What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-05-05 compared with 2022-11-07 · 226 added, 453 removed, 378 unchanged (64% of the section changed)

8 unchanged sentences

● changes in general economic conditions

● recent adverse developments in the banking industry highlighted by high-profile bank failures and the potential impact of such developments on customer confidence, sources of liquidity and capital funding, and regulatory responses to these developments (including potential increases in the cost of deposit insurance assessments)

● the Corporation’s credit standards and its on-going credit assessment processes might not protect it from significant credit losses

● the effect of the novel coronavirus (COVID-19) and related events

● legislative or regulatory changes

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● failure to achieve merger-related synergies and difficulties in integrating the business and operations of acquired institutions

● the effect of the novel coronavirus (COVID-19) and related events

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

EARNINGS OVERVIEW

Third Quarter 2022 as Compared to Third Quarter 2021

Third quarter 2022 net income was $4,455,000, or $0.29 per diluted share.

In comparison, third quarter 2021 net income was $7,399,000, or $0.47 per diluted share.

Significant variances were as follows:

● Third quarter 2022 net interest income of $20,879,000 was $1,420,000 higher than the third quarter 2021 total.

The net interest rate spread remained unchanged at 3.46%, as the average yield on earning assets increased 0.29% to 4.18%, and the average rate on interest-bearing liabilities increased 0.29% to 0.72%.

The net interest margin was 3.69% in the third quarter 2022, up from 3.59% in the third quarter 2021.

Total interest and fees from loans excluding loans originated under the U.S.

Small Business Administration (SBA) Paycheck Protection Program (PPP) were $20,602,000 in the third quarter 2022, an increase of $3,144,000 from the third quarter 2021 total of $17,458,000.

Total interest and fees from SBA PPP loans were $118,000 in the third quarter 2022, a decrease of $1,521,000 from the third quarter 2021 total of $1,639,000.

Interest income from available-for-sale debt securities, on a fully taxable-equivalent basis, increased $939,000 in the third quarter 2022 as compared to the third quarter 2021, as the average balance (at amortized cost) of available-for-sale debt securities increased $173.8 million.

Accretion and amortization of purchase accounting adjustments had a net positive impact on net interest income of $400,000 in the third quarter 2022 as compared to a net positive impact of $563,000 in the third quarter 2021.

Average outstanding loans increased $82.4 million, despite a reduction in average PPP loans of $83.0 million.

Average loans, excluding PPP loans, were up $165.5 million in the third quarter 2022 over the third quarter 2021, an increase of 11.0%.

Average total deposits increased $61.8 million (3.2%).

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

● The provision for loan losses was $3,794,000 in the third quarter 2022, up $2,264,000 from $1,530,000 in the third quarter 2021.

The third quarter 2022 provision included net charge-offs of $2,171,000 and an increase of $1,623,000 in the collectively determined portion of the allowance.

In the third quarter 2022, the Corporation recorded a partial charge-off of $2,160,000 on a commercial real estate secured loan with a principal balance of $6,920,000 at the time of charge-off.

The charge-off resulted from the borrower’s default due to deterioration in financial performance accompanied by a significant decrease in the appraised value of property at a recently closed facility that had been one of the primary sources of collateral on the loan.

In comparison, the third quarter 2021 provision included a net charge of $611,000 related to specific loans (net charge-offs of $1,205,000 offset by a net decrease in specific allowances on loans of $594,000), and an increase of $919,000 in the collectively determined portion of the allowance.

In the third quarter 2021, the Corporation recorded a partial charge-off of $1,194,000 on a commercial loan with an outstanding balance of $3,496,000 at the time of the charge-off.

● Noninterest income for the third quarter 2022 was down $711,000 from the third quarter 2021 total.

Significant variances included the following:

o Net gains from sales of loans of $131,000 decreased $666,000 from the third quarter 2021, reflecting a reduction in volume of residential mortgage loans sold.

o Service charges on deposit accounts of $1,105,000 decreased $144,000 from the third quarter 2021.

In the third quarter 2022, the Corporation recorded accrued refunds of consumer overdraft fees totaling $290,000 as the result of updated regulatory guidance on certain overdraft fees.

o Brokerage and insurance revenue of $696,000 increased $136,000 from the third quarter 2021, due to commissions on higher transaction volume.

● Noninterest expense increased $2,097,000 in the third quarter 2022 over the third quarter 2021 amount.

Significant variances included the following:

o Salaries and employee benefits of $10,826,000 increased $1,399,000 from the third quarter 2021 total, including an increase in base salaries expense of $992,000.

In addition to the impact of merit-based salary increases, the number of employees increased, reflecting expansion of the Southcentral PA market with the opening of an office in Lancaster as well as additions to staffing for information technology (IT), human resources and other functions.

In total, the number of full-time equivalent employees (FTEs) increased by 21 (5.4%) to 412 in the third quarter 2022 as compared to the third quarter 2021.

Also within this category, there was an increase in health care expense of $220,000 due to higher claims on the Corporation’s partially self-insured plan.

o Net occupancy and equipment expense of $1,498,000 increased $281,000 from the third quarter 2021 total, including accelerated depreciation expense of $205,000 related to planned closures of two branches in November 2022.

o Data processing and telecommunications of $1,719,000 increased $244,000 from the third quarter 2021 total, including the impact of increases in software licensing and maintenance costs as well as costs related to enhancements of data management capabilities.

● The income tax provision was $858,000, or 16.1% of pre-tax income for the third quarter 2022, down from $1,566,000, or 17.5% of pre-tax income for the third quarter 2021.

The decrease in income tax provision reflected the decrease in pre-tax income of $3,652,000.

Nine Months Ended September 30, 2022 as Compared to Nine Months Ended September 30, 2021

Net income for the nine-month period ended September 30, 2022 was $18,839,000, or $1.21 per diluted share, while net income for the first nine months of 2021 was $23,246,000 or $1.46 per diluted share.

First Quarter 2023 as Compared to First Quarter 2022

First quarter 2023 net income was $6,253,000, or $0.40 per diluted share.

In comparison, first quarter 2022 net income was $6,895,000, or $0.44 per diluted share.

Significant variances were as follows:

● First quarter 2023 net interest income of $20,781,000 was $449,000 higher than the first quarter 2022 total.

The increase in net interest income was mainly driven by loan growth, as average earning assets increased $131,608,000, including an increase in average loans of $178,002,000, or 11.5%, while average interest-bearing due from banks decreased $52,478,000.

Average total deposits of $1,931,126,000 were flat in the first quarter 2023 as compared to the first quarter 2022 while average borrowed funds increased $136,303,000.

The net interest margin was 3.71% in the first quarter 2023, down from 3.86% in the first quarter 2022.

The interest rate spread decreased 0.43%, as the average rate on interest-bearing liabilities increased 0.96%, while the average yield on earning assets increased 0.53%.

Contributing to the comparatively lower margin and spread, total interest and fees on loans in the first quarter 2022 included $1,398,000 from repayments received on purchased credit impaired loans in excess of previous carrying amounts with no comparable amount in the first quarter 2023.

● The credit for credit losses (reduction in expense) was $352,000 in the first quarter 2023 as compared to the first quarter 2022 provision for loan losses of $891,000.

The credit for credit losses in the first quarter 2023 resulted mainly from a reduction in

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

● For the nine-month period ended September 30, 2022, net interest income of $60,836,000 was $2,613,000 higher than in the same period in 2021.

Interest income from available-for-sale debt securities, on a fully taxable-equivalent basis, increased $2,883,000 in 2022 as compared to 2021, as the average balance (at amortized cost) of available-for-sale debt securities increased $192.7 million.

Total interest and fees on loans increased $623,000 in 2022 as compared to 2021.

Interest and fees on loans included $1,585,000 in 2022 and $35,000 in 2021 from repayments received on purchased credit impaired loans in excess of previous carrying amounts.

Total interest and fees from PPP loans were $899,000 in 2022, a decrease of $3,987,000 from the 2021 total of $4,886,000.

Accretion and amortization of purchase accounting adjustments had a net positive impact on net interest income of $1,347,000 in 2022 as compared to a net positive impact of $2,228,000 in 2021.

Average outstanding loans decreased $6.9 million, including a reduction in average PPP loans of $106.2 million.

Average loans, excluding PPP loans, were up $99.3 million (6.6%) in the first nine months of 2022 as compared to the first nine months of 2021.

Average total deposits increased $68.6 million (3.6%) in comparing the first nine months of 2022 over the total for the first nine months of 2021.

● For the first nine months of 2022, the provision for loan losses was $4,993,000, an increase in expense of $2,460,000 as compared to $2,533,000 recorded in the first nine months of 2021.

The provision for the first nine months of 2022 includes $2,047,000 related to specific loans (net decrease in specific allowances on loans of $313,000 and net charge-offs of $2,360,000), an increase of $2,617,000 in the collectively determined portion of the allowance and a $329,000 increase in the unallocated portion.

In comparison, the provision for loan losses in the first nine months of 2021 includes $1,176,000 related to specific loans (net charge-offs of $1,218,000 and a decrease in specific allowances on loans of $42,000), an increase of $1,271,000 in the collectively determined portion of the allowance and an $86,000 increase in the unallocated portion.

● Noninterest income of $18,323,000 for the first nine months of 2022 decreased $1,143,000 from the total for the first nine months of 2021.

the allowance related to the commercial segment of the portfolio.

Within the net credit for credit losses on loans in the first quarter 2023, the provision related to specific loans was $205,000, including net charge-offs of $61,000 and an increase in specific allowances on loans of $144,000.

In comparison, the first quarter 2022 provision included a net charge of $147,000 related to specific loans (net charge-offs of $157,000 offset by a net decrease in specific allowances on loans of $10,000).

