sale of loans
5,403
Loan servicing fees, net
(61)
Increase in cash surrender value of life insurance
Other noninterest income
3,010
1,875
Sub-total
24,344
19,284
Realized gains on available-for-sale debt securities, net
Total noninterest income
24,513
19,307
NONINTEREST EXPENSE
Salaries and wages
25,599
20,644
Pensions and other employee benefits
7,463
5,837
Occupancy expense, net
3,010
2,629
Furniture and equipment expense
1,451
1,289
Data processing expenses
4,453
3,403
Automated teller machine and interchange expense
1,231
1,103
Pennsylvania shares tax
1,689
1,380
Professional fees
1,692
1,069
Telecommunications
Directors' fees
Loss on prepayment of borrowings
1,636
Merger-related expenses
7,708
4,099
Other noninterest expense
7,428
6,667
Total noninterest expense
64,953
49,537
Income before income tax provision
23,212
23,409
Income tax provision
3,990
3,905
NET INCOME
$
19,222
$
19,504
EARNINGS PER COMMON SHARE - BASIC
$
1.30
$
1.46
EARNINGS PER COMMON SHARE - DILUTED
$
1.30
$
1.46
The accompanying notes are an integral part of consolidated financial statements.
Consolidated Statements of Comprehensive Income
Years Ended December 31,
(In Thousands)
Net income
$
19,222
$
19,504
Unrealized gains on available-for-sale debt securities:
Unrealized holding gains on available-for-sale debt securities
10,504
9,920
Reclassification adjustment for gains realized in income
(169)
(23)
Other comprehensive income on available-for-sale debt securities
10,335
9,897
Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses
(49)
Amortization of prior service cost and net actuarial loss included in net periodic benefit cost
(29)
(32)
Other comprehensive (loss) income on unfunded retirement obligations
(78)
Other comprehensive income before income tax
10,257
9,952
Income tax related to other comprehensive income
(2,153)
(2,091)
Net other comprehensive income
8,104
7,861
Comprehensive income
$
27,326
$
27,365
The accompanying notes are an integral part of the consolidated financial statements.
Consolidated Statements of Changes in Stockholders’ Equity
(In Thousands Except Share and Per Share Data)
Accumulated
Other
Common
Treasury
Common
Paid-in
Retained
Comprehensive
Treasury
Shares
Shares
Stock
Capital
Earnings
(Loss) Income
Stock
Total
Balance, January 1, 2019
12,655,171
335,841
$
12,655
$
72,602
$
122,643
$
(4,170)
$
(6,362)
$
197,368
Net income
19,504
19,504
Other comprehensive income, net
7,861
7,861
Cash dividends declared on common stock, $1.18 per share
(15,667)
(15,667)
Shares issued for dividend reinvestment plan
(62,232)
1,187
1,626
Shares issued from treasury and redeemed related to exercise of stock options
(18,071)
(146)
Restricted stock granted
(48,137)
(918)
Forfeiture of restricted stock
3,758
(71)
Stock-based compensation expense
Purchase of restricted stock for tax withholding
7,392
(189)
(189)
Shares issued for acquisition of Monument Bancorp, Inc., net of equity issuance costs
1,279,825
1,280
31,673
32,953
Balance, December 31, 2019
13,934,996
218,551
13,935
104,519
126,480
3,691
(4,173)
244,452
Net income
19,222
19,222
Other comprehensive income, net
8,104
8,104
Cash dividends declared on common stock, $1.08 per share
(15,999)
(15,999)
Shares issued for dividend reinvestment plan
(77,525)
1,496
1,530
Shares issued from treasury and redeemed related to exercise of stock options
(10,407)
(70)
Restricted stock granted
(70,940)
(1,370)
1,370
Forfeiture of restricted stock
5,290
(100)
Stock-based compensation expense
1,050
1,050
Purchase of restricted stock for tax withholding
5,862
(163)
(163)
Shares issued for acquisition of Covenant Financial, Inc., net of equity issuance costs
2,047,819
2,048
39,381
41,429
Balance, December 31, 2020
15,982,815
70,831
$
15,983
$
143,644
$
129,703
$
11,795
$
(1,369)
$
299,756
The accompanying notes are an integral part of the consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income
$
19,222
$
19,504
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses
3,913
Loss on prepayment of borrowings
1,636
Realized gains on available-for-sale debt securities, net
(169)
(23)
Net amortization of securities
1,570
1,341
Increase in cash surrender value of life insurance
(515)
(402)
Depreciation and amortization of bank premises and equipment
1,981
1,749
Net accretion of purchase accounting adjustments
(2,524)
(375)
Stock-based compensation
1,050
Deferred income taxes
(361)
Decrease in fair value of servicing rights
Gains on sales of loans, net
(5,403)
(924)
Origination of loans held for sale
(158,909)
(29,978)
Proceeds from sales of loans held for sale
163,149
30,144
(Increase) decrease in accrued interest receivable and other assets
(2,645)
1,188
Increase (decrease) in accrued interest payable and other liabilities
2,473
(2,068)
Other
(260)
Net Cash Provided by Operating Activities
24,784
22,461
CASH FLOWS FROM INVESTING ACTIVITIES:
Net cash and cash equivalents provided by (used in) business combination
75,955
(1,778)
Proceeds from maturities of certificates of deposit
Purchase of certificates of deposit
(2,500)
Proceeds from sales of available-for-sale debt securities
28,941
96,148
Proceeds from calls and maturities of available-for-sale debt securities
94,486
81,204
Purchase of available-for-sale debt securities
(105,354)
(57,655)
Redemption of Federal Home Loan Bank of Pittsburgh stock
8,496
10,137
Purchase of Federal Home Loan Bank of Pittsburgh stock
(5,146)
(9,208)
Net decrease (increase) in loans
1,564
(96,628)
Proceeds from bank owned life insurance
Purchase of premises and equipment
(3,137)
(2,870)
Proceeds from sale of foreclosed assets
2,262
1,768
Other
Net Cash Provided by Investing Activities
96,580
22,668
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits
86,941
(4,822)
Net decrease in short-term borrowings
(99,969)
(38,307)
Proceeds from long-term borrowings
25,891
48,500
Repayments of long-term borrowings and subordinated debt
(54,831)
(38,173)
Sale of treasury stock
Purchase of vested restricted stock for tax withholding
(163)
(189)
Common dividends paid
(14,469)
(14,041)
Net Cash Used in Financing Activities
(56,469)
(46,834)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
64,895
(1,705)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR
31,122
32,827
CASH AND CASH EQUIVALENTS, END OF YEAR
$
96,017
$
31,122
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Right-of-use assets recognized at adoption of ASU 2016-02
$
$
1,132
Leased assets obtained in exchange for new operating lease liabilities
$
$
Accrued purchase of available-for-sale securities
$
$
Accrued income from life insurance claim
$
$
Assets acquired through foreclosure of real estate loans
$
$
2,053
Interest paid
$
10,742
$
9,601
Income taxes paid
$
3,137
$
3,234
The accompanying notes are an integral part of the consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF CONSOLIDATION - 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”), as well as C&N Bank’s wholly-owned subsidiaries, C&N Financial Services Corporation and Northern Tier Holding LLC. C&N Bank is the sole member of Northern Tier Holding LLC. All material intercompany balances and transactions have been eliminated in consolidation.
NATURE OF OPERATIONS - The Corporation provides banking and related services to individual and corporate customers. Lending products include commercial, mortgage and consumer loans, as well as specialized instruments such as commercial letters-of-credit. Deposit products include various types of checking accounts, passbook and statement savings, money market accounts, interest checking accounts, Individual Retirement Accounts and certificates of deposit. As discussed further in Note 3, in 2020 the Corporation expanded its presence in Southeastern Pennsylvania by acquiring Covenant Financial, Inc. (“Covenant”). The Covenant acquisitions follows the acquisition of Monument Bancorp, Inc. (“Monument”) in 2019, as well as the opening of a lending office in York, Pennsylvania which is located in southcentral Pennsylvania.
The Corporation provides wealth management services through its trust department, including administration of trusts and estates, retirement plans, and other employee benefit plans, and investment management services. The Corporation offers a variety of personal and commercial insurance products through C&N Financial Services Corporation. C&N Financial Services Corporation also offers mutual funds, annuities, educational savings accounts and other investment products through registered agents.
Management has determined that the Corporation has one reportable segment, “Community Banking.” All of the Corporation’s activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Corporation supports the others.
The Corporation is subject to competition from other financial institutions. It is also subject to regulation by certain federal and state agencies and undergoes periodic examination by those regulatory authorities. As a consequence, the Corporation’s business is particularly susceptible to being affected by future federal and state legislation and regulations.
USE OF ESTIMATES - The financial information is presented in accordance with generally accepted accounting principles and general practice for financial institutions in the United States of America (“U.S. GAAP”). In preparing financial statements, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements. In addition, these estimates and assumptions affect revenues and expenses in the financial statements and as such, actual results could differ from those estimates.
Material estimates that are particularly susceptible to change include: (1) the allowance for loan losses, (2) fair values of debt securities based on estimates from independent valuation services or from brokers and (3) assessment of goodwill for possible impairment.
INVESTMENT SECURITIES - Investment securities are accounted for as follows:
Available-for-sale debt securities - includes debt securities not classified as held-to-maturity or trading. Such securities are reported at fair value, with unrealized gains and losses excluded from earnings and reported separately through accumulated other comprehensive income (loss), net of tax. Premiums on non-amortizing available-for-sale debt securities are amortized using the level yield method to the earliest call date, while discounts on non-amortizing securities are amortized to the maturity date. Premiums and discounts on amortizing securities (mortgage-backed securities) are amortized using the level yield method over the remaining contractual life of the securities, adjusted for actual prepayments. Realized gains and losses on sales of available-for-sale securities are computed on the basis of specific identification of the adjusted cost of each security. Securities within the available-for-sale portfolio may be used as part of the Corporation’s asset and liability management strategy and may be sold in response to changes in interest rate risk, prepayment risk or other factors.
Other-than-temporary impairment - Credit-related declines in the fair value of available-for-sale debt securities that are deemed to be other-than-temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment (OTTI) losses,
management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value, and (4) whether the Corporation intends to sell the security or if it is more likely than not that the Corporation will be required to sell the security before the recovery of its amortized cost basis. The credit-related impairment is recognized in earnings and is the difference between a security’s amortized cost basis and the present value of expected future cash flows discounted at the security’s effective interest rate. For debt securities classified as held-to-maturity, if any, the amount of noncredit-related impairment is recognized in other comprehensive income and accreted over the remaining life of the debt security as an increase in the carrying value of the security.
Marketable equity security - The marketable equity security is carried at fair value with unrealized gains and losses included in other noninterest income in the consolidated statements of income.
Restricted equity securities - Restricted equity securities consist primarily of Federal Home Loan Bank of Pittsburgh stock, and are carried at cost and evaluated for impairment. Holdings of restricted equity securities are included in Other Assets in the consolidated balance sheets, and dividends received on restricted securities are included in Other Income in the consolidated statements of income.
DERIVATIVES - In connection with the acquisition of Covenant, the Corporation became a party to derivative financial instruments. These financial instruments consist of interest rate swap agreements which contain master netting and collateral provisions designed to protect the party at risk. Interest rate swaps with commercial 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 from Covenant (acquired by the Corporation) into fixed interest rate exposures. Those interest rate swaps have been simultaneously economically hedged by offsetting interest rate swaps that Covenant had in place with a third party (assumed by the Corporation), 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. Interest differentials paid or received under the swap agreements are reflected as adjustments to interest and fees on loans. The notional amounts of the interest rate swaps are not exchanged and do not represent exposure to credit loss. The fair value of interest rate derivatives is included in the balance of other assets and other liabilities in the consolidated balance sheets.
LOANS HELD FOR SALE - Mortgage loans held for sale are reported at the lower of cost or market, determined in the aggregate.
LOANS RECEIVABLE - Loans originated by the Corporation which management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at unpaid principal balances, less the allowance for loan losses and net deferred loan fees. Interest income is accrued on the unpaid principal balance. Loan origination and commitment fees, as well as certain direct origination costs, are deferred and amortized as a yield adjustment over the lives of the related loans using the interest method.
The loans receivable portfolio is segmented into residential mortgage, commercial and consumer loans. The residential mortgage segment includes the following classes: first and junior lien residential mortgages, home equity lines of credit and residential construction loans. The most significant classes of commercial loans are commercial loans secured by real estate, non-real estate secured commercial and industrial loans, loans to political subdivisions, commercial construction, multi-family residential and loans secured by farmland.
Loans are placed on nonaccrual status for all classes of loans when, in the opinion of management, collection of interest is doubtful. Any unpaid interest previously accrued on those loans is reversed from income. Interest income is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on loans for which the risk of further loss is greater than remote are applied as a reduction of the loan principal balance. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectability of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans receivable is determined based on contractual due dates for loan payments. Also, the amortization of deferred loan fees is discontinued when a loan is placed on nonaccrual status.
PURCHASED LOANS - The Corporation purchased loans in connection with its acquisition of Covenant in 2020 and Monument in 2019, some of which had, at the acquisition dates, shown evidence of credit deterioration since origination. The Corporation considers several factors as indicators that an acquired loan has evidence of deterioration in credit quality. These factors include loans 90 days or more past due, loans with an internal risk rating of substandard or below, loans classified as nonaccrual by the acquired institution and loans that have been previously modified in a troubled debt restructuring. The purchased loans that showed evidence of credit impairment were designated as the purchased credit impaired (“PCI”) loans and were recorded at fair value, with no carryover of the allowance for loan losses. The PCI loans acquired are secured by real estate and the fair value of each loan at the acquisition date was determined based on the estimated proceeds to be derived from selling the collateral, net of selling costs. The PCI loans were placed into nonaccrual status upon acquisition (and remained in nonaccrual status at December 31, 2020) as the Corporation cannot reasonably estimate cash flows expected to be collected in order to compute yield on the loans.
The excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable yield. The nonaccretable yield represents estimated future credit losses expected to be incurred over the life of the loan. Subsequent decreases to the expected cash flows require us to evaluate the need for an allowance for credit losses. Subsequent improvements in expected cash flows result in the reversal of a corresponding amount of the nonaccretable yield which we then reclassify as accretable yield that is recognized into interest income over the remaining life of the loan using the interest method. Our evaluation of the amount of future cash flows that we expect to collect is performed in a similar manner as that used to determine our allowance for credit losses. Charge-offs of the principal amount on acquired loans would be first applied to the nonaccretable yield portion of the fair value adjustment.
ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the collection of all, or part, of the principal balance is highly unlikely. Non-residential consumer loans are generally charged off no later than when they are 120 days past due on a contractual basis, or earlier in the event of bankruptcy or if there is an amount deemed uncollectible.
The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Corporation’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination. In the process of evaluating the loan portfolio, management also considers the Corporation’s exposure to losses from unfunded loan commitments. As of December 31, 2020 and 2019, management determined that no allowance for credit losses related to unfunded loan commitments was required.
The allowance consists primarily of two major components - (1) a specific component based on a detailed assessment of certain larger loan relationships, mainly commercial purpose, determined on a loan-by-loan basis; and (2) a general component for the remainder of the portfolio based on a collective evaluation of pools of loans with similar risk characteristics. The general component is assigned to each pool of loans based on both historical net charge-off experience, and an evaluation of certain qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the above methodologies for estimating specific and general losses in the portfolio.
The specific component relates to loans that are classified as impaired based on a detailed assessment of certain larger loan relationships evaluated by a management committee referred to as the Watch List Committee. Specific loan relationships are identified for evaluation based on the related credit risk rating. For individual loans classified as impaired, an allowance is established when the collateral value less estimated selling costs, present value of discounted cash flows or observable market price of the impaired loan is lower than the carrying value of that loan.
The scope of loans reviewed individually each quarter to determine if they are impaired include 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. Loans that are individually reviewed, but which are determined to not be impaired, are combined with all remaining loans that are not reviewed on a specific basis, and such loans are included within larger pools of loans based on similar risk and loss characteristics for purposes of determining the general component of the allowance. 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, are individually evaluated for impairment.
The general component covers pools of loans by loan class including commercial loans not considered individually impaired, as well as smaller balance homogeneous classes of loans, such as residential real estate, home equity lines of credit and other consumer loans. Accordingly, the Corporation generally does not separately identify individual consumer and residential loans for impairment disclosures, unless such a loan: (1) is subject to a restructuring agreement, (2) has an outstanding balance of $400,000 or more and a credit grade of Special Mention, Substandard or Doubtful, or (3) has an estimated loss of $100,000 or more. The pools of loans for each loan segment are evaluated for loss exposure based upon average historical net charge-off rates, adjusted for qualitative factors. The time period used in determining the average historical net charge-off rate for each loan class is based on management’s evaluation of an appropriate time period that captures an historical loss experience relevant to the current portfolio. Qualitative risk factors (described in the following paragraph) are evaluated for the impact on each of the three distinct segments (residential mortgage, commercial and consumer) within the loan portfolio. Each qualitative factor is assigned a value to reflect improving, stable or declining conditions based on management’s judgment using relevant information available at the time of the evaluation. Any adjustments to the factors are supported by a narrative documentation of changes in conditions accompanying the allowance for loan losses calculation.
The qualitative factors used in the general component calculations are designed to address credit risk characteristics associated with each segment. The Corporation’s credit risk associated with all of the segments is significantly impacted by these factors, which include economic conditions within its market area, the Corporation’s lending policies, changes or trends in the portfolio, risk profile, competition, regulatory requirements and other factors.
Purchased loans that did not show evidence of credit deterioration at the acquisition dates were initially recorded at fair value, including a discount for credit losses reflecting an estimate of the present value of credit losses based on market expectations. The general component of the allowance on purchased loans is evaluated separately from the rest of the portfolio. This evaluation includes consideration of the qualitative risk factors described above as well as the remaining purchased discount.
