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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q

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

For the quarterly period ended September 30, 2023
Or

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

For the transition period from_____________________ to ___________________

Commission file number 0-13222

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

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

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

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

N/A

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

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, Par value $1.0 per share
 
CZFS
 
The Nasdaq Stock Market, LLC
Title of Each Class
 
Trading
Symbol (s)

Name of Each Exchange
on Which Registered

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes ☒ No ☐

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

Large accelerated filer     ☐
Accelerated filer     ☐
   
Non-accelerated filer     ☒
Smaller reporting company     ☒
   
Emerging growth company     ☐
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

The number of outstanding shares of the Registrant’s Common Stock, as of November 1, 2023, was 4,706,111.



Citizens Financial Services, Inc.
Form 10-Q

INDEX

   
PAGE
Part I
FINANCIAL INFORMATION
 
Item 1.
Financial Statements (unaudited):
 

1

2

3

4

5

Notes to Consolidated Financial Statements
 6-38
Item 2.
39-63
Item 3.
64
Item 4.
64
     
Part II
OTHER INFORMATION
 
Item 1.
64
Item 1A.
64-65
Item 2.
66
Item 3.
66
Item 4.
66
Item 5.
66
Item 6.
66

Signatures
67

CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED BALANCE SHEET
(UNAUDITED)

(in thousands except share data)
 
September 30,
2023
   
December 31,
2022
 
ASSETS:
           
Cash and due from banks:
           
Noninterest-bearing
 
$
25,267
   
$
24,814
 
Interest-bearing
   
18,069
     
1,397
 
Total cash and cash equivalents
   
43,336
     
26,211
 
Interest bearing time deposits with other banks
   
4,566
     
6,055
 
Equity securities
   
1,858
     
2,208
 
Available-for-sale securities
   
417,807
     
439,506
 
Loans held for sale
   
14,155
     
725
 
 
               
Loans (net of allowance for credit losses - loans: 2023 $21,455 and 2022, $18,552)
   
2,224,941
     
1,706,447
 
 
               
Premises and equipment
   
21,421
     
17,619
 
Accrued interest receivable
   
10,327
     
7,332
 
Goodwill
   
84,758
     
31,376
 
Bank owned life insurance
   
49,586
     
39,355
 
Other intangibles
   
3,866
     
1,272
 
Fair value of derivative instruments
    18,144       16,599  
Deferred tax asset
    21,384       12,886  
Other assets
   
43,067
     
25,802
 
TOTAL ASSETS
 
$
2,959,216
   
$
2,333,393
 
 
               
LIABILITIES:
               
Deposits:
               
Noninterest-bearing
 
$
542,144
   
$
396,260
 
Interest-bearing
   
1,792,991
     
1,447,948
 
Total deposits
   
2,335,135
     
1,844,208
 
Borrowed funds
   
316,151
     
257,278
 
Accrued interest payable
   
2,726
     
1,232
 
Fair value of derivative instruments - liability
    10,694       9,726  
Other liabilities
   
31,824
     
20,802
 
TOTAL LIABILITIES
   
2,696,530
     
2,133,246
 
STOCKHOLDERS’ EQUITY:
               
Preferred Stock                
$1.00 par value; authorized 3,000,000 shares at September 30, 2023 and December 31, 2022; none issued in 2023 or 2022
   
-
     
-
 
Common Stock                
$1.00 par value; authorized 25,000,000 shares at September 30, 2023 and December 31, 2022; issued 5,160,754 at September 30, 2023 and 4,427,687 at December 31, 2022
   
5,161
     
4,428
 
Additional paid-in capital
   
143,302
     
80,911
 
Retained earnings
   
167,740
     
164,922
 
Accumulated other comprehensive loss
   
(36,643
)
   
(33,141
)
Treasury stock, at cost: 454,643 shares at September 30, 2023 and 456,478 shares at December 31, 2022
   
(16,874
)
   
(16,973
)
TOTAL STOCKHOLDERS’ EQUITY
   
262,686
     
200,147
 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
 
$
2,959,216
   
$
2,333,393
 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

1
CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)

 
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
(in thousands, except share and per share data)
 
2023
   
2022
   
2023
   
2022
 
INTEREST INCOME:
                       
Interest and fees on loans
 
$
33,772
   
$
19,396
   
$
80,438
   
$
52,436
 
Interest-bearing deposits with banks
   
264
     
61
     
462
     
333
 
Investment securities:
                               
Taxable
   
1,734
     
1,514
     
4,973
     
4,050
 
Nontaxable
   
540
     
630
     
1,729
     
1,830
 
Dividends
   
379
     
182
     
1,004
     
356
 
TOTAL INTEREST INCOME
   
36,689
     
21,783
     
88,606
     
59,005
 
INTEREST EXPENSE:
                               
Deposits
   
10,100
     
1,838
     
19,519
     
4,469
 
Borrowed funds
   
4,185
     
1,099
     
10,682
     
1,699
 
TOTAL INTEREST EXPENSE
   
14,285
     
2,937
     
30,201
     
6,168
 
NET INTEREST INCOME
   
22,404
     
18,846
     
58,405
     
52,837
 
Provision for credit losses
   
475
     
725
     
737
     
1,425
 
Provision for credit losses - acquisition day 1 non-PCD
    -       -       4,591       -  
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES
   
21,929
     
18,121
     
53,077
     
51,412
 
NON-INTEREST INCOME:
                               
Service charges
   
1,692
     
1,509
     
4,196
     
4,081
 
Trust
   
172
     
187
     
583
     
620
 
Brokerage and insurance
   
473
     
446
     
1,429
     
1,428
 
Gains on loans sold
   
460
     
95
     
674
     
241
 
Equity security gains (losses), net
   
69
     
(19
)
   
(223
)
   
(198
)
Available for sale security gains (losses), net
   
-
     
(6
)
   
(51
)
   
(6
)
Earnings on bank owned life insurance
   
489
     
216
     
941
     
635
 
Other
   
307
     
264
     
567
     
626
 
TOTAL NON-INTEREST INCOME
   
3,662
     
2,692
     
8,116
     
7,427
 
NON-INTEREST EXPENSES:
                               
Salaries and employee benefits
   
10,005
     
6,933
     
25,598
     
20,964
 
Occupancy
   
1,221
     
779
     
2,870
     
2,327
 
Furniture and equipment
   
255
     
122
     
568
     
416
 
Professional fees
   
506
     
588
     
1,274
     
1,321
 
FDIC insurance
   
375
     
160
     
1,000
     
440
 
Pennsylvania shares tax
   
297
     
339
     
893
     
1,017
 
Amortization of intangibles
   
157
     
40
     
219
     
120
 
Merger and acquisition
    623       -       9,269
      -
 
Software expenses
   
551
     
370
     
1,274
     
1,069
 
ORE expenses (income)
   
111
     
122
     
126
     
(125
)
Other
   
2,343
     
2,161
     
5,811
     
5,496
 
TOTAL NON-INTEREST EXPENSES
   
16,444
     
11,614
     
48,902
     
33,045
 
Income before provision for income taxes
   
9,147
     
9,199
     
12,291
     
25,794
 
Provision for income taxes
   
1,599
     
1,655
     
2,020
     
4,609
 
NET INCOME
 
$
7,548
   
$
7,544
   
$
10,271
   
$
21,185
 
                                 
PER COMMON SHARE DATA:
                               
Net Income - Basic
 
$
1.61
   
$
1.88
   
$
2.40
   
$
5.28
 
Net Income - Diluted
 
$
1.61
   
$
1.88
   
$
2.40
   
$
5.28
 
Cash Dividends Paid
 
$
0.490
   
$
0.475
   
$
1.451
   
$
1.407
 
                                 
Number of shares used in computation - basic
   
4,699,952
     
4,006,794
     
4,275,259
     
4,009,855
 
Number of shares used in computation - diluted
   
4,699,952
     
4,007,028
     
4,275,259
     
4,009,857
 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

2
CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(UNAUDITED)

   
Three Months Ended
September 30,
   
Nine Months Ended,
September 30,
 
(in thousands)
 
2023
   
2022
   
2023
   
2022
 
Net income
 
$
7,548
   
$
7,544
   
$
10,271
   
$
21,185
 
Other comprehensive income (loss):
                               
Change in unrealized gains (losses) on available for sale securities
   
(7,627
)
   
(13,578
)
   
(4,645
)
   
(50,581
)
Income tax effect
   
1,602
     
2,851
     
976
     
10,622
 
Change in unrecognized pension cost
   
7
     
24
     
21
     
72
 
Income tax effect
   
(1
)
   
(5
)
   
(4
)
   
(15
)
Change in unrealized loss on interest rate swaps
   
450
     
1,781
     
140
     
5,314
 
Income tax effect
   
(94
)
   
(374
)
   
(29
)
   
(1,117
)
   Less:  Reclassification adjustment for investment security gains included in net income
    -       6       51       6  
   Income tax effect
    -       (1 )     (12 )     (1 )
Other comprehensive income (loss), net of tax
   
(5,663
)
   
(9,296
)
   
(3,502
)
   
(35,700
)
Comprehensive income (loss)
 
$
1,885
   
$
(1,752
)
 
$
6,769
   
$
(14,515
)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

3
CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
(UNAUDITED)

 
 
Common Stock
   
Additional
Paid-in
    Retained    
Accumulated
Other
Comprehensive
    Treasury        
(in thousands, except share data)
 
Shares
   
Amount
   
Capital
   
Earnings
   
Income (Loss)
   
Stock
   
Total
 
                                           
Balance, June 30, 2023
   
5,160,754
     
5,161
     
143,351
     
162,499
     
(30,980
)
   
(16,803
)
   
263,228
 
                                                         
Comprehensive income:
                                                       
Net income
                           
7,548
                     
7,548
 
Net other comprehensive income (loss)
                                   
(5,663
)
           
(5,663
)
Purchase of treasury stock (2,772 shares)
                                            (264 )     (264 )
Restricted stock, executive and Board of Director awards (2,167 shares)                     (86 )                     168       82  
Restricted stock vesting
                    34
                      -       34  
Sale of treasury stock to employees (410 shares)                     -                       28       28  
Forfeited restricted stock (52 shares)
                    3                       (3 )     -  
Cash dividends, $0.490 per share
                           
(2,307
)
                   
(2,307
)
Balance, September 30, 2023
   
5,160,754
   
$
5,161
   
$
143,302
   
$
167,740
   
$
(36,643
)
 
$
(16,874
)
 
$
262,686
 
                                                         
Balance, December 31, 2022
   
4,427,687
   
$
4,428
   
$
80,911
   
$
164,922
   
$
(33,141
)
 
$
(16,973
)
 
$
200,147
 
 
                                                       
Comprehensive income:
                                                       
Net income
                           
10,271
                     
10,271
 
Net other comprehensive income (loss)
                                   
(3,502
)
           
(3,502
)
Stock dividend     39,209       39       2,982       (3,021 )                     -  
Issuance of Common stock     693,858       694       59,443                               60,137  
Purchase of treasury stock (2,772 shares)                                             (264 )     (264 )
Restricted stock, executive and Board of Director awards (2,242 shares)
                   
(231
)
                   
348
      117
 
Restricted stock vesting
                   
184
                             
184
 
Sale of treasury stock to employees (410 shares)                     -                       28       28  
Forfeited restricted stock (213 shares)
                   
13
                     
(13
)
   
-
 
Change in Accounting policy for allowance for credit losses                             1,766       -               1,766  
Cash dividends, $1.451 per share
                           
(6,198
)
                   
(6,198
)
Balance, September 30, 2023
   
5,160,754
   
$
5,161
   
$
143,302
   
$
167,740
   
$
(36,643
)
 
$
(16,874
)
 
$
262,686
 
                                                         
Balance, June 30, 2022
   
4,427,687
     
4,428
     
80,892
     
153,315
     
(26,559
)
   
(17,044
)
   
195,032
 
                                                         
Comprehensive income:
                                                       
Net income
                           
7,544
                     
7,544
 
Net other comprehensive income (loss)
                                   
(9,296
)
           
(9,296
)
Purchase of treasury stock (18,584 shares)
                                           
-
     
-
 
Restricted stock, executive and Board of Director awards (769 shares)
                   
(52
)
                   
52
     
-
 
Restricted stock vesting
                    16                               16  
Sale of treasury stock to employees (540 shares)
                    5                       35       40  
Forfeited restricted stock (120 shares)                     8                       (8 )     -  
Cash dividends, $0.475 per share
                           
(1,906
)
                   
(1,906
)
Balance, September 30, 2022
   
4,427,687
   
$
4,428
   
$
80,869
   
$
158,953
   
$
(35,855
)
 
$
(16,965
)
 
$
191,430
 
                                                         
Balance, December 31, 2021
   
4,388,901
   
$
4,389
   
$
78,395
   
$
146,010
   
$
(155
)
 
$
(16,147
)
 
$
212,492
 
                                                         
Comprehensive income:
                                                       
Net income
                           
21,185
                     
21,185
 
Net other comprehensive income (loss)
                                   
(35,700
)
           
(35,700
)
Stock dividend     38,786       39       2,521       (2,560 )                     -  
Purchase of treasury stock (18,697 shares)
                                           
(1,279
)
   
(1,279
)
Restricted stock, executive and Board of Director awards (5,392 shares)
                   
(221
)
                   
365
     
144
 
Restricted stock vesting
                   
158
                             
158
 
Sale of treasury stock to employees (1,600 shares)                     6                       106       112  
Forfeited restricted stock (159 shares)                     10                       (10 )     -  
Cash dividends, $1.407 per share
                           
(5,682
)
                   
(5,682
)
Balance, September 30, 2022
   
4,427,687
   
$
4,428
   
$
80,869
   
$
158,953
   
$
(35,855
)
 
$
(16,965
)
 
$
191,430
 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

4
CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)

 
Nine Months Ended
September 30,
 
(in thousands)
 
2023
   
2022
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income
 
$
10,271
   
$
21,185
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for credit losses
   
5,328
     
1,425
 
Depreciation and amortization
   
1,022
     
773
 
Amortization and accretion of loans and other assets
   
(2,392
)
   
(1,386
)
Amortization and accretion of investment securities
   
1,197
     
1,467
 
Deferred income taxes
   
355
     
86
 
Investment securities losses, net
   
274
     
204
 
Earnings on bank owned life insurance
   
(941
)
   
(635
)
          Vesting of restricted stock
    184       158  
Originations of loans held for sale
   
(53,510
)
   
(9,447
)
Proceeds from sales of loans held for sale
   
51,428
     
12,864
 
Realized gains on loans sold
   
(674
)
   
(241
)
Increase in accrued interest receivable
   
(769
)
   
(1,309
)
Gain on sale of foreclosed assets held for sale
    (98 )     (481 )
Increase in accrued interest payable
   
609
     
211
 
Other, net
   
(1,955
)
   
(536
)
Net cash provided by operating activities
   
10,329
     
24,338
 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Available-for-sale securities:
               
        Proceeds from sales
    86,504       4,492  
Proceeds from maturity and principal repayments
   
18,847
     
28,553
 
Purchase of securities
   
(10,246
)
   
(117,913
)
Purchase of equity securities
    -       (218 )
Proceeds from sale of equity securities
    127       33  
Purchase of interest bearing time deposits with other banks
   
-
     
(3,720
)
   Proceeds from sale of interest bearing time deposits with other banks     -       2,733  
    Proceeds from life insurance     1,097       -  
Proceeds from matured interest bearing time deposits with other banks
    1,489       5,954  
Proceeds from redemption of regulatory stock
   
19,936
     
3,811
 
Purchase of regulatory stock
   
(22,105
)
   
(12,081
)
Net increase in loans
   
(42,162
)
   
(295,059
)
Purchase of premises and equipment
   
(2,308
)
   
(1,150
)
Investments in low income housing partnerships
    (616 )     (949 )
Proceeds from sale of foreclosed assets held for sale
   
314
     
845
 
   Acquisition, net of cash paid
    4,905       -  
Net cash provided by (used in) investing activities
   
55,782
     
(384,669
)
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Net (decrease) increase in deposits
   
(42,438
)
   
32,559
 
   Proceeds from long-term borrowings
    20,000       -  
Repayments of long-term borrowings
   
-
     
(4,725
)
Net (decrease) increase in short-term borrowed funds
   
(20,115
)
   
189,661
 
Purchase of treasury stock
   
(264
)
   
(1,279
)
   Sale of treasury stock to employees     28       112  
Dividends paid
   
(6,197
)
   
(5,682
)
Net cash (used in) provided by financing activities
   
(48,986
)
   
210,646
 
Net  increase (decrease) in cash and cash equivalents
   
17,125
     
(149,685
)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
   
26,211
     
172,833
 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
 
$
43,336
   
$
23,148
 
                 
Supplemental Disclosures of Cash Flow Information:
               
Interest paid
 
$
28,707
   
$
5,957
 
Income taxes paid
 
$
4,600
   
$
4,600
 
Loans transferred to foreclosed property
 
$
147
   
$
61
 
Right of use asset and liability
 
$
5
   
$
1,518
 
       Stock Dividend   $ 3,021     $ 2,560  
CECL adjustment
  $ 3,300     $ -  

Acquisition of
 
HV Bancorp, Inc.
 
      Non-cash assets acquired
     
            Available-for-sale securities
 
$
79,248
 
            Interest bearing time deposits with other banks
   
-
 
            Loans held for sale
   
10,750
 
            Loans
   
475,338
 
            Premises and equipment
   
2,310
 
            Accrued interest receivable
   
2,226
 
            Bank owned life insurance
   
10,387
 
            Intangibles
   
2,972
 
            Deferred tax asset
   
8,392
 
            Other assets
   
18,213
 
            Goodwill
   
53,382
 
      663,218  
      Liabilities assumed
       
           Noninterest-bearing deposits
   
197,549
 
           Interest-bearing deposits
   
335,815
 
           Accrued interest payable
   
885
 
           Borrowed funds
   
58,647
 
           Other liabilities
   
11,674
 
     
604,570
 
      Net non-cash assets acquired
   
58,648
 
      Cash and cash equivalents acquired
 
$
18,017
 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

5
CITIZENS FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1 – Basis of Presentation


Citizens Financial Services, Inc. (individually and collectively with its direct and indirect subsidiaries, the “Company”) is a Pennsylvania corporation and its wholly owned subsidiary is CZFS Acquisition Company, LLC. CZFS Acquisition Company, LLC is the holding company of its wholly owned subsidiary, First Citizens Community Bank (the “Bank”), and of the Bank’s wholly owned subsidiaries, First Citizens Insurance Agency, Inc. (“First Citizens Insurance”) and 1st Realty of PA LLC (“Realty”).


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


In the opinion of management of the Company, the accompanying interim consolidated financial statements at September 30, 2023 and for the periods ended September 30, 2023 and 2022 include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the financial condition and the results of operations at the dates and for the periods presented. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and of revenues and expenses for the periods covered by the Consolidated Statement of Income. The financial performance reported for the Company for the nine month period ended September 30, 2023 is not necessarily indicative of the results to be expected for the full year.  This information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.

Accounting Pronouncements Adopted in 2023


In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” and subsequent related updates. This ASU replaces the incurred loss methodology for recognizing credit losses and requires businesses and other organizations to measure the current expected credit losses (CECL) on financial assets measured at amortized cost, including loans and held-to-maturity securities, net investments in leases, off-balance sheet credit exposures such as unfunded commitments, and other financial instruments. In addition, ASC 326 requires credit losses on available-for-sale debt securities to be presented as an allowance rather than as a write-down when management does not intend to sell or believes that it is not more likely than not they will be required to sell. This guidance became effective on January 1, 2023 for the Company. The results reported for periods beginning after January 1, 2023 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable accounting standards.


The Company adopted this guidance, and subsequent related updates, using the modified retrospective approach for all financial assets measured at amortized cost, including loans and held-to-maturity debt securities, available-for-sale debt securities and unfunded commitments. On January 1, 2023, the Bank recorded a cumulative effect increase to retained earnings of $1.8 million, net of tax, of which $3.3 million related to loans and ($1.1) million related to unfunded commitments.


The Company adopted the provisions of ASC 326 related to financial assets purchased with credit deterioration (PCD) that were previously classified as purchased credit impaired (PCI) and accounted for under ASC 310-30 using the prospective transition approach. In accordance with the standard, management did not reassess whether PCI assets met the criteria of PCD assets as of the date of adoption.

6

The Company expanded the pooling utilized under the legacy incurred loss method to include additional segmentation based on risk. The impact of the change from the incurred loss model to the current expected credit loss model is detailed below (in thousands):


   
January 1, 2023
 
   
Pre-adoption
   
Adoption Impact
   
As Reported
 
Assets
                 
Allowance for credit losses - loans
                 
Real estate loans:
                 
     Residential
 
$
1,056
   
$
79
   
$
1,135
 
     Commercial
   
10,120
     
(3,070
)
   
7,050
 
     Agricultural
   
4,589
     
(1,145
)
   
3,444
 
     Construction
   
801
     
(103
)
   
698
 
Consumer
   
135
     
1,040
     
1,175
 
Other commercial loans
   
1,040
     
(328
)
   
712
 
Other agricultural loans
   
489
     
(219
)
   
270
 
State and political subdivision loans
   
322
     
(280
)
   
42
 
Unallocated
   
-
     
726
     
726
 
Total
 
$
18,552
   
$
(3,300
)
 
$
15,252
 
                         
Liabilities
                       
Allowance for Credit Losses - Off-Balance Sheet credit Exposure
 
$
165
   
$
1,064
   
$
1,229
 


The Company adopted the provisions of ASC 326 related to presenting other-than-temporary impairment on available-for-sale debt securities prior to January 1, 2023 using the prospective transition approach, though no such charges had been recorded on the securities held by the Company as of the date of adoption.



In March 2022, the FASB issued ASU No. 2022-02, “Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures.” The amendments eliminate the accounting guidance for troubled debt restructurings by creditors that have adopted CECL and enhance the disclosure requirements for modifications of receivables made with borrowers experiencing financial difficulty. In addition, the amendments require disclosure of current period gross write-offs by year of origination for financing receivables and net investment in leases in the existing vintage disclosures. This ASU became effective on January 1, 2023 for the Corporation. The adoption of this ASU resulted in updated disclosures within our financial statements but otherwise did not have a material impact on the Company’s consolidated financial statements.



Loans



 A loan is classified as a modified loan to a borrower experiencing financial difficulty when a contractual loan modification in the form of principal forgiveness, an interest rate reduction, an other-than-significant payment delay or a term extension (or a combination thereof) has been granted to an existing borrower experiencing financial difficulties. The goal when modifying a credit is to establish a reasonable period of time to provide cash flow relief to customers experiencing cash flow difficulties. Accruing modified loans to borrowers experiencing financial difficulty are primarily comprised of loans on which interest is being accrued under the modified terms, and the loans are current or less than 90 days past due.


7

Loans and Leases - Prior to ASU No. 2022-02 Adoption



In situations where, for economic or legal reasons related to a borrower’s financial difficulties, management granted a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the related loan is classified as a Troubled Debt Restructuring (TDR). Management strives to identify borrowers in financial difficulty early and work with them to modify their loans to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where borrowers are granted new terms that provide for a reduction of either interest or principal, management measures any impairment on the restructuring as noted above for impaired loans.



Allowance for Credit losses – Loans



The allowance for credit losses (ACL) on loans and leases is a valuation account that is used to present the net amount expected to be collected on a loan or lease. The ACL for loans and leases is adjusted through provision for credit losses as a charge against, or credit to, earnings. Loans and leases deemed to be uncollectible are charged against the ACL on loans and leases, and any subsequent recoveries are credited to the ACL. Management evaluates the ACL on a quarterly basis. When changes in the reserve are necessary, an adjustment is made.



Management utilizes a discounted cash flow (DCF) model to calculate the present value of the expected cash flows for pools of loans and leases that share similar risk characteristics and compares the results of this calculation to the amortized cost basis to determine its allowance for credit loss balance.



Management uses relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts in calculating its ACL. Historical credit loss experience provides the basis for the estimation of expected credit losses. Management determines whether there is a need to make qualitative adjustments to historical loss information by monitoring certain factors including differences in current loan-specific risk characteristics as well as for changes in external or environmental conditions, or other relevant factors.



The contractual term used in projecting the cash flows of a loan is based on the maturity date of a loan, and is adjusted for prepayment or curtailment assumptions which may shorten that contractual time period. Options to extend are considered by management in determining the contractual term.



The key inputs to the DCF model are (1) probability of default, (2) loss given default, (3) prepayment and curtailment rates, (4) reasonable and supportable economic forecasts, (5) forecast reversion period, (6) expected recoveries on charged off loans, and (7) discount rate.



Probability of Default (PD)



In order to incorporate economic factors into forecasting within the DCF model, management elected to use the Loss Driver method to generate the PD rate inputs. The Loss Driver method analyzes how one or more economic factors change the default rate using a statistical regression analysis. Management selected economic factors that had strong correlations to historical default rates.



Loss Given Default (LGD)



Management elected to use the Frye Jacobs parameter for determining the LGD input, which is an estimation technique that derives a LGD input from segment specific risk curves that correlates LGD with PD.



Prepayment and Curtailment Rates



Prepayment Rates: Loan level transaction data is used to calculate a semi-annual prepayment rate. Those semi-annual rates are annualized and the average of the annualized rates is used in the DCF calculation for fixed payment or term loans. Rates are calculated for each pool.


8

Curtailment Rates: Loan level transaction data is used to calculate annual curtailment rates using any available historical loan level data. The average of the historical rates is used in the DCF model for interest only payment or line of credit type loans. Rates are calculated for each pool.



Reasonable and Supportable Forecasts



The forecast data used in the DCF model is obtained via a subscription to a widely recognized and relied upon company who publishes various forecast scenarios. Management evaluates the various scenarios to determine a reasonable and supportable scenario.



Forecast Reversion Period



Management uses forecasts to predict how economic factors will perform and has determined to use a four quarter forecast period as well as a four quarter straight-line reversion period to historical averages (also commonly referred to as the mean reversion period).



Expected Recoveries on Charged-off Loans



Management performs an analysis to estimate recoveries that could be reasonably expected based on historical experience in order to account for expected recoveries on loans that have already been fully charged-off and are not included in the ACL calculation.