● Noninterest income of $5,616,000 in the first quarter 2023 decreased $207,000 from the first quarter 2022 amount.

Significant variances included the following:

o Net gains from sales of loans of $733,000 decreased $2,053,000 reflecting a reduction in volume of residential mortgage loans sold.

o Other noninterest income totaled $2,666,000, a decrease of $171,000.

Within this category, the fair value of a marketable equity security decreased $114,000 in 2022 as compared to a decrease of $19,000 in 2021.

o Brokerage and insurance revenue of $1,784,000 increased $392,000, due to commissions on higher transaction volumes.

o Service charges on deposit accounts of $3,662,000 increased $325,000 as the volume of consumer and business overdraft and other activity increased partially offset by the impact of accrued refunds of $290,000 related to consumer overdraft fees.

o Loan servicing fees, net of $757,000 increased $210,000, reflecting growth in volume of residential mortgage loans sold with servicing retained.

Further, the fair value of servicing rights increased $128,000 in 2022 as compared to a decrease of $9,000 in 2021 mainly due to changes in assumptions related to prepayments of mortgage loans.

● Noninterest expense of $51,368,000 for the first nine months of 2022 increased $4,914,000 from the total for the first nine months of 2021.

o Net gains from sale of loans of $74,000 decreased $308,000 from the first quarter 2022, reflecting a reduction in volume of residential mortgage loans sold.

o Brokerage and insurance revenue of $430,000 decreased $92,000 from the first quarter 2022, due to lower volume of new transactions.

o Loan servicing fees, net of $122,000 decreased $88,000, as the fair value of servicing rights decreased $83,000 in the first quarter 2023 as compared to an increase of $2,000 in the first quarter 2022.

o Other noninterest income of $771,000 increased $183,000 from the first quarter 2022, including dividends on FHLB-Pittsburgh stock totaling $217,000, an increase of $100,000 from the first quarter 2022, and a gain on sale of premises and equipment of $68,000 with no comparable amount in the first quarter 2022.

● Noninterest expense of $19,087,000 in the first quarter 2023 increased $2,201,000 from the first quarter 2022 amount.

Significant variances included the following:

o Salaries and employee benefits of $31,698,000 increased $3,877,000, including an increase in base salaries expense of $2.8 million reflecting merit-based salary increases and an increase in number of personnel related to expansion of the Southcentral PA market with the opening of an office in Lancaster.

Additional increases include an increase in health care expense of $665,000 due to higher claims on the Corporation’s partially self-insured plan, $227,000 due to a lower portion of payroll costs capitalized (added to the carrying value of loans) due to the high volume of PPP loans originated in 2021, and $204,000 related to payroll taxes.

Decreases include a reduction in estimated cash and stock-based incentive compensation expense of $126,000 and severance expense of $248,000 in 2021 with no comparable amount in 2022.

o Salaries and employee benefits expense of $11,427,000 increased $820,000 from the first quarter 2022, including an increase in base salaries expense of $597,000.

In total, the number of full-time equivalent employees (FTEs) increased by 10 (2.5%) to 412 in the first quarter 2023 as compared to the first quarter 2022.

Total cash and stock-based compensation expense increased $167,000 and health care expense increased $102,000 due to higher claims on the Corporation’s partially self-insured plan.

o Other noninterest expense of $2,507,000 increased $623,000 from the first quarter 2022.

Within this category, significant variances included the following:

● In the first quarter 2022 the allowance for SBA claim adjustments decreased, reflecting more favorable claim results than previously estimated, resulting in a reduction in expense of $242,000 with no comparable amount in the first quarter 2023.

● Other operational losses totaled $206,000, an increase of $82,000.

● Net collection expense totaled $44,000 in the first quarter 2023, an increase of $85,000 over net recoveries of $41,000 in the first quarter 2022.

● Advertising expense totaled $213,000 in the first quarter 2023, an increase of $77,000 reflecting expenses related to social media strategy and brand monitoring analysis.

o Professional fees of $937,000 increased $448,000, including $389,000 of conversion costs related to a change in Wealth Management platform for providing brokerage and investment advisory services.

o Data processing and telecommunications of $1,936,000 increased $313,000 from the first quarter 2022, including the impact of increases in software licensing and maintenance costs as well as costs related to enhancements of data management capabilities.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

o Data processing and telecommunications of $5,062,000 increased $720,000, including the impact of increases in software licensing and maintenance costs as well as costs related to enhancements of data management capabilities.

o Net occupancy and equipment expense of $4,217,000 increased $477,000, including computer supplies and repairs and maintenance related to IT and Digital departments and increases related to a new branch location in Lancaster, PA as well as accelerated depreciation expense of $205,000 related to planned closures of two branches in November 2022.

o Professional fees of $1,490,000 decreased $193,000, mainly due to decreases in recruiting services and PPP loan processing-related professional fees.

● The income tax provision of $3,959,000, or 17.4% of pre-tax income for the nine months ended September 30, 2022 decreased $1,497,000 from $5,456,000, or 19.0% of pre-tax income for the nine months ended September 30, 2021.

The lower provision in 2022 includes the impact of a reduction in pre-tax income.

The lower effective tax rate in 2022 includes the impact of higher tax-exempt interest as a percentage of pre-tax income, a larger permanent difference (deduction) related to restricted stock compensation and the benefit of a $301,000 reduction in expense from the reversal of tax penalties being non-taxable.

● The income tax provision was $1,409,000, or 18.4% of pre-tax income for the first quarter 2023, as compared to $1,483,000, or 17.7% of pre-tax income for the fourth quarter 2022.

The decrease in income tax provision reflected the decrease in pre-tax income of $716,000.

TABLE I – QUARTERLY FINANCIAL DATA

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September 30,

Interest income

1 unchanged sentence

Net interest income

Provision for loan losses

Net interest income after provision for loan losses

(Credit) provision for credit losses

Net interest income after (credit) provision for credit losses

Noninterest income

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Three Months Ended

September 30,

Trust revenue

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Total noninterest income

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

(Dollars in Thousands)

Nine Months Ended

September 30,

Trust revenue

Brokerage and insurance revenue

Service charges on deposit accounts

Interchange revenue from debit card transactions

Net gains from sales of loans

Loan servicing fees, net

Increase in cash surrender value of life insurance

Other noninterest income

Realized gains on available-for-sale debt securities, net

Total noninterest income

NONINTEREST EXPENSE

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Three Months Ended

September 30,

Salaries and employee benefits

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Total noninterest expense

(Dollars in Thousands)

Nine Months Ended

September 30,

Salaries and employee benefits

Net occupancy and equipment expense

Data processing and telecommunications expense

Automated teller machine and interchange expense

Pennsylvania shares tax

Professional fees

Other noninterest expense

Total noninterest expense

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

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

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Actual results could differ from these estimates.

Allowance for Loan Losses – A material estimate that is particularly susceptible to significant change is the determination of the allowance for loan losses.

The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and recorded as a reduction of the investment in loans.

Management believes

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

the allowance for loan losses is adequate and reasonable.

Note 6 to the unaudited consolidated financial statements provides an overview of the process management uses for evaluating and determining the allowance for loan losses, and additional discussion of the allowance for loan losses is provided in a separate section later in Management’s Discussion and Analysis.

Given the very subjective nature of identifying and valuing loan losses, it is likely that well-informed individuals could make materially different assumptions, and could, therefore calculate a materially different allowance value.

While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years.

In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses.

Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.

Allowance for Credit Losses on Loans – A material estimate that is particularly susceptible to significant change is the determination of the allowance for credit losses (ACL) on loans.

The Corporation maintains an ACL on loans which represents management’s estimate of expected net charge-offs over the life of the loans.

The ACL includes two primary components:

(i) an allowance established on loans which share similar risk characteristics collectively evaluated for credit losses (collective basis), and (ii) an allowance established on loans which do not share similar risk characteristics with any loan segment and which are individually evaluated for credit losses (individual basis).

Management considers the determination of the ACL on loans to be critical because it requires significant judgment regarding estimates of expected credit losses based on the Corporation’s historical loss experience, current conditions and economic forecasts.

Management’s evaluation is based upon a continuous review of the Corporation’s loans, with consideration given to evaluations resulting from examinations performed by regulatory authorities.

Note 6 to the unaudited consolidated financial statements provides an overview of the process management uses for determining the ACL, and additional discussion of the ACL is provided in a separate section of Management’s Discussion and Analysis.

The ACL may increase or decrease due to changes in economic conditions affecting borrowers and macroeconomic variables, including new information regarding existing problem loans, identification of additional problem loans, changes in the fair value of underlying collateral, unforeseen events such as natural disasters and pandemics, and other factors.

Because current economic conditions and forecasts can change and future events are inherently difficult to predict, the anticipated amount of estimated credit losses on loans, and therefore the appropriateness of the ACL, could change significantly.

Fair Value of Available-For-Sale Debt Securities – Another material estimate is the calculation of fair values of the Corporation’s debt securities.

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The Corporation’s primary source of operating income is net interest income, which is equal to the difference between the amounts of interest income and interest expense.

Tables IV, V and VI include information regarding the Corporation’s net interest income for the three-month and nine-month periods ended September 30, 2022 and 2021.

Tables IV, V and VI include information regarding the Corporation’s net interest income for the three-month periods ended March 31, 2023 and 2022.

In each of these tables, the amounts of interest income earned on tax-exempt securities and loans have been adjusted to a fully taxable-equivalent basis.

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The discussion that follows is based on amounts in the related Tables.