Loans are classified as impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of shortfall in relation to the principal and interest owed. Impairment is 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.
For commercial loans secured by real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property. 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.
For commercial and industrial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging data or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.
Loans whose terms are modified are classified as troubled debt restructurings if the Corporation grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a troubled debt restructuring generally involve reductions in required payments, an extension of a loan’s stated maturity date or a temporary reduction in interest rate. Loans classified as troubled debt restructurings are designated as impaired. Nonaccrual troubled debt restructurings may be restored to accrual status if the ultimate collectability of principal and interest payments under the modified terms is not in doubt, and there has been a period (generally, for at least six consecutive months) of satisfactory payment performance by the borrower either immediately before or after the restructuring.
In March 2020, various regulatory agencies, including the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by COVID-19. The interagency statement was effective immediately and impacted accounting for loan modifications. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs. Provisions of the CARES Act Section 4013 largely mirrored the provisions of the interagency statement, providing that modified loans were not to be considered TDRs if they were performing at December 31, 2019 and other consideration set forth in the interagency statements were met. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented or at December 31, 2019.
BANK PREMISES AND EQUIPMENT - Bank premises and equipment are stated at cost less accumulated depreciation. Repair and maintenance expenditures which extend the useful lives of assets are capitalized, and other repair and maintenance expenditures are expensed as incurred. Depreciation expense is computed using the straight-line method.
IMPAIRMENT OF LONG-LIVED ASSETS - The Corporation reviews long-lived assets, such as premises and equipment and intangibles, for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. These changes in circumstances may include a significant decrease in the market value of an asset or the manner in which an asset is used. If there is an indication the carrying value of an asset may not be recoverable, future undiscounted cash flows expected to result from use of the asset are estimated. If the sum of the expected cash flows is less than the carrying value of the asset, a loss is recognized for the difference between the carrying value and fair market value of the asset.
FORECLOSED ASSETS HELD FOR SALE - Foreclosed assets held for sale consist of real estate acquired by foreclosure and are initially recorded at fair value, less estimated selling costs.
GOODWILL - Goodwill represents the excess of the cost of acquisitions over the fair value of the net assets acquired. Goodwill is tested at least annually at December 31 for impairment, or more often if events or circumstances indicate there may be impairment. The Corporation has the option of performing a qualitative assessment to determine whether any further quantitative testing for impairment is necessary. The option of whether or not to perform a qualitative assessment is made annually.
CORE DEPOSIT INTANGIBLES - Amortization of core deposit intangibles is calculated using an accelerated method. In determining amortization using the accelerated method for any given period, the amount of expected cash flows for that period that were used in determining the acquisition-date fair value is divided by the total amount of expected cash flows over the life of the asset. That percentage is multiplied by the initial carrying amount of the asset to arrive at amortization expense for that period. If the Corporation’s cash flow patterns differ significantly from the initial estimates, the amortization schedule would be adjusted prospectively.
SERVICING RIGHTS - The estimated fair value of servicing rights related to mortgage loans sold and serviced by the Corporation is recorded as an asset upon the sale of such loans. The valuation of servicing rights is adjusted quarterly, with changes in fair value included in Loan Servicing Fees, Net, in the consolidated statements of income. Significant inputs to the valuation include expected net servicing income to be received, the expected life of the underlying loans and the discount rate. The servicing rights asset is included in Other Assets in the consolidated balance sheets.
INCOME TAXES - Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases given the provisions of the enacted tax laws. Deferred tax assets are reduced, if necessary, by the amount of such benefits that are not expected to be realized based upon
available evidence. Tax benefits from investments in limited partnerships that have qualified for federal low-income tax credits are recognized as a reduction in the provision for income tax over the term of the investment using the effective yield method. The Corporation includes income tax penalties in the provision for income tax. The Corporation has no accrued interest related to unrecognized tax benefits.
STOCK COMPENSATION PLANS - The Corporation’s stock-based compensation policy applies to all forms of stock-based compensation including stock options and restricted stock. All stock-based compensation is accounted for under the fair value method as required by U.S. GAAP. The expense associated with stock-based compensation is recognized over the vesting period of each individual arrangement.
The fair value of each stock option is estimated on the date of grant using the Black-Scholes-Merton option valuation model. The fair value of restricted stock is based on the current market price on the date of grant.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS - In the ordinary course of business, the Corporation has entered into off-balance sheet financial instruments consisting of commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they become payable.
CASH FLOWS - The Corporation utilizes the net reporting of cash receipts and cash payments for certain deposit and lending activities. Cash equivalents include federal funds sold and all cash and amounts due from depository institutions and interest-bearing deposits in other banks with original maturities of three months or less.
REVENUE RECOGNITION - The Corporation generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed; charged either on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in the determination of the amount and timing of revenue from contracts with customers.
Additional disclosures related to the Corporation’s largest sources of noninterest income within the consolidated statements of income from contracts with customers that are subject to Accounting Standards Codification (ASC) Topic 606 are as follows:
Trust and financial management revenue - C&N Bank’s trust department provides a wide range of financial services, including wealth management services for individuals, businesses and retirement funds, administration of 401(k) and other retirement plans, retirement planning, estate planning and estate settlement services. Trust clients are located primarily within the Corporation’s geographic markets. Assets held in a fiduciary capacity by C&N Bank are not the Corporation’s assets and are therefore not included in the consolidated balance sheets. The fair value of trust assets under management was approximately $1,103,228,000 at December 31, 2020 and $1,007,113,000 at December 31, 2019. Trust and financial management revenue is included within noninterest income in the consolidated statements of income.
Trust revenue is recorded on a cash basis, which is not materially different from the accrual basis. The majority (approximately 83%, based on annual 2020 results) of trust revenue is earned and collected monthly, with the amount determined based on a percentage of the fair value of the trust assets under management. Wealth management fees are contractually agreed with each customer, and fee levels vary based mainly on the size of assets under management. The services provided under such a contract represent a single performance obligation under the Accounting Standards Updates (ASUs) because it embodies a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer. None of the contracts with trust customers provide for incentive-based fees. In addition to wealth management fees, trust revenue includes fees for provision of services, including employee benefit plan administration, tax return preparation and estate planning and settlement. Fees for such services are billed based on contractual arrangements or established fee schedules and are typically billed upon completion of providing such services. The costs of acquiring trust customers are incremental and recognized within noninterest expense in the consolidated statements of income.
Service charges on deposit accounts - Deposits are included as liabilities in the consolidated balance sheets. Service charges on deposit accounts include: overdraft fees, which are charged when customers overdraw their accounts beyond available funds; automated teller machine (ATM) fees charged for withdrawals by deposit customers from other financial institutions’ ATMs; and a variety of other monthly or transactional fees for services provided to retail and business customers, mainly associated with checking accounts. All deposit liabilities are considered to have one-day terms and therefore related fees are recognized in income at the time when the
services are provided to the customers. Incremental costs of obtaining deposit contracts are not significant and are recognized as expense when incurred within noninterest expense in the consolidated statements of income.
Interchange revenue from debit card transactions - The Corporation issues debit cards to consumer and business customers with checking, savings or money market deposit accounts. Debit card and ATM transactions are processed via electronic systems that involve several parties. The Corporation’s debit card and ATM transaction processing is executed via contractual arrangements with payment processing networks, a processor and a settlement bank. As described above, all deposit liabilities are considered to have one-day terms and therefore interchange revenue from customers’ use of their debit cards to initiate transactions are recognized in income at the time when the services are provided and related fees received in the Corporation’s deposit account with the settlement bank. Incremental costs associated with ATM and interchange processing are recognized as expense when incurred within noninterest expense in the consolidated statements of income.
2. RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board (FASB) issues ASUs to the FASB 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 financial statements issued in the foreseeable future.
Recent Accounting Pronouncements - Adopted
Effective January 1, 2020, the Corporation adopted ASU 2018-13, Fair Value Measurement (Topic 820), which modifies disclosure requirements on fair value measurements. This ASU removes requirements to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for timing of transfers between levels and the valuation processes for Level 3 fair value measurements. ASU 2018-13 clarifies that disclosure regarding measurement uncertainty is intended to communicate information about the uncertainty in measurement as of the reporting date. ASU 2018-13 adds certain disclosure requirements, including disclosure of changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty should be applied prospectively, while all other amendments should be applied retrospectively for all periods presented. Note 22 provides disclosure regarding fair value measurements of the Corporation’s financial instruments. Adoption of this ASU did not have a material impact on the Corporation’s consolidated financial position or results of operations.
Recently Issued But Not Yet Effective Accounting Pronouncements
ASU 2016-13, Financial Instruments-Credit Losses (Topic 326), as modified by subsequent ASUs, changes accounting for credit losses on loans receivable and debt securities from an incurred loss methodology to an expected credit loss methodology. Among other things, ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Accordingly, ASU 2016-13 requires the use of forward-looking information to form credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, though the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, ASU 2016-13 amends the accounting for credit losses on debt securities and purchased financial assets with credit deterioration. The effect of implementing this ASU is recorded through a cumulative-effect adjustment to retained earnings. The Corporation has formed a cross functional management team and is working with an outside vendor assessing alternative loss estimation methodologies and the Corporation’s data and system needs to evaluate the impact that adoption of this standard will have on the Corporation’s financial condition and results of operations. In November 2019, the FASB approved a delay of the required implementation date of ASU 2016-13 for smaller reporting companies, including the Corporation, resulting in a required implementation date for the Corporation of January 1, 2023.
ASU 2020-04, Reference Rate Reform (Topic 848) provides temporary optional guidance to ease the potential burden in accounting for reference rate reform. The amendments in Update 2020-04 are elective and apply to all entities that have contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued. The guidance includes a general principle that permits an entity to consider contract modifications due to reference rate reform to be an event that does not require
contract remeasurement at the modification date or reassessment of a previous accounting determination. Some specific optional expedients are as follows:
● Simplifies accounting for contract modifications, including modifications to loans receivable and debt, by prospectively adjusting the effective interest rate.
● Simplifies the assessment of hedge effectiveness and allows hedging relationships affected by reference rate reform to continue.
The amendments in ASU 2020-04 are effective as of March 12, 2020 through December 31, 2022. The Corporation expects to apply the amendments prospectively for applicable loan and other contracts within the effective period of ASU 2020-04.
3. BUSINESS COMBINATIONS
Acquisition of Covenant Financial, Inc.
On July 1, 2020, the Corporation completed its acquisition of Covenant Financial, Inc. (“Covenant”). Covenant was the holding company for Covenant Bank, which operated banking offices in Bucks and Chester Counties of Pennsylvania. Management believes the acquisition provides an opportunity to expand the Corporation’s presence in a higher growth market and further leverage the Corporation’s capital to enhance long-term shareholder value.
The consolidated financial statements include the formerly separate Covenant operations from July 1, 2020 through December 31, 2020. Since the activities of the former Covenant operations have been combined with those of the Corporation, separate disclosure of Covenant-related financial information included in the consolidated financial statements is not practicable.
Total purchase consideration was $63,266,000, including cash paid to former Covenant shareholders totaling $21,654,000 and 2,047,819 shares of Corporation common stock issued with a value of $41,612,000. In the table below, the cash portion of merger consideration includes $183,000 of costs directly related to issuance of stock, and the equity portion of merger consideration has been reduced by these costs.
The merger was accounted for using the acquisition method of accounting and, accordingly, purchased assets, including identifiable intangible assets, and assumed liabilities were recorded at their respective acquisition date fair values. The fair value measurements of assets acquired and liabilities assumed are subject to refinement for up to one year after the closing date of the acquisition as additional information relative to closing date fair values becomes available.
As adjusted in the fourth quarter 2020, the fair value of assets acquired, excluding goodwill, totaled $608,485,000, while the fair value of liabilities assumed totaled $569,336,000. Goodwill represents consideration transferred in excess of the fair value of the net assets acquired. At December 31, 2020, goodwill associated with the acquisition was $24,117,000. The goodwill resulting from the acquisition represents the value expected from the further expansion of the Corporation’s market penetration into Southeastern Pennsylvania, adding to the base established in the acquisition of Monument Bancorp, Inc. in 2019. Goodwill acquired in the Covenant merger is not deductible for tax purposes as the acquisition is accounted for as a tax-free exchange for tax purposes.
In the fourth quarter 2020, the Corporation recorded adjustments to the initial fair value measurements of certain assets and liabilities that resulted in a net decrease in goodwill of $21,000, summarized as follows:
(In Thousands)
Preliminary goodwill balance, September 30, 2020
$
24,138
Adjustments in fourth quarter 2020:
Write-down purchased credit impaired loan
Increase deferred tax asset, net
(410)
Decrease other liabilities
(167)
Goodwill balance, December 31, 2020
$
24,117
The following table summarizes the consideration paid for Covenant and the estimated fair values of the assets acquired and liabilities assumed at the acquisition date:
(In Thousands)
Fair value of consideration transferred:
Cash
$
21,837
Common stock issued
41,429
Total consideration transferred
$
63,266
Estimated fair value of assets acquired and (liabilities) assumed:
Cash and cash equivalents
$
97,792
Available-for-sale debt securities
10,754
Loans receivable
464,236
Bank-owned life insurance
11,170
Accrued interest receivable
1,922
Bank premises and equipment
3,250
Foreclosed assets held for sale
Deferred tax asset, net
1,879
Core deposit intangible
3,144
Goodwill
24,117
Other assets
13,478
Deposits
(481,796)
Short-term borrowings
(33,950)
Long-term borrowings
(30,025)
Subordinated debt
(10,091)
Accrued interest and other liabilities
(13,474)
Estimated excess fair value of assets acquired over liabilities assumed
$
63,266
In the consolidated statements of cash flows, investing and financing activities exclude the following noncash items: the issuance of common stock as part of the merger consideration as well as the following categories of assets acquired and liabilities assumed from Covenant as reflected in the table above: available-for-sale debt securities, loans receivable, bank-owned life insurance, bank premises and equipment, foreclosed assets held for sale, core deposit intangible, goodwill, other assets (including Federal Home Loan Bank of Pittsburgh stock of $2,939,000), deposits, short-term borrowings, long-term borrowings, subordinated debt and accrued interest and other liabilities.
Acquisition date fair values for available-for-sale securities were determined using Level 1 inputs consistent with the methods discussed further in Note 22.
The determination of estimated fair values of the acquired loans required the Corporation to make certain estimates about discount rates, future expected cash flows, market conditions and other future events that are highly subjective in nature. Based on such factors as past due status, nonaccrual status, bankruptcy status, and credit risk ratings, the acquired loans were evaluated, and twenty-four loans displayed evidence of credit quality deterioration. These loans are accounted for under ASC 310-30 (purchased credit impaired, or “PCI”). The majority of the purchased loans did not display evidence of impairment, and thus are accounted for under ASC 310-20. Expected cash flows, both principal and interest, were estimated based on key assumptions covering such factors as prepayments, default rates and severity of loss given default. These assumptions were developed using both Covenant’s historical experience and the portfolio characteristics as of the acquisition date as well as available market research. The fair value estimates for acquired loans were based on the amount and timing of expected principal, interest and other cash flows, including expected prepayments, discounted at prevailing market interest rates applicable to the types of acquired loans, which the Corporation considers Level 3 fair value measurements.
Loans acquired from Covenant were measured at fair value at the acquisition date with no carryover of an allowance for loan losses. The following table presents performing and PCI loans acquired, by loan segment and class, as adjusted, at July 1, 2020:
(In Thousands)
Performing
PCI
Total
Residential mortgage:
Residential mortgage loans - first liens
$
65,883
$
$
65,883
Residential mortgage loans - junior liens
4,141
4,216
Home equity lines of credit
8,368
8,368
1-4 Family residential construction
11,437
11,437
Total residential mortgage
89,829
89,904
Commercial:
Commercial loans secured by real estate
240,482
4,152
244,634
Commercial and industrial
39,068
39,874
Commercial construction and land
63,740
63,740
Loans secured by farmland
Multi-family (5 or more) residential
23,065
1,615
24,680
Other commercial loans
Total commercial
367,380
6,573
373,953
Consumer
Total
$
457,588
$
6,648
$
464,236
The following table presents the updated fair value adjustments made to the amortized cost basis of loans acquired on July 1, 2020:
(In Thousands)
Gross amortized cost at acquisition
$
472,012
Fair value adjustments:
Market rates
2,909
Credit adjustment on non-impaired loans
(7,219)
Credit adjustment on impaired loans
(3,466)
Fair value at acquisition
$
464,236
The market rate adjustment represents the movement in interest rates, irrespective of credit adjustments, compared to the contractual rates of the acquired loans. The credit adjustment made on non-PCI loans represents changes in credit quality of the underlying borrowers from loan inception to the acquisition date.
The credit adjustment on PCI loans is derived in accordance with ASC 310-30 and represents the portion of the loan balances that have been deemed uncollectible for each loan. The PCI loans are secured by real estate or other collateral, and the fair value of each loan was determined based on the estimated proceeds to be derived from selling the collateral, net of selling costs. The PCI loans were placed into nonaccrual status upon acquisition (and remained in nonaccrual status at December 31, 2020) as the Corporation cannot reasonably estimate cash flows expected to be collected in order to compute yield on the loans.
The Corporation recognized a core deposit intangible of $3,144,000. The core deposit intangible represents the estimated value of lower-cost funding provided by the nonmaturity deposits assumed in comparison with the Corporation’s estimated cost of borrowing funds in the market. The valuation assumptions to determine the core deposit intangible were comprised of level 2 and level 3 inputs. The core deposit intangible will be amortized over a weighted-average life of 5.4 years.