Discount Rate



The effective interest rate of the underlying loans and leases of the Company serves as the discount rate applied to the expected periodic cash flows. Management adjusts the effective interest rate used to discount expected cash flows to incorporate expected prepayments.



Individual Evaluation



Management evaluates individual instruments for expected credit losses when those instruments do not share similar risk characteristics with instruments evaluated using a collective (pooled) basis. Instruments will not be included in both collective and individual analyses. Individual analysis will establish a specific reserve for instruments in scope.


Management considers a financial asset as collateral-dependent when the debtor is experiencing financial difficulty and repayment is expected to be provided substantially through the sale or operation of the collateral, based on management’s assessment as of the reporting date.



Accrued Interest Receivable on Loans and Leases



Accrued interest receivable on loans held for investment totaled $7.8 million at September 30, 2023 and is included within Accrued interest receivable. This amount is excluded from the estimate of expected credit losses.



Reserve for Unfunded Commitments



The Company maintains a reserve in other liabilities for off-balance sheet credit exposures such as unfunded commitments that are currently unfunded in categories with historical loss experience. Management calculates funding rates annually using loan level data history at the portfolio level. The applicable pool level loss rates for the is then applied to calculate the reserve for unfunded commitments liability each period.

9
Note 2 – Acquisition of HV Bancorp, Inc.


In the fourth quarter of 2022, the Company announced the signing of a definitive merger agreement to acquire 100% of the outstanding equity interest of HV Bancorp, Inc. (“HVBC”) for $30.50 per share in cash and stock. HVBC was a Pennsylvania corporation that conducted its business primarily through its wholly owned subsidiary Huntingdon Valley Bank (“HVB”), which operated from a main office in Doylestown, Pennsylvania, and had five service branches, four mortgage production office and one business banking office.


The transaction closed on June 16, 2023, with HVB having been merged into First Citizens Community Bank, with First Citizens Community Bank as the surviving entity. The acquisition established the Company’s presence in the Montgomery, Bucks and Philadelphia counties markets.


Under the terms of the merger agreement, the Company acquired all of the outstanding shares of HVBC for a total purchase price of approximately $76,665,000.  As a result of the acquisition, the Company issued 693,858 common shares and $16.5 million in cash to the former shareholders of HVBC. The shares were issued with a value of $86.67 per share, which was based on the closing price of the Company’s stock on June 16, 2023.


The following table summarizes the purchase of HVBC as of June 16, 2023:

(In Thousands, Except Per Share Data)
           
Purchase Price Consideration in Common Stock
           
Citizens Financial Services, Inc. shares issued
   
693,858
       
Value assigned to Citizens Financial Services, Inc. common share
 
$
86.67
       
Purchase price assigned to HVBC common shares exchanged for Citizens Financial Services, Inc.
         
$
60,137
 
Purchase Price Consideration - Cash for Common Stock
               
Purchase price assigned to HVBC’s common shares exchanged for cash
           
13,112
 
Purchase Price Related to Cash Payout of Stock Options
           
3,416
 
Total Purchase Price
           
76,665
 
Net Assets Acquired:
               
HVBC shareholders’ equity
 
$
40,630
         
Adjustments to reflect assets acquired at fair value:
               
Investments
   
31
         
Loans
               
Interest rate
   
(24,097
)
       
General credit
   
(1,834
)
       
Credit - PCD Loans
   
(2,042
)
       
Core deposit intangible
   
2,770
         
Owned premises
   
67
         
Other assets
   
(193
)
       
Deferred tax assets
   
3,737
         
Adjustments to reflect liabilities acquired at fair value:
               
Time deposits
   
586
         
Borrowings
   
3,017
         
Other liabilities
   
611
         
             
23,283
 
Goodwill resulting from merger
         
$
53,382
 

10

The following condensed statement reflects the amounts recognized as of the acquisition date for each major class of asset acquired and liability assumed:



(In Thousands, Except Per Share Data)
           
Total purchase price
         
76,665
 
Fair value of assets acquired
             
Cash and due from banks
   
18,017
         
Investment securities
   
79,248
         
Loans held for sale
   
10,750
         
Loans
   
475,338
         
Premises and equipment
   
2,310
         
Intangible assets
   
2,972
         
Bank owned life insurance
   
10,387
         
Interest receivable
   
2,226
         
Deferred taxes
   
8,392
         
Other assets
   
18,213
         
Total assets acquired
   
627,853
         
Fair value of liabilities assumed
               
Deposits
   
533,364
         
Borrowings
   
58,647
         
Accrued interest payable
   
885
         
Other liabilities
   
11,674
         
Total liabilities assumed
   
604,570
         
Total fair value of identifiable net assets
           
23,283
 
Goodwill resulting from merger
           
53,382
 


The Company determined that this acquisition constitutes a business combination and therefore was accounted for using the acquisition method of accounting. Accordingly, as of the date of the acquisition, the Company recorded the assets acquired, liabilities assumed and consideration paid at fair value. The $53.4 million excess of the consideration paid over the fair value of assets acquired was recorded as goodwill and is not amortizable or deductible for tax purposes. The amount of goodwill arising from the acquisition consists largely of the synergies and economies of scale expected from combining the operations of the Company with HVBC.


The fair value of the 693,858 common shares issued was determined based on the $86.67 closing market price of the Company’s common shares on the acquisition date, June 16, 2023. While the valuation of the acquired assets and liabilities is substantially complete, fair value estimates are subject to adjustment during the provisional period, which may last up to twelve months subsequent to the acquisition date. During this period, the Company may obtain additional information to refine the valuations and adjust the recorded fair value, although such adjustments are not expected to be significant. Valuations subject to adjustments include, but are not limited to, the fair value of acquired loans, deposits, land and building, core deposit intangible and other assets and liabilities.


The following is a description of the valuation methodologies used to estimate the fair values of major categories of assets acquired and liabilities assumed. The Company used an independent valuation specialist to assist with the determination of fair values for certain acquired assets and assumed liabilities.

 
Cash and due from banks - The estimated fair value was determined to approximate the carrying amount of these assets.
 
Investment securities - The estimated fair value of the investment portfolio was based on quoted market prices, dealer quotes, and pricing obtained from independent pricing services.
 
Loans - The estimated fair value of loans were based on a discounted cash flow methodology applied on a pooled basis for nonpurchased credit-deteriorated (“non-PCD”) loans, accruing purchased credit-deteriorated loans and on an individual basis for nonaccruing purchased credit-deteriorated (“PCD”) loans. The valuation considered underlying characteristics including loan type, term, rate, payment schedule and credit rating. The discounted cash flow methodology involved assumptions and judgements as to credit risk, expected lifetime losses, environmental factors, collateral values, discount rates, expected payments and expected prepayments.
 
Premises and equipment - The estimated fair value of land and buildings were determined by independent market-based appraisals.
 
Core deposit intangible - The core deposit intangible was valued utilizing a discounting cash flow method approach, which recognizes the cost savings represented by the expense of maintaining the core deposit base (net of deposit fee income) versus the cost of an alternative funding source. The valuation incorporates assumptions related to account retention, discount rates, deposit interest rates, deposit maintenance costs and alternative funding rates.
11
 
Time deposits - The estimated fair value of time deposits was determined using a discounted cash flow approach incorporating a discount rate equal to current market interest rates offered on time deposits with similar terms and maturities.
 
Borrowings - The estimated fair value of short-term borrowings was determined to approximate stated value. The estimated fair value of long-term borrowings from the FHLB were determined using a discounted cash flow approach incorporating a discount rate equal to current market interest rates offered on borrowings with similar terms and maturities. Subordinated debentures were valued using a discounted cash flow approach incorporating a discount rate that incorporated similar terms, maturity and credit rating.

Accounting for Acquired Loans


Acquired loans are classified into two categories: PCD loans and non-PCD loans. PCD loans are defined as a loan or group of loans that have experienced more than insignificant credit deterioration since origination. Non-PCD loans will have an allowance established on acquisition date, which is recognized as an expense through provision for credit losses. For PCD loans, an allowance is recognized on day 1 by adding it to the fair value of the loan, which is the “Day 1 amortized cost”. There is no provision for credit loss expense recognized on PCD loans because the initial allowance is established by grossing-up the amortized cost of the PCD loan.


A Day 1 allowance for credit losses on non-PCD loans of $4.6 million was recorded through the provision for credit losses within the Consolidated Statements of Income. At the date of acquisition, of the $506.9 million of loans acquired from HVB, $18.0 million, or 3.6%, of HVB’s loan portfolio, was accounted for as PCD loans.


The following table provides details related to the fair value of acquired PCD loans (in thousands):

 
 
Unpaid
principal
balance
   
PCD Allowance for
Credit Loss at
Acquisition
   
(Discount)
Premium on
Acquired Loans
   
Fair Value of
PCD Loans at
Acquisition
 
Real estate loans:
                       
     Mortgages
 
$
2,398
   
$
(108
)
 
$
-
   
$
2,290
 
     Home Equity
   
34
     
-
     
(4
)
   
30
 
     Commercial
   
4,774
     
(39
)
   
(507
)
   
4,228
 
     Construction
   
4,278
     
(37
)
   
(293
)
   
3,948
 
Consumer
   
1,343
     
(677
)
   
(271
)
   
395
 
Other commercial loans
   
5,214
     
(828
)
   
(48
)
   
4,338
 
 
 
$
18,041
   
$
(1,689
)
 
$
(1,123
)
 
$
15,229
 


The following table provides details related to the fair value and Day 1 provision related to the acquired non-PCD loans (in thousands):

 
 
Unpaid principal
balance
   
(Discount)Premium on
Acquired Loans
   
Fair Value of Non-PCD
Loans at Acquisition
   
Day 1 Provision for Credit
Losses- Non-PCD Loans
 
Real estate loans:
                       
     Mortgages
 
$
155,799
   
$
(17,506
)
 
$
138,293
   
$
1,015
 
     Home Equity
   
2,165
     
(55
)
   
2,110
     
15
 
     Commercial
   
203,638
     
(9,226
)
   
194,412
     
1,968
 
     Construction
   
76,703
     
(1,420
)
   
75,283
     
747
 
Consumer
   
2,794
     
(222
)
   
2,572
     
159
 
Other commercial loans
   
47,753
     
(314
)
   
47,439
     
687
 
 
 
$
488,852
   
$
(28,743
)
 
$
460,109
   
$
4,591
 


Amounts recognized separately from the acquisition include primarily legal fees, investment banking fees, system conversion costs, severance costs and contract termination costs. These costs were included in merger and acquisition expenses within non-interest expenses on the Consolidated Statement of Income and amounted to approximately $9,269,000 for the nine months ended September 30, 2023.

12

Results of operations for HVBC prior to the acquisition date are not included in the Consolidated Statement of Income for the quarter ended September 30, 2023.


The following table presents financial information regarding the former HVBC operations included in our Consolidated Statement of Income from the date of acquisition through September 30, 2023 under the column “Actual from Acquisition Date through September 30, 2023”.  In addition, the following table presents unaudited pro forma information as if the acquisition of HVBC had occurred on January 1, 2022 under the “Pro Forma” columns.  The table below has been prepared for comparative purposes only and is not necessarily indicative of the actual results that would have been attained had the acquisition occurred as of the beginning of the periods presented, nor is it indicative of future results. Furthermore, the unaudited proforma information does not reflect management’s estimate of any revenue-enhancing opportunities nor anticipated cost savings as a result of the integration and consolidation of the acquisition.  Merger and acquisition integration costs and amortization of fair value adjustments are included in the numbers below.

 
     
Actual from Acquisition Date
Through September 30, 2023
   
Unaudited Pro Forma for
 
 
     
Three Months Ended
   
Nine Months Ended
 
 
     
September 30,
   
September 30,
 
(In Thousands, Except Per Share Data)
     
2023
   
2022
   
2023
   
2022
 
Net interest income
 
$
8,046
   
$
21,775
   
$
25,369
   
$
68,025
   
$
70,329
 
Non-interest income
   
600
     
3,797
     
4,372
     
10,502
     
14,638
 
Net income
   
3,140
     
7,061
   
9,070
     
8,008
     
22,652
 
Pro forma earnings per share:
                                       
Basic
         
$
1.31
 
$
1.93
     
1.61
   
$
4.82
 
Diluted
         
$
1.31
 
$
1.93
   
$
1.61
   
$
4.82
 

Note 3 – Revenue Recognition


In accordance with ASC 606, Management determined that the primary sources of revenue emanating from interest and dividend income on loans and investments along with noninterest revenue resulting from investment security gains, loan servicing, gains on loans sold, earnings on bank owned life insurances, gains and losses from derivative instruments and changes in the fair of loans held for sale  are not within the scope of ASC 606. The main types of noninterest income within the scope of the standard are as follows:

Service charges on deposit accounts – The Company has contracts with its deposit customers where fees are charged if certain parameters are not met. These agreements can be cancelled at any time by either the Company or the deposit customer. Revenue from these transactions is recognized on a monthly basis as the Company has an unconditional right to the fee consideration. The Company also has transaction fees related to specific transactions or activities resulting from a customer request or activity that include overdraft fees, online banking fees, interchange fees, ATM fees and other transaction fees. All of these fees are attributable to specific performance obligations of the Company where the revenue is recognized at a defined point in time upon the completion of the requested service/transaction.

13
Trust fees – Typical contracts for trust services are based on a fixed percentage of the assets earned ratably over a defined period and billed on a monthly basis. Fees charged to customers’ accounts are recognized as revenue over the period during which the Company fulfills its performance obligation under the contract (i.e., holding client asset in a managed fiduciary trust account). For these accounts, the performance obligation of the Company is typically satisfied by holding and managing the customer’s assets over time. Other fees related to specific customer requests are attributable to specific performance obligations of the Company where the revenue is recognized at a defined point in time, upon completion of the requested service/transaction.

Gains and losses on sale of other real estate owned – Gains and losses are recognized at the completion of the property sale when the buyer obtains control of the real estate and all of the performance obligations of the Company have been satisfied. Evidence of the buyer obtaining control of the asset include transfer of the property title, physical possession of the asset, and the buyer obtaining control of the risks and rewards related to the asset. In situations where the Company agrees to provide financing to facilitate the sale, additional analysis is performed to ensure that the contract for sale identifies the buyer and seller, the asset to be transferred, payment terms, and that the contract has a true commercial substance and that collection of amounts due from the buyer are reasonable. In situations where financing terms are not reflective of current market terms, the transaction price is discounted impacting the gain/loss and the carrying value of the asset.

Brokerage and insurance – Fees includes commissions from the sales of investments and insurance products recognized on a trade date basis as the performance obligation is satisfied at the point in time in which the trade is processed. Additional fees are based on a percentage of the market value of customer accounts and billed on a monthly or quarterly basis. The Company’s performance obligation under the contracts with certain customers is generally satisfied through the passage of time as the Company monitors and manages the assets in the customer’s portfolio and is not dependent on certain return or performance level of the customer’s portfolio. Fees for these services are billed monthly and are recorded as revenue at the end of the month for which the wealth management service has been performed. Other performance obligations (such as the delivery of account statements to customers) are generally considered immaterial to the overall transaction price.


The following table depicts the disaggregation of revenue derived from contracts with customers to depict the nature, amount, timing, and uncertainty of revenue and cash flows for the three and nine months ended September 30, 2023 and 2022 (in thousands). All revenue in the table below relates to goods and services transferred at a point in time.

 
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
Revenue stream
 
2023
   
2022
   
2023
   
2022
 
Service charges on deposit accounts
                       
Overdraft fees
 
$
408
     
374
   
$
1,138
   
$
993
 
Statement fees
   
47
     
51
     
153
     
158
 
Interchange revenue
   
1,008
     
953
     
2,469
     
2,495
 
ATM income
   
35
     
39
     
107
     
194
 
Other service charges
   
194
     
92
     
329
     
241
 
Total Service Charges
   
1,692
     
1,509
     
4,196
     
4,081
 
Trust
   
172
     
187
     
583
     
620
 
Brokerage and insurance
   
473
     
446
     
1,429
     
1,428
 
Other
   
260
     
125
     
494
     
387
 
Total
 
$
2,597
   
$
2,267
   
$
6,702
   
$
6,516
 

14
Note 4 – Earnings per Share


The following table sets forth the computation of earnings per share.

   
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2023
   
2022
   
2023
   
2022
 
Net income applicable to common stock
 
$
7,548,000

 
$
7,544,000
   
$
10,271,000
   
$
21,185,000
 
                                 
Basic earnings per share computation
                               
Weighted average common shares outstanding
   
4,699,952
     
4,006,794
     
4,275,259
     
4,009,855
 
Earnings per share - basic
 
$
1.61
 
$
1.88
   
$
2.40
   
$
5.28
 
                                 
Diluted earnings per share computation
                               
Weighted average common shares outstanding for basic earnings per share
   
4,699,952
     
4,006,794
     
4,275,259
     
4,009,855
 
Add: Dilutive effects of restricted stock
   
-
     
234
     
-
     
2
 
Weighted average common shares outstanding for dilutive earnings per share
   
4,699,952
     
4,007,028
     
4,275,259
     
4,009,857
 
Earnings per share - diluted
 
$
1.61
 
$
1.88
   
$
2.40
   
$
5.28
 


For the three months ended September 30, 2023 and 2022, there were 5,535 and 356 shares, respectively, related to the restricted stock plan that were excluded from the diluted earnings per share calculations since they were anti-dilutive. These anti-dilutive shares had per share prices ranging from $44.93-$83.38 for the three month period ended September 30, 2023 and per share prices ranging from $57.36-$74.27 for the three month period ended September 30, 2022. For the nine months ended September 30, 2023 and 2022, 5,535 and 5,811 shares, respectively, related to the restricted stock plan were excluded from the diluted earnings per share calculations since they were anti-dilutive. These anti-dilutive shares had prices ranging from $44.93-$83.38 for the nine month period ended September 30, 2023 and prices ranging from $44.93-$74.27 for the nine month period ended September 30, 2022.
 
Note 5 – Investments


The amortized cost, gross unrealized gains and losses, and fair value of investment securities at September 30, 2023 and December 31, 2022 were as follows (in thousands):

September 30, 2023
 
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
 Losses
   
Fair
Value
 
Available-for-sale securities:
                       
  U.S. agency securities
 
$
71,567
   
$
-
   
$
(7,920
)
 
$
63,647
 
  U.S. treasury securities
   
160,426
     
-
     
(12,995
)
   
147,431
 
  Obligations of state and political subdivisions
   
108,569
     
5
     
(12,552
)
   
96,022
 
  Corporate obligations
   
13,381
     
229
     
(1,490
)
   
12,120
 
  Mortgage-backed securities in government sponsored entities
   
115,945
     
9
     
(17,367
)
   
98,587
 
Total available-for-sale securities
 
$
469,888
   
$
243
   
$
(52,324
)
 
$
417,807
 

December 31, 2022
                       
Available-for-sale securities:
                       
  U.S. agency securities
 
$
78,556
   
$
-
   
$
(7,879
)
 
$
70,677
 
  U.S. treasury securities
   
162,236
     
-
     
(13,666
)
   
148,570
 
  Obligations of state and political subdivisions
    120,562       35       (10,297 )     110,300  
  Corporate obligations
   
10,335
     
-
     
(952
)
   
9,383
 
  Mortgage-backed securities in government sponsored entities
    115,304       15       (14,743 )     100,576  
Total available-for-sale securities
 
$
486,993
   
$
50
   
$
(47,537
)
 
$
439,506
 

15

The following table shows the Company’s gross unrealized losses and fair value of the Company’s investments with unrealized losses for which an allowance for credit losses has not been recorded, aggregated by investment category and length of time, which individual securities have been in a continuous unrealized loss position, at September 30, 2023 and December 31, 2022 (in thousands). As of September 30, 2023, the Company owned 338 securities whose fair value was less than their cost basis.

September 30, 2023
 
Less than Twelve Months
   
Twelve Months or Greater
   
Total
 
   
Fair
Value
   
Gross
Unrealized
Losses
   
Fair
Value
   
Gross
Unrealized
Losses
   
Fair
Value
   
Gross
Unrealized
Losses
 
U.S. agency securities
 
$
-
   
$
-
 
$
61,646
   
$
(7,920
)
 
$
61,646
   
$
(7,920
)
U.S. treasury securities
   
-
     
-
   
147,431
     
(12,995
)
   
147,431
     
(12,995
)
Obligations of state and  political subdivisions
   
4,731
     
(130
)
   
89,094
     
(12,422
)
   
93,825
     
(12,552
)
Corporate obligations
   
1,458
     
(289
)
   
8,102
     
(1,201
)
   
9,560
     
(1,490
)
Mortgage-backed securities in government sponsored entities
   
9,207
     
(293
)
   
86,820
     
(17,074
)
   
96,027
     
(17,367
)
Total securities
 
$
15,396
   
$
(712
)
 
$
393,093
   
$
(51,612
)
 
$
408,489
   
$
(52,324
)

December 31, 2022
                                   
U.S. agency securities
 
$
39,729
   
$
(1,892
)
 
$
30,948
   
$
(5,987
)
 
$
70,677
   
$
(7,879
)
U.S. treasury securities     32,673       (1,337 )     115,897       (12,329 )     148,570       (13,666 )
Obligations of states and political subdivisions
   
66,725
     
(4,887
)
   
35,782
     
(5,410
)
   
102,507
     
(10,297
)
Corporate obligations     2,165       (165 )     6,218       (787 )     8,383       (952 )
Mortgage-backed securities in government sponsored entities
   
40,270
     
(3,367
)
   
57,319
     
(11,376
)
   
97,589
     
(14,743
)
Total securities
 
$
181,562
   
$
(11,648
)
 
$
246,164
   
$
(35,889
)
 
$
427,726
   
$
(47,537
)


Allowance for Credit Losses – Available for Sale Securities


The Company measures expected credit losses on available-for-sale debt securities when the Company does not intend to sell, or when it is not more likely than not that it will be required to sell, the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For available-for-sale debt securities that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, the Company considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this evaluation indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, equal to the amount that the fair value is less than the amortized cost basis. Economic forecast data is utilized to calculate the present value of expected cash flows. The Company obtains its forecast data through a subscription to a widely recognized and relied upon company who publishes various forecast scenarios. Management evaluates the various scenarios to determine a reasonable and supportable scenario, and utilizes a single scenario in the model. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income.


The allowance for credit losses on available-for-sale debt securities is included within Investment securities available-for-sale on the consolidated balance sheet. Changes in the allowance for credit losses are recorded within Provision for credit losses on the consolidated statement of income. Losses are charged against the allowance when the Company believes the collectability of an available-for-sale security is in jeopardy or when either of the criteria regarding intent or requirement to sell is met.



Accrued interest receivable on available-for-sale debt securities totaled $2,145,000 at September 30, 2023 and is included within accrued interest receivable on the consolidated balance sheet. This amount is excluded from the estimate of expected credit losses. Available-for-sale debt securities are typically classified as nonaccrual when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about the further collectability of principal or interest. When available-for-sale debt securities are placed on nonaccrual status, unpaid interest credited to income is reversed.

16

Credit Losses on Investment Securities – Prior to adopting ASU 2016-13


The Company adopted ASU No. 2016-13 effective January 1, 2023. Financial statement amounts related to Investment Securities recorded as of December 31, 2022 and for the periods ending December 31, 2022 are presented in accordance with the accounting policies described in the following sections. The following sections were carried forward from the Annual Report on Form 10-K for the year ended December 31, 2022.


Securities are evaluated on at least a quarterly basis, and more frequently when market conditions warrant such an evaluation, to determine whether a decline in their value is other than temporary. To determine whether a loss is other than temporary, management utilizes criteria such as the reasons underlying the decline, the magnitude and duration of the decline, and whether or not management intends to sell or expects that it is more likely than not that it will be required to sell the security prior to an anticipated recovery of the fair value. The term “other than temporary” is not intended to indicate that the decline is permanent but indicates that the prospects for a near-term recovery of value are not necessarily favorable or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment.


Declines in the fair value of securities below their cost that are deemed to be other than temporary are separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss), and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive (loss) income.



Proceeds from sales of securities available-for-sale for the nine months ended September 30, 2023 and 2022 were $86,504,000 and $4,492,000, respectively. Proceeds from sales of securities available-for-sale for the three months ended September 30, 2022 were $4,492,000. There were no sales of available for sale securities during the three months ended September 30, 2023.



The gross gains and losses were as follows (in thousands):


 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2023
 
2022
 
2023
 
2022
 
Gross gains on available for sale securities
 
$
-
   
$
-
   
$
38
   
$
-
 
Gross losses on available for sale securities
   
-
     
(6
)
   
(89
)
   
(6
)
Net gains
 
$
-
   
$
(6
)
 
$
(51
)
 
$
(6
)


The following table presents the net gains (losses) on the Company’s equity investments recognized in earnings during the three and nine month periods ended September 30, 2023 and 2022, and the portion of unrealized gains for the period that relates to equity investments held at September 30, 2023 and 2022 (in thousands):

 
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
Equity securities
 
2023
   
2022
   
2023
   
2022
 
Net gains (losses) recognized in equity securities during the period
 
$
69
 
$
(19
)
 
$
(223
)
 
$
(198
)
Less: Net gains realized on the sale of equity securities during the period
   
9
     
4
     
14
     
4
 
Net unrealized  gains (losses)
 
$
60
 
$
(23
)
 
$
(237
)
 
$
(202
)

17

Investment securities with an approximate carrying value of $353.2 million and $311.8 million at September 30, 2023 and December 31, 2022, respectively, were pledged to secure public funds, certain other deposits and borrowing lines.


Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.   The amortized cost and fair value of debt securities at September 30, 2023, by contractual maturity, are shown below (in thousands):

 
Amortized
Cost
   
Fair Value
 
Available-for-sale debt securities:
           
Due in one year or less
 
$
44,257
   
$
43,316
 
Due after one year through five years
   
170,521
     
155,161
 
Due after five years through ten years
   
98,835
     
86,730
 
Due after ten years
   
156,275
     
132,600
 
Total
 
$
469,888
   
$
417,807
 

Note 6 – Loans


The Company grants commercial, industrial, agricultural, residential, and consumer loans primarily to customers throughout north central, central and south central Pennsylvania, southern New York and Wilmington and Dover, Delaware. The recently completed HVBC acquisition has expanded our lending market further into southeast Pennsylvania, including Montgomery, Bucks and Philadelphia Counties as well as Burlington County, New Jersey. Although the Company had a diversified loan portfolio at September 30, 2023 and December 31, 2022, a substantial portion of its debtors’ ability to honor their contracts is dependent on the economic conditions within these regions. The following table summarizes the primary segments of the loan portfolio and how those segments are analyzed within the allowance for credit losses - loans as of September 30, 2023 and December 31, 2022 (in thousands):


 
September 30, 2023
    December 31, 2022  
Real estate loans:
           
Residential
 
$
356,381
   
$
210,213
 
Commercial
   
1,081,123
     
876,569
 
Agricultural
   
314,164
     
313,614
 
Construction
   
175,320
     
80,691
 
Consumer
   
115,753
     
86,650
 
Other commercial loans
   
120,347
     
63,222
 
Other agricultural loans
   
26,648
     
34,832
 
State and political subdivision loans
   
56,660
     
59,208
 
Total
   
2,246,396
     
1,724,999
 
Allowance for credit losses - loans
   
21,455
     
18,552
 
Net loans
 
$
2,224,941
   
$
1,706,447
 


Allowance for Credit Losses, effective January 1, 2023
 

As discussed in Note 1 “Basis of Presentation”, the Company adopted CECL effective January 1, 2023. CECL requires estimated credit losses on loans to be determined based on an expected life of loan model, as compared to an incurred loss model (in effect for periods prior to 2023). Accordingly, allowance for losses disclosures subsequent to January 1, 2023 are not always comparable to prior dates. In addition, certain new disclosures required under CECL are not applicable to prior periods. As a result, the following tables present disclosures separately for each period, where appropriate. New disclosures required under CECL are only shown for the current period and are noted. See Note 1, “Basis of Presentation”, for a summary of the impact of adopting CECL on January 1, 2023.

18

Under CECL, loans evaluated for impairment consist of non-accrual commercial loans and recently modified loans that were experiencing financial difficulty at the time of the modification. Under the incurred loss model in effect prior to the adoption of CECL, loans evaluated individually for impairment were referred to as impaired loans.


The allowance for credit losses related to loans consists of loans evaluated collectively and individually for expected credit losses. It represents an estimate of credit losses over the expected life of the loans as of the balance sheet date and is recorded as a reduction to net loans. The allowance for credit losses for off-balance sheet credit exposures includes estimated losses on unfunded loan commitments, letters of credit and other off-balance sheet credit exposures. The total allowance for credit losses is increased by charges to expense, through the provision for credit losses, and decreased by charge-offs, net of recoveries.
 

The following table presents the components of the allowance for credit losses as of September 30, 2023 (in thousands):

   
September 30, 2023
 
Allowance for Credit Losses - Loans
 
$
21,455
 
Allowance for Credit Losses - Off-Balance Sheet credit Exposure
   
1,265
 
Total allowance for credit losses
 
$
22,720
 


The following table presents the activity in the allowance for credit losses for the three and nine months ended September 30, 2023 (in thousands):

   
Allowance for Credit
Losses - Loans
   
Allowance for Credit Losses - Off-
Balance Sheet credit Exposure
   
Total
 
Balance at June 30, 2023
 
$
21,652
   
$
1,391
   
$
23,043
 
Loans charge-off
   
(808
)
   
-
     
(808
)
Recoveries of loans previously charged-off
   
10
     
-
     
10
 
Net loans charged-off
   
(798
)
   
-
     
(798
)
Provision for credit losses
   
601
     
(126
)
   
475
 
Balance at September 30, 2023
 
$
21,455
   
$
1,265
   
$
22,720
 

   
Allowance for Credit
Losses -Loans
   
Allowance for Credit Losses - Off-
Balance Sheet credit Exposure
    Total
 
Balance at December 31, 2022
 
$
18,552
   
$
165
   
$
18,717
 
Impact of adopting CECL
   
(3,300
)
   
1,064
     
(2,236
)
Allowance for credit loss on PCD acquired loans
   
1,689
     
-
     
1,689
 
Loans charge-off
   
(819
)
   
-
     
(819
)
Recoveries of loans previously charged-off
   
41
     
-
     
41
 
Net loans charged-off
   
(778
)
   
-
     
(778
)
Provision for credit losses - acquisition day 1 non-PCD
   
4,591
     
-
     
4,591
 
Provision for credit losses
   
701
     
36
     
737
 
Balance at September 30, 2023
 
$
21,455
   
$
1,265
   
$
22,720
 

19

The following tables presents the activity in the allowance for credit losses – loans, by portfolio segment, for the three and nine months ended September 30, 2023 (in thousands).


 
 
For the three months ended September 30, 2023
 
 
 
Balance at
June 30, 2023
   
Charge-offs
   
Recoveries
   
Provision
   
Balance at
September 30, 2023
 
Real estate loans:
                             
     Residential
 
$
2,675
   
$
-
   
$
-
   
$
(110
)
 
$
2,565
 
     Commercial
   
9,274
     
-
     
2
     
(91
)
   
9,185
 
     Agricultural
   
3,579
     
-
     
-
     
(104
)
   
3,475
 
     Construction
   
1,667
     
-
     
-
     
166
     
1,833
 
Consumer
   
1,259
     
(45
)
   
3
     
503
     
1,720
 
Other commercial loans
   
2,477
     
(763
)
   
5
     
353
     
2,072
 
Other agricultural loans
   
268
     
-
     
-
     
(39
)
   
229
 
State and political subdivision loans
   
52
     
-
     
-
     
(4
)
   
48
 
Unallocated
   
401
     
-
     
-
     
(73
)
   
328
 
Total
 
$
21,652
   
$
(808
)
 
$
10
   
$
601
   
$
21,455
 


 
For the nine months ended September 30, 2023
 
   
Balance at
December 31, 2022
   
Impact of
adopting
CECL
   
Allowance for
credit loss on
PCD acquired
loans
   
Charge-offs
   
Recoveries
   
Provision
   
Balance at
September 30, 2023
 
Real estate loans:
                                         
     Residential
 
$
1,056
   
$
79
    $ 108    
$
(1
)
 
$
-
   
$
1,323
   
$
2,565
 
     Commercial
   
10,120
     
(3,070
)
    39      
-
     
2
     
2,094
     
9,185
 
     Agricultural
   
4,589
     
(1,145
)
    37      
-
     
-
     
(6
)
   
3,475
 
     Construction
   
801
     
(103
)
           
-
     
-
     
1,135
     
1,833
 
Consumer
   
135
     
1,040
      677      
(55
)
   
30
     
(107
)
   
1,720
 
Other commercial loans
   
1,040
     
(328
)
    828      
(763
)
   
9
     
1,286
     
2,072
 
Other agricultural loans
   
489
     
(219
)
    -      
-
     
-
     
(41
)
   
229
 
State and political subdivision loans
    322       (280 )     -       -       -       6       48  
Unallocated
   
-
     
726
      -      
-
     
-
     
(398
)
   
328
 
Total
 
$
18,552
   
$
(3,300
)
  $ 1,689    
$
(819
)
 
$
41
   
$
5,292
    $ 21,455  


The following table presents the allowance for credit losses – loans and amortized cost basis of loans under CECL methodology as of September 30, 2023 (in thousands):




Allowance for Credit Losses - Loans



Loans

September 30, 2023
 
Collectively evaluated
   
Individually evaluated
   
Total Allowance
for Credit
Losses - Loans
   
Collectively evaluated
   
Individually evaluated
   
Total
Loans
 
Real estate loans:
                                   
     Residential
 
$
2,484
   
$
81
   
$
2,565
   
$
355,129
   
$
1,252
   
$
356,381
 
     Commercial
   
9,030
     
155
     
9,185
     
1,078,360
     
2,763
     
1,081,123
 
     Agricultural
   
3,456
     
19
     
3,475
     
310,507
     
3,657
     
314,164
 
     Construction
   
1,547
     
286
     
1,833
     
172,963
     
2,357
     
175,320
 
Consumer
   
1,316
     
404
     
1,720
     
114,613
     
1,140
     
115,753
 
Other commercial loans
   
1,697
     
375
     
2,072
     
118,419
     
1,928
     
120,347
 
Other agricultural loans
   
229
     
-
     
229
     
26,349
     
299
     
26,648
 
State and political subdivision loans
   
48
     
-
     
48
     
56,660
     
-
     
56,660
 
Unallocated
   
328
     
-
     
328
     
-
     
-
     
-
 
Total
 
$
20,135
   
$
1,320
   
$
21,455
   
$
2,233,000
   
$
13,396
   
$
2,246,396
 

20

Allowance for Credit Losses, prior to January 1, 2023


The allowance for credit losses consists of the allowance for loan losses and the reserve for unfunded lending commitments. The allowance for loan losses represents management’s estimate of incurred losses in the loan portfolio as of the balance sheet date and is recorded as a reduction to net loans. The reserve for unfunded lending commitments represents management’s estimate of incurred losses in unfunded commitments and letters of credit, and is recorded in other liabilities on the consolidated balance sheet. The allowance for credit losses is increased by charges to expense, through the provision for credit losses and decreased by charge-offs, net of recoveries. The following table presents the components of the allowance for credit losses as of December 31, 2022 (in thousands):


 
December 31, 2022
 
Allowance for loan Losses
 
$
18,552
 
Reserve for unfunded commitments
   
165
 
Total allowance for credit losses
 
$
18,717
 


The following table presents the activity in the allowance for credit losses for the three and nine months ended September 30, 2022 (in thousands):


 
Allowance for
Credit Losses - Loans
   
Reserve for
unfunded
commitments
   
Total
 
Balance at June 30, 2022   $ 17,570     $ 165     $ 17,735  
Loans charge-off     (13 )     -       (13 )
Recoveries of loans previously charged-off     9       -       9  
Net loans charged-off     (4 )     -       (4 )
Provision for credit losses     725       -       725  
Balance at September 30, 2022   $ 18,291     $ 165     $ 18,456  
                         
Balance at December 31, 2021
 
$
17,304
   
$
165
   
$
17,469
 
Loans charge-off
   
(464
)
   
-
     
(464
)
Recoveries of loans previously charged-off
   
26
     
-
     
26
 
Net loans charged-off
   
(438
)
   
-
     
(438
)
Provision for credit losses
   
1,425
     
-
     
1,425
 
Balance at September 30, 2022
 
$
18,291
   
$
165
   
$
18,456
 



The following table presents the activity in the allowance for loan losses, by portfolio segment, for the three and nine months ended September 30, 2022 (in thousands).


 
 
For the three months ended September 30, 2022
 
 
 
Balance at
June 30, 2022
   
Charge-offs
   
Recoveries
   
Provision
   
Balance at
September 30, 2022
 
Real estate loans:
                             
     Residential
 
$
1,015
   
$
-
   
$
-
   
$
(10
)
 
$
1,005
 
     Commercial
   
9,216
     
-
     
-
     
721
     
9,937
 
     Agricultural
   
4,484
     
-
     
-
     
54
     
4,538
 
     Construction
   
563
     
-
     
-
     
115
     
678
 
Consumer
   
464
     
(13
)
   
5
     
(224
)
   
232
 
Other commercial loans
   
1,173
     
-
     
4
     
(784
)
   
393
 
Other agricultural loans
   
446
     
-
     
-
     
913
     
1,359
 
State and political subdivision loans
   
323
     
-
     
-
     
2
     
325
 
Unallocated
   
(114
)
   
-
     
-
     
(62
)
   
(176
)
Total
 
$
17,570
   
$
(13
)
 
$
9
   
$
725
   
$
18,291
 

21
 
 
For the nine months ended September 30, 2022
 
 
 
Balance at
December 31, 2021
   
Charge-offs
   
Recoveries
   
Provision
   
Balance at
September 30, 2022
 
Real estate loans:
                             
     Residential
 
$
1,147
   
$
-
   
$
-
   
$
(142
)
 
$
1,005
 
     Commercial
   
8,099
     
-
     
-
     
1,838
     
9,937
 
     Agricultural
   
4,729
     
-
     
-
     
(191
)
   
4,538
 
     Construction
   
434
     
-
     
-
     
244
     
678
 
Consumer
   
262
     
(30
)
   
15
     
(15
)
   
232
 
Other commercial loans
   
1,023
     
(434
)
   
11
     
(207
)
   
393
 
Other agricultural loans
   
558
     
-
     
-
     
801
     
1,359
 
State and political subdivision loans
   
281
     
-
     
-
     
44
     
325
 
Unallocated
   
771
     
-
     
-
     
(947
)
   
(176
)
Total
 
$
17,304
   
$
(464
)
 
$
26
   
$
1,425
   
$
18,291
 


The following table presents loans and their related allowance for loan losses, by portfolio segment, as of December 31, 2022 (in thousands):


 
Allowance for loan losses
   
Loans
 

 
Collectively evaluated for impairment
   
Individually evaluated for impairment
   
Total allowance for loan losses
   
Collectively evaluated for impairment
   
Individually evaluated for impairment
   
Loans acquired with deteriorated credit quality
   
Total Loans
 
Real estate loans:
                                         
     Residential
 
$
4
   
$
1,052
   
$
1,056
   
$
209,869
   
$
335
   
$
9
   
$
210,213
 
     Commercial
   
57
     
10,063
     
10,120
     
869,038
     
5,675
     
1,856
     
876,569
 
     Agricultural
   
24
     
4,565
     
4,589
     
306,793
     
5,380
     
1,441
     
313,614
 
     Construction
   
-
     
801
     
801
     
80,691
     
-
     
-
     
80,691
 
Consumer
   
4
     
131
     
135
     
86,646
     
4
     
-
     
86,650
 
Other commercial loans
   
13
     
1,027
     
1,040
     
63,120
     
102
     
-
     
63,222
 
Other agricultural loans
   
-
     
489
     
489
     
34,359
     
473
     
-
     
34,832
 
State and political subdivision loans
   
-
     
322
     
322
     
59,208
     
-
     
-
     
59,208
 
Total
 
$
102
   
$
18,450
   
$
18,552
   
$
1,709,724
   
$
11,969
   
$
3,306
   
$
1,724,999
 

Non-performing Loans



Non-performing loans include those loans that are considered nonaccrual, described in more detail below and all loans past due 90 or more days. Loans are considered for non-accrual status upon reaching 90 days delinquency, although the Company may be receiving partial payments of interest and partial repayments of principal on such loans, or if full payment of principal and interest is not expected. Additionally, if management is made aware of other information including bankruptcy, repossession, death, or legal proceedings, the loan may be placed on non-accrual status. If a loan is 90 days or more past due and is well secured and in the process of collection, it may still be considered accruing.

22

The following table reflects the non-performing loan receivables, as well as those on non-accrual status as of September 30, 2023 and December 31, 2022, respectively. The balances are presented by class of loan receivable (in thousands):

   
September 30, 2023
    December 31, 2022   
 
   
Nonaccrual With a
related allowance
   
Nonaccrual Without
a related allowance
   
90 days or greater
past due and
accruing
   
Total non-performing
loans
    Nonaccrual    
90 days or greater past
due and accruing
   
Total non-performing
loans
 
Real estate loans:
                                         
     Mortgages
 
$
318
   
$
2,517
   
$
-
   
$
2,835
    $ 562     $ -     $ 562  
     Home Equity
   
-
     
121
     
-
     
121
      29       -       29  
     Commercial
   
260
     
1,337
     
-
     
1,597
      2,778       -       2,778  
     Agricultural
   
182
     
2,803
     
-
     
2,985
      3,222       -       3,222  
     Construction
   
2,357
     
-
     
-
     
2,357
      -       -       -  
Consumer
   
1,007
     
10
     
8
     
1,025
      -       7       7  
Other commercial loans
   
526
     
1,402
     
-
     
1,928
      62       -       62  
Other agricultural loans
     -
       299
       -
       299
       285
       -
       285
 
   
$
4,650
   
$
8,489
   
$
8
   
$
13,147
    $ 6,938     $ 7     $
6,945  


As of September 30, 2023, there were $8.5 million of non-accrual loans that did not have a related allowance for credit losses. The estimated fair values of the collateral securing these loans exceeded their carrying amount, or the loans were previously charge down to the realizable collateral values. Accordingly, no specific valuation allowance was considered to be necessary.


The following table presents, by class of loans and leases, the amortized cost basis of collateral-dependent nonaccrual loans and leases and type of collateral as of  September 30, 2023 and December 31, 2022 (in thousands):

September 30, 2023  
Real Estate
   
Other
   
None
   
Total
 
Real estate loans:
                       
     Mortgages
 
$
2,835
   
$
-
   
$
-
   
$
2,835
 
     Home Equity
   
121
     
-
     
-
     
121
 
     Commercial
   
1,597
     
-
     
-
     
1,597
 
     Agricultural
   
2,985
     
-
     
-
     
2,985
 
     Construction
   
2,357
     
-
     
-
     
2,357
 
Consumer
   
-
     
-
     
1,017
     
1,017
 
Other commercial loans
   
-
     
1,928
     
-
     
1,928
 
Other agricultural loans
   
-
     
299
     
-
     
299
 
   
$
9,895
   
$
2,227
    $
1,017
   
$
13,139
 
   
 
December 31, 2022
 

   
   

   

 
Real estate loans:
                       
     Mortgages
 
$
562
   
$
-
   
$
-
   
$
562
 
     Home Equity
   
29
     
-
     
-
     
29
 
     Commercial
   
2,778
     
-
     
-
     
2,778
 
     Agricultural
   
3,222
     
-
     
-
     
3,222
 
     Construction
   
-
     
-
     
-
     
-
 
Consumer
   
-
     
-
     
-
     
-
 
Other commercial loans
   
-
     
62
     
-
     
62
 
Other agricultural loans
   
-
     
285
     
-
     
285
 
   
$
6,591
   
$
347
   
$
-
   
$
6,938
 

Credit Quality Information


For commercial real estate, agricultural real estate, construction, other commercial, other agricultural, and state and political subdivision loans, management uses a internal risk rating system to monitor and assess credit quality. During the third quarter of 2023, this rating system was expanded from a nine grade rating system to a ten grade rating system. The first six categories under the revised system are considered not criticized and are aggregated as “Pass” rated. Under the prior system, the first five categories were considered not criticized and aggregated as “Pass” rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The definitions of each rating are defined below:

23

Pass (Grades 1-6) – These loans are to customers with credit quality ranging from an acceptable to very high quality and are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral.


Special Mention (Grade 7) – This loan grade is in accordance with regulatory guidance and includes loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected.


Substandard (Grade 8) – This loan grade is in accordance with regulatory guidance and includes loans that have a well-defined weakness based on objective evidence and be characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.


Doubtful (Grade 9) – This loan grade is in accordance with regulatory guidance and includes loans that have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, based on existing circumstances.


Loss (Grade 10) – This loan grade is in accordance with regulatory guidance and includes loans that are considered uncollectible, or of such value that continuance as an asset is not warranted.


To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay the loan as agreed, the Company’s loan rating process includes several layers of internal and external oversight. The Company’s loan officers are responsible for the timely and accurate risk rating of the loans in each of their portfolios at origination and on an ongoing basis under the supervision of management.  All commercial, agricultural and state and political relationships over $500,000 are reviewed annually to ensure the appropriateness of the loan grade. In addition, the Company engages an external consultant on at least an annual basis to: 1) review a minimum of 50% of the dollar volume of the commercial, agricultural and municipal loan portfolios on an annual basis, 2) review a sample of new loans originated for over $1.0 million in the last year, 3) review a sample of borrowers with commitments greater than or equal to $1.0 million,  4) review selected loan relationships over $750,000 which are over 30 days past due or classified Special Mention, Substandard, Doubtful, or Loss, and 5) such other loans which management or the consultant deems appropriate.

24

The following tables represent credit exposures by internally assigned grades, by origination year, as of September 30, 2023 (in thousands):


                                       
Revolving
   
Revolving
       
         
Loans
   
Loans
       
                                       
Amortized
   
Converted
       
September 30, 2023
 
2023
   
2022
   
2021
   
2020
   
2019
   
Prior
   
Cost Basis
   
to Term
   
Total
 
Commercial real estate
                                                     
Risk Rating
                                                     
Pass
 
$
65,893
   
$
333,600
   
$
215,198
   
$
123,779
   
$
82,640
   
$
195,576
   
$
29,476
   
$
1,166
   
$
1,047,328
 
Special Mention
   
-
     
8,824
     
3,412
     
1,563
     
7,659
     
9,391
     
123
     
-
     
30,972
 
Substandard
   
-
     
233
     
6
     
-
     
161
     
1,686
     
729
     
8
     
2,823
 
Doubtful
    -       -       -       -       -       -       -       -       -  
Total
 
$
65,893
   
$
342,657
   
$
218,616
   
$
125,342
   
$
90,460
   
$
206,653
   
$
30,328
   
$
1,174
   
$
1,081,123
 
Current period gross charge-offs
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
                                                                         
Agricultural real estate
                                                                       
Risk Rating
                                                                       
Pass
 
$
16,361
   
$
54,306
   
$
29,828
   
$
32,559
   
$
26,760
   
$
123,598
   
$
12,926
   
$
1,689
   
$
298,027
 
Special Mention
   
149
     
1,915
     
1,211
     
-
     
-
     
6,702
     
94
     
-
     
10,071
 
Substandard
   
-
     
-
     
-
     
-
     
103
     
5,645
     
75
     
243
     
6,066
 
Doubtful
    -       -       -       -       -       -       -       -       -  
Total
 
$
16,510
   
$
56,221
   
$
31,039
   
$
32,559
   
$
26,863
   
$
135,945
   
$
13,095
   
$
1,932
   
$
314,164
 
Current period gross charge-offs
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
                                                                         
Construction
                                   
-
                                 
Risk Rating
                                                                       
Pass
 
$
37,135
   
$
92,252
   
$
35,486
   
$
-
   
$
-
   
$
385
   
$
-
   
$
-
   
$
165,258
 
Special Mention
   
2,130
     
1,165
     
4,410
     
-
     
-
     
-
     
-
     
-
     
7,705
 
Substandard
   
-
     
-
     
2,357
     
-
     
-
     
-
     
-
     
-
     
2,357
 
Doubtful
    -       -       -       -       -       -       -       -       -  
Total
 
$
39,265
   
$
93,417
   
$
42,253
   
$
-
   
$
-
   
$
385
   
$
-
   
$
-
   
$
175,320
 
Current period gross charge-offs
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
                                                                         
Other commercial loans
                                   
-
                                 
Risk Rating
                                                                       
Pass
 
$
5,227
   
$
12,057
   
$
9,234
   
$
5,487
   
$
5,291
   
$
4,213
   
$
71,633
   
$
99
   
$
113,241
 
Special Mention
   
-
     
81
     
1,555
     
216
     
286
     
22
     
1,214
     
1,708
     
5,082
 
Substandard
   
-
     
100
     
-
     
-
     
186
     
1,202
     
294
     
-
     
1,782
 
Doubtful
   
-
     
-
     
-
     
-
     
-
     
-
     
218
     
24
     
242
 
Total
 
$
5,227
   
$
12,238
   
$
10,789
   
$
5,703
   
$
5,763
   
$
5,437
   
$
73,359
   
$
1,831
   
$
120,347
 
Current period gross charge-offs
 
$
-
   
$
-
   
$
-
   
$
763
   
$
-
   
$
-
   
$
-
   
$
-
   
$
763
 
                                                                         
Other agricultural loans
                                   
-
                                 
Risk Rating
                                                                       
 Pass
 
$
3,464
   
$
1,645
   
$
7,005
   
$
1,154
   
$
666
   
$
521
   
$
10,554
   
$
-
   
$
25,009
 
Special Mention
   
-
     
491
     
223
     
45
     
8
     
42
     
500
     
-
     
1,309
 
Substandard
   
-
     
-
     
-
     
-
     
6
     
265
     
25
     
34
     
330
 
Doubtful
    -       -       -       -       -       -       -       -       -  
Total
 
$
3,464
   
$
2,136
   
$
7,228
   
$
1,199
   
$
680
   
$
828
   
$
11,079
   
$
34
   
$
26,648
 
Current period gross charge-offs
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
                                                                         
State and political subdivision loans
                                   
-
                                 
Risk Rating
                                                                       
 Pass
 
$
1,426
   
$
14,207
   
$
10,984
   
$
4,363
   
$
2
   
$
25,678
   
$
-
   
$
-
   
$
56,660
 
Special Mention
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Substandard
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Doubtful
    -       -       -       -       -       -       -       -       -  
Total
 
$
1,426
   
$
14,207
   
$
10,984
   
$
4,363
   
$
2
   
$
25,678
   
$
-
   
$
-
   
$
56,660
 
Current period gross charge-offs
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
                                                                         
Total
                                   
-
                                 
Risk Rating
                                                                       
Pass
 
$
129,506
   
$
508,067
   
$
307,735
   
$
167,342
   
$
115,359
   
$
349,971
   
$
124,589
   
$
2,954
   
$
1,705,523
 
Special Mention
   
2,279
     
12,476
     
10,811
     
1,824
     
7,953
     
16,157
     
1,931
     
1,708
     
55,139
 
Substandard
   
-
     
333
     
2,363
     
-
     
456
     
8,798
     
1,123
     
285
     
13,358
 
Doubtful
   
-
     
-
     
-
     
-
     
-
     
-
     
218
     
24
     
242
 
Total
 
$
131,785
   
$
520,876
   
$
320,909
   
$
169,166
   
$
123,768
   
$
374,926
   
$
127,861
   
$
4,971
   
$
1,774,262
 


Information presented in the table above is not required for periods prior to adoption of CECL. The following table presents the most comparable information for the prior period, internal credit risk ratings for the indicated loan class segments as of December 31, 2022 (in thousands).