Three-Month Periods Ended September 30, 2022 and 2021

Three-Month Periods Ended March 31, 2023 and 2022

For the three-month periods, fully taxable equivalent net interest income (a non-GAAP measure) was $21,050,000 in 2023, which was $416,000 (2.0%) higher than in 2022.

Interest income in the third quarter 2022 was $24,019,000 which was $2,654,000 higher as compared to 2021.

Interest income in the first quarter 2023 was $26,408,000 which was $4,333,000 higher as compared to 2022.

Interest expense of $5,358,000 in 2023 was $3,917,000 higher than in 2022.

As presented in Table V, the Net Interest Margin was 3.69% in 2022 as compared to 3.59% in 2021, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) remained unchanged at 3.46%.

As presented in Table V, the Net Interest Margin was 3.71% in 2023 as compared to 3.86% in 2022, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) decreased to 3.30% in 2023 from 3.73% in 2022.

The average yield on earning assets of 4.66% was 0.53% higher in 2023 as compared to 2022, and the average rate on interest-bearing liabilities of 1.36% in 2023 was 0.96% higher.

Income from purchase accounting-related adjustments in the third quarter 2022 had a positive effect on net interest income of $400,000, including an increase in income on loans of $313,000 and net reductions in interest expense on time deposits and borrowed funds totaling $87,000.

The positive impact to the third quarter 2022 net interest margin from purchase accounting adjustments was 0.07%.

In comparison, the positive impact of purchase accounting adjustments to the third quarter 2021 net interest margin was $563,000, or 0.10%.

Contributing to the comparatively lower margin and spread, total interest and fees on loans in the first quarter

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

2022 included $1,398,000 from repayments received on purchased credit impaired loans in excess of previous carrying amounts with no comparable amount in the first quarter 2023.

INTEREST INCOME AND EARNING ASSETS

Interest income totaled $24,019,000 in 2022, an increase of $2,654,000 from 2021.

Interest income totaled $26,408,000 in 2023, an increase of $4,333,000, or 19.6% from 2022.

Interest and fees from loans receivable increased $4,022,000 in 2023 as compared to 2022.

Total interest and fees from loans excluding PPP loans increased $3,144,000 in 2022 as compared to 2021.

Interest and fees on PPP loans totaled $118,000 in the third quarter 2022, a decrease of $1,521,000 from the third quarter 2021, as previously deferred fees were recognized in income upon the SBA’s repayment of loans based on forgiveness of the underlying borrowers.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Average outstanding loans receivable increased $82,413,000 (5.2%) to $1,674,270,000 in 2022 from $1,591,857,000 in 2021, despite a reduction in average PPP loans of $83,038,000.

Average total loans outstanding, excluding PPP loans, increased $165,451,000 (11.0%).

The average yield on loans in the third quarter 2022 was 4.91%, up from 4.76% in the third quarter 2021.

Excluding PPP loans, the average yield on loans was 4.90% in the third quarter 2022, up from 4.60% excluding PPP loans in the third quarter 2021.

The increase in loan yields reflects the impact of higher interest rates on loans originated in 2022 and higher yields on floating-rate loans.

Floating-rate loans totaled approximately 18% of gross loans receivable at September 30, 2022.

Interest income from available-for-sale debt securities increased $939,000 in 2022 from 2021.

The average balance of available-for-sale debt securities (at amortized cost) increased to $564,920,000 in 2022 from $391,148,000 in 2021.

The increase in available-for-sale debt securities reflects the investment of funds, primarily in the fourth quarter 2021 and first quarter 2022, that would otherwise have represented excess cash.

The average yield on available-for-sale debt securities was 2.17% for 2022, down slightly from 2.18% in 2021.

Income from interest-bearing due from banks totaled $176,000 in 2022, an increase of $70,000 from 2021.

The fully taxable equivalent yield on loans in 2023 was 5.44% compared to 5.01% in 2022.

Average outstanding loans receivable increased $178,002,000 (11.5%) to $1,725,863,000 in 2023 from $1,547,861,000 in 2022.

In the first quarter 2022, total interest and fees on loans included $1,398,000 from repayments received on purchased credit impaired loans in excess of previous carrying amounts with no comparable income in 2023.

Income from interest-bearing due from banks totaled $278,000 in 2023, an increase of $211,000 from the total for 2022.

The average yield on interest-bearing due from banks was 3.56% in 2023 and 0.32% in 2022.

The average balance of interest-bearing due from banks was $34,465,000 in the third quarter 2022, down from $195,359,000 in the third quarter 2021.

The average balance of interest-bearing due from banks was $31,637,000 in 2023 as compared to $84,115,000 in 2022.

Within this category, the largest asset balance in 2023 and 2022 has been interest-bearing deposits held with the Federal Reserve.

Interest income from available-for-sale debt securities, on a fully taxable-equivalent basis, increased $104,000 in 2023 as compared to 2022, as the average balance (at amortized cost) of available-for-sale debt securities increased $6,867,000.

The average yield on available-for-sale debt securities was 2.23% for 2023, up slightly from 2.18% in 2022.

INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES

For the three-month periods, interest expense increased $1,217,000 to $2,831,000 in 2022 from $1,614,000 in 2021.

Interest expense increased $3,917,000 to $5,358,000 in 2023 from $1,441,000 in 2022.

Interest expense on deposits increased $2,320,000, as the average rate on interest-bearing deposits increased to 0.94% in 2023 from 0.26% in 2022.

The increase in average rate on deposits includes increases of 1.13% on time deposits, 0.74% on money market accounts and 0.69% on interest checking accounts.

The Corporation’s deposit rates have increased in response to the impact on market rates of increases in the Fed Funds Target Rate.

The Fed Funds Target Rate ranged from 0% to 0.25% throughout 2021, while the Federal Reserve implemented a series of rate increases in March, May, June, July, and September 2022 resulting in a Fed Funds Target Rate ranging from 3% to 3.25% at September 30, 2022.

Average total deposits increased $61,825,000 (3.2%) to $1,998,583,000 in the third quarter 2022 from $1,936,758,000 in the third quarter 2021.

Average time deposits decreased $14,351,000 and average money market accounts decreased $7,615,000, while the average total balance of other categories of noninterest-bearing demand and other deposits increased $83,791,000.

The increase in average deposits includes the impact of funding received by consumers, businesses and municipal entities from government stimulus programs as well as growth in commercial deposits from new business.

Interest expense on short-term borrowings in the third quarter 2022 was $179,000 as compared to less than $1,000 in 2021.

The average balance of short-term borrowings increased to $33,970,000 in 2022 from $2,185,000 in 2021 reflecting an increase in overnight borrowings to provide temporary funding to support loan growth.

The average rate on short-term borrowings was 2.09% in 2022.

Average total deposits (interest-bearing and noninterest-bearing) remained stable with $1,931,126,000 for the first quarter 2023 compared to $1,931,681,000 for the first quarter 2022.

Average interest checking deposits increased $38,147,000, average time deposits increased $35,092,000 and the average total balance of other categories of noninterest-bearing demand and other deposits increased $18,464,000, while average money market accounts decreased $92,258,000.

Interest expense on short-term borrowings in 2023 was $1,097,000 in 2023 as compared to $1,000 in 2022.

The average balance of short-term borrowings increased to $91,767,000 in 2023 from $1,746,000 in 2022.

The average rate on short-term borrowings was 4.85% in 2023 compared to 0.23% in 2022.

Interest expense on long-term borrowings (FHLB advances) increased $632,000 to $681,000 in 2023 from $49,000 in 2022.

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Nine-Month Periods Ended September 30, 2022 and 2021

For the nine-month periods, fully taxable equivalent net interest income was $61,759,000 in 2022, which was $2,703,000 (4.6%) higher than in 2021.

Interest income in 2022 was $67,715,000 which was $3,627,000 higher in 2022 as compared to 2021, while interest expense of $5,956,000 was higher by $924,000 in comparing the same periods.

As presented in Table V, the Net Interest Margin was 3.72% in 2022 as compared to 3.70% in 2021, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) remained unchanged at 3.55% in 2022 and 2021.

The average yield on earning assets of 4.08% was 0.07% higher in 2022 as compared to 2021, and the average rate on interest-bearing liabilities of 0.53% in 2022 was also 0.07% higher.

Income from purchase accounting-related adjustments in the nine months ended September 30, 2022 had a positive effect on net interest income of $1,347,000, including an increase in income on loans of $1,016,000 and net reductions in interest expense on time deposits and borrowed funds totaling $331,000.

The positive impact of purchase accounting-related adjustments to the net interest margin was 0.08% in the first nine months of 2022.

In comparison, the net positive impact of purchase accounting-related adjustments was $2,228,000, with a positive impact on the net interest margin of 0.14% in the first nine months of 2021.

INTEREST INCOME AND EARNING ASSETS

Interest income totaled $67,715,000 in 2022, an increase of $3,627,000 from 2021.

Interest income from available-for-sale debt securities increased $2,883,000 in 2022 from 2021.

The average balance of available-for-sale debt securities (at amortized cost) increased to $557,155,000 in 2022 from $364,452,000 in 2021.

The increase in available-for-sale debt securities reflects the investment of funds that would otherwise have represented excess cash over the course of 2021 and the first quarter 2022.

The average yield on available-for-sale debt securities was 2.15% for 2022, down from 2.23% in 2021.

Interest and fees from loans receivable increased $623,000 in 2022 as compared to 2021.

Total interest and fees from loans excluding PPP loans increased $4,610,000 in 2022 as compared to 2021.

Interest and fees on PPP loans totaled $899,000 in 2022, a decrease of $3,987,000 from 2021, as previously deferred fees were recognized in income upon the SBA’s repayment of loans based on forgiveness of the underlying borrowers.