Deposit liabilities assumed were segregated into two categories: (1) nonmaturity deposits (checking, savings and money market), and (2) time deposits (deposit accounts with a stated maturity). The fair values of both categories of deposits were determined using level 2 fair value measurements. For nonmaturity deposits, the acquisition date outstanding balance of the assumed demand deposit accounts approximates fair value. In determining the fair value of time deposits, the Corporation discounted the contractual cash flows of the deposit accounts using prevailing market interest rates for time deposit accounts of similar type and duration.
Short-term and long-term borrowings assumed consisted of advances from the Federal Home Loan Bank of Pittsburgh. The fair value of borrowings was determined using Level 2 measurements by discounting the contractual cash flows of the borrowings using Federal Home Loan Bank interest rates available July 1, 2020 for advances to the same maturities as those of the deposits assumed.
Subordinated debt assumed included two issues: (1) agreements with par values totaling $8,000,000, maturing in June 2026, redeemable at par beginning in June 2021 and bearing interest at 6.25%; and (2) an agreement with a par value of $2,000,000, maturing in July 2027, redeemable at par beginning in July 2022 and bearing interest at 6.50%. The fair value of subordinated debt was determined using Level 2 measurements by comparing the interest rates on the debt to the rates on similar recent issues of comparable size by other similar-sized banking companies.
The Corporation incurred merger-related expenses associated with the Covenant transaction of $7,708,000 in 2020 and $287,000 in 2019. Merger-related expenses include severance and similar expenses, costs associated with termination of data processing contracts and conversion of Covenant’s customer accounting data into the Corporation’s core system, legal and other professional fees and various other costs.
The following table presents pro forma information as if the merger between the Corporation and Covenant had been completed on January 1, 2019. The pro forma information does not necessarily reflect the results of operations that would have occurred had the merger taken place at the beginning of 2019. The supplemental pro forma information excludes merger-related expenses totaling $9,061,000 in 2020 (including $1,353,000 incurred by Covenant), or $7,245,000 net of tax (including $1,111,000 incurred by Covenant). The pro forma also excludes a tax benefit of $600,000 that Covenant realized from stock-based compensation vested upon completion of the merger. The pro forma information does not include the impact of possible business model changes nor does it consider any potential impacts of current market conditions or revenues, expense efficiencies or other factors.
Year Ended
Dec. 31,
Dec. 31,
(In Thousands Except Per Share Data)
Interest income
$
88,379
$
88,830
Interest expense
13,407
15,156
Net interest income
74,972
73,674
Provision for loan losses
4,013
1,309
Net interest income after provision for loan losses
70,959
72,365
Noninterest income
24,657
20,550
Net gains on securities
Loss on prepayment of borrowings
1,636
Other noninterest expenses
60,094
62,377
Income before income tax provision
34,055
30,561
Income tax provision
6,227
5,311
Net income
$
27,828
$
25,250
Earnings per common share - basic
$
1.75
$
1.64
Earnings per common share - diluted
$
1.75
$
1.63
Business Combination - Acquisition of Monument Bancorp, Inc.
On April 1, 2019, the Corporation completed its acquisition of 100% of the common stock of Monument Bancorp, Inc. (“Monument”). Monument was the parent company of Monument Bank, a commercial bank which operated two community bank offices and one lending office in Bucks County, Pennsylvania. Pursuant to the merger, Monument was merged into Citizens & Northern Corporation and Monument Bank was merged into C&N Bank.
Total purchase consideration was $42.7 million, including cash paid to former Monument shareholders totaling $9.6 million and 1,279,825 shares of Corporation common stock issued with a value of $33.1 million, net of costs directly related to stock issuance of $181,000.
In connection with the transaction, the Corporation recorded goodwill of $16.4 million and a core deposit intangible asset of $1.5 million. Total loans acquired on April 1, 2019 were valued at $259.3 million, while total deposits assumed were valued at $223.3 million, borrowings were valued at $111.6 million and subordinated debt was valued at $12.4 million. The subordinated debt included an instrument with a fair value of $5.4 million that was redeemed on April 1, 2019 with no realized gain or loss. The Corporation acquired available-for-sale debt securities valued at $94.6 million and sold the securities in early April for approximately no realized gain or loss. The assets purchased and liabilities assumed in the merger were recorded at their estimated fair values at the time of closing, subject to refinement for up to one year after the closing date. There were no adjustments to the fair value measurements of assets or liabilities in 2020.
Merger-related expenses associated with the Monument acquisition, including legal and professional expenses and conversion of Monument’s customer accounting data into the Corporation’s core system, were $3,812,000 in 2019.
4. 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)
Years Ended
December 31,
December 31,
Basic
Net income
$
19,222
$
19,504
Less: Dividends and undistributed earnings allocated to participating securities
(116)
(100)
Net income attributable to common shares
$
19,106
$
19,404
Basic weighted-average common shares outstanding
14,743,386
13,298,736
Basic earnings per common share (a)
$
1.30
$
1.46
Diluted
Net income attributable to common shares
$
19,106
$
19,404
Basic weighted-average common shares outstanding
14,743,386
13,298,736
Dilutive effect of potential common stock arising from stock options
3,662
22,823
Diluted weighted-average common shares outstanding
14,747,048
13,321,559
Diluted earnings per common share (a)
$
1.30
$
1.46
(a) Basic and diluted earnings per share under the two-class method are determined on net income reported on the income statement less earnings allocated to nonvested restricted shares with nonforfeitable dividends (participating securities).
The weighted-average number of nonvested restricted shares outstanding was 89,718 shares in 2020 and 68,358 shares in 2019.
Anti-dilutive stock options are excluded from net income per share calculations. Weighted-average common shares available from anti-dilutive instruments totaled 32,538 shares in 2020. There were no anti-dilutive instruments in 2019.
5. COMPREHENSIVE INCOME
Comprehensive income 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:
(In Thousands)
Before-Tax
Income Tax
Net-of-Tax
Amount
Effect
Amount
Unrealized gains on available-for-sale debt securities:
Unrealized holding gains on available-for-sale debt securities
$
10,504
$
(2,205)
$
8,299
Reclassification adjustment for (gains) realized in income
(169)
(134)
Other comprehensive income on available-for-sale debt securities
10,335
(2,170)
8,165
Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses included in other comprehensive income
(49)
(38)
Amortization of prior service cost and net actuarial loss included in net periodic benefit cost
(29)
(23)
Other comprehensive loss on unfunded retirement obligations
(78)
(61)
Total other comprehensive income
$
10,257
$
(2,153)
$
8,104
(In Thousands)
Before-Tax
Income Tax
Net-of-Tax
Amount
Effect
Amount
Unrealized gains on available-for-sale debt securities:
Unrealized holding gains on available-for-sale debt securities
$
9,920
$
(2,084)
$
7,836
Reclassification adjustment for (gains) realized in income
(23)
(18)
Other comprehensive income on available-for-sale debt securities
$
9,897
$
(2,079)
$
7,818
Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses included in other comprehensive income
(19)
Amortization of prior service cost and net actuarial loss included in net periodic benefit cost
(32)
(25)
Other comprehensive income on unfunded retirement obligations
(12)
Total other comprehensive income
$
9,952
$
(2,091)
$
7,861
Items reclassified out of each component of accumulated other comprehensive income (loss) are as follows:
Affected Line Item in the
Description
Consolidated Statements of Income
Amortization of prior service cost and net actuarial loss included in net periodic benefit cost (before-tax)
Other noninterest expense
Reclassification adjustment for (gains) realized in income (before-tax)
Realized gains on available-for-sale debt securities, net
Income tax effect
Income tax provision
Changes in the components of accumulated other comprehensive income (loss), included in stockholders’ equity, are as follows:
(In Thousands)
Unrealized
Accumulated
Gains
Unfunded
Other
(Losses)
Retirement
Comprehensive
on Securities
Obligations
Income (Loss)
Balance, beginning of period
$
3,511
$
$
3,691
Other comprehensive income (loss) during year ended December 31, 2020
8,165
(61)
8,104
Balance, end of period
$
11,676
$
$
11,795
Balance, beginning of period
$
(4,307)
$
$
(4,170)
Other comprehensive income during year ended December 31, 2019
7,818
7,861
Balance, end of period
$
3,511
$
$
3,691
6. CASH AND DUE FROM BANKS
Cash and due from banks at December 31, 2020 and 2019 include the following:
(In Thousands)
December 31,
December 31,
Cash and cash equivalents
$
96,017
$
31,122
Certificates of deposit
5,840
4,080
Total cash and due from banks
$
101,857
$
35,202
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.
Historically, C&N Bank has been required to maintain reserves against deposit liabilities in the form of cash and balances with the Federal Reserve Bank of Philadelphia. The reserves are based on deposit levels, account activity, and other services provided by the Federal Reserve Bank. In March 2020, the Federal Reserve Board reduced reserve requirements for U.S. banks to 0%. Accordingly, C&N Bank had no required reserves at December 31, 2020 and $20,148,000 at December 31, 2019.
7. SECURITIES
Amortized cost and fair value of available-for-sale debt securities at December 31, 2020 and 2019 are summarized as follows:
(In Thousands)
December 31, 2020
Gross
Gross
Unrealized
Unrealized
Amortized
Holding
Holding
Fair
Cost
Gains
Losses
Value
Obligations of the U.S. Treasury
$
12,184
$
$
(2)
$
12,182
Obligations of U.S. Government agencies
25,349
1,003
(8)
26,344
Obligations of states and political subdivisions:
Tax-exempt
116,427
6,000
(26)
122,401
Taxable
45,230
2,246
(24)
47,452
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities
36,853
1,323
38,176
Residential collateralized mortgage obligations
56,048
1,428
(9)
57,467
Commercial mortgage-backed securities
42,461
2,849
45,310
Total available-for-sale debt securities
$
334,552
$
14,849
$
(69)
$
349,332
(In Thousands)
December 31, 2019
Gross
Gross
Unrealized
Unrealized
Amortized
Holding
Holding
Fair
Cost
Gains
Losses
Value
Obligations of U.S. Government agencies
$
16,380
$
$
$
17,000
Obligations of states and political subdivisions:
Tax-exempt
68,787
2,011
(38)
70,760
Taxable
35,446
(70)
36,303
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities
58,875
(137)
59,210
Residential collateralized mortgage obligations
115,025
(610)
114,723
Commercial mortgage-backed securities
47,765
1,069
(107)
48,727
Total available-for-sale debt securities
$
342,278
$
5,407
$
(962)
$
346,723
The following table presents gross unrealized losses and fair value of available-for-sale debt securities with unrealized loss positions that are not deemed to be other-than-temporarily impaired, aggregated by length of time that individual securities have been in a continuous unrealized loss position at December 31, 2020 and 2019:
December 31, 2020
Less Than 12 Months
12 Months or More
Total
(In Thousands)
Fair
Unrealized
Fair
Unrealized
Fair
Unrealized
Value
Losses
Value
Losses
Value
Losses
Obligations of the U.S. Treasury
$
9,159
$
(2)
$
$
$
9,159
$
(2)
Obligations of U.S. Government agencies
4,992
(8)
4,992
(8)
Obligations of states and political subdivisions:
Tax-exempt
3,811
(26)
3,811
(26)
Taxable
5,235
(24)
5,235
(24)
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies,
Residential collateralized mortgage obligations
2,861
(9)
2,861
(9)
Total temporarily impaired available for sale debt securities
$
26,058
$
(69)
$
$
$
26,058
$
(69)
December 31, 2019
Less Than 12 Months
12 Months or More
Total
(In Thousands)
Fair
Unrealized
Fair
Unrealized
Fair
Unrealized
Value
Losses
Value
Losses
Value
Losses
Obligations of states and political subdivisions:
Tax-exempt
$
6,429
$
(38)
$
$
$
6,429
$
(38)
Taxable
5,624
(68)
(2)
5,785
(70)
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities
9,771
(35)
14,787
(102)
24,558
(137)
Residential collateralized mortgage obligations
31,409
(195)
30,535
(415)
61,944
(610)
Commercial mortgage-backed securities
8,507
(107)
8,507
(107)
Total temporarily impaired available-for-sale debt securities
$
53,233
$
(336)
$
53,990
$
(626)
$
107,223
$
(962)
Gross realized gains and losses from available-for-sale securities and the related income tax provision were as follows:
(In Thousands)
Gross realized gains from sales
$
$
Gross realized losses from sales
(53)
(1)
Net realized gains
$
$
Income tax provision related to 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 December 31, 2020. 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.
(In Thousands)
December 31, 2020
Amortized
Fair
Cost
Value
Due in one year or less
$
13,409
$
13,506
Due from one year through five years
46,172
47,758
Due from five years through ten years
47,535
50,110
Due after ten years
92,074
97,005
Sub-total
199,190
208,379
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities
36,853
38,176
Residential collateralized mortgage obligations
56,048
57,467
Commercial mortgage-backed securities
42,461
45,310
Total
$
334,552
$
349,332
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.
Investment securities carried at $247,373,000 at December 31, 2020 and $215,270,000 at December 31, 2019 were pledged as collateral for public deposits, trusts and certain other deposits as provided by law. See Note 12 for information concerning securities pledged to secure borrowing arrangements and Note 21 for information related to securities pledged against interest rate swap obligations.
Management evaluates securities for OTTI at least on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether the Corporation intends to sell the security or more likely than not will be required to sell the security before its anticipated recovery.
A summary of information management considered in evaluating debt and equity securities for OTTI at December 31, 2020 and 2019 is provided below.
Debt Securities
At December 31, 2020 and 2019, management performed an assessment for possible OTTI 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. The extent of individual analysis applied to each security depended on the size of the Corporation’s investment, as well as management’s perception of the credit risk associated with each security. Based on the results of the assessment, management believes impairment of these debt securities at December 31, 2020 and 2019 to be temporary.
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 $9,720,000 at December 31, 2020 and $10,131,000 at December 31, 2019. The Corporation evaluated its holding of FHLB-Pittsburgh stock for impairment and deemed the stock to not be impaired at December 31, 2020 and December 31, 2019. 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.
The Corporation’s marketable equity security, with a carrying value of $1,000,000 at December 31, 2020 and $979,000 at December 31, 2019, consisted exclusively of one mutual fund. There was no unrealized gain/loss on the mutual fund at December 31, 2020 and an unrealized loss of $21,000 at December 31, 2019. The decrease in the unrealized loss of $21,000 in 2020 and the decrease in the unrealized loss of $29,000 in 2019 are included in other noninterest income in the consolidated statements of income. There were no sales of equity securities in 2020 and 2019.
8. LOANS
The loans receivable portfolio is segmented into residential mortgage, commercial and consumer loans. Loans outstanding at December 31, 2020 and December 31, 2019 are summarized by segment, and by classes within each segment, as follows:
Summary of Loans by Type
(In Thousands)
Dec. 31,
Dec. 31,
Residential mortgage:
Residential mortgage loans - first liens
$
532,947
$
510,641
Residential mortgage loans - junior liens
27,311
27,503
Home equity lines of credit
39,301
33,638
1-4 Family residential construction
20,613
14,798
Total residential mortgage
620,172
586,580
Commercial:
Commercial loans secured by real estate
531,810
301,227
Commercial and industrial
159,577
126,374
Small Business Administration - Paycheck Protection Program
132,269
Political subdivisions
53,221
53,570
Commercial construction and land
42,874
33,555
Loans secured by farmland
11,736
12,251
Multi-family (5 or more) residential
55,811
31,070
Agricultural loans
3,164
4,319
Other commercial loans
17,289
16,535
Total commercial
1,007,751
578,901
Consumer
16,286
16,741
Total
1,644,209
1,182,222
Less: allowance for loan losses
(11,385)
(9,836)
Loans, net
$
1,632,824
$
1,172,386
In the table above, outstanding loan balances are presented net of deferred loan origination fees, of $6,286,000 at December 31, 2020 and $2,482,000 at December 31, 2019.
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 the northern tier and northcentral Pennsylvania, the southern tier of New York State and southeastern 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. There is no concentration of loans to borrowers engaged in similar businesses or activities that exceed 10%of total loans at either December 31, 2020 or December 31, 2019.
On March 27, 2020, the CARES Act was signed into law. The CARES Act is a $2 trillion stimulus package designed to provide relief to U.S. businesses and consumers struggling as a result of the pandemic. A provision in the CARES Act includes creation of the Paycheck Protection Program (“PPP”) through the Small Business Administration (“SBA”) and Treasury Department. Under the PPP, the Corporation, as an SBA-certified lender, provides SBA-guaranteed loans to small businesses to pay their employees, rent, mortgage
interest, and utilities. PPP loans will be forgiven subject to clients’ providing documentation evidencing their compliant use of funds and otherwise complying with the terms of the program.
The maximum term of PPP loans is five years, though most of the Corporation’s PPP loans have two-year terms, and the Corporation will be repaid sooner to the extent the loans are forgiven. The interest rate on PPP loans is 1%, and the Corporation has received fees from the SBA ranging between 1% and 5% per loan, depending on the size of the loan. Fees on PPP loans, net of origination costs and a market rate adjustment on PPP loans acquired from Covenant, are recognized in interest income as a yield adjustment over the term of the loans.
The Corporation began accepting and processing applications for loans under the PPP on April 3, 2020. Covenant also engaged in PPP lending starting in early April 2020. As of December 31, 2020, the recorded investment in PPP loans was $132,269,000, including contractual principal balances of $134,802,000, increased by a market rate adjustment on PPP loans acquired from Covenant of $504,000 and reduced by net deferred origination fees of $3,037,000. Net deferred origination fees and the market rate adjustment on PPP loans are recognized in interest income as yield adjustments (net accretion over the term of the loans). Accretion of fees received on PPP loans, net of amortization of the market rate adjustment on PPP loans acquired from Covenant, was $1,945,000 for the year ended December 31, 2020.
