CITIZENS & NORTHERN CORP 10-Q

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK Market risk is the risk of loss arising from adverse changes in market rates and prices of the Corporation’s financial instruments. In addition to the effects of interest rates, the market prices of the Corporation’s available-for-sale debt securities are affected by fluctuations in the risk premiums (amounts of spread over risk-free rates) demanded by investors. Management attempts to limit the risk that economic conditions would force the Corporation to sell securities for realized losses by maintaining a strong capital position (discussed in the “Stockholders’ Equity and Capital Adequacy” section of Management’s Discussion and Analysis) and ample sources of liquidity (discussed in the “Liquidity” section of Management’s Discussion and Analysis). The Corporation’s major category of market risk, interest rate risk, is discussed in the following section. INTEREST RATE RISK The Corporation uses a simulation model to calculate the potential effects of interest rate fluctuations on net interest income and the economic value of equity. For purposes of these calculations, the economic value of equity includes the discounted present values of financial instruments, such as securities, loans, deposits and borrowed funds, and the book values of nonfinancial assets and liabilities, such as premises and equipment and accrued expenses. The model measures and projects the amount of potential changes in net interest income, and calculates the discounted present value of anticipated cash flows of financial instruments, assuming an immediate increase or decrease in interest rates. Management ordinarily runs a variety of scenarios within a range of plus or minus 100-400 basis points of current rates. The projected results based on the model includes the impact of estimates, at each level of interest rate change, regarding cash flows from principal repayments on loans and mortgage-backed securities and call activity on other investment securities. Further, the projected results are impacted by assumptions regarding the run-off and the extent of sensitivity to interest rate changes of deposits with no stated maturity (checking, savings and money market accounts). Actual results could vary significantly from these estimates, which could result in significant differences in the calculations of projected changes in net interest income and economic value of equity. Also, the model does not make estimates related to changes in the composition of the deposit portfolio that could occur due to rate competition, and the table does not necessarily reflect changes that management would make to realign the portfolio as a result of changes in interest rates. The Corporation’s Board of Directors has established policy guidelines for acceptable levels of interest rate risk, based on an immediate increase or decrease in interest rates. The policy limits acceptable fluctuations in net interest income from the baseline (flat rates) one-year scenario and variances in the economic value of equity from the baseline values based on current rates. ​ Table XI, which follows this discussion, is based on the results of calculations performed using the simulation model as of September 30, 2023 and December 31, 2022. In the analysis based on September 30, 2023 data, the amounts of net interest income decrease, as compared to the amounts based on current interest rates, in both the upward and downward rate scenarios. Further, the economic value of equity is modeled to decrease in the rising rate scenarios and in all of the falling rate scenarios except -200 basis points for which the economic value of equity is modeled to increase 0.2%. The results based on September 30, 2023 data as presented in Table XI are significantly different from the results based on the modeling performed using December 31, 2022 data which showed the net interest income profile to be asset-sensitive. In the analysis based on September 30, 2023 data, management assumed that, in rising rate scenarios, the average rate to be paid on interest checking, savings and money market accounts would increase by a higher percentage of the baseline scenario as compared to the assumptions used in the December 31, 2022 analysis. This change reflects management’s assessment that, in light of significant increases in short-term interest rates that have occurred over the course of 2022 and year-to-date in 2023, the Corporation’s deposit rates would increase to a greater extent if such scenarios would occur. The change in results also reflects changes in deposit mix, as the carrying amount of total deposits without stated maturities was $99.4 million lower at September 30, 2023 as compared to December 31, 2022, while time deposits were higher by $126.8 million. Further, results in the downward rate scenarios reflect limitations on the benefit of falling rates on some deposit types due to a 0% assumed floor. The Table also shows that as of the respective dates, despite the impact of the modeling changes and changes in deposit mix, the changes in net interest income and changes in economic value were within the policy limits in all scenarios. 