In 2022, total interest and fees on loans included $1,585,000 from repayments received on purchased credit impaired loans in excess of previous carrying amounts as compared to income from similar repayments of $35,000 in 2021.

Average outstanding loans receivable decreased $6,897,000 (0.4%) to $1,604,135,000 in 2022 from $1,611,032,000 in 2021, including a reduction in average PPP loans of $106,186,000.

Average total loans outstanding, excluding PPP loans, increased $99,289,000 (6.6%).

The average yield on loans in 2022 was 4.86%, up from 4.79% in 2021.

The average yield on loans included the positive impact of the income on PCI loans in 2022.

The comparatively high yield on PPP loans provided a benefit to the margin in both periods though the higher volume resulted in a larger benefit in 2021.

Excluding PPP loans and income from excess repayments on purchased credit impaired loans, the adjusted yield on loans was 4.69% for the first nine months of 2022, up from the similarly adjusted yield of 4.38% in 2021.

Income from interest-bearing due from banks totaled $335,000 in 2022, an increase of $105,000 from 2021.

The average yield on interest-bearing due from banks was 0.81% in 2022 and 0.20% in 2021.

The average balance of interest-bearing due from banks was $55,154,000 in 2022 as compared to $157,231,000 in 2021.

Within this category, the largest asset balance in 2022 and 2021 has been interest-bearing deposits held with the Federal Reserve.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES

For the nine-month periods, interest expense increased $924,000 to $5,956,000 in 2022 from $5,032,000 in 2021.

Interest expense on deposits increased $454,000, as the average rate on interest-bearing deposits increased to 0.38% in 2022 from 0.34% in 2021 reflecting the impact of increases in market rates in 2022 as described earlier.

Average total deposits increased $68,640,000 (3.6%) to $1,964,663,000 in 2022 from $1,896,023,000 in 2021.

Average time deposits decreased $57,885,000, while the average total balance of other categories of deposits increased $126,525,000, or 8.1%.

The increase in average deposits includes the impact of funding received from government stimulus programs as well as growth in commercial deposits from new business.

Interest expense on short-term borrowings in 2022 was $302,000 as compared to $22,000 in 2021.

The average balance of short-term borrowings increased to $24,306,000 in 2022 from $7,648,000 in 2021.

The average rate on short-term borrowings was 1.66% in 2022 compared to 0.38% in 2021.

Interest expense on long-term borrowings (FHLB advances) increased $106,000 to $436,000 in 2022 from $330,000 in 2021.

The average balance of long-term borrowings was $32,509,000 in 2022, down from an average balance of $46,863,000 in 2021.

Borrowings are classified as long-term within the Tables based on their term at origination or assumption in business combinations.

The average rate on long-term borrowings was 1.79% in 2022 compared to 0.94% in 2021.

Interest expense on senior notes issued in May 2021 totaled $357,000 in 2022 as compared to $175,000 in 2021.

The average balance of the senior notes increased to $14,725,000 in 2022 from $7,255,000 in 2021.

The average rate on senior notes was 3.24% in 2022 and 3.23% in 2021.

Interest expense on subordinated debt decreased $98,000 to $849,000 in 2022 from $947,000 in 2021.

The average balance of subordinated debt increased to $27,966,000 in 2022 from $25,539,000 in 2021.

The average rate on subordinated debt decreased to 4.06% in 2022 from 4.96% in 2021 including the net impact of a new issue of subordinated debt of $24,437,000, net, at an effective rate of 3.74% in May 2021 and the redemption of subordinated notes totaling $8,000,000 in the second quarter 2021 and $8,500,000 in the second quarter 2022.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

TABLE IV - ANALYSIS OF INTEREST INCOME AND EXPENSE

Three Months Ended

Nine Months Ended

September 30,

(In Thousands)

4 unchanged sentences

Loans receivable:

Paycheck Protection Program - 1st Draw

Paycheck Protection Program - 2nd Draw

Paycheck Protection Program

Total loans receivable

18 unchanged sentences

Three Months Ended

Nine Months Ended

September 30,

Net Interest Income Under U.S.

10 unchanged sentences

Loans receivable:

Paycheck Protection Program - 1st Draw

Paycheck Protection Program - 2nd Draw

Paycheck Protection Program

Total loans receivable

1 unchanged sentence

Total Earning Assets

Unrealized (loss) gain on securities

Unrealized loss on securities

Allowance for loan losses

16 unchanged sentences

Total Liabilities

Stockholders' equity, excluding accumulated other comprehensive (loss) income

Accumulated other comprehensive (loss) income

Stockholders' equity, excluding accumulated other comprehensive loss

Accumulated other comprehensive loss

Total Stockholders' Equity

10 unchanged sentences

Three Months Ended 3/31/23 vs.

Nine Months Ended 9/30/22 vs.

EARNING ASSETS

3 unchanged sentences

Loans receivable:

Paycheck Protection Program - 1st Draw

Paycheck Protection Program - 2nd Draw

Paycheck Protection Program

Total loans receivable

16 unchanged sentences

The income tax provision in interim periods is based on the Corporation’s estimate of the effective tax rate expected to be applicable for the full year.

The income tax provision for the first nine months of 2022 was $3,959,000, which was $1,497,000 lower than the provision for the first nine months of 2021.

The effective tax rate (tax provision as a percentage of pre-tax income) was 17.4% in the first nine months of 2022 compared to 19.0% in the first nine months of 2021.

The Corporation’s effective tax rates differ from the statutory rate of 21% in the first nine months of 2022 and 2021 principally because of the effects of tax-exempt interest income, state income taxes and other permanent differences.

The lower provision in 2022 includes the impact of a reduction in pre-tax income.

The lower effective tax rate in 2022 includes the impact of higher tax-exempt interest income as a percentage of pre-tax income, a larger permanent difference

The income tax provision for the first quarter 2023 was $1,409,000, which was $74,000 lower than the provision for the first quarter 2022.

The effective tax rate (tax provision as a percentage of pre-tax income) was 18.4% in the first quarter 2023 compared to 17.7% in the first quarter 2022.

The Corporation’s effective tax rates differ from the statutory rate of 21% principally because of the effects of tax-exempt interest income, state income taxes and other permanent differences.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

(deduction) related to restricted stock compensation and the benefit of a $301,000 reduction in expense from the reversal of tax penalties being non-taxable.

The Corporation recognizes deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax basis of assets and liabilities.

The net deferred tax asset at September 30, 2022 and December 31, 2021 represents the following temporary difference components:

September 30,

The net deferred tax asset at March 31, 2023 and December 31, 2022 represents the following temporary difference components:

(In Thousands)

1 unchanged sentence

Unrealized holding losses on securities

Allowance for loan losses

Allowance for credit losses on loans

Purchase accounting adjustments on loans

1 unchanged sentence

Operating leases liability

Deferred loan origination fees

Net operating loss carryforward

3 unchanged sentences

Deferred tax liabilities:

Unrealized holding gains on securities

Defined benefit plans - ASC 835

7 unchanged sentences

Realization of deferred tax assets ultimately depends on the existence of sufficient taxable income.

Management believes the recorded net deferred tax asset at September 30, 2022 is fully realizable;

Management believes the recorded net deferred tax asset at March 31, 2023 is fully realizable;

however, if management determines the Corporation will be unable to realize all or part of the net deferred tax asset, the Corporation would adjust the deferred tax asset, which would negatively impact earnings .

Management continually evaluates several objectives in determining the size, securities mix and other characteristics of the available-for-sale debt securities (investment) portfolio.

Key objectives include supporting liquidity needs, maximizing return on earning assets within reasonable risk parameters and providing a means to hedge the Corporation’s overall asset-sensitive interest rate risk exposure, while maintaining high credit quality.

Key objectives include supporting liquidity needs and maximizing return on earning assets within reasonable risk parameters.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

The composition of the available-for-sale debt securities portfolio at September 30, 2022, December 31, 2021 and December 31, 2020 is as follows:

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

(Dollars In Thousands)

September 30, 2022

March 31, 2023

December 31, 2022

17 unchanged sentences

Treasury.gov (Daily Treasury Par Yield Curve Rates)

The amortized cost of available-for-sale debt securities increased to $559,837,000 at September 30, 2022 from $511,592,000 at December 31, 2021 and $334,552,000 at December 31, 2020.

The increase in the securities portfolio resulted from management’s decision to invest excess funds available from the fast growth in deposits and loan repayments throughout most of 2020, 2021 and the first quarter 2022.

As reflected in the table above, the fair value of available-for-sale securities as of September 30, 2022 was lower than the amortized cost basis by $71,857,000, or 12.8%.

In comparison, the aggregate unrealized gain position was $6,087,000 (1.2%) at December 31, 2021 and $14,780,000 (4.4%) at December 31, 2020.

The unrealized decrease in fair value of the portfolio in the first nine months of 2022 and in 2021 resulted from an increase in interest rates.

As reflected in the table above, the fair value of available-for-sale securities was lower than the amortized cost basis by $54,775,000, or 10.4% at March 31, 2023 and $63,761,000 (11.3%) at December 31, 2022.

In comparison, the aggregate unrealized gain position was $6,087,000 (1.2%) at December 31, 2021.

The volatility in the fair value of the portfolio, including the significant reduction in fair value in 2022, resulted from changes in interest rates.

As shown above, the market yield on the 5-year U.S.

Treasury Note was 2.80% higher at September 30, 2022 in comparison to December 31, 2021, and 3.70% higher than at December 31, 2020.

Management reviewed the Corporation’s holdings as of September 30, 2022 and concluded there were no credit-related declines in fair value and that the unrealized losses on all of the securities in an unrealized loss position are considered temporary.