Section 4013 of the CARES Act provides that, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the coronavirus (COVID-19) pandemic declared by the President of the United States under the National Emergencies Act terminates (the “applicable period”), the Corporation may elect to suspend U.S. GAAP for loan modifications related to the pandemic that would otherwise be categorized as TDRs and suspend any determination of a loan modified as a result of the effects of the pandemic as being a TDR, including impairment for accounting purposes. The suspension is applicable for the term of the loan modification that occurs during the applicable period for a loan that was not more than 30 days past due as of December 31, 2019. The suspension is not applicable to any adverse impact on the credit of a borrower that is not related to the pandemic.
On December 27, 2020, the President of the United States signed into law the Consolidated Appropriations Act, 2021 (the “CAA Act”), which both funds the federal government until September 30, 2021 and broadly addresses additional COVID-19 responses and relief. Among the additional relief measures included are certain extensions to elements of the CARES Act, including extension of temporary relief from troubled debt restructurings established under Section 4013 of the CARES Act to the earlier of a) January 1, 2022, or b) the date that is 60 days after the date on which the national COVID-19 emergency terminates. The CAA also includes additional funding for the PPP with additional eligibility requirements for borrowers with generally the same loan terms as provided under the CARES Act.
In addition, the banking regulators and other financial regulators, on March 22, 2020 and revised April 7, 2020, issued a joint interagency statement titled the “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of the COVID-19 pandemic. Pursuant to the interagency statement, loan modifications that do not meet the conditions of Section 4013 of the CARES Act may still qualify as a modification that does not need to be accounted for as a TDR. Specifically, the agencies confirmed with the FASB staff that short-term modifications made in good faith in response to the pandemic to borrowers who were current prior to any relief are not TDRs under U.S. GAAP. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. Appropriate allowances for loan and lease losses are expected to be maintained. With regard to loans not otherwise reportable as past due, financial institutions are not expected to designate loans with deferrals granted due to the pandemic as past due because of the deferral. The interagency statement also states that during short-term pandemic-related loan modifications, these loans generally should not be reported as nonaccrual.
To work with clients impacted by COVID-19, the Corporation is offering short-term loan modifications on a case-by-case basis to borrowers who were current in their payments at the inception of the loan modification program. Prior to the merger, Covenant had a similar program in place, and these modified loans have been incorporated into the Corporation’s program. These efforts have been designed to assist borrowers as they deal with the current crisis and help the Corporation mitigate credit risk. For loans subject to the program, each borrower is required to resume making regularly scheduled loan payments at the end of the modification period and the
deferred amounts will be moved to the end of the loan term. Consistent with Section 4013 of the CARES Act, the modified loans have not been reported as past due, nonaccrual or as TDRs at December 31, 2020. Most of the modifications under the program became effective in March and the second quarter 2020 and provided a deferral of interest or principal and interest for 90-to-180 days. Accordingly, many of the loans for which deferrals were granted returned to full payment status prior to December 31, 2020. The quantity and balances of modifications outstanding under the program at December 31, 2020 are as follows:
Deferrals Remaining
As of December 31, 2020
(Dollars in Thousands)
Number
of
Recorded
Loans
Investment
COVID-19-related loan modifications:
Residential mortgage
$
2,334
Consumer
Commercial
35,002
Total
$
37,397
The ultimate effect of COVID-19 on the local or broader economy is not known. In 2020, the Corporation increased the allowance for loan losses $785,000 based on an increase in qualitative factors related to potential deterioration in economic conditions. Further, in June, September and December 2020, the Corporation’s credit administration and commercial lending staffs performed reviews of commercial credits with “Pass” ratings in an effort to reduce the risk of failing to identify loans that should be evaluated for risk rating downgrade or a specific allowance. Updated risk ratings and specific allowances based on the December 2020 review have been included in the December 31, 2020 information presented below. Because of the significant uncertainties related to the ultimate duration of the COVID-19 pandemic and its economic impact, the total impact on the Corporation’s loan portfolio is not determinable.
As described in Note 3, effective July 1, 2020, the Corporation acquired loans pursuant to its acquisition of Covenant, and effective April 1, 2019, the Corporation acquired loans pursuant to the acquisition of Monument. The acquired loans were recorded at their initial fair value, with adjustments made to the gross amortized cost of loans based on movements in interest rates (market rate adjustment) and based on credit fair value adjustments on non-impaired loans and impaired loans. In the last three quarters of 2019 and year ended December 31, 2020, the Corporation recognized amortization and accretion of a portion of the market rate adjustments and credit adjustments on non-impaired (performing) loans, and a partial recovery of purchased credit impaired (PCI) loans. For the years ended December 31, 2020 and 2019, adjustments to the initial market rate and credit fair value adjustments of performing loans were recognized as follows:
(In Thousands)
Year Ended
December 31,
December 31,
Market Rate Adjustment
Adjustments to gross amortized cost of loans at beginning of period
$
(1,415)
$
Market rate adjustment recorded in acquisition
2,909
(1,807)
(Amortization) accretion recognized in interest income
(776)
Adjustments to gross amortized cost of loans at end of period
$
$
(1,415)
Credit Adjustment on Non-impaired Loans
Adjustments to gross amortized cost of loans at beginning of period
$
(1,216)
$
Credit adjustment recorded in acquisition
(7,219)
(1,914)
Accretion recognized in interest income
2,456
Adjustments to gross amortized cost of loans at end of period
$
(5,979)
$
(1,216)
The following table presents the components of the purchase accounting adjustments related to the PCI loans acquired from Covenant as of July 1, 2020:
(In Thousands)
July 1, 2020
Contractually required principal at acquisition
$
10,114
Non-accretable discount
(3,466)
Expected cash flows
$
6,648
A summary of PCI loans held at December 31, 2020 and December 31, 2019 is as follows:
(In Thousands)
December 31,
December 31,
Outstanding balance
$
10,316
$
Carrying amount
6,841
Transactions within the allowance for loan losses, summarized by segment and class, were as follows:
December 31,
December 31,
Year Ended December 31, 2020
Provision
(In Thousands)
Balance
Charge-offs
Recoveries
(Credit)
Balance
Allowance for Loan Losses:
Residential mortgage:
Residential mortgage loans - first liens
$
3,405
$
$
$
$
3,524
Residential mortgage loans - junior liens
(36)
Home equity lines of credit
1-4 Family residential construction
(18)
Total residential mortgage
4,182
4,253
Commercial:
Commercial loans secured by real estate
1,921
1,130
3,051
Commercial and industrial
1,391
(2,236)
3,074
2,245
Commercial construction and land
(107)
(405)
Loans secured by farmland
(38)
Multi-family (5 or more) residential
Agricultural loans
(7)
Other commercial loans
Total commercial
4,788
(2,343)
3,847
6,308
Consumer
(122)
Unallocated
Total Allowance for Loan Losses
$
9,836
$
(2,465)
$
$
3,913
$
11,385
December 31,
December 31,
Year Ended December 31, 2019
Provision
(In Thousands)
Balance
Charge-offs
Recoveries
(Credit)
Balance
Allowance for Loan Losses:
Residential mortgage:
Residential mortgage loans - first liens
$
3,156
$
(166)
$
$
$
3,405
Residential mortgage loans - junior liens
(24)
Home equity lines of credit
(31)
1-4 Family residential construction
(87)
Total residential mortgage
3,986
(190)
4,182
Commercial:
Commercial loans secured by real estate
2,538
(617)
1,921
Commercial and industrial
1,553
(6)
(162)
1,391
Commercial construction and land
Loans secured by farmland
Multi-family (5 or more) residential
Agricultural loans
(5)
Other commercial loans
Total commercial
4,591
(6)
4,788
Consumer
(183)
Unallocated
Total Allowance for Loan Losses
$
9,309
$
(379)
$
$
$
9,836
For the year ended December 31, 2020, the provision for loan losses was $3,913,000, an increase in expense of $3,064,000 as compared to 2019. The provision included the impact of a $2,219,000 charge-off on a commercial loan of $3,500,000. In total, the provision for 2020 included a net charge of $2,238,000 related to specific loans (net decrease in specific allowances on loans of $126,000 and net charge-offs of $2,364,000) and a $1,675,000 increase in the collectively determined portion of the allowance for loan losses. The increase in the collectively determined portion of the allowance includes the impact of an increase in the net charge-off experience factor for commercial loans and an increase in qualitative factors.
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. 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. 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. Risk ratings are updated any time that conditions or the situation warrants. Loans not classified are included in the “Pass” column in the table below.
The following tables summarize the aggregate credit quality classification of outstanding loans by risk rating as of December 31, 2020 and 2019:
December 31, 2020
Purchased
(In Thousands)
Special
Credit
Pass
Mention
Substandard
Doubtful
Impaired
Total
Residential Mortgage:
Residential Mortgage loans - first liens
$
516,685
$
6,192
$
9,994
$
$
$
532,947
Residential Mortgage loans - junior liens
26,480
27,311
Home equity lines of credit
38,529
39,301
1-4 Family residential construction
20,613
20,613
Total residential mortgage
602,307
6,392
11,328
620,172
Commercial:
Commercial loans secured by real estate
494,876
17,374
15,262
4,298
531,810
Commercial and Industrial
143,500
8,025
7,268
159,577
Small Business Administration - Paycheck Protection Program
132,269
132,269
Political subdivisions
53,221
53,221
Commercial construction and land
42,110
42,874
Loans secured by farmland
10,473
11,736
Multi-family (5 or more) residential
50,563
2,405
1,229
1,614
55,811
Agricultural loans
2,569
3,164
Other commercial loans
17,289
17,289
Total commercial
946,870
28,924
25,261
6,696
1,007,751
Consumer
16,172
16,286
Totals
$
1,565,349
$
35,316
$
36,703
$
$
6,841
$
1,644,209
December 31, 2019
Purchased
(In Thousands)
Special
Credit
Pass
Mention
Substandard
Doubtful
Impaired
Total
Residential Mortgage:
Residential Mortgage loans - first liens
$
500,963
$
$
9,324
$
$
$
510,641
Residential Mortgage loans - junior liens
26,953
27,503
Home equity lines of credit
33,170
33,638
1-4 Family residential construction
14,798
14,798
Total residential mortgage
575,884
10,204
586,580
Commercial:
Commercial loans secured by real estate
294,397
4,773
1,693
301,227
Commercial and Industrial
114,293
9,538
2,543
126,374
Political subdivisions
53,570
53,570
Commercial construction and land
32,224
1,331
33,555
Loans secured by farmland
6,528
4,681
1,042
12,251
Multi-family (5 or more) residential
30,160
31,070
Agricultural loans
3,343
4,319
Other commercial loans
16,416
16,535
Total commercial
550,931
19,327
8,279
578,901
Consumer
16,720
16,741
Totals
$
1,143,535
$
19,658
$
18,504
$
$
$
1,182,222
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, 2020 and 2019:
December 31, 2020
Loans:
Allowance for Loan Losses:
(In Thousands)
Individually
Collectively
Individually
Collectively
Evaluated
Evaluated
Totals
Evaluated
Evaluated
Totals
Residential mortgage:
Residential mortgage loans - first liens
$
2,385
$
530,562
$
532,947
$
$
3,515
$
3,524
Residential mortgage loans - junior liens
26,897
27,311
Home equity lines of credit
39,301
39,301
1-4 Family residential construction
20,613
20,613
Total residential mortgage
2,799
617,373
620,172
4,091
4,253
Commercial:
Commercial loans secured by real estate
11,962
519,848
531,810
2,359
3,051
Commercial and industrial
1,359
158,218
159,577
2,174
2,245
Small Business Administration - Paycheck Protection Program
132,269
132,269
Political subdivisions
53,221
53,221
Commercial construction and land
42,874
42,874
Loans secured by farmland
11,652
11,736
Multi-family (5 or more) residential
1,614
54,197
55,811
Agricultural loans
3,164
3,164
Other commercial loans
17,289
17,289
Total commercial
15,019
992,732
1,007,751
5,545
6,308
Consumer
16,286
16,286
Unallocated
Total
$
17,818
$
1,626,391
$
1,644,209
$
$
9,875
$
11,385
December 31, 2019
Loans:
Allowance for Loan Losses:
(In Thousands)
Individually
Collectively
Individually
Collectively
Evaluated
Evaluated
Totals
Evaluated
Evaluated
Totals
Residential mortgage:
Residential mortgage loans - first liens
$
1,023
$
509,618
$
510,641
$
$
3,405
$
3,405
Residential mortgage loans - junior liens
27,135
27,503
Home equity lines of credit
33,638
33,638
1-4 Family residential construction
14,798
14,798
Total residential mortgage
1,391
585,189
586,580
4,006
4,182
Commercial:
Commercial loans secured by real estate
300,543
301,227
1,921
1,921
Commercial and industrial
1,467
124,907
126,374
1,242
1,391
Political subdivisions
53,570
53,570
Commercial construction and land
1,261
32,294
33,555
Loans secured by farmland
11,644
12,251
Multi-family (5 or more) residential
31,070
31,070
Agricultural loans
4,243
4,319
Other commercial loans
16,535
16,535
Total commercial
4,095
574,806
578,901
3,913
4,788
Consumer
16,741
16,741
Unallocated
Total
$
5,486
$
1,176,736
$
1,182,222
$
1,051
$
8,200
$
9,836
Summary information related to impaired loans as of December 31, 2020 and 2019 is as follows:
(In Thousands)
December 31, 2020
December 31, 2019
Unpaid
Unpaid
Principal
Recorded
Related
Principal
Recorded
Related
Balance
Investment
Allowance
Balance
Investment
Allowance
With no related allowance recorded:
Residential mortgage loans - first liens
$
1,248
$
1,248
$
$
$
$
Residential mortgage loans - junior liens
Commercial loans secured by real estate
7,168
5,398
Commercial and industrial
1,781
1,287
Loans secured by farmland
Multi-family (5 or more) residential
2,770
1,614
Agricultural loans
Total with no related allowance recorded
13,211
9,736
2,139
2,111
With a related allowance recorded:
Residential mortgage loans - first liens
1,200
1,200
Residential mortgage loans - junior liens
Commercial loans secured by real estate
6,501
6,501
Commercial and industrial
Construction and other land loans
1,261
1,261
Loans secured by farmland
Total with a related allowance recorded
8,082
8,082
3,375
3,375
1,051
Total
$
21,293
$
17,818
$
$
5,514
$
5,486
$
1,051
In the table immediately above, loans to two borrowers are presented under the Residential mortgage loans - first liens and Residential mortgage loans - junior liens classes. Each of these loans is collateralized by one property, and the allowance associated with each of these loans was determined based on an analysis of the total amounts of the Corporation’s exposure in comparison to the estimated net proceeds if the Corporation were to sell the property. The total allowance related to these two borrowers was $153,000 at December 31, 2020 and $176,000 at December 31, 2019.
The average balance of impaired loans and interest income recognized on impaired loans is as follows:
(In Thousands)
Interest Income Recognized on
Average Investment in
on Impaired Loans
Impaired Loans
on a Cash Basis
Year Ended December 31,
Year Ended December 31,
Residential mortgage:
Residential mortgage loans - first lien
$
1,853
$
1,440
$
$
Residential mortgage loans - junior lien
Home equity lines of credit
Total residential mortgage
2,302
1,754
Commercial:
Commercial loans secured by real estate
5,266
1,562
Commercial and industrial
2,542
1,186
Commercial construction and land
Loans secured by farmland
1,276
Multi-family (5 or more) residential
Agricultural loans
Other commercial loans
Total commercial
8,944
4,999
Consumer
Total
$
11,246
$
6,756
$
$
The breakdown by portfolio segment and class of nonaccrual loans and loans past due ninety days or more and still accruing is as follows:
(In Thousands)
December 31, 2020
December 31, 2019
Past Due
Past Due
90+ Days and
90+ Days and
Accruing
Nonaccrual
Accruing
Nonaccrual
Residential mortgage:
Residential mortgage loans - first liens
$
$
6,387
$
$
4,679
Residential mortgage loans - junior liens
Home equity lines of credit
Total residential mortgage
1,123
7,064
1,002
5,078
Commercial:
Commercial loans secured by real estate
11,550
1,148
Commercial and industrial
1,051
Commercial construction and land
1,311
Loans secured by farmland
Multi-family (5 or more) residential
1,614
Other commercial
Total commercial
14,267
4,124
Consumer
Totals
$
1,975
$
21,416
$
1,207
$
9,218
The amounts shown in the table immediately above include loans classified as troubled debt restructurings (described in more detail below), if such loans are past due ninety days or more or nonaccrual. PCI loans with a total recorded investment of $6,841,000 at December 31, 2020 and $441,000 at December 31, 2019 are classified as nonaccrual.