December 31, 2022
 
Pass
   
Special Mention
   
Substandard
   
Doubtful
   
Loss
   
Ending Balance
 
Real estate loans:
                                   
     Commercial
 
$
842,912
   
$
28,047
   
$
5,610
   
$
-
   
$
-
   
$
876,569
 
     Agricultural
   
295,443
     
11,960
     
6,211
     
-
     
-
     
313,614
 
     Construction
   
75,703
     
2,642
     
2,346
     
-
     
-
     
80,691
 
Other commercial loans
   
59,902
     
2,953
     
337
     
30
     
-
     
63,222
 
Other agricultural loans
   
32,708
     
1,307
     
817
     
-
     
-
     
34,832
 
State and political
                                               
subdivision loans
   
59,208
     
-
     
-
     
-
     
-
      59,208
 
Total
 
$
1,365,876
   
$
46,909
   
$
15,321
   
$
30
   
$
-
   
$
1,428,136
 

25

For residential real estate mortgage loans, home equity loans, and consumer loans, credit quality is monitored based on whether the loan is performing or non-performing, which is typically based on the aging status of the loan and payment activity, unless a specific action, such as bankruptcy, repossession, death or significant delay in payment occurs to raise awareness of a possible credit event. Non-performing loans include those loans that are considered nonaccrual, described in more detail above, and all loans past due 90 or more days and still accruing. The following table presents the recorded investment in those loan classes based on payment activity, by origination year, as of September 30, 2023 (in thousands):


                                       
Revolving
   
Revolving
       
         
Loans
   
Loans
       
                                       
Amortized
   
Converted
       
September 30, 2023
 
2023
   
2022
   
2021
   
2020
   
2019
   
Prior
   
Cost Basis
   
to Term
   
Total
 
Residential real estate
                                                     
Payment Performance
                                                     
Performing
 
$
15,478
   
$
89,640
   
$
48,451
   
$
30,300
   
$
19,086
   
$
101,162
   
$
-
   
$
-
   
$
304,117
 
Nonperforming
   
-
     
406
     
771
     
399
     
-
     
1,259
     
-
     
-
     
2,835
 
Total
 
$
15,478
   
$
90,046
   
$
49,222
   
$
30,699
   
$
19,086
   
$
102,421
   
$
-
   
$
-
   
$
306,952
 
Current period gross charge-offs
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
1
   
$
-
   
$
-
   
$
1
 
                                                                         
Home equity
                                   
-
                                 
Payment Performance
                                                                       
Performing
 
$
3,188
   
$
3,105
   
$
1,980
   
$
2,142
   
$
2,593
   
$
8,412
   
$
27,613
   
$
275
   
$
49,308
 
Nonperforming
   
-
     
-
     
-
     
-
     
-
     
53
     
68
     
-
     
121
 
Total
 
$
3,188
   
$
3,105
   
$
1,980
   
$
2,142
   
$
2,593
   
$
8,465
   
$
27,681
   
$
275
   
$
49,429
 
Current period gross charge-offs
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
                                                                         
Consumer
                                   
-
                                 
Payment Performance
                                                                       
Performing
 
$
1,742
   
$
1,115
   
$
598
   
$
509
   
$
570
   
$
3,024
   
$
107,168
   
$
2
   
$
114,728
 
Nonperforming
   
-
     
18
     
-
     
-
     
-
     
1,007
     
-
     
-
     
1,025
 
Total
 
$
1,742
   
$
1,133
   
$
598
   
$
509
   
$
570
   
$
4,031
   
$
107,168
   
$
2
   
$
115,753
 
Current period gross charge-offs
 
$
-
   
$
-
   
$
-
   
$
-
   
$
1
   
$
38
   
$
16
   
$
-
   
$
55
 
                                                                         
Total
                                   
-
                                 
Payment Performance
                                                                       
Performing
 
$
20,408
   
$
93,860
   
$
51,029
   
$
32,951
   
$
22,249
   
$
112,593
   
$
134,781
   
$
277
   
$
468,148
 
Nonperforming
   
-
     
424
     
771
     
399
     
-
     
2,324
     
68
     
-
     
3,986
 
Total
 
$
20,408
   
$
94,284
   
$
51,800
   
$
33,350
   
$
22,249
   
$
114,917
   
$
134,849
   
$
277
   
$
472,134
 



Information presented in the table above is not required for periods prior to adoption of CECL. The following table presents the most comparable information for the prior period, internal credit risk ratings for the indicated loan class segments as of December 31, 2022 (in thousands).

December 31, 2022
 
Performing
   
Non-performing
   
PCI
   
Total
 
Real estate loans:
                               
Mortgages
 
$
161,998
   
$
562
   
$
9
   
$
162,569
 
Home Equity
   
47,615
     
29
     
-
     
47,644
 
Consumer
   
86,643
     
7
     
-
     
86,650
 
Total
 
$
296,256
   
$
598
   
$
9
   
$
296,863
 

26
Aging Analysis of Past Due Loan Receivables


Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following table includes an aging analysis of the recorded investment of past due loan receivables as of September 30, 2023 and December 31, 2022 (in thousands):

September 30, 2023
 
30-59 Days
Past Due
   
60-89 Days
Past Due
   
90 Days
Or Greater
   
Total Past
Due
   
Current
   
Total
Loans
Receivables
   
90 Days or
Greater and
Accruing
 
Real estate loans:
                                         
Mortgages
 
$
836
   
$
282
   
$
2,335
   
$
3,453
   
$
303,499
   
$
306,952
   
$
-
 
Home Equity
   
130
     
77
     
100
     
307
     
49,122
     
49,429
     
-
 
Commercial
   
1,797
     
514
     
1,003
     
3,314
     
1,077,809
     
1,081,123
     
-
 
Agricultural
   
299
     
-
     
1,367
     
1,666
     
312,498
     
314,164
     
-
 
Construction
   
677
     
-
     
2,357
     
3,034
     
172,286
     
175,320
     
-
 
Consumer
   
647
     
124
     
1,025
     
1,796
     
113,957
     
115,753
     
8
 
Other commercial loans
   
633
     
59
     
-
     
692
     
119,655
     
120,347
     
-
 
Other agricultural loans
   
-
     
224
     
-
     
224
     
26,424
     
26,648
     
-
 
State and political subdivision loans
   
-
     
-
     
-
     
-
     
56,660
     
56,660
     
-
 
Total
 
$
5,019
   
$
1,280
   
$
8,187
   
$
14,486
   
$
2,231,910
   
$
2,246,396
   
$
8
 
                                                         
Loans considered non-accrual
 
$
241
   
$
98
   
$
8,179
   
$
8,518
   
$
4,621
   
$
13,139
         
Loans still accruing
   
4,778
     
1,182
     
8
     
5,968
     
2,227,289
     
2,233,257
         
Total
 
$
5,019
   
$
1,280
   
$
8,187
   
$
14,486
   
$
2,231,910
   
$
2,246,396
         

December 31, 2022
 
30-59 Days
Past Due
   
60-89 Days
Past Due
   
90 Days
Or Greater
   
Total Past
Due
   
Current
   
PCI
   
Total
Loan
Receivables
   
90 Days or
Greater and
Accruing
 
Real estate loans:
                                               
Mortgages
 
$
356
   
$
132
   
$
229
   
$
717
   
$
161,843
   
$
9
   
$
162,569
   
$
-
 
Home Equity
   
48
     
9
     
29
     
86
     
47,558
     
-
     
47,644
     
-
 
Commercial
   
1,065
     
115
     
1,788
     
2,968
     
871,745
     
1,856
     
876,569
     
-
 
Agricultural
   
-
     
-
     
1,368
     
1,368
     
310,805
     
1,441
     
313,614
     
-
 
Construction
   
-
     
-
     
-
     
-
     
80,691
     
-
     
80,691
     
-
 
Consumer
   
147
     
-
     
7
     
154
     
86,496
     
-
     
86,650
     
7
 
Other commercial loans
   
1,660
     
35
     
32
     
1,727
     
61,495
     
-
     
63,222
     
-
 
Other agricultural loans
   
-
     
-
     
-
     
-
     
34,832
     
-
     
34,832
     
-
 
State and political subdivision loans
   
-
     
-
     
-
     
-
     
59,208
     
-
     
59,208
     
-
 
Total
 
$
3,276
   
$
291
   
$
3,453
   
$
7,020
   
$
1,714,673
   
$
3,306
   
$
1,724,999
   
$
7
 
Loans considered non-accrual
 
$
46
   
$
76
   
$
3,446
   
$
3,568
   
$
3,370
   
$
-
   
$
6,938
         
Loans still accruing
   
3,230
     
215
     
7
     
3,452
     
1,711,303
     
3,306
     
1,718,061
         
Total
 
$
3,276
   
$
291
   
$
3,453
   
$
7,020
   
$
1,714,673
   
$
3,306
   
$
1,724,999
         


Modifications to Borrowers Experiencing Financial Difficulty



Occasionally, the Company modifies loans to borrowers in financial distress by providing principal forgiveness, term extension, an other-than-insignificant payment delay or interest rate reduction. When principal forgiveness is provided, the amount of forgiveness is charged-off against the allowance for credit losses.


27

In some cases, the Company provides multiple types of concessions on one loan. Typically, one type of concession, such as a term extension, is granted initially. If the borrower continues to experience financial difficulty, another concession, such as principal forgiveness, may be granted.



The following table shows, the amortized cost basis by class of loans receivable, information regarding accruing and nonaccrual modified loans to borrowers experiencing financial difficulty during the three and nine months ended September 30, 2023 (dollars in thousands):



 
 
Three months ended September 30, 2023
 
 
 
Number of loans
 
Amortized Cost Basis
 
% of Total Class of
Financing Receivable
 
Accruing Modified Loans to Borrowers Experiencing Financial Difficulty
 
Real estate loans:
         
     Commercial
   
1
   
$
42
     
0.00
%
     Agricultural
   
2
     
673
     
0.21
%
Other commercial loans
    5       1,378       1.15 %
Total
   
8
   
$
2,093
         



   
Nine months ended September 30, 2023
 
 
 
Number of loans
   
Amortized Cost Basis
   
% of Total Class of
Financing Receivable
 
Accruing Modified Loans to Borrowers Experiencing Financial Difficulty
 
Real estate loans:
             
     Mortgages
   
1
   
$
129
     
0.04
%
     Commercial
   
7
     
1,969
     
0.18
%
Agricultural
    3       728       0.23 %
Other commercial loans
   
5
     
1,378
     
1.15
%
Total
   
16
   
$
4,204
         
 
                       
Non-Accruing Modified Loans to Borrowers Experiencing Financial Difficulty
 
Real estate loans:
                 
     Commercial
   
1
   
$
86
     
0.01
%
Total
   
1
   
$
86
         



The following table shows, by class of loans receivable, information regarding the financial effect on accruing and nonaccrual modified loans to borrowers experiencing financial difficulty during the three and nine months ended September 30, 2023:



Three months ended September 30, 2023
Term Extension
Loan Type
Number of loans
 
Financial Effect
Accruing Modified Loans to Borrowers Experiencing Financial Difficulty
 
 
Real estate loans:
   
   
     Commercial
   
1
 
Extended the weighted average loan maturity 6 months
     Agricultural
   
2
 
Extended the weighted average loan maturity 3 months
Consumer
    5   Extended the loan maturity 10 months
Total
   
8
 
 


28
Nine months ended September 30, 2023
Term Extension
Loan Type
 
Number of loans
 
Financial Effect
Accruing Modified Loans to Borrowers Experiencing Financial Difficulty
 
 
Real estate loans:
     
  
Mortgages
   
1
 
Extended the loan maturity 4 months
Commercial
   
7
 
Extended the weighted average loan maturity 22 months
Agricultural
    3  
Extended the weighted average loan maturity 5 months
Other commercial loans
   
5
 
Extended the loan maturity 10 months
Total
   
16
 
 
 
       
   
Non-Accruing Modified Loans to Borrowers Experiencing Financial Difficulty
 
 
Real estate loans:
       
  
     Commercial
   
1
 
Extended the loan maturity 6 months
Total
   
1
 
 



There were no accruing or nonaccrual modified loans to borrowers experiencing financial difficulty for which there were payment defaults after the modification date for the three and nine months ended September 30, 2023.


The following presents, by class of loans, the amortized cost and payment status of accruing and nonaccrual modified loans to borrowers experiencing financial difficulty at September 30, 2023 (in thousands):

    September 30, 2023  
 
       
30-89 Days
   
90 Days
       
Accruing Modified Loans to Borrowers Experiencing Financial Difficulty
 
Current
   
Past Due
   
Or Greater
   
Total
 
Real estate loans:
                       
     Mortgages
 
$
129
   
$
-
   
$
-
   
$
129
 
     Commercial
   
1,969
     
-
     
-
     
1,969
 
Agricultural
    728       -       -       728  
Total
 
$
4,204
   
$
-
   
$
-
   
$
4,204
 
 
                               
Non-Accruing Modified Loans to Borrowers Experiencing Financial Difficulty
                               
Real estate loans:
                               
     Commercial
 
$
86
    $
-
    $
-
   
$
86
 
    Total
 
$
86
   
$
-
   
$
-
   
$
86
 

Foreclosed Assets Held For Sale


Foreclosed assets acquired in settlement of loans are carried at fair value, less estimated costs to sell, and are included in other assets on the Consolidated Balance Sheet. As of September 30, 2023 and December 31, 2022, included within other assets are $474,000 and $543,000, respectively, of foreclosed assets. As of September 30, 2023, included within the foreclosed assets are $176,000 of consumer residential mortgages that were foreclosed on or received via a deed in lieu transaction prior to the period end. As of September 30, 2023, the Company had initiated formal foreclosure proceedings on $241,000 of residential mortgage loans, the collateral properties which have not yet been transferred into foreclosed assets.

Note 7 – Goodwill and Other Intangible Assets


The following table provides the gross carrying value and accumulated amortization of intangible assets as of September 30, 2023 and December 31, 2022 (in thousands):

 
September 30, 2023
   
December 31, 2022
 
   
Gross
carrying
value
   
Accumulated
amortization
   
Net
carrying
value
   
Gross
carrying
value
   
Accumulated
amortization
   
Net
carrying
value
 
Amortized intangible assets (1):
                                   
MSRs
 
$
2,607
   
$
(1,590
)
 
$
1,017
   
$
2,336
   
$
(1,362
)
 
$
974
 
Core deposit intangibles
   
4,713
     
(1,864
)
   
2,849
     
1,943
     
(1,645
)
   
298
 
Total amortized intangible assets
 
$
7,320
   
$
(3,454
)
 
$
3,866
   
$
4,279
   
$
(3,007
)
 
$
1,272
 
Unamortized intangible assets:
                                               
Goodwill
 
$
84,758
                   
$
31,376
                 
(1) Excludes fully amortized intangible assets


The following table provides the current year and estimated future amortization expense for amortized intangible assets for the next five years (in thousands). The Company based its projections of amortization expense shown below on existing asset balances at September 30, 2023. Future amortization expense may vary from these projections:

 
MSRs
   
Core deposit intangibles
   
Total
 
Three months ended September 30, 2023 (actual)
 
$
80
   
$
157
   
$
237
 
Nine months ended September 30, 2023 (actual)
   
228
     
219
     
447
 
Three months ended September 30, 2022 (actual)
   
74
     
40
     
114
 
Nine months ended September 30, 2022 (actual)
   
234
     
120
     
354
 
Estimate for year ending December 31,
                       
Remaining 2023
   
76
     
154
     
230
 
2024
   
277
     
564
     
841
 
2025
   
226
     
478
     
704
 
2026
   
174
     
395
     
569
 
2027
   
118
     
339
     
457
 
Thereafter
   
146
     
919
     
1,065
 
Total
  $ 1,017    
$
2,849
    $ 3,866  

Note 8 – Employee Benefit Plans


For additional detailed disclosure on the Company’s pension and employee benefits plans, please refer to Note 11 of the Company’s Audited Consolidated Financial Statements included in the 2022 Annual Report on Form 10-K.


Noncontributory Defined Benefit Pension Plan


The Bank sponsors a trusteed noncontributory defined benefit pension plan (“Pension Plan”) covering substantially all employees and officers hired prior to January 1, 2007. The Bank’s funding policy is to make annual contributions, if needed, based upon the funding formula developed by the plan’s actuary. Any employee with a hire date of January 1, 2007 or later is not eligible to participate in the Pension Plan.


In lieu of the Pension Plan, employees with a hire date of January 1, 2007 or later are eligible to receive, after meeting certain length of service requirements, an annual discretionary 401(k) plan contribution from the Bank equal to a percentage of an employee’s base compensation.  The contribution amount, if any, is placed in a separate account within the 401(k) plan and is subject to a vesting requirement.


For employees who are eligible to participate in the Pension Plan, the Pension Plan requires benefits to be paid to eligible employees based primarily upon age and compensation rates during employment.  Upon retirement or other termination of employment, employees can elect either an annuity benefit or a lump sum distribution of vested benefits in the Pension Plan.


29

The following sets forth the components of net periodic benefit costs of the Pension Plan and the line item on the Consolidated Statement of Income where such amounts are included, for the three and nine months ended September 30, 2023 and 2022, respectively (in thousands):

 
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
   
   
2023
   
2022
   
2023
   
2022
 
Affected line item on the Consolidated
Statement of Income (Loss)
Service cost
 
$
75
   
$
89
   
$
230
   
$
267
 
Salary and Employee Benefits
Interest cost
   
104
     
69
     
324
     
207
 
Other Expenses
Expected return on plan assets
   
(183
)
   
(234
)
   
(577
)
   
(701
)
Other Expenses
Partial Settlement     -       144       -       144   Other Expenses
Net amortization and deferral
   
17
     
24
     
31
     
72
 
Other Expenses
Net periodic benefit cost
 
$
13
 
$
92
 
$
8
 
$
(11
)
 


The Bank does not expect to contribute to the Pension Plan during 2023.


Restricted Stock Plan


The Company maintains a Restricted Stock Plan (the “Plan”) whereby employees and non-employee corporate directors are eligible to receive awards of restricted stock based upon performance related requirements.  Awards granted under the Plan are in the form of the Company’s common stock and are subject to certain vesting requirements including continuous employment or service with the Company.  In April 2016, the Company’s stockholders authorized a total of 150,000 shares of the Company’s common stock to be made available under the Plan. As of September 30, 2023, 113,449 shares remain available to be issued under the Plan.  The Plan assists the Company in attracting, retaining and motivating employees to make substantial contributions to the success of the Company and to increase the emphasis on the use of equity as a key component of compensation.


The following table details the vesting, awarding and forfeiting of restricted stock during the three and nine months ended September 30, 2023:


 
Three months
   
Nine months
 
   
Unvested
Shares
   
Weighted
Average
Market Price
   
Unvested
Shares
   
Weighted
Average
Market Price
 
Outstanding, beginning of period
   
6,254
   
$
71.61
     
6,622
   
$
63.63
 
Granted
   
367
     
81.58
     
2,609
     
83.13
 
Forfeited
   
(52
)
   
(63.09
)
   
(213
)
   
(63.12
)
Vested
   
(499
)
   
(67.37
)
   
(2,948
)
   
(62.39
)
Outstanding, end of period
   
6,070
   
$
72.63
     
6,070
   
$
72.63
 


Compensation expense related to restricted stock is recognized, based on the market price of the stock at the grant date, over the vesting period. Compensation expense related to restricted stock was $178,000 and $210,000 for the nine months ended September 30, 2023 and 2022, respectively. For the three months ended September 30, 2023 and 2022, compensation expense totaled $62,000 and $68,000, respectively. At September 30, 2023, the total compensation cost related to nonvested awards that had not yet been recognized was $441,000, which is expected to be recognized over the next three years.

30
Note 9 – Accumulated Other Comprehensive Loss


The following tables present the changes in accumulated other comprehensive income by component, net of tax, for the three and nine months ended September 30, 2023 and 2022 (in thousands):

 
Three months ended September 30, 2023
 
   
Unrealized gain (loss)
on available for sale
 securities (a)
   
Defined Benefit
Pension Items (a)
   
Unrealized gain
on interest rate
swap (a)
   
Total
 
Balance as of June 30, 2023
 
$
(35,119
)
 
$
(1,045
)
 
$
5,184
   
$
(30,980
)
Other comprehensive income (loss) before reclassifications (net of tax)
   
(6,025
)
   
-
     
823
     
(5,202
)
Amounts reclassified from accumulated other comprehensive income (loss) (net of tax)
   
-
     
6
     
(467
)
   
(461
)
Net current period other comprehensive income (loss)
   
(6,025
)
   
6
     
356
     
(5,663
)
Balance as of September 30, 2023
 
$
(41,144
)
 
$
(1,039
)
 
$
5,540
   
$
(36,643
)

 
Nine months ended September 30, 2023
 
   
Unrealized gain (loss)
on available for sale
securities (a)
   
Defined Benefit
Pension Items (a)
   
Unrealized gain
on interest rate
swap (a)
   
Total
 
Balance as of December 31, 2022
 
$
(37,514
)
 
$
(1,056
)
 
$
5,429
   
$
(33,141
)
Other comprehensive income (loss) before reclassifications (net of tax)
   
(3,669
)
   
-
     
1,352
     
(2,317
)
Amounts reclassified from accumulated other comprehensive income (loss) (net of tax)
   
39
     
17
     
(1,241
)
   
(1,185
)
Net current period other comprehensive income (loss)
   
(3,630
)
   
17
     
111
     
(3,502
)
Balance as of September 30, 2023
 
$
(41,144
)
 
$
(1,039
)
 
$
5,540
   
$
(36,643
)


 
Three months ended September 30, 2022
 
   
Unrealized gain (loss)
on available for sale
securities (a)
   
Defined Benefit
Pension Items (a)
   
Unrealized gain
on interest rate
swap (a)
   
Total
 
Balance as of June 30, 2022
 
$
(28,928
)
 
$
(1,930
)
 
$
4,299
   
$
(26,559
)
Other comprehensive income (loss) before reclassifications (net of tax)
   
(10,727
)
   
-
     
1,444
     
(9,283
)
Amounts reclassified from accumulated other comprehensive income (loss) (net of tax)
   
5
     
19
     
(37
)
   
(13
)
Net current period other comprehensive income (loss)
   
(10,722
)
   
19
     
1,407
     
(9,296
)
Balance as of September 30, 2022
 
$
(39,650
)
 
$
(1,911
)
 
$
5,706
   
$
(35,855
)

 
Nine months ended September 30, 2022
 
   
Unrealized gain (loss)
on available for sale
securities (a)
   
Defined Benefit
Pension Items (a)
   
Unrealized gain
on interest rate
swap (a)
   
Total
 
Balance as of December 31, 2021
 
$
304
   
$
(1,968
)
 
$
1,509
   
$
(155
)
Other comprehensive income (loss) before reclassifications (net of tax)
   
(39,959
)
   
-
     
4,185
     
(35,774
)
Amounts reclassified from accumulated other comprehensive income (loss) (net of tax)
   
5
     
57
     
12
     
74
 
Net current period other comprehensive income (loss)
   
(39,954
)
   
57
     
4,197
     
(35,700
)
Balance as of September 30, 2022
 
$
(39,650
)
 
$
(1,911
)
 
$
5,706
   
$
(35,855
)

(a) Amounts in parentheses indicate debits on the Consolidated Balance Sheet.

31

The following table presents the significant amounts reclassified out of each component of accumulated other comprehensive loss for the three and nine months ended September 30, 2023 and 2022 (in thousands):

Details about accumulated other comprehensive income (loss)
 
Amount reclassified from
accumulated comprehensive
income (loss) (a)
 
Affected line item in the Consolidated Statement of Income
 
 
Three Months Ended September 30,
 
 
 
 
2023
   
2022
 
 
Unrealized gains and losses on available for sale securities
           
             
   
$
-
   
$
(6
)
Available for sale securities gains, net
     
-
     
1
 
Provision for income taxes
   
$
-
   
$
(5
)
Net of tax
Defined benefit pension items
                                       
 
 
$
(7
)
 
$
(24
)
Other expenses
 
   
1
     
5
 
Provision for income taxes
 
 
$
(6
)
 
$
(19
)
Net of tax
                                               
Unrealized gain (loss) on interest rate swap
  $ 591     $ 47  
Interest expense
      (124 )     (10 )
Provision for income taxes
    $ 467     $ 37  
Net of tax
                                       
Total reclassifications
 
$
461
   
$
13
 
 

Nine Months Ended September 30,
 
 
2023
   
2022
 
 
Unrealized gains and losses on available for sale securities
           
               
   
$
(51
)
 
$
(6
)
Available for sale securities gains, net
     
12
     
1
 
Provision for income taxes
   
$
(39
)
 
$
(5
)
Net of tax
Defined benefit pension items
                                           
 
 
$
(21
)
 
$
(72
)
Other expenses
 
   
4
     
15
 
Provision for income taxes
 
 
$
(17
)
 
$
(57
)
Net of tax
                                       
Unrealized gain (loss) on interest rate swap   $ 1,571     $ (15 )
Interest expense
      (330 )     3  
Provision for income taxes
    $ 1,241     $ (12 )
Net of tax
                                                    
Total reclassifications
 
$
1,185
   
$
(74
)
 

(a) Amounts in parentheses indicate expenses and other amounts indicate income on the Consolidated Statement of Income Note 10 – Fair Value Measurements

32


The Company has established a hierarchal disclosure framework associated with the level of pricing observability utilized in measuring assets and liabilities at fair value. The three broad levels defined by this hierarchy are as follows:

Level I:
Quoted prices are available in active markets for identical assets or liabilities as of the reported date.

Level II:
Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but traded less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed.

Level III:
Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.


A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.


In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality, the Company’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company’s monthly and/or quarterly valuation process.