In assessing whether there were other-than-temporary impairment losses, management considered (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value, and (4) whether the Corporation intends to sell the security or if it is more likely than not that the Corporation will be required to sell the security before the recovery of its amortized cost basis.

Treasury Note was 0.39% lower at March 31, 2023 in comparison to December 31, 2022, and 2.34% higher than at December 31, 2021.

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

As described in Note 5 to the unaudited, consolidated financial statements, management determined the Corporation does not have the intent to sell, nor is it more likely than not that it will be required to sell, available-for-sale debt securities in an unrealized loss position at March 31, 2023 before it is able to recover the amortized cost basis.

Further, management reviewed the Corporation’s holdings as of March 31, 2023 and concluded there were no credit-related declines in fair value.

Additional information related to the types of securities held at March 31, 2023, other than securities issued or guaranteed by U.S.

Government entities or agencies, is as follows:

● Bank holding company debt securities – All of the Corporation’s holdings of bank holding company debt securities were investment grade and there have been no payment defaults.

There were seven securities with face amounts ranging from $3 million to $5 million, including one senior security and six subordinated securities.

All of the issuers have publicly traded common stock.

At March 31, 2023, the securities have external ratings ranging from BBB-/Baa3 to A-.

● Obligations of states and political subdivisions (municipal bonds) – All of the Corporation’s holdings of municipal bonds were investment grade and there have been no payment defaults.

Summary ratings information at March 31, 2023, based on the amortized cost basis and reflecting the lowest enhanced or underlying rating by Moody’s, Standard & Poors or Fitch, is as follows:

AAA or prerefunded – 23% of the portfolio;

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

● Private label commercial mortgage-backed securities (PLCMBS) – There were two PLCMBS securities, both of which were from the most senior payment (subordination) classes of their respective issuances.

These securities were investment grade (rated Aaa), and there have been no payment defaults on these securities.

Based on the results of management’s assessment, there was no ACL required on available-for-sale debt securities in an unrealized loss position at March 31, 2023.

FINANCIAL CONDITION

1 unchanged sentence

Significant changes in the average balances of the Corporation’s earning assets and interest-bearing liabilities are described in the Net Interest Income section of Management’s Discussion and Analysis.

Other significant balance sheet items, including securities, the allowance for loan losses and stockholders’ equity, are discussed in separate sections of Management’s Discussion and Analysis.

There are no significant concerns that have arisen related to the Corporation’s off-balance sheet loan commitments or outstanding letters of credit at September 30, 2022, and management does not expect the amount of purchases of bank premises and equipment to have a material, detrimental effect on the Corporation’s financial condition in 2022.

Table VII shows the composition of the loan portfolio at September 30, 2022 and at year-end from 2017 through 2021.

The significant loan growth in 2019 and 2020 reflects the impact of acquisitions.

Also, the Corporation increased the proportion of residential mortgage loans sold into the secondary market, particularly in 2020 and 2021 when mortgage refinancings and other originations were at historically high volumes, contributing to a reduction of $30,188,000 in residential mortgage loans outstanding at September 30, 2022 compared to December 31, 2020.

At September 30, 2022, commercial loans represented approximately 64% of the portfolio while residential mortgage loans totaled 35% of the portfolio.

At September 30, 2022, gross loans outstanding totaled $1,690,246,000, an increase of $125,397,000 from December 31, 2021, despite a reduction in PPP loans of $24,829,000 due to repayments.

Excluding PPP loans, total commercial loans at September 30, 2022 were up $128,813,000 from December 31, 2021.

Commercial lending activity was particularly robust in the second and third quarters of 2022 as commercial real estate investors and other business borrowers generally displayed a sense of urgency to execute transactions prior to potential additional increases in interest rates.

The pace of loan growth in the fourth quarter 2022 and in 2023 will depend on the impact of potential further increases in interest rates, potential deterioration in economic conditions and other factors.

Other significant balance sheet items, including securities, the allowance for credit losses and stockholders’ equity, are discussed in separate sections of Management’s Discussion and Analysis.

Management does not expect the amount of purchases of bank premises and equipment to have a material, detrimental effect on the Corporation’s financial condition in 2023.

Table VII shows the composition of the loan portfolio at March 31, 2023 and at year-end from 2018 through 2022.

The segments presented in Table VII have been revised from those used in prior year disclosures to be consistent with the pools used in determining the collectively evaluated portion of the allowance for credit losses based on the CECL methodology in 2023.

As presented in Table VII, total loans outstanding at March 31, 2023 of $1,745,139,000 was more than double the corresponding total at December 31, 2018.

The increase in loans outstanding includes the impact of acquisitions of banks located in Southeastern Pennsylvania in 2018 and 2019.

Primarily as a result of the acquisitions, as well as expansion by opening 2 offices in Southcentral Pennsylvania, the mix of the loan portfolio has changed to become predominantly commercial in nature.

At March 31, 2023, commercial loans represented 74% of the portfolio while residential loans totaled 23% of the portfolio;

in comparison, commercial loans totaled 48% and residential loans totaled 47% of the portfolio at December 31, 2018.

Table VII shows an increase in commercial and industrial loans to $222,923,000 at December 31, 2020 followed by reductions in 2021, 2022 and the first quarter 2023.

The elevated balance of commercial and industrial loans at December 31, 2020 included Paycheck Protection Program (PPP) loans of $132,269,000, a substantial portion of which were subsequently repaid.

The outstanding balance of PPP loans was $155,000 at March 31, 2023.

At March 31, 2023, gross loans outstanding increased $5,099,000 from December 31, 2022.

Gross loans outstanding at December 31, 2022 increased $175,191,000, or 11.2%, from the total at December 31, 2021.

The pace of loan growth in 2023 will depend on the impact of potential further increases in interest rates, potential deterioration in economic conditions and other factors.

While the Corporation’s lending activities are primarily concentrated in its market areas, a portion of the Corporation’s commercial loan segment consists of participation loans.

1 unchanged sentence

Although not the lead bank, the Corporation conducts detailed underwriting and monitoring of participation loan opportunities.

Participation loans are included in the “Commercial and industrial”, “Commercial loans secured by real estate”, “Political subdivisions” and “Other commercial” classes in the loan tables presented in this Form 10-Q.

Total participation loans outstanding amounted to $41,451,000 at September 30, 2022, down from $54,372,000 at December 31, 2021.

As described in more detail in the Provision and Allowance for Loan Losses section of Management’s Discussion and Analysis, in the third quarter 2022 the Corporation recorded a partial charge-off of $2,160,000 on a commercial real estate secured participation loan with a recorded investment of $4,740,000 at September 30, 2022.

At September 30, 2022, the balance of participation loans outstanding includes a total of $13,667,000 to businesses located outside of the Corporation’s market areas.

Also, included within participation loans are “leveraged loans,” meaning loans to businesses with minimal tangible book equity and for which the extent of collateral available is limited, though typically at the time of origination the businesses have demonstrated strong cash flow performance in their recent histories.

Leveraged participation loans totaled $6,600,000 at September 30, 2022 and $7,469,000 at December 31, 2021.

Total participation loans outstanding amounted to $42,047,000 at March 31, 2023, down from $44,723,000 at December 31, 2022.

At March 31, 2023, the total recorded investment in non-owner occupied commercial real estate loans for which the primary purpose is utilization of office space by third parties was $95,524,000, or 5.5% of total gross loans receivable.

Within this segment, at March 31, 2023, there was 1 loan with a recorded investment of $2,615,000 risk rated as Special Mention with no related ACL, and 1 loan with a recorded investment of $1,379,000 risk rated as Substandard and nonaccrual with an ACL of $182,000.

The remainder of the non-owner occupied commercial real estate loans for the primary purpose of office space utilization totaling $91,530,000 were accruing interest and risk rated Pass at March 31, 2023.

The Corporation originates and sells residential mortgage loans to the secondary market through the MPF Xtra program administered by the Federal Home Loan Banks of Pittsburgh and Chicago.

Residential mortgages originated and sold through the MPF Xtra program consist primarily of conforming, prime loans sold to the Federal National Mortgage Association (Fannie Mae), a quasi-government entity.

Residential mortgages originated and sold through the MPF Xtra program consist primarily of conforming, prime loans sold to the Federal National Mortgage Association (Fannie Mae), a quasi-government

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

The Corporation also originates and sells residential mortgage loans to the secondary market through the MPF Original program, administered by the Federal Home Loan Banks of Pittsburgh and Chicago.

2 unchanged sentences

The Corporation does not retain servicing rights for loans sold under the MPF Direct Program.

Through September 30, 2022, the Corporation’s activity under the MPF Direct Program has been minimal.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Through March 31, 2023, the Corporation’s activity under the MPF Direct Program has been minimal.

For loan sales originated under the MPF programs, the Corporation provides customary representations and warranties to investors that specify, among other things, that the loans have been underwritten to the standards established by the investor.

1 unchanged sentence

Such repurchases or reimbursements generally result from an underwriting or documentation deficiency.

At September 30, 2022, the total outstanding balance of loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $1,529,000, and the corresponding total outstanding balance of repurchased loans at December 31, 2021 was $1,571,000.

At September 30, 2022, outstanding balances of loans sold and serviced through the MPF Xtra and Original programs totaled $331,495,000, including loans sold through the MPF Xtra program of $158,612,000 and loans sold through the Original program of $172,883,000.

At March 31, 2023, the total outstanding balance of loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $1,376,000, and the corresponding total outstanding balance of repurchased loans at December 31, 2022 was $1,515,000.

At March 31, 2023, outstanding balances of loans sold and serviced through the MPF Xtra and Original programs totaled $331,326,000, including loans sold through the MPF Xtra program of $153,437,000 and loans sold through the Original program of $167,889,000.