The table below presents a summary of the contractual aging of loans as of December 31, 2020 and 2019. Loans modified under the Corporation’s program designed to work with clients impacted by COVID-19, as described above, are included in the current and past due less than 30 days category in the table that follows:
(In Thousands)
As of December 31, 2020
As of December 31, 2019
Current &
Current &
Past Due
Past Due
Past Due
Past Due
Past Due
Past Due
Less than
30-89
90+
Less than
30-89
90+
30 Days
Days
Days
Total
30 Days
Days
Days
Total
Residential mortgage:
Residential mortgage loans - first liens
$
523,191
$
5,703
$
4,053
$
532,947
$
499,024
$
7,839
$
3,778
$
510,641
Residential mortgage loans - junior liens
27,009
27,311
27,041
27,503
Home equity lines of credit
38,919
39,301
33,115
33,638
1-4 Family residential construction
20,457
20,613
14,758
14,798
Total residential mortgage
609,576
6,071
4,525
620,172
573,938
8,414
4,228
586,580
Commercial:
Commercial loans secured by real estate
529,998
1,746
531,810
299,640
301,227
Commercial and industrial
158,523
159,577
126,221
126,374
Small Business Administration - Paycheck Protection Program
132,269
132,269
Political subdivisions
53,221
53,221
53,570
53,570
Commercial construction and land
42,590
42,874
33,505
33,555
Loans secured by farmland
11,419
11,736
11,455
12,251
Multi-family (5 or more) residential
53,860
1,951
55,811
31,070
31,070
Agricultural loans
3,091
3,164
4,318
4,319
Other commercial loans
17,289
17,289
16,535
16,535
Total commercial
1,002,260
2,453
3,038
1,007,751
576,314
1,420
1,167
578,901
Consumer
16,063
16,286
16,496
16,741
Totals
$
1,627,899
$
8,607
$
7,703
$
1,644,209
$
1,166,748
$
10,023
$
5,451
$
1,182,222
Nonaccrual loans are included in the contractual aging immediately above. A summary of the contractual aging of nonaccrual loans at December 31, 2020 and 2019 is as follows:
(In Thousands)
Current &
Past Due
Past Due
Past Due
Less than
30-89
90+
30 Days
Days
Days
Total
December 31, 2020 Nonaccrual Totals
$
12,999
$
2,689
$
5,728
$
21,416
December 31, 2019 Nonaccrual Totals
$
3,840
$
1,134
$
4,244
$
9,218
Loans whose terms are modified are classified as TDRs if the Corporation grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty. Loans classified as TDRs are designated as impaired and reviewed each quarter to determine if a specific allowance for loan losses is required. Loans deferred under COVID-19 CARES Act Section 4013 are not classified as TDRs as they meet COVID-19 relief guidance. The outstanding balance of loans subject to TDRs, as well as the contractual aging information at December 31, 2020 and 2019 is as follows:
Troubled Debt Restructurings (TDRs):
(In Thousands)
Current &
Past Due
Past Due
Past Due
Less than
30-89
90+
30 Days
Days
Days
Nonaccrual
Total
December 31, 2020 Totals
$
$
$
$
6,867
$
7,451
December 31, 2019 Totals
$
$
$
$
1,737
$
2,626
At December 31, 2020 and 2019, there were no commitments to loan additional funds to borrowers whose loans have been classified as TDRs.
A summary of TDRs that occurred during 2020 and 2019 is as follows:
(Balances in Thousands)
Post-
Post-
Number
Modification
Number
Modification
of
Recorded
of
Recorded
Loans
Investment
Loans
Investment
Residential mortgage - junior liens:
Reduced monthly payments and extended maturity date
$
$
New loan at lower than risk-adjusted market rate to borrower from whom short sale of other collateral was accepted
Commercial loans secured by real estate:
Interest only payments for a nine-month period
Principal and interest payment deferral non-COVID related
4,831
Extended interest only payments and reduced monthly payments with a balloon payment at maturity
1,261
Commercial and industrial,
Reduced monthly payments and extended maturity date
Multi-family (5 or more) residential,
Principal and interest payment deferral non-COVID related
2,170
Agricultural loans,
Reduced monthly payments and extended maturity date
Total
$
7,271
$
1,811
In the year ended December 31, 2020, the Corporation recorded a specific allowance for loan losses of $416,000 related to a loan secured by commercial real estate for which a TDR concession was also made in 2020 and included in the table above. The other loans for which TDRs were granted in 2020 had no specific impact on the provision or allowance for loan losses.
In the year ended December 31, 2019, the Corporation recorded a specific allowance for loan losses of $678,000 related to the commercial loan secured by real estate in the table above. This loan was subsequently paid off in the first quarter of 2020 for less than the full principal balance, resulting in a charge-off of $107,000.
In 2020 and 2019, payment defaults on loans for which modifications considered to be TDRs were entered into within the previous 12 months are summarized as follows:
Number
Number
of
Recorded
of
Recorded
(Balances in Thousands)
Loans
Investment
Loans
Investment
Residential mortgage - first liens
$
$
Residential mortgage - junior liens
Commercial and industrial
Agricultural loans
Total
$
$
In 2020, one commercial real estate loan experienced a payment default. This loan was individually evaluated for impairment at December 31, 2020 and no specific allowance was recorded as the estimated value of collateral exceeded the outstanding balance. All of the TDRs for which payment defaults occurred in 2019 were related to one commercial relationship. These loans were individually evaluated for impairment at December 31, 2020 and 2019, and no specific allowance for loan losses was recognized because the estimated values of collateral and U.S. Government (Small Business Administration) guarantees exceeded the outstanding balances of the loans.
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 consolidated balance sheets) is as follows:
(In Thousands)
December 31,
December 31,
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:
(In Thousands)
December 31,
December 31,
Residential real estate in process of foreclosure
$
1,246
$
1,717
9. BANK PREMISES AND EQUIPMENT
December 31,
(In Thousands)
Land
$
3,826
$
3,199
Buildings and improvements
33,058
28,403
Furniture and equipment
15,235
13,618
Construction in progress
1,655
Total
52,127
46,875
Less: accumulated depreciation
(30,601)
(29,705)
Net
$
21,526
$
17,170
Depreciation expense is included in the following line items of the consolidated statements of income:
(In Thousands)
Occupancy expense
$
$
Furniture and equipment expense
Data processing expenses
Telecommunications expenses
Total
$
1,981
$
1,749
10. GOODWILL AND OTHER INTANGIBLE ASSETS, NET
Information related to the core deposit intangibles is as follows:
(In Thousands)
December 31,
Gross amount
$
6,639
$
3,495
Accumulated amortization
(2,788)
(2,248)
Net
$
3,851
$
1,247
Amortization expense related to core deposit intangibles is included in other noninterest expense in the consolidated statements of income, as follows:
(In Thousands)
Year Ended
December 31,
December 31,
Amortization expense
$
$
In 2020, amortization expense included $292,000 related to the Covenant acquisition and $248,000 related to the Monument acquisition as described in Note 3. In 2019, amortization expense included $214,000 related to the Monument acquisition and $9,000 related to a previous acquisition. The amount of amortization expense to be recognized in each of the ensuing five years is as follows:
(In Thousands)
$
Goodwill represents the excess of the cost of acquisitions over the fair value of the net assets acquired. Changes in the carrying amount of goodwill are summarized in the following table:
(In Thousands)
Year Ended
December 31,
December 31,
Balance, beginning of period
$
28,388
$
11,942
Goodwill arising in business combination
24,117
16,446
Balance, end of period
$
52,505
$
28,388
In testing goodwill for impairment at December 31, 2020, the Corporation by-passed performing a qualitative assessment and performed a quantitative assessment based on comparison of the Corporation’s market capitalization to its stockholders’ equity, resulting in the determination that the fair value of its reporting unit, its community banking operation, exceeded its carrying amount. Accordingly, there was no goodwill impairment at December 31, 2020.
There were no goodwill impairment charges recorded in the years ended December 31, 2020 and 2019.
11. DEPOSITS
At December 31, 2020, the scheduled maturities of time deposits are as follows:
(In Thousands)
$
262,358
76,447
27,730
12,621
11,192
Total
$
390,407
Time deposits of more than $250,000 totaled $103,024,000 at December 31, 2020 and $84,476,000 at December 31, 2019. As of December 31, 2020, the remaining maturities or time to next re-pricing of time deposits more than $250,000 was as follows:
(In Thousands)
Three months or less
$
25,566
Over 3 months through 12 months
54,883
Over 1 year through 3 years
15,574
Over 3 years
7,001
Total
$
103,024
12. BORROWED FUNDS AND SUBORDINATED DEBT
Short-term borrowings (initial maturity within one year) include the following:
(In Thousands)
December 31,
December 31,
FHLB-Pittsburgh borrowings
$
18,066
$
84,292
Customer repurchase agreements
1,956
1,928
Total short-term borrowings
$
20,022
$
86,220
Short-term borrowings from FHLB-Pittsburgh are as follows:
(In Thousands)
December 31,
December 31,
Overnight borrowing
$
$
64,000
Other short-term advances
18,066
20,292
Total short-term FHLB-Pittsburgh borrowings
$
18,066
$
84,292
The overnight borrowing from FHLB-Pittsburgh had an interest rate of 1.81% at December 31, 2019. At December 31, 2020, other short-term advances included five advances totaling $18,000,000 which are presented in the table inclusive of the unaccreted purchase accounting adjustment, with a weighted-average effective rate of 0.43%. At December 31, 2019, other short-term advances included seven advances totaling $20,297,000 which are presented in the table net of the unamortized purchase accounting adjustment, with a weighted-average effective rate of 2.28%.
The weighted average interest rate on total short-term borrowings outstanding was 0.40% at December 31, 2020 and 1.88% at December 31, 2019. The maximum amount of total short-term borrowings outstanding at any month-end was $56,647,000 in 2020 and $86,220,000 in 2019.
The Corporation had available credit with other correspondent banks totaling $45,000,000 at December 31, 2020 and 2019. These lines of credit are primarily unsecured. No amounts were outstanding at December 31, 2020 or 2019.
The Corporation has a line of credit with the Federal Reserve Bank of Philadelphia’s Discount Window. At December 31, 2020, the Corporation had available credit in the amount of $14,654,000 on this line with no outstanding advances. At December 31, 2019, the Corporation had available credit in the amount of $14,244,000 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 $15,126,000 at December 31, 2020 and $14,728,000 at December 31, 2019.
The FHLB-Pittsburgh loan facility is collateralized by qualifying loans secured by real estate with a book value totaling $1,049,690,000 at December 31, 2020 and $778,877,000 at December 31, 2019. 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) were $9,720,000 at December 31, 2020 and $10,131,000 at December 31, 2019. The Corporation’s total credit facility with FHLB-Pittsburgh was $771,199,000 at December 31, 2020, including an unused (available) amount of $698,977,000. At December 31, 2019, the Corporation’s total credit facility with FHLB-Pittsburgh was $552,546,000, including an unused (available) amount of $416,127,000.
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 December 31, 2020 and December 31, 2019. The carrying value of the underlying securities was $1,980,000 at December 31, 2020 and $1,951,000 at December 31, 2019.
LONG-TERM BORROWINGS
Long-term borrowings from FHLB-Pittsburgh are as follows:
(In Thousands)
December 31,
December 31,
Loans matured in 2020 with a weighted-average rate of 2.71%
$
$
5,069
Loans maturing in 2021 with a weighted-average rate of 1.36%
26,098
6,000
Loans maturing in 2022 with a weighted-average rate of 0.60%
15,682
20,000
Loans maturing in 2023 with a weighted-average rate of 0.73%
7,224
20,500
Loans maturing in 2024 with a weighted-average rate of 0.75%
5,137
Loan maturing in 2025 with a rate of 4.91%
Total long-term FHLB-Pittsburgh borrowings
$
54,608
$
52,127
Note: Weighted-average rates are presented as of December 31, 2020.
SUBORDINATED DEBT
At December 31, 2020 and 2019, outstanding subordinated debt agreements are as follows:
(In Thousands)
December 31,
December 31,
Agreements with an aggregate par value of $8,000,000; bearing interest at 6.25%; maturing in June 2026 and redeemable at par in June 2021
$
8,027
$
Agreements with an aggregate par value of $6,500,000; bearing interest at 6.50%; maturing in April 2027 and redeemable at par in April 2022
6,500
6,500
Agreement with a par value of $2,000,000; bearing interest at 6.50%; maturing in July 2027 and redeemable at par in July 2022
2,026
Total carrying value
$
16,553
$
6,500
13. EMPLOYEE AND POSTRETIREMENT BENEFIT PLANS
DEFINED BENEFIT PLANS
The Corporation sponsors a defined benefit health care plan that provides postretirement medical benefits and life insurance to employees who meet certain age and length of service requirements. Full-time employees no longer accrue service time toward the Corporation-subsidized portion of the medical benefits. The plan contains a cost-sharing feature which causes participants to pay for all future increases in costs related to benefit coverage. Accordingly, actuarial assumptions related to health care cost trend rates do not significantly affect the liability balance at December 31, 2020 and December 31, 2019 and are not expected to significantly affect the Corporation’s future expenses. The Corporation uses a December 31 measurement date for the postretirement plan.
In an acquisition in 2007, the Corporation assumed the Citizens Trust Company Retirement Plan, a defined benefit pension plan. This plan covers certain employees who were employed by Citizens Trust Company on December 31, 2002, when the plan was amended to discontinue admittance of any future participant and to freeze benefit accruals. Information related to the Citizens Trust Company Retirement Plan has been included in the tables that follow. The Corporation uses a December 31 measurement date for this plan.
The following table shows the funded status of the defined benefit plans:
Pension
Postretirement
(In Thousands)
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation at beginning of year
$
$
$
1,326
$
1,349
Service cost
Interest cost
Plan participants' contributions
Actuarial loss (gain)
(63)
Benefits paid
(6)
(13)
(260)
(227)
Benefit obligation at end of year
$
1,101
$
$
1,347
$
1,326
CHANGE IN PLAN ASSETS:
Fair value of plan assets at beginning of year
$
$
$
$
Actual return on plan assets
Employer contribution
Plan participants' contributions
Benefits paid
(6)
(13)
(260)
(227)
Fair value of plan assets at end of year
$
1,062
$
$
$
Funded status at end of year
$
(39)
$
(5)
$
(1,347)
$
(1,326)
At December 31, 2020 and 2019, the following pension plan and postretirement plan liability amounts were recognized in the consolidated balance sheets:
Pension
Postretirement
(In Thousands)
Accrued interest and other liabilities
$
$
$
1,347
$
1,326
At December 31, 2020 and 2019, the following items included in accumulated other comprehensive income had not been recognized as components of expense:
Pension
Postretirement
(In Thousands)
Prior service cost
$
$
$
(217)
$
(248)
Net actuarial loss (gain)
(211)
(236)
Total
$
$
$
(428)
$
(484)
For the defined benefit pension plan, amortization of the net actuarial loss is expected to be $19,000 in 2021. For the postretirement plan, the estimated amount of prior service cost that will be amortized from accumulated other comprehensive income into net periodic benefit cost in 2021 is a reduction in expense of $31,000, and net actuarial gain of $5,000 is expected to be amortized in 2021.
The accumulated benefit obligation for the defined benefit pension plan was $1,101,000 at December 31, 2020 and $976,000 at December 31, 2019.
The components of net periodic benefit costs from defined benefit plans are as follows:
Pension
Postretirement
(In Thousands)
Service cost
$
$
$
$
Interest cost
Expected return on plan assets
(27)
(22)
Amortization of prior service cost
(31)
(31)
Recognized net actuarial loss (gain)
(14)
(21)
Total net periodic benefit cost
$
$
$
$
The weighted-average assumptions used to determine net periodic benefit cost are as follows:
Pension
Postretirement
Citizens Trust Company Retirement Plan and postretirement plan:
Discount rate
3.10
%
4.10
%
3.25
%
4.50
%
Expected return on plan assets
4.99
%
4.68
%
N/A
N/A
Rate of compensation increase
N/A
N/A
N/A
N/A
The weighted-average assumptions used to determine benefit obligations as of December 31, 2020 and 2019 are as follows:
Pension
Postretirement
Discount rate
2.30
%
3.10
%
2.50
%
3.25
%
Rate of compensation increase
N/A
N/A
N/A
N/A
Estimated future benefit payments, including only estimated employer contributions for the postretirement plan, which reflect expected future service, are as follows:
(In Thousands)
Pension
Postretirement
$
$
2026-2030
No estimated minimum contribution to the defined benefit pension plan is required in 2021, though the Corporation may make discretionary contributions.
The expected return on pension plan assets is a significant assumption used in the calculation of net periodic benefit cost. This assumption reflects the average long-term rate of earnings expected on the funds invested or to be invested to provide for the benefits included in the projected benefit obligation.
The fair values of pension plan assets at December 31, 2020 and 2019 are as follows:
Mutual funds invested principally in:
Cash and cash equivalents
%
%
Debt securities
%
%
Equity securities
%
%
Alternative funds
%
%
Total
%
%
C&N Bank’s Wealth Management Department manages the investment of the pension plan assets. The Plan’s securities include mutual funds invested principally in debt securities, a diversified mix of large, mid- and small-capitalization U.S. stocks, foreign stocks and alternative asset classes such as real estate, commodities, and inflation-protected securities. The fair values of plan assets are determined based on Level 1 inputs (as described in Note 22). The Plan’s assets do not include any shares of the Corporation’s common stock.
PROFIT SHARING AND DEFERRED COMPENSATION PLANS
The Corporation has a profit sharing plan that incorporates the deferred salary savings provisions of Section 401(k) of the Internal Revenue Code. The Corporation’s matching contributions to the Plan depend upon the tax deferred contributions of employees. The Corporation’s total basic and matching contributions were $1,050,000 in 2020 and $891,000 in 2019.
The Corporation has an Employee Stock Ownership Plan (ESOP). Contributions to the ESOP are discretionary, and the ESOP uses funds contributed to purchase Corporation stock for the accounts of ESOP participants. These purchases are made in the market (not directly from the Corporation), and employees are not permitted to purchase Corporation stock under the ESOP. The ESOP includes a diversification feature, which allows participants, upon reaching age 55 and 10 years of service (as defined), to sell up to 50% of their Corporation shares over a period of 6 years. As of December 31, 2020, and 2019, there were no shares allocated for repurchase by the ESOP.
Dividends paid on shares held by the ESOP are charged to retained earnings. All Corporation shares owned through the ESOP are included in the calculation of weighted-average shares outstanding for purposes of calculating earnings per share - basic and diluted. The ESOP held 481,478 shares of Corporation stock at December 31, 2020 and 473,171 shares at December 31, 2019, all of which had been allocated to Plan participants. The Corporation’s contributions to the ESOP totaled $912,000 in 2020 and $718,000 in 2019.
The Corporation has a nonqualified supplemental deferred compensation arrangement with its key officers. Charges to operating expense for officers’ supplemental deferred compensation were $286,000 in 2020 and $251,000 in 2019.
