CITIZENS & NORTHERN CORP 10-Q

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK Market risk is the risk of loss arising from adverse changes in market rates and prices of the Corporation’s financial instruments. In addition to the effects of interest rates, the market prices of the Corporation’s debt securities within the available-for-sale securities portfolio are affected by fluctuations in the risk premiums (amounts of spread over risk-free rates) demanded by investors. Management attempts to limit the risk that economic conditions would force the Corporation to sell securities for realized losses by maintaining a strong capital position (discussed in the “Stockholders’ Equity and Capital Adequacy” section of Management’s Discussion and Analysis) and ample sources of liquidity (discussed in the “Liquidity” section of Management’s Discussion and Analysis). The Corporation’s major category of market risk, interest rate risk, is discussed in the following section. INTEREST RATE RISK Business risk arising from changes in interest rates is an inherent factor in operating a bank. A significant portion of the Corporation’s assets are long-term, fixed-rate loans and debt securities. Funding for these assets comes principally from shorter-term deposits and borrowed funds. Accordingly, there is an inherent risk of lower future earnings or decline in fair value of the Corporation’s financial instruments when interest rates change. The Corporation uses a simulation model to calculate the potential effects of interest rate fluctuations on net interest income and the market value of portfolio equity. For purposes of these calculations, the market value of portfolio equity includes the fair values of financial instruments, such as securities, loans, deposits and borrowed funds, and the book values of nonfinancial assets and liabilities, such as premises and equipment and accrued expenses. The model measures and projects the amount of potential changes in net interest income, and calculates the discounted present value of anticipated cash flows of financial instruments, assuming an immediate increase or decrease in interest rates. Management ordinarily runs a variety of scenarios within a range of plus or minus 100-400 basis points of current rates. The model makes estimates, at each level of interest rate change, regarding cash flows from principal repayments on loans and mortgage-backed securities and call activity on other investment securities. Actual results could vary significantly from these estimates, which could result in significant differences in the calculations of projected changes in net interest income and market value of portfolio equity. Also, the model does not make estimates related to changes in the composition of the deposit portfolio that could occur due to rate competition, and the table does not necessarily reflect changes that management would make to realign the portfolio as a result of changes in interest rates. The Corporation’s Board of Directors has established policy guidelines for acceptable levels of interest rate risk, based on an immediate increase or decrease in interest rates. The policy limits acceptable fluctuations in net interest income from the baseline (flat rates) one-year scenario and variances in the market value of portfolio equity from the baseline values based on current rates. ​ 55 Table of Contents CITIZENS & NORTHERN CORPORATION – FORM 10-Q