At December 31, 2022, outstanding balances of loans sold and serviced through the two programs totaled $325,677,000, including loans sold through the MPF Xtra program of $155,506,000 and loans sold through the Original Program of $170,171,000.

Based on the fairly limited volume of required repurchases to date, no allowance has been established for representation and warranty exposures as of September 30, 2022 and December 31, 2021.

For loans sold under the Original program, the Corporation provides a credit enhancement whereby the Corporation would assume credit losses in excess of a defined First Loss Account (“FLA”) balance, up to specified amounts.

The FLA is funded by the Federal Home Loan Bank of Pittsburgh based on a percentage of the outstanding balance of loans sold.

At September 30, 2022, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $9,090,000, and the Corporation has recorded a related allowance for credit losses in the amount of $500,000 which is included in accrued interest and other liabilities in the accompanying consolidated balance sheets.

At December 31, 2021, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $8,656,000, and the related allowance for credit losses was $635,000.

Income related to providing the credit enhancement (included in other noninterest income in the consolidated statements of income) totaled $251,000 for the nine months ended September 30, 2022 and $265,000 for the nine months ended September 30, 2021.

A credit for losses related to the credit enhancement obligation (included in other noninterest expense in the consolidated statements of income) of $97,000 was recorded in the nine months ended September 30, 2022 with a provision for losses of $50,000 in the nine months ended September 30, 2021.

The Corporation does not provide a credit enhancement for loans sold through the Xtra program.

Based on the fairly limited volume of required repurchases to date, no allowance has been established for representation and warranty exposures as of March 31, 2023 and December 31, 2022.

The Corporation is a participating SBA lender.

3 unchanged sentences

Determination of the allowance was subjective in nature and was based on the Corporation’s assessment of the credit quality of the loans and the quality of the documentation supporting compliance with SBA requirements.

The Corporation’s total exposure related to SBA guarantees on purchased loans was $5,992,000 at September 30, 2022 and $12,856,000 at December 31, 2021 with an allowance for SBA claim adjustments (included in accrued interest and other liabilities in the consolidated balance sheets) of $90,000 at September 30, 2022 and $457,000 at December 31, 2021.

In the nine months ended September 30, 2022, the Corporation recorded a reduction in other noninterest expense of $367,000 representing amounts realized on SBA claims in excess of prior estimates, as compared to a reduction of $208,000 in the nine months ended September 30, 2021.

The Corporation’s total exposure related to SBA guarantees on purchased loans was $4,799,000 at March 31, 2023 and $4,847,000 at December 31, 2022 with an allowance for SBA claim adjustments (included in accrued interest and other liabilities in the consolidated balance sheets) of $90,000 at March 31, 2023 and December 31, 2022.

In the three months ended March 31, 2023, the Corporation did not record an increase or reduction in other noninterest expense related to amounts realized on SBA claims in excess of prior estimates, as compared to a reduction of $242,000 in the three months ended March 31, 2022.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

2 unchanged sentences

(In Thousands)

September 30,

Commercial loans secured by real estate

Commercial real estate - nonowner occupied:

Nonowner occupied

Multi-family (5 or more) residential

1-4 Family - commercial purpose

Total commercial real estate - nonowner occupied

Commercial real estate - owner occupied

All other commercial loans:

Commercial and industrial

Paycheck Protection Program - 1st Draw

Paycheck Protection Program - 2nd Draw

Commercial lines of credit

Political subdivisions

Commercial construction and land

Loans secured by farmland

Multi-family (5 or more) residential

Agricultural loans

Other commercial loans

Total commercial

Residential mortgage:

Residential mortgage loans - first liens

Residential mortgage loans - junior liens

Home equity lines of credit

Total all other commercial loans

Residential mortgage loans:

1-4 Family - residential

1-4 Family residential construction

Total residential mortgage

allowance for loan losses

PROVISION AND ALLOWANCE FOR LOAN LOSSES

Note 6 to the unaudited consolidated financial statements provides an overview of the process management uses for evaluating and determining the allowance for loan losses.

While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years.

In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses.

Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.

The allowance for loan losses was $16,170,000 at September 30, 2022, up from $13,537,000 at December 31, 2021.

Table IX shows total specific allowances on impaired loans of $427,000 at September 30, 2022, down from $740,000 at December 31, 2021.

Table IX also shows the increase in the allowance in 2022 is mainly related to commercial loans, as the collectively evaluated portion of the allowance related to the commercial segment increased to $9,811,000 at September 30, 2022 from $7,553,000 at December 31, 2021.

Table X shows the allowance for loan losses totaled 0.96% of gross loans outstanding at September 30, 2022, up from 0.87% at December 31, 2021 and down from levels in excess of 1.00% from 2017 and 2018.

Table X also shows that the total of the allowance and the credit adjustment on purchased non-impaired loans, as a percentage of total loans plus the credit adjustment, was 1.08% at September 30, 2022, in line with ratios from the previous years.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

The provision (credit) for loan losses by segment in the three-month and nine-month periods ended September 30, 2022 and 2021 are as follows:

Three Months Ended

Nine Months Ended

September 30,

(In Thousands)

Residential mortgage

The provision (credit) for loan losses is further detailed as follows:

Commercial segment

Three Months Ended

Nine Months Ended

September 30,

(In Thousands)

Net change in total specific allowance on impaired loans, adjusted for the effect of net charge-offs

Increase (decrease) in collectively determined portion of the allowance attributable to:

Changes in loan volume

Changes in historical loss experience factors

Changes in qualitative factors

Total provision for loan losses - Commercial segment

Residential mortgage segment

Three Months Ended

Nine Months Ended

September 30,

(In Thousands)

Net change in total specific allowance on impaired loans, adjusted for the effect of net charge-offs

Increase (decrease) in collectively determined portion of the allowance attributable to:

Changes in loan volume

Changes in historical loss experience factors

Changes in qualitative factors

Total provision for loan losses - Residential mortgage segment

Consumer segment

Three Months Ended

Nine Months Ended

September 30,

(In Thousands)

Net change in total specific allowance on impaired loans, adjusted for the effect of net charge-offs

(Decrease) increase in collectively determined portion of the allowance attributable to:

Changes in loan volume

Changes in historical loss experience factors

Changes in qualitative factors

Total (credit) provision for loan losses - Consumer segment

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Total - All segments

Three Months Ended

Nine Months Ended

September 30,

(In Thousands)

Net change in total specific allowance on impaired loans, adjusted for the effect of net charge-offs

Increase (decrease) in collectively determined portion of the allowance attributable to:

Changes in loan volume

Changes in historical loss experience factors

Changes in qualitative factors

Total provision for loan losses - All segments

As presented in the tables above, the provision for the third quarter 2022 includes the impact of a partial charge-off of $2,160,000 on a commercial real estate secured loan with a principal balance of $6,920,000 at the time of charge-off.

This is a participation loan to a borrower in the health care industry.

Realization of the recorded investment in the loan of $4,760,000 at September 30, 2022 is principally dependent upon the amount of proceeds from sales of the real estate and, if necessary, payments of any shortfall by the guarantors.

The third quarter 2022 provision also includes $687,000 related to changes in historical loss factors, most of which resulted from the partial charge-off just described.

Further, the third quarter 2022 provision includes $757,000 attributable to increases in loan volume resulting from significant loan growth, particularly for the commercial segment, as well as an increase in the collectively determined portion of the allowance related to management’s updated assessment of purchased performing loans.

Similar to the discussion of the third quarter 2022 above, the provision for the nine months ended September 30, 2022 includes the impact of the $2,160,000 partial charge-off and related increase in the Corporation’s historical loss experience as well as $3,180,000 attributable to increases in loan volume.

In the nine months ended September 30, 2022, changes in qualitative factors resulted in a reduction in the provision of $1,226,000.

The reduction in the provision related to changes in qualitative factors reflects management’s judgment that despite concerns related to the commercial loan described above, the credit quality of the portfolio has generally been improving over the past several quarters.

In the tables immediately above, the portion of the net change in the collectively determined allowance attributable to loan growth was determined by applying the historical loss experience and qualitative factors used in the allowance calculation at the end of the preceding period to the net increase or reduction in loans outstanding (excluding loans specifically evaluated for impairment) for the period.

The effect on the provision of changes in historical loss experience and qualitative factors, as shown in the tables above, was determined by:

(1) calculating the net change in each factor used in determining the allowance at the end of the period as compared to the preceding period, and (2) applying the net change in each factor to the outstanding balance of loans at the end of the preceding period (excluding loans specifically evaluated for impairment).

In the nine months ended September 30, 2022, net charge-offs were $2,360,000, including recoveries of $57,000 and charge-offs of $2,417,000.

Table VIII shows the average rate of net charge-offs as a percentage of loans was 0.15% in the nine months ended September 30, 2022, and annual average rates ranging from a high of 0.16% in 2020 to a low of 0.02% in 2018.

Table X presents information related to past due and impaired loans, and loans that have been modified under terms that are considered TDRs.

At September 30, 2022, the recorded investment of $4,760,000 in the commercial loan with the partial charge-off referred to above was classified as nonperforming (nonaccrual) and impaired with no specific allowance.

Total nonperforming loans of $20,458,000 at September 30, 2022 was down from $21,218,000 at December 31, 2021.

Total nonperforming loans as a percentage of outstanding loans was 1.21% at September 30, 2022, down from 1.36% at December 31, 2021, and nonperforming assets as a percentage of total assets was 0.87% at September 30, 2022, down from 0.94% at December 31, 2021.

Table X presents data at the end of each of the years ended December 31, 2017 through 2021.