In connection with the Covenant acquisition, the Corporation assumed an obligation to provide a supplemental retirement benefit to a former Covenant executive. Under the terms of the agreement, the executive or his heirs will receive monthly payments totaling $1 million over a 10-year period starting in October 2025. Effective July 1, 2020, the Corporation recorded a liability of $499,000 representing the present value of the obligation prior to the executive fully vesting in the benefit. In 2020, the Corporation recorded expense totaling $366,000 related to this obligation, including: (1) $360,000, which is included in merger-related expenses in the consolidated statements of income, representing the impact of the executive fully vesting upon the change in control, and (2) $6,000, which is included in pensions and other employee benefits in the consolidated statements of income, representing the effective interest cost on the obligation from July 1, 2020 through December 31, 2020. The discount rate used to measure the liability at July 1, 2020 and December 31, 2020 was 1.5%. The balance of the liability at December 31, 2020, which is included in accrued interest and other liabilities in the consolidated balance sheets, is $865,000.
The Corporation also has a nonqualified deferred compensation plan that allows selected officers the option to defer receipt of cash compensation, including base salary and any cash bonuses or other cash incentives. This nonqualified deferred compensation plan does not provide for Corporation contributions.
STOCK-BASED COMPENSATION PLANS
The Corporation has a Stock Incentive Plan for a selected group of senior officers. A total of 850,000 shares of common stock may be issued under the Stock Incentive Plan. Awards may be made under the Stock Incentive Plan in the form of qualified options (“Incentive Stock Options,” as defined in the Internal Revenue Code), nonqualified options, stock appreciation rights or restricted stock. Historically through December 31, 2020, all awards made under this Plan have consisted of Incentive Stock Options or restricted stock. Incentive Stock Options have an exercise price equal to the market value of the stock at the date of grant, vest after 6 months and expire after 10 years. There are 166,603 shares available for issuance under the Stock Incentive Plan as of December 31, 2020.
Also, the Corporation has an Independent Directors Stock Incentive Plan. This plan permits awards of nonqualified stock options and/or restricted stock to non-employee directors. A total of 235,000 shares of common stock may be issued under the Independent Directors Stock Incentive Plan. The recipients’ rights to exercise stock options under this plan expire 10 years from the date of grant. The exercise prices of all stock options awarded under the Independent Directors Stock Incentive Plan are equal to market value as of the dates of grant. There are 103,143 shares available for issuance under the Independent Directors Stock Incentive Plan as of December 31, 2020.
Total stock-based compensation expense is as follows:
(In Thousands)
Restricted stock
$
1,050
$
Stock options
Total
$
1,050
$
The following summarizes non-vested restricted stock activity for the year ended December 31, 2020:
Weighted
Average
Number
Grant Date
of Shares
Fair Value
Outstanding, December 31, 2019
68,200
$
24.53
Granted
70,940
$
23.18
Vested
(31,908)
$
24.97
Forfeited
(5,290)
$
25.09
Outstanding, December 31, 2020
101,942
$
23.42
Compensation cost related to restricted stock is recognized based on the market price of the stock at the grant date over the vesting period, adjusted for estimated and actual forfeitures. As of December 31, 2020, there was $1,340,000 total unrecognized compensation cost related to restricted stock, which is expected to be recognized over a weighted average period of 1.5 years.
In 2020 and 2019, the Corporation awarded shares of restricted stock under the Stock Incentive Plan, as follows:
Time-based awards to independent directors
7,580
7,620
Time-based awards to employees
45,457
26,827
Performance-based awards to employees
17,903
13,690
Total
70,940
48,137
Time-based restricted stock awards granted under the Independent Directors Stock Incentive Plan in 2020 and 2019 vest over one-year terms. Time-based restricted stock awards granted to employees in 2020 and 2019 vest ratably over three-year terms, subject to continued employment and satisfactory job performance. Performance-based restricted stock awards granted in 2020 and 2019 vest ratably over three-year terms, with vesting contingent upon meeting conditions based on the Corporation’s earnings as specified in the agreements.
There were no stock options granted in 2020 or 2019. A summary of stock option activity is presented below:
Weighted
Weighted
Average
Average
Exercise
Exercise
Shares
Price
Shares
Price
Outstanding, beginning of year
75,897
$
18.69
115,714
$
18.49
Granted
Exercised
(17,222)
$
18.25
(31,304)
$
17.65
Forfeited
(1,564)
$
15.06
Expired
(8,513)
$
19.88
Outstanding, end of year
57,111
$
18.92
75,897
$
18.69
Options exercisable at year-end
57,111
$
18.92
75,897
$
18.69
Weighted-average fair value of options forfeited
$
4.26
N/A
The weighted-average remaining contractual term of outstanding stock options at December 31, 2020 was 1.9 years. The aggregate intrinsic value of stock options outstanding was $63,000 at December 31, 2020. The total intrinsic value of options exercised was $128,000 in 2020 and $276,000 in 2019.
The Corporation has issued shares from treasury stock for almost all stock option exercises through December 31, 2020. Management does not anticipate that stock repurchases will be necessary to accommodate stock option exercises in 2021.
In January 2021, the Corporation awarded 63,402 shares of restricted stock under the Stock Incentive Plan and 10,989 shares of restricted stock under the Independent Directors Stock Incentive Plans. The January 2021 restricted stock awards under the Stock Incentive Plan vest ratably over three years. The 2021 restricted stock issued under the Independent Directors Stock Incentive Plan vests over one year. Total estimated stock-based compensation for 2021 is $1,400,000. The restricted stock awards made in January 2021 are not included in the tables above.
14. INCOME TAXES
The net deferred tax asset at December 31, 2020 and 2019 represents the following temporary difference components:
December 31,
December 31,
(In Thousands)
Deferred tax assets:
Allowance for loan losses
$
2,154
$
2,080
Purchase accounting adjustments on loans
1,930
Net operating loss carryforward
Operating leases liability
Other deferred tax assets
3,089
2,173
Total deferred tax assets
8,793
5,237
Deferred tax liabilities:
Unrealized holding gains on securities
3,104
Defined benefit plans - ASC 835
Bank premises and equipment
1,216
Core deposit intangibles
Right-of-use assets from operating leases
Other deferred tax liabilities
Total deferred tax liabilities
6,088
2,619
Deferred tax asset, net
$
2,705
$
2,618
The provision for income taxes includes the following:
(In Thousands)
Currently payable
$
4,230
$
3,618
Tax expense resulting from allocations of certain tax benefits to equity or as a reduction in other assets
Deferred
(361)
Total provision
$
3,990
$
3,905
A reconciliation of income tax at the statutory rate to the Corporation’s effective rate is as follows:
(Dollars In Thousands)
Amount
%
Amount
%
Expected provision
$
4,875
21.0
$
4,916
21.0
Tax-exempt interest income
(808)
(3.5)
(853)
(3.6)
Increase in cash surrender value and other income from life insurance, net
(170)
(0.7)
(91)
(0.4)
ESOP Dividends
(110)
(0.5)
(113)
(0.5)
State income tax, net of Federal benefit
0.7
0.5
Other, net
0.1
(76)
(0.3)
Effective income tax provision
$
3,990
17.2
$
3,905
16.7
In connection with the Covenant merger, the Corporation received a net operating loss (“NOL”) available to be carried forward against future federal taxable income of $4.6 million. Availability of the NOL does not expire; however, the amount that may be offset against taxable income is limited to approximately $563,000 per year and further limited annually to no more than 80% of taxable income without regard to the NOL. At December 31, 2020, the unused amount of the NOL is $4.3 million.
The Corporation has no unrecognized tax benefits, nor pending examination issues related to tax positions taken in preparation of its income tax returns. With limited exceptions, the Corporation is no longer subject to examination by the Internal Revenue Service for years prior to 2017.
15. RELATED PARTY TRANSACTIONS
Loans to executive officers, directors of the Corporation and its subsidiaries and any associates of the foregoing persons are as follows:
Beginning
New
Other
Ending
(In Thousands)
Balance
Loans
Repayments
Changes
Balance
13 directors, 9 executive officers 2020
$
14,455
$
$
(2,150)
$
5,898
$
18,445
11 directors, 8 executive officers 2019
$
15,144
$
1,027
$
(1,850)
$
$
14,455
In the table above, other changes represent net changes in the balance of existing lines of credit and transfers in and out of the related party category.
Deposits from related parties held by the Corporation amounted to $13,182,000 at December 31, 2020 and $8,828,000 at December 31, 2019.
16. OFF-BALANCE SHEET RISK
The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit, interest rate or liquidity risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of these instruments express the extent of involvement the Corporation has in particular classes of financial instruments.
The Corporation’s exposure to credit loss from nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Financial instruments whose contract amounts represent credit risk at December 31, 2020 and 2019 are as follows:
(In Thousands)
Commitments to extend credit
$
317,470
$
256,896
Standby letters of credit
9,107
8,446
Commitments to extend credit are legally binding agreements to lend to customers. Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future liquidity requirements. The Corporation evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation, for extensions of credit is based on management’s credit assessment of the counterparty.
Standby letters of credit are conditional commitments issued by the Corporation guaranteeing performance by a customer to a third party. Those guarantees are issued primarily to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Some of the standby letters of credit are collateralized by real estate or other assets, and others are unsecured. The extent to which proceeds from liquidation of collateral would be expected to cover the maximum potential amount of future payments related to standby letters of credit is not estimable. The Corporation has recorded no liability associated with standby letters of credit as of December 31, 2020 and 2019.
Standby letters of credit as of December 31, 2020 expire as follows:
Year of Expiration
(In Thousands)
$
8,701
Total
$
9,107
17. OPERATING LEASE COMMITMENTS AND CONTINGENCIES
Operating Lease Commitments
The Corporation leases certain branch locations, office space and equipment. All leases are classified as operating leases. Leases with an initial term of 12 months or less are not recorded on the balance sheet and the related lease expense is recognized on a straight-line basis over the lease term.
Certain leases include options to renew, with renewal terms that can extend the lease term from one to eight years that are reasonably certain of being exercised. The discount rate used in determining the lease liability for each individual lease was the FHLB fixed advance rate which corresponded with the remaining lease term as of January 1, 2019 for leases that existed at adoption and as of the lease commencement date for leases subsequently entered into after January 1, 2019. At December 31, 2020, discount rates ranged from 0.84% to 3.50% with a weighted-average discount rate of 2.07%.
As shown in the table below, at December 31, 2020, right-of-use assets of $3,446,000 were included in other assets, and the related liabilities totaling the same amount were included in accrued interest and other liabilities, in the consolidated balance sheets. At December 31, 2019, right of use assets totaled $1,637,000. In 2020, the Corporation recorded right-of-use asset and lease liabilities from the Covenant acquisition of $1,956,000 and additional right-of-use assets obtained in exchange for lease liabilities of $167,000.
December 31,
December 31,
(In Thousands)
Other assets
$
3,446
$
1,637
Other liabilities
$
3,446
$
1,637
In 2020 and 2019, operating lease expenses are included in the line items of the consolidated statements of income:
(In Thousands)
Occupancy expense, net
$
$
Furniture and equipment expense
Total
$
$
A maturity analysis of the Corporation’s lease liabilities at December 31, 2020 is as follows:
(In Thousands)
Lease Payments Due
$
Thereafter
1,494
Total lease payments
3,768
Discount on cash flows
(322)
Total lease liabilities
$
3,446
Litigation Matters
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.
Trust Department Tax Reporting Contingency
Estimated losses related to trust department tax compliance matters totaled $571,000 in 2020, up from $12,000 in 2019. These losses are included in other noninterest expense in the consolidated statements of income. The operational losses in 2020 arose mainly from compliance oversight and failure of the trust department to provide timely responses to tax notices which occurred between 2007 and 2019 but were identified in 2020. In 2020, the Corporation made changes in internal controls and personnel responsible for trust department tax administration activities. Management implemented the changes in internal controls and personnel in an effort to mitigate and prevent the likelihood of new instances of non-compliance from trust department tax administration activities. At December 31, 2020, the balance of accrued interest and other liabilities in the consolidated balance sheets includes $322,000 related to specific tax compliance matters that have been identified; however, no estimate can be made of the amount of additional expenses that may be incurred related to these matters.
18. REGULATORY MATTERS
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 December 31, 2020; however, C&N Bank remains subject to regulatory capital requirements administered by the federal banking agencies.
Details concerning capital ratios at December 31, 2020 and December 31, 2019 are presented below. Management believes, as of December 31, 2020, 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 December 31, 2020 and December 31, 2019 exceed the Corporation’s Board policy threshold levels.
Minimum To Be Well
Minimum
Minimum To Maintain
Capitalized Under
Minimum To Meet
Capital
Capital Conservation
Prompt Corrective
the Corporation's
Actual
Requirement
Buffer at Reporting Date
Action Provisions
Policy Thresholds
(Dollars In Thousands)
Amount
Ratio
Amount
Ratio
Amount
Ratio
Amount
Ratio
Amount
Ratio
December 31, 2020:
Total capital to risk-weighted assets:
Consolidated
$
260,015
17.49
%
N/A
N/A
N/A
N/A
N/A
N/A
$
156,113
≥10.5
%
C&N Bank
236,943
15.98
%
118,602
≥8
%
155,665
≥10.5
%
148,252
≥10
%
155,665
≥10.5
%
Tier 1 capital to risk-weighted assets:
Consolidated
231,577
15.58
%
N/A
N/A
N/A
N/A
N/A
N/A
126,377
≥8.5
%
C&N Bank
225,058
15.18
%
88,951
≥6
%
126,015
≥8.5
%
118,602
≥8
%
126,015
≥8.5
%
Common equity tier 1 capital to risk-weighted assets:
Consolidated
231,577
15.58
%
N/A
N/A
N/A
N/A
N/A
N/A
104,075
≥7
%
C&N Bank
225,058
15.18
%
66,714
≥4.5
%
103,777
≥7.0
%
96,364
≥6.5
%
103,777
≥7
%
Tier 1 capital to average assets:
Consolidated
231,577
10.34
%
N/A
N/A
N/A
N/A
N/A
N/A
179,206
≥8
%
C&N Bank
225,058
10.12
%
88,959
≥4
%
N/A
N/A
111,199
≥5
%
177,919
≥8
%
December 31, 2019:
Total capital to risk-weighted assets:
Consolidated
$
228,057
20.70
%
N/A
N/A
N/A
N/A
N/A
N/A
$
115,689
≥10.5
%
C&N Bank
205,863
18.75
%
87,817
≥8
%
115,260
≥10.5
%
109,771
≥10
%
115,260
≥10.5
%
Tier 1 capital to risk-weighted assets:
Consolidated
211,388
19.19
%
N/A
N/A
N/A
N/A
N/A
N/A
93,653
≥8.5
%
C&N Bank
195,694
17.83
%
65,863
≥6
%
93,306
≥8.5
%
87,817
≥8
%
93,306
≥8.5
%
Common equity tier 1 capital to risk-weighted assets:
Consolidated
211,388
19.19
%
N/A
N/A
N/A
N/A
N/A
N/A
77,126
≥7
%
C&N Bank
195,694
17.83
%
49,397
≥4.5
%
76,840
≥7.0
%
71,351
≥6.5
%
76,840
≥7
%
Tier 1 capital to average assets:
Consolidated
211,388
13.10
%
N/A
N/A
N/A
N/A
N/A
N/A
129,126
≥8
%
C&N Bank
195,694
12.24
%
63,940
≥4
%
N/A
N/A
79,925
≥5
%
127,879
≥8
%
Federal regulatory authorities impose a capital rule providing that, 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 December 31, 2020, 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
8.5
%
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%
60%
≤1.875% and >1.25%
40%
≤1.25% and >0.625%
20%
≤0.625%
0%
At December 31, 2020, C&N Bank’s Capital Conservation Buffer, determined based on the minimum total capital ratio, was 7.98%.
Banking regulators limit the amount of dividends that may be paid by C&N Bank to the Corporation. Retained earnings against which dividends may be paid without prior approval of the banking regulators amounted to approximately $76,527,000 at December 31, 2020, subject to the minimum capital ratio requirements noted above.
Restrictions imposed by federal law prohibit the Corporation from borrowing from C&N Bank unless the loans are secured in specific amounts. Such secured loans to the Corporation are generally limited to 10% of C&N Bank’s tangible stockholder’s equity (excluding accumulated other comprehensive income) or $22,509,000 at December 31, 2020.