Table XI, which follows this discussion, is based on the results of calculations performed using the simulation model as of March 31, 2022 and December 31, 2021. The table shows the Corporation is asset-sensitive, meaning the amounts of net interest income and market value of portfolio equity increase in the upward rate scenarios and decrease in the downward rate scenarios. The table also shows that as of the respective dates, the changes in net interest income and changes in market value were within the policy limits in all scenarios. ​ TABLE XI – THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ March 31, 2022 Data ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ (In Thousands) ​ Period Ending March 31, 2023 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Basis Point ​ ​ Interest ​ ​ Interest ​ ​ Net Interest ​ NII ​ ​ NII ​ Change in Rates ​ ​ Income ​ ​ Expense ​ ​ Income (NII) ​ % Change ​ ​ Risk Limit ​ +400 ​ $ 101,995 ​ $ 17,804 ​ $ 84,191 ​ 19.5 % ​ 25.0 % +300 ​ ​ 95,469 ​ ​ 14,798 ​ ​ 80,671 ​ 14.5 % ​ 20.0 % +200 ​ ​ 89,022 ​ ​ 11,793 ​ ​ 77,229 ​ 9.6 % ​ 15.0 % +100 ​ ​ 82,584 ​ ​ 8,788 ​ ​ 73,796 ​ 4.7 % ​ 10.0 % 0 ​ ​ 76,265 ​ ​ 5,783 ​ ​ 70,482 ​ 0.0 % ​ 0.0 % -100 ​ ​ 72,037 ​ ​ 4,664 ​ ​ 67,373 ​ (4.4) % ​ 10.0 % -200 ​ ​ 69,795 ​ ​ 4,238 ​ ​ 65,557 ​ (7.0) % ​ 15.0 % ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Market Value of Portfolio Equity at March 31, 2022 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Present ​ ​ Present ​ ​ Present ​ ​ ​ ​ ​ ​ Basis Point ​ ​ Value ​ ​ Value ​ ​ Value ​ ​ ​ ​ ​ ​ Change in Rates ​ ​ Equity ​ ​ % Change ​ ​ Risk Limit ​ ​ ​ ​ ​ ​ +400 ​ $ 498,635 ​ ​ 10.0 % ​ 50.0 % ​ ​ ​ ​ ​ +300 ​ ​ 488,691 ​ ​ 7.8 % ​ 45.0 % ​ ​ ​ ​ ​ +200 ​ ​ 478,667 ​ ​ 5.6 % ​ 35.0 % ​ ​ ​ ​ ​ +100 ​ ​ 466,970 ​ ​ 3.0 % ​ 25.0 % ​ ​ ​ ​ ​ 0 ​ ​ 453,227 ​ ​ 0.0 % ​ 0.0 % ​ ​ ​ ​ ​ -100 ​ ​ 435,057 ​ ​ (4.0) % ​ 25.0 % ​ ​ ​ ​ ​ -200 ​ ​ 409,709 ​ ​ (9.6) % ​ 35.0 % ​ ​ ​ ​ ​ ​ 56 Table of Contents CITIZENS & NORTHERN CORPORATION – FORM 10-Q ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, 2021 Data ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ (In Thousands) ​ Period Ending December 31, 2022 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Basis Point ​ ​ Interest ​ ​ Interest ​ ​ Net Interest ​ NII ​ ​ NII ​ Change in Rates ​ ​ Income ​ ​ Expense ​ ​ Income (NII) ​ % Change ​ ​ Risk Limit ​ +400 ​ $ 98,839 ​ $ 18,142 ​ $ 80,697 ​ 19.1 % ​ 25.0 % +300 ​ ​ 92,438 ​ ​ 15,061 ​ ​ 77,377 ​ 14.2 % ​ 20.0 % +200 ​ ​ 86,112 ​ ​ 11,981 ​ ​ 74,131 ​ 9.4 % ​ 15.0 % +100 ​ ​ 79,740 ​ ​ 8,900 ​ ​ 70,840 ​ 4.5 % ​ 10.0 % 0 ​ ​ 73,536 ​ ​ 5,760 ​ ​ 67,776 ​ 0.0 % ​ 0.0 % -100 ​ ​ 70,118 ​ ​ 4,820 ​ ​ 65,298 ​ (3.7) % ​ 10.0 % -200 ​ ​ 68,824 ​ ​ 4,503 ​ ​ 64,321 ​ (5.1) % ​ 15.0 % ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Market Value of Portfolio Equity at December 31, 2021 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Present ​ ​ Present ​ ​ Present ​ ​ ​ ​ ​ ​ Basis Point ​ ​ Value ​ ​ Value ​ ​ Value ​ ​ ​ ​ ​ ​ Change in Rates ​ ​ Equity ​ ​ % Change ​ ​ Risk Limit ​ ​ ​ ​ ​ ​ +400 ​ $ 471,951 ​ ​ 14.1 % ​ 50.0 % ​ ​ ​ ​ ​ +300 ​ ​ 459,810 ​ ​ 11.1 % ​ 45.0 % ​ ​ ​ ​ ​ +200 ​ ​ 447,354 ​ ​ 8.1 % ​ 35.0 % ​ ​ ​ ​ ​ +100 ​ ​ 431,856 ​ ​ 4.4 % ​ 25.0 % ​ ​ ​ ​ ​ 0 ​ ​ 413,767 ​ ​ 0.0 % ​ 0.0 % ​ ​ ​ ​ ​ -100 ​ ​ 388,721 ​ ​ (6.1) % ​ 25.0 % ​ ​ ​ ​ ​ -200 ​ ​ 365,331 ​ ​ (11.7) % ​ 35.0 % ​ ​ ​ ​ ​ ​