Table X shows that total nonperforming loans as a percentage of loans of 1.21% at September

Consumer loans:

Consumer lines of credit (including HELOCs)

All other consumer

Total consumer

allowance for credit losses on loans

PROVISION AND ALLOWANCE FOR CREDIT LOSSES

On January 1, 2023, the Corporation adopted ASU 2016-13 Financial Instruments – Credit Losses (Topic 326):

Measurement of Credit Losses on Financial Instruments (ASC 326).

This standard replaced the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (CECL) methodology.

CECL requires an estimate of credit losses for the remaining estimated life of the financial asset using historical experience, current conditions, and reasonable and supportable forecasts.

Note 1 to the unaudited consolidated financial statements provides a detailed explanation of the Corporation’s adopted accounting policies related to the application of CECL.

Effective January 1, 2023, the Corporation adopted ASC 326 using the modified retrospective approach for all financial assets measured at amortized cost and off-balance sheet credit exposures.

Results for reporting periods beginning after January 1, 2023 are presented under CECL while prior period amounts continue to be reported in accordance with previously applicable accounting standards (“Incurred Loss”).

At January 1, 2023, the impact of adopting CECL included an increase in gross loans receivable of $806,000 as compared to December 31, 2022 and an increase in the allowance for credit losses of $2,104,000 as compared to the allowance for loan losses determined under the Incurred Loss method at December 31, 2022.

The credit for credit losses (reduction in expense) was $352,000 in the first quarter 2023 as compared to the first quarter 2022 provision for loan losses of $891,000.

The credit for credit losses in the first quarter 2023 resulted mainly from a reduction in the allowance related to the commercial segment of the portfolio.

The net credit for loan losses in the first quarter 2023 included the impact of a reduction in qualitative factors applied to commercial loan pools, mainly due to an improvement in data used to evaluate commercial real estate values in the Corporation’s relevant market areas at March 31, 2023 as compared to January 1, 2023, along with a reduction in the

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

30, 2022, though up from December 31, 2019, was lower than the corresponding year-end ratio for all other years presented.

Similarly, the September 30, 2022 ratio of total nonperforming assets as a percentage of assets of 0.87% was lower than the corresponding ratio for all years presented except December 31, 2019.

Total impaired loans of $13,309,000 at September 30, 2022 are down $2,425,000 from the corresponding amount at December 31, 2021 of $15,734,000.

Although impaired loans without a valuation allowance increased $3,494,000, mainly due to the classification in the third quarter 2022 as impaired of the commercial loan with the partial charge-off described above, the balances of purchased credit impaired loans and impaired loans with a valuation allowance decreased.

Purchased credit impaired loans totaled $3,783,000 at September 30, 2022, down from $6,558,000 at December 31, 2021.

In the nine months ended September 30, 2022, the Corporation received pay-offs on a few purchased credit impaired loans and recognized interest income of $1,585,000 for the excess received over previous carrying amounts.

Total impaired loans with a valuation allowance was $3,396,000 at September 30, 2022, down from $6,540,000 at December 31, 2021.

At September 30, 2022, there was one commercial real estate secured loan within this category with a related valuation allowance of $427,000.

This loan was also classified as impaired at December 31, 2021, when the balance was $3,409,000 and the allowance was $427,000.

There were two other commercial loans classified as impaired at December 31, 2021, with balances totaling $3,136,000 and specific allowances totaling $313,000, that were removed from that classification with the allowances reversed in 2022 because of improved circumstances.

Over the period 2017-2021 and the first nine months of 2022, each period includes a few large commercial relationships that have required significant monitoring and workout efforts.

As a result, a limited number of relationships may significantly impact the total amount of allowance required on impaired loans, and may significantly impact the provision for loan losses and the amount of total charge-offs reported in any one period.

Management believes it has been conservative in its decisions concerning identification of impaired loans, estimates of loss, and nonaccrual status;

however, the actual losses realized from these relationships could vary materially from the allowances calculated as of September 30, 2022.

historical net charge-off percentage for non-owner occupied commercial real estate.

These adjustments were partially offset by the impact of an increase in the allowance at March 31, 2023 as compared to January 1, 2023 based on changes in the economic forecast.

Table X shows that total nonperforming assets as a percentage of total assets was 0.60% at March 31, 2023, down from 1.04% at December 31, 2022 and lower than that at year-end 2018 through 2021.

Total nonperforming assets were $14.6 million at March 31, 2023, down from $25.6 million at December 31, 2022.

Similarly, total loans individually evaluated for credit loss decreased to $9.3 million at March 31, 2023 from $19.4 million at December 31, 2022.

The net decrease in nonperforming assets at March 31, 2023 compared to December 31, 2022 included the impact of a $10.0 million payoff in the first quarter 2023 on a commercial loan relationship that was classified as nonaccrual at December 31, 2022.

The reduction also included a paydown of $2,180,000 in the first quarter 2023 on a commercial loan for which partial charge-offs totaling $3,942,000 were recorded in 2022.

The remaining carrying value of this loan was $474,000 at March 31, 2023.

These reductions were partially offset by the addition to nonaccrual of a commercial loan relationship totaling $1,931,000 at March 31, 2023.

Based on an estimate of the liquidation value of the real estate collateralizing the relationship, an allowance of $182,000 was recorded at March 31, 2023.

In the first quarter 2023, net charge-offs were minimal by historical standards, totaling $61,000.

Table VIII shows annual average net charge-off rates ranging from a high of 0.26% in 2022 to a low of 0.02% in 2018.

Over the period 2018-2022 and the first three months of 2023, each period includes a few large commercial relationships that have required significant monitoring and workout efforts.

As a result, a limited number of relationships may significantly impact the total amount of allowance required on individual loans, and may significantly impact the provision for credit losses and the amount of total charge-offs reported in any one period.

Management believes it has been conservative in its decisions concerning identification of loans requiring individual evaluation for credit loss, estimates of loss, and nonaccrual status;

however, the actual losses realized from these relationships could vary materially from the allowances calculated as of March 31, 2023.

Management continues to closely monitor its commercial loan relationships for possible credit losses and will adjust its estimates of loss and decisions concerning nonaccrual status, if appropriate.

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

TABLE VIII - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES

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

TABLE VIII - ANALYSIS OF THE ALLOWANCE FOR CREDIT LOSSES

(Dollars In Thousands)

Nine Months Ended

September 30,

Three Months Ended

Years Ended December 31,

Balance, beginning of year

Residential mortgage

Total charge-offs

Residential mortgage

Total recoveries

Increase due to adoption of CECL

Net charge-offs

Provision for loan losses

(Credit) provision for credit losses

Balance, end of period

1 unchanged sentence

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

TABLE IX - COMPONENTS OF THE ALLOWANCE FOR LOAN LOSSES

TABLE IX - COMPONENTS OF THE ALLOWANCE FOR CREDIT LOSSES

UPON ADOPTION OF CECL

(In Thousands)

September 30,

Loans individually evaluated

Loans collectively evaluated:

Commercial real estate - nonowner occupied

Commercial real estate - owner occupied

All other commercial loans

Residential mortgage

Total Allowance

PRIOR TO CECL ADOPTION

(In Thousands)

As of December 31,

3 unchanged sentences

Total Allowance

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

TABLE X - PAST DUE AND IMPAIRED LOANS, NONPERFORMING ASSETS

AND TROUBLED DEBT RESTRUCTURINGS (TDRs)

TABLE X - PAST DUE LOANS AND NONPERFORMING ASSETS

(Dollars In Thousands)

September 30,

As of December 31,

Impaired loans with a valuation allowance

Impaired loans without a valuation allowance

Loans individually evaluated with a valuation allowance

Loans individually evaluated without a valuation allowance

Purchased credit impaired loans

9 unchanged sentences

Total nonperforming assets

Loans subject to troubled debt restructurings (TDRs):

Nonperforming

Total nonperforming loans as a % of loans

Total nonperforming assets as a % of assets

Allowance for loan losses as a % of total loans

Credit adjustment on purchased non-impaired loans and allowance for loan losses as a % of total loans and the credit adjustment (a)

Allowance for loan losses as a % of nonperforming loans

(a) Credit adjustment on purchased non-impaired loans at end of period

Allowance for loan losses

Total credit adjustment on purchased non-impaired loans at end of period and allowance for loan losses (1)

Total loans receivable

Credit adjustment on purchased non-impaired loans at end of period

Credit adjustment on purchased non-impaired loans and allowance for loan losses as a % of total loans and the credit adjustment (1)/(2)

Allowance for credit losses as a % of total loans

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

1 unchanged sentence

An adequate liquidity position permits the Corporation to pay creditors, compensate for unforeseen deposit fluctuations and fund unexpected loan demand.

At September 30, 2022, the Corporation maintained overnight interest-bearing deposits with the Federal Reserve Bank of Philadelphia and other correspondent banks totaling $24,485,000.

The Corporation maintains overnight borrowing facilities with several correspondent banks that provide a source of day-to-day liquidity.

2 unchanged sentences

Management intends to use this line of credit as a contingency funding source.

As collateral for the line, the Corporation has pledged available-for-sale debt securities with a carrying value of $23,420,000 at September 30, 2022.

The Corporation’s outstanding, available, and total credit facilities at September 30, 2022 and December 31, 2021 are as follows:

As collateral for the line, the Corporation has pledged available-for-sale debt securities with a carrying value of $23,314,000 at March 31, 2023.

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

(In Thousands)

September 30,

Federal Home Loan Bank of Pittsburgh

2 unchanged sentences

Total credit facilities

At September 30, 2022, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of long-term borrowings of $55,338,000 and letters of credit totaling $11,527,000.