19. PARENT COMPANY ONLY
The following is condensed financial information for Citizens & Northern Corporation:
CONDENSED BALANCE SHEET
Dec. 31,
Dec. 31,
(In Thousands)
ASSETS
Cash
$
7,246
$
6,485
Investment in subsidiaries:
Citizens & Northern Bank
292,455
228,413
Citizens & Northern Investment Corporation
12,959
12,353
Bucktail Life Insurance Company
3,804
3,669
Other assets
TOTAL ASSETS
$
316,468
$
251,029
LIABILITIES AND STOCKHOLDERS' EQUITY
Subordinated debt
$
16,553
$
6,500
Other liabilities
Stockholders' equity
299,756
244,452
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
$
316,468
$
251,029
CONDENSED INCOME STATEMENT
(In Thousands)
Dividends from Citizens & Northern Bank
$
38,507
$
24,600
Expenses
(1,488)
(1,086)
Income before distributions in excess of income from subsidiaries
37,019
23,514
Distributions in excess of income from subsidiaries
(17,797)
(4,010)
NET INCOME
$
19,222
$
19,504
CONDENSED STATEMENT OF CASH FLOWS
(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income
$
19,222
$
19,504
Adjustments to reconcile net income to net cash provided by operating activities:
Accretion of purchase accounting adjustment
(38)
Loss on repayment of subordinated debt
Distributions in excess of income from subsidiaries
17,797
4,010
Decrease (increase) in other assets
(107)
Increase (decrease) in other liabilities
(81)
Net Cash Provided by Operating Activities
37,099
23,336
CASH FLOWS FROM INVESTING ACTIVITIES,
Net cash used in business combination
(21,837)
(9,698)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of subordinated debt
(510)
Proceeds from sale of treasury stock
Purchase of treasury stock
(163)
(189)
Dividends paid
(14,469)
(14,041)
Net Cash Used in Financing Activities
(14,501)
(14,542)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(904)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR
6,485
7,389
CASH AND CASH EQUIVALENTS, END OF YEAR
$
7,246
$
6,485
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Investment of net assets acquired in business combination in Citizens & Northern Bank
$
73,426
$
49,765
Common equity issued in business combination
$
41,429
$
32,953
Subordinated debt assumed in business combination
$
10,091
$
7,000
Other liabilities assumed in business combination
$
$
Interest paid
$
$
20. SUMMARY OF QUARTERLY CONSOLIDATED FINANCIAL DATA (Unaudited)
The following table presents summarized quarterly financial data for 2020 and 2019:
2020 Quarter Ended
March 31,
June 30,
Sept. 30,
Dec. 31,
(In Thousands Except Per Share Data) (Unaudited)
Interest income
$
17,037
$
16,513
$
21,751
$
21,859
Interest expense
2,755
2,267
2,469
2,104
Net interest income
14,282
14,246
19,282
19,755
Provision (credit) for loan losses
1,528
(176)
1,941
Net interest income after provision (credit) for loan losses
12,754
14,422
17,341
19,135
Other income
5,281
5,528
6,970
6,565
Net gains on available-for-sale debt securities
Loss on prepayment of borrowings
1,636
Merger-related expenses
6,402
Other expenses
12,912
12,274
14,648
15,775
Income before income tax provision
4,982
6,693
3,286
8,251
Income tax provision
1,255
1,481
Net income
$
4,166
$
5,438
$
2,848
$
6,770
Net income attributable to common shares
$
4,146
$
5,405
$
2,830
$
6,727
Net income per share - basic
$
0.30
$
0.39
$
0.18
$
0.43
Net income per share - diluted
$
0.30
$
0.39
$
0.18
$
0.43
2019 Quarter Ended
March 31,
June 30,
Sept. 30,
Dec. 31,
Interest income
$
13,065
$
17,139
$
17,277
$
17,290
Interest expense
1,350
2,934
3,000
2,999
Net interest income
11,715
14,205
14,277
14,291
(Credit) provision for loan losses
(957)
(4)
1,158
Net interest income after (credit) provision for loan losses
12,672
14,209
13,119
13,639
Other income
4,406
4,849
4,963
5,066
Net gains on available-for-sale debt securities
Merger-related expenses
3,301
Other expenses
10,696
11,422
11,486
11,834
Income before income tax provision
6,071
4,342
6,403
6,593
Income tax provision
1,096
1,135
Net income
$
5,090
$
3,649
$
5,307
$
5,458
Net income attributable to common shares
$
5,063
$
3,630
$
5,281
$
5,431
Net income per share - basic
$
0.41
$
0.27
$
0.39
$
0.40
Net income per share - diluted
$
0.41
$
0.27
$
0.39
$
0.40
21. DERIVATIVE FINANCIAL INSTRUMENTS
In connection with the acquisition of Covenant, the Corporation became a party to derivative financial instruments. These financial instruments consist of interest rate swap agreements which contain master netting and collateral provisions designed to protect the party at risk. At July 1, 2020, the aggregate notional amount of commercial loans subject to interest rate swaps was $137,176,000, and the Corporation recorded the fair value of the derivative asset of $7,932,000 and the fair value of the derivative liability of $7,932,000.
Interest rate swaps with commercial 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 from Covenant (acquired by the Corporation) into fixed interest rate exposures. Those interest rate swaps have been simultaneously economically hedged by offsetting interest rate swaps that Covenant had in place with a third party (assumed by the Corporation), 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.
At December 31, 2020, the aggregate notional amount of interest rate swaps was $135,740,000. Subsequent to the merger there were no interest rate swaps originated in 2020. There were no gross amounts of interest rate swap-related assets and liabilities not offset in the consolidated balance sheets at December 31, 2020. For the year ended December 31, 2020, the net impact on the consolidated statements of income from interest rate swaps was a reduction in interest income on loans of $698,000.
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 December 31, 2020:
(In Thousands)
At December 31, 2020
Asset Derivatives
Liability Derivatives
Notional
Fair
Notional
Fair
Amount
Value (1)
Amount
Value (2)
Interest rate swap agreements
$
67,870
$
6,566
$
67,870
$
6,566
(1) Included in other assets in the consolidated balance sheets.
(2) Included in accrued interest and other liabilities in the consolidated balance sheets.
The Corporation’s agreement with its derivative counterparty provides 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 counterparty 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 $12,182,000 were pledged as collateral against the Corporation’s liability related to the interest rate swaps at December 31, 2020.
22. FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS
The Corporation measures certain assets at fair value. Fair value is defined as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date. FASB ASC 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. 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 through corroboration with observable market data. Level 2 inputs include quoted market prices in active markets for similar assets, quoted market prices in markets that are not active for identical or similar assets 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 becoming active or inactive, changes in the availability of quoted prices, or changes in the availability of other market data.
At December 31, 2020 and 2019, assets measured at fair value and the valuation methods used are as follows:
December 31, 2020
Quoted
Prices
Other
in Active
Observable
Unobservable
Total
Markets
Inputs
Inputs
Fair
(In Thousands)
(Level 1)
(Level 2)
(Level 3)
Value
Recurring fair value measurements, assets:
AVAILABLE-FOR-SALE DEBT SECURITIES:
Obligations of the U.S. Treasury
$
$
12,182
$
$
12,182
Obligations of U.S. Government agencies
26,344
26,344
Obligations of states and political subdivisions:
Tax-exempt
122,401
122,401
Taxable
47,452
47,452
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities
38,176
38,176
Residential collateralized mortgage obligations
57,467
57,467
Commercial mortgage-backed securities
45,310
45,310
Total available-for-sale debt securities
349,332
349,332
Marketable equity security
1,000
1,000
Servicing rights
1,689
1,689
Interest rate swap agreements, assets
6,566
6,566
Total recurring fair value measurements, assets
$
1,000
$
355,898
$
1,689
$
358,587
Recurring fair value measurements, liabilities,
Interest rate swap agreements, liabilities
$
$
6,566
$
$
6,566
Nonrecurring fair value measurements, assets:
Impaired loans with a valuation allowance
$
$
$
8,082
$
8,082
Valuation allowance
(925)
(925)
Impaired loans, net
7,157
7,157
Foreclosed assets held for sale
1,338
1,338
Total nonrecurring fair value measurements, assets
$
$
$
8,495
$
8,495
December 31, 2019
Quoted
Prices
Other
in Active
Observable
Unobservable
Total
Markets
Inputs
Inputs
Fair
(In Thousands)
(Level 1)
(Level 2)
(Level 3)
Value
Recurring fair value measurements, assets:
AVAILABLE-FOR-SALE DEBT SECURITIES:
Obligations of U.S. Government agencies
$
$
17,000
$
$
17,000
Obligations of states and political subdivisions:
Tax-exempt
70,760
70,760
Taxable
36,303
36,303
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities
59,210
59,210
Residential collateralized mortgage obligations
114,723
114,723
Commercial mortgage-backed securities
48,727
48,727
Total available-for-sale debt securities
346,723
346,723
Marketable equity security
Servicing rights
1,277
1,277
Total recurring fair value measurements
$
$
346,723
$
1,277
$
348,979
Nonrecurring fair value measurements, assets
Impaired loans with a valuation allowance
$
$
$
3,375
$
3,375
Valuation allowance
(1,051)
(1,051)
Impaired loans, net
2,324
2,324
Foreclosed assets held for sale
2,886
2,886
Total nonrecurring fair value measurements, assets
$
$
$
5,210
$
5,210
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. The following table shows quantitative information regarding significant techniques and inputs used at December 31, 2020 and 2019 for servicing rights assets measured using unobservable inputs (Level 3 methodologies) on a recurring basis:
Fair Value at
12/31/2020
Valuation
Unobservable
Method or Value As of
Asset
(In Thousands)
Technique
Input(s)
12/31/2020
Servicing rights
$
1,689
Discounted cash flow
Discount rate
13.00
%
Rate used through modeling period
Loan prepayment speeds
277.00
%
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
Fair Value at
12/31/2019
Valuation
Unobservable
Method or Value As of
Asset
(In Thousands)
Technique
Input(s)
12/31/2019
Servicing rights
$
1,277
Discounted cash flow
Discount rate
12.50
%
Rate used through modeling period
Loan prepayment speeds
183.00
%
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
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.
Following is a reconciliation of activity for Level 3 assets (servicing rights) measured at fair value on a recurring basis:
(In Thousands)
Years Ended December 31,
Servicing rights balance, beginning of period
$
1,277
$
1,404
Originations of servicing rights
Unrealized losses included in earnings
(576)
(331)
Servicing rights balance, end of period
$
1,689
$
1,277
Loans are classified as impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Foreclosed
assets held for sale consist of real estate acquired by foreclosure. For impaired 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.
At December 31, 2020 and 2019, quantitative information regarding significant techniques and inputs used for nonrecurring fair value measurements using unobservable inputs (Level 3 methodologies) are as follows:
(Dollars In Thousands)
Weighted
Valuation
Average
Balance at
Allowance at
Fair Value at
Valuation
Unobservable
Discount at
Asset
12/31/2020
12/31/2020
12/31/2020
Technique
Inputs
12/31/2020
Impaired loans:
Residential mortgage loans - first and junior liens
$
1,509
$
$
1,347
Sales comparison
Discount to appraised value
%
Commercial:
Commercial loans secured by real estate
6,501
5,810
Sales comparison
Discount to appraised value
%
Commercial and industrial
Liquidation of assets
Discount to appraised value
%
Total impaired loans
$
8,082
$
$
7,157
Foreclosed assets held for sale - real estate:
Residential (1-4 family)
$
$
$
Sales comparison
Discount to appraised value
%
Commercial real estate
1,258
1,258
Sales comparison
Discount to appraised value
%
Total foreclosed assets held for sale
$
1,338
$
$
1,338
(Dollars In Thousands)
Weighted
Valuation
Average
Balance at
Allowance at
Fair Value at
Valuation
Unobservable
Discount at
Asset
12/31/2019
12/31/2019
12/31/2019
Technique
Inputs
12/31/2019
Impaired loans:
Residential mortgage loans - first and junior liens
$
$
$
Sales comparison
Discount to appraised value
%
Commercial:
Commercial and industrial
Sales comparison
Discount to appraised value
%
Commercial and industrial
Liquidation of accounts receivable
Discount to borrower's financial statement value
%
Commercial construction and land
1,261
Sales comparison
Discount to appraised value
%
Loans secured by farmland
Sales comparison
Discount to appraised value
%
Total impaired loans
$
3,375
$
1,051
$
2,324
Foreclosed assets held for sale - real estate:
Residential (1-4 family)
$
$
$
Sales comparison
Discount to appraised value
%
Land
Sales comparison
Discount to appraised value
%
Commercial real estate
2,524
2,524
Sales comparison
Discount to appraised value
%
Total foreclosed assets held for sale
$
2,886
$
$
2,886
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:
(In Thousands)
Fair Value
December 31, 2020
December 31, 2019
Hierarchy
Carrying
Fair
Carrying
Fair
Level
Amount
Value
Amount
Value
Financial assets:
Cash and cash equivalents
Level 1
$
96,017
$
96,017
$
31,122
$
31,122
Certificates of deposit
Level 2
5,840
6,054
4,080
4,227
Restricted equity securities (included in Other Assets)
Level 2
9,970
9,970
10,321
10,321
Loans, net
Level 3
1,632,824
1,646,207
1,172,386
1,181,000
Accrued interest receivable
Level 2
8,293
8,293
5,001
5,001
Interest rate swap agreements
Level 2
6,566
6,566
Financial liabilities:
Deposits with no stated maturity
Level 2
1,430,062
1,430,062
877,965
877,965
Time deposits
Level 2
390,407
393,566
374,695
376,738
Short-term borrowings
Level 2
20,022
19,974
86,220
86,166
Long-term borrowings
Level 2
54,608
55,723
52,127
52,040
Subordinated debt
Level 2
16,553
16,680
6,500
6,499
Accrued interest payable
Level 2
Interest rate swap agreements
Level 2
6,566
6,566
Report of Independent Registered Public Accounting Firm
Stockholders and Board of Directors of
Citizens & Northern Corporation
Opinions on the Financial Statements and Internal Control Over Financial Reporting
We have audited the accompanying consolidated balance sheets of Citizens & Northern Corporation and subsidiaries (collectively, the Corporation) as of December 31, 2020 and 2019, and the related consolidated statements of income, comprehensive income, changes in stockholders' equity and cash flows, for the years then ended, and the related notes (collectively referred to as the consolidated financial statements). We also have audited the Corporation's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Corporation as of December 31, 2020 and 2019, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework: (2013) issued by COSO.
Basis for Opinions
The Corporation's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Corporation's consolidated financial statements and an opinion on the Corporation's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
As described in Management's Report on Internal Control over Financial Reporting, management has excluded from its assessment the internal control over financial reporting of Covenant Financial, Inc., which was acquired on July 1, 2020, and whose financial statements constitute assets of approximately 22.7 percent of the Corporation's consolidated total assets, and interest income and noninterest income of approximately 10.7 percent of the Corporation's consolidated total interest income and noninterest income, as of and for the year ended December 31, 2020. Accordingly, our audit did not include the internal control over financial reporting of Covenant Financial, Inc.
Definition and Limitations of Internal Control Over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Allowance for Loan Losses, General Reserve - Qualitative Factors - Refer to Notes 1 and 8 to the Consolidated Financial Statements
Critical Audit Matter Description
As disclosed in Note 8 to the Corporation's consolidated financial statements, the Corporation's loan portfolio totaled $1,644,209,000 as of December 31, 2020, and the related allowance for loan losses was $11,385,000. As described in Note 1 and Note 8, the allowance for loan losses consists of two major components: (1) a specific component consisting of the valuation allowance for loans individually evaluated for impairment (specific component), representing $925,000 and (2) a general component consisting of the valuation allowance for pool of loans with similar risk characteristics collectively evaluated for impairment (general reserves), representing $10,460,000. The general reserves are further broken down as reserves assigned to each pool of loans based on both historical net charge-off experience ($1,146,000), and reserves related to qualitative factors ($9,314,000).
The determination of the allowance for loan losses requires significant estimates and subjective assumptions which require a high degree of judgment relating to how those assumptions impact probable incurred credit losses within the loan portfolio. Changes in these assumptions could have a material effect on the Corporation's financial results. Qualitative risk factors are evaluated for the impact on each of the three distinct loan segments (residential mortgage, commercial and consumer) within the loan portfolio. Each qualitative factor is assigned a value to reflect improving, stable or declining conditions based on management's judgment using relevant information available at the time of the evaluation. Management has designed qualitative factors that include such factors as 1) economic conditions within its market area, 2) the Corporation's lending policies, 3) changes or trends in the portfolio, 4) risk profile, 5) competition and 6) regulatory requirements. To formulate the additional allocations to the allowance for loan losses for general reserve qualitative factors, management multiplies the outstanding principal balance of the various commercial loan classes by the applicable qualitative factor. Management's identification and analysis of these issues requires significant judgment. We identified the estimate of the general reserves qualitative factors of the allowance for loan losses with respect to the commercial loan segments as a critical audit matter as it involved especially subjective auditor judgment.
How the Critical Audit Matter was Addressed in the Audit
The primary procedures we performed to address this critical audit matter included:
● Testing the design and operating effectiveness of internal controls relating to the evaluation of the management's assumptions and inputs used to develop the qualitative factor adjustments, including controls addressing:
o Management's review of the accuracy of inputs related to qualitative factor adjustments included within the allowance for loan losses calculation.
o Management's review of the qualitative and quantitative conclusions reached related to the qualitative factor adjustments and the resulting allocation to the allowance for loan losses.
o Management's process for determining classification and valuation of loans that have been separately evaluated from the general reserves of the allowance for loan losses due to their status as impaired or acquired loans.
o Management's review of risk rating changes of commercial loans which could have an impact on determination of qualitative factor adjustments.
● Substantively testing the appropriateness of the judgments and assumptions used in management's estimation process for developing the qualitative factor adjustments, including:
o Analyzing loans separately evaluated from the general reserve qualitative factors calculation for propriety of classification as acquired or impaired loans.
o Evaluating the relevance and reliability of underlying internal and external data inputs used as a basis for the qualitative factor adjustments and corroborating these inputs by comparing to the Corporation's lending practices, historical loan portfolio performance and third-party macroeconomic data, as well as giving appropriate consideration to current economic factors.
o Evaluating the completeness and accuracy of risk ratings for a selection of commercial loans and timeliness of commercial loan risk rating changes.
o Analytically evaluating the qualitative factors allocation year over year and testing allocations for reasonableness.
Business Combination, Fair Value of Acquired Loans Receivable - Refer to Note 3 to the Consolidated Financial Statements
Critical Audit Matter Description
As disclosed in Note 3 to the Corporation's consolidated financial statements, the Corporation completed the acquisition of Covenant Financial, Inc. on July 1, 2020. The Corporation accounted for the acquisition under the acquisition method of accounting for business combinations. Accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based on their respective fair values, including loans receivable of $464.2 million. Management estimated the fair value of loans receivable using a discounted cash flow method, which required management to make significant estimates and assumptions related to the prepayment speeds and recoveries, loss severities, as well as, determine discount rates to present value the cash flows. Changes in assumptions could impact the amount allocated to loans and ultimately the amount recorded as goodwill.
We identified the assessment of the fair value measurement of loans acquired in the Covenant acquisition as a critical audit matter. The assessment encompassed the evaluation of the fair value methodology for acquired loans, including the valuation assumptions and the inputs used to determine those assumptions. The valuation assumptions related to prepayment speeds, default rates, loss severities and discount rates, involved significant measurement uncertainty and required specialized skills and knowledge to evaluate. Additionally, there was a high degree of auditor judgment involved in designing and performing audit procedures in order to evaluate and test these key assumptions and inputs, including the involvement of fair value specialists.
How the Critical Audit Matter was Addressed in the Audit
The primary procedures we performed to address this critical audit matter included:
● Testing the design and operating effectiveness of internal controls relating to the evaluation of management's judgments and assumptions in estimating the fair value of acquired loans, including controls addressing:
o Development of the fair value methodology for the acquired loans.
o Determining completeness and accuracy of the data inputs used for key valuation assumptions.
o Evaluating the reasonableness of the judgments used for key assumptions.
● Substantively testing management's process, including evaluating their judgments and assumptions, for estimating the fair value of acquired loans receivable which included:
o Evaluating management's fair value measurement methodology for compliance with U.S. generally accepted accounting principles.
o Involving valuation professionals with specialized skills and knowledge to assess the appropriateness of the judgments, assumptions and data used and overall reasonableness of the fair values.
o Testing the completeness and accuracy of the acquired loan data used and evaluating the relevance of the loan data on the date of acquisition.
o Developing an independent estimate of the fair value of the loans using the Corporation's assumptions and independently developing key assumptions including prepayment speeds, default rates, loss severities and discount rates used by other market participants, and comparing the result to the Corporation's fair value estimate.
/s/ Baker Tilly US, LLP
We have served as the Corporation’s auditor since 1979.
Baker Tilly US, LLP (formerly known as Baker Tilly Virchow Krause, LLP)
Williamsport, Pennsylvania
March 5, 2021

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None

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ITEM 9A. CONTROLS AND PROCEDURES
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE 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. This evaluation did not include an assessment of those disclosure controls and procedures that are involved in, and did not include an assessment of, internal control over financial reporting as it relates to Covenant Financial, Inc. 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.
Except as described in the following paragraph, there were no significant changes in 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.
The Covenant Financial, Inc. acquisition was completed July 1, 2020, and during the last six months of 2020 the Corporation has been engaged in integrating processes and internal control over financial reporting for the former Covenant locations into those of the Corporation. Through August 24, 2020, information related to former Covenant loans, deposits and other customer data was processed using Covenant’s legacy computer system. Effective August 24, 2020, the integration of Covenant’s core customer data system into the Corporation’s system was completed. Though completion of the Covenant core system conversion was a significant milestone, at December 31, 2020, the Corporation’s management had not yet completed changes to processes, information technology systems and other components of internal control over financial reporting as part of integration activities.
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The Corporation’s management is responsible for establishing and maintaining effective internal control over financial reporting, as that term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). The Corporation’s system of internal control over financial reporting has been designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation and fair presentation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. The Corporation’s internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Corporation’s assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Corporation are being made only in accordance with authorizations of the Corporation’s management and directors; and (3) provide reasonable assurance regarding prevention, or timely detection and correction of unauthorized acquisition, use or disposition of the Corporation’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect and correct misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.
The Corporation’s management assessed the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2020, based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework (2013). Based on that assessment, we concluded that, as of December 31, 2020, the
Corporation’s internal control over financial reporting is effective based on the criteria established in Internal Control - Integrated Framework (2013).
The Corporation acquired Covenant Financial, Inc. (“Covenant”) effective July 1, 2020. Management excluded from its assessment of the Corporation’s internal control over financial reporting, as of December 31, 2020, Covenant’s internal control over financial reporting associated with assets of approximately 22.7% of the Corporation’s consolidated total assets, and interest income and noninterest income of approximately 10.7% of the Corporation’s consolidated total interest income and noninterest income, as of and for the year ended December 31, 2020.
Baker Tilly US, LLP, the independent registered public accounting firm that audited the Corporation’s consolidated financial statements, has issued an audit report on the Corporation’s internal control over financial reporting as of December 31, 2020. That report appears immediately prior to this report.
March 5, 2021
By:
/s/ J. Bradley Scovill
Date
President and Chief Executive Officer
March 5, 2021
By:
/s/ Mark A. Hughes
Date
Treasurer and Chief Financial Officer

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ITEM 9B. OTHER INFORMATION
ITEM 9B. OTHER INFORMATION
There was no information the Corporation was required to disclose in a report on Form 8-K during the fourth quarter 2020 that was not disclosed.
PART III

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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information concerning Directors and Executive Officers is incorporated herein by reference to disclosure under the captions “Proposal 1 - Election of Directors,” “Executive Officers,” “Information Concerning Security Ownership” and “Meetings and Committees of the Board of Directors” of the Corporation’s proxy statement dated March 12, 2021 for the annual meeting of stockholders to be held on April 22, 2021.
The Corporation’s Board of Directors has adopted a Code of Ethics, available on the Corporation’s web site at www.cnbankpa.com for the Corporation’s employees, officers and directors. (The provisions of the Code of Ethics are also included in the Corporation’s employee handbook.)

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ITEM 11. EXECUTIVE COMPENSATION
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated herein by reference to disclosure under the captions “Compensation Discussion and Analysis” and “Executive Compensation Tables” of the Corporation’s proxy statement dated March 12, 2021 for the annual meeting of stockholders to be held on April 22, 2021.

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference to disclosure under the caption “Beneficial Ownership of Executive Officers and Directors” of the Corporation’s proxy statement dated March 12, 2021 for the annual meeting of stockholders to be held on April 22, 2021.
“Equity Compensation Plan Information” as required by Item 201(d) of Regulation S-K is incorporated by reference herein from Item 5 (Market for Registrant’s Common Equity and Related Stockholder Matters) of this Form 10-K.

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information concerning loans and deposit balances with Directors and Executive Officers is provided in Note 15 to the Consolidated Financial Statements, which is included in Part II, Item 8 of this Annual Report on Form 10-K. Additional information, including information concerning director independence, is incorporated herein by reference to disclosure appearing under the captions “Director Independence” and “Related Person Transaction and Policies” of the Corporation’s proxy statement dated March 12, 2021 for the annual meeting of stockholders to be held on April 22, 2021.

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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information concerning services provided by the Corporation’s independent auditor Baker Tilly US, LLP, the audit committee’s pre-approval policies and procedures for such services, and fees paid by the Corporation to that firm, is incorporated herein by reference to disclosure under the caption “Fees of Independent Public Accountants” of the Corporation’s proxy statement dated March 12, 2021 for the annual meeting of stockholders to be held on April 22, 2021.
PART IV

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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1). The following consolidated financial statements are set forth in Part II, Item 8:
Page
Report of Independent Registered Public Accounting Firm
92-95
Financial Statements:
Consolidated Balance Sheets - December 31, 2020 and 2019
Consolidated Statements of Income - Years Ended December 31, 2020 and 2019
Consolidated Statements of Comprehensive Income - Years Ended December 31, 2020 and 2019
Consolidated Statements of Changes in Stockholders’ Equity - Years Ended December 31, 2020 and 2019
Consolidated Statements of Cash Flows - Years Ended December 31, 2020 and 2019
Notes to Consolidated Financial Statements
42-91
(a) (2) Financial statement schedules are not applicable or included in the financial statements or related notes.
2. Plan of acquisition, reorganization, arrangement, liquidation or succession:
2.1 Agreement and Plan of Merger dated September 27, 2018, between the Corporation and Monument Bancorp, Inc.
Incorporated by reference to Exhibit 2.1 of the Corporation’s Form 8-K filed September 28, 2018
2.2 Agreement and Plan of Merger dated December 18, 2019, between the Corporation and Covenant Financial, Inc.
Incorporated by reference to Exhibit 2.1 of the Corporation’s Form 8-K filed December 18, 2019
3. (i) Articles of Incorporation
Incorporated by reference to Exhibit 3.1 of the Corporation’s Form 8-K filed September 21, 2009
3. (ii) By-laws
Incorporated by reference to Exhibit 3.1(ii) of the Corporation's Form S-4/A filed April 20, 2020
4. (i) through (v) Instruments defining the rights of securities holders, including indentures
Not applicable
4. (vi) Description of registrant’s securities
Incorporated by reference to Exhibit 4.(vi) of the Corporation’s Form 10-K filed February 20, 2020
9. Voting trust agreement
Not applicable
10. Material contracts:
10.1 Form of Time-Based Restricted Stock agreement dated January 29, 2021 between the Corporation and Executive Officers pursuant to the Citizens & Northern Corporation Stock Incentive Plan
Filed herewith
10.2 Form of Performance-Based Restricted Stock Agreement dated January 29, 2021 between the Corporation and Executive Officers pursuant to the Citizens & Northern Corporation Stock Incentive Plan
Filed herewith
10.3 Form of Restricted Stock agreement dated January 29, 2021 between the Corporation and its independent directors pursuant to the Citizens & Northern Corporation Independent Directors Stock Incentive Plan
Filed herewith
10.4 2020 Annual Performance Incentive Award Plan, as Amended
Filed herewith
10.5 2021 Annual Performance Incentive Award Plan
Filed herewith
10.6 2021 Annual Performance Incentive Award Plan - Mortgage Lenders
Filed herewith
10.7 Deferred Compensation Agreement dated December 17, 2015
Incorporated by reference to Exhibit 10.8 filed with Corporation’s Form 10-K on February 15, 2018
10.8 Second Amendment to Employment Agreement dated August 24, 2018 between the Corporation and J. Bradley Scovill
Incorporated by reference to Exhibit 10.1 filed with Corporation’s Form 8-K on August 24, 2018
10.9 First Amendment to Employment Agreement dated June 26, 2017 between the Corporation and J. Bradley Scovill
Incorporated by reference to Exhibit 10.1 filed with Corporation’s Form 8-K on June 27, 2017
10.10 Employment agreement dated March 2, 2015 between the Corporation and J. Bradley Scovill
Incorporated by reference to Exhibit 10.1 filed with Corporation’s Form 8-K on February 9, 2015
10.11 Employment agreement dated September 19, 2013 between the Corporation and Mark A. Hughes
Incorporated by reference to Exhibit 10.2 filed with Corporation’s Form 8-K on September 19, 2013
10.12 Employment agreement dated September 19, 2013 between the Corporation and Harold F. Hoose, III
Incorporated by reference to Exhibit 10.3 filed with Corporation’s Form 8-K on September 19, 2013
10.13 Employment agreement dated September 19, 2013 between the Corporation and Deborah E. Scott
Incorporated by reference to Exhibit 10.4 filed with Corporation’s Form 8-K on September 19, 2013
10.14 Employment agreement dated May 18, 2020 between the Corporation and Janice E. Ward
Incorporated by reference to Exhibit 10.1 filed with Corporation's Form 10-Q on August 6, 2020
10.15 Employment agreement dated December 18, 2019 between the Corporation and Blair T. Rush
Filed herewith
10.16 Form of Indemnification Agreement dated June 27, 2020 between the Corporation and Janice E. Ward
Incorporated by reference to Exhibit 10.3 filed with Corporation's Form 10-Q on August 6, 2020
10.17 Form of Indemnification Agreement dated September 20, 2018 between the Corporation and J. Bradley Scovill
Incorporated by reference to Exhibit 10.1 filed with Corporation’s Form 10-Q on November 1, 2018
10.18 Form of Indemnification Agreement dated January 9, 2018 between the Corporation and Tracy E. Watkins
Incorporated by reference to Exhibit 10.6 filed with Corporation’s Form 10-K on February 15, 2018
10.19 Form of Indemnification Agreement dated February 11, 2015 between the Corporation and Stan R. Dunsmore
Incorporated by reference to Exhibit 10.9 filed with Corporation’s Form 10-K on February 26, 2015
10.20 Form of Indemnification Agreement dated January 2, 2013 between the Corporation and Shelley L. D’Haene
Incorporated by reference to Exhibit 10.5 filed with Corporation’s Form 10-K on February 21, 2013
10.21 Form of Indemnification Agreement dated January 19, 2011 between the Corporation and John M. Reber
Incorporated by reference to Exhibit 10.8 filed with Corporation’s Form 10-K on March 1, 2011
10.22 Form of Indemnification Agreements dated May 2004 between the Corporation and the Directors and certain officers
Incorporated by reference to Exhibit 10.1 filed with Corporation’s Form 10-K on March 14, 2005
10.23 Form of Indemnification Agreement dated February 16, 2021 between the Corporation and Blair T. Rush
Filed herewith
10.24 Change in Control Agreement dated January 9, 2018 between the Corporation and Tracy E. Watkins
Incorporated by reference to Exhibit 10.7 filed with Corporation’s Form 10-K on February 15, 2018
10.25 Change in Control Agreement dated March 17, 2015 between the Corporation and Stan R. Dunsmore
Incorporated by reference to Exhibit 10.1 filed with Corporation’s Form 10-Q on May 8, 2015
10.26 Change in Control Agreement dated January 2, 2013 between the Corporation and Shelley L. D’Haene
Incorporated by reference to Exhibit 10.7 filed with Corporation’s Form 10-K on February 21, 2013
10.27 Change in Control Agreement dated January 20, 2005 between the Corporation and John M. Reber
Incorporated by reference to Exhibit 10.18 filed with Corporation’s Form 10-K on February 18, 2016
10.28 Change in Control Agreement dated December 31, 2003 between the Corporation and Thomas L. Rudy, Jr.
Incorporated by reference to Exhibit 10.2 filed with the Corporation’s Form 10-K on March 14, 2005
10.39 Executive Compensation Recoupment Policy dated September 19, 2013
Incorporated by reference to Exhibit 10.5 filed with Corporation’s Form 8-K on September 19, 2013
10.30 Fifth Amendment to Citizens & Northern Corporation Stock Incentive Plan
Incorporated by reference to Exhibit 10.1 filed with Form 8-K on December 21, 2018
10.31 Fourth Amendment to Citizens & Northern Corporation Stock Incentive Plan and Annual Incentive Plan
Incorporated by reference to Exhibit 10.6 filed with Corporation’s Form 8-K on September 19, 2013
10.32 Third Amendment to Citizens & Northern Corporation Stock Incentive Plan
Incorporated by reference to Exhibit A to the Corporation’s proxy statement dated March 18, 2008 for the annual meeting of stockholders held on April 15, 2008
10.33 Second Amendment to Citizens & Northern Corporation Stock Incentive Plan
Incorporated by reference to Exhibit 10.5 filed with the Corporation’s Form 10-K on March 10, 2004
10.34 First Amendment to Citizens & Northern Corporation Stock Incentive Plan
Incorporated by reference to Exhibit 10.6 filed with the Corporation’s Form 10-K on March 10, 2004
10.35 Citizens & Northern Corporation Stock Incentive Plan
Incorporated by reference to Exhibit 10.7 filed with the Corporation’s Form 10-K on March 10, 2004
10.36 Second Amendment to Citizens & Northern Independent Directors Stock incentive Plan
Incorporated by reference to Exhibit 10.2 filed with Form 8-K on December 21, 2018
10.37 First Amendment to Citizens & Northern Corporation Independent Directors Stock Incentive Plan
Incorporated by reference to Exhibit B to the Corporation’s proxy statement dated March 18, 2008 for the annual meeting of stockholders held on April 15, 2008
10.38 Citizens & Northern Corporation Independent Directors Stock Incentive Plan
Incorporated by reference to Exhibit A to the Corporation’s proxy statement dated March 19, 2001 for the annual meeting of stockholders held on April 17, 2001.
10.39 Citizens & Northern Corporation Supplemental Executive Retirement Plan (as amended and restated)
Incorporated by reference to Exhibit 10.21 filed with the Corporation’s Form 10-K on March 6, 2009
10.40 Form of Indemnification Agreements dated May 24, 2018 between the Corporation and Directors Bobbi J. Kilmer, Terry L. Lehman, Frank G. Pellegrino and Aaron K. Singer
Incorporated by reference to Exhibit 10.1 filed with the Corporation’s Form 10-Q filed August 6, 2018
10.41 Form of Indemnification Agreement dated July 16, 2020 between the Corporation and Stephen M. Dorwart
Incorporated by reference to Exhibit 10.4 filed with the Corporation's Form 10-Q on August 6, 2020
10.42 Form of Indemnification Agreement dated July 16, 2020 between the Corporation and Robert G. Loughery
Incorporated by reference to Exhibit 10.5 filed with the Corporation's Form 10-Q on August 6, 2020
11. Statement re: computation of per share earnings
Information concerning the computation of earnings per share is provided in Note 4 to the Consolidated Financial Statements, which is included in Part II, Item 8 of Form 10-K
12. Statements re: computation of ratios
Not applicable
13. Annual report to security holders, Form 10-Q or quarterly report to security holders
Not applicable
14. Code of ethics
The Code of Ethics is available through the Corporation’s website at www.cnbankpa.com. To access the Code of Ethics, click on “About,” “Investor Relations,” “Corporate Governance Policies,” and “Code of Ethics.”
16. Letter re: change in certifying accountant
Not applicable
18. Letter re: change in accounting principles
Not applicable
21. Subsidiaries of the registrant
Filed herewith
22. Published report regarding matters submitted to vote of security holders
Not applicable
23. Consent of Independent Registered Public Accounting Firm
Filed herewith
24. Power of attorney
Not applicable
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
Filed herewith
32. Section 1350 certifications
Filed herewith
33. Report on assessment of compliance with servicing criteria for asset-backed securities
Not applicable
34. Attestation report on assessment of compliance with servicing criteria for asset-backed securities
Not applicable
35. Service compliance statement
Not applicable
99. Additional exhibits:
99.1 Additional information mailed or made available online to shareholders with proxy statement and Form 10-K on March 12, 2021
Filed herewith
100. XBRL-related documents
Not applicable
101. Interactive data file
Filed herewith
104. Cover page interactive data file
Not applicable