66 Table of Contents CITIZENS & NORTHERN CORPORATION – FORM 10-Q ​ Under U.S. generally accepted accounting principles, available-for-sale debt securities are carried at fair value as of each balance sheet date. The difference between amortized cost and fair value of available-for-sale debt securities, net of deferred income tax, is included in accumulated other comprehensive income (loss) within stockholders’ equity. Increases in interest rates have caused the fair value of the Corporation’s available-for-sale debt securities to decrease, resulting in an accumulated other comprehensive loss of $60.3 million at September 30, 2023. In contrast, most of the Corporation’s other financial instruments, including loans receivable (held for investment), deposits and borrowed funds are carried on the balance sheet at historical cost without adjustment for the impact of changes in interest rates. ​ ​ TABLE XI – THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ September 30, 2023 Data ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ (In Thousands) ​ Period Ending September 30, 2024 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Basis Point ​ ​ Interest ​ ​ Interest ​ ​ Net Interest ​ NII ​ ​ NII ​ Change in Rates ​ ​ Income ​ ​ Expense ​ ​ Income (NII) ​ % Change ​ ​ Risk Limit ​ +400 ​ $ 145,051 ​ $ 78,526 ​ $ 66,525 ​ (21.1) % ​ 25.0 % +300 ​ ​ 140,116 ​ ​ 67,183 ​ ​ 72,933 ​ (13.5) % ​ 20.0 % +200 ​ ​ 135,219 ​ ​ 57,108 ​ ​ 78,111 ​ (7.4) % ​ 15.0 % +100 ​ ​ 130,286 ​ ​ 48,302 ​ ​ 81,984 ​ (2.8) % ​ 10.0 % 0 ​ ​ 125,123 ​ ​ 40,771 ​ ​ 84,352 ​ 0.0 % ​ 0.0 % -100 ​ ​ 119,799 ​ ​ 35,837 ​ ​ 83,962 ​ (0.5) % ​ 10.0 % -200 ​ ​ 114,410 ​ ​ 30,942 ​ ​ 83,468 ​ (1.0) % ​ 15.0 % -300 ​ ​ 108,555 ​ ​ 26,543 ​ ​ 82,012 ​ (2.8) % ​ 20.0 % -400 ​ ​ 102,316 ​ ​ 22,255 ​ ​ 80,061 ​ (5.1) % ​ 25.0 % ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Economic Value of Equity at September 30, 2023 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Present ​ ​ Present ​ ​ Present ​ ​ ​ ​ ​ ​ Basis Point ​ ​ Value ​ ​ Value ​ ​ Value ​ ​ ​ ​ ​ ​ Change in Rates ​ ​ Equity ​ ​ % Change ​ ​ Risk Limit ​ ​ ​ ​ ​ ​ +400 ​ $ 346,292 ​ ​ (23.8) % ​ 50.0 % ​ ​ ​ ​ ​ +300 ​ ​ 379,784 ​ ​ (16.5) % ​ 45.0 % ​ ​ ​ ​ ​ +200 ​ ​ 410,450 ​ ​ (9.7) % ​ 35.0 % ​ ​ ​ ​ ​ +100 ​ ​ 436,196 ​ ​ (4.1) % ​ 25.0 % ​ ​ ​ ​ ​ 0 ​ ​ 454,742 ​ ​ 0.0 % ​ 0.0 % ​ ​ ​ ​ ​ -100 ​ ​ 453,578 ​ ​ (0.3) % ​ 25.0 % ​ ​ ​ ​ ​ -200 ​ ​ 455,691 ​ ​ 0.2 % ​ 35.0 % ​ ​ ​ ​ ​ -300 ​ ​ 443,816 ​ ​ (2.4) % ​ 45.0 % ​ ​ ​ ​ ​ -400 ​ ​ 428,885 ​ ​ (5.7) % ​ 50.0 % ​ ​ ​ ​ ​ ​ ​ 67 Table of Contents CITIZENS & NORTHERN CORPORATION – FORM 10-Q ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ December 31, 2022 Data ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ (In Thousands) ​ Period Ending December 31, 2023 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Basis Point ​ ​ Interest ​ ​ Interest ​ ​ Net Interest ​ NII ​ ​ NII ​ Change in Rates ​ ​ Income ​ ​ Expense ​ ​ Income (NII) ​ % Change ​ ​ Risk Limit ​ +400 ​ $ 131,145 ​ $ 34,767 ​ $ 96,378 ​ 8.9 % ​ 25.0 % +300 ​ ​ 125,127 ​ ​ 30,816 ​ ​ 94,311 ​ 6.6 % ​ 20.0 % +200 ​ ​ 119,561 ​ ​ 26,864 ​ ​ 92,697 ​ 4.8 % ​ 15.0 % +100 ​ ​ 113,703 ​ ​ 22,912 ​ ​ 90,791 ​ 2.6 % ​ 10.0 % 0 ​ ​ 107,451 ​ ​ 18,961 ​ ​ 88,490 ​ 0.0 % ​ 0.0 % -100 ​ ​ 101,048 ​ ​ 15,516 ​ ​ 85,532 ​ (3.3) % ​ 10.0 % -200 ​ ​ 94,854 ​ ​ 13,240 ​ ​ 81,614 ​ (7.8) % ​ 15.0 % -300 ​ ​ 89,405 ​ ​ 11,325 ​ ​ 78,080 ​ (11.8) % ​ 20.0 % -400 ​ ​ 85,076 ​ ​ 9,439 ​ ​ 75,637 ​ (14.5) % ​ 25.0 % ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Economic Value of Equity at December 31, 2022 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Present ​ ​ Present ​ ​ Present ​ ​ ​ ​ ​ ​ Basis Point ​ ​ Value ​ ​ Value ​ ​ Value ​ ​ ​ ​ ​ ​ Change in Rates ​ ​ Equity ​ ​ % Change ​ ​ Risk Limit ​ ​ ​ ​ ​ ​ +400 ​ $ 498,368 ​ ​ 0.3 % ​ 50.0 % ​ ​ ​ ​ ​ +300 ​ ​ 496,186 ​ ​ (0.1) % ​ 45.0 % ​ ​ ​ ​ ​ +200 ​ ​ 501,422 ​ ​ 1.0 % ​ 35.0 % ​ ​ ​ ​ ​ +100 ​ ​ 501,991 ​ ​ 1.1 % ​ 25.0 % ​ ​ ​ ​ ​ 0 ​ ​ 496,650 ​ ​ 0.0 % ​ 0.0 % ​ ​ ​ ​ ​ -100 ​ ​ 485,332 ​ ​ (2.3) % ​ 25.0 % ​ ​ ​ ​ ​ -200 ​ ​ 468,195 ​ ​ (5.7) % ​ 35.0 % ​ ​ ​ ​ ​ -300 ​ ​ 445,129 ​ ​ (10.4) % ​ 45.0 % ​ ​ ​ ​ ​ -400 ​ ​ 417,505 ​ ​ (15.9) % ​ 50.0 % ​ ​ ​ ​ ​ ​