At December 31, 2021, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of long-term borrowings of $27,727,000 and letters of credit totaling $5,584,000.

At March 31, 2023, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowings of $91,000,000, long-term borrowings of $98,649,000 and letters of credit totaling $11,708,000.

At December 31, 2022, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowing of $77,000,000, long-term borrowings of $62,272,000 and letters of credit totaling $10,827,000 .

Additional information regarding borrowed funds is included in Note 8 to the unaudited consolidated financial statements.

1 unchanged sentence

If required to raise cash in an emergency situation, the Corporation could sell available-for-sale securities to meet its obligations or use repurchase agreements placed with brokers to borrow funds secured by investment assets.

In light of the unrealized loss at September 30, 2022 resulting from increases in interest rates in 2022, as described in more detail in the Securities section of Management’s Discussion and Analysis, management would be more likely in the near term to utilize securities as collateral for borrowings than to sell securities in such an emergency situation.

At September 30, 2022, the carrying value of available-for-sale securities in excess of amounts required to meet pledging or repurchase agreement obligations was $218,473,000.

Management believes the Corporation is well-positioned to meet its short-term and long-term funding obligations.

In light of the unrealized loss at March 31, 2023 resulting from increases in interest rates in 2022, as described in more detail in the Securities section of Management’s Discussion and Analysis, management would be more likely in the near term to utilize securities as collateral for borrowings than to sell securities in such an emergency situation.

At March 31, 2023, the carrying value of available-for-sale securities in excess of amounts required to meet pledging or repurchase agreement obligations was $269,763,000.

Deposits totaled $1,916,040,000 at March 31, 2023, down $81,553,000 (4.1%) from $1,997,593,000 at December 31, 2022.

Average total deposits of $1,931,126,000 for the first quarter 2023 were down $96,020,000 (4.7%) from the fourth quarter 2022 and were flat as compared to average deposits of $1,931,681,000 for the first quarter 2022.

The reduction in total deposits included a reduction in the estimated amount of deposits in excess of FDIC insurance levels (uninsured deposit balances) of $75.6 million as compared to December 31, 2022.

The net reduction in deposits resulted from several factors, including the impact of customer funds transferred to higher-yielding investment alternatives and seasonal reductions in municipal deposits.

At March 31, 2023, the Corporation’s estimated uninsured deposits totaled $613.9 million, or 31.7% of total deposits, down from $689.4 million or 34.2% of total deposits at December 31, 2022.

Included in uninsured deposits are deposits collateralized by securities (almost exclusively municipal deposits) totaling $189.2 million, or 9.8% of total deposits at March 31, 2023.

The highly liquid sources of available funds described above, including unused borrowing capacity with the Federal Home Loan Bank of Pittsburgh, unused availability on the Federal Reserve Bank of Philadelphia’s discount window, available federal funds lines with other banks and unencumbered available-for-sale debt securities totaled $1.043 billion at March 31, 2023.

Available funding from these sources exceeded the amount of uninsured deposits noted above by 69.9% at March 31, 2023.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

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

STOCKHOLDERS’ EQUITY AND CAPITAL ADEQUACY

5 unchanged sentences

The interim final rule provides that, if warranted for supervisory purposes, the Federal Reserve may exclude a company from the threshold increase.

Management believes the Corporation meets the conditions of the Federal Reserve’s small bank holding company policy statement and is therefore excluded from consolidated capital requirements at September 30, 2022;

however, C&N Bank remains subject to regulatory capital requirements administered by the federal banking agencies.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Details concerning capital ratios at September 30, 2022 and December 31, 2021 are presented below.

Management believes, as of September 30, 2022, that C&N Bank meets all capital adequacy requirements to which it is subject and maintains a capital conservation buffer (described in more detail below) that allows the Bank to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers.

Further, as reflected in the table below, the Corporation’s and C&N Bank’s capital ratios at September 30, 2022 and December 31, 2021 exceed the Corporation’s Board policy threshold levels.

Details concerning capital ratios at March 31, 2023 and December 31, 2022 are presented below.

Management believes, as of March 31, 2023, that C&N Bank meets all capital adequacy requirements to which it is subject and maintains a capital conservation buffer (described in more detail below) that allows the Bank to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers.

Further, as reflected in the table below, the Corporation’s and C&N Bank’s capital ratios at March 31, 2023 and December 31, 2022 exceed the Corporation’s Board policy threshold levels.

(Dollars in Thousands)

9 unchanged sentences

Policy Thresholds

September 30, 2022:

March 31, 2023:

Total capital to risk-weighted assets:

9 unchanged sentences

Under the amended program, the Corporation is authorized to repurchase up to 1,000,000 shares of its common stock.

In the third quarter 2022, 10,269 shares were repurchased for a total cost of $246,000, at an average price of $23.97 per share.

Cumulatively through September 30, 2022, 674,700 shares have been repurchased for a total cost of $16,587,000, at an average price of $24.58 per share.

In the first quarter 2023, 77,430 shares were repurchased for a total cost of $1,662,000, at an average price of $21.47 per share.

Cumulatively through March 31, 2023, 752,130 shares have been repurchased for a total cost of $18,249,000, at an average price of $24.26 per share.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Future dividend payments and repurchases of common stock will depend upon maintenance of a strong financial condition, future earnings and capital and regulatory requirements.

1 unchanged sentence

Further, although the Corporation is no longer subject to the specific consolidated capital requirements described herein, the Corporation’s ability to pay dividends, repurchase stock or engage in other activities may be limited by the Federal Reserve if the Corporation fails to hold capital commensurate with its overall risk profile.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

To avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization subject to the rule must hold a capital conservation buffer composed of common equity tier 1 capital above its minimum risk-based capital requirements.

The buffer is measured relative to risk-weighted assets.

At September 30, 2022, the minimum risk-based capital ratios, and the capital ratios including the capital conservation buffer, are as follows:

At March 31, 2023, the minimum risk-based capital ratios, and the capital ratios including the capital conservation buffer, are as follows:

Minimum common equity tier 1 capital ratio

18 unchanged sentences

≤1.25% and >0.625%

At September 30, 2022, C&N Bank’s Capital Conservation Buffer, determined based on the minimum total capital ratio, was 6.74%.

At March 31, 2023, C&N Bank’s Capital Conservation Buffer, determined based on the minimum total capital ratio, was 7.44%.

The Corporation’s total stockholders’ equity is affected by fluctuations in the fair values of available-for-sale debt securities.

1 unchanged sentence

Accumulated other comprehensive (loss) income is excluded from the Bank’s and Corporation’s regulatory capital ratios.

The balance in accumulated other comprehensive loss related to unrealized losses on available-for-sale debt securities, net of deferred income tax, amounted to $56,766,000 at September 30, 2022 as compared to the balance in accumulated other comprehensive income related to unrealized gains on available-for-sale debt securities, net of deferred income tax of $4,809,000 at December 31, 2021.

The decrease in stockholders’ equity in the first nine months of 2022 from the change in accumulated other comprehensive (loss) income resulted from an increase in interest rates.

Changes in accumulated other comprehensive (loss) income are excluded from earnings and directly increase or decrease stockholders’ equity.

If available-for-sale debt securities are deemed to be other-than-temporarily impaired, unrealized losses are recorded as a charge against earnings, and amortized cost for the affected securities is reduced.

The securities section of Management’s Discussion and Analysis and Note 5 to the unaudited consolidated financial statements provides additional information concerning management’s evaluation of available-for-sale debt securities for other-than-temporary impairment at September 30, 2022.

Inflation affects the cost of labor, supplies and services used to provide banking services as well as interest rates.

After many years of low inflation, disruptions to labor markets and supply chains triggered by the COVID-19 pandemic, government policies and the Russia-Ukraine war, have led to high inflation.

The annual inflation rate for the 12-month period ended September 30, 2022, based on changes in the Consumer Price Index, was 8.2%, significantly higher than the Federal Reserve’s 2% objective.

The balance in accumulated other comprehensive loss related to unrealized losses on available-for-sale debt securities, net of deferred income tax, amounted to $43,271,000 at March 31, 2023 and $50,370,000 at December 31, 2022.

The increase in stockholders’ equity in the first three months of 2023 from the change in accumulated other comprehensive loss resulted from a decrease in interest rates.

Changes in accumulated other comprehensive loss are excluded from earnings and directly increase or decrease stockholders’ equity.

To the extent unrealized losses on available-for-sale debt securities result from credit losses, unrealized losses are recorded as a charge against earnings.

The securities section of Management’s Discussion and Analysis and Notes 1 and 5 to the unaudited consolidated financial statements provide additional information concerning management’s evaluation of available-for-sale debt securities for credit losses at March 31, 2023 .

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

The Corporation is significantly affected by the Federal Reserve Board’s efforts to control inflation through changes in short-term interest rates.

In March of 2020, in response to significant concerns about the impact of the COVID-19 pandemic on the U.S.

economy, the Federal Reserve lowered the fed funds target rate (at the high end of the range) from 1.75% to 0.25% and resumed injections of massive amounts of liquidity into the nation’s monetary system through a variety of programs including purchases of large amounts of securities.

In 2022, the Federal Open Market Committee (FOMC) has changed course, raising the fed funds target rate in March, May, June, July and September, with the high end of the range at 3.25% at September 22, 2022.

Further, at its September 21-22, 2022 meeting, the FOMC announced that it anticipates ongoing increases to its target rate will be appropriate and that it expects to continue reducing its holdings of securities.

The Committee noted its desire to achieve maximum employment and that it is strongly committed to returning inflation to its 2% objective.

Although management cannot predict future changes in the rates of inflation, management monitors the impact of economic trends, including indicators of inflationary pressures, in managing interest rate and other financial risks.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis