Citizens & Northern Corp: Form 10-Q for the period ended Jun 30, 2023

Certain statements in this section and elsewhere in this quarterly report on Form 10-Q are forward-looking statements. Citizens & Northern Corporation and its wholly-owned subsidiaries (collectively, the Corporation) intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995. Forward-looking statements, which are not historical facts, are based on certain assumptions and describe future plans, business objectives and expectations, and are generally identifiable by the use of words such as, "should", “likely”, "expect", “plan”, "anticipate", “target”, “forecast”, and “goal”. These forward-looking statements are subject to risks and uncertainties that are difficult to predict, may be beyond management’s control and could cause results to differ materially from those expressed or implied by such forward-looking statements. Factors which could have a material, adverse impact on the operations and future prospects of the Corporation include, but are not limited to, the following:

• 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
• recent adverse developments in the banking industry highlighted by high-profile bank failures and the potential impact of such developments on customer confidence, sources of liquidity and capital funding, and regulatory responses to these developments (including potential increases in the cost of deposit insurance assessments)
• the Corporation’s credit standards and its on-going credit assessment processes might not protect it from significant credit losses
• 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
• information security breach or other technology difficulties or failures
• 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
• the effect of the novel coronavirus (COVID-19) and related events

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.

EARNINGS OVERVIEW

Second Quarter 2023 as Compared to Second Quarter 2022

Second quarter 2023 net income was $6,043,000, or $0.39 per diluted share, as compared to $7,489,000, or $0.48 per diluted share, in the second quarter 2022. Significant variances were as follows:

• Net interest income of $20,362,000 in the second quarter 2023 was higher than the second quarter 2022 total by $737,000. The increase in net interest income was mainly driven by loan growth, as average earning assets increased $131,391,000, with an increase in average loans of $198,967,000, or 12.5%, while the average amortized cost balance of available-for-sale debt securities decreased $49,013,000 and average interest-bearing due from banks decreased $17,567,000. Average total deposits decreased $14,586,000, or 0.7%, while average total borrowed funds increased $140,333,000. The net interest margin was 3.53% in the second quarter 2023, down from 3.62% in the second quarter 2022. The interest rate spread decreased 0.49%, as the average rate on interest-bearing liabilities increased 1.41%, while the average yield on earning assets increased 0.92%.
• The provision for credit losses of $812,000 in the second quarter 2023 exceeded the second quarter 2022 amount by $504,000. The provision in the second quarter 2023 resulted mainly from an increase in the allowance for credit losses

(“ACL”) attributable to commercial loan growth, while the lower second quarter 2022 provision included the impact of a net reduction related to specific loans of $271,000.

• Noninterest income of $6,634,000 in the second quarter 2023 decreased $195,000 from the second quarter 2022 amount. Significant variances included the following:
• Brokerage and insurance revenue of $365,000 decreased $201,000 from the second quarter 2022, due to lower volume of new transactions.
• Loan servicing fees, net, of $190,000 decreased $168,000, as the fair value of servicing rights decreased $12,000 in the second quarter 2023 as compared to an increase of $150,000 in the second quarter 2022.
• Net gains from sale of loans of $139,000 decreased $81,000 from the second quarter 2022, reflecting a reduction in volume of residential mortgage loans sold.
• Other noninterest income of $1,587,000 increased $131,000 from the second quarter 2022, including dividends on FHLB-Pittsburgh stock totaling $290,000, an increase of $131,000 from the second quarter 2022.
• Trust revenue of $1,804,000 increased $89,000, consistent with recent appreciation in the trading prices of many U.S. equity securities.
• Noninterest expense of $18,722,000 in the second quarter 2023 increased $1,683,000 from the second quarter 2022 amount. Significant variances included the following:
• Other noninterest expense of $3,359,000 increased $928,000 from the second quarter 2022. Within this category, significant variances included the following:
• Legal fees totaled $327,000 in the second quarter 2023, an increase of $236,000 over the second quarter 2022 total, mainly due to fees incurred related to non-litigation-related corporate matters.
• FDIC insurance expense increased $224,000, reflecting the impact of an increase in the base deposit insurance assessment rate schedules applicable to all FDIC-insured banks.
• The reduction in expense related to other operational losses of $82,000 in the second quarter 2023, as previously described, was a lesser benefit by $158,000 as compared to a reduction in other operational losses of $240,000 in the second quarter 2022. The reduction in expense in the second quarter 2023 was related to check fraud and Trust Department tax-related compliance matters while most of the reduction in the second quarter 2022 was related to Trust Department tax compliance matters.
• Salaries and employee benefits expense of $10,777,000 increased $512,000 from the second quarter 2022, including an increase in base salaries expense of $555,000, or 8.0%. The increase in base salaries expense includes the effects of annual merit-based increases and an increase of 7 full-time employees to 412 at June 30, 2023 from 405 at June 30, 2022.
• Data processing and telecommunications of $1,900,000 increased $180,000 from the second quarter 2022, including the impact of increases in software licensing and maintenance costs as well as costs related to enhancements of data management capabilities.
• Professional fees of $564,000 increased $84,000, mainly due to increased costs related to commercial loan-related external credit reviews.

Six Months Ended June 30, 2023 as Compared to Six Months Ended June 30, 2022

Net income for the six-month period ended June 30, 2023 was $12,296,000, or $0.80 per diluted share, as compared to $14,384,000, or $0.92 per diluted share, for the first six months of 2022. Significant variances were as follows:

• Net interest income totaled $41,143,000 in the six months ended June 30, 2023, an increase of $1,186,000 over the total for the first six months of 2022. Average earning assets increased $131,499,000, with an increase in average loans of $188,542,000, or 12.0%, while interest-bearing due from banks decreased $34,926,000 and the average amortized cost balance of available-for-sale debt securities decreased $21,227,000. Average total deposits decreased $7,609,000, or 0.4%, while average total borrowed funds increased $138,329,000. The net interest margin was 3.62% for the first six months of 2023, down from 3.74% in the corresponding period of 2022. The interest rate spread decreased 0.46%, as the average rate on interest-bearing liabilities was higher by 1.19% while the average yield on earning assets increased 0.73%.
• Effective January 1, 2023, the Corporation adopted Accounting Standards Update (ASU) 2016-13, Financial Instruments-Credit Losses (Topic 326), as modified by subsequent ASUs, that required a change in accounting for credit losses on loans receivable from an incurred loss methodology to an expected credit loss methodology commonly referred to as “CECL.” Effective January 1, 2023, the Corporation recorded adjustments resulting from adopting CECL which increased the ACL on loans $2,104,000, increased the allowance for credit losses on off-balance sheet exposures $793,000, increased loans receivable $806,000, and decreased retained earnings (stockholders’ equity) $1,652,000. For the six months ended June 30, 2023, the provision for credit losses was $460,000, a reduction in expense of $739,000 from the first six months of 2022. The provision for the first six months of 2023 included a provision related to loans receivable of $524,000, partially offset by a credit related to off-balance sheet exposures of $64,000. The provision related to loans receivable was mainly attributable to loan growth, as the ACL as a percentage of gross loans receivable was 1.05% at June 30, 2023 as compared to 1.08% at January 1, 2023 upon the initial adoption of CECL.
• Noninterest income totaled $12,250,000 in the first six months of 2023, down $407,000 from the total for the first six months of 2022. Significant variances included the following:
• Net gains from sale of loans of $213,000 decreased $389,000, reflecting a reduction in volume of residential mortgage loans sold.
• Brokerage and insurance revenue of $795,000 decreased $293,000 due to lower volume of new transactions.
• Loan servicing fees, net, of $312,000 decreased $256,000, as the fair value of servicing rights decreased $95,000 in the first six months of 2023 as compared to an increase of $152,000 in the first six months of 2022.
• Other noninterest income of $2,358,000 increased $314,000 as dividends on FHLB-Pittsburgh stock totaled $507,000, an increase of $279,000.
• Noninterest expense totaled $37,809,000 for the first six months of 2023, an increase of $3,884,000 from the total for the first six months of 2022. Significant variances included the following:
• Other noninterest expense of $5,886,000 increased $1,551,000. Within this category, significant variances included the following:
• Other operational losses totaled $171,000 in the first six months of 2023 as compared to a net reduction in expense of $182,000 in the first six months of 2022. Most of the reduction in expense in 2022 was related to Trust Department tax compliance matters.
• Legal fees totaled $513,000 in the first six months of 2023, an increase of $293,000, mainly due to fees incurred related to non-litigation-related corporate matters.
• In the six-month period ended June 30, 2023, the allowance for disallowed SBA claims decreased $35,000, resulting in a reduction in expense of the same amount, reflecting better than previously estimated claims experience. In comparison, in the first six months of 2022, the allowance for disallowed SBA claims decreased $290,000, resulting in a decrease in expense of $290,000. At June 30, 2023, the allowance for disallowed SBA claims, which was included in accrued interest and other liabilities in the unaudited consolidated balance sheets, was $55,000.
• FDIC insurance expense increased $242,000, reflecting the impact of the increase in base deposit insurance assessment rate previously described.
• Salaries and employee benefits expense of $22,204,000 increased $1,332,000, including an increase in base salaries expense of $1,168,000, or 8.6%.
• Professional fees of $1,501,000 increased $532,000, including $389,000 of conversion costs related to a change in Wealth Management platform for providing brokerage and investment advisory services.
• Data processing and telecommunications of $3,836,000 increased $493,000, including the impact of increases in software licensing and maintenance costs as well as costs related to enhancements of data management capabilities.
• Pennsylvania shares tax expense of $807,000 for the first six months of 2023 is lower by $169,000, consistent with a reduction in C&N Bank’s equity that provides the base for determining the annual tax.

TABLE I – QUARTERLY FINANCIAL DATA

(Dollars In Thousands,

Except Per Share Data)

(Unaudited)

NONINTEREST INCOME

TABLE II – COMPARISON OF NONINTEREST INCOME

(Dollars in Thousands)

(Dollars in Thousands)

NONINTEREST EXPENSE

TABLE III - COMPARISON OF NONINTEREST EXPENSE

(Dollars in Thousands)

(Dollars in Thousands)

Additional detailed information concerning fluctuations in the Corporation’s earnings results and other financial information are provided in other sections of Management’s Discussion and Analysis.

CRITICAL ACCOUNTING POLICIES

The presentation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect many of the reported amounts and disclosures. Actual results could differ from these estimates.

Allowance for Credit Losses on Loans – A material estimate that is particularly susceptible to significant change is the determination of the allowance for credit losses (ACL) on loans. The Corporation maintains an ACL on loans which represents management’s estimate of expected net charge-offs over the life of the loans. The ACL includes two primary components: (i) an allowance established on loans which share similar risk characteristics collectively evaluated for credit losses (collective basis), and (ii) an allowance established on loans which do not share similar risk characteristics with any loan segment and which are individually evaluated for credit losses (individual basis). Management considers the determination of the ACL on loans to be critical because it requires significant judgment regarding estimates of expected credit losses based on the Corporation’s historical loss experience, current conditions and economic forecasts. Management’s evaluation is based upon a continuous review of the Corporation’s loans, with consideration given to evaluations resulting from examinations performed by regulatory authorities. Note 6 to the unaudited consolidated financial statements provides an overview of the process management uses for determining the ACL, and additional discussion of the ACL is provided in a separate section of Management’s Discussion and Analysis.

The ACL may increase or decrease due to changes in economic conditions affecting borrowers and macroeconomic variables, including new information regarding existing problem loans, identification of additional problem loans, changes in the fair value of underlying collateral, unforeseen events such as natural disasters and pandemics, and other factors. Because current economic conditions and forecasts can change and future events are inherently difficult to predict, the anticipated amount of estimated credit losses on loans, and therefore the appropriateness of the ACL, could change significantly.

Fair Value of Available-For-Sale Debt Securities – Another material estimate is the calculation of fair values of the Corporation’s debt securities. For most of the Corporation’s debt securities, the Corporation receives estimated fair values of debt securities from an independent valuation service, or from brokers. In developing fair values, the valuation service and the brokers use estimates of cash flows, based on historical performance of similar instruments in similar interest rate environments. Based on experience, management is aware that estimated fair values of debt securities tend to vary among brokers and other valuation services.

NET INTEREST INCOME

The Corporation’s primary source of operating income is net interest income, which is equal to the difference between the amounts of interest income and interest expense. Tables IV, V and VI include information regarding the Corporation’s net interest income for the three-month and six-month periods ended June 30, 2023 and 2022. In each of these tables, the amounts of interest income earned on tax-exempt securities and loans have been adjusted to a fully taxable-equivalent basis. The Corporation believes presentation of net interest income on a fully taxable-equivalent basis provides investors with meaningful information for purposes of comparing returns on tax-exempt securities and loans with returns on taxable securities and loans. Accordingly, the net interest income amounts reflected in these tables exceed the amounts presented in the consolidated financial statements. The discussion that follows is based on amounts in the related Tables.

Three-Month Periods Ended June 30, 2023 and 2022

For the three-month periods, fully taxable equivalent net interest income (a non-GAAP measure) of $20,601,000 in 2023 was $664,000 (3.3%) higher than in 2022. The increase in net interest income reflected the impact of growth in average earning assets of $131,391,000 (5.9%) in the second quarter 2023 as compared to the second quarter 2022, mainly attributable to loan growth. As presented in Table VI, the net impact of changes in volume of earning assets and interest-bearing liabilities increased net interest income in the second quarter 2023 as compared to second quarter 2022 by $1,106,000, while the net impact of changes in interest rates (primarily increases) decreased net interest income by $442,000. As presented in Table V, the Net Interest Margin was 3.53% in the second 2023 as compared to 3.62% in the second quarter 2022, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) decreased to 2.98% in 2023 from 3.47% in 2022. The average yield on earning assets of 4.84% was 0.92% higher in 2023 as compared to 2022, and the average rate on interest-bearing liabilities of 1.86% in 2023 was 1.41% higher.

INTEREST INCOME AND EARNING ASSETS

Interest income totaled $28,250,000 in 2023, an increase of $6,629,000, or 30.7% from 2022.

Interest and fees from loans receivable increased $6,547,000 in 2023 as compared to 2022. The fully taxable equivalent yield on loans in 2023 increased to 5.62% from 4.67% in 2022, reflecting the effects of rising interest rates on new loan originations. Average outstanding loans receivable increased $198,967,000 (12.5%) to $1,787,851,000 in 2023 from $1,588,884,000 in 2022. The Corporation has experienced robust loan growth over the last three quarters of 2022 and first six months of 2023, including growth in commercial real estate and residential mortgage loans.

Income from interest-bearing due from banks totaled $309,000 in 2023, an increase of $217,000 from the total for 2022. The average yield on interest-bearing due from banks was 4.15% in 2023, up from 0.78% in 2022. The average balance of interest-bearing due from banks was $29,861,000 in 2023, down from $47,428,000 in 2022. Within this category, the largest asset balance in 2023 and 2022 has been interest-bearing deposits held with the Federal Reserve.

Interest income from available-for-sale debt securities, on a fully taxable-equivalent basis, totaled $2,865,000 in 2023, down $130,000 from 2022, as the average balance (at amortized cost) of available-for-sale debt securities decreased $49,013,000. The average yield on available-for-sale debt securities was 2.20% for 2023, up from 2.10% in 2022.

INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES

Interest expense increased $5,965,000 to $7,649,000 in 2023 from $1,684,000 in 2022.

Interest expense on deposits increased $3,969,000, as the average rate on interest-bearing deposits increased to 1.45% in 2023 from 0.32% in 2022. Average total deposits (interest-bearing and noninterest-bearing) amounted to $1,948,405,000 for the second quarter 2023, down $14,586,000 (0.7%) from the second quarter 2022. Average time deposits increased $106,804,000 and average interest checking deposits increased $31,303,000, while the average total balance of money market accounts decreased $121,075,000 and average noninterest-bearing demand deposits decreased $23,474,000.

Interest expense on borrowed funds increased $1,996,000 in 2023 as compared to 2022, as the Corporation utilized higher levels of short-term and long-term FHLB borrowings to help provide funding for loan growth. Interest expense on short-term borrowings was $1,144,000 in 2023, up from $122,000 in 2022. The average balance of short-term borrowings increased to $87,479,000 in 2023 from $36,848,000 in 2022. The average rate on short-term borrowings was 5.25% in 2023 compared to 1.33% in 2022. Interest expense on long-term borrowings (FHLB advances) increased $1,001,000 to $1,056,000 in 2023 from $55,000 in 2022. The average balance of long-term borrowings was $110,982,000 in 2023, up from an average balance of $19,516,000 in 2022. Borrowings are classified as long-term within the Tables based on their term at origination or assumption in business combinations. The average rate on long-term borrowings was 3.82% in 2023 compared to 1.13% in 2022.

Six-Month Periods Ended June 30, 2023 and 2022

For the six-month periods, fully taxable equivalent net interest income was $41,651,000 in 2023, which was $1,080,000 (2.7%) higher than in 2022. Similar to the discussion for the second quarter 2023, the increase in net interest income reflected the impact of growth in average earning assets of $131,499,000 (6.0%) for the first six months of 2023 as compared to the first six months of 2022, including significant loan growth. As presented in Table VI, the net impact of changes in volume of earning assets and interest-bearing liabilities increased net interest income for the six months ended June 30, 2023 over the six months ended June 30, 2022 by $2,227,000, while the net impact of changes in interest rates (primarily increases) decreased net interest income by $1,147,000. As presented in Table V, the Net Interest Margin was 3.62% in the first six months of 2023 as compared to 3.74% in the first six months of 2022, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) decreased to 3.14% in 2023 from 3.60% in 2022. The average yield on earning assets of 4.75% was 0.73% higher in 2023 as compared to 2022, while the average rate on interest-bearing liabilities of 1.61% in 2023 was 1.19% higher.

INTEREST INCOME AND EARNING ASSETS

Interest income totaled $54,658,000 in 2023, an increase of $10,962,000 from 2022.

Interest and fees from loans receivable increased $10,569,000 in 2023 as compared to 2022. In the six-month period ended June 30, 2023, the fully taxable equivalent yield on loans was 5.53%, up from 4.84% in the first half of 2022, reflecting the effects of rising interest rates on new loan originations. Average outstanding loans receivable increased $188,542,000 (12.0%) to $1,757,028,000 in 2023 from $1,568,486,000 in 2022. As noted above, the Corporation has experienced growth in outstanding commercial real estate and residential mortgage loans over the last three quarters of 2022 and first six months of 2023.

Income from interest-bearing due from banks totaled $587,000 in 2023, an increase of $428,000 from 2022. The average yield on interest-bearing due from banks was 3.85% in 2023, up from 0.49% in 2022. The average balance of interest-bearing due from banks was $30,744,000 in 2023, down from $65,670,000 in 2022. The reduction in interest-bearing due from bank balances reflects the use of funds to help support loan growth. Within this category, the largest asset balance in 2023 and 2022 has been interest-bearing deposits held with the Federal Reserve.

Interest income from available-for-sale debt securities decreased $26,000 in 2023 from 2022. The average balance of available-for-sale debt securities (at amortized cost) decreased to $531,981,000 in 2023 from $553,208,000 in 2022, as net proceeds from maturities and sales of securities have been used to help fund loan growth. The average yield on available-for-sale debt securities was 2.21% for 2023 as compared to 2.14% in 2022.

INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES

For the six-month periods, interest expense increased $9,882,000 to $13,007,000 in 2023 from $3,125,000 in 2022.

Interest expense on deposits increased $6,289,000, as the average rate on interest-bearing deposits increased to 1.20% in 2023 from 0.29% in 2022. Average total deposits (interest-bearing and noninterest-bearing) amounted to $1,939,813,000 for the first six months of 2023, down $7,609,000 (0.3%) from the first six months of 2022. Average time deposits increased $71,146,000 and average interest checking deposits increased $34,706,000, while the average total balance of money market accounts decreased $106,746,000.

Interest expense on borrowed funds increased $3,593,000 in 2023 as compared to 2022. Interest expense on short-term borrowings of $2,241,000 in 2023 was up from $123,000 in 2022 as the average balance of short-term borrowings increased to $89,611,000 in 2023 from $19,394,000 in 2022. The average rate on short-term borrowings was 5.04% in 2023 compared to 1.28% in 2022. Interest expense on long-term borrowings (FHLB advances) increased $1,633,000 to $1,737,000 in 2023 from $104,000 in 2022. The average balance of long-term borrowings was $95,899,000 in 2023, up from an average balance of $22,791,000 in 2022. Borrowings are classified as long-term within the Tables based on their term at origination or assumption in business combinations. The average rate on long-term borrowings was 3.65% in 2023 compared to 0.92% in 2022. Interest expense on subordinated debt decreased $159,000 to $461,000 in 2023 from $620,000 in 2022. The average balance of subordinated debt decreased to $24,634,000 in 2023 from $29,694,000 in 2022, and the average rate on subordinated debt decreased to 3.77% in 2023 from 4.21% in 2022. In the second quarter 2022, the Corporation redeemed subordinated debt with aggregate par values of $8.5 million and a weighted-average interest rate of 6.29%.

TABLE IV - ANALYSIS OF INTEREST INCOME AND EXPENSE

(In Thousands)

Note: Interest income from tax-exempt securities and loans has been adjusted to a fully taxable-equivalent basis (a non-GAAP measure), using the Corporation’s marginal federal income tax rate of 21%. The following table is a reconciliation of net interest income under U.S. GAAP as compared to net interest income as adjusted to a fully taxable-equivalent basis.

(In Thousands)

48

TABLE V - Analysis of Average Daily Balances and Rates

(Dollars in Thousands)

(1) Annualized 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.

(3) Rates of return on earning assets and costs of funds are presented on an annualized basis.

TABLE VI - ANALYSIS OF VOLUME AND RATE CHANGES

(In Thousands)

(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 amount of the change in each.

INCOME TAXES

The income tax provision in interim periods is based on the Corporation’s estimate of the effective tax rate expected to be applicable for the full year. Due to lower levels of pre-tax income in 2023, the income tax provision for the second quarter 2023 of $1,419,000 was $199,000 lower than the provision for the second quarter 2022 and the provision for the six months ended June 30, 2023 of $2,828,000 was $273,000 lower than the amount for the first six months of 2022. The effective tax rate (tax provision as a percentage of pre-tax income) was 19.0% in the second quarter 2023 compared to 17.8% in the second quarter 2022 and 18.7% for the first six months of 2023 as compared to 17.7% for the first six months of 2022. The Corporation’s effective tax rates differ from the statutory rate of 21% principally because of the effects of tax-exempt interest income, state income taxes and other permanent differences.

The Corporation recognizes deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax basis of assets and liabilities. The net deferred tax asset at June 30, 2023 and December 31, 2022 represents the following temporary difference components:

(In Thousands)

The Corporation regularly reviews deferred tax assets for recoverability based on history of earnings, expectations for future earnings and expected timing of reversals of temporary differences. Realization of deferred tax assets ultimately depends on the existence of sufficient taxable income.

Management believes the recorded net deferred tax asset at June 30, 2023 is fully realizable; however, if management determines the Corporation will be unable to realize all or part of the net deferred tax asset, the Corporation would adjust the deferred tax asset, which would negatively impact earnings.

SECURITIES

Management continually evaluates several objectives in determining the size, securities mix and other characteristics of the available-for-sale debt securities (investment) portfolio. Key objectives include supporting liquidity needs and maximizing return on earning assets within reasonable risk parameters.

The composition of the available-for-sale debt securities portfolio at June 30, 2023, December 31, 2022 and December 31, 2021 is as follows:

(Dollars In Thousands)

(a) Source: Treasury.gov (Daily Treasury Par Yield Curve Rates)

As reflected in the table above, the fair value of available-for-sale securities was lower than the amortized cost basis by $61,437,000, or 12.1% at June 30, 2023 and $63,761,000 (11.3%) at December 31, 2022. In comparison, the aggregate unrealized gain position was $6,087,000 (1.2%) at December 31, 2021. The volatility in the fair value of the portfolio, including the significant reduction in fair value in 2022, resulted from changes in interest rates. As shown above, the market yield on the 5-year U.S. Treasury Note was 0.14% higher at June 30, 2023 in comparison to December 31, 2022, and 2.87% higher than at December 31, 2021.

Additional information regarding the potential impact of interest rate changes on all of the Corporation’s financial instruments is provided in Item 3, Quantitative and Qualitative Disclosures about Market Risk.

As described in Note 5 to the unaudited, consolidated financial statements, management determined the Corporation does not have the intent to sell, nor is it more likely than not that it will be required to sell, available-for-sale debt securities in an unrealized loss position at June 30, 2023 before it is able to recover the amortized cost basis. Further, management reviewed the Corporation’s holdings as of June 30, 2023 and concluded there were no credit-related declines in fair value. Additional information related to the types of securities held at June 30, 2023, other than securities issued or guaranteed by U.S. Government entities or agencies, is as follows:

• Bank holding company debt securities – All of the Corporation’s holdings of bank holding company debt securities were investment grade and there have been no payment defaults. There were seven securities with face amounts ranging from $3 million to $5 million, including one senior security and six subordinated securities. All of the issuers have publicly traded common stock. At June 30, 2023, the securities have external ratings ranging from BBB-/Baa3 to A-.
• Obligations of states and political subdivisions (municipal bonds) – All of the Corporation’s holdings of municipal bonds were investment grade and there have been no payment defaults. Summary ratings information at June 30, 2023, based on the amortized cost basis and reflecting the lowest enhanced or underlying rating by Moody’s, Standard & Poors or Fitch, is as follows: AAA or pre-refunded – 23% of the portfolio; AA – 70%; A – 7%.
• Private label commercial mortgage-backed securities (PLCMBS) – There were two PLCMBS securities, both of which were from the most senior payment (subordination) classes of their respective issuances. These securities were investment grade (rated Aaa), and there have been no payment defaults on these securities.

Based on the results of management’s assessment, there was no ACL required on available-for-sale debt securities in an unrealized loss position at June 30, 2023.

FINANCIAL CONDITION

This section includes information regarding the Corporation’s lending activities or other significant changes or exposures that are not otherwise addressed in Management’s Discussion and Analysis. Significant changes in the average balances of the Corporation’s earning assets and interest-bearing liabilities are described in the Net Interest Income section of Management’s Discussion and Analysis. Other significant balance sheet items, including securities, the allowance for credit losses and stockholders’ equity, are discussed in separate sections of Management’s Discussion and Analysis. Management does not expect the amount of purchases of bank premises and equipment to have a material, detrimental effect on the Corporation’s financial condition in 2023.

Table VII shows the composition of the loan portfolio at June 30, 2023 and at year-end from 2018 through 2022. The segments presented in Table VII have been revised from those used in prior year disclosures to be consistent with the pools used in determining the collectively evaluated portion of the allowance for credit losses based on the CECL methodology in 2023.

As presented in Table VII, total loans outstanding at June 30, 2023 of $1,814,510,000 was more than double the corresponding total at December 31, 2018. The increase in loans outstanding includes the impact of acquisitions of banks located in Southeastern Pennsylvania in 2018 and 2019. Primarily as a result of the acquisitions, as well as expansion by opening two offices in Southcentral Pennsylvania, the mix of the loan portfolio has changed to become predominantly commercial in nature. At June 30, 2023, commercial loans represented 75% of the portfolio while residential loans totaled 22% of the portfolio; in comparison, commercial loans totaled 48% and residential loans totaled 47% of the portfolio at December 31, 2018.

Table VII shows an increase in commercial and industrial loans to $222,923,000 at December 31, 2020 followed by reductions in 2021, 2022 and the first six months of 2023. The elevated balance of commercial and industrial loans at December 31, 2020 included Paycheck Protection Program (PPP) loans of $132,269,000, a substantial portion of which were subsequently repaid. The outstanding balance of PPP loans was $143,000 at June 30, 2023.

At June 30, 2023, gross loans outstanding increased $74,040,000 from December 31, 2022. Gross loans outstanding at December 31, 2022 increased $175,191,000, or 11.2%, from the total at December 31, 2021. The pace of loan growth in the second half of 2023 will depend on the impact of potential further increases in interest rates, potential deterioration in economic conditions and other factors.

While the Corporation’s lending activities are primarily concentrated in its market areas, a portion of the Corporation’s commercial loan segment consists of participation loans. Participation loans represent portions of larger commercial transactions for which other institutions are the “lead banks”. Although not the lead bank, the Corporation conducts detailed underwriting and monitoring of participation loan opportunities. Total participation loans outstanding amounted to $39,366,000 at June 30, 2023, down from $44,723,000 at December 31, 2022.

At June 30, 2023, the total recorded investment in non-owner occupied commercial real estate loans for which the primary purpose is utilization of office space by third parties was $95,644,000, or 5.3% of total gross loans receivable. Within this segment, at June 30, 2023, there was one loan with a recorded investment of $2,591,000 risk rated as Special Mention with no related ACL, and one loan with a recorded investment of $1,381,000 risk rated as Substandard and nonaccrual with an ACL of $38,000. The remainder of the non-owner occupied commercial real estate loans for the primary purpose of office space utilization totaling $91,672,000 were accruing interest and risk rated Pass at June 30, 2023.

The Corporation originates and sells residential mortgage loans to the secondary market through the MPF Xtra program administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Residential mortgages originated and sold through the MPF Xtra program consist primarily of conforming, prime loans sold to the Federal National Mortgage Association (Fannie Mae), a quasi-government entity. The Corporation also originates and sells residential mortgage loans to the secondary market through the MPF Original program, administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Residential mortgages originated and sold through the MPF Original program consist primarily of conforming, prime loans sold to the Federal Home Loan Bank of Pittsburgh. In late 2019, the Corporation began to originate and sell larger-balance, nonconforming mortgages under the MPF Direct Program, which is also administered by the Federal Home Loan Banks of Pittsburgh and Chicago. The Corporation does not retain servicing rights for loans sold under the MPF Direct Program. Through June 30, 2023, the Corporation’s activity under the MPF Direct Program has been minimal.

For loan sales originated under the MPF programs, the Corporation provides customary representations and warranties to investors that specify, among other things, that the loans have been underwritten to the standards established by the investor. The Corporation may be required to repurchase a loan and reimburse a portion of fees received or reimburse the investor for a credit loss incurred on a loan, if it is determined that the representations and warranties have not been met. Such repurchases or reimbursements generally result from an underwriting or documentation deficiency. At June 30, 2023, the total outstanding balance of loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $1,363,000, and the corresponding total outstanding balance of repurchased loans at December 31, 2022 was $1,515,000.

At June 30, 2023, outstanding balances of loans sold and serviced through the MPF Xtra and Original programs totaled $318,267,000, including loans sold through the MPF Xtra program of $152,930,000 and loans sold through the Original program of $165,337,000. At December 31, 2022, outstanding balances of loans sold and serviced through the two programs totaled $325,677,000, including loans sold through the MPF Xtra program of $155,506,000 and loans sold through the Original Program of $170,171,000. Based on the fairly limited volume of required repurchases to date, no allowance has been established for representation and warranty exposures as of June 30, 2023 and December 31, 2022.

TABLE VII - SUMMARY OF LOANS BY TYPE

Summary of Loans by Type

(In Thousands)

Additional details regarding the composition of the nonowner occupied commercial real estate loan portfolio at June 30, 2023 is as follows:

NONOWNER OCCUPIED COMMERCIAL REAL ESTATE

(In Thousands)

PROVISION AND ALLOWANCE FOR CREDIT LOSSES

On January 1, 2023, the Corporation adopted ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (ASC 326). This standard replaced the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (CECL) methodology. CECL requires an estimate of credit losses for the remaining estimated life of the financial asset using historical experience, current conditions, and reasonable and supportable forecasts. Note 1 to the unaudited consolidated financial statements provides a detailed explanation of the Corporation’s adopted accounting policies related to the application of CECL.

Effective January 1, 2023, the Corporation adopted ASC 326 using the modified retrospective approach for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2023 are presented under CECL while prior period amounts continue to be reported in accordance with previously applicable accounting standards (“Incurred Loss”). At January 1, 2023, the impact of adopting CECL included an increase in gross loans receivable of $806,000 as compared to December 31, 2022 and an increase in the allowance for credit losses of $2,104,000 as compared to the allowance for loan losses determined under the Incurred Loss method at December 31, 2022.

A summary of the provision for credit losses for the second and first quarters of 2023, and for the six-month period ended June 30, 2023, is as follows:

(In Thousands)

(1) The provision (credit) for credit losses on off-balance sheet exposures prior to January 1, 2023 was included in other noninterest expense in the consolidated statements of income.

The provision for credit losses for the second quarter and six-month periods ended June 30, 2023 was mainly attributable to loan growth, as the ACL as a percentage of gross loans receivable was 1.05% at June 30, 2023 and March 31, 2023 as compared to 1.08% at January 1, 2023 upon initial adoption of CECL. The net impact of changes in qualitative factors and the economic forecast used to calculate the ACL at June 30, 2023 was not significant in comparison to March 31, 2023. In comparison, the credit for credit losses in the first quarter 2023 resulted mainly from a reduction in the allowance related to the commercial segment of the portfolio resulting from a reduction in qualitative factors applied to commercial loan pools, mainly due to an improvement in data used to evaluate commercial real estate values in the Corporation’s relevant market areas, along with a reduction in the historical net charge-off percentage for non-owner occupied commercial real estate. In the first quarter 2023, these adjustments were partially offset by the impact of an increase in the allowance based on changes in the economic forecast. Within the net provision for credit losses on loans in the first six months of 2023, the net provision related to specific loans was $156,000, including net charge-offs of $187,000 and a net decrease in specific allowances on loans of $31,000. In comparison, the provision for the first six months of 2022 included a net credit of $124,000 related to specific loans (net charge-offs of $189,000 offset by a net decrease in specific allowances on loans of $313,000).

Table X shows that total nonperforming assets as a percentage of total assets was 0.58% at June 30, 2023, down from 1.04% at December 31, 2022 and lower than that at year-end 2018 through 2021. Total nonperforming assets were $14.5 million at June 30, 2023, down from $25.6 million at December 31, 2022. Similarly, total loans individually evaluated for credit loss decreased to $9.1 million at June 30, 2023 from $19.4 million at December 31, 2022. The net decrease in nonperforming assets at June 30, 2023 compared to December 31, 2022 included the impact of a $10.0 million payoff in the first quarter 2023 on a commercial loan relationship that was classified as nonaccrual at December 31, 2022. The reduction also included paydowns totaling $2,221,000 in the first six months of 2023 on a commercial loan for which partial charge-offs totaling $3,942,000 were recorded in 2022. The remaining carrying value of this loan was $433,000 at June 30, 2023. These reductions were partially offset by the addition to nonaccrual of a commercial loan relationship totaling

$1,931,000 at June 30, 2023. Based on an updated appraisal, the allowance related to the loans to this borrower was reduced from $182,000 at March 31, 2023 to $38,000 at June 30, 2023.

In the first six months of 2023, net charge-offs were minimal by historical standards, totaling $187,000, or 0.01% of average outstanding loans. Table VIII shows annual average net charge-off rates ranging from a high of 0.26% in 2022 to a low of 0.02% in 2018.

Over the period 2018-2022 and the first six months of 2023, each period includes a few large commercial relationships that have required significant monitoring and workout efforts. As a result, a limited number of relationships may significantly impact the total amount of allowance required on individual loans and may significantly impact the provision for credit losses and the amount of total charge-offs reported in any one period.

Management believes it has been conservative in its decisions concerning identification of loans requiring individual evaluation for credit loss, estimates of loss, and nonaccrual status; however, the actual losses realized from these relationships could vary materially from the allowances calculated as of June 30, 2023. Management continues to closely monitor its commercial loan relationships for possible credit losses and will adjust its estimates of loss and decisions concerning nonaccrual status, if appropriate.

Tables VIII through X present historical data related to loans and the allowance for credit losses.

TABLE VIII - ANALYSIS OF THE ALLOWANCE FOR CREDIT LOSSES

(Dollars In Thousands)

TABLE IX - COMPONENTS OF THE ALLOWANCE FOR CREDIT LOSSES

UPON ADOPTION OF CECL

(In Thousands)

PRIOR TO CECL ADOPTION

(In Thousands)

TABLE X - PAST DUE LOANS AND NONPERFORMING ASSETS

(Dollars In Thousands)

LIQUIDITY

Liquidity is the ability to quickly raise cash at a reasonable cost. An adequate liquidity position permits the Corporation to pay creditors, compensate for unforeseen deposit fluctuations and fund unexpected loan demand.

The Corporation maintains overnight borrowing facilities with several correspondent banks that provide a source of day-to-day liquidity. Also, the Corporation maintains borrowing facilities with the Federal Home Loan Bank of Pittsburgh, secured by various mortgage loans.

The Corporation has a line of credit with the Federal Reserve Bank of Philadelphia’s Discount Window. Management intends to use this line of credit as a contingency funding source. As collateral for the line, the Corporation has pledged available-for-sale debt securities with a carrying value of $22,814,000 at June 30, 2023.

The Corporation’s outstanding, available, and total credit facilities at June 30, 2023 and December 31, 2022 are as follows:

(In Thousands)

At June 30, 2023, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight and short-term advances of $30,500,000, long-term borrowings of $115,220,000 and letters of credit totaling $11,708,000. At December 31, 2022, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowing of $77,000,000, long-term borrowings of $62,272,000 and letters of credit totaling $10,827,000. Additional information regarding borrowed funds is included in Note 8 to the unaudited consolidated financial statements.

Additionally, the Corporation uses “RepoSweep” arrangements to borrow funds from commercial banking customers on an overnight basis. If required to raise cash in an emergency situation, the Corporation could sell available-for-sale securities to meet its obligations or use repurchase agreements placed with brokers to borrow funds secured by investment assets. In light of the unrealized loss at June 30, 2023 resulting from increases in interest rates in 2022, as described in more detail in the Securities section of Management’s Discussion and Analysis, management would be more likely in the near term to utilize securities as collateral for borrowings than to sell securities in such an emergency situation. At June 30, 2023, the carrying value of available-for-sale securities in excess of amounts required to meet pledging or repurchase agreement obligations was $257,537,000.

Deposits totaled $2,010,118,000 at June 30, 2023, up $12,525,000 (0.6%) from $1,997,593,000 at December 31, 2022. Excluding brokered deposits, adjusted total deposits at June 30, 2023 were lower by $37,145,000 (1.9%) as compared to December 31, 2022. Brokered deposits, consisting mainly of short-term certificates of deposits, totaled $70,653,000 at June 30, 2023, an increase of $49,670,000 from December 31, 2022. Average total deposits of $1,948,405,000 for the second quarter 2023 were up $17,279,000 from the first quarter 2023 and were down $14,586,000 (0.7%) as compared to the second quarter 2022. For the six months ended June 30, 2023, average total deposits of $1,939,813,000 were down $7,609,000 (0.4%) as compared to the first six months of 2022. The reduction in total deposits, excluding brokered deposits, included a reduction in the estimated amount of deposits in excess of FDIC insurance levels (uninsured deposit balances) of $83.6 million as compared to December 31, 2022. The net reduction in uninsured deposits resulted from several factors, including the impact of customer funds transferred to higher-yielding investment alternatives and seasonal reductions in municipal deposits. As shown in the table below, at June 30, 2023, estimated uninsured deposits totaled $605.8 million, or 29.9% of total deposits, down from $689.4 million or 34.2% of total deposits at December 31, 2022. Included in uninsured deposits are deposits collateralized by securities (almost exclusively municipal deposits) totaling $173.0 million at June 30, 2023. As shown in the table below, total uninsured and uncollateralized deposits amounted to 21.4% of total deposits, down from 24.0% at December 31, 2022.

As summarized in the table that immediately follows, the Corporation’s highly liquid sources of available funds described above, including unused borrowing capacity with the Federal Home Loan Bank of Pittsburgh, unused availability on the Federal Reserve Bank of Philadelphia’s discount window, available federal funds lines with other banks and unencumbered available-for-sale debt securities totaled $1.1 billion at June 30, 2023. Available funding from these sources totaled 181.6% of uninsured deposits and 254.1% of total uninsured and uncollateralized deposits at June 30, 2023.

Despite the reduction in deposits, excluding brokered deposits, in the first six months of 2023, based on the ample sources of highly liquid funds as described above, management believes the Corporation is well-positioned to meet its short-term and long-term funding obligations.

STOCKHOLDERS’ EQUITY AND CAPITAL ADEQUACY

In August 2018, the Federal Reserve Board issued an interim final rule that expanded applicability of the Board’s small bank holding company policy statement. The interim final rule raised the policy statement’s asset threshold from $1 billion to $3 billion in total consolidated assets for a bank holding company or savings and loan holding company that: (1) is not engaged in significant nonbanking activities; (2) does not conduct significant off-balance sheet activities; and (3) does not have a material amount of debt or equity securities, other than trust-preferred securities, outstanding. The interim final rule provides that, if warranted for supervisory purposes, the Federal Reserve may exclude a company from the threshold increase. Management believes the Corporation meets the conditions of the Federal Reserve’s small bank holding company policy statement and is therefore excluded from consolidated capital requirements at June 30, 2023; however, C&N Bank remains subject to regulatory capital requirements administered by the federal banking agencies.

Details concerning capital ratios at June 30, 2023 and December 31, 2022 are presented below. Management believes, as of June 30, 2023, that C&N Bank meets all capital adequacy requirements to which it is subject and maintains a capital conservation buffer (described in more detail below) that allows the Bank to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. Further, as reflected in the table below, the Corporation’s and C&N Bank’s capital ratios at June 30, 2023 and December 31, 2022 exceed the Corporation’s Board policy threshold levels.

(Dollars in Thousands)

In February 2021, the Corporation amended its treasury stock repurchase program. Under the amended program, the Corporation was authorized to repurchase up to 1,000,000 shares of its common stock. In the second quarter 2023, 237,187 shares were repurchased for a total cost of $4,635,000, at an average price of $19.54 per share. For the six months ended June 30, 2023, 314,617 shares were repurchased for a total cost of $6,297,000, at an average price of $20.01 per share. At June 30, 2023, there were 10,683 shares available to be repurchased under the program, all of which were repurchased in July 2023. Cumulatively, the Corporation repurchased 1,000,000 shares for a total cost of $23,086,000, at an average price of $23.09 per share. The Board of Directors has not announced a new treasury stock repurchase program, though the Board may consider doing so in the future depending on market conditions.

Future dividend payments and repurchases of common stock will depend upon maintenance of a strong financial condition, future earnings and capital and regulatory requirements. In addition, the Corporation and C&N Bank are subject to restrictions on the amount of dividends that may be paid without approval of banking regulatory authorities. Further, although the Corporation is no longer subject to the specific consolidated capital requirements described herein, the Corporation’s ability to pay dividends, repurchase stock or engage in other activities may be limited by the Federal Reserve if the Corporation fails to hold capital commensurate with its overall risk profile.

To avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization subject to the rule must hold a capital conservation buffer composed of common equity tier 1 capital above its minimum risk-based capital requirements. The buffer is measured relative to risk-weighted assets. At June 30, 2023, the minimum risk-based capital ratios, and the capital ratios including the capital conservation buffer, are as follows:

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:

At June 30, 2023, C&N Bank’s Capital Conservation Buffer, determined based on the minimum total capital ratio, was 7.37%.

The Corporation’s total stockholders’ equity is affected by fluctuations in the fair values of available-for-sale debt securities. The difference between amortized cost and fair value of available-for-sale debt securities, net of deferred income tax, is included in accumulated other comprehensive (loss) income within stockholders’ equity. Accumulated other comprehensive (loss) income is excluded from the Bank’s and Corporation’s regulatory capital ratios. The balance in accumulated other comprehensive loss related to unrealized losses on available-for-sale debt securities, net of deferred income tax, amounted to $48,536,000 at June 30, 2023 and $50,370,000 at December 31, 2022. The increase in stockholders’ equity in the first six months of 2023 from the change in accumulated other comprehensive loss resulted from a decrease in interest rates. Changes in accumulated other comprehensive loss are excluded from earnings and directly increase or decrease stockholders’ equity. To the extent unrealized losses on available-for-sale debt securities result from credit losses, unrealized losses are recorded as a charge against earnings. The securities section of Management’s Discussion and Analysis and Notes 1 and 5 to the unaudited consolidated financial statements provide additional information concerning management’s evaluation of available-for-sale debt securities for credit losses at June 30, 2023.

MARKET RISK

Market risk is the risk of loss arising from adverse changes in market rates and prices of the Corporation’s financial instruments. In addition to the effects of interest rates, the market prices of the Corporation’s available-for-sale debt securities are affected by fluctuations in the risk premiums (amounts of spread over risk-free rates) demanded by investors. Management attempts to limit the risk that economic conditions would force the Corporation to sell securities for realized losses by maintaining a strong capital position (discussed in the “Stockholders’ Equity and Capital Adequacy” section of Management’s Discussion and Analysis) and ample sources of liquidity (discussed in the “Liquidity” section of Management’s Discussion and Analysis).

The Corporation’s major category of market risk, interest rate risk, is discussed in the following section.

INTEREST RATE RISK

The Corporation uses a simulation model to calculate the potential effects of interest rate fluctuations on net interest income and the economic value of equity. For purposes of these calculations, the economic value of equity includes the discounted present values of financial instruments, such as securities, loans, deposits and borrowed funds, and the book values of nonfinancial assets and liabilities, such as premises and equipment and accrued expenses. The model measures and projects the amount of potential changes in net interest income, and calculates the discounted present value of anticipated cash flows of financial instruments, assuming an immediate increase or decrease in interest rates. Management ordinarily runs a variety of scenarios within a range of plus or minus 100-400 basis points of current rates.

The projected results based on the model includes the impact of estimates, at each level of interest rate change, regarding cash flows from principal repayments on loans and mortgage-backed securities and call activity on other investment securities. Further, the projected results are impacted by assumptions regarding the run-off and the extent of sensitivity to interest rate changes of deposits with no stated maturity (checking, savings and money market accounts). Actual results could vary significantly from these estimates, which could result in significant differences in the calculations of projected changes in net interest income and economic value of equity. Also, the model does not make estimates related to changes in the composition of the deposit portfolio that could occur due to rate competition, and the table does not necessarily reflect changes that management would make to realign the portfolio as a result of changes in interest rates. As described in more detail below, the Corporation made changes in the estimated rate sensitivity of nonmaturity deposits in the June 30, 2023 analysis presented in Table XI.

The Corporation’s Board of Directors has established policy guidelines for acceptable levels of interest rate risk, based on an immediate increase or decrease in interest rates. The policy limits acceptable fluctuations in net interest income from the baseline (flat rates) one-year scenario and variances in the economic value of equity from the baseline values based on current rates.

Table XI, which follows this discussion, is based on the results of calculations performed using the simulation model as of June 30, 2023 and December 31, 2022. In the analysis based on June 30, 2023 data, the amounts of net interest income and economic value of equity decrease, as compared to the amounts based on current interest rates, in both the upward and downward rate scenarios. The results based on June 30, 2023 data as presented in Table XI are significantly different from the results based on the modeling performed using December 31, 2022 data which showed the net interest income profile to be asset-sensitive. In the analysis based on June 30, 2023 data, management assumed that, in rising rate scenarios, the average rate to be paid on interest checking, savings and money market accounts would increase by a higher percentage of the baseline scenario as compared to the assumptions used in the December 31, 2022 analysis. This change reflects management’s assessment that, in light of significant increases in short-term interest rates that have occurred over the course of 2022 and year-to-date in 2023, the Corporation’s deposit rates would increase to a greater extent if such scenarios would occur. The change in results also reflects changes in deposit mix, as the carrying amount of total deposits without stated maturities was $101.9 million lower at June 30, 2023 as compared to December 31, 2022, while time deposits were higher by $114.4 million. Further, the reduction in net interest income in the downward rate scenarios reflects the limitations on the benefit of falling rates on some deposit types due to a 0% assumed floor. The Table also shows that as of the respective dates, despite the impact of the modeling changes and changes in deposit mix, the changes in net interest income and changes in economic value were within the policy limits in all scenarios.

Under U.S. generally accepted accounting principles, available-for-sale debt securities are carried at fair value as of each balance sheet date. The difference between amortized cost and fair value of available-for-sale debt securities, net of deferred income tax, is included in accumulated other comprehensive income (loss) within stockholders’ equity. Increases in interest rates have caused the fair value of the Corporation’s available-for-sale debt securities to decrease, resulting in an accumulated other comprehensive loss of $48.5 million at June 30, 2023. In contrast, most of the Corporation’s other financial instruments, including loans receivable (held for investment), deposits and borrowed funds are carried on the balance sheet at historical cost without adjustment for the impact of changes in interest rates.

TABLE XI – THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES

(In Thousands)

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

(In Thousands)

The Corporation’s management, under the supervision of and with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, has carried out an evaluation of the design and effectiveness of the Corporation’s disclosure controls and procedures as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Securities Exchange Act of 1934 as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Corporation’s disclosure controls and procedures are effective to ensure that all material information required to be disclosed in reports the Corporation files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.

There were no significant changes made to the Corporation’s internal control over financial reporting that occurred during the period covered by this report that have materially affected, or that are reasonably likely to affect, our internal control over financial reporting.

There have been no material changes from the risk factors previously disclosed in Item 1A of the Corporation’s Form 10-K filed March 16, 2023 except for the following:

Risks Related to Recent Banking Industry Turmoil

The Corporation is exposed to the risk that when a bank or other financial institution experiences financial difficulties, there could be an adverse “contagion” impact on other banking institutions. The recent failures of Silicon Valley Bank in California, Signature Bank in New York and First Republic Bank in California during the first and second quarters of 2023 have caused an element of panic and uncertainty in the investor community and among bank customers generally, including, specifically, deposit customers. While the Corporation does not believe that the circumstances of these three failures are necessarily indicators of broader issues for concern with all other banks or with the banking system itself, the failures are likely to reduce customer confidence, affect sources of funding and liquidity, increase regulatory requirements and costs, adversely affect financial markets and/or have negative reputational ramifications for institutions in the banking industry, including, possibly, the Corporation. The Corporation will continue to closely monitor the ongoing events and volatility in the financial services industry, together with any responsive measures taken by the banking regulators to mitigate or manage the turmoil.