Assets and Liabilities Required to be Measured at Fair Value on a Recurring Basis


The fair values of equity securities and securities available for sale are determined by quoted prices in active markets, when available, and classified as Level I. If quoted market prices are not available, the fair value is determined by a matrix pricing, which is a mathematical technique, widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities and classified as Level II. The fair values consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

33

The following tables present the assets and liabilities reported on the Consolidated Balance Sheet at their fair value on a recurring basis as of September 30, 2023 and December 31, 2022 by level within the fair value hierarchy (in thousands). Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

September 30, 2023
 
Level I
   
Level II
   
Level III
   
Total
 
Fair value measurements on a recurring basis:
                       
Assets
                       
Equity securities
 
$
1,858
   
$
-
   
$
-
   
$
1,858
 
Available for sale securities:
                               
U.S. Agency securities
   
-
     
63,647
     
-
     
63,647
 
U.S. Treasury securities
   
147,431
     
-
     
-
     
147,431
 
Obligations of state and political subdivisions
   
-
     
96,022
     
-
     
96,022
 
Corporate obligations
   
-
     
12,120
     
-
     
12,120
 
Mortgage-backed securities in government sponsored entities
   
-
     
98,587
     
-
     
98,587
 
Loans held for sale
    -       14,155       -       14,155  
Other Assets
                               
Derivative instruments
   
-
     
17,707
     
437
     
18,144
 
Liabilities
                               
Derivative instruments
   
-
     
(10,694
)
   
-
     
(10,694
)

December 31, 2022
 
Level I
   
Level II
   
Level III
   
Total
 
Fair value measurements on a recurring basis:
                       
Assets:
                       
Equity securities
 
$
2,208
   
$
-
   
$
-
   
$
2,208
 
Available for sale securities:
                               
U.S. Agency securities
   
-
     
70,677
     
-
     
70,677
 
U.S. Treasuries securities
   
148,570
     
-
     
-
     
148,570
 
Obligations of state and political subdivisions
   
-
     
110,300
     
-
     
110,300
 
Corporate obligations
   
-
     
9,383
     
-
     
9,383
 
Mortgage-backed securities in government sponsored entities
   
-
     
100,576
     
-
     
100,576
 
Derivative instruments
   
-
     
16,599
     
-
     
16,599
 
Liabilities:
                               
Derivative instruments
   
-
     
(9,726
)
   
-
     
(9,726
)


The following tables represent the change in the assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2023 (in thousands):



 
 
IRLC-
Asset
 
Balance: June 30, 2023
 
$
529
 
Total unrealized losses:
       
Included in other comprehensive loss
   
-
 
Total losses included in earnings and held at reporting date
   
(92
)
Purchases, sales and settlements
   
-
 
Transfers in and/or out of Level 3
   
-
 
Ending Balance: September 30, 2023
 
$
437
 
Change in unrealized (losses) for the period included in earnings (or changes in net assets) for assets held as of September 30, 2023
 
$
(92
)

   
IRLC-
Asset
 
Beginning Balance: June 16, 2023   $ 657  
Total unrealized losses:        
Included in other comprehensive loss
    -  
Total losses included in earnings and held at reporting date     (220 )
Purchases, sales and settlements     -  
Transfers in and/or out of Level 3     -  
Ending Balance: September 30, 2023   $
437  
Change in unrealized (losses) for the period included in earnings (or changes in net assets) for assets held as of September 30, 2023   $
(220 )


At September 30, 2023, the Company had classified as Level 3 $437,000 of net derivative assets and liabilities related to IRLC. The fair value of IRLCs is based on prices obtained for loans with similar characteristics from third parties, adjusted by the pull-through rate, which represents the Company’s best estimate of the probability that a committed loan will fund. The weighted average pull-through rates applied ranged from 75.39% to 99.64% at September 30, 2023.

34

Significant unobservable inputs for assets measured at fair value on a recurring basis at September 30, 2023 (in thousands):


    Quantitative Information about Level 3 Fair Value Measurements at September 30, 2023  
   
Fair Value
 
Valuation
Technique
 
Significant
Unobservable Input
 
Range
   
Weighted Average
 
Measured at Fair Value on a Recurring Basis:
                       
Net derivative asset and liability:
                       
IRLC
 
$
437
 
Discounted cash flows
 
Pull-through rates
   
75.39%-99.64
%
   
90.40
%

Assets and Liabilities Required to be Measured and Reported at Fair Value on a Nonrecurring Basis


Assets measured at fair value on a nonrecurring basis as of September 30, 2023 and December 31, 2022 are included in the table below (in thousands):

September 30, 2023
 
Level I
   
Level II
   
Level III
   
Total
 
Individually analyzed loans held for investment
 
$
-
   
$
-
   
$
3,980
   
$
3,980
 
Other real estate owned
   
-
     
-
     
97
     
97
 
                                 
December 31, 2022
 
Level I
   
Level II
   
Level III
   
Total
 
Individually analyzed loans held for investment
 
$
-
   
$
-
   
$
496
   
$
496
 
Other real estate owned
   
-
     
-
     
297
     
297
 

Individually analyzed loans held for investment - The Company has measured impairment on impaired loans generally based on the fair value of the loan’s collateral.  Fair value is generally determined based upon independent third-party appraisals of the properties. In some cases, management may adjust the appraised value due to the age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed.   Additionally, management makes estimates about expected costs to sell the property which are also included in the net realizable value.  If the fair value of the collateral dependent loan is less than the carrying amount of the loan a specific reserve for the loan is made in the allowance for credit losses - loans or a charge-off is taken to reduce the loan to the fair value of the collateral (less estimated selling costs) and the loan is included in the table above as a Level III measurement.  If the fair value of the collateral exceeds the carrying amount of the loan, then the loan is not included in the table above as it is not currently being carried at its fair value. The fair values above excluded estimated selling costs of $393,000 and $50,000 at September 30, 2023 and December 31, 2022, respectively.

Other Real Estate Owned (OREO) – OREO is carried at the lower of cost or fair value, less estimated costs to sell, which is measured at the date of foreclosure.  If the fair value of the collateral exceeds the carrying amount of the loan, no charge-off or adjustment is necessary, the loan is not considered to be carried at fair value, and is therefore not included in the table above. If the fair value of the collateral is less than the carrying amount of the loan, management will charge the loan down to its estimated realizable value. The fair value of OREO is based on the appraised value of the property, which is generally unadjusted by management and is based on comparable sales for similar properties in the same geographic region as the subject property, and is included in the above table as a Level II measurement.  In some cases, management may adjust the appraised value due to the age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed.  In these cases, the loans are categorized in the above table as a Level III measurement since these adjustments are considered to be unobservable inputs. Income and expenses from operations and further declines in the fair value of the collateral subsequent to foreclosure are included in net expenses from OREO.

35

The following table provides a listing of the significant unobservable inputs used in the fair value measurement process for items valued utilizing Level III techniques (dollars in thousands).


Quantitative Information about Level III Fair Value Measurements
September 30, 2023
 
Fair
Value
 
Valuation Technique(s)
 
Unobservable input
 
Range
   
Weighted average
 
Individually analyzed loans held for investment
 
$
3,980
 
Appraised Collateral Values
 
Discount for time since appraisal
   
0-100
%
   
26.55
%
         
              
 
Selling costs
   
8%-10
%
   
9.89
%
         
              
 
Holding period
 
0 - 12 months
   
6.70 months
 
         
 
 
 
               
Other real estate owned
   
97
 
Appraised Collateral Values
 
Discount for time since appraisal
   
32
%
   
32.00
%

December 31, 2022
 
Fair
Value
 
Valuation Technique(s)
 
Unobservable input
 
Range
   
Weighted
average
 
Individually analyzed loans held for investment
   
496
 
Appraised Collateral Values
 
Discount for time since appraisal
   
0-100
%
   
25.16
%
         
     
 
Selling costs
   
8%-10
%
   
8.41
%
         
     
 
Holding period
 
6 - 12 months
   
11.51 months
 
         
 
 
 
               
Other real estate owned
   
297
 
Appraised Collateral Values
 
Discount for time since appraisal
   
20-84
%
   
39.84
%

Financial Instruments Not Required to be Measured or Reported at Fair Value


The carrying amount and fair value of the Company’s financial instruments that are not required to be measured or reported at fair value on a recurring basis are as follows (in thousands):

September 30, 2023
 
Carrying
Amount
   
Fair Value
   
Level I
   
Level II
   
Level III
 
Financial assets:
                             
Interest bearing time deposits with other banks
 
$
4,566
   
$
4,566
   
$
-
   
$
-
   
$
4,566
 
Net loans
   
2,224,941
     
2,145,060
     
-
     
-
     
2,080,817
 
                                         
Financial liabilities:
                                       
Deposits
   
2,335,135
     
2,324,624
     
1,958,842
     
-
     
365,782
 
Borrowed funds
   
316,151
     
298,617
     
-
     
-
     
298,617
 
 
                                       
December 31, 2022
 
   
   
   
   
 
Financial assets:
                                       
Interest bearing time deposits with other banks
 
$
6,055
   
$
6,055
   
$
-
   
$
-
   
$
6,055
 
Loans held for sale
   
725
     
725
     
-
     
-
     
725
 
Net loans
   
1,706,447
     
1,662,514
     
-
     
-
     
1,662,514
 
                                         
Financial liabilities:
                                       
Deposits
   
1,844,208
     
1,832,037
     
1,566,517
     
-
     
265,520
 
Borrowed funds
   
257,278
     
246,288
     
-
     
-
     
246,288
 


The carrying amounts for cash and due from banks, bank owned life insurance, regulatory stock, accrued interest receivable and payable approximate fair value and are considered Level I measurements.
36
  
Note 11 – Recent Accounting Pronouncements


In January 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, March 2020, to provide temporary optional expedients and exceptions to the U.S. GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from LIBOR and other interbank offered rates to alternative reference rates, such as the Secured Overnight Financing Rate. Entities can elect not to apply certain modification accounting requirements to contracts affected by what the guidance calls “reference rate reform” if certain criteria are met. An entity that makes this election would not have to remeasure the contracts at the modification date or reassess a previous accounting determination. Also, entities can elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform if certain criteria are met, and can make a one-time election to sell and/or reclassify held-to-maturity debt securities that reference an interest rate affected by reference rate reform. The amendments in this ASU are effective for all entities upon issuance through December 31, 2022. In December 2022, the FASB issued ASU 2022-06, Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848, which extends the sunset (or expiration) date of Accounting Standards Codification (ASC) Topic 848 to December 31, 2024. This gives reporting entities two additional years to apply the accounting relief provided under ASC Topic 848 for matters related to reference rate reform. ASU 2022-06 is effective for all reporting entities immediately upon issuance and must be applied on a prospective basis.



In January 2021, the FASB issued ASU 2021-01, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, which added to ASU 2020-04 optional expedients and exceptions to the U.S. GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from LIBOR and other interbank offered rates to alternative reference rates, such as the Secured Overnight Financing Rate. Entities can elect not to apply certain modification accounting requirements to contracts affected by what the guidance calls “reference rate reform” if certain criteria are met. An entity that makes this election would not have to remeasure the contracts at the modification date or reassess a previous accounting determination. Also, entities can elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform if certain criteria are met, and can make a onetime election to sell and/or reclassify held-to-maturity debt securities that reference an interest rate affected by reference rate reform. ASU 2022-06, Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848 deferred the sunset date of Topic 848 from December 31, 2022 to December 31, 2024. The amendments in this ASU are effective for all entities upon issuance through December 31, 2024. The Company has identified our loan receivables that have an interest rate indexed to LIBOR and is currently assessing the appropriate transition path. As such, the Company does not have an estimate of the financial impact of this update but does not expect the impact to be material to the financial statements of the Company.


37

In March 2023, the FASB issued ASU No. 2023-02, “Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method (a consensus of the Emerging Issues Task Force)”. The ASU allows entities to elect the proportional amortization method, on a tax-credit-program-by-tax-credit-program basis, for all equity investments in tax credit programs meeting the eligibility criteria in Accounting Standards Codification (ASC) 323-740-25-1. While the ASU does not significantly alter the existing eligibility criteria, it does provide clarifications to address existing interpretive issues. It also prescribes specific information reporting entities must disclose about tax credit investments each period. This ASU is effective for reporting periods beginning after December 15, 2023, for public business entities, or January 1, 2024 for the Corporation. The Corporation does not expect the adoption of this ASU to have a material impact on the Corporation’s financial statements.



Other accounting standards that have been issued by the FASB or other standards-setting bodies are not currently expected to have a material effect on the Company’s consolidated financial position, results of operations or cash flows.


38
ITEM 2. 
Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

We have made forward-looking statements in this document, and in documents that we incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or expected future results of operations of Citizens Financial Services, Inc., CZFS Acquisition Company, LLC, First Citizens Community Bank, First Citizens Insurance Agency, Inc., 1st Realty of PA LLC or the combined Company. When we use words such as “believes,” “expects,” “anticipates,” or similar expressions, we are making forward-looking statements. For a variety of reasons, actual results could differ materially from those contained in or implied by forward-looking statements.  The Company cautions readers that the following important factors, among others, could in the future affect the Company’s actual results and could cause the Company’s actual results for subsequent periods to differ materially from those expressed in any forward-looking statement:


Interest rates could change more rapidly or more significantly than we expect.

The economy could change significantly in an unexpected way, which would cause the demand for new loans and the ability of borrowers to repay outstanding loans to change in ways that our models do not anticipate.

The financial markets could suffer a significant disruption, which may have a negative effect on our financial condition and that of our borrowers, and on our ability to raise money by issuing new securities.

It could take us longer than we anticipate to implement strategic initiatives, including expansions, designed to increase revenues or manage expenses, or we may be unable to implement those initiatives at all.

Acquisitions and dispositions of assets could affect us in ways that management has not anticipated.

We may become subject to new legal obligations or the resolution of litigation may have a negative effect on our financial condition or operating results.

We may become subject to new and unanticipated accounting, tax, regulatory or compliance practices or requirements. Failure to comply with any one or more of these requirements could have an adverse effect on our operations.

We could experience greater loan delinquencies than anticipated, adversely affecting our earnings and financial condition.

We could experience greater losses than expected due to the ever increasing volume of information theft and fraudulent scams impacting our customers and the banking industry.

We could lose the services of some or all of our key personnel, which would negatively impact our business because of their business development skills, financial expertise, lending experience, technical expertise and market area knowledge.

The agricultural economy is subject to extreme swings in both the costs of resources and the prices received from the sale of products as a result of forces of nature like weather and various viruses, government regulations, international trade agreements and consumer tastes, which could negatively impact certain of our customers.

Loan concentrations in certain industries could negatively impact our results, if financial results or economic conditions deteriorate.

Companies providing support services related to the exploration and drilling of the natural gas reserves in our market area may be affected by federal, state and local laws and regulations such as restrictions on production, permitting, changes in taxes and environmental protection, which could negatively impact our customers and, as a result, negatively impact our loan and deposit volume and loan quality. Additionally, the activities the companies providing support services related to the exploration and drilling of the natural gas reserves may be dependent on the market price of natural gas.  As a result, decreases in the market price of natural gas could also negatively impact these companies, our customers.

39
Additional factors that may affect our results are discussed under “Part II – Item 1A – Risk Factors” in this report and in the Company’s 2022 Annual Report on Form 10-K under “Item 1.A/ Risk Factors.”  Except as required by applicable law and regulation, we assume no obligation to update or revise any forward-looking statements after the date on which they are made.

Critical Accounting Policies

See Note 1, “Basis of Presentation” for additional information on the adoption of ASC 326, which changes the methodology under which management calculates its reserve for loans and investment securities, now referred to as the allowance for credit losses. Management considers the measurement of the allowance for credit losses to be a critical accounting policy.

Introduction

The following is management’s discussion and analysis of the financial condition and results of operations at the dates and for the periods presented in the accompanying consolidated financial statements for the Company.  Our consolidated financial condition and results of operations consist almost entirely of the Bank’s financial condition and results of operations. Management’s discussion and analysis should be read in conjunction with the preceding financial statements presented under Part I.  The results of operations for the three and nine months ended September 30, 2023 are not necessarily indicative of the results you may expect for the full year.

The Company engages in the general business of banking throughout our service area of Potter, Tioga, Clinton, Bradford and Centre counties in north central Pennsylvania, Lebanon, Berks, Schuylkill, Lancaster and Chester counties in south central Pennsylvania and Allegany County in southern New York and with the MidCoast acquisition, the Cities of Wilmington and Dover, Delaware. We also have a limited branch office in Union county, Pennsylvania, which primarily serves agricultural and commercial customers in the central Pennsylvania market. With the recently completed HVBC acquisition, we have expanded further into southeast Pennsylvania, including Montgomery, Bucks and Philadelphia Counties as well as Burlington County, New Jersey through the acquisition of five full service branaches, four mortgage centers and one business banking facility. We maintain our central office in Mansfield, Pennsylvania. Presently we operate 47 banking facilities, 38 of which operate as bank branches.  In Pennsylvania, the Company has full service offices located in Mansfield, Blossburg, Ulysses, Genesee, Wellsboro, Troy, Sayre, Canton, Gillett, Millerton, LeRaysville, Towanda, Rome, the Mansfield Wal-Mart Super Center, Mill Hall, Schuylkill Haven, Friedensburg, Mt. Aetna, Fredericksburg, Mount Joy, Ephrata, Fivepointville, State College, Kennett Square, Warrington, Plumsteadville, Philadelphia, two branches near the city of Lebanon and two branches in Huntington Valley. The limited branch office is located in Winfield, Pennsylvania. In New York, our office is in Wellsville. In Delaware, we have three branches in Wilmington and one in Dover. The mortgage centers acquired as part of the acquisition are located  in Montgomeryville, PA, Huntington Valley, PA, Philadelphia, PA and Mount Laurel, NJ. The business banking facility is located in Philadelphia, PA. We have received approval to open a branch in Williamsport, Pennsylvania, which we expect to open in the fourth quarter of 2023.

Risk Management

Risk identification and management are essential elements for the successful management of the Company.  In the normal course of business, the Company is subject to various types of risk, including interest rate, credit, liquidity, reputational and regulatory risk.

Interest rate risk is the sensitivity of net interest income and the market value of financial instruments to the direction, frequency and magnitude of changes in market interest rates.  Interest rate risk results from various re-pricing frequencies and the maturity structure of the financial instruments owned by the Company.  The Company uses its asset/liability and funds management policy to control and manage interest rate risk.

40
Credit risk represents the possibility that a customer may not perform in accordance with contractual terms.  Credit risk results from loans with customers and the purchasing of securities.  The Company’s primary credit risk is in the loan portfolio.  The Company manages credit risk by adhering to an established credit policy and through a disciplined evaluation of the adequacy of the allowance for credit losses.  Also, the investment policy limits the amount of credit risk that may be taken in the investment portfolio.

Liquidity risk represents the inability to generate or otherwise obtain funds at reasonable rates to satisfy commitments to borrowers and obligations to depositors.  The Company has established guidelines within its asset/liability and funds management policy to manage liquidity risk.  These guidelines include, among other things, contingent funding alternatives.

Reputational risk, or the risk to our business, earnings, liquidity, and capital from negative public opinion, could result from our actual or alleged conduct in a variety of areas, including legal and regulatory compliance, lending practices, corporate governance, litigation, ethical issues, or inadequate protection of customer information, including fraudulent activity outside the Company’s control. We expend significant resources to comply with regulatory requirements. Failure to comply could result in reputational harm or significant legal or remedial costs. Damage to our reputation could adversely affect our ability to retain and attract new customers, and adversely impact our earnings and liquidity.

Regulatory and compliance risk represents the possibility that a change in law, regulations or regulatory policy may have a material effect on the business of the Company. We cannot predict what legislation might be enacted or what regulations might be adopted, or if adopted, the effect thereof on our operations.

Competition

The banking industry in the Bank’s service areas continue to be extremely competitive, both among commercial banks and with other financial service providers such as consumer finance companies, thrifts, investment firms, mutual funds, insurance companies, credit unions, agricultural cooperatives and internet entities for loans and deposits. Competition in our north central Pennsylvania market has increased as a result of other financial institutions looking to expand into new markets. With larger population centers in our central, south central and south east Pennsylvania markets, as well as in our Delaware market, we experience more competition to gather deposits and to make loans. Mortgage banking firms, financial companies, financial affiliates of industrial companies, brokerage firms, retirement fund management firms and even government agencies provide additional competition for loans, deposits and other financial services. Fintech and blockchain entities offering crypto services are also increasing competition for the Company’s financial services. The Bank is generally competitive with all competing financial institutions in its service areas with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans.

Trust and Investment Services; Oil and Gas Lease Services

Our Investment and Trust Services Division offers professional trust administration, investment management services, estate planning and administration, and custody of securities.  In addition to traditional trust and investment services offered, we assist our customers through various oil and gas specific leasing matters from lease negotiations to establishing a successful approach to personal wealth management. Assets held by the Company in a fiduciary or agency capacity for its customers are not included in the Consolidated Balance Sheets since such items are not assets of the Company.  Revenues and fees of the Trust Department are reflected in trust income in the Consolidated Statement of Income. As of September 30, 2023 and December 31, 2022, the Trust Department had $164.0 million and $150.0 million of assets under management, respectively.

41
Our Investment Representatives offer full service brokerage services and financial planning throughout the Bank’s market area. Products such as mutual funds, annuities, health and life insurance are made available through our insurance subsidiary, First Citizens Insurance Agency, Inc.  The assets associated with these products are not included in the Consolidated Balance Sheets since such items are not assets of the Company. Assets owned and invested by customers of the Bank through the Bank’s Investment Representatives increased from $283.5 million at December 31, 2022 to $306.0 million at September 30, 2023. Fee income from the sale of these products is reflected in brokerage and insurance income in the Consolidated Statement of Income. Management believes that there are opportunities to increase non-interest income through these products and services, especially in our central south central and south eastern Pennsylvania markets.

Results of Operations

Overview of the Income Statement

The Company had net income of $10,271,000 for the first nine months of 2023 compared to $21,185,000 for last year’s comparable period, a decrease of $10,914,000, or 51.5%, primarily due to the one-time costs associated with the HVBC acquisition. Basic earnings per share for the first nine months of 2023 were $2.40, compared to $5.28 for last year’s comparable period, representing a 54.6% decrease.  Annualized return on assets and return on equity for the nine months of 2023 were 0.53% and 5.21%, respectively, compared with 1.27% and 12.77% for last year’s comparable period.

Net income for the three months ended September 30, 2023 was $7,548,000 compared to net income of $7,544,000 in the comparable 2022 period, an increase of $4,000. Basic earnings per share for the three months ended September 30, 2023 were $1.61, compared to $1.88 for last year’s comparable period, representing a 14.4% decrease due to the shares issued as part of the acquisition and consistent net income. Annualized return on assets and return on equity for the quarter ended September 30, 2023 was 1.02% and 10.10%, respectively, compared with 1.31% and 13.34% for the same 2022 period.

Net Interest Income

Net interest income, the most significant component of the Company’s earnings, is the amount by which interest income generated from interest-earning assets exceeds interest expense paid on interest-bearing liabilities.

Net interest income for the first nine months of 2023 was $58,405,000, an increase of $5,568,000, or 10.5%, compared to the same period in 2022.  For the first nine months of 2023 the provision for credit losses was $5,328,000, including $4,591,000 for non-PCD loans acquired as part of the acquisition. Excluding the $4,591,000 related to the acquisition, the provision for credit losses decreased $688,000. Consequently, net interest income after the provision for credit losses was $53,077,000 in the first nine months of 2023 compared to $51,412,000 during the first nine months of 2022.

For the three months ended September 30, 2023, net interest income was $22,404,000 compared to $18,846,000, an increase of $3,558,000, or 18.9%, over the comparable period in 2022. The provision for credit losses in the third quarter was $475,000, a decreased of $250,000 to the third quarter of 2022. Consequently, net interest income after the provision for credit losses was $21,929,000 for the quarter ended September 30, 2023 compared to $18,121,000 in 2022.

The following table sets forth the average balances of, and the interest earned or incurred on, for each principal category of assets, liabilities and stockholders’ equity, the related rates, net interest income and interest rate spread created for the three and nine months ended September 30, 2023 and 2022 on a tax equivalent basis (dollars in thousands):

42
   
Analysis of Average Balances and Interest Rates
 
   
Nine Months Ended
 
   
September 30, 2023
   
September 30, 2022
 
   
Average
   

   
Average
   
Average
   
   
Average
 
 
Balance (1)
Interest  Rate Balance (1) Interest
 Rate
(dollars in thousands)
 
$
    $
   

%
   
 $     $
   

%
 
ASSETS
                                           
Short-term investments:
                                           
Interest-bearing deposits at banks
   
21,772
     
333
     
2.04
     
65,727
     
150
     
0.31
 
Total short-term investments
   
21,772
     
333
     
2.04
     
65,727
     
150
     
0.31
 
Interest bearing time deposits at banks
   
5,540
     
129
     
3.11
     
9,126
     
183
     
2.70
 
Investment securities:
                                               
Taxable
   
385,246
     
5,977
     
2.07
     
368,702
     
4,406
     
1.59
 
Tax-exempt (3)
   
114,307
     
2,188
     
2.55
     
120,107
     
2,316
     
2.57
 
Total investment securities
   
499,553
     
8,165
     
2.18
     
488,809
     
6,722
     
1.83
 
Loans (2)(3)(4):
                                               
Residential mortgage loans
   
268,562
     
10,797
     
5.38
     
202,856
     
7,128
     
4.70
 
Construction
   
114,386
     
5,831
     
6.82
     
69,437
     
2,213
     
4.26
 
Commercial Loans
   
1,039,006
     
45,079
     
5.80
     
829,366
     
28,808
     
4.64
 
Agricultural Loans
   
344,079
     
12,759
     
4.96
     
347,771
     
11,342
     
4.36
 
Loans to state & political subdivisions
   
60,183
     
1,736
     
3.86
     
54,836
     
1,327
     
3.24
 
Other loans
   
82,405
     
4,579
     
7.43
     
47,732
     
1,868
     
5.23
 
Loans, net of discount
   
1,908,621
     
80,781
     
5.66
     
1,551,998
     
52,686
     
4.54
 
Total interest-earning assets
   
2,435,486
     
89,408
     
4.91
     
2,115,660
     
59,741
     
3.78
 
Cash and due from banks
   
8,709
                     
6,652
                 
Bank premises and equipment
   
19,340
                     
17,199
                 
Other assets
   
126,075
                     
82,726
                 
Total non-interest earning assets
   
154,124
                     
106,577
                 
Total assets
   
2,589,610
                     
2,222,237
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
                                         
Interest-bearing liabilities:
                                               
NOW accounts
   
616,103
     
8,052
     
1.75
     
520,882
     
1,392
     
0.36
 
Savings accounts
   
320,227
     
897
     
0.37
     
323,667
     
260
     
0.11
 
Money market accounts
   
352,055
     
5,802
     
2.20
     
347,422
     
1,037
     
0.40
 
Certificates of deposit
   
303,825
     
4,768
     
2.10
     
305,878
     
1,780
     
0.78
 
Total interest-bearing deposits
   
1,592,210
     
19,519
     
1.64
     
1,497,849
     
4,469
     
0.40
 
Other borrowed funds
   
318,180
     
10,682
     
4.49
     
112,582
     
1,699
     
2.02
 
Total interest-bearing liabilities
   
1,910,390
     
30,201
     
2.11
     
1,610,431
     
6,168
     
0.51
 
Demand deposits
   
380,638
                     
370,785
                 
Other liabilities
   
35,566
                     
19,785
                 
Total non-interest-bearing liabilities
   
416,204
                     
390,570
                 
Stockholders’ equity
   
263,016
                     
221,236
                 
Total liabilities & stockholders’ equity
   
2,589,610
                     
2,222,237
                 
Net interest income
           
59,207
                     
53,573
         
Net interest spread (5)
                   
2.80
%
                   
3.27
%
Net interest income as a percentage of average interest-earning assets
                   
3.25
%
                   
3.39
%
Ratio of interest-earning assets to interest-bearing liabilities
                   
127
%
                   
131
%

(1)
Averages are based on daily averages.
(2)
Includes loan origination and commitment fees.
(3)
Tax exempt interest revenue is shown on a tax equivalent basis for proper comparison using
a statutory federal income tax rate of 21%.
(4)
Income on non-accrual loans is accounted for on a cash basis, and the loan balances are included in interest-earning assets.
(5)
Interest rate spread represents the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities.

43
   
Analysis of Average Balances and Interest Rates
 
   
Three Months Ended
 
   
September 30, 2023
   
September 30, 2022
 
   
Average
         
Average
   
Average
         
Average
 
   
Balance (1)
   
Interest
   
Rate
   
Balance (1)
   
Interest
   
Rate
 
(dollars in thousands)
  $
   
$
   

%
    $
   
$
   

%
 
ASSETS
                                           
Short-term investments:
                                           
Interest-bearing deposits at banks
   
24,096
     
225
     
3.70
     
14,255
     
12
     
0.33
 
Total short-term investments
   
24,096
     
225
     
3.70
     
14,255
     
12
     
0.33
 
Interest bearing time deposits at banks
   
4,579
     
39
     
3.38
     
6,640
     
49
     
2.93
 
Investment securities:
                                               
Taxable
   
386,806
     
2,113
     
2.19
     
391,774
     
1,696
     
1.73
 
Tax-exempt (3)
   
108,959
     
683
     
2.51
     
123,046
     
797
     
2.59
 
Total investment securities
   
495,765
     
2,796
     
2.26
     
514,820
     
2,493
     
1.94
 
Loans (2)(3)(4):
                                               
Residential mortgage loans
   
357,388
     
4,925
     
5.47
     
204,352
     
2,416
     
4.69
 
Construction
   
166,204
     
3,339
     
7.97
     
76,934
     
885
     
4.56
 
Commercial Loans
   
1,196,675
     
18,983
     
6.29
     
900,297
     
10,732
     
4.73
 
Agricultural Loans
   
342,499
     
4,285
     
4.96
     
346,380
     
3,887
     
4.45
 
Loans to state & political subdivisions
   
60,820
     
611
     
3.99
     
59,454
     
502
     
3.35
 
Other loans
   
88,710
     
1,750
     
7.83
     
81,499
     
1,074
     
5.23
 
Loans, net of discount
   
2,212,296
     
33,893
     
6.08
     
1,668,916
     
19,496
     
4.63
 
Total interest-earning assets
   
2,736,736
     
36,953
     
5.36
     
2,204,631
     
22,050
     
3.96
 
Cash and due from banks
   
10,696
                     
6,755
                 
Bank premises and equipment
   
21,401
                     
17,437
                 
Other assets
   
190,431
                     
82,012
                 
Total non-interest earning assets
   
222,528
                     
106,204
                 
Total assets
   
2,959,264
                     
2,310,835
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
                                         
Interest-bearing liabilities:
                                               
NOW accounts
   
789,513
     
4,468
     
2.25
     
530,234
     
675
     
0.51
 
Savings accounts
   
326,452
     
426
     
0.52
     
328,056
     
106
     
0.13
 
Money market accounts
   
403,628
     
2,682
     
2.64
     
347,460
     
515
     
0.59
 
Certificates of deposit
   
347,783
     
2,524
     
2.88
     
288,926
     
542
     
0.74
 
Total interest-bearing deposits
   
1,867,376
     
10,100
     
2.15
     
1,494,676
     
1,838
     
0.49
 
Other borrowed funds
   
347,326
     
4,185
     
4.78
     
189,174
     
1,099
     
2.30
 
Total interest-bearing liabilities
   
2,214,702
     
14,285
     
2.56
     
1,683,850
     
2,937
     
0.69
 
Demand deposits
   
408,531
                     
380,110
                 
Other liabilities
   
37,118
                     
20,618
                 
Total non-interest-bearing liabilities
   
445,649
                     
400,728
                 
Stockholders’ equity
   
298,913
                     
226,257
                 
Total liabilities & stockholders’ equity
   
2,959,264
                     
2,310,835
                 
Net interest income
           
22,668
                     
19,113
         
Net interest spread (5)
                   
2.80
%
                   
3.27
%
Net interest income as a percentage of average interest-earning assets
                   
3.29
%
                   
3.44
%
Ratio of interest-earning assets to interest-bearing liabilities
                   
124
%
                   
131
%

(1)
Averages are based on daily averages.
(2)
Includes loan origination and commitment fees.
(3)
Tax exempt interest revenue is shown on a tax equivalent basis for proper comparison using a statutory federal income tax rate of 21%.
(4)
Income on non-accrual loans is accounted for on a cash basis, and the loan balances are included in interest-earning assets.
(5)
Interest rate spread represents the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities.

44
Tax exempt revenue is shown on a tax-equivalent basis (non-Gaap) for proper comparison using a federal statutory income tax rate of 21% for the three and nine months ended September 30, 2023 and 2022.  For purposes of the comparison, as well as the discussion that follows, this presentation facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Company’s Federal statutory rate during the corresponding period. The following table represents the adjustment to convert net interest income to net interest income on a fully taxable equivalent basis for the periods ended September 30, 2023 and 2022 (in thousands):

   
For the Three Months
   
For the Nine Months
 
   
Ended September 30,
   
Ended September 30,
 
   
2023
   
2022
   
2023
   
2022
 
Interest and dividend income from investment securities
and interest bearing deposits at banks (non-tax adjusted)
 
$
2,917
   
$
2,387
   
$
8,168
   
$
6,569
 
Tax equivalent adjustment
   
143
     
167
     
459
     
486
 
Interest and dividend income from investment securities
and interest bearing deposits at banks (tax equivalent basis)
 
$
3,060
   
$
2,554
   
$
8,627
   
$
7,055
 

                               
Interest and fees on loans (non-tax adjusted)
 
$
33,772
   
$
19,396
   
$
80,438
   
$
52,436
 
Tax equivalent adjustment
   
121
     
100
     
343
     
250
 
Interest and fees on loans (tax equivalent basis)
 
$
33,893
   
$
19,496
   
$
80,781
   
$
52,686
 
                                 
Total interest income
 
$
36,689
   
$
21,783
   
$
88,606
   
$
59,005
 
Total interest expense
   
14,285
     
2,937
     
30,201
     
6,168
 
Net interest income
   
22,404
     
18,846
     
58,405
     
52,837
 
Total tax equivalent adjustment
   
264
     
267
     
802
     
736
 
Net interest income (tax equivalent basis)
 
$
22,668
   
$
19,113
   
$
59,207
   
$
53,573
 

The following table shows the tax-equivalent effect of changes in volume and rate on interest income and expense (in thousands):

   
Three months ended September 30, 2023 vs 2022 (1)
   
Nine months ended September 30, 2023 vs 2022 (1)
 
   
Change in
   
Change
   
Total
   
Change in
   
Change
   
Total
 
   
Volume
   
in Rate
   
Change
   
Volume
   
in Rate
   
Change
 
Interest Income:
                                   
Short-term investments:
                                   
Interest-bearing deposits at banks
 
$
14
   
$
199
   
$
213
   
$
(25
)
 
$
208
   
$
183
 
Interest bearing time deposits at banks
   
(20
)
   
10
     
(10
)
   
(90
)
   
36
     
(54
)
Investment securities:
                                               
Taxable
   
(22
)
   
439
     
417
     
205
     
1,366
     
1,571
 
Tax-exempt
   
(89
)
   
(25
)
   
(114
)
   
(111
)
   
(17
)
   
(128
)
Total investments
   
(111
)
   
414
     
303
     
94
     
1,349
     
1,443
 
Loans:
                                               
Residential mortgage loans
   
2,055
     
454
     
2,509
     
2,539
     
1,130
     
3,669
 
Construction
   
1,493
     
961
     
2,454
     
1,878
     
1,740
     
3,618
 
Commercial Loans
   
4,116
     
4,135
     
8,251
     
8,195
     
8,076
     
16,271
 
Agricultural Loans
   
(43
)
   
441
     
398
     
(119
)
   
1,536
     
1,417
 
Loans to state & political subdivisions
   
12
     
97
     
109
     
138
     
271
     
409
 
Other loans
   
102
     
574
     
676
     
1,718
     
993
     
2,711
 
Total loans, net of discount
   
7,735
     
6,662
     
14,397
     
14,349
     
13,746
     
28,095
 
Total Interest Income
   
7,618
     
7,285
     
14,903
     
14,328
     
15,339
     
29,667
 
Interest Expense:
                                               
Interest-bearing deposits:
                                               
NOW accounts
   
471
     
3,322
     
3,793
     
298
     
6,362
     
6,660
 
Savings accounts
   
(1
)
   
321
     
320
     
(3
)
   
640
     
637
 
Money Market accounts
   
96
     
2,071
     
2,167
     
13
     
4,752
     
4,765
 
Certificates of deposit
   
131
     
1,851
     
1,982
     
(12
)
   
3,000
     
2,988
 
Total interest-bearing deposits
   
697
     
7,565
     
8,262
     
296
     
14,754
     
15,050
 
Other borrowed funds
   
1,351
     
1,735
     
3,086
     
5,377
     
3,606
     
8,983
 
Total interest expense
   
2,048
     
9,300
     
11,348
     
5,673
     
18,360
     
24,033
 
Net interest income
 
$
5,570
   
$
(2,015
)
 
$
3,555
   
$
8,655
   
$
(3,021
)
 
$
5,634
 

(1)
The portion of the total change attributable to both volume and rate changes, which can not be separated, has been allocated proportionally to the change due to volume and the change due to rate prior to allocation.

45
Tax equivalent net interest income increased from $53,573,000 for the nine month period ended September 30, 2022 to $59,207,000 for the nine month period ended September 30, 2023, an increase of $5,634,000. The acquisition of HVBC had a substantial impact on the increase, in addition to growth that occurred in the fourth quarter of 2022 in the Delaware region. The tax equivalent net interest margin decreased from 3.39% for the first nine months of 2022 to 3.25% for the comparable period in 2023. The decrease is primarily caused by the increase in the cost of interest-bearing liabilities due to higher market interest rates in 2023 compared to 2022.
 
Total tax equivalent interest income for the 2023 nine month period increased $29,667,000 as compared to the 2022 nine month period. This increase was a result of an increase of $14,328,000 due to a change in volume as average interest-bearing assets increased $319.8 million. As a result of the higher market interest rate environment, the yield on average interest earning assets increased 1.13% from 3.78% to 4.91% resulting in an increase interest income of $15,339,000.
 
Tax equivalent investment income for the nine months ended September 30, 2023 increased $1,443,000 over the same period last year. The primary cause of the increase was due to the increase in yield on investment securities of 35 basis points to 2.18%.
 

The average balance of taxable securities increased $16.5 million, which resulted in an increase in investment income of $205,000. The yield on taxable securities increased 48 basis points from 1.59% to 2.07% as a result of lower yielding securities maturing in the second half of 2022 and first nine months of 2023. This resulted in an increase in investment income of $1,366,000. For a discussion of the Company’s current investment strategy, see the “Financial Condition – Investments”.
 
Total loan interest income increased $28,095,000 for the nine months ended September 30, 2023 compared to the same period last year, as a result of higher volume and yields.
 

Interest income on residential mortgage loans increased $3,669,000. The change due to rate was an increase of $1,130,000 as the average yield on residential mortgages increased from 4.70% to 5.38% as a result of the higher rate environment during the second half of 2022 and all of 2023. The average balance of residential mortgage loans increased $65.7 million primarily due to the HVBC acquisition and additional organic growth. This resulted in an increase of $2,539,000 on total interest income due to volume.
 

The average balance of construction loans increased $44.9 million as a result of projects in our Delaware market and the HVBC acquisition. This resulted in an increase of $1,878,000 on total interest income due to volume. The change due to rate was an increase of $1,740,000 as the average yield on construction loans increased from 4.26% to 6.82% as a result of the higher rate environment during the second half of 2022 and all of 2023.
 

The average balance of commercial loans increased $209.6 million from a year ago. The growth was primarily attributable to growth in the Delaware market and the HVCB acquisition. This had a positive impact of $8,195,000 on total interest income due to volume. The yield increased 1.16% to 5.80% as a result of the higher rate environment during the second half of 2022 and all of 2023, which increased loan interest income $8,076,000.
 
46

Interest income on agricultural loans increased $1,417,000 from 2022 to 2023. The yield increased 60 basis points to 4.96% as a result of the higher rate environment during the second half of 2022 and all of 2023, which increased loan interest income $1,536,000. The decrease in the average balance of agricultural loans of $3.7 million resulted in a decrease in interest income due to volume of $119,000.
 

The average yield of state and political subdivision loans increased 62 basis points to 3.86% due to the higher rate environment resulting in an increase in income of $271,000. The average balance of state and political subdivision loans increased $5.3 million resulting in an increase in loan interest income of $138,000.
 

The average balance of other loans increased $34.7 million as a result of outstanding student loans. This resulted in an increase of $1,718,000 on total interest income due to volume. The average yield of other loans increased 220 basis points to 7.43% due to the higher rate environment resulting in an increase in income of $993,000.
 
Total interest expense increased $24,033,000 for the nine months ended September 30, 2023 compared with the comparative period last year as a result of an increase in the volume of other borrowed funds and an increase in rate on interest-bearing liabilities. Interest expense increased $5,673,000 due to volume as a result of an increase in the average balance of other borrowed funds of $205.6 million. The average rate paid on interest-bearing liabilities increased from 0.51% to 2.11%. The increase was driven by the Federal Reserve interest rate increases in 2022 and 2023, which caused interest expenses to increase $18,360,000.

The average balance of interest bearing deposits increased $95.2 million from September 30, 2022 to September 30, 2023. The increase was due to the HVBC acquisition. The effect of these volume changes was an increase in interest expense of $296,000. The average rate paid on interest bearing deposits was 1.64% for the first nine months of 2023 and 0.40% for the comparable period in 2022. This resulted in an increase in interest expense of $14,754,000. The increase was due to the Federal Reserve increasing interest rates during 2022 and 2023.

The average balance of other borrowed funds increased $205.6 million to fund loan growth experienced in 2022 and 2023. This resulted in an increase in interest expense of $5,377,000. There was an increase in the average rate paid on other borrowed funds from 2.02% to 4.49% due to the interest rate increases by the Federal Reserve that increased borrowings costs resulting in an increase in interest expense of $3,606,000.
 
Tax equivalent net interest income for the three months ended September 30, 2023 was $22,668,000 which compares to $19,113,000 for the same period last year.  This represents an increase of $3,555,000, or 18.6% and was primarily caused by an increase in the volume of interest earning assets due to the HVBC acquisition.
 
Total tax equivalent interest income was $36,953,000 for the three month period ended September 30, 2023, compared to $22,050,000 for the comparable period last year, an increase of $14,903,000. This increase was a result of an increase of $7,618,000 due to a change in volume as average interest-bearing assets increased $532.1 million due to the HVBC acquisition. As a result of the higher market interest rate environment, the yield on average interest earning assets increased 140 basis point from 3.96% to 5.36% resulting in an increase interest income of $7,285,000.
 
Tax equivalent investment income for the three months ended September 30, 2023 increased $303,000 over the same period last year. The yield on taxable securities increased 46 basis points from 1.73% to 2.19% as a result of the purchases made in a higher rate environment. This resulted in an increase in investment income of $439,000.

Total loan interest income increased $14,397,000 for the three months ended September 30, 2023 compared to the same period last year, primarily as a result of the HVBC acquisition.

47

Interest income on residential mortgage loans increased $2,509,000. The change due to rate was an increase of $454,000 as the average yield on residential mortgages increased from 4.69% to 5.47% as a result of the higher rate environment during the second half of 2022 and all of 2023.  The average balance of residential mortgage loans increased $153.0 million primarily as a result of the HVBC acquisition. This resulted in an increase of $2,055,000 on total interest income due to volume.

The average balance of construction loans increased $89.3 million primarily as a result of the HVBC acquisition. This resulted in an increase of $1,493,000 on total interest income due to volume. The change due to rate was an increase of $961,000 as the average yield on construction loans increased from 4.56% to 7.97% as a result of the higher rate.

The average balance of commercial loans increased $296.4 million from a year ago. The growth was primarily attributable to growth in the Delaware market and the HVBC acquisition. This had a positive impact of $4,116,000 on total interest income due to volume. The yield increased 156 basis points to 6.29% due to the higher rate environment experienced during the second half of 2022 and all of 2023, which increased loan interest income $4,135,000.

The average yield of agricultural loans increased 51 basis points to 4.96% due to the higher rate environment resulting in an increase in income of $441,000.

The average balance of other loans increased $7.2 million as a result of outstanding student loans. This resulted in an increase of $102,000 on total interest income due to volume. The average yield on other loans increased 260 basis points to 7.50% due to the rate earned on the student loans, resulting in an increase in interest income of $574,000.

Total interest expense increased $11,348,000 for the three months ended September 30, 2023 compared with the comparative period last year as a result of an increase in the volume of other borrowed funds and an increase in rate on interest-bearing liabilities. Interest expense increased $1,351,000 due to volume as a result of an increase in the average balance of other borrowed funds of $158.2 million. The average rate paid on interest-bearing liabilities increased from 0.69% to 2.56%. The increase was driven by the Federal Reserve interest rate increases in 2022 and 2023, which caused interest expenses to increase $9,300,000.


The average balance of interest bearing deposits increased $372.7 million from September 30, 2022 to September 30, 2023 primarily due to the HVBC acquisition, which was offset by customer funds transferred to higher-yielding investment alternatives as well as a reduction in municipal deposits to fund projects in various municipalities. The effect of these volume changes was an increase in interest expense of $697,000. The average rate paid on interest bearing deposits was 2.15% for the three months ended September 30, 2023 and 0.49% for the comparable period in 2022. This resulted in an increase in interest expense of $7,565,000. The increase was due to the Federal Reserve increasing interest rates during 2022 and 2023.

The average balance of other borrowed funds increased $158.2 million to fund loan growth experienced in 2022 and borrowings acquired as part of the HVBC acquisition. This resulted in an increase in interest expense of $1,351,000. There was an increase in the average rate paid on other borrowed funds from 2.30% to 4.78% due to the interest rate increases by the Federal Reserve that increased borrowings costs resulting in an increase in interest expense of $1,735,000.

Provision for Credit Losses

For the nine month period ended September 30, 2023, we recorded a provision for credit losses of $5,328,000, which represents an increase of $3,903,000 from the $1,425,000 provision recorded in the corresponding nine months of last year. The provision for 2023 includes $4,591,000 associated with the HVBC acquisition and $36,000 as a provision for off-balance sheet items. Excluding these items, the provision for 2023 is $724,000 less than the comparable period in 2022 and is due to limited organic loan activity in  2023. (see “Financial Condition – Allowance for Credit Losses and Credit Quality Risk”).

48
For the three months ended September 30, 2023, we recorded a provision for credit losses of $475,000, which represents a decrease of $250,000 from the $725,000 provision recorded in the corresponding three months of last year. The provision for 2023 includes a $126,000 credit for off-balance sheet items. Excluding this item, the provision for the 2023 third quarter is $124,000 less than the comparable period in 2022 and is due to limited organic loan activity in 2023 compared to 2022.

Non-interest Income

The following table shows the breakdown of non-interest income for the three and nine  months ended September 30, 2023 and 2022 (dollars in thousands):

   
Nine months ended September 30,
   
Change
 
   
2023
   
2022
   
Amount
   
%
 
Service charges
 
$
4,196
   
$
4,081
   
$
115
     
2.8
 
Trust
   
583
     
620
     
(37
)
   
(6.0
)
Brokerage and insurance
   
1,429
     
1,428
     
1
     
0.1
 
Gains on loans sold
   
674
     
241
     
433
     
179.7
 
Equity security (losses), net
   
(223
)
   
(198
)
   
(25
)
   
12.6
 
Available for sale security (losses), net
   
(51
)
   
(6
)
   
(45
)
   
750.0
 
Earnings on bank owned life insurance
   
941
     
635
     
306
     
48.2
 
Other
   
567
     
626
     
(59
)
   
(9.4
)
Total
 
$
8,116
   
$
7,427
   
$
689
     
9.3
 

   
Three months ended September 30,
   
Change
 
   
2023
   
2022
   
Amount
   
%
 
Service charges
 
$
1,692
   
$
1,509
   
$
183
     
12.1
 
Trust
   
172
     
187
     
(15
)
   
(8.0
)
Brokerage and insurance
   
473
     
446
     
27
     
6.1
 
Gains on loans sold
   
460
     
95
     
365
     
384.2
 
Equity security gains (losses0, net
   
69
     
(19
)
   
88
     
(463.2
)
Available for sale security gains (losses), net
   
-
     
(6
)
   
6
     
(100.0
)
Earnings on bank owned life insurance
   
489
     
216
     
273
     
126.4
 
Other
   
307
     
264
     
43
     
16.3
 
Total
 
$
3,662
   
$
2,692
   
$
970
     
36.0
 

Non-interest income for the nine months ended September 30, 2023 totaled $8,116,000, an increase of $689,000 when compared to the same period in 2022. For the three months ended September 30, 2023, non-interest income increased $1,105,000 to $3,797,000.  During the first nine   months of 2023, net equity security losses amounted to $223,000 as a result of market losses associated with general banking stock losses compared with a $198,000 loss in the comparable 2022 period associated with market conditions for that period. During the  nine months ended September 30, 2023, there were $51,000 of losses from the sale of $10.0 million available for sale municipal securities. Additionally, $76.5 million of securities obtained as part of the acquisition were sold for no gain or loss during the second quarter of 2023. There were no sales of available during the three ended September 30, 2023. During the first nine months of 2022, $4.5 million of US Agency securities were sold for a pre-tax loss of $6,000.

49
The increase in gains on loans sold for the three and nine month periods ended September 30 2023 compared to 2022 is attributable the HVBC acquisition and their residential lending model, which focused on originating and selling residential mortgage loans, which includes the use of interest rate locks and other derivative activities, which is included in other income. The increase in earnings on bank owned life insurance is due to the HVBC acquisition, as well as the death benefit of approximately $200,000 received upon the passing of a former employee.

Non-interest Expense

The following tables reflect the breakdown of non-interest expense for the three and nine months ended September 30, 2023 and 2022 (dollars in thousands):

   
Nine months ended September 30,
   
Change
       
   
2023
   
2022
   
Amount
   
%
 
Salaries and employee benefits
 
$
25,733
   
$
20,964
   
$
4,769
     
22.7
 
Occupancy
   
2,870
     
2,327
     
543
     
23.3
 
Furniture and equipment
   
568
     
416
     
152
     
36.5
 
Professional fees
   
1,274
     
1,321
     
(47
)
   
(3.6
)
FDIC insurance
   
1,000
     
440
     
560
     
127.3
 
Pennsylvania shares tax
   
893
     
1,017
     
(124
)
   
(12.2
)
Amortization of intangibles
   
219
     
120
     
99
     
82.5
 
Merger and acquisition
   
9,269
     
-
     
9,269
   
NA
 
Software expenses
   
1,274
     
1,069
     
205
     
19.2
 
ORE expenses (income)
   
126
     
(125
)
   
251
     
(200.8
)
Other
   
5,811
     
5,496
     
315
     
5.7
 
Total
 
$
49,037
   
$
33,045
   
$
15,992
     
48.4
 

   
Three months ended September 30,
   
Change
       
   
2023
   
2022
   
Amount
   
%
 
Salaries and employee benefits
 
$
10,140
   
$
6,933
   
$
3,207
     
46.3
 
Occupancy
   
1,221
     
779
     
442
     
56.7
 
Furniture and equipment
   
255
     
122
     
133
     
109.0
 
Professional fees
   
506
     
588
     
(82
)
   
(13.9
)
FDIC insurance
   
375
     
160
     
215
     
134.4
 
Pennsylvania shares tax
   
297
     
339
     
(42
)
   
(12.4
)
Amortization of intangibles
   
157
     
40
     
117
     
292.5
 
Merger and acquisition
   
623
     
-
     
623
   
NA
 
Software expenses
   
551
     
370
     
181
     
48.9
 
ORE expenses
   
111
     
122
     
(11
)
   
(9.0
)
Other
   
2,343
     
2,161
     
182
     
8.4
 
Total
 
$
16,579
   
$
11,614
   
$
4,965
     
42.8
 

Non-interest expenses increased $15,992,000 for the nine months ended September 30, 2023 compared to the same period in 2022. Salaries and employee benefits increased $4,769,000 or 22.7%. The increase was due to merit increases effective at the beginning of 2023, additional full time equivalent employees (FTE) of 35.3, which is an increase of 11.4%, and an increase in health care expenses due to higher claims on the Company’s partially self-funded plan and the additional headcount.

50
The increase in merger and acquisition expenses was due to fees associated with the acquisition of HVBC that closed in June 2023 and includes severance costs, change in control payments, contract termination payments and various professional and consulting fees. The increase in ORE expenses was due to the sales of OREO properties in 2022 for a gain of $481,000. The increase in occupancy, furniture and fixtures, amortization of intangibles and other expenses was due to the HVBC acquisition. The increase in FDIC insurance is due to the acquisition and organic growth.

For the three months ended, September 30, 2023, non-interest expenses increased $4,965,000 when compared to the same period in 2022. The changes in salaries and employee benefits, merger and acquisition expenses, occupancy, furniture and equipment, FDIC insurance, amortization of intangibles and other expenses  correspond to the changes for the nine month period.

Provision for Income Taxes

The provision for income taxes was $2,020,000 for the nine month period ended September 30, 2023 compared to $4,609,000 for the same period in 2022. The decrease is primarily attributable to the decrease in income before the provision for income taxes of $13,503,000 for the comparable periods due to the one-time costs associated with the HVBC acquisition.  Through management of our municipal loan and bond portfolios, management is focused on minimizing our effective tax rate.  Our effective tax rate was 16.4% and 17.9% for the first nine months of 2023 and 2022, respectively, compared to the statutory rate of 21%.

For the three months ended September 30, 2023, the provision for income taxes was $1,599,000 compared to a provision of $1,655,000 for the same period in 2022. The decrease is attributable to the decrease in income before the provision for income taxes of $52,000 for the comparable periods and life insurance proceeds being excluded from taxable income. Our effective tax rate was 17.5% and 18.0% for the three months ended September 30, 2023 and 2022, respectively.

We are invested in seven limited partnerships that have established low-income housing projects in our market areas with our most recent investments made in the second half of 2022. Three projects are currently in construction phase with credits being recognized on one of the projects for the first time in the third quarter of 2023. The remaining four partnership credits are fully utilized as of December 31, 2023. We anticipate recognizing an aggregate of $6.5 million of tax credits over the next 13 years.

Financial Condition

Total assets were $2.96 billion at September 30, 2023, an increase of $625.8 million from $2.33 billion at December 31, 2022, due primarily to the HVBC acquisition that closed on June 16, 2023. Cash and cash equivalents increased $17.1 million to $43.3 million with the increase attributable to the acquisition and collateral held for derivative instruments. Available for sale securities decreased $21.7 million and net loans increased $518.5 million to $2.22 billion at September 30, 2023 due to the acquisition. Total deposits increased $490.9 million to $2.34 billion since year-end 2022 as a result of the acquisition, while borrowed funds increased $58.9 million to $316.2 million.

Cash and Cash Equivalents
 
Cash and cash equivalents totaled $43.3 million at September 30, 2023 compared to $26.2 million at December 31, 2022. The increase is due to the acquisition and cash held as collateral for certain derivative positions the Bank is exposed to with third parties.  Management actively measures and evaluates the Company’s liquidity position through our Asset–Liability Committee and believes the Company’s liquidity needs are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources including the Bank’s core deposits, Federal Home Loan Bank financing, federal funds lines with correspondent banks, brokered certificates of deposit and the portion of the investment and loan portfolios that mature within one year.  Management expects that these sources of funds will permit us to meet cash obligations and off-balance sheet commitments as they come due.
 
51
Investments

The following table shows the composition of the investment portfolio (including debt and equity securities) as of September 30 2023 and December 31, 2022 (dollars in thousands):

   
September 30, 2023
   
December 31, 2022
 
   
Amount
   
%
   
Amount
   
%
 
Debt securities:
                       
U. S. Agency securities
 
$
63,647
     
15.2
   
$
70,677
     
16.0
 
U. S. Treasury notes
   
147,431
     
35.1
     
148,570
     
33.6
 
Obligations of state & political subdivisions
   
96,022
     
22.9
     
110,300
     
25.0
 
Corporate obligations
   
12,120
     
2.9
     
9,383
     
2.1
 
Mortgage-backed securities in government sponsored entities
   
98,587
     
23.5
     
100,576
     
22.8
 
Equity securities
   
1,858
     
0.4
     
2,208
     
0.5
 
Total
 
$
419,665
     
100.0
   
$
441,714
     
100.0
 

   
September 30, 2023/
 
   
December 31, 2022
 
   
Change
 
   
Amount
   
%
 
Debt securities:
           
U. S. Agency securities
 
$
(7,030
)
   
(9.9
)
U. S. Treasury notes
   
(1,139
)
   
(0.8
)
Obligations of state & political subdivisions
   
(14,278
)
   
(12.9
)
Corporate obligations
   
2,737
     
29.2
 
Mortgage-backed securities in government sponsored entities
   
(1,989
)
   
(2.0
)
Equity securities
   
(350
)
   
(15.9
)
Total
 
$
(22,049
)
   
(5.0
)

Our investment portfolio decreased by $22.0 million, or 5.0%, from December 31, 2022 to September 30, 2023. As part of the HVBC acquisition, $79.2 million of available for sale securities were acquired. Excluding the acquisition, $10.3 million of mortgage backed securities were purchased. We experienced $9.4 million of principal repayments and $9.4 million of calls and maturities. We sold $86.6 million of securities to deleverage the balance sheet during 2023 that included a loss of $51,000. The majority of the securities sold were acquired as part of the HVBC acquisition.  As a result of increases in market interest rates, the unrealized loss on available for sale investment portfolio increased $4.6 million. Excluding our short-term investments consisting of monies held primarily at the Federal Reserve for liquidity purposes, our investment portfolio for the nine month period ended September 30, 2023 yielded 2.18%, compared to 1.83% in the comparable period in 2022, on a tax equivalent basis.

The investment strategy for 2023 has been to utilize cashflows from the investment portfolio to repay overnight borrowings. The decrease in the investment portfolio was due to long-term interest rates increasing in the first nine months of 2023 compared to December 31, 2022 and investment repayments and maturities. We continually monitor interest rate trading ranges and seek to time investment security purchases when rates are in the top third of the trading range. The Company believes its investment strategy has appropriately mitigated its interest rate risk exposure for various rate environments, including a rising rate environment, while providing sufficient cashflows to meet liquidity needs.

Management continues to monitor the earnings performance and the liquidity of the investment portfolio on a regular basis.  Through active balance sheet management and analysis of the investment portfolio, the Company believes it maintains sufficient liquidity to satisfy depositor withdrawal requirements and various credit needs of its customers.

52
Loans Held for Sale

Loans held for sale increased $13.4 million to $14.2 million as of September 30, 2023 from December 31, 2022 due to the HVBC acquisition and their focus on residential mortgage lending and related loan sales into the secondary market.

Loans

The following table shows the composition of the loan portfolio as of September 30, 2023 and December 31, 2022 (dollars in thousands):

   
September 30,
2023
   
December 31,
2022
 
   
Amount
   
%
   
Amount
   
%
 
Real estate:
                       
Residential
 
$
356,381
     
15.9
   
$
210,213
     
12.2
 
Commercial
   
1,081,123
     
48.1
     
876,569
     
50.8
 
Agricultural
   
314,164
     
14.0
     
313,614
     
18.2
 
Construction
   
175,320
     
7.8
     
80,691
     
4.7
 
Consumer
   
115,753
     
5.2
     
86,650
     
5.0
 
Other commercial loans
   
120,347
     
5.4
     
63,222
     
3.7
 
Other agricultural loans
   
26,648
     
1.2
     
34,832
     
2.0
 
State & political subdivision loans
   
56,660
     
2.4
     
59,208
     
3.4
 
Total loans
   
2,246,396
     
100.0
     
1,724,999
     
100.0
 
Less allowance for loan losses
   
21,455
             
18,552
         
Net loans
 
$
2,224,941
           
$
1,706,447
         

   
September 30, 2023/
 
   
December 31, 2022
 

 
Change
 
   
Amount
   
%
 
Real estate:
           
Residential
 
$
146,168
     
69.5
 
Commercial
   
204,554
     
23.3
 
Agricultural
   
550
     
0.2
 
Construction
   
94,629
     
117.3
 
Consumer
   
29,103
     
33.6
 
Other commercial loans
   
57,125
     
90.4
 
Other agricultural loans
   
(8,184
)
   
(23.5
)
State & political subdivision loans
   
(2,548
)
   
(4.3
)
Total loans
 
$
521,397
     
30.2
 

The Bank’s lending efforts have historically been focused in north central Pennsylvania, the south central Pennsylvania counties of Lebanon, Schuylkill, Berks and Lancaster, the central Pennsylvania counties of Clinton and Centre, and southern New York. We have a limited branch office in Union County that is staffed by a lending team to primarily support agricultural opportunities in central Pennsylvania. In April 2020, we completed the MidCoast acquisition, which expanded our markets into the State of Delaware with activity centered around the cities of Wilmington and Dover, Delaware. Since the MidCoast acquisition, we have opened two additional branches in the Delaware market to better serve customers in the Wilmington market, as well as the surrounding area of Chester County, Pennsylvania. In June 2023, we completed the HVBC acquisition, which expanded our markets into south east Pennsylvania, including the counties of Montgomery, Bucks and Philadelphia. It also includes a Mortgage production in Mount Laurel, New Jersey. We have received approval to open an office in Williamsport, Pennsylvania, which is expected in the fourth quarter of 2023. We originate loans primarily through direct loans to our existing customer base, with new customers generated through the strong relationships our lending teams have with their customers and our lenders expertise in certain areas, as well as by referrals from real estate brokers, building contractors, attorneys, accountants, corporate and advisory board members, existing customers and the Bank’s website.  The Bank offers a variety of loans although historically most of our lending has focused on real estate loans including residential, commercial, agricultural, and construction loans.  All lending is governed by a lending policy that is developed and administered by management and approved by the Board of Directors.

53
As part of the HVBC acquisition, we acquired $477.0 million of loans for the portfolio. Excluding this, organic loan growth has been limited, and totaled $42.2 million during 2023.
 
While the Bank lends to companies that service companies that explore for natural gas in our market area, the Bank has not originated any loans to companies performing the actual drilling and exploration activities. Loans made by the Bank are to service industry customers which include trucking companies, stone quarries and other support businesses, favoring customers that have had a relationship with the Bank prior to supporting the exploration for natural gas. We also have originated loans to businesses and individuals for restaurants, hotels and apartment rentals that have been developed and expanded to meet the housing and living needs of the gas industry workers. Due to our understanding of the industry and its cyclical nature, the loans made for natural gas-related activities have been originated in accordance with specific policies and procedures for lending to these entities, which include more stringent loan to value thresholds, shortened amortization periods, and expansion of our monitoring of loan concentrations associated with this activity.
 
For loans sold on the secondary market, the Company recognizes fee income for servicing certain sold loans, which is included in non-interest income.

Allowance for Credit Losses - Loans

The allowance for credit losses - loans is maintained at a level which, in management’s judgment, is adequate to absorb losses in the loan portfolio. The provision for credit losses - loans is charged against current income.  Loans deemed not collectable are charged-off against the allowance while subsequent recoveries increase the allowance.  The allowance for credit losses - loans was $21,455,000 or 0.96% of total loans as of September 30, 2023 as compared to $18,552,000 or 1.08% of loans as of December 31, 2022. During the first quarter of 2023, the Company adopted CECL, which resulted in a decrease in the allowance for credit losses – loans of $3.3 million. As a result of the acquisition, the Bank recorded a provision for credit losses for non-PCD loans of $4,591,000 and an allowance of $1,689,000 for PCD loans. An additional $701,000 of provision for credit losses-loans was recorded in 2023. Net charge-offs for the first nine months of 2023 totaled $778,000, which was primarily associated with one loan acquired as part of the HVBC acquisition that was fully reserved for at the time of the acquisition. The following table shows the distribution of the allowance for credit losses - loans and the percentage of loans compared to total loans by loan category as of September 30, 2023 and December 31, 2022 (dollars in thousands):
 
   
September 30,
   
December 31
 
   
2023
   
2022
 
   
Amount
   
%
   
Amount
   
%
 
Real estate loans:
                       
Residential
 
$
2,565
     
15.9
   
$
1,056
     
12.2
 
Commercial
   
9,185
     
48.1
     
10,120
     
50.8
 
Agricultural
   
3,475
     
14.0
     
4,589
     
18.2
 
Construction
   
1,833
     
7.8
     
801
     
4.7
 
Consumer
   
1,720
     
5.2
     
135
     
5.0
 
Other commercial loans
   
2,072
     
5.4
     
1,040
     
3.7
 
Other agricultural loans
   
229
     
1.2
     
489
     
2.0
 
State & political subdivision loans
   
48
     
2.4
     
322
     
3.4
 
Unallocated
   
328
     
N/A
     
-
     
N/A
 
Total allowance for loan losses
 
$
21,455
     
100.0
   
$
18,552
     
100.0
 

54
The following table provides information related to credit loss experience and loan quality for the nine months ended September 30, 2023 and the year ended December 31, 2022 (dollars in thousands).

September 30, 2023
 
Credit Loss Expense (Benefit)
   
Net (charge-offs) Recoveries
   
Average Loans
   
Ratio of net (charge-offs) recoveries to Average loans
   
Allowance to total loans
   
Non-accrual loans as a percent of loans
   
Allowance to total non-accrual loans
 
Real estate:
                                         
Residential
 
$
1,323
   
$
(1
)
 
$
268,562
     
0.00
%
   
0.72
%
   
0.83
%
   
86.77
%
Commercial
   
2,094
     
2
     
954,043
     
0.00
%
   
0.85
%
   
0.15
%
   
575.14
%
Agricultural
   
(6
)
   
-
     
312,436
     
0.00
%
   
1.11
%
   
0.95
%
   
116.42
%
Construction
   
1,135
     
-
     
114,386
     
0.00
%
   
1.05
%
   
1.34
%
   
77.77
%
Consumer
   
(107
)
   
(25
)
   
82,405
     
(0.03
%)
   
1.49
%
   
0.88
%
   
169.12
%
Other commercial loans
   
1,286
     
(754
)
   
84,963
     
(0.89
%)
   
1.72
%
   
1.60
%
   
107.47
%
Other agricultural loans
   
(41
)
   
-
     
31,643
     
0.00
%
   
0.86
%
   
1.12
%
   
76.59
%
State & political subdivision loans
   
6
     
-
     
60,183
     
0.00
%
   
0.08
%
   
0.00
%
 
NA
 
Unallocated
   
(398
)
   
-
     
-
   
NA
   
NA
   
NA
   
NA
 
Total
 
$
5,292
   
$
(778
)
 
$
1,908,621
     
(0.04
%)
   
0.96
%
   
0.58
%
   
163.29
%

December 31, 2022
                                         
Real estate:
                                         
Residential
 
$
(91
)
 
$
-
   
$
204,063
     
0.00
%
   
0.50
%
   
0.28
%
   
178.68
%
Commercial
   
2,018
     
3
     
782,016
     
0.00
%
   
1.15
%
   
0.32
%
   
364.29
%
Agricultural
   
(140
)
   
-
     
312,999
     
0.00
%
   
1.46
%
   
1.03
%
   
142.43
%
Construction
   
367
     
-
     
73,214
     
0.00
%
   
0.99
%
   
0.00
%
 
NA
 
Consumer
   
(111
)
   
(16
)
   
58,715
     
(0.03
%)
   
0.16
%
   
0.00
%
 
NA
 
Other commercial loans
   
439
     
(422
)
   
72,444
     
(0.58
%)
   
1.64
%
   
0.10
%
   
1,677.42
%
Other agricultural loans
   
(69
)
   
-
     
34,421
     
0.00
%
   
1.40
%
   
0.82
%
   
171.58
%
State & political subdivision loans
   
41
     
-
     
56,004
     
0.00
%
   
0.54
%
   
0.00
%
 
NA
 
Unallocated
   
(771
)
   
-
     
-
   
NA
   
NA
   
NA
   
NA
 
Total
 
$
1,683
   
$
(435
)
 
$
1,593,876
     
(0.03
%)
   
1.08
%
   
0.40
%
   
267.40
%

The Company believes it utilizes a disciplined and thorough loan review process based upon its internal loan policy approved by the Company’s Board of Directors.  The purpose of the review is to assess loan quality, analyze delinquencies, identify problem loans, evaluate potential charge-offs and recoveries, and assess general overall economic conditions in the markets served.  An external independent loan review is performed on our commercial portfolio at least semi-annually for the Company.  The external consultant is engaged to 1) review a minimum of 50%  of the dollar volume of the commercial loan portfolio on an annual basis, 2) new loans originated for over $1.0 million in the last year, 3) review a sample of borrowers with commitments greater than or equal to $1.0 million,  4) selected loan relationships over $750,000 which are over 30 days past due, or classified Special Mention, Substandard, Doubtful, or Loss, and 5) such other loans which management or the consultant deems appropriate. As part of this review, our underwriting process and loan grading system is evaluated.

Management believes it uses the best information available to make such determinations and that the allowance for credit losses - loans is adequate as of September 30, 2023. However, future adjustments could be required if circumstances differ substantially from assumptions and estimates used in making the initial determination.  A prolonged downturn in the economy, changes in the economies of various segments of our agricultural and commercial portfolios, high unemployment rates, significant changes in the value of collateral and delays in receiving financial information from borrowers could result in increased levels of non-performing assets, charge-offs, loan loss provisions and reduction in income.  Additionally, bank regulatory agencies periodically examine the Bank’s allowance for credit losses.  The banking agencies could require the recognition of additions to the allowance for credit losses - loans based upon their judgment of information available to them at the time of their examination.

55
On a monthly basis, problem loans are identified and updated primarily using internally prepared past due reports.  Based on data surrounding the collection process of each identified loan, the loan may be added or deleted from the monthly watch list.  The watch list includes loans graded special mention, substandard, doubtful, and loss, as well as additional loans that management may choose to include.  Watch list loans are continually monitored going forward until satisfactory conditions exist that allow management to upgrade and remove the loan from the watchlist.  In certain cases, loans may be placed on non-accrual status or charged-off based upon management’s evaluation of the borrower’s ability to pay.  All commercial loans, which include commercial real estate, agricultural real estate, state and political subdivision loans, other commercial loans and other agricultural loans, on non-accrual are evaluated quarterly for impairment.

See also “Note 6 – Loans and Related Allowance for Credit Loan Losses - Loans” to the consolidated financial statements.
 
The following table is a summary of our non-performing assets as of September 30, 2023 and December 31, 2022.
 
   
September 30,
   
December 31,
 
(dollars in thousands)
 
2023
   
2022
 
Non-performing loans:
           
Non-accruing loans
 
$
13,139
   
$
6,938
 
Accrual loans - 90 days or more past due
   
8
     
7
 
Total non-performing loans
   
13,147
     
6,945
 
Foreclosed assets held for sale
   
474
     
543
 
Total non-performing assets
 
$
13,621
   
$
7,488
 
 
The following table identifies amounts of loans contractually past due 30 to 90 days and non-performing loans by loan category, as well as the change from December 31, 2022 to September 30, 2023 in non-performing loans (in thousands).  Non-performing loans include those accruing loans that are contractually past due 90 days or more and non-accrual loans. Interest does not accrue on non-accrual loans.  Subsequent cash payments received are applied to the outstanding principal balance or recorded as interest income, depending upon management’s assessment of its ultimate ability to collect principal and interest.
 
   
September 30, 2023
   
December 31, 2022
 
         
Non-Performing Loans
         
Non-Performing Loans
 
   
30 - 89 Days
                     
30 - 89 Days
                   
   
Past Due
   
90 Days Past
   
Non-
   
Total Non-
   
Past Due
   
90 Days Past
   
Non-
   
Total Non-
 
(in thousands)
 
Accruing
   
Due Accruing
   
accrual
   
Performing
   
Accruing
   
Due Accruing
   
accrual
   
Performing
 
Real estate:
                                               
Residential
 
$
1,203
   
$
-
   
$
2,956
   
$
2,956
   
$
469
   
$
-
   
$
591
   
$
591
 
Commercial
   
2,311
     
-
     
1,597
     
1,597
     
1,018
     
-
     
2,778
     
2,778
 
Agricultural
   
299
     
-
     
2,985
     
2,985
     
-
     
-
     
3,222
     
3,222
 
Construction
   
677
     
-
     
2,357
     
2,357
     
-
     
-
     
-
     
-
 
Consumer
   
771
     
8
     
1,017
     
1,025
     
147
     
7
     
-
     
7
 
Other commercial loans
   
224
     
-
     
1,928
     
1,928
     
1,695
     
-
     
62
     
62
 
Other agricultural loans
   
475
     
-
     
299
     
299
     
-
     
-
     
285
     
285
 
Total nonperforming loans
 
$
5,960
   
$
8
   
$
13,139
   
$
13,147
   
$
3,329
   
$
7
   
$
6,938
   
$
6,945
 
 
56
   
Change in Non-Performing Loans
 
   
September 30, 2023 /December 31, 2022
 
(in thousands)
 
Amount
   
%
 
Real estate:
           
Residential
 
$
2,365
     
400.2
 
Commercial
   
(1,181
)
   
(42.5
)
Agricultural
   
(237
)
   
(7.4
)
Construction
   
2,357
   
NA
 
Consumer
   
1,018
     
14,542.9
 
Other commercial loans
   
1,866
     
3,009.7
 
Other agricultural loans
   
14
     
4.9
 
Total nonperforming loans
 
$
6,202
     
89.3
 
 
Nonperforming loans increased $6.2 million during 2023. As part of the HVBC acquisition, we acquired $1.8 million of non-performing residential loans, $1.1 million of non-performing consumer loans and $763,000 of non-performing other commercial loans. During the first quarter of 2023, the Bank place two large relationships totaling $3.8 million on non-accrual status, one of which was secured by real estate and the other was secured by airplanes and camera equipment. At September 30, 2023, approximately 54.7% of the Bank’s non-performing loans are associated with the following five customer relationships:
 

A commercial loan relationship with $617,000 outstanding, and additional letters of credit of $1.2 million available, secured by undeveloped land, stone quarries and equipment, was on non-accrual status as of September 30, 2023. The Company services the natural gas industry, as well as local municipalities. As a result, the reduced exploration for natural gas in north central Pennsylvania has significantly impacted the cash flows of the customer, who provides excavation services and stone for pad construction related to these activities. During 2020, the Company had the underlying equipment collateral appraised and in the first quarter of 2022, the Company had the quarry appraised. The appraisals indicated a decrease in collateral values compared to the appraisal ordered for the loan origination, however, the loan was still considered well secured on a loan to value basis at September 30, 2023. In 2022 and 2023, the customer  liquidated some excess equipment and the funds have been utilized to pay down a portion of the loans. Management determined that no specific reserve was required as of September 30, 2023.

An agricultural loan customer with a total loan relationship of $1.7 million, secured by real estate, equipment and cattle, was on non-accrual status as of September 30, 2023. The customer declared bankruptcy during the fourth quarter of 2018 and developed a workout plan that was approved by the bankruptcy court in the fourth quarter of 2019 and resulted in monthly payments resuming in late 2019 that continue into 2023. Included within these loans to this customer are loans which are subject to Farm Service Agency guarantees in excess of $700,000. Depressed milk prices and the pandemic have created cash flow difficulties for this customer.  Absent a sizable and sustained increase in milk prices, which is not assured, we will need to rely upon the collateral for repayment of interest and principal. During 2023, the Company had the underlying collateral appraised. Management determined that no specific reserve was required as of September 30, 2023.

An agricultural loan customer with a total loan relationship of $1.2 million, secured by real estate was on non-accrual status as of September 30, 2023. The customer filed bankruptcy in the first quarter of 2023. The COVID-19 pandemic  escalated the cash flow difficulties this customer was experiencing. We expect that we will need to rely upon the collateral for repayment of interest and principal. During 2023, the Company had the underlying collateral appraised.  Management reviewed the collateral and determined that no specific reserve was required as of September 30, 2023.

A commercial loan customer with a total loan relationship of $1.4 million, secured by airplanes and camera equipment was on non-accrual status as of September 30, 2023. The customer is in the process of selling its business, which has taken longer than expected causing cashflow difficulties. A forbearance agreement was agreed to by the Customer that calls for $180,000 of payments in the fourth quarter of 2023 and a pay-off of the entire relationship during the fourth quarter of 2023 as well. Management reviewed the collateral and determined that no specific reserve was required as of September 30, 2023.

A construction loan customer with a total loan relationship of $2.4 million, secured by partially  developed real estate, was on non-accrual status as of September 30, 2023. The customer has experienced delays in developing the real estate for resale resulting in financing difficulties. Management reviewed the collateral and determined that a specific reserve of $286,000 was required as of September 30, 2023.

57
Management believes that the allowance for credit losses - loans at September 30, 2023 was adequate at that date, which was based on the following factors:


Five loan relationships comprise 54.7% of the non-performing loan balance, which required a specific reserve of $286,000 as of September 30, 2023.

The Company has a history of low charge-offs, which were 0.05% of average loans on an annualized basis for 2023, including the acquired loan charged off that was reserved for as of the acquisition date and 0.3% for 2022.

Bank Owned Life Insurance

The Company owns bank owned life insurance policies to offset future employee benefit costs. These policies provide the Bank with an asset that generates earnings to partially offset the current costs of benefits, and eventually (at the death of the insureds) provide partial recovery of cash outflows associated with the benefits.  As of September 30, 2023, and December 31, 2022, the cash surrender value of the life insurance was $49.6 million and $39.4 million, respectively. As part of the HVBC acquisition, the Bank acquired $10.4 million of bank owned life insurance.  The change in cash surrender value, net of purchases and amounts acquired through acquisitions, is recognized in the results of operations. The amounts recorded as non-interest income totaled $489,000 and $216,000 for the three month periods ended September 30, 2023 and 2022, respectively. For the nine months ended September 30, 2023 and 2022, $941,000 and $635,000, respectively, was recorded in non-interest income. During the third quarter of 2023, the Bank received proceeds of $1,097,000 upon the passing of a former employee, which generate income of approximately $200,000. The Company evaluates annually the risks associated with the life insurance policies, including limits on the amount of coverage and an evaluation of the various carriers’ credit ratings.

The Company policies that were purchased directly from insurance companies and acquired as part of the HVBC acquisition are structured so that any death benefits received from a policy while the insured person is an active employee of the Bank will be split with the beneficiary of the policy.  Under these agreements, the employee’s beneficiary will be entitled to receive 50% of the net amount at risk from the proceeds.  The net amount at risk is the total death benefit payable less the cash surrender value of the policy as of the date of death. The policies acquired as part of the acquisition of FNB provide a fixed split-dollar benefit for the beneficiary’s estate, which is dependent on several factors including whether the covered individual was a former Director of First National Bank of Fredericksburg (“FNB”) or a former employee of FNB and their salary level. As of September 30, 2023, and December 31, 2022, included in other liabilities on the Consolidated Balance Sheet was a liability of $618,000 and $660,000, respectively, for the obligation under the split-dollar benefit agreements.

58
Premises and Equipment

Premises and equipment increased $3.8 million to $21.4 million as of September 30, 2023 from December 31, 2022. As part of the HVBC acquisition, $2.3 million of property was acquired. Additionally, during 2023, the Bank acquired $1.6 million of real estate in Mansfield, Pennsylvania that will hold its corporate headquarters and operations.

Other assets

Other assets increased $17.3 million to $43.1 million. The primary driver of the increase was the HVBC acquisition, which increased other assets $14.8 million, which was due to leases, restricted stocks and prepaid expenses.

Deposits

The following table shows the composition of deposits as of September 30, 2023 and December 31, 2022 (dollars in thousands):

   
September 30,
   
December 31,
 
   
2023
   
2022
 
   
Amount
   
%
   
Amount
   
%
 
Non-interest-bearing deposits
 
$
542,144
     
23.2
   
$
396,260
     
21.5
 
NOW accounts
   
671,020
     
28.7
     
512,502
     
27.8
 
Savings deposits
   
319,045
     
13.7
     
321,917
     
17.5
 
Money market deposit accounts
   
426,633
     
18.3
     
335,838
     
18.2
 
Certificates of deposit
   
376,293
     
16.1
     
277,691
     
15.0
 
Total
 
$
2,335,135
     
100.0
   
$
1,844,208
     
100.0
 

   
September 30, 2023/
December 31, 2022 Change
 
   
Amount
   
%
 
Non-interest-bearing deposits
 
$
145,884
     
36.8
 
NOW accounts
   
158,518
     
30.9
 
Savings deposits
   
(2,872
)
   
(0.9
)
Money market deposit accounts
   
90,795
     
27.0
 
Certificates of deposit
   
98,602
     
35.5
 
Total
 
$
490,927
     
26.6
 

Deposits increased $490.9 million since December 31, 2022. As part of the HVBC acquisition, we acquired $533.4 million of deposits. Excluding the acquisition, deposits would have decreased $42.4 million.  The reduction in deposits resulted from customer funds transferred to higher-yielding investment alternatives; and seasonal reductions in municipal deposits as well as funds used for various projects within municipalities. Brokered deposits totaled $80.9 million and $16.0 million as of September 30, 2023 and December 31, 2022, respectively. As part of the acquisition, we acquired $36.2 million of brokered deposits,  which matured during the third quarter of 2023. At September 30, 2023, the Bank estimates that balances held by customers in excess of the FDIC insurance limit ($250,000 per insured account) totaled $1.08 billion, or 46.4% of the Bank’s total deposits. Included in this balance are balances held through Intrafi, which provides customers with  FDIC insurance coverage by placing customer funds with insured banks within the Intrafi network, as well as deposits collateralized by securities (almost exclusively municipal deposits). The total of these items was $491.6 million, or 21.1% of the Bank’s total deposits, as of September 30, 2023.

Borrowed Funds

Borrowed funds were $316.2 million and $257.3 million as of September 30, 2023 and December 31, 2022, respectively. As part of the HVBC acquisition, the Company acquired $58.6 million of borrowings, which accounts for the majority of the increase. The acquired borrowings included $49.8 million of FHLB advances and $8.9 million of subordinated debt.

59
In April 2020, the Bank entered into two interest rate swap agreements to convert floating-rate debt to fixed rate debt on notional amounts of $15.0 million and $10.0 million. The interest rate swap instruments involve an agreement to receive a floating rate and pay a fixed rate, at specified intervals, calculated on the agreed-upon notional amounts. The differentials paid or received on interest rate swap agreements are recognized as adjustments to interest expense in the period. The interest rate swap agreements were entered into on April 1, 2020 and expire on April 1, 2025 and April 1, 2027. In April 2020, the Company entered into an interest rate swap agreement to convert floating-rate debt to fixed rate debt on a notional amounts of $7.5 million. The interest rate swap instrument involves an agreement to receive a floating rate and pay a fixed rate, at specified intervals, calculated on the agreed-upon notional amount. The differentials paid or received on interest rate swap agreements are recognized as adjustments to interest expense in the period. The interest rate swap agreements were entered into on April 13, 2020 and expire on June 17, 2027. In May of 2020, the Bank entered into three two year forward interest rate swaps that will convert floating rate debt to fixed rate debt on notional amounts of $6.0 million each.  The interest rate swap instruments involves an agreement to receive a floating rate and pay a fixed rate, at specified intervals, calculated on the agreed-upon notional amount. The differentials paid or received on interest rate swap agreements are recognized as adjustments to interest expense in the period. The interest rate swap agreements were entered into on May 14, 2020 and expire on May 14, 2027, 2029 and 2032. The fair value of the interest rate swaps at September 30, 2023 was $7,012,000 and is included within fair value of derivative instruments on the consolidated balance sheets.

The Company’s current strategy for borrowings is to consider terms and structures to manage interest rate risk and liquidity in a rising rate environment. The Company’s daily cash requirements or short-term investments are primarily met by using the financial instruments available through the Federal Home Loan Bank of Pittsburgh.

Stockholders’ Equity

We evaluate stockholders’ equity in relation to total assets and the risks associated with those assets.  The greater the capital resource, the more likely a corporation will meet its cash obligations and absorb unforeseen losses.  For these reasons, capital adequacy has been, and will continue to be, of paramount importance to the Company. As such, the Company has implemented policies and procedures to ensure that it has adequate capital levels. As part of this process, we routinely stress test our capital levels and identify potential risk and alternative sources of additional capital should the need arise.

Total stockholders’ equity was $262.7 million at September 30, 2023 compared to $200.1 million at December 31, 2022, an increase of $62,539,000, or 31.3%.  As part of the HVBC acquisition, the Company issued 693,858 shares that had a fair value at the time of issuance of $60.1 million. Excluding accumulated other comprehensive loss, stockholders’ equity increased $66.0 million, or 28.3%. The accumulated comprehensive loss increased $3.5 million, which was primarily the result of the decrease in fair value of the Company’s available for sale investment portfolio caused by the increase in longer term market interest rates. For the nine months of 2023, the Company had net income of $10.3 million and declared cash dividends of $6.2 million, or $1.451 per share, representing a cash dividend payout ratio of 60.3%. As a result of implementing CECL, retained earnings increased $1,766,000.

All of the Company’s debt investment securities are classified as available-for-sale, making this portion of the Company’s balance sheet more sensitive to the changing market value of investments due to changes in market interest rates. As a result of increases in longer term market interest rates, the defined benefit plan obligations and the interest rate swaps entered into during 2020, accumulated other comprehensive loss increased approximately $3.5 million from December 31, 2022.

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory-and possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under U.S. GAAP, regulatory reporting requirements, and regulatory capital standards. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
60
Quantitative measures established by regulatory capital standards to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and Tier 1 capital (as defined) to risk-weighted assets (as defined), common equity Tier 1 capital (as defined) to total risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). As permitted by applicable federal regulation, the Bank has opted to use the community bank leverage ratio (the “CBLR”) framework for determining its capital adequacy.  Under the CBLR framework a qualifying community bank is considered well-capitalized if its leverage ratio (Tier 1 capital divided by average total consolidated assets) exceeds 9%. Following the passage of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act in response to the COVID-19 pandemic, the federal banking regulators revised the CBLR framework as follows: (i) beginning in the second quarter of 2020, a qualifying community bank need only have a leverage ratio of at least 8%, subject to the other qualifying requirements, and (ii) if a qualifying community bank’s leverage ratio falls below 8%, then it will have two calendar quarters to maintain a leverage ratio of 7% or greater.  These revisions under the CARES Act are effective April 23, 2020 and terminated on December 31, 2020.  Following such termination there is a grace period for returning to the 9% CBLR threshold.  The CBLR was set at 8.5% for 2021, and 9% thereafter.  The grace period is also adjusted to account for the graduating increase. As a result, in 2021, a qualifying community bank utilizing the grace period must maintain a CBLR of at least 7.5%. Thereafter, a qualifying community bank utilizing the grace period must maintain a CBLR of at least 8%. If a qualifying community bank fails to maintain the applicable minimum CBLR during the grace period, or if it is unable to restore compliance with the CBLR within the grace period, then it will revert to the Basel III capital framework and the normal Prompt Corrective Action capital categories will apply. At September 30, 2023, the Bank leverage ratio under the CBLR framework was 8.64%. This ratio allows the Bank to fall within the grace period of the CBLR, and the Bank will have to meet the 9.0% requirement to be considered “well-capitalized” by the end of the first quarter of 2024. The Bank leverage ratio as of December 31, 2022 was 8.77%, which did not meet the ratio to be considered “well-capitalized”  under the CBLR as of December 31, 2022. As such, the following table provides the Bank’s computed risk‑based capital ratios as of December 31, 2022, which reflects the Bank being well capitalized at that date (dollars in thousands):
   
Actual
   
For Capital Adequacy Purposes
   
To Be Well Capitalized Under
Prompt Corrective Action Provisions
 
December 31, 2022
 
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
Total Capital (to Risk Weighted Assets):
 
Company
 
$
238,966
     
12.87
%
 
$
148,567
     
8.00
%
 
$
185,709
     
10.00
%
Bank
 
$
222,714
     
12.01
%
 
$
148,348
     
8.00
%
 
$
185,435
     
10.00
%

Tier 1 Capital (to Risk Weighted Assets):
 
Company
 
$
210,250
     
11.32
%
 
$
111,425
     
6.00
%
 
$
148,567
     
8.00
%
Bank
 
$
203,998
     
11.00
%
 
$
111,261
     
6.00
%
 
$
148,348
     
8.00
%

Common Equity Tier 1 Capital (to Risk Weighted Assets):
 
Company
 
$
202,750
     
10.92
%
 
$
83,569
     
4.50
%
 
$
120,711
     
6.50
%
Bank
 
$
203,998
     
11.00
%
 
$
83,446
     
4.50
%
 
$
120,533
     
6.50
%

Tier 1 Capital (to Average Assets):
 
Company
 
$
210,250
     
9.03
%
 
$
93,161
     
4.00
%
 
$
116,451
     
5.00
%
Bank
 
$
203,998
     
8.77
%
 
$
93,075
     
4.00
%
 
$
116,344
     
5.00
%

Off-Balance Sheet Activities

Some financial instruments, such as loan commitments, credit lines, and letters of credit, are issued to meet customer financing needs but are not recorded on the Company’s balance sheet.  The contractual amount of financial instruments with off-balance sheet risk was as follows at September 30, 2023 and December 31, 2022 (in thousands):

61
   
September 30, 2023
   
December 31, 2022
 
Commitments to extend credit
 
$
505,950
   
$
437,449
 
Standby letters of credit
   
19,011
     
15,972
 
   
$
524,961
   
$
453,421
 
                 
Allowance for Credit Losses - Off-Balance Sheet credit Exposure
 
$
1,265
   
$
165
 

We also offer limited overdraft protection as a non-contractual courtesy which is available to demand deposit accounts in good standing. Overdraft charges as a result of ATM withdrawals and one-time point of sale (non-recurring) transactions require prior approval of the customer. The non-contractual amount of financial instruments with off-balance sheet risk at September 30, 2023 and December 31, 2022 was $13,111,000 and $12,232,000, respectively. The Company reserves the right to discontinue this service without prior notice.

Liquidity

Liquidity is a measure of the Company’s ability to efficiently meet normal cash flow requirements of both borrowers and depositors.  To maintain proper liquidity, we use funds management policies, which include liquidity target ratios, along with our investment policies to assure we can meet our financial obligations to depositors, credit customers and stockholders.  Liquidity is needed to meet depositors’ withdrawal demands, extend credit to meet borrowers’ needs, provide funds for normal operating expenses and cash dividends, and to fund other capital expenditures.

Cash generated by operating activities, investing activities and financing activities influences liquidity management. Our Company’s historical activity in this area can be seen in the Consolidated Statement of Cash Flows.  The most important source of funds is core deposits.  Repayment of principal on outstanding loans and cash flows created from the investment portfolio are also factors in liquidity management.  Other sources of funding include brokered certificates of deposit and the sale of loans or investments, if needed.

The Company’s use of funds is shown in the investing activity section of the Consolidated Statement of Cash Flows, where the net loan activity is presented.  Other uses of funds include purchasing stock from the Federal Home Loan Bank (FHLB) of Pittsburgh, as well as capital expenditures.  Capital expenditures (including software purchases), during the first nine months of 2023 were $2,308,000 compared to $1,150,000 during the same time period in 2022.

Short-term debt from the FHLB supplements the Bank’s availability of funds.  The Bank achieves liquidity primarily from temporary or short‑term investments in the Federal Reserve and the FHLB.  The Bank had a maximum borrowing capacity at the FHLB of approximately $1.10 billion, of which $391.9 million was outstanding, at September 30, 2023. The Bank also has two federal funds line with third party providers for $34.0 million as of September 30, 2023, which is unsecured and undrawn upon. We also have a borrower in custody line with the Federal Reserve Bank of approximately $960,000, which also is not drawn upon as of September 30, 2023. The Bank also has available through the Bank Term Funding program initiated by the Federal Reserve during the second quarter of 2023, a line of $54.5 million, which is undrawn upon as of September 30, 2023. The Company has a $20.0 million line of credit with a Pennsylvania community bank, of which $17.5 million is utilized as of September 30, 2023. The Company continues to evaluate its liquidity needs and as necessary finds additional sources.

62
Citizens Financial Services, Inc. is a separate legal entity from the Bank and must provide for its own liquidity.  In addition to its operating expenses, Citizens Financial Services, Inc. is responsible for paying any dividends declared to its shareholders.  Citizens Financial also has repurchased shares of its common stock.  Citizens Financial Services, Inc.’s primary source of income is dividends received from the Bank.  Both federal and state laws impose restrictions on the ability of the Bank to pay dividends. In particular, the Bank may not, as a state-chartered bank which is a member of the Federal Reserve System, declare a dividend without approval of the Federal Reserve, unless the dividend to be declared by the Bank’s Board of Directors does not exceed the total of:  (i) the Bank’s net profits for the current year to date, plus (ii) its retained net profits for the preceding two current years, less any required transfers to surplus.  The Federal Reserve Board and the FDIC have formal and informal policies which provide that insured banks and bank holding companies should generally pay dividends only out of current operating earnings, with some exceptions.  The Prompt Corrective Action Rules, described above, further limit the ability of banks to pay dividends, because banks which are not classified as well capitalized or adequately capitalized may not pay dividends and no dividend may be paid which would make the Bank undercapitalized after the dividend.  At September 30, 2023, Citizens Financial Services, Inc. (on an unconsolidated basis) had liquid assets of approximately $3.4 million.

Interest Rate and Market Risk Management

The objective of interest rate sensitivity management is to maintain an appropriate balance between the stable growth of income and the risks associated with maximizing income through interest sensitivity imbalances and the market value risk of assets and liabilities.

Because of the nature of our operations, we are not subject to foreign currency exchange or commodity price risk and, because we have no trading portfolio, we are not subject to trading risk. At September 30, 2023, the Company has equity securities that represent only 0.06% of its total assets and, therefore, equity risk is not significant.

The primary components of interest-sensitive assets include adjustable-rate loans and investments, loan repayments, investment maturities and money market investments.  The primary components of interest-sensitive liabilities include maturing certificates of deposit, IRA certificates of deposit and short-term borrowings.  Savings deposits, NOW accounts and money market investor accounts are considered core deposits and are not short-term interest sensitive (except for the top-tier money market investor accounts, typically help by local governments, which are paid current market interest rates).

Gap analysis, one of the methods used by us to analyze interest rate risk, does not necessarily show the precise impact of specific interest rate movements on our Company’s net interest income because the re-pricing of certain assets and liabilities is discretionary and is subject to competitive and other pressures.  In addition, assets and liabilities within the same period may, in fact, be repaid at different times and at different rate levels.  We have not experienced the kind of earnings volatility that might be indicated from gap analysis.
 
The Company currently uses a computer simulation model to better measure the impact of interest rate changes on net interest income. We use the model as part of our risk management and asset liability management processes that we believe will effectively identify, measure, and monitor the Company’s risk exposure.  In this analysis, the Company examines the results of movements in interest rates with additional assumptions made concerning prepayment speeds on mortgage loans and mortgage securities.   Shock scenarios, which assume a parallel shift in interest rates and is instantaneous, typically have the greatest impact on net interest income. The following is a rate shock analysis and the impact on net interest income as of September 30, 2023 (dollars in thousands):
 
         
Change In
   
% Change In
 
   
Prospective One-Year
   
Prospective
   
Prospective
 
Changes in Rates
 
Net Interest Income
   
Net Interest Income
   
Net Interest Income
 
-400 Shock
 
$
93,737
   
$
5,834
     
6.64
 
-300 Shock
   
91,035
     
3,132
     
3.56
 
-200 Shock
   
90,235
     
2,332
     
2.65
 
-100 Shock
   
89,458
     
1,555
     
1.77
 
Base
   
87,903
     
-
     
-
 
+100 Shock
   
85,903
     
(2,000
)
   
(2.28
)
+200 Shock
   
83,456
     
(4,447
)
   
(5.06
)
+300 Shock
   
81,507
     
(6,396
)
   
(7.28
)
+400 Shock
   
79,545
     
(8,358
)
   
(9.51
)

63
The model makes estimates, at each level of interest rate change, regarding cash flows from principal repayments on loans and mortgage backed securities, call activity of other investment securities, and deposit selection, re-pricing and maturity structure.  Because of these assumptions, actual results could differ significantly from these estimates which would result in significant differences in the calculated projected change on net interest income. Additionally, the changes above do not necessarily represent the level of change under which management would undertake specific measures to realign its portfolio in order to reduce the projected level of change. The changes in net interest income noted above are in line with Company policy for interest rate risk.

Item 3-Quantitative and Qualitative Disclosure about Market Risk

In the normal course of conducting business activities, the Company is exposed to market risk, principally interest rate risk, through the operations of its banking subsidiary.  Interest rate risk arises from market driven fluctuations in interest rates that affect cash flows, income, expense and values of financial instruments and was discussed previously in this Form 10-Q.  Management and a committee of the Board of Directors manage interest rate risk (see also “Interest Rate and Market Risk Management”).

Item 4-Control and Procedures

(a) Disclosure Controls and Procedures

The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”).  Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the SEC (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

(b) Changes to Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting during the quarter ended September 30, 2023 that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting.

PART II ‑ OTHER INFORMATION

Item 1 ‑
Legal Proceedings

Management is not aware of any pending or threatened litigation that would have a material adverse effect on the consolidated financial position of the Company.  Any pending proceedings are ordinary, routine litigation incidental to the business of the Company and its subsidiary.  In addition, no material proceedings are pending or are known to be threatened or contemplated against the Company and its subsidiary by government authorities.

Item 1A –
Risk Factors

In addition to the risk factor discussed below and the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1.A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2022, which could materially affect our business, financial condition or future results. At September 30, 2023, the risk factors of the Company have not changed materially from those reported in our Annual Report on Form 10-K.  However, the risks described in our Annual Report on Form 10-K are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

64
Our funding sources may prove insufficient to replace deposits at maturity and support our future growth.

We must maintain sufficient funds to respond to the needs of depositors and borrowers. As a part of our liquidity management, we use a number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments. As we continue to grow, we are likely to depend more on these sources, which may include Federal Home Loan Bank advances, federal funds purchased and brokered certificates of deposit. Adverse operating results or changes in industry conditions could lead to difficulty or an inability to access these additional funding sources. Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. If we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our operating margins and profitability would be adversely affected.

Our stock price may be negatively impacted by recent unrelated bank failures and negative depositor confidence in depository institutions.  Further, if we are unable to adequately manage our liquidity, interest rate risk, and capital levels, which have come under greater scrutiny in light of recent bank failures, it may have a material adverse effect on our financial condition and results of operations.

The recent failures of Silicon Valley Bank, Signature Bank and First Republic Bank have led to volatility and declines in the market for bank stocks and questions about depositor confidence in depository institutions.  These events have led to a greater focus by investors and bank regulators on financial institutions’ on-balance sheet liquidity and funding sources, deposit composition, including the amount of uninsured deposits, capital levels, and liquidity and interest rate risk management practices.  If we are unable to adequately manage our liquidity and interest rate management and capital levels, it may have a material adverse effect on our financial condition and results of operations.

Failure to address the federal debt ceiling in a timely manner, downgrade of the U.S. credit rating, and uncertain credit and financial market conditions may affect the stability of securities issued or guaranteed by the federal government, which may adversely affect the valuation or liquidity of our investment securities portfolio and increase future borrowing costs.

As a result of uncertain political, credit and financial market conditions, including the potential consequences of the federal government defaulting on its obligations for a period of time due to federal debt ceiling limitations or other unresolved political issues, investments in financial instruments issued or guaranteed by the federal government pose credit default and liquidity risks.  Downgrades to the U.S. credit rating could affect the stability of securities issued or guaranteed by the federal government and the valuation or liquidity of our portfolio of such investment securities, and could result in our counterparties requiring additional collateral for our borrowings.  Further, unless and until U.S. political, credit and financial market conditions have been sufficiently resolved or stabilized, it may increase our future funding costs.

65
Item 2 –
Unregistered Sales of Equity Securities, Use of Proceeds, and Issuer Purchases of Equity Securities

ISSUER PURCHASES OF EQUITY SECURITIES

Period
 
Total Number of Shares
(or units Purchased)
   
Average Price Paid
per Share (or Unit)
   
Total Number of
Shares (or Units)
Purchased as Part of
Publicly Announced
Plans of Programs
   
Maximum Number (or
Approximate Dollar Value) of
Shares (or Units) that May
Yet Be Purchased Under the
Plans or Programs (1)
 
                         
7/1/23 to 7/31/23
   
-
   
$
0.00
     
-
     
116,389
 
8/1/23 to 8/31/23
   
2,772
   
$
86.67
     
-
     
116,389
 
9/1/23 to 9/30/23
   
-
   
$
0.00
     
-
     
116,389
 
Total
   
2,772
   
$
86.67
     
-
     
116,389
 
 
  (1)
On April 21, 2020, the Company announced that the Board of Directors authorized the Company to repurchase up to an additional 150,000 shares at an aggregate purchase price not to exceed $12.0 million over a period of 36 months. The repurchases will be conducted through open-market purchases or privately negotiated transactions and will be made from time to time depending on market conditions and other factors.  No time limit was placed on the duration of the share repurchase program.  Any repurchased shares will be held as treasury stock and will be available for general corporate purposes.
 
Item 3 ‑
Defaults Upon Senior Securities

Not applicable.

Item 4 –
Mine Safety Disclosure

Not applicable.

Item 5 ‑
Other Information

None

Item 6 ‑
Exhibits

 
(a)
The following documents are filed as a part of this report:
   
Restated Articles of Incorporation of Citizens Financial Services, Inc. (1)
   
Articles of Amendment of Restated Articles of Incorporation of Citizens Financial Services, Inc. (2)
   
Bylaws of Citizens Financial Services, Inc. (3)
   
Amendment No. 1 to Amended and Restated Bylaws of Citizens Financial Services, Inc. (4)
   
Form of Common Stock Certificate. (5)
   
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
   
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
   
Section 1350 Certification of Chief Executive Officer and Chief Financial Officer
   
101
The following materials from the Company’s Quarterly Report on Form 10-Q for the period ended  September 30, 2023, formatted in XBRL (Extensible Business Reporting Language): (i) The Consolidated Balance Sheet (unaudited), (ii) the Consolidated Statement of Income (unaudited), (iii) the Consolidated Statement of Comprehensive Income (unaudited), (iv) the Consolidated Statement of Changes in Stockholders’ Equity, (v) the Consolidated Statement of Cash Flows (unaudited) and (vi) related notes (unaudited).
   
104
Cover Page Interactive Data File (embedded within the Inline XBRL document)



(1) Incorporated by reference to Exhibit 3.1 to the Company’s Form 10-Q for the quarter ended June 30, 2018, as filed with the Commission on August 9, 2018.

(2) Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, as filed with the Commission on April 26, 2021.

(3)  Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, as filed with the Commission on December 17, 2020.

(4)  Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, as filed with the Commission on November 23, 2022

(5)  Incorporated by reference to Exhibit 4 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2022, as filed with the Commission on March 10, 2023.

66
Signatures

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

 
Citizens Financial Services, Inc.
 
(Registrant)

November 8, 2023
/s/ Randall E. Black
 
By:
Randall E. Black
 
President and Chief Executive Officer
 
(Principal Executive Officer)

November 8, 2023
/s/ Stephen J. Guillaume
 
By:
Stephen J. Guillaume
 
Chief Financial Officer
 
(Principal Financial and Accounting Officer)


67

EX-31.1 2 ef20012444_ex31-1.htm EXHIBIT 31.1

Exhibit 31.1
Certification of Chief Executive Officer

I, Randall E. Black, certify that:
1.    I have reviewed this Form 10-Q of Citizens Financial Services, Inc.;
2.    Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.    Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.    The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;
(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5.    The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date: November 8, 2023 By: 
/s/ Randall E. Black
 
 
By: 
Randall E. Black
 
President and Chief Executive Officer
 
(Principal Executive Officer)



EX-31.2 3 ef20012444_ex31-2.htm EXHIBIT 31.2

Exhibit 31.2
Certification of Chief Financial Officer

I, Stephen J. Guillaume, certify that:
1.    I have reviewed this Form 10-Q of Citizens Financial Services, Inc.;
2.    Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.    Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.    The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;
(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5.    The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date: November 8, 2023
By: 
 /s/ Stephen J. Guillaume  
 
By: 
Stephen J. Guillaume
 
Chief Financial Officer
 
(Principal Financial and Accounting Officer)



EX-32.1 4 ef20012444_ex32-1.htm EXHIBIT 32.1

EXHIBIT 32.1
Section 1350 Certification
of Chief Executive Officer and Chief Financial Officer

In connection with the Quarterly Report of Citizens Financial Services, Inc. (the "Company") on Form 10-Q (the "Report") for the period ended September 30 2023 as filed with the Securities and Exchange Commission, the undersigned certify, pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002, that:
 

1.
The Report fully complies with the requirements of section 13(a) or 15 (d) of the Securities Exchange Act of 1934; and
 

2.
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of the dates and for the periods covered in the Report.
 
By:
/s/ Randall E. Black
 
By:
Randall E. Black
President and Chief Executive Officer

(Principal Executive Officer)



Date:  November 8, 2023


By:
/s/ Stephen J. Guillaume
 
By:
Stephen J. Guillaume
Chief Financial Officer

(Principal Financial and Accounting Officer)



Date:  November 8, 2023