UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q10‑Q


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

For the quarterly period ended June 30, 20152016
Or

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

For the transition period from_____________________ to ___________________

Commission file number 0-132220‑13222

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

            PENNSYLVANIA                                                                                                       23-226504523‑2265045
   (State or other jurisdiction of incorporation or organization)(I.R.S. Employer Identification No.)


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

Registrant's telephone number, including area code: (570) 662-2121662‑2121

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

Indicate by check mark whether the registrant (1) has filed all reports to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __X__ No_____

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes __X__ No_____

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

Large accelerated filer ____   Accelerated filer _X__

Non-accelerated filer ____   Smaller reporting company ____
(Do not check if a smaller reporting company)

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

The number of outstanding shares of the Registrant’sRegistrant's Common Stock, as of July 28, 2015,26, 2016, was 3,028,676.

3,349,753.


Citizens Financial Services, Inc.
Form 10-Q

INDEX

  PAGE
Part IFINANCIAL INFORMATION 
Item 1.Financial Statements (unaudited): 
 Consolidated Balance Sheet as of June 30,201530,2016 and December 31, 201420151
 Consolidated Statement of Income for the Three and Six monthsMonths Ended June 30,201530, 2016 and 201420152
 Consolidated Statement of Comprehensive Income for the Three and Six monthsMonths ended June 30, 20152016 and 201420153
 Consolidated Statement of Cash Flows for the Six Months ended June 30, 20152016 and 201420154
 Notes to Consolidated Financial Statements5-295-34
Item 2.Management’sManagement's Discussion and Analysis of Financial Condition and Results of Operations30-5135-57
Item 3.Quantitative and Qualitative Disclosures About Market Risk5157
Item 4.Controls and Procedures51-5257
   
Part IIOTHER INFORMATION 
Item 1.Legal Proceedings5257
Item 1A.Risk Factors5258
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds5258
Item 3.Defaults Upon Senior Securities5258
Item 4.Mine Safety Disclosures52-5358
Item 5.Other Information5358
Item 6.Exhibits5358-59
 Signatures5460


CITIZENS FINANCIAL SERVICES, INC.      
CONSOLIDATED BALANCE SHEET      
(UNAUDITED)      
       
  June 30  December 31 
(in thousands except share data) 2016  2015 
ASSETS:      
Cash and due from banks:      
  Noninterest-bearing $14,908  $14,088 
  Interest-bearing  11,914   10,296 
Total cash and cash equivalents  26,822   24,384 
Interest bearing time deposits with other banks  6,954   7,696 
Available-for-sale securities  360,944   359,737 
Loans held for sale  1,304   603 
         
Loans (net of allowance for loan losses:        
  2016, $7,359 and 2015, $7,106)  701,756   687,925 
         
Premises and equipment  17,239   17,263 
Accrued interest receivable  4,176   4,211 
Goodwill  21,089   21,089 
Bank owned life insurance  25,877   25,535 
Other intangibles  2,183   2,437 
Other assets  11,174   12,104 
         
TOTAL ASSETS $1,179,518  $1,162,984 
         
LIABILITIES:        
Deposits:        
  Noninterest-bearing $142,327  $150,960 
  Interest-bearing  861,155   837,071 
Total deposits  1,003,482   988,031 
Borrowed funds  38,786   41,631 
Accrued interest payable  644   734 
Other liabilities  12,150   12,828 
TOTAL LIABILITIES  1,055,062   1,043,224 
STOCKHOLDERS' EQUITY:        
Preferred Stock        
  $1.00 par value; authorized 3,000,000 shares June 30, 2016 and December 31, 2015;        
   none issued in 2016 or 2015  -   - 
Common stock        
  $1.00 par value; authorized 15,000,000 shares;  issued 3,704,375 at June 30, 2016 and        
   3,671,751 at December 31, 2015  3,704   3,672 
Additional paid-in capital  42,241   40,715 
Retained earnings  87,753   85,790 
Accumulated other comprehensive income (loss)  2,042   (236)
Treasury stock, at cost:  358,921 shares at June 30, 2016        
  and 335,876 shares at December 31, 2015  (11,284)  (10,181)
TOTAL STOCKHOLDERS' EQUITY  124,456   119,760 
TOTAL LIABILITIES AND        
   STOCKHOLDERS' EQUITY $1,179,518  $1,162,984 
         
The accompanying notes are an integral part of these unaudited consolidated financial statements.     
 
1
CITIZENS FINANCIAL SERVICES, INC.            
CONSOLIDATED STATEMENT OF INCOME            
(UNAUDITED)            
  Three Months Ended  Six Months Ended 
  June 30,  June 30, 
(in thousands, except share and per share data) 2016  2015  2016  2015 
INTEREST INCOME:            
Interest and fees on loans $8,587  $7,129  $17,183  $14,168 
Interest-bearing deposits with banks  64   39   135   70 
Investment securities:                
`    Taxable  959   765   1,903   1,519 
    Nontaxable  755   801   1,526   1,649 
    Dividends  61   34   141   133 
TOTAL INTEREST INCOME  10,426   8,768   20,888   17,539 
INTEREST EXPENSE:                
Deposits  1,072   1,035   2,146   2,044 
Borrowed funds  183   172   366   347 
TOTAL INTEREST EXPENSE  1,255   1,207   2,512   2,391 
NET INTEREST INCOME  9,171   7,561   18,376   15,148 
Provision for loan losses  135   120   270   240 
NET INTEREST INCOME AFTER                
    PROVISION FOR LOAN LOSSES  9,036   7,441   18,106   14,908 
NON-INTEREST INCOME:                
Service charges  1,128   1,028   2,230   2,004 
Trust  182   180   378   374 
Brokerage and insurance  158   255   367   382 
Gains on loans sold  70   60   116   98 
Investment securities gains, net  128   175   155   301 
Earnings on bank owned life insurance  172   154   342   306 
Other  145   103   311   218 
TOTAL NON-INTEREST INCOME  1,983   1,955   3,899   3,683 
NON-INTEREST EXPENSES:                
Salaries and employee benefits  3,900   2,993   7,782   6,049 
Occupancy  455   348   900   717 
Furniture and equipment  171   87   328   215 
Professional fees  266   180   553   412 
FDIC insurance  160   116   317   232 
Pennsylvania shares tax  240   200   390   401 
Amortization of other intangibles  82   -   164   - 
ORE expenses  212   357   305   358 
Other  1,815   1,147   3,474   2,379 
TOTAL NON-INTEREST EXPENSES  7,301   5,428   14,213   10,763 
Income before provision for income taxes  3,718   3,968   7,792   7,828 
Provision for income taxes  687   779   1,478   1,519 
NET INCOME $3,031  $3,189  $6,314  $6,309 
                 
PER COMMON SHARE DATA:                
Net Income - Basic $0.91  $1.04  $1.88  $2.06 
Net Income - Diluted $0.91  $1.04  $1.88  $2.06 
Cash Dividends Paid $0.419  $0.402  $0.829  $0.802 
                 
Number of shares used in computation - basic  3,343,254   3,052,285   3,349,913   3,055,569 
Number of shares used in computation - diluted  3,343,663   3,053,349   3,350,118   3,056,103 
                 
The accompanying notes are an integral part of these unaudited consolidated financial statements.         

2
CITIZENS FINANCIAL SERVICES, INC.                        
CONSOLIDATED STATEMENT OF                        
       COMPREHENSIVE INCOME    `                   
(UNAUDITED)                        
  Three Months Ended  Six Months Ended 
  June 30,  June 30, 
(in thousands)    2016     2015     2016     2015 
Net income    $3,031     $3,189     $6,314     $6,309 
Other comprehensive income (loss):                            
      Unrealized gains on available for sale securities  1,794       (2,049)      3,489       (704)    
      Income tax effect  (610)      698       (1,188)      240     
      Change in unrecognized pension cost  60       54       121       102     
      Income tax effect  (21)      (19)      (42)      (35)    
      Less:  Reclassification adjustment for investment                                
                 security gains included in net income  (128)      (175)      (155)      (301)    
      Income tax effect  44       59       53       102     
Other comprehensive income (loss), net of tax      1,139       (1,432)      2,278       (596)
Comprehensive income     $4,170      $1,757      $8,592      $5,713 
                                 
The accompanying notes are an integral part of these unaudited consolidated financial statements.
 


3
CITIZENS FINANCIAL SERVICES, INC.      
CONSOLIDATED STATEMENT OF CASH FLOWS      
(UNAUDITED) Six Months Ended 
  June 30, 
(in thousands) 2016  2015 
CASH FLOWS FROM OPERATING ACTIVITIES:      
  Net income $6,314  $6,309 
  Adjustments to reconcile net income to net        
   cash provided by operating activities:        
    Provision for loan losses  270   240 
    Provision for off-balance sheet items  30   - 
    Depreciation and amortization  175   236 
    Amortization and accretion of investment securities  1,148   992 
    Deferred income taxes  81   112 
    Investment securities gains, net  (155)  (301)
    Earnings on bank owned life insurance  (342)  (306)
    Originations of loans held for sale  (8,580)  (7,479)
    Proceeds from sales of loans held for sale  7,995   6,922 
    Realized gains on loans sold  (116)  (98)
    Increase in accrued interest receivable  35   60 
    Decrease in accrued interest payable  (90)  (81)
    Other, net  (519)  (1,158)
      Net cash provided by operating activities  6,246   5,448 
CASH FLOWS FROM INVESTING ACTIVITIES:        
  Available-for-sale securities:        
    Proceeds from sales  12,077   18,393 
    Proceeds from maturity and principal repayments  21,561   31,163 
    Purchase of securities  (32,507)  (49,579)
  Proceeds from matured interest bearing time deposits with other banks  744   - 
  Proceeds from redemption of regulatory stock  184   1,513 
  Purchase of regulatory stock  (132)  (1,342)
  Net increase in loans  (14,135)  (17,792)
  Purchase of premises and equipment  (398)  (514)
  Proceeds from sale of foreclosed assets held for sale  374   100 
      Net cash used in investing activities  (12,232)  (18,058)
CASH FLOWS FROM FINANCING ACTIVITIES:        
  Net increase in deposits  15,451   17,954 
  Proceeds from long-term borrowings  539   5,286 
  Repayments of long-term borrowings  (534)  (551)
  Net increase in short-term borrowed funds  (2,850)  (7,340)
  Purchase of treasury and restricted stock  (1,482)  (997)
  Dividends paid  (2,700)  (2,253)
      Net cash provided by financing activities  8,424   12,099 
          Net (decrease) increase in cash and cash equivalents  2,438   (511)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD  24,384   11,423 
CASH AND CASH EQUIVALENTS AT END OF PERIOD $26,822  $10,912 
         
Supplemental Disclosures of Cash Flow Information:        
    Interest paid $2,602  $2,472 
    Income taxes paid $1,400  $2,025 
    Loans transferred to foreclosed property $519  $241 
    Investments purchased and not settled $-  $319 
         
The accompanying notes are an integral part of these unaudited consolidated financial statements. 


4

CITIZENS FINANCIAL SERVICES, INC.  
CONSOLIDATED BALANCE SHEET  
(UNAUDITED)  
   
 
       June 30,
    December 31,
(in thousands except share data)
       2015
    2014
ASSETS:  
Cash and due from banks:  
  Noninterest-bearing $               9,910 $          10,091
  Interest-bearing                  1,002               1,332
Total cash and cash equivalents                10,912             11,423
Interest bearing time deposits with other banks                  5,960               5,960
Available-for-sale securities              304,792           306,146
Loans held for sale                  1,152                  497
   
Loans (net of allowance for loan losses:  
  2015, $6,959 and 2014, $6,815)              564,692           547,290
   
Premises and equipment                12,582             12,357
Accrued interest receivable                  3,584               3,644
Goodwill                10,256             10,256
Bank owned life insurance                20,615             20,309
Other assets                  7,934               7,166
   
TOTAL ASSETS $           942,479 $        925,048
   
LIABILITIES:  
Deposits:  
  Noninterest-bearing $           100,469 $          95,526
  Interest-bearing              691,418           678,407
Total deposits              791,887           773,933
Borrowed funds                39,194             41,799
Accrued interest payable                     674                  756
Other liabilities                  7,499               8,032
TOTAL LIABILITIES              839,254           824,520
STOCKHOLDERS' EQUITY:  
Preferred Stock  
  $1.00 par value; authorized 3,000,000 shares: none issued or outstanding at  
   June 30, 2015 and December 31, 2014;                          -                      -
Common stock  
  $1.00 par value; authorized 15,000,000 shares;  issued 3,335,236 at June 30, 2015 and  
  December 31, 2014                  3,335               3,335
Additional paid-in capital                25,124             25,150
Retained earnings                83,371             79,512
Accumulated other comprehensive income                     171                  767
Treasury stock, at cost:  306,560 shares at June 30, 2015  
  and 296,280 shares at December 31, 2014                 (8,776)             (8,236)
TOTAL STOCKHOLDERS' EQUITY              103,225           100,528
TOTAL LIABILITIES AND  
   STOCKHOLDERS' EQUITY $           942,479 $        925,048
   
The accompanying notes are an integral part of these unaudited consolidated financial statements. 

1

CITIZENS FINANCIAL SERVICES, INC.
    
CONSOLIDATED STATEMENT OF INCOME    
(UNAUDITED)    
 
       Three Months Ended
       Six Months Ended
 
       June 30
       June 30,
(in thousands, except share and per share data)
       2015
       2014
       2015
    2014
INTEREST INCOME:    
Interest and fees on loans $        7,129 $      7,118 $       14,168 $     14,106
Interest-bearing deposits with banks                 39               13                  70               26
Investment securities:    
    Taxable               765             849             1,519          1,737
    Nontaxable               801             840             1,649          1,682
    Dividends                 34               69                133             119
TOTAL INTEREST INCOME           8,768         8,889          17,539        17,670
INTEREST EXPENSE:    
Deposits           1,035         1,094             2,044          2,199
Borrowed funds               172             145                347             309
TOTAL INTEREST EXPENSE           1,207         1,239             2,391          2,508
NET INTEREST INCOME           7,561         7,650          15,148        15,162
Provision for loan losses               120             150                240             330
NET INTEREST INCOME AFTER    
    PROVISION FOR LOAN LOSSES           7,441         7,500          14,908        14,832
NON-INTEREST INCOME:    
Service charges           1,028         1,102             2,004          2,141
Trust               180             186                374             377
Brokerage and insurance               255             137                382             257
Gains on loans sold                 60               30                  98               70
Investment securities gains, net               175               75                301             246
Earnings on bank owned life insurance               154             121                306             242
Other               103             104                218             209
TOTAL NON-INTEREST INCOME           1,955         1,755             3,683          3,542
NON-INTEREST EXPENSES:    
Salaries and employee benefits           2,993         2,893             6,049          5,810
Occupancy               348             304                717             654
Furniture and equipment                 87               94                215             194
Professional fees               180             208                412             442
FDIC insurance               116             116                232             229
Pennsylvania shares tax               200             191                401             384
Other           1,504         1,194             2,737          2,378
TOTAL NON-INTEREST EXPENSES           5,428         5,000          10,763        10,091
Income before provision for income taxes           3,968         4,255             7,828          8,283
Provision for income taxes               779             890             1,519          1,742
NET INCOME $        3,189 $      3,365 $         6,309 $       6,541
     
PER COMMON SHARE DATA:    
Net Income - Basic $          1.06 $        1.11 $            2.09 $         2.15
Net Income - Diluted $          1.06 $        1.11 $            2.09 $         2.15
Cash Dividends Paid $        0.405 $      0.385 $         0.810 $       0.770
     
Number of shares used in computation - basic   3,019,661  3,039,734     3,022,945  3,040,822
Number of shares used in computation - diluted   3,020,725  3,040,661     3,023,479  3,041,227
     
The accompanying notes are an integral part of these unaudited consolidated financial statements.  
2

CITIZENS FINANCIAL SERVICES, INC.        
CONSOLIDATED STATEMENT OF        
       COMPREHENSIVE INCOME        
(UNAUDITED)        
 
                   Three Months Ended
       Six Months Ended
 
       June 30,
       June 30,
(in thousands) 2015 2014 2015 2014
Net income $ 3,189  $ 3,365  $ 6,309  $   6,541
Other comprehensive income (loss):        
      Change in unrealized gains on available        
                 for sale securities (2,049) 1,494  (704) 3,743 
      Income tax effect698  (508) 240  (1,272) 
      Change in unrecognized pension cost54 13 102   25 
      Income tax effect (19)  (4) (35)    (9) 
      Less:  Reclassification adjustment for investment        
                 security gains included in net income (175)  (75)  (301)  (246) 
      Income tax effect59 26 102   84 
Other comprehensive income (loss), net of tax (1,432) 946  (596) 2,325
Comprehensive income  $ 1,757  $ 4,311  $ 5,713  $   8,866
         
The accompanying notes are an integral part of these unaudited consolidated financial statements.      

3

CITIZENS FINANCIAL SERVICES, INC.  
CONSOLIDATED STATEMENT OF CASH FLOWS  
(UNAUDITED)
          Six Months Ended
 
          June 30,
(in thousands)
          2015
          2014
CASH FLOWS FROM OPERATING ACTIVITIES:  
  Net income $          6,309 $          6,541
  Adjustments to reconcile net income to net  
   cash provided by operating activities:  
    Provision for loan losses                240                330
    Depreciation and amortization                236                233
    Amortization and accretion of investment securities                992             1,100
    Deferred income taxes                112                498
    Investment securities gains, net              (301)              (246)
    Earnings on bank owned life insurance              (306)              (242)
    Originations of loans held for sale           (7,479)           (5,286)
    Proceeds from sales of loans held for sale             6,922             5,089
    Realized gains on loans sold                (98)                (70)
    Increase in accrued interest receivable                  60                171
    Decrease in accrued interest payable                (81)              (160)
    Other, net           (1,158)           (1,107)
      Net cash provided by operating activities             5,448             6,851
CASH FLOWS FROM INVESTING ACTIVITIES:  
  Available-for-sale securities:  
    Proceeds from sales           18,393           12,151
    Proceeds from maturity and principal repayments           31,163           29,294
    Purchase of securities         (49,579)         (33,822)
  Proceeds from redemption of regulatory stock             1,513             2,216
  Purchase of regulatory stock           (1,342)           (1,484)
  Net increase in loans         (17,792)              (113)
  Purchase of premises and equipment              (514)              (145)
  Proceeds from sale of foreclosed assets held for sale                100                296
      Net cash (used) provided by investing activities         (18,058)             8,393
CASH FLOWS FROM FINANCING ACTIVITIES:  
  Net increase in deposits           17,954           17,140
  Proceeds from long-term borrowings             5,286             4,010
  Repayments of long-term borrowings              (551)           (4,200)
  Net decrease in short-term borrowed funds           (7,340)         (23,667)
  Purchase of treasury and restricted stock              (997)              (733)
  Dividends paid           (2,253)           (2,137)
      Net cash provided (used) by financing activities           12,099           (9,587)
          Net (decrease) increase in cash and cash equivalents              (511)             5,657
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD           11,423           10,083
CASH AND CASH EQUIVALENTS AT END OF PERIOD $        10,912 $        15,740
   
Supplemental Disclosures of Cash Flow Information:  
    Interest paid $          2,472 $          2,668
    Income taxes paid $          2,025 $          1,885
    Loans transferred to foreclosed property $             241 $             239
    Premises and equipment transferred from other assets $                  - $             549
    Investments purchased and not settled $             319 $                 -
   
The accompanying notes are an integral part of these unaudited consolidated financial statements.
4
CITIZENS FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1 - Basis of Presentation

Citizens Financial Services, Inc. (individually and collectively with its direct and indirect subsidiaries, the “Company”"Company") is a Pennsylvania corporation organized as the holding company of its wholly owned subsidiary, First Citizens Community Bank (the “Bank”"Bank"), and the Bank’sBank's wholly owned subsidiary, First Citizens Insurance Agency, Inc. (“("First Citizens Insurance”Insurance").On December 11, 2015, the Company completed its acquisition of The First National Bank of Fredericksburg (FNB) by merging FNB into the Bank.

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

In the opinion of management of the Company, the accompanying interim financial statements at June 30, 20152016 and for the periods ended June 30, 20152016 and 20142015 include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the financial condition and the results of operations for the period.periods.  In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. The financial performance reported for the Company for the six month period ended June 30, 20152016 is not necessarily indicative of the results to be expected for the full year.  This information should be read in conjunction with the Company’sCompany's Annual Report on Form 10-K for the year ended December 31, 2014.2015.

Note 2 - Earnings per Share

The following table sets forth the computation of earnings per share. Earnings per share calculations give retroactive effect to stock dividends declared by the Company.
 
    Three months ended
    Six months ended
 
    June 30,
    June 30,
 
    2015
    2014
    2015
    2014
Net income applicable to common stock$3,189,000$3,365,000$6,309,000$6,541,000
     
Basic earnings per share computation    
Weighted average common shares outstanding   3,019,661   3,039,734     3,022,945   3,040,822
Earnings per share - basic$1.06$1.11$2.09$2.15
     
Diluted earnings per share computation    
Weighted average common shares outstanding for basic earnings per share   3,019,661   3,039,734     3,022,945   3,040,822
Add: Dilutive effects of restricted stock          1,064             927               534             405
Weighted average common shares outstanding for dilutive earnings per share   3,020,725   3,040,661     3,023,479   3,041,227
Earnings per share - diluted$1.06$1.11$2.09$2.15

  Three months ended  Six months ended 
  June 30,  June 30, 
  2016  2015  2016  2015 
Net income applicable to common stock $3,031,000  $3,189,000  $6,314,000  $6,309,000 
                 
Basic earnings per share computation                
Weighted average common shares outstanding  3,343,254   3,052,285   3,349,913   3,055,569 
Earnings per share - basic $0.91  $1.04  $1.88  $2.06 
                 
Diluted earnings per share computation                
Weighted average common shares outstanding for basic earnings per share  3,343,254   3,052,285   3,349,913   3,055,569 
Add: Dilutive effects of restricted stock  409   1,064   205   534 
Weighted average common shares outstanding for dilutive earnings per share  3,343,663   3,053,349   3,350,118   3,056,103 
Earnings per share - diluted $0.91  $1.04  $1.88  $2.06 

For the three months ended June 30, 20152016 and 2014,2015, there were 3,2874,521 and 2,1883,287 shares, respectively, related to the restricted stock plan that were excluded from the diluted earnings per share calculations since they were anti-dilutive. These anti-dilutive shares had prices ranging from $46.69-$53.15 for the three month period ended June 30, 2016 and prices ranging from $44.50-$53.15 for the three month period ended June 30, 2015 and prices ranging from $50.15-$50.50 for the three month period ended June 30, 2014.2015. For the six months ended June 30, 2016 and 2015, 4,521 and 2014, 3,287 and 2,409 shares, respectively, related to the restricted stock plan were excluded from the diluted earnings per share calculations since they were anti-dilutive. These anti-dilutive shares had prices ranging from $46.69-$53.15 for the six month period ended June 30, 2016 and prices ranging from $44.50-$53.15 for the six month period ended June 30, 2015 and prices ranging from $34.70-$50.50 for the six month period ended June 30, 2014.2015.

5
Note 3 - Income Tax Expense

Income tax expense is less than the amount calculated using the statutory tax rate, primarily as a result of tax-exempt income earned from state and municipal securities and loans and investments in affordable housing tax credits.

Investments in Qualified Affordable Housing Projects

As of June 30, 20152016 and December 31, 2014,2015, the Company was invested in four partnerships that provide affordable housing. The balance of the investments, which is included within other assets in the Consolidated Balance Sheet, was $1,088,000$829,000 and $1,218,000$959,000 as of June 30, 20152016 and December 31, 2014,2015, respectively. Investments purchased prior to January 1, 2015, are accounted for utilizing the effective yield method. As of June 30, 2015,2016, the Company has $1,143,000$945,000 of tax credits remaining that will be recognized over seven6.4 years. Tax credits of $49,000 were recognized as a reduction of tax expense during the three months ended June 30, 2016 and 2015. Tax credits of $99,000 were recognized as a reduction of tax expense during the three and six months ended June 30, 2015, respectively.2016 and 2015.

Note 4 – Investments

The amortized cost, gross unrealized gains and losses, and fair value of investment securities at June 30, 20152016 and December 31, 20142015 were as follows (in thousands):

 
    Gross
    Gross
     Gross  Gross    
    Amortized
    Unrealized
    Unrealized
    Fair
 Amortized  Unrealized  Unrealized  Fair 
June 30, 2015
    Cost
    Gains
    Losses
    Value
June 30, 2016 Cost  Gains  Losses  Value 
Available-for-sale securities:               
U.S. agency securities $    167,187 $                  778 $            (385) $       167,580 $203,461  $2,359  $(1) $205,819 
U.S. treasury securities  5,046   7   -   5,053 
Obligations of state and                   
political subdivisions         93,796                  2,829               (343)            96,282  101,144   3,338   (10)  104,472 
Corporate obligations         12,713                     141                 (49)            12,805  11,430   50   -   11,480 
Mortgage-backed securities in                   
government sponsored entities         26,096                     287                 (33)            26,350  31,190   456   (40)  31,606 
Equity securities in financial institutions           1,318                     457                      -              1,775
Equity securities in financial                
Institutions  2,001   518   (5)  2,514 
Total available-for-sale securities $    301,110 $               4,492 $            (810) $       304,792 $354,272  $6,728  $(56) $360,944 
                   
December 31, 2014   
                
December 31, 2015                
Available-for-sale securities:                   
U.S. agency securities $    150,847 $                  638 $            (600) $       150,885 $199,749  $369  $(527) $199,591 
U.S. treasury securities           4,944                          -                 (95)              4,849  10,103   -   (21)  10,082 
Obligations of state and                   
political subdivisions       101,281                  3,854                 (99)          105,036  99,856   3,080   (73)  102,863 
Corporate obligations         13,853                     190                 (85)            13,958  14,583   68   (86)  14,565 
Mortgage-backed securities in                   
government sponsored entities         29,397                     368                 (37)            29,728  30,107   186   (89)  30,204 
Equity securities in financial institutions           1,137                     553                      -              1,690  2,001   436   (5)  2,432 
Total available-for-sale securities $    301,459 $               5,603 $            (916) $       306,146 $356,399  $4,139  $(801) $359,737 

The following table shows the Company’sCompany's gross unrealized losses and fair value of the Company’sCompany's investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time, which individual securities have been in a continuous unrealized loss position, at June 30, 20152016 and December 31, 20142015 (in thousands). As of June 30, 2015,2016, the Company owned 7217 securities whose fair value was less than their cost basis.

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June 30, 2016 Less than Twelve Months  Twelve Months or Greater  Total 
     Gross     Gross     Gross 
  Fair  Unrealized  Fair  Unrealized  Fair  Unrealized 
  Value  Losses  Value  Losses  Value  Losses 
U.S. agency securities $8,509  $(1) $-  $-  $8,509  $(1)
Obligations of state and                        
    political subdivisions  4,342   (9)  503   (1)  4,845   (10)
Mortgage-backed securities in                        
   government sponsored entities  3,716   (22)  1,987   (18)  5,703   (40)
Equity securities in financial institutions  111   (5)  -   -   111   (5)
    Total securities $16,678  $(37) $2,490  $(19) $19,168  $(56)
                         
                         
December 31, 2015                        
U.S. agency securities $123,591  $(527) $-  $-  $123,591  $(527)
U.S. treasury securities  10,082   (21)  -   -   10,082   (21)
Obligations of states and                        
     political subdivisions  7,023   (57)  2,914   (16)  9,937   (73)
Corporate obligations  5,822   (61)  2,138   (25)  7,960   (86)
Mortgage-backed securities in                        
   government sponsored entities  9,830   (77)  227   (12)  10,057   (89)
Equity securities in financial institutions  106   (5)  -   -   106   (5)
    Total securities $156,454  $(748) $5,279  $(53) $161,733  $(801)

June 30, 2015
    Less than Twelve Months
    Twelve Months or Greater
    Total
   
    Gross
 
    Gross
 
    Gross
  
    Fair
    Unrealized
    Fair
    Unrealized
    Fair
    Unrealized
  
    Value
    Losses
    Value
    Losses
    Value
    Losses
U.S. agency securities $        60,908 $           (302) $        10,910 $             (83) $        71,818 $           (385)
Obligations of state and      
    political subdivisions23,486(263)             5,212                (80)28,698(343)
Corporate obligations             5,434                (31)             2,184                (18)7,618(49)
Mortgage-backed securities in      
   government sponsored entities4,616(21)                273                (12)4,889(33)
    Total securities $        94,444 $           (617) $        18,579 $           (193) $      113,023 $           (810)
        
December 31, 2014       
U.S. agency securities $        27,382 $           (110) $        43,642 $           (490) $        71,024 $           (600)
U.S. treasury securities                     -                     -             4,849                (95)             4,849                (95)
Obligations of states and      
     political subdivisions             3,596                (19)             8,584                (80)           12,180                (99)
Corporate obligations                505                  (1)             7,707                (84)             8,212                (85)
Mortgage-backed securities in      
     government sponsored entities             5,025                  (4)             2,229                (33)             7,254                (37)
    Total securities $        36,508 $           (134) $        67,011 $           (782) $      103,519 $           (916)
As of June 30, 2015,2016, the Company’sCompany's investment securities portfolio contained unrealized losses on agency securities issued or backed by the full faith and credit of the United States government or are generally viewed as having the implied guarantee of the U.S. government, obligations of states and political subdivisions, corporate obligations and mortgage backed securities issued by government sponsored entities.entities, and equity securities in financial institutions. For fixed maturity investments management considers whether the present value of cash flows expected to be collected are less than the security’ssecurity's amortized cost basis (the difference defined as the credit loss), the magnitude and duration of the decline, the reasons underlying the decline and the Company’sCompany's intent to sell the security or whether it is more likely than not that the Company would be required to sell the security before its anticipated recovery in market value, to determine whether the loss in value is other than temporary. Once a decline in value is determined to be other than temporary, if the Company does not intend to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of the security’ssecurity's amortized cost basis, the charge to earnings is limited to the amount of credit loss. Any remaining difference between fair value and amortized cost (the difference defined as the non-credit portion) is recognized in other comprehensive income, net of applicable taxes. Otherwise, the entire difference between fair value and amortized cost is charged to earnings. For equity securities where the fair value has been significantly below cost for one year, the Company’sCompany's policy is to recognize an impairment loss unless sufficient evidence is available that the decline is not other than temporary and a recovery period can be predicted.  The Company has concluded that any impairment of its investment securities portfolio outlined in the above table is not other than temporary and is the result of interest rate changes, sector credit rating changes, or issuer-specific rating changes that are not expected to result in the non-collection of principal and interest during the period.

Proceeds from sales of securities available-for-sale for the six months ended June 30, 2016 and 2015 were $12,077,000 and 2014 were $18,393,000, and $12,151,000, respectively.  For the three months ended June 30, 20152016 and 2014,2015, there were sales of $3,770,000$7,057,000 and $6,595,000,$3,770,000, respectively, of available-for-sale securities. The gross gains and losses were as follows (in thousands):

 
          Three Months Ended
       Six Months Ended
 
         June 30,
        June 30,
 
       2015
       2014
       2015
    2014
Gross gains $           175 $                    75 $              312 $              246
Gross losses                   -                          -                 (11)                      -
Net gains $           175 $                    75 $              301 $              246
  Three Months Ended  Six Months Ended 
  June 30,  June 30, 
  2016  2015  2016  2015 
Gross gains $128  $175  $155  $312 
Gross losses  -   -   -   (11)
Net gains $128  $175  $155  $301 

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Investment securities with an approximate carrying value of $170.9$221.9 million and $186.4$203.8 million at June 30, 20152016 and December 31, 2014,2015, respectively, were pledged to secure public funds and certain other deposits.

7
Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.   The amortized cost and fair value of debt securities at June 30, 2015,2016, by contractual maturity, are shown below (in thousands):

       Amortized
  Amortized    
       Cost
       Fair Value
 Cost  Fair Value 
Available-for-sale debt securities:        
Due in one year or less $        3,420 $               3,459 $41,555  $41,758 
Due after one year through five years       166,695              167,737  190,450   193,673 
Due after five years through ten years         44,355                45,146  41,023   42,092 
Due after ten years         85,322                86,675  79,243   80,907 
Total $    299,792 $           303,017 $352,271  $358,430 

Note 5 – Loans

The Company grants loans primarily to customers throughout North Centralnorth central, central and south central Pennsylvania and Southernthe southern tier New York.  Although the Company had a diversified loan portfolio at June 30, 20152016 and December 31, 2014,2015, a substantial portion of its debtors’debtors' ability to honor their contracts is dependent on the economic conditions within these regions. The following table summarizes the primary segments of the loan portfolio and how those segments are analyzed within the allowance for loan losses as of June 30, 20152016 and December 31, 20142015 (in thousands):

June 30, 2016 Total Loans  
Individually
evaluated for impairment
  
Loans acquired
with deteriorated
credit quality
  
Collectively
evaluated for impairment
 
Real estate loans:            
     Residential $203,980  $518  $34  $203,428 
     Commercial and agricultural  309,287   6,404   2,753   300,130 
     Construction  10,481   -   -   10,481 
Consumer  11,439   -   6   11,433 
Other commercial and agricultural loans  74,089   5,682   876   67,531 
State and political subdivision loans  99,839   -   -   99,839 
Total  709,115   12,604   3,669   692,842 
Allowance for loan losses  7,359   587   -   6,772 
Net loans $701,756  $12,017  $3,669  $686,070 
June 30, 2015 
    Total Loans
Individually
evaluated for
impairment
Collectively
evaluated for
 impairment
Real estate loans:    
     Residential  $                 181,566 $                        333 $                 181,233
     Commercial and agricultural                     224,450                        5,578                    218,872
     Construction                         8,025                                -                        8,025
Consumer                         8,374                                -                        8,374
Other commercial and agricultural loans                      64,506                        2,248                      62,258
State and political subdivision loans                       84,730                                -                      84,730
Total                     571,651 $                     8,159 $                 563,492
Allowance for loan losses                         6,959  
Net loans  $                 564,692  
     
December 31, 2014    
Real estate loans:    
     Residential  $                 185,438 $                        316 $                 185,122
     Commercial and agricultural                     215,584                        6,112                    209,472
     Construction                         6,353                                -                        6,353
Consumer                         8,497                                -                        8,497
Other commercial and agricultural loans                       58,516                        2,394                      56,122
State and political subdivision loans                       79,717                                -                      79,717
Total                     554,105 $                     8,822 $                 545,283
Allowance for loan losses                         6,815  
Net loans  $                 547,290  

December 31, 2015 Total Loans  
Individually
 evaluated for
impairment
  
Loans acquired
with deteriorated
credit quality
  
Collectively
evaluated for
impairment
 
Real estate loans:            
     Residential $203,407  $304  $35  $203,068 
     Commercial and agricultural  295,364   6,235   2,908   286,221 
     Construction  15,011   -   -   15,011 
Consumer  11,543   -   9   11,534 
Other commercial and agricultural loans  71,206   5,745   866   64,595 
State and political subdivision loans  98,500   -   -   98,500 
Total  695,031   12,284   3,818   678,929 
Allowance for loan losses  7,106   355   -   6,751 
Net loans $687,925  $11,929  $3,818  $672,178 

Purchased loans acquired in the FNB acquisition were recorded at fair value on their purchase date without a carryover of the related allowance for loan losses.

8
Upon acquisition, the Company evaluated whether an acquired loan was within the scope of ASC 310-30, Receivables-Loans and Debt Securities Acquired with Deteriorated Credit Quality. Purchased credit-impaired loans are loans that have evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. There were no material increases or decreases in the expected cash flows of these loans between December 11, 2015 (the "acquisition date") and June 30, 2016. The fair value of purchased credit-impaired loans, on the acquisition date, was determined, primarily based on the fair value of loan collateral. The carrying value of purchased loans acquired with deteriorated credit quality was $3,669,000 and $3,818,000 at June 30, 2016 and December 31, 2015, respectively.
 
On the acquisition date, the preliminary estimate of the unpaid principal balance for all loans evidencing credit impairment acquired in the FNB acquisition was $6,969,000 and the estimated fair value of the loans was $3,809,000. Total contractually required payments on these loans, including interest, at the acquisition date was $9,913,000. However, the Company's preliminary estimate of expected cash flows was $4,474,000. At such date, the Company established a credit risk related non-accretable discount (a discount representing amounts which are not expected to be collected from the customer nor liquidation of collateral) of $5,439,000 relating to these impaired loans, reflected in the recorded net fair value. Such amount is reflected as a non-accretable fair value adjustment to loans. The Company further estimated the timing and amount of expected cash flows in excess of the estimated fair value and established an accretable discount of $665,000 on the acquisition date relating to these impaired loans.

The carrying value of the loans acquired in the FNB acquisition with specific evidence of deterioration in credit quality was determined by projected discounted contractual cash flows.

Changes in the accretable yield for purchased credit-impaired loans were as follows for the three and six months ended June 30, 2016 (in thousands):

  Three Months Ended  
Six Months
Ended
 
Balance at beginning of period $551  $637 
Accretion  (87)  (173)
Balance at end of period $464  $464 

The following table presents additional information regarding loans acquired with specific evidence of deterioration in credit quality under ASC 310-30 (in thousands):

  June 30, 2016  December 31, 2015 
Outstanding balance $6,616  $6,950 
Carrying amount  3,669   3,818 

The segments of the Company’sCompany's loan portfolio are disaggregated into classes to a level that allows management to monitor risk and performance. Residential real estate mortgages consistsconsist primarily of 15 to 30 year first mortgages on residential real estate, while residential real estate home equity loans are consumer purpose installment loans or lines of credit with terms of 15 years or less secured by a mortgage which is often a second lien on residential real estate with terms of 15 years or less.estate. Commercial real estate loans are business purpose loans secured by a mortgage on commercial real estate. Agricultural real estate loans are loans secured by a mortgage on real estate used in agriculture production. Construction real estate loans are loans secured by residential or commercial real estate used during the construction phase of residential and commercial projects. Consumer loans are typically unsecured or primarily secured by assets other than real estate and overdraft lines of credit are typically secured by customer deposit accounts. Other commercial loans are loans for commercial purposes primarily secured by non-real estate collateral. Other agricultural loans are loans for agricultural purposes primarily secured by non-real estate collateral. State and political subdivision loans are loans to state and local municipalities for capital and operating expenses or tax free loans used to finance commercial development.

Management considers commercial loans, other agricultural loans, state and political subdivision loans, commercial real estate loans and agricultural real estate loans which are 90 days or more past due to be impaired. Management will also consider a loan impaired based on other factors it becomes aware of, including the customer’scustomer's results of operations and cash flows or if the loan is modified in a troubled debt restructuring. In addition, certaincertain residential mortgages, home equity and consumer loans that are cross collateralized with commercial relationships that are determined to be impaired may also be classified as impaired. Impaired loans are analyzed to determine if it is probable that all amounts will not be collected according to the contractual terms of the loan agreement. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allocation of the allowance for loan losses or a charge-off to the allowance for loan losses.

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The following table includes the recorded investment and unpaid principal balances for impaired financing receivables by class, with the associated allowance amount, if applicable (in(in thousands):

     Recorded  Recorded       
  Unpaid  Investment  Investment  Total    
  Principal  With No  With  Recorded  Related 
June 30, 2016 Balance  Allowance  Allowance  Investment  Allowance 
Real estate loans:               
     Mortgages $502  $114  $345  $459  $35 
     Home Equity  59   -   59   59   11 
     Commercial  8,888   5,944   295   6,239   126 
     Agricultural  165   165   -   165   - 
     Construction  -   -   -   -   - 
Consumer  -   -   -   -   - 
Other commercial loans  5,717   4,547   1,031   5,578   415 
Other agricultural loans  104   104   -   104   - 
State and political subdivision loans  -   -   -   -   - 
Total $15,435  $10,874  $1,730  $12,604  $587 
                     
December 31, 2015                    
Real estate loans:                    
     Mortgages $281  $114  $129  $243  $26 
     Home Equity  61   -   61   61   11 
     Commercial  8,654   5,843   225   6,068   62 
     Agricultural  167   167   -   167   - 
     Construction  -   -   -   -   - 
Consumer  -   -   -   -   - 
Other commercial loans  5,535   4,653   987   5,640   256 
Other agricultural loans  105   105   -   105   - 
State and political subdivision loans  -   -   -   -   - 
Total $14,803  $10,882  $1,402  $12,284  $355 
  RecordedRecorded  
 UnpaidInvestmentInvestmentTotal 
 PrincipalWith NoWithRecordedRelated
June 30, 2015BalanceAllowanceAllowanceInvestmentAllowance
Real estate loans:     
     Mortgages $       305 $          118 $          152 $          270 $          29
     Home Equity            63                  -               63               63             12
     Commercial       8,051          5,469             109          5,578             48
     Agricultural               -                  -                  -                  -                -
     Construction               -                  -                  -                  -                -
Consumer               -                  -                  -                  -                -
Other commercial loans       2,354          1,164          1,084          2,248           185
Other agricultural loans               -                  -                  -                  -                -
State and political subdivision loans               -                  -                  -                  -                -
Total $  10,773 $       6,751 $       1,408 $       8,159 $        274
      
December 31, 2014     
Real estate loans:     
     Mortgages $       222 $          125 $            66 $          191 $          13
     Home Equity          130               60               65             125             12
     Commercial       8,433          5,708             404          6,112             72
     Agricultural               -                  -                  -                  -                -
     Construction               -                  -                  -                  -                -
Consumer               -                  -                  -                  -                -
Other commercial loans       2,480          2,346               48          2,394               1
Other agricultural loans               -                  -                  -                  -                -
State and political subdivision loans               -                  -                  -                  -                -
Total $  11,265 $       8,239 $          583 $       8,822 $          98
9

The following tables includes the average balance of impaired financing receivables by class and the income recognized on impaired loans for the three and six month periods ended June 30, 20152016 and 2014(2015(in thousands):

  For the Six Months ended
 June 30, 2015June 30, 2014
   Interest  Interest
 AverageInterestIncomeAverageInterestIncome
 RecordedIncomeRecognizedRecordedIncomeRecognized
 InvestmentRecognizedCash BasisInvestmentRecognizedCash Basis
Real estate loans:      
     Mortgages $       224 $              4 $              5 $          202 $            4 $               -
     Home Equity          114                 2                  -             132               2                  -
     Commercial       5,862               32                  -          8,039             44                  -
     Agricultural               -                  -                  -                  -                -                  -
     Construction               -                  -                  -                  -                -                  -
Consumer               -                  -                  -               15                -                  -
Other commercial loans       2,678               49                 3          2,000             46                  -
Other agricultural loans               -                  -                  -                  -                -                  -
State and political      
   subdivision loans               -                  -                  -                  -                -                  -
Total $    8,878 $            87 $              8 $     10,388 $          96 $               -
       
  For the Three Months Ended
 June 30, 2015June 30, 2014
Real estate loans:      
     Mortgages $       259 $              2 $              5 $          200 $            2 $               -
     Home Equity          103                 1                  -             131               1                  -
     Commercial       5,700               19                  -          7,544             18                  -
     Agricultural               -                  -                  -                  -                -                  -
     Construction               -                  -                  -                  -                -                  -
Consumer               -                  -                  -               15                -                  -
Other commercial loans       2,629               24                 2          2,108             13                  -
Other agricultural loans               -                  -                  -                  -                -                  -
State and political      
   subdivision loans               -                  -                  -                  -                -                  -
Total $    8,691 $            46 $              7 $       9,998 $          34 $               -
10
  For the Six Months ended 
  June 30, 2016  June 30, 2015 
        Interest        Interest 
  Average  Interest  Income  Average  Interest  Income 
  Recorded  Income  Recognized  Recorded  Income  Recognized 
  Investment  Recognized  Cash Basis  Investment  Recognized  Cash Basis 
Real estate loans:                  
     Mortgages $425  $9  $-  $224  $4  $5 
     Home Equity  60   2   -   114   2   - 
     Commercial  6,142   52   -   5,862   32   - 
     Agricultural  165   5   -   -   -   - 
     Construction  -   -   -   -   -   - 
Consumer  -   -   -   -   -   - 
Other commercial loans  5,942   134   3   2,678   49   3 
Other agricultural loans  104   3   -   -   -   - 
State and political                        
   subdivision loans  -   -   -   -   -   - 
Total $12,838  $205  $3  $8,878  $87  $8 
                         
  For the Three Months Ended 
  June 30, 2016  June 30, 2015 
Real estate loans:                        
     Mortgages $460  $5  $-  $259  $2  $5 
     Home Equity  59   1   -   103   1   - 
     Commercial  6,158   26   -   5,700   19   - 
     Agricultural  165   3   -   -   -   - 
     Construction  -   -   -   -   -   - 
Consumer  -   -   -   -   -   - 
Other commercial loans  5,933   68   2   2,629   24   2 
Other agricultural loans  104   2   -   -   -   - 
State and political                        
   subdivision loans  -   -   -   -   -   - 
Total $12,879  $105  $2  $8,691  $46  $7 

Credit Quality Information

For commercial real estate, agricultural real estate, construction, other commercial, other agricultural and state and political subdivision loans, management uses a nine grade internal risk rating system to monitor credit quality. The first five categories are considered not criticized and are aggregated as “Pass”"Pass" rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The definitions of each rating are defined below:
·Pass (Grades 1-5) – These loans are to customers with credit quality ranging from an acceptable to very high quality and are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral.
·Special Mention (Grade 6) – This loan grade is in accordance with regulatory guidance and includes loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected.
·Substandard (Grade 7) – This loan grade is in accordance with regulatory guidance and includes loans that have a well-defined weakness based on objective evidence and be characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
10
·Doubtful (Grade 8) – This loan grade is in accordance with regulatory guidance and includes loans that have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, based on existing circumstances.
·Loss (Grade 9) – This loan grade is in accordance with regulatory guidance and includes loans that are considered uncollectible, or of such value that continuance as an asset is not warranted.

11
To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay the loan as agreed, the Company’sCompany's loan rating process includes several layers of internal and external oversight. The Company’sCompany's loan officers are responsible for the timely and accurate risk rating of the loans in each of their portfolios at origination and on an ongoing basis under the supervision of management.  All commercial and agricultural loans are reviewed annually to ensure the appropriateness of the loan grade. In addition, the Company engages an external consultant on at least an annual basis to 1) review a minimum of 55% of the dollar volume of the commercial loan portfolio on an annual basis, 2) review new loans originated for over $1.0 million in the last year, 3) review a majority of borrowers with commitments greater than or equal to $1.0 million,  4) review selected loan relationships over $750,000 which are over 30 days past due or classified Special Mention, Substandard, Doubtful, or Loss, and 5) such other loans which management or the consultant deems appropriate.

The following tables represent credit exposures by internally assigned grades as of June 30, 20152016 and December 31, 2014 (in2015 (in thousands):

June 30, 2016 Pass  Special Mention  Substandard  Doubtful  Loss  Ending Balance 
Real estate loans:                  
     Commercial $228,452  $3,619  $14,796  $28  $-  $246,895 
     Agricultural  53,701   5,951   2,740   -   -   62,392 
     Construction  10,481   -   -   -   -   10,481 
Other commercial loans  48,344   2,148   5,061   133   -   55,686 
Other agricultural loans  14,454   2,320   1,629   -   -   18,403 
State and political                        
   subdivision loans  91,639   8,200   -   -   -   99,839 
Total $447,071  $22,238  $24,226  $161  $-  $493,696 
                         
December 31, 2015                        
Real estate loans:                        
     Commercial $217,544  $4,150  $15,816  $32  $-  $237,542 
     Agricultural  53,695   2,865   1,262   -   -   57,822 
     Construction  14,422   589   -   -   -   15,011 
Other commercial loans  51,297   446   5,669   137   -   57,549 
Other agricultural loans  13,318   234   105   -   -   13,657 
State and political                        
   subdivision loans  98,500   -   -   -   -   98,500 
Total $448,776  $8,284  $22,852  $169  $-  $480,081 
June 30, 2015Pass
Special
Mention
SubstandardDoubtfulLossEnding Balance
Real estate loans:      
     Commercial $          177,073 $           4,390 $                  12,220 $                44 $              - $          193,727
     Agricultural               27,638              2,600                          485                      -                 -               30,723
     Construction                 8,025                      -                              -                      -                 -                 8,025
Other commercial loans               45,715                 817                       5,443                 145                 -               52,120
Other agricultural loans               11,989                 397                              -                      -                 -               12,386
State and political      
   subdivision loans               84,730                      -                              -                      -                 -               84,730
Total $          355,170 $           8,204 $                  18,148 $              189 $              - $          381,711
       
December 31, 2014      
Real estate loans:      
     Commercial $          169,383 $           8,948 $                  12,614 $                   - $              - $          190,945
     Agricultural               19,575              3,394                       1,670                      -                 -               24,639
     Construction                 6,353                      -                              -                      -                 -                 6,353
Other commercial loans               40,683              4,413                       2,355                      -                 -               47,451
Other agricultural loans                 9,221                 727                       1,117                      -                 -               11,065
State and political      
   subdivision loans               79,717                      -                              -                      -                 -               79,717
Total $          324,932 $         17,482 $                  17,756 $                   - $              - $          360,170

For residential real estate mortgages, home equity and consumer loans, credit quality is monitored based on whether the loan is performing or non-performing, which is typically based on the aging status of the loan and payment activity, unless a specific action, such as bankruptcy, repossession, death or significant delay in payment occurs to raise awareness of a possible credit event. Non-performing loans include those loans that are considered nonaccrual, described in more detail below, and all loans past due 90 or more days and still accruing. The following table presents the recorded investment in those loan classes based on payment activity as of June 30, 20152016 and December 31, 2014 (in2015 (in thousands):

June 30, 2016 Performing  Non-performing  PCI  Total 
Real estate loans:            
     Mortgages $142,633  $1,474  $34  $144,141 
     Home Equity  59,709   130   -   59,839 
Consumer  11,385   48   6   11,439 
Total $213,727  $1,652  $40  $215,419 
 
1112


June 30, 2015PerformingNon-performingTotal
December 31, 2015 Performing  Non-performing  PCI  Total 
Real estate loans:              
Mortgages $          119,649 $             1,160 $                120,809 $139,734  $1,270  $35  $141,039 
Home Equity               60,608                 149                     60,757  62,236   132   -  $62,368 
Consumer                 8,320                   54                       8,374  11,470   64   9  $11,543 
Total $          188,577 $           1,363 $                189,940 $213,440  $1,466  $44  $214,950 
  
December 31, 2014  
Real estate loans:  
Mortgages $          121,968 $              890 $                122,858
Home Equity               62,296                 284                     62,580
Consumer                 8,444                   53                       8,497
Total $          192,708 $           1,227 $                193,935

Aging Analysis of Past Due Financing Receivables

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following table includes an aging analysis of the recorded investment of past due financing receivables as of June 30, 20152016 and December 31, 2014 (in2015 (in thousands):

     90 Days or                   Total  90 Days or 
 30-59 Days60-89 Days90 DaysTotal Past Total FinancingGreater and 30-59 Days  60-89 Days  90 Days  Total Past        Financing  Greater and 
June 30, 2015Past DueOr GreaterDueCurrentReceivablesAccruing
June 30, 2016 Past Due  Past Due  Or Greater  Due  Current  PCI  Receivables  Accruing 
Real estate loans:Real estate loans:                             
Mortgages Mortgages $        502 $        154 $        866 $     1,522 $   119,287 $           120,809 $            380 $1,564  $25  $704  $2,293  $141,814  $34  $144,141  $195 
Home Equity Home Equity           395             84           136           615        60,142                60,757                 80  478   74   77   629   59,210   -   59,839   24 
Commercial Commercial           114           524        4,034        4,672      189,055              193,727               104  1,257   958   4,147   6,362   238,517   2,016   246,895   461 
Agricultural Agricultural             39           170                -           209        30,514                30,723                   -  166   58   165   389   61,266   737   62,392   165 
Construction Construction                -                -          8,025                  8,025                   -  -   -   -   -   10,481   -   10,481   - 
ConsumerConsumer             38             30             12             80          8,294                  8,374                   1  210   39   48   297   11,136   6   11,439   9 
Other commercial loansOther commercial loans           526      ��      56           919        1,501        50,619                52,120               261  15   3,062   1,012   4,089   50,721   876   55,686   146 
Other agricultural loansOther agricultural loans                -             97                -             97        12,289                12,386                   -  66   91   104   261   18,142   -   18,403   104 
State and political subdivision loans                -                -        84,730                84,730                   -
State and political                                
subdivision loans  -   -   -   -   99,839   -   99,839   - 
Total $3,756  $4,307  $6,257  $14,320  $691,126  $3,669  $709,115  $1,104 
Total $     1,614 $     1,115 $     5,967 $     8,696 $   562,955 $           571,651 $            826                                
Loans considered non-accrualLoans considered non-accrual $        524 $        496 $     5,141 $     6,161 $          406 $               6,567  $373  $3,759  $5,153  $9,285  $921  $-  $10,206     
Loans still accruingLoans still accruing        1,090           619           826        2,535      562,549              565,084   3,383   548   1,104   5,035   690,205   3,669   698,909     
Total $3,756  $4,307  $6,257  $14,320  $691,126  $3,669  $709,115     
Total $     1,614 $     1,115 $     5,967 $     8,696 $   562,955 $           571,651                                 
                               Total  90 Days or 
December 31, 2014     
 30-59 Days  60-89 Days  90 Days  Total Past          Financing  Greater and 
December 31, 2015 Past Due  Past Due  Or Greater  Due  Current  PCI  Receivables  Accruing 
Real estate loans:Real estate loans:                                     
Mortgages Mortgages $        318 $        230 $        675 $     1,223 $   121,635 $           122,858 $            214 $487  $283  $687  $1,457  $139,547  $35  $141,039  $321 
Home Equity Home Equity           442             99           260           801        61,779                62,580               132  630   15   121   766   61,602   -   62,368   73 
Commercial Commercial             97           231        1,432        1,760      189,185              190,945               310  824   57   4,139   5,020   230,352   2,170   237,542   60 
Agricultural Agricultural                -                -        24,639                24,639                   -  177   167   -   344   56,740   738   57,822   - 
Construction Construction                -                -          6,353                  6,353                   -  -   -   -   -   15,011   -   15,011   - 
ConsumerConsumer           119               4               7           130          8,367                  8,497                   6  239   37   49   325   11,209   9   11,543   9 
Other commercial loansOther commercial loans           503           258           476        1,237        46,214                47,451               174  143   214   1,010   1,367   55,316   866   57,549   160 
Other agricultural loansOther agricultural loans                -                -        11,065                11,065                   -  9   -   -   9   13,648   -   13,657   - 
State and political subdivision loans                -                -        79,717                79,717                   -
State and political                                
subdivision loans  -   -   -   -   98,500   -   98,500   - 
Total $2,509  $773  $6,006  $9,288  $681,925  $3,818  $695,031  $623 
Total $     1,479 $        822 $     2,850 $     5,151 $   548,954 $           554,105 $            836                                
Loans considered non-accrualLoans considered non-accrual $          48 $        181 $     2,014 $     2,243 $       4,356 $               6,599  $54  $171  $5,383  $5,608  $923  $-  $6,531     
Loans still accruingLoans still accruing        1,431           641           836        2,908      544,598              547,506   2,455   602   623   3,680   681,002   3,818   688,500     
Total $     1,479 $        822 $     2,850 $     5,151 $   548,954 $           554,105 
Total $2,509  $773  $6,006  $9,288  $681,925  $3,818  $695,031     

1213
Nonaccrual Loans

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

The following table reflects the financing receivables on non-accrual status as of June 30, 20152016 and December 31, 2014,2015, respectively. The balances are presented by class of financing receivable (in(in thousands):

 
       June 30, 2015
 
       December 31, 2014
 June 30, 2016  December 31, 2015 
Real estate loans:Real estate loans:         
Mortgages Mortgages $                780  $                   676 $1,279  $949 
Home Equity Home Equity                     69                       152  106   59 
Commercial Commercial                4,547                    5,010  4,711   4,422 
Agricultural Agricultural                      -                         -  29   34 
Construction                      -                         -
ConsumerConsumer                     53                         47  39   55 
Other commercial loansOther commercial loans                1,118                       714  4,042   1,012 
Other agricultural loans                      -                         -
State and political subdivision loans                      -                         -
  $             6,567  $                6,599 $10,206  $6,531 

Troubled Debt Restructurings

In situations where, for economic or legal reasons related to a borrower's financial difficulties, management may grant a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the related loan is classified as a Troubled Debt Restructuring (TDR). Management strives to identify borrowers in financial difficulty early and work with them to modifystructure more affordable terms before their loan reaches nonaccrual status. These modifiedrestructured terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where borrowers are granted new terms that provide for a reduction of interest or principal, or both, management measures any impairment on the restructuring by calculating the present value of the revised loan terms and comparing this balance to the Company’sCompany's investment in the loan prior to the restructuring. As these loans are individually evaluated, they are excluded from pooled portfolios when calculating the allowance for loan and lease losses and a separate allocation within the allowance for loan and lease losses is provided. Management continually evaluates loans that are considered TDRs, including payment history under the modified loan terms, the borrower’sborrower's ability to continue to repay the loan based on continued evaluation of their operating results and cash flows from operations.  Based on this evaluation management would no longer consider a loan to be a TDR when the relevant facts support such a conclusion. As of June 30, 20152016 and December 31, 2014,2015, included within the allowance for loan losses are reserves of $41,000$33,000 and $26,000$37,000 respectively, that are associated with loans modified as TDRs.

Loan modifications that are considered TDRs completed during the three and six months ended June 30, 20152016 and 20142015 were as follows (dollars in thousands):

  For the Three Months Ended June 30, 2016 
  Number of contracts  
Pre-modification Outstanding
Recorded Investment
  
Post-Modification Outstanding
Recorded Investment
 
  
Interest
Modification
  
Term
Modification
  
Interest
Modification
  
Term
Modification
  
Interest
Modification
  
Term
Modification
 
Real estate loans:                  
     Commercial  -   3  $-  $438  $-  $438 
Total  -   3  $-  $438  $-  $438 


1314
  For the Six Months Ended June 30, 2016 
  Number of contracts  
Pre-modification Outstanding
Recorded Investment
  
Post-Modification Outstanding
Recorded Investment
 
  
Interest
Modification
  
Term
Modification
  
Interest
Modification
  
Term
Modification
  
Interest
Modification
  
Term
Modification
 
Real estate loans:                  
     Commercial  -   3  $-  $438  $-  $438 
Total  -   3  $-  $438  $-  $438 
 
  For the Three Months Ended June 30, 2015 
  Number of contracts  
Pre-modification Outstanding
Recorded Investment
  
Post-Modification Outstanding
Recorded Investment
 
  
Interest
Modification
  
Term
Modification
  
Interest
Modification
  
Term
Modification
  
Interest
Modification
  
Term
Modification
 
Real estate loans:                  
     Mortgages  -   1  $-  $19  $-  $19 
Total  -   1  $-  $19  $-  $19 

For the Three Months Ended June 30, 2015 For the Six Months Ended June 30, 2015 
Number of contracts
Pre-modification Outstanding
Recorded Investment
Post-Modification
Outstanding Recorded
Investment
 Number of contracts  
Pre-modification Outstanding
Recorded Investment
  
Post-Modification Outstanding
Recorded Investment
 
Interest
 Modification
Term Modification
Interest
Modification
Term ModificationInterest Modification
Term
Modification
 
Interest
Modification
  
Term
Modification
  
Interest
Modification
  
Term
Modification
  
Interest
Modification
  
Term
Modification
 
Real estate loans:                       
Mortgages                     -                          1 $                    -  $                  19 $                  -  $              19  1   1  $71  $19  $71  $19 
Total                     -                          1 $                    - $                  19 $                  - $              19  1   1  $71  $19  $71  $19 

 For the Six Months Ended June 30, 2015
 Number of contracts
Pre-modification Outstanding
 Recorded Investment
Post-Modification
Outstanding Recorded
Investment
 
Interest
Modification
Term Modification
Interest
Modification
Term
Modification
Interest
Modification
Term
Modification
Real estate loans:      
     Mortgages                    1                          1 $                 71 $                  19 $               71  $               19
Total                    1                          1 $                 71 $                  19 $               71 $               19

 For the Three Months Ended June 30, 2014
 Number of contracts
Pre-modification Outstanding
Recorded Investment
Post-Modification Outstanding
Recorded Investment
 
Interest
Modification
Term Modification
Interest
Modification
Term Modification
Interest
Modification
Term Modification
Real estate loans:      
     Commercial                     -                          1$                   -$                28$                  -$             28
Total                     -                          1 $                   - $                28 $                  - $             28

 For the Six Months Ended June 30, 2014
 Number of contracts
Pre-modification Outstanding
Recorded Investment
Post-Modification Outstanding
Recorded Investment
 
Interest
Modification
Term Modification
Interest
Modification
Term Modification
Interest
 Modification
Term
 Modification
Real estate loans:      
     Commercial                     -2$                   -$                153$                  -$             153
Total                     -                         2 $                   - $                153 $                  - $             153
Recidivism, or the borrower defaulting on its obligation pursuant to a modified loan, results in the loan once again becoming a non-accrual loan. Recidivism occurs at a notably higher rate than do defaults on new origination loans, so modified loans present a higher risk of loss than do new origination loans. The following table presents the recorded investment inThere were no loans that were modified as TDRs during each 12-month period prior to the current reporting periods, which begin January 1, 20152016 and 20142015 (six month periods) and April 1, 20152016 and 20142015 (3 month periods), respectively, and that subsequently defaulted during these reporting periods (dollars in thousands):
14

 For the Three Months EndedFor the Six Months Ended
 June 30, 2015June 30, 2014June 30, 2015June 30, 2014
 
Number of
contracts
Recorded
investment
Number of
contracts
Recorded
 investment
Number of
contracts
Recorded
investment
Number of
contracts
Recorded
investment
Real estate loans:        
     Commercial                   - $              -                   - $              -                   - $              -             1 $              483
Total recidivism                   - $              -                   - $              -                   - $              -             1 $              483
periods.

Allowance for Loan Losses
The following table segregates the allowance for loan losses (ALLL) into the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of June 30,201530, 2016 and December 31, 2014,2015, respectively (in(in thousands):
  June 30, 2016  December 31, 2015 
  
Individually
evaluated for impairment
  
Collectively
evaluated for impairment
  Total  
Individually
evaluated for
 impairment
  
Collectively
evaluated for
impairment
  Total 
Real estate loans:                  
     Residential $46  $944  $990  $37  $868  $905 
     Commercial and agricultural  126   3,793   3,919   62   3,723   3,785 
     Construction  -   18   18   -   24   24 
Consumer  -   104   104   -   102   102 
Other commercial and agricultural loans  415   1,149   1,564   256   1,049   1,305 
State and political                        
  subdivision loans  -   764   764   -   593   593 
Unallocated  -   -   -   -   392   392 
Total $587  $6,772  $7,359  $355  $6,751  $7,106 

15
 June 30, 2015  December 31, 2014
 
Individually
evaluated for impairment
Collectively
evaluated for impairment
Total Individually evaluated for impairment
Collectively
evaluated for impairment
Total
Real estate loans:       
     Residential $           41 $         890 $         931  $           25 $           853 $             878
     Commercial and agricultural              48         3,6313,679               72           3,798             3,870
     Construction                 -              1414                  -                26                  26
Consumer                 -              8989                  -                84                  84
Other commercial and agricultural loans            185         1,3171,502                 1           1,223             1,224
State and political subdivision loans                 -            568568                  -              545                545
Unallocated                 -            176176                  -              188                188
Total $         274 $      6,685 $      6,959  $           98 $        6,717 $          6,815
The following tables roll forward the balance of the ALLL by portfolio segment for the three and six month periods ended June 30, 2016 and 2015, and 2014, respectively (in(in thousands):
  
Balance at
March 31, 2016
  Charge-offs  Recoveries  Provision  
Balance at
June 30, 2016
 
Real estate loans:               
     Residential $966  $(43) $-  $67  $990 
     Commercial and agricultural  3,938   -   4   (23)  3,919 
     Construction  14   -   -   4   18 
Consumer  96   (23)  29   2   104 
Other commercial and agricultural loans  1,347   (18)  -   235   1,564 
State and political              -     
  subdivision loans  666   -   -   98   764 
Unallocated  248   -   -   (248)  - 
Total $7,275  $(84) $33  $135  $7,359 
                     
  
Balance at
December 31, 2015
  Charge-offs  Recoveries  Provision  
Balance at
June 30, 2016
 
Real estate loans:                    
     Residential $905  $(43) $-  $128  $990 
     Commercial and agricultural  3,785   -   8   126   3,919 
     Construction  24   -   -   (6)  18 
Consumer  102   (38)  68   (28)  104 
Other commercial and agricultural loans  1,305   (18)  6   271   1,564 
State and political              -     
  subdivision loans  593   -   -   171   764 
Unallocated  392   -   -   (392)  - 
Total $7,106  $(99) $82  $270  $7,359 
                     

Balance at March 31, 2015Charge-offsRecoveriesProvisionBalance at June 30, 2015 
Balance at
March 31, 2015
  Charge-offs  Recoveries  Provision  
Balance at
June 30, 2015
 
Real estate loans:                   
Residential $         923 $          (17) $              - $         25 $         931 $923  $(17) $-  $25  $931 
Commercial and agricultural         3,699             (56)                3            33         3,679  3,699   (56)  3   33   3,679 
Construction              11                 -              3              14  11   -   -   3   14 
Consumer              82             (17)                4            20              89  82   (17)  4   20   89 
Other commercial and agricultural loans         1,286                 -          216         1,502  1,286   -   -   216   1,502 
State and political subdivision loans            572                 -            (4)            568
State and political              -     
subdivision loans  572   -   -   (4)  568 
Unallocated            349                 -        (173)            176  349   -   -   (173)  176 
Total $      6,922 $          (90) $             7 $       120 $      6,959 $6,922  $(90) $7  $120  $6,959 
                        
Balance at December 31, 2014Charge-offsRecoveriesProvisionBalance at June 30, 2015 
Balance at
December 31, 2014
  Charge-offs  Recoveries  Provision  
Balance at
June 30, 2015
 
Real estate loans:                        
Residential $         878 $          (34) $              - $         87 $         931 $878  $(34) $-  $87  $931 
Commercial and agricultural         3,870             (56)                7        (142)         3,679  3,870   (56)  7   (142)  3,679 
Construction              26                 -          (12)              14  26   -   -   (12)  14 
Consumer              84             (24)              12            17              89  84   (24)  12   17   89 
Other commercial and agricultural loans         1,224               (1)                 -          279         1,502  1,224   (1)  -   279   1,502 
State and political subdivision loans            545                 -            23            568
State and political              -     
subdivision loans  545   -   -   23   568 
Unallocated            188                 -          (12)            176  188   -   -   (12)  176 
Total $      6,815 $        (115) $           19 $       240 $      6,959 $6,815  $(115) $19  $240  $6,959 

1516
 
Balance at
March 31,
2014
Charge-offsRecoveriesProvision
Balance at
June 30,
2014
Real estate loans:     
     Residential $         886 $            (7) $              - $            - $         879
     Commercial and agricultural         4,530           (465)                3        (259)         3,809
     Construction                8                 -                 -              5              13
Consumer              83               (6)                6              3              86
Commercial and other loans         1,173           (163)                 -          141         1,151
State and political subdivision loans            396                 -                 -            59            455
Unallocated            157                 -                 -          201            358
Total $      7,233 $        (641) $             9 $       150 $      6,751
      
 
Balance at
December 31,
2013
Charge-offsRecoveriesProvision
Balance at
June 30,
2014
Real estate loans:     
     Residential $         946 $          (45) $              - $       (22) $         879
     Commercial and agricultural         4,558           (475)                5        (279)         3,809
     Construction              50                 -                 -          (37)              13
Consumer            105             (14)              15          (20)              86
Commercial and other loans            942           (163)                 -          372         1,151
State and political subdivision loans            330                 -                 -          125            455
Unallocated            167                 -                 -          191            358
Total $      7,098 $        (697) $           20 $       330 $      6,751
The Company allocates the ALLL based on the factors described below, which conform to the Company’sCompany's loan classification policy and credit quality measurements. In reviewing risk within the Company’sCompany's loan portfolio, management has determined there to be several different risk categories within the loan portfolio. The ALLL consists of amounts applicable to: (i) residential real estate loans; (ii) residential real estate home equity loans; (iii) commercial real estate loans; (iv) agricultural real estate loans; (v) real estate construction loans; (vi) other commercial and agricultural loans; (vii) consumer loans; (viii) other agricultural loans and (ix) state and political subdivision loans. Factors considered in this process include general loan terms, collateral, and availability of historical data to support the analysis. Historical loss percentages are calculated and used as the basis for calculating allowance allocations. Certain qualitative factors are evaluated to determine additional inherent risks in the loan portfolio, which are not necessarily reflected in the historical loss percentages. These factors are then added to the historical allocation percentage to get the adjusted factor to be applied to non-classified loans. The following qualitative factors are analyzed:

·Level of and trends in delinquencies and impaired/classified loans
§Change in volume and severity of past due loans
§Volume of non-accrual loans
§Volume and severity of classified, adversely or graded loans;
·Level of and trends in charge-offs and recoveries;
·Trends in volume, terms and nature of the loan portfolio;
·Effects of any changes in risk selection and underwriting standards and any other changes in lending and recovery policies, procedures and practices;
·Changes in the quality of the Company’sCompany's loan review system;
·Experience, ability and depth of lending management and other relevant staff;
16
·National, state, regional and local economic trends and business conditions
§General economic conditions
§Unemployment rates
§Inflation rate/ Consumer Price Index
§Changes in values of underlying collateral for collateral-dependent loans;
·Industry conditions including the effects of external factors such as competition, legal, and regulatory requirements on the level of estimated credit losses; and
·Existence and effect of any credit concentrations, and changes in the level of such concentrations; and
·Any change in the level of board oversight.

The Company also maintains an unallocated allowance to account for any factors or conditions that may cause a potential loss but are not specifically addressed in the process described above. The Company analyzes its loan portfolio each quarter to determine the appropriatenessadequacy of its ALLL.

Loans determined to be TDRs are impaired and for purposes of estimating the ALLL must be individually evaluated for impairment. In calculating the impairment, the Company calculates the present value utilizing an analysis of discounted cash flows. If the present value calculated is below the recorded investment of the loan, impairment is recognized by a charge to the provision for loan and lease losses and a credit to the ALLL.

We continually review the model utilized in calculating the required ALLL. The following qualitative factors experienced changes during the first six months of 2015:2016:

·The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans were increased for residential, consumer and agricultural related loans due to an increase in past due, non-accrual and classified loans.
·The qualitative factor for industry conditions, including the effects of external factors such as competition, legal, and regulatory requirements on the level of estimated credit losses was increased for agricultural related loans due to the decrease in the price received for product sold and the increase in feed costs that has occurred in 2016, which negatively affected customer earnings.
·The qualitative factor for national, state, regional and local economic trends and business conditions was increased for all loan categories due to an increase in the unemployment rates in the local economy during the first six months of 2016.

The following qualitative factors experienced changes during the three months ended June 30, 2016:

·The qualitative factor for national, state, regional and local economic trends and business conditions was increased for all loan categories due to an increase in the unemployment rates in the local economy during the quarter.
·The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans were increased for agricultural related loans due to an increase in past due, non-accrual and classified loans.

17
The following qualitative factors experienced changes during the first six months of 2015:

·The qualitative factor for national, state, regional and local economic trends and business conditions was increased for all loan categories due to an increase in the unemployment rates in the local economy during the first six months of 2015.
·The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans were decreased for commercial and agricultural real estate due to the decrease in the amount of loans classified as substandard.
·The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans were increased for other commercial and agricultural loans due to an increase in the amount of loans classified as substandard.
·The qualitative factor for levels of and trends in charge-offs and recoveries was decreased for commercial and agricultural real estate and other commercial and agricultural loans due to the decrease in charge-offs compared to the prior year as charge-offs returned to historical levels for the Bank.
·The qualitative factor for experience, ability and depth of lending management and other relevant staff was decreased for commercial real estate, agricultural real estate, other commercial and other agricultural loans due to the length of time employees involved throughout the loan process have been in their positions.
·The qualitative factor for industry conditions, including the effects of external factors such as competition, legal, and regulatory requirements on the level of estimated credit losses was increased for commercial and agricultural related loans due to the decrease in the price received for product sold and the increase in feed costs that has occurred in 2015, which negatively affected customer earnings.
·The qualitative factor for levels of and trends in charge-offs and recoveries was increased for residential real estate loans due to the increase in charge-offs compared to historical norms for the Company.
·The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans was increased for residential mortgages due to increases in the amount of delinquent loans.

The following qualitative factors experienced changes during the three months ended June 30, 2015:

·The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans were decreased for commercial and agricultural real estate due to the decrease in the amount of loans classified as substandard.
·The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans were increased for other commercial and agricultural loans due to an increase in the amount of loans classified as substandard.
17
·The qualitative factor for levels of and trends in charge-offs and recoveries was decreased for commercial and agricultural real estate and other commercial and agricultural loans due to the decrease in charge-offs compared to the prior year as charge-offs returned to historical levels for the Bank.
·The qualitative factor for experience, ability and depth of lending management and other relevant staff was decreased for all commercial real estate, agricultural real estate, other commercial and other agricultural loans due to the length of time employees involved throughout the loan process have been in their positions.

The primary factor that resulted in negative provision for commercial and agricultural loans for the six month period ended June 30, 2015 was the reduction in the amount of special mention and substandard loans since December 31, 2014.
The following qualitative factors experienced changes during the first six months of 2014:
·  The qualitative factor for national, state, regional and local economic trends and business conditions was decreased for all loan categories due to a decrease in the unemployment rates in the local economy.
·  The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans were decreased for commercial and agricultural real estate due to the decrease in the Company’s classified loans to its lowest level in three years.
·  The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans were increased for other commercial and agricultural loans due to an increase in classified loans during the quarter.
·  The qualitative factor for levels of and trends in charge-offs and recoveries was increased for commercial and agricultural real estate and other commercial and agricultural loans due to the increase in charge-offs compared to historical norms for the Bank.
·  The qualitative factor for experience, ability and depth of lending management and other relevant staff was decreased for all loan categories due to the length of time employees involved throughout the loan process have been in their positions.

The following qualitative factors experienced changes during the three months ended June 30, 2014:

·  The qualitative factor for national, state, regional and local economic trends and business conditions was decreased for all loan categories due to a decrease in the unemployment rates in the local economy.
·  The qualitative factor for levels of and trends in charge-offs and recoveries was increased for commercial and agricultural real estate and other commercial and agricultural loans due to the increase in charge-offs compared to historical norms for the Bank.
·  The qualitative factor for experience, ability and depth of lending management and other relevant staff was decreased for all loan categories due to the length of time employees involved throughout the loan process have been in their positions.
·  The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans were decreased for commercial and agricultural real estate due to the decrease in the Company’s classified loans.
·  The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans were increased for other commercial and agricultural loans due to an increase in classified loans during the quarter.
The primary factor that resulted in negative provisions for certain portfolio segments for the three and six month periods ended June 30, 2014 was due to decreases in the outstanding balances for certain portfolio segments compared to December 31, 2013, a reduction in the amount of substandard loans and the decrease in the qualitative factor associated with the improvement in unemployment rates noted above.
18
Foreclosed Assets Held For Sale

Foreclosed assets acquired in settlement of loans are carried at fair value, less estimated costs to sell, and are included in other assets on the Consolidated Balance Sheet. As of June 30, 20152016 and December 31, 20142015 included with other assets are $1,815,000$1,558,000 and 1,792,000,$1,354,000, respectively, of foreclosed assets. As of June 30, 2015,2016, included within the foreclosed assets is $422,000$453,000 of consumer residential mortgages that were foreclosed on or received via a deed in lieu transaction prior to the period end. As of June 30, 2015,2016, the Company has initiated formal foreclosure proceedsproceedings on $1,329,000$1,424,000 of consumer residential mortgages, which have not yet been transferred into foreclosed assets.

Note 6 – Goodwill and Other Intangible Assets

The following table provides the gross carrying value and accumulated amortization of intangible assets as of June 30, 2016 and December 31, 2015 (in thousands):

  June 30, 2016  December 31, 2015 
  
Gross
carrying
value
  Accumulated amortization  
Net
carrying
value
  
Gross
carrying
value
  
Accumulated
amortization
  
Net
carrying
value
 
Amortized intangible assets (1):                  
MSRs $1,336  $(728) $608  $1,336  $(638) $698 
Core deposit intangibles  1,641   (173)  1,468 �� 1,641   (25)  1,616 
Covenant not to compete  125   (18)  107   125   (2)  123 
Total amortized intangible assets $3,102  $(919) $2,183  $3,102  $(665) $2,437 
Unamortized intangible assets:                        
Goodwill $21,089          $21,089         
(1) Excludes fully amortized intangible assets                        

The following table provides the current year and estimated future amortization expense for amortized intangible assets. We based our projections of amortization expense shown below on existing asset balances at June 30, 2016. Future amortization expense may vary from these projections (in thousands):

  MSRs  Core deposit intangibles  Covenant not to compete  Total 
Six months ended June 30, 2016 (actual) $90  $148  $16  $254 
Three months ended June 30, 2016 (actual) $44  $74  $8  $126 
Estimate for year ended December 31,                
Remaining 2016  83   148   15   246 
2017  142   266   31   439 
2018  113   236   31   380 
2019  88   206   30   324 
2020  66   177   -   243 

Note 67 – Federal Home Loan Bank Stock

The Bank is a member of the FHLB of Pittsburgh and, as such, is required to maintain a minimum investment in stock of the FHLB that varies with the level of advances outstanding with the FHLB. As of June 30, 20152016 and December 31, 2014,2015, the Bank’sBank's investment in FHLB stock was $1,590,000$2,643,000 and $1,761,000,$2,800,000, respectively. The stock does not have a readily determinable fair value and, as such, is classified as restricted stock, carried at cost and evaluated by management.  The stock’sstock's value is determined by the ultimate recoverability of the par value rather than by recognizing temporary declines. The determination of whether the par value will ultimately be recovered is influenced by criteria such as the following: (a) a significant decline in net assets of the FHLB as compared to the capital stock amount and the length of time this situation has persisted (b) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance (c) the impact of legislative and regulatory changes on the customer base of the FHLB and (d) the liquidity position of the FHLB. Management evaluated the stock and concluded that the stock was not impaired for the periods presented herein.  Management considered that the FHLB’sFHLB's regulatory capital ratios have improved, liquidity appears adequate, new shares of FHLB stock continue to exchange hands at the $100 par value and the FHLB has repurchased shares of excess capital stock from its members and has paid a quarterly cash dividend.

19
Note 8 – Repurchase Agreements

We utilize securities sold under agreements to repurchase to facilitate the needs of our customers and to facilitate secured short-term funding needs. Securities sold under agreements to repurchase are stated at the amount of cash received in connection with the transaction. We monitor collateral levels on a continuous basis. We may be required to provide additional collateral based on the fair value of the underlying securities. Securities pledged as collateral under repurchase agreements are maintained with our safekeeping agents.

The value of the collateral segmented by the remaining contractual maturity of the repurchase agreements in the Consolidated Balance Sheets as of June 30, 2016 and December 31, 2015 is presented in the following tables (in thousands):

  Remaining Contractual Maturity of the Agreements 
  Overnight and  Up to     Greater than    
June 30, 2016 Continuous  30 Days  30 - 90 Days  90 days  Total 
Repurchase Agreements:               
U.S. agency securities $18,024  $-  $-  $2,129  $20,153 
Total carrying value of collateral pledged $18,024  $-  $-  $2,129  $20,153 
Total liability recognized for repurchase agreements                 $14,761 
                     
  Remaining Contractual Maturity of the Agreements 
  Overnight and  Up to      Greater than     
December 31, 2015 Continuous  30 Days  30 - 90 Days  90 days  Total 
Repurchase Agreements:                    
U.S. agency securities $18,144  $-  $-  $2,049  $20,193 
Total carrying value of collateral pledged $18,144  $-  $-  $2,049  $20,193 
                     
Total liability recognized for repurchase agreements                 $16,008 

Note 79 - Employee Benefit Plans

For additional detailed disclosure on the Company's pension and employee benefits plans, please refer to Note 11 of the Company's Consolidated Financial Statements included in the 20142015 Annual Report on Form 10-K.

Noncontributory Defined Benefit Pension Plan

The Bank sponsors a noncontributory defined benefit pension plan (“("Pension Plan”Plan") covering substantially all employees and officers that were hired prior to January 1, 2007. Additionally, the Bank assumed the noncontributory defined benefit pension plan of FNB when it was acquired during 2015. The Bank’sFNB plan was frozen prior to the acquisition and therefore, no additional benefits will accrue for employees covered under that plan. These two plans are collectively referred to herein as "the Plans." The Bank's funding policy is to make annual contributions, if needed, based upon the funding formula developed by the plan’splans' actuary. Any employee with a hire date of January 1, 2007 or later is not eligible to participate in the Pension Plan. In lieu of the Pension Plan, employees with a hire date of January 1, 2007 or later are eligible to receive, after meeting certain length of service requirements, an annual discretionary 401(k) plan contribution from the Bank equal to a percentage of an employee’semployee's base compensation.  The contribution amount, if any, is placed in a separate account within the 401(k) plan and is subject to a vesting requirement.

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

20
The following sets forth the components of net periodic benefit costs of the Pension Plan for the three and six months ended June 30, 20152016 and 2014,2015, respectively (in thousands):

19
  Three Months Ended  Six Months Ended 
  June 30,  June 30, 
  2016  2015  2016  2015 
Service cost $89  $78  $179  $132 
Interest cost  173   90   345   153 
Expected return on plan assets  (260)  (172)  (520)  (290)
Net amortization and deferral  60   45   121   76 
Net periodic benefit cost $62  $41  $125  $71 

 Three Months EndedSix Months Ended
  June 30, June 30,
 2015201420152014
Service cost $               78 $   63 $             132 $                  153
Interest cost                   90    111                153                     207
Expected return on plan assets              (172)  (215)              (290)                    (393)
Net amortization and deferral                   45    (43)                   76                       25
Net periodic cost (benefit) $               41 $ (84) $               71 $                     (8)
The Company expects to contribute $400,000$700,000 to the Pension PlanPlans in 2015.2016.

Defined Contribution Plan

The Company sponsors a voluntary 401(k) savings plan which eligible employees can elect to contribute up to the maximum amount allowable not to exceed the limits of IRS Code Sections 401(k).  Under the plan, the Company also makes required contributions on behalf of the eligible employees.  The Company’sCompany's contributions vest immediately. Contributions by the Company totaled $155,000$180,000 and $146,000$155,000 for the six months ended June 30, 20152016 and 2014,2015, respectively. For the three months ended June 30, 20152016 and 2014,2015, contributions by the Company totaled $93,000$97,000 and $88,000,$93,000, respectively.

Directors’Directors' Deferred Compensation Plan

The Company’sCompany's directors may elect to defer all or portions of their fees until their retirement or termination from service.  Amounts deferred under the plan earn interest based upon the highest current rate offered to certificate of deposit customers.  Amounts deferred under the plan are not guaranteed and represent a general liability of the Company.  At June 30, 20152016 and December 31, 2014,2015, an obligation of $945,000$929,000 and $969,000,$958,000, respectively, was included in other liabilities for this plan in the Consolidated Balance Sheet. Amounts included in interest expense on the deferred amounts totaled $5,000$4,000 and $6,000$5,000 for each of the three months ended June 30, 2016 and 2015, and 2014.respectively. For the six months ended June 30, 20152016 and 2014,2015, amounts included in interest expense on the deferred amounts totaled $12,000$8,000 and $11,000,$12,000, respectively.

Restricted Stock Plan

The Company maintains a Restricted Stock Plan (the “Plan”"Plan") whereby employees and non-employee corporate directors are eligible to receive awards of restricted stock based upon performance related requirements.  Awards granted under the Plan are in the form of the Company’sCompany's common stock and are subject to certain vesting requirements including continuous employment or service with the Company.  A total of 100,000150,000 shares of the Company’sCompany's common stock have been authorized under the Plan, which terminates in April 2016.Plan. As of June 30, 2015, 60,6622016, 146,350 shares remain available to be issued under the Plan.  The Plan assists the Company in attracting, retaining and motivating employees to make substantial contributions to the success of the Company and to increase the emphasis on the use of equity as a key component of compensation.

The following table details the vesting, awarding and forfeiting of restricted shares during 2015the three and 2014:six month periods ended June 30, 2016:

  Three months  Six months 
     Weighted     Weighted 
  Unvested  Average  Unvested  Average 
  Shares  Market Price  Shares  Market Price 
Outstanding, beginning of period  8,111  $49.96   8,269  $49.98 
Granted  3,650   47.81   3,650   47.81 
Forfeited  -   -   -   - 
Vested  (3,158)  50.41   (3,316)  (50.45)
Outstanding, end of period  8,603  $48.88   8,603  $48.88 
 Three months ended June 30,Six months ended June 30,
 2015201420152014
  Weighted Weighted Weighted Weighted
 UnvestedAverageUnvestedAverageUnvestedAverageUnvestedAverage
 SharesMarket PriceSharesMarket PriceSharesMarket PriceSharesMarket Price
Outstanding, beginning of period6,998 $          48.61   6,240 $       43.556,971 $          48.55   7,172 $       42.02
Granted3,340             49.87   3,206          53.103,496             50.02   3,598          52.82
Forfeited-                     -           -                  --                     -           -                  -
Vested (3,320)             45.62  (2,259)          42.06 (3,449)             45.80  (3,583)          40.30
Outstanding, end of period7,018 $          50.63   7,187 $       48.287,018 $          50.63   7,187 $       48.28

21
 
Compensation cost related to restricted stock is recognized, based on the market price of the stock at the grant date, over the vesting period. Compensation expense related to restricted stock was $85,000$92,000 and $73,000$85,000 for the six months ended June 30, 20152016 and 2014,2015, respectively. For the three months ended June 30, 20152016 and 2014,2015, compensation expense totaled $43,000$45,000 and $37,000,$43,000, respectively. At June 30, 20152016 the total compensation cost related to nonvested awards that has not yet been recognized was $355,000,$421,000, which is expected to be recognized over the next 2.832.75 years.

20
Supplemental Executive Retirement Plan

The Company maintains a non-qualified supplemental executive retirement plan (“SERP”("SERP") for certain executives to compensate those executive participants in the Company’sCompany's noncontributory defined benefit pension plan whose benefits are limited by compensation limitations under current tax law. At June 30, 20152016 and December 31, 2014,2015, an obligation of $1,269,000$1,400,000 and $1,198,000,$1,339,000, respectively, was included in other liabilities for this plan in the Consolidated Balance Sheet. Expenses related to this plan totaled $71,000$61,000 and $76,000$71,000 for the six months ended June 30, 2016 and 2015, and 2014, respectively. For the three months ended June 30, 20152016 and 2014,2015, expenses totaled $36,000$31,000 and $38,000,$36,000, respectively.

Salary Continuation Plan

The Company maintains a salary continuation plan for certain employees acquired through the acquisition of the FNB.  At June 30, 2016 and December 31 2015, an obligation of $716,000 and $710,000 was included in other liabilities for this plan in the Consolidated Balance Sheet.  Expenses related to this plan totaled $16,000 for the three months ended June 30, 2016. For the six months ended June 30, 2016, expenses related to this plan totaled $32,000.
Continuation of Life Insurance Plan

The Company, as part of the acquisition of FNB, has promised a continuation of certain split-dollar life insurance policies that provide coverage to certain persons post-retirement. U.S. generally accepted accounting principles require the recording of post-retirement costs and a liability equal to the present value of the cost of post-retirement insurance during the person's term of service. The estimated present value of future benefits to be paid totaled $574,000 at both June 30, 2016 and December 31, 2015, which is included in other liabilities in the Consolidated Balance Sheet.

22
Note 89 – Accumulated Comprehensive Income

The following tables present the changes in accumulated other comprehensive income by component net of tax for the three and six months ended June 30, 20152016 and 20142015 (in thousands):

 Three months ended June 30, 2016 
 
Unrealized gain
(loss) on available
for sale securities (a)
  Defined Benefit Pension Items (a)  Total 
Balance as of March 31, 2016 $3,303  $(2,400) $903 
Other comprehensive income before reclassifications (net of tax)  1,184   -   1,184 
Amounts reclassified from accumulated other            
comprehensive income (loss) (net of tax)  (84)  39   (45)
Net current period other comprehensive income  1,100   39   1,139 
Balance as of June 30, 2016 $4,403  $(2,361) $2,042 
            
 Six months ended June 30, 2016 
Balance as of December 31, 2015 $2,204  $(2,440) $(236)
Other comprehensive income before reclassifications (net of tax)  2,301   -   2,301 
Amounts reclassified from accumulated other            
comprehensive income (loss) (net of tax)  (102)  79   (23)
Net current period other comprehensive income  2,199   79   2,278 
Balance as of June 30, 2016 $4,403  $(2,361) $2,042 
Three months ended June 30, 2015            
Unrealized gain (loss) on
available for sale securities (a)
Defined Benefit
Pension Items (a)
Total Three months ended June 30, 2015 
Balance as of March 31, 2015 $                     3,897 $     (2,294) $      1,603 $3,897  $(2,294) $1,603 
Other comprehensive income (loss) before reclassifications (net of tax)                      (1,351)               -        (1,351)  (1,351)  -   (1,351)
Amounts reclassified from accumulated other               
comprehensive income (net of tax)                         (116)              35             (81)
comprehensive income (loss) (net of tax)  (116)  35   (81)
Net current period other comprehensive income (loss)                      (1,467)              35        (1,432)  (1,467)  35   (1,432)
Balance as of June 30, 2015 $                     2,430 $     (2,259) $         171 $2,430  $(2,259) $171 
   
Six months ended June 30, 2015            
Unrealized gain (loss) on
available for sale securities (a)
Defined Benefit
Pension Items (a)
Total Six months ended June 30, 2015 
Balance as of December 31, 2014 $                     3,093 $     (2,326) $         767 $3,093  $(2,326) $767 
Other comprehensive income (loss) before reclassifications (net of tax)                         (464)               -           (464)  (464)  -   (464)
Amounts reclassified from accumulated other               
comprehensive income (net of tax)                         (199)              67           (132)
comprehensive income (loss) (net of tax)  (199)  67   (132)
Net current period other comprehensive income (loss)                  (663)          67       (596)  (663)  67   (596)
Balance as of June 30, 2015 $                     2,430 $     (2,259) $         171 $2,430  $(2,259) $171 
               
Three months ended June 30, 2014
Unrealized gain (loss) on available
for sale securities (a)
Defined Benefit
Pension Items (a)
Total
Balance as of March 31, 2014 $                     1,264 $     (1,110) $         154
Other comprehensive income (loss) before reclassifications (net of tax)                           986               -            986
Amounts reclassified from accumulated other   
comprehensive income (net of tax)                           (49)                9             (40)
Net current period other comprehensive income (loss)                           937                9            946
Balance as of June 30, 2014 $                     2,201 $     (1,101) $      1,100
   
Six months ended June 30, 2014
Unrealized gain (loss) on available
for sale securities (a)
Defined Benefit
Pension Items (a)
Total
Balance as of December 31, 2013 $                      (108) $     (1,117) $     (1,225)
Other comprehensive income (loss) before reclassifications (net of tax)                        2,471               -         2,471
Amounts reclassified from accumulated other   
comprehensive income (net of tax)                         (162)              16           (146)
Net current period other comprehensive income (loss)                2,309          16     2,325
Balance as of June 30, 2014 $                     2,201 $     (1,101) $      1,100
   
(a) Amounts in parentheses indicate debits to the Consolidated Balance Sheet (a) Amounts in parentheses indicate debits to the Consolidated Balance Sheet   (a) Amounts in parentheses indicate debits to the Consolidated Balance Sheet         

2123
The following table presents the significant amounts reclassified out of each component of accumulated other comprehensive income for the three and six months ended June 30, 20152016 and 20142015 (in thousands):


Details about accumulated other comprehensive income
Amount reclassified from accumulated
comprehensive income (a)
 
Affected line item in the
statement where net Income is
presented
Details about accumulated other comprehensive income (loss) Amount reclassified from accumulated comprehensive income (loss) (a) Affected line item in the statement where net Income is presented
Three Months Ended  June 30,   Three Months Ended June 30,  
20152014   2016  2015  
Unrealized gains and losses on available for sale securities             
 $128  $175 Investment securities gains, net
 $                          175 $                      75 Investment securities gains, net  (44)  (59)Provision for income taxes
                             (59)                       (26) Provision for income taxes $84  $116 Net of tax
 $                          116 $                      49 Net of tax            
Defined benefit pension items               
 $                          (54) $                    (13) Salaries and employee benefits $(60) $(54)Salaries and employee benefits
                               19                           4 Provision for income taxes  21   19 Provision for income taxes
 $                          (35) $                      (9) Net of tax $(39) $(35)Net of tax
                
Total reclassifications $                            81 $                      40   $45  $81  
                
Six Months Ended  June 30,   Six Months Ended June 30,  
20152014    2016   2015  
Unrealized gains and losses on available for sale securities               
 $                          301 $                    246 Investment securities gains, net $155  $301 Investment securities gains, net
                           (102)                       (84) Provision for income taxes  (53)  (102)Provision for income taxes
 $                          199 $                    162 Net of tax $102  $199 Net of tax
            
Defined benefit pension items               
 $                        (102) $                    (25) Salaries and employee benefits $(121) $(102)Salaries and employee benefits
                               35                           9 Provision for income taxes  42   35 Provision for income taxes
 $                          (67) $                    (16) Net of tax $(79) $(67)Net of tax
                
Total reclassifications $                          132 $                    146   $23  $132  
                
(a) Amounts in parentheses indicate expenses and other amounts indicate income on the Consolidated Statement of Income (a) Amounts in parentheses indicate expenses and other amounts indicate income on the Consolidated Statement of Income   (a) Amounts in parentheses indicate expenses and other amounts indicate income on the Consolidated Statement of Income

Note 910 – Fair Value Measurements

The Company has established a hierarchal disclosure framework associated with the level of pricing observability utilized in measuring assets and liabilities at fair value. The three broad levels defined by this hierarchy are as follows:follows:
 
Level I:Quoted prices are available in active markets for identical assets or liabilities as of the reported date.
 
Level II:Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but traded less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed.
22
  
Level III:Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’smanagement's best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

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

24
In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality, the Company's creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. Our valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’sCompany's valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company’sCompany's monthly and/or quarterly valuation process.

Financial Instruments Recorded at Fair Value on a Recurring Basis
The fair values of securities available for sale are determined by quoted prices in active markets, when available, and classified as Level I. If quoted market prices are not available, the fair value is determined by a matrix pricing, which is a mathematical technique, widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’securities' relationship to other benchmark quoted securities and classified as Level II. The fair values consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’sbond's terms and conditions, among other things.
The following tables present the assets and liabilities reported on the Consolidated Balance Sheet at their fair value on a recurring basis as of June 30, 20152016 and December 31, 20142015 by level within the fair value hierarchy (in thousands). Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

June 30, 2016 Level I  Level II  Level III  Total 
Fair value measurements on a recurring basis:            
Assets            
  Securities available for sale:            
     U.S. Agency securities $-  $205,819  $-  $205,819 
     U.S. Treasury securities  5,053   -   -   5,053 
     Obligations of state and                
        political subdivisions  -   104,472   -   104,472 
     Corporate obligations  -   11,480   -   11,480 
     Mortgage-backed securities in                
       government sponsored entities  -   31,606   -   31,606 
     Equity securities in financial institutions  2,514   -   -   2,514 
                 
December 31, 2015                
Fair value measurements on a recurring basis:                
Securities available for sale:                
     U.S. Agency securities $-  $199,591  $-  $199,591 
     U.S. Treasuries securities  10,082   -   -   10,082 
     Obligations of state and                
       political subdivisions  -   102,863   -   102,863 
     Corporate obligations  -   14,565   -   14,565 
     Mortgage-backed securities in                
       government sponsored entities  -   30,204   -   30,204 
     Equity securities in financial institutions  2,432   -   -   2,432 
June 30, 2015 Level I Level II Level III  Total
Assets         
  Securities available for sale:         
     U.S. Agency securities  $                -  $             167,580  $                    -   $             167,580
     Obligations of state and         
        political subdivisions                    - 96,282                        -  96,282
     Corporate obligations                    - 12,805                        -  12,805
     Mortgage-backed securities in         
       government sponsored entities                    - 26,350                        -  26,350
     Equity securities in financial         
       institutions            1,775                             -                        -  1,775

2325
December 31, 2014 Level I Level II Level III  Total
Securities available for sale:         
     U.S. agency securities  $                -  $             150,885  $                    -   $             150,885
     U.S. treasuries securities                    - 4,849                        -  4,849
     Obligations of state and         
       political subdivisions                    - 105,036                        -  105,036
     Corporate obligations                    - 13,958                        -  13,958
     Mortgage-backed securities in         
       government sponsored entities                    - 29,728                        -  29,728
     Equity securities in financial         
       institutions            1,690                             -                        -  1,690
Financial Instruments, Non-Financial Assets and Non-Financial Liabilities Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain financial assets, financial liabilities, non-financial assets and non-financial liabilities at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market value that were recognized at fair value below cost at the end of the period. Certain non-financial assets measured at fair value on a non-recurring basis include foreclosed assets (upon initial recognition or subsequent impairment).
, non-financial assets and non-financial liabilities measured at fair value in the second step of a goodwill impairment test, and intangible assets and other non-financial long-lived assets measured at fair value for impairment assessment. Non-financial assets measured at fair value on a non-recurring basis during 20152016 and 20142015 include certain foreclosed assets which, upon initial recognition, were remeasured and reported at fair value through a charge-off to the allowance for possible loan losses and certain foreclosed assets which, subsequent to their initial recognition, were remeasured at fair value through a write-down included in other non-interest expense.

·  
Impaired Loans - Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. Collateral values are estimated using Level II inputs based on observable market data and Level III inputs based on customized discounting criteria. For a majority of impaired real estate related loans, the Company obtains a current external appraisal. Other valuation techniques are used as well, including internal valuations, comparable property analysis and contractual sales information.
·  
Other Real Estate owned – Other real estate owned, which is obtained through the Bank’s foreclosure process, is valued utilizing the appraised collateral value. Collateral values are estimated using Level II inputs based on observable market data and Level III inputs based on customized discounting criteria. At the time the foreclosure is completed, the Company obtains an updated external appraisal.

Assets measured at fair value on a nonrecurring basis as of June 30, 20152016 and December 31, 20142015 are included in the table below (in(in thousands):

June 30, 2016 Level I  Level II  Level III  Total 
Impaired Loans $-  $-  $989  $989 
Other real estate owned  -   -   1,007   1,007 
                 
December 31, 2015                
Impaired Loans $-  $-  $894  $894 
Other real estate owned  -   -   1,197   1,197 
June 30, 2015 Level I Level II Level III  Total
Impaired Loans  $                -  $                         -  $            7,885   $                 7,885
Other real estate owned                    -                             - 1,815  1,815
          
December 31, 2014         
Impaired Loans  $                -  $       ��                 -  $            8,724   $                 8,724
Other real estate owned                    -                             -                1,792  1,792

·
Impaired Loans - The Company has measured impairment on impaired loans generally based on the fair value of the loan's collateral.  Fair value is generally determined based upon independent third-party appraisals of the properties. In some cases, management may adjust the appraised value due to the age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed.   Additionally, management makes estimates about expected costs to sell the property which are also included in the net realizable value.  If the fair value of the collateral dependent loan is less than the carrying amount of the loan a specific reserve for the loan is made in the allowance for loan losses or a charge-off is taken to reduce the loan to the fair value of the collateral (less estimated selling costs) and the loan is included in the table above as a Level III measurement.  If the fair value of the collateral exceeds the carrying amount of the loan, then the loan is not included in the table above as it is not current being carried at its fair value. The fair values above excluded estimated selling costs of $126,000 and $91,000 at June 30, 2016 and December 31, 2015, respectively.
·
Other Real Estate owned – OREO is carried at the lower of cost or fair value, which is measured at the date foreclosure.  If the fair value of the collateral exceeds the carrying amount of the loan, no charge-off or adjustment is necessary, the loan is not considered to be carried at fair value, and is therefore not included in the table above. If the fair value of the collateral is less than the carrying amount of the loan, management will charge the loan down to its estimated realizable value. The fair value of OREO is based on the appraised value of the property, which is generally unadjusted by management and is based on comparable sales for similar properties in the same geographic region as the subject property, and is included in the above table as a Level II measurement.  In some cases, management may adjust the appraised value due to the age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed.  In these cases, the loans are categorized in the above table as Level III measurement since these adjustments are considered to be unobservable inputs. Income and expenses from operations and further declines in the fair value of the collateral subsequent to foreclosure are included in net expenses from OREO.
 
26
The following table provides a listing of the significant unobservable inputs used in the fair value measurement process for items valued utilizing level III techniques.techniques (dollars in thousands).

Quantitative Information about Level 3 Fair Value Measurements 
June 30, 2016 Fair Value Valuation Technique(s)Unobservable input Range  Weighted average 
Impaired Loans $989 Appraised Collateral ValuesDiscount to appraised value  0-75%  36.64%
        Selling costs  5%-10%  8.18%
        Holding period 0 - 12 months  10 months 
               
Other real estate owned  1,007 Appraised Collateral ValuesDiscount to appraised value  0-37%  24.70%
               
December 31, 2015 Fair Value Valuation Technique(s)Unobservable input Range     
Impaired Loans  894 Appraised Collateral ValuesDiscount to appraised value  0-70%  46.50%
        Selling costs  4%-10%  7.75%
        Holding period 0 - 12 months  10 months 
               
Other real estate owned  1,197 Appraised Collateral ValuesDiscount to appraised value  0-75%  25%
24
Quantitative Information about Level 3 Fair Value Measurements 
June 30, 2015Fair Value Valuation Technique(s)Unobservable inputRangeWeighted average
       
Impaired Loans $  206 Discounted Cash FlowsChange in interest rates0-5.5%3.21%
       
   7,679 Appraised Collateral ValuesDiscount for time since appraisal0-30%17.09%
    Selling costs5%-10%9.28%
    Holding period0 - 18 months12 months
       
Other real estate owned  1,815 Appraised Collateral ValuesDiscount for time since appraisal0-20%20%
    Selling costs4%-10%9%
    Holding period0 - 18 months12
       
December 31, 2014Fair Value Valuation Technique(s)Unobservable inputRange 
Impaired Loans $  230 Discounted Cash FlowsChange in interest rates0-5.5%1.99%
       
   8,494 Appraised Collateral ValuesDiscount for time since appraisal0-30%22.00%
    Selling costs4%-10%8.55%
    Holding period0 - 18 months15 months
       
Other real estate owned  1,792 Appraised Collateral ValuesDiscount for time since appraisal0-20%20%
    Selling costs4%-10%9%
    Holding period0 - 18 months12

The fair values of the Company’sCompany's financial instruments are as follows (in thousands):

  Carrying             
June 30, 2016 Amount  Fair Value  Level I  Level II  Level III 
Financial assets:               
Cash and due from banks $26,822  $26,822  $26,822  $-  $- 
Interest bearing time deposits with other banks  6,954   6,961   -   -   6,961 
Available-for-sale securities  360,944   360,944   7,567   353,377     
Loans held for sale  1,304   1,304   1,304         
Net loans  701,756   726,584   -   -   726,584 
Bank owned life insurance  25,877   25,877   25,877   -   - 
Regulatory stock  3,407   3,407   3,407   -   - 
Accrued interest receivable  4,176   4,176   4,176   -   - 
                     
Financial liabilities:                    
Deposits $1,003,482  $1,005,158  $734,593  $-  $270,565 
Borrowed funds  38,786   37,240   -   -   37,240 
Accrued interest payable  644   644   644   -   - 
                     
  Carrying                 
December 31, 2015 Amount  Fair Value  Level I  Level II  Level III 
Financial assets:                    
Cash and due from banks $24,384  $24,384  $24,384  $-  $- 
Interest bearing time deposits with other banks  7,696   7,705   -   -   7,705 
Available-for-sale securities  359,737   359,737   12,514   347,223   - 
Loans held for sale  603   603   603         
Net loans  687,925   712,524   -   -   712,524 
Bank owned life insurance  25,535   25,535   25,535   -   - 
Regulatory stock  3,459   3,459   3,459   -   - 
Accrued interest receivable  4,211   4,211   4,211   -   - 
                     
Financial liabilities:                    
Deposits $988,031  $987,542  $706,121  $-  $281,421 
Borrowed funds  41,631   38,863   1,598   -   37,265 
Accrued interest payable  734   734   734   -     
 Carrying    
June 30, 2015AmountFair ValueLevel ILevel IILevel III
Financial assets:     
Cash and due from banks $   10,912 $   10,912 $   10,912 $          - $             -
Interest bearing time deposits with other banks        5,960        5,969  5,969
Available-for-sale securities    304,792    304,792        1,775 303,017 
Loans held for sale        1,152        1,152        1,152  
Net loans    564,692    580,732                -             -    580,732
Bank owned life insurance      20,615      20,615      20,615             -                -
Regulatory stock        1,864        1,864        1,864             -                -
Accrued interest receivable        3,584        3,5843,584             -                -
      
Financial liabilities:     
Deposits $ 791,887 $ 792,477 $ 544,830 $          - $ 247,647
Borrowed funds      39,194      36,080        6,287             -      29,793
Accrued interest payable           674           674674             -                -
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 Carrying    
December 31, 2014AmountFair ValueLevel ILevel IILevel III
Financial assets:     
Cash and due from banks $   11,423 $   11,423 $   11,423 $          - $             -
Interest bearing time deposits with other banks        5,960        5,969                -             -        5,969
Available-for-sale securities    306,146    306,146        1,690 304,456                -
Loans held for sale           497           497           497  
Net loans    547,290    564,944                -             -    564,944
Bank owned life insurance      20,309      20,309      20,309             -                -
Regulatory stock        2,035        2,035        2,035             -                -
Accrued interest receivable        3,644        3,644        3,644             -                -
      
Financial liabilities:     
Deposits $ 773,933 $ 774,387 $ 525,166 $          - $ 249,221
Borrowed funds      41,799      38,219      16,593             -      21,626
Accrued interest payable           756           756756             -                -

Fair value is determined based on relevant market information and information about the financial instrument.  These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’sCompany's entire holdings of a particular financial instrument.  Because no market exists for a significant portion of the Company’sCompany's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions can significantly affect the estimates.

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Fair values have been determined by the Company using historical data, as generally provided in the Company’sCompany's regulatory reports, and an estimation methodology suitable for each category of financial instruments. The Company’sCompany's fair value estimates, methods and assumptions are set forth below for the Company’sCompany's other financial instruments.

Cash and Cash Equivalents:

The carrying amounts for cash and cash equivalents approximate fair value because they have original maturities of 90 days or less and do not present unanticipated credit concerns.

Accrued Interest Receivable and Payable:

The carrying amounts for accrued interest receivable and payable approximate fair value because they are generally received or paid in 90 days or less and do not present unanticipated credit concerns.

Interest bearing time deposits with other banks:

The fair value of interest bearing time deposits with other banks is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.

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Available-For-Sale Securities:

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

Loans held for sale:

The carrying amount for loans held for sale approximates fair value as the loans are only held for less than a week from origination.

Loans:

Fair values are estimated for portfolios of loans with similar financial characteristics.  The fair value of performing loans has been estimated by discounting expected future cash flows. The discount rate used in these calculations is derived from the Treasury yield curve adjusted for credit quality, operating expense and prepayment option price, and is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Company’sCompany's historical experience with repayments for each loan classification, modified as required by an estimate of the effect of current economic and lending conditions.

Bank Owned Life Insurance:

The carrying value of bank owned life insurance approximates fair value based on applicable redemption provisions.

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Regulatory Stock:

The carrying value of regulatory stock approximates fair value based on applicable redemption provisions.

Deposits:

The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings and NOW accounts, and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.

The deposits’deposits' fair value estimates do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market, commonly referred to as the core deposit intangible.

Borrowed Funds:

Rates available to the Company for borrowed funds with similar terms and remaining maturities are used to estimate the fair value of borrowed funds.

Note 1011 – Recent Accounting Pronouncements

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (a new revenue recognition standard). The Update’sUpdate's core principle is that a company will recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, this update specifies the accounting for certain costs to obtain or fulfill a contract with a customer and expands disclosure requirements for revenue recognition. This Update is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. The Company is evaluating the effect of adopting this new accounting Update.

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In June 2014, the FASB issued ASU 2014-11, Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures.  The amendments in this Update change the accounting for repurchase-to-maturity transactions to secured borrowing accounting.  For repurchase financing arrangements, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, which will result in secured borrowing accounting for the repurchase agreement.  The amendments also require enhanced disclosures. The accounting changes in this Update are effective for the first interim or annual period beginning after December 15, 2014.  An entity is required to present changes in accounting for transactions outstanding on the effective date as a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. Earlier application is prohibited.  The disclosure for certain transactions accounted for as a sale is required to be presented for interim and annual periods beginning after December 15, 2014, and the disclosure for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and for interim periods beginning after March 15, 2015. The disclosures are not required to be presented for comparative periods before the effective date. This Update did not have a significant impact on the Company’s financial statements.
In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements -Going Concern (Subtopic 205-40).  The amendments in this Update provide guidance in accounting principles generally accepted in the United States of America about management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures.  The amendments in this Update are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted.  This Update is not expected to have a significant impact on the Company’sCompany's financial statements.
In November 2014, the FASB issued ASU 2014-17, Business Combinations (Topic 805): Pushdown Accounting. The amendments in this Update apply to the separate financial statements of an acquired entity and its subsidiaries that are a business or nonprofit activity (either public or nonpublic) upon the occurrence of an event in which an acquirer (an individual or an entity) obtains control of the acquired entity.  An acquired entity may elect the option to apply pushdown accounting in the reporting period in which the change-in-control event occurs. If pushdown accounting is not applied in the reporting period in which the change-in-control event occurs, an acquired entity will have the option to elect to apply pushdown accounting in a subsequent reporting period to the acquired entity's most recent change-in-control event. The amendments in this Update are effective on November 18, 2014. After the effective date, an acquired entity can make an election to apply the guidance to future change-in-control events or to its most recent change-in-control event. This Update did not have a significant impact on the Company’s financial statements.

In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810). The amendments in this Update affect reporting entities that are required to evaluate whether they should consolidate certain legal entities. All legal entities are subject to reevaluation under the revised consolidation model. Specifically, the amendments (1) Modifymodify the evaluation of whether limited partnerships and similar legal entities are variable interest entities (VIEs) or voting interest entities; (2) Eliminateeliminate the presumption that a general partner should consolidate a limited partnership; (3) Affectaffect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships; (4) Provideprovide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds.  The amendments in this Update are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015.  For all other entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2016, and for interim periods within fiscal years beginning after December 15, 2017. This Update is not expected to have a significant impact on the Company’sCompany's financial statements.

In April 2015, the FASB issued ASU 2015-03, Interest-Imputation of Interest (Subtopic 835-30), as part of its initiative to reduce complexity in accounting standards.  To simplify presentation of debt issuance costs, the amendments in this Update require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this Update.  For public business entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years.  For all other entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within fiscal years beginning after December 15, 2016.  An entity should apply the new guidance on a retrospective basis, wherein the balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the new guidance. This Update is not expected to have a significant impact on the Company’sCompany's financial statements.

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In May 2015, the FASB issued ASU 2015-08, Business Combinations - Pushdown Accounting - Amendment to SEC Paragraphs Pursuant to Staff Accounting Bulletin No. 115. This ASU was issued to amend various SEC paragraphs pursuant to the issuance of Staff Accounting Bulletin No. 115. This Update is not expected to have a significant impact on the Company’s financial statements.
In June 2015, the FASB issued ASU 2015-10, Technical Corrections and Improvements. The amendments in this Update represent changes to clarify the Codification, correct unintended application of guidance, or make minor improvements to the Codification that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. Transition guidance varies based on the amendments in this Update. The amendments in this Update that require transition guidance are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. All other amendments will be effective upon the issuance of this Update.  This Update is not expected to have a significant impact on the Company’sCompany's financial statements.

In August 2015, the FASB issued ASU 2015-14, Revenue from Contract with Customers (Topic 606). The amendments in this Update defer the effective date of ASU 2014-09 for all entities by one year.  Public business entities, certain not-for-profit entities, and certain employee benefit plans should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period.  All other entities should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019.  The Company is evaluating the effect of adopting this new accounting Update.

In September 2015, the FASB issued ASU 2015-16, Business Combinations (Topic 805).  The amendments in this Update require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments in this Update require that the acquirer record, in the same period's financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date.  The amendments in this Update require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date.  For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years.  For all other entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017. The Company is currently evaluating the impact the adoption of the standard will have on the Company's financial position or results of operations.

In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes.  The amendments in this Update require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments in this Update apply to all entities that present a classified statement of financial position.  For public business entities, the amendments in this Update are effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. For all other entities, the amendments in this Update are effective for financial statements issued for annual periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018.  Earlier application is permitted for all entities as of the beginning of an interim or annual reporting period.  The amendments in this Update may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. This Update is not expected to have a significant impact on the Company's financial statements.

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In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10):  Recognition and Measurement of Financial Assets and Financial Liabilities.  This Update applies to all entities that hold financial assets or owe financial liabilities and is intended to provide more useful information on the recognition, measurement, presentation, and disclosure of financial instruments.  Among other things, this Update (a) requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (b) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (c) eliminates the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities; (d) eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (e) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (f) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (g) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (h) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity's other deferred tax assets.  For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.  For all other entities including not-for-profit entities and employee benefit plans within the scope of Topics 960 through 965 on plan accounting, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. All entities that are not public business entities may adopt the amendments in this Update earlier as of the fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the impact the adoption of the standard will have on the Company's financial position or results of operations.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842).  The standard requires lessees to recognize the assets and liabilities that arise from leases on the balance sheet.  A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term.  A short-term lease is defined as one in which: (a) the lease term is 12 months or less, and (b) there is not an option to purchase the underlying asset that the lessee is reasonably certain to exercise.  For short-term leases, lessees may elect to recognize lease payments over the lease term on a straight-line basis.  For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within those years.  For all other entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2019, and for interim periods within fiscal years beginning after
December 15, 2020.  The amendments should be applied at the beginning of the earliest period presented using a modified retrospective approach with earlier application permitted as of the beginning of an interim or annual reporting period.  The Company is currently evaluating the impact the adoption of the standard will have on the Company's financial position or results of operations.

In March 2016, the FASB issued ASU 2016-04, Liabilities – Extinguishments of Liabilities (Subtopic 405-20). The standard provides that liabilities related to the sale of prepaid stored-value products within the scope of this Update are financial liabilities. The amendments in the Update provide a narrow scope exception to the guidance in Subtopic 405-20 to require that breakage for those liabilities be accounted for consistent with the breakage guidance in Topic 606. The amendments in this Update are effective for public business entities, certain not-for-profit entities, and certain employee benefit plans for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. For all other entities, the amendments are effective for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. Earlier application is permitted, including adoption in an interim period.  This Update is not expected to have a significant impact on the Company's financial statements.


2931
In March 2016, the FASB issued ASU 2016-05, Derivatives and Hedging (Topic 815). The amendments in this Update apply to all reporting entities for which there is a change in the counterparty to a derivative instrument that has been designated as a heading instrument under Topic 815. The standards in this Update clarify that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument under Topic 815 does not, in and of itself, require designation of that hedging relationship provided that all other hedge accounting criteria continue to be met. For public business entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. For all other entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within fiscal years beginning after December 15, 2018. An entity has an option to apply the amendments in this Update on either a prospective basis or a modified retrospective basis. Early adoption is permitted, including adoption in an interim period. This Update is not expected to have a significant impact on the Company's financial statements.

In March 2016, the FASB issued ASU 2016-06, Derivatives and Hedging (Topic 815).  The amendments apply to all entities that are issuers of or investors in debt instruments (or hybrid financial instruments that are determined to have a debt host) with embedded call (put) options. The amendments in this update clarify the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt host. An entity performing the assessment under the amendments in this Update is required to assess the embedded call (put) options solely in accordance with the four-step decision sequence. For public business entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. For entities other than public business entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within fiscal years beginning after December 15, 2018. Early adoption is permitted, including adoption in an interim period. The Company is currently evaluating the impact the adoption of the standard will have on the Company's financial position or results of operations.

In March 2016, the FASB issued ASU 2016-07, Investments – Equity Method and Joint Ventures (Topic 323).  The Update affects all entities that have an investment that becomes qualified for the equity method of accounting as a result of an increase in the level of ownership interest or degree of influence. The amendments in this Update eliminate the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. The amendments require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor's previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. Therefore, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required. The amendments in this Update require that an entity that has an available-for-sale equity security that becomes qualified for the equity method of accounting recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method. The amendments in this Update are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. The amendments should be applied prospectively upon their effective date to increases in the level of ownership interest or degree of influence that result in the adoption of the equity method. Earlier application is permitted. This Update is not expected to have a significant impact on the Company's financial statements.

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606). The amendments in this Update affect entities with transactions included within the scope of Topic 606, which includes entities that enter into contracts with customers to transfer goods or services (that are an output of the entity's ordinary activities) in exchange for consideration. The amendments in this update do not change the core principle of the guidance in Topic 606; they simply clarify the implementation guidance on principal versus agent considerations. The amendments in this Update are intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations. The amendments in this Update affect the guidance in ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which is not yet effective. The effective date and transition requirements for the amendments in this Update are the same as the effective date and transition requirements of Update 2014-09. ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, defers the effective date of Update 2014-09 by one year.  The Company is currently evaluating the impact the adoption of the standard will have on the Company's financial position or results of operations.

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In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718). The amendments in this Update affect all entities that issue share-based payment awards to their employees. The standards in this Update provide simplification for several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as with equity or liabilities, and classification on the statement of cash flows. Some of the areas for simplification apply only to nonpublic entities. In addition to those simplifications, the amendments eliminate the guidance in Topic 718 that was indefinitely deferred shortly after the issuance of FASB Statement No. 123 (revised 2004), Share-Based Payment. This should not result in a change in practice because the guidance that is being superseded was never effective. For public business entities, the amendments in this Update are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. For all other entities, the amendments are effective for annual periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. Early adoption is permitted for any entity in any interim or annual period. The Company is currently evaluating the impact the adoption of the standard will have on the Company's financial position or results of operations.

In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606).  The amendments in this Update affect entities with transactions included within the scope of Topic 606, which includes entities that enter into contracts with customers to transfer goods or services in exchange for consideration. The amendments in this Update do not change the core principle for revenue recognition in Topic 606. Instead, the amendments provide (1) more detailed guidance in a few areas and (2) additional implementation guidance and examples based on feedback the FASB received from its  stakeholders. The amendments are expected to reduce the degree of judgment necessary to comply with Topic 606, which the FASB expects will reduce the potential for diversity arising in practice and reduce the cost and complexity of applying the guidance.  The amendments in this Update affect the guidance in ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which is not yet effective. The effective date and transition requirements for the amendments in this Update are the same as the effective date and transition requirements in Topic 606 (and any other Topic amended by Update 2014-09). ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, defers the effective date of Update 2014-09 by one year.  The Company is currently evaluating the impact the adoption of the standard will have on the Company's financial position or results of operations.

In May 2016, the FASB issued ASU 2016-11, Revenue Recognition (Topic 605) and Derivative and Hedging (Topic 815), which rescinds SEC paragraphs pursuant to two SEC Staff Announcements at the March 3, 2016, Emerging Issues Task Force meeting.  This Update did not have a significant impact on the Company's financial statements

In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606), which among other things clarifies the objective of the collectability criterion in Topic 606, as well as certain narrow aspects of Topic 606. The amendments in this Update affect the guidance in ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which is not yet effective. The effective date and transition requirements for the amendments in this Update are the same as the effective date and transition requirements for Topic 606 (and any other Topic amended by Update 2014-09). ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, defers the effective date of Update 2014-09 by one year. This Update is not expected to have a significant impact on the Company's financial statements

33
In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses: Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"), which changes the impairment model for most financial assets. This ASU is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations.  The underlying premise of the ASU is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management's current estimate of credit losses that are expected to occur over the remaining life of a financial asset.  The income statement will be effected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted for annual and interim periods beginning after December 15, 2018. With certain exceptions, transition to the new requirements will be through a cumulative effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is adopted.  The Company is currently evaluating the impact the adoption of the standard will have on the Company's financial position or results of operations.

34
ITEM 2. Management’sManagement's Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
We have made forward-looking statements in this document, and in documents that we incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumedexpected future results of operations of Citizens Financial Services, Inc., First Citizens Community Bank, First Citizens Insurance Agency, Inc. or the combined Company. When we use words such as “believes,” “expects,” “anticipates,”"believes," "expects," "anticipates," or similar expressions, we are making forward-looking statements. For a variety of reasons, actual results could differ materially from those contained in or implied by forward-looking statements.  The Company cautions readers that the following important factors, among others, could in the future affect the Company’sCompany's actual results and could cause the Company’sCompany's actual results for subsequent periods to differ materially from those expressed in any forward-looking statement:
·
Interest rates could change more rapidly or more significantly than we expect.
expect.
·The economy could change significantly in an unexpected way, which would cause the demand for new loans and the ability of borrowers to repay outstanding loans to change in ways that our models do not anticipate.
·The financial markets could suffer a significant disruption, which may have a negative effect on our financial condition and that of our borrowers, and on our ability to raise money by issuing new securities.
·It could take us longer than we anticipate implementingto implement strategic initiatives designed to increase revenues or manage expenses, or we may be unable to implement those initiatives at all.
·We may not be able to successfully integrate businesses we acquire or be able to fully realize the expected financial and other benefits from acquisitions.
·Acquisitions and dispositions of assets could affect us in ways that management has not anticipated.
·We may become subject to new legal obligations or the resolution of litigation may have a negative effect on our financial condition or operating results.
·We may become subject to new and unanticipated accounting, tax, or regulatory practices or requirements.
·We could experience greater loan delinquencies than anticipated, adversely affecting our earnings and financial condition.
·  We could also experience greater losses than expected due to the ever increasing volume of information theft and fraudulent scams impacting our customers and the banking industry.
·We could lose the services of some or all of our key personnel, which would negatively impact our business because of their business development skills, financial expertise, lending experience, technical expertise and market area knowledge.
·The agricultural economy is subject to extreme swings in both the costs of resources and the prices received from the sale of products, which could negatively impact our customers.
·ExplorationDelays in passing a budget by the Commonwealth of Pennsylvania could impact our asset values, liquidity and profitability.
·Companies providing support services related to the exploration and drilling of the natural gas reserves in our market area may be affected by federal, state and local laws and regulations such as restrictions on production, permitting, changes in taxes and environmental protection, which could negatively impact our customers and, as a result, negatively impact our loan and deposit volume and loan quality.
·  Similarly, customers dependent on Additionally, the activities of the companies providing support services related to the exploration and drilling of the natural gas reserves may be dependent on the market price of natural gas.  As a result, decreases in the market price of natural gas could also negatively impact these companies, our customers.

Additional factors that may affect our results are discussed under “Part"Part II – Item 1A – Risk Factors”Factors" in this report and in the Company’s 2014Company's 2015 Annual Report on Form 10-K under “Item"Item 1.A/ Risk Factors.”"  Except as required by applicable law and regulation, we assume no obligation to update or revise any forward-looking statements after the date on which they are made.
 
3035
Introduction
Introduction

The following is management's discussion and analysis of the financial condition and results of operations at the dates and for the periods presented in the accompanying consolidated financial statements for the Company.  Our Company's consolidated financial condition and results of operations consist almost entirely of the Bank’sBank's financial condition and results of operations. Management’sManagement's discussion and analysis should be read in conjunction with the preceding financial statements presented under Part I.  The results of operations for the three and six months ended June 30, 20152016 are not necessarily indicative of the results you may expect for the full year.

The Company currently engages in the general business of banking throughout our service area of Clinton, Potter, Tioga, Clinton and Bradford counties in North Centralnorth central Pennsylvania, Lebanon, Lancaster, Berks and Schuylkill counties in south central Pennsylvania and Allegany Steuben, Chemung and Tioga countiescounty in Southernsouthern New York. We maintain our maincentral office in Mansfield, Pennsylvania. Presently we operate 2026 banking facilities, 1824 of which operate as bank branches.  In Pennsylvania, we have branchthese offices are located in Mansfield, Blossburg, Ulysses, Genesee, Wellsboro, Troy, Sayre, Canton, Gillett, Millerton, LeRaysville, Towanda, Rome, the Wellsboro Weis Market store, the Mansfield Wal-Mart Super Center, and Mill Hall, which was openedSchuylkill Haven, Friedensburg, Mt. Aetna, Fredericksburg and three branches near the city of Lebanon, Pennsylvania. In New York, our office is in 2015.Wellsville. We also have a loan production office in Dallas, Pennsylvania.Winfield, Pennsylvania, which primarily serves agricultural customers in the central Pennsylvania market. In New York,the third quarter of 2016, we havereceived regulatory approval to establish a branch officeto be located in Wellsville, Allegany County.Mount Joy, Pennsylvania, which we anticipate opening in September 2016.

In the second quarter of 2015, the Company entered into a definitive agreement to acquire The First National Bank of Fredericksburg, which is expected to close in the fourth quarter of 2015.

Risk Management

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

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

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

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

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

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

3136
Competition
Competition

The banking industry in the Bank’sBank's service area continuesareas continue to be extremely competitive, both among commercial banks and with financial service providers such as consumer finance companies, thrifts, investment firms, mutual funds, insurance companies, credit unions, agricultural cooperatives and internet entities.  The increased competition has resulted from changes in the legal and regulatory guidelines as well as from economic conditions specifically, the additional wealth resulting from the exploration of natural gas in our primary marketnorth central and south central Pennsylvania markets and the limited loan growth opportunities in our primarythe north central market and surrounding areas.  Mortgage banking firms, financial companies, financial affiliates of industrial companies, brokerage firms, retirement fund management firms and even government agencies provide additional competition for loans and other financial services.  The Bank is generally competitive with all competing financial institutions in its service area with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans.

Trust and Investment Services; Oil and Gas Services

Our Investment and Trust Services DepartmentDivision offers professional trust administration, investment management services, estate planning and administration, and custody of securities.  Assets held by the Company in a fiduciary or agency capacity for its customers are not included in the Consolidated Financial Statements since such items are not assets of the Company.  Revenues and fees of the Trust Department are reflected in trust income in the Company’s financial statements.Consolidated Statement of Income. As of June 30, 20152016 and December 31, 2014,2015, the Trust Department had $96.5$110.8 million and $100.7$110.2 million of assets under management, respectively. The decrease in assets under management was primarily due to one trust account closing in the second quarter of 2015.

Our Investment Representatives offer full service brokerage services and financial planning throughout the Bank’sBank's market area. Products such as mutual funds, annuities, health and life insurance are made available through our insurance subsidiary, First Citizens Insurance Agency, Inc.  The assets associated with these products are not included in the Consolidated Financial Statements since such items are not assets of the Company. Assets owned and invested by customers of the Bank through the Bank’sBank's Investment Representatives increased from $111.7$119.7 million at December 31, 20142015 to $116.8$130.1 million at June 30, 2015.2016. Fee income from the sale of these products is reflected in the Company’s financial statements as a component of non-interestbrokerage and insurance income in the Consolidated Statement of Income. Management believes that there are opportunities to increase non-interest income through these products and services, and as such, has added additional resources to support these opportunities.

In addition to the trust and investment services offered we have an oil and gasa mineral management division, which serves as a network of experts to assist our customers through various oil and gas specific leasing matters from lease negotiations to establishing a successful approach to personal wealth management. As of June 30, 2015,2016, customers owning 8,3005,955 acres have signed agreements with the Bank that provide for the Bank to manage oil and gas matters related to the customers land, which may include negotiating lease payments and royalty percentages, resolving leasing issues, accounting for and ensuring the accuracy of royalty checks, distributing revenue to satisfy investment objectives and providing customized reports outlining payment and distribution information.

Results of Operations

Overview of the Income Statement

The Company had net income of $6,309,000$6,314,000 for the first six months of 20152016 compared to $6,541,000$6,309,000 for last year’syear's comparable period, a decreasean increase of $232,000 or 3.6%.$5,000. Basic earnings per share for the first six months of 20152016 were $2.09,$1.88, compared to $2.15$2.06 last year, representing a 3.0%an 8.7% decrease.  Annualized return on assets and return on equity for the six months of 20152016 were 1.36%1.06% and 12.41%10.34%, respectively, compared with 1.45%1.36% and 13.63%12.41% for last year’syear's comparable period.

Net income for the three months ended June 30, 20152016 was $3,189,000$3,031,000 compared to $3,365,000$3,189,000 in the comparable 20142015 period, a decrease of $176,000$158,000 or 5.2%5.0%. Basic earnings per share for the three months ended June 30, 20152016 were $1.06,$0.91, compared to $1.11$1.04 last year, representing a 4.6%12.5% decrease. Annualized return on assets and return on equity for the quarter ended June 30, 20152016 was 1.36%1.02% and 12.45%9.88%, respectively, compared with 1.49%1.36% and 13.88%12.45% for the same 20142015 period.

3237

Net Interest Income

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

Net interest income for the first six months of 20152016 was $15,148,000, a decrease$18,376,000, an increase of $14,000,$3,228,000, or 0.1%21.3%, compared to the same period in 2014.2015.  For the first six months of 2015,2016, the provision for loan losses totaled $240,000, a decrease$270,000, an increase of $90,000$30,000 over the comparable period in 2014.2015.  Consequently, net interest income after the provision for loan losses was $14,908,000$18,106,000 compared to $14,832,000$14,908,000 during the first six months of 2014.2015.

For the three months ended June 30, 2015,2016, net interest income was $7,561,000$9,171,000 compared to $7,650,000, a decrease$7,561,000, an increase of $89,000,$1,610,000, or 1.2%21.3% over the comparable period in 2014.2015. The provision for loan losses this quarter was $120,000$135,000 compared to $150,000$120,000 for last year’syear's second quarter.  Consequently, net interest income after the provision for loan losses was $7,441,000$9,036,000 for the quarter ended June 30, 20152016 compared to $7,500,000$7,441,000 in 2014.2015.

The following table sets forth the average balances of, and the interest earned or incurred on, for each principal category of assets, liabilities and stockholders’stockholders' equity, the related rates, net interest income and interest rate spread created for the six months and three months ended June 30, 20152016 and 20142015 on a tax equivalent basis (dollars in thousands):

3338
  Analysis of Average Balances and Interest Rates (1) 
  Six Months Ended 
  June 30, 2016  June 30, 2015 
  Average     Average  Average     Average 
  Balance (1)  Interest  Rate  Balance (1)  Interest  Rate 
(dollars in thousands) $  $   %  $ $  % 
ASSETS                      
Short-term investments:                      
   Interest-bearing deposits at banks  32,770   65   0.40   14,331   12   0.17 
Total short-term investments  32,770   65   0.40   14,331   12   0.17 
Interest bearing time deposits at banks  7,513   70   1.89   5,960   58   1.97 
Investment securities:                        
  Taxable  263,302   2,044   1.55   195,079   1,652   1.69 
  Tax-exempt (3)  100,766   2,313   4.59   99,925   2,498   5.00 
  Total investment securities  364,068   4,357   2.39   295,004   4,150   2.81 
Loans:                        
  Residential mortgage loans  202,813   5,337   5.29   183,827   5,057   5.55 
  Construction  11,247   286   5.12   6,313   160   5.11 
  Commercial & agricultural loans  371,026   9,627   5.22   280,823   7,377   5.30 
  Loans to state & political subdivisions  103,707   2,201   4.27   83,055   1,853   4.50 
  Other loans  11,103   449   8.13   8,120   322   8.00 
  Loans, net of discount (2)(3)(4)  699,896   17,900   5.14   562,138   14,769   5.30 
Total interest-earning assets  1,104,247   22,392   4.08   877,433   18,989   4.36 
Cash and due from banks  7,352           3,933         
Bank premises and equipment  17,264           12,579         
Other assets  57,268           35,788         
Total non-interest earning assets  81,884           52,300         
Total assets  1,186,131           929,733         
LIABILITIES AND STOCKHOLDERS' EQUITY                     
Interest-bearing liabilities:                        
  NOW accounts  303,297   468   0.31   231,106   407   0.36 
  Savings accounts  174,141   93   0.11   112,734   67   0.12 
  Money market accounts  114,478   257   0.45   94,474   219   0.47 
  Certificates of deposit  275,925   1,328   0.97   249,866   1,351   1.09 
Total interest-bearing deposits  867,841   2,146   0.50   688,180   2,044   0.60 
Other borrowed funds  39,500   366   1.86   33,603   347   2.08 
Total interest-bearing liabilities  907,341   2,512   0.56   721,783   2,391   0.67 
Demand deposits  144,198           97,498         
Other liabilities  12,487           8,813         
Total non-interest-bearing liabilities  156,685           106,311         
Stockholders' equity  122,105           101,639         
Total liabilities & stockholders' equity  1,186,131           929,733         
Net interest income      19,880           16,598     
Net interest spread (5)          3.52%          3.69%
Net interest income as a percentage                        
  of average interest-earning assets          3.62%          3.81%
Ratio of interest-earning assets                        
  to interest-bearing liabilities          122%          122%
                         
(1) Averages are based on daily averages.                     
(2) Includes loan origination and commitment fees.                     
(3) Tax exempt interest revenue is shown on a tax equivalent basis for proper comparison using         
a statutory federal income tax rate of 34%.             
(4) Income on non-accrual loans is accounted for on a cash basis, and the loan balances are included in interest-earning assets. 
(5) Interest rate spread represents the difference between the average rate earned on interest-earning assets 
and the average rate paid on interest-bearing liabilities.                 


 Analysis of Average Balances and Interest Rates (1)
 Six Months Ended
 June 30, 2015June 30, 2014
 Average AverageAverage Average
 Balance (1)InterestRateBalance (1)InterestRate
(dollars in thousands)$$%$$%
ASSETS      
Short-term investments:      
   Interest-bearing deposits at banks       14,331               120.17          5,701                  10.04
Total short-term investments       14,331               120.17          5,701                  10.04
Interest bearing time deposits at banks         5,960               581.97          2,480                252.02
Investment securities:      
  Taxable     195,079         1,6521.69      217,369          1,8561.71
  Tax-exempt (3)       99,925         2,4985.00        95,832          2,5485.32
  Total investment securities     295,004         4,1502.81      313,201          4,4042.81
Loans:      
  Residential mortgage loans     183,827         5,0575.55      186,727          5,2845.71
  Construction         6,313             1605.11          5,383              1234.61
  Commercial & agricultural loans     280,823         7,3775.30      270,348          7,3205.46
  Loans to state & political subdivisions       83,055         1,8534.50        64,911          1,5224.73
  Other loans         8,120             3228.00          8,862              3598.17
  Loans, net of discount (2)(3)(4)     562,138       14,7695.30      536,231        14,6085.49
Total interest-earning assets     877,433       18,9894.36      857,613        19,0384.48
Cash and due from banks         3,933            3,777  
Bank premises and equipment       12,579          11,122  
Other assets       35,788          29,174  
Total non-interest earning assets       52,300          44,073  
Total assets     929,733        901,686  
LIABILITIES AND STOCKHOLDERS' EQUITY     
Interest-bearing liabilities:      
  NOW accounts     231,106             407            0.36      218,528              388            0.36
  Savings accounts     112,734               67            0.12        98,444                55            0.11
  Money market accounts       94,474             219            0.47        84,579              189            0.45
  Certificates of deposit     249,866         1,351            1.09      261,932          1,567            1.21
Total interest-bearing deposits     688,180         2,044            0.60      663,483          2,199            0.67
Other borrowed funds       33,603             347            2.08        45,569              309            1.37
Total interest-bearing liabilities     721,783         2,391            0.67      709,052          2,508            0.71
Demand deposits       97,498          89,396  
Other liabilities         8,813            7,252  
Total non-interest-bearing liabilities     106,311          96,648  
Stockholders' equity     101,639          95,986  
Total liabilities & stockholders' equity     929,733        901,686  
Net interest income        16,598          16,530 
Net interest spread (5)  3.69%  3.77%
Net interest income as a percentage      
  of average interest-earning assets  3.81%  3.89%
Ratio of interest-earning assets      
  to interest-bearing liabilities  122%  121%
       
(1) Averages are based on daily averages.     
(2) Includes loan origination and commitment fees.     
(3) Tax exempt interest revenue is shown on a tax equivalent basis for proper comparison using  
       a statutory federal income tax rate of 34%.   
(4) Income on non-accrual loans is accounted for on a cash basis, and the loan balances are included in interest-earning assets.
(5) Interest rate spread represents the difference between the average rate earned on interest-earning assets
      and the average rate paid on interest-bearing liabilities.    
3439
 
  Analysis of Average Balances and Interest Rates (1) 
  Three Months Ended 
  June 30, 2016  June 30, 2015 
  Average     Average  Average     Average 
  Balance (1)  Interest  Rate  Balance (1)  Interest  Rate 
(dollars in thousands) $      $%  $      $% 
ASSETS                      
Short-term investments:                      
   Interest-bearing deposits at banks  31,880   30   0.38   19,879   10   0.19 
Total short-term investments  31,880   30   0.38   19,879   10   0.19 
Interest bearing time deposits at banks  7,332   34   1.85   5,960   29   1.97 
Investment securities:                        
  Taxable  258,197   1,020   1.58   188,736   799   1.69 
  Tax-exempt (3)  101,428   1,144   4.51   97,443   1,212   4.98 
  Total investment securities  359,625   2,164   2.41   286,179   2,011   2.87 
Loans:                        
  Residential mortgage loans  203,091   2,665   5.28   183,251   2,519   5.51 
  Construction  9,198   121   5.29   6,912   89   5.15 
  Commercial & farm loans  376,795   4,865   5.19   285,580   3,730   5.24 
  Loans to state & political subdivisions  101,348   1,058   4.20   84,776   936   4.43 
  Other loans  10,975   220   8.07   8,064   160   7.94 
  Loans, net of discount (2)(3)(4)  701,407   8,929   5.12   568,583   7,434   5.24 
Total interest-earning assets  1,100,244   11,157   4.08   880,601   9,484   4.32 
Cash and due from banks  7,530           3,988         
Bank premises and equipment  17,236           12,611         
Other assets  64,904           41,736         
Total non-interest earning assets  89,670           58,335         
Total assets  1,189,914           938,936         
LIABILITIES AND STOCKHOLDERS' EQUITY                     
Interest-bearing liabilities:                        
  NOW accounts  310,640   243   0.31   236,864   209   0.35 
  Savings accounts  173,176   46   0.11   114,764   35   0.12 
  Money market accounts  113,373   126   0.45   94,609   109   0.46 
  Certificates of deposit  272,809   657   0.97   250,091   682   1.09 
Total interest-bearing deposits  869,998   1,072   0.50   696,328   1,035   0.60 
Other borrowed funds  39,369   183   1.87   30,849   172   2.24 
Total interest-bearing liabilities  909,367   1,255   0.55   727,177   1,207   0.67 
Demand deposits  145,164           100,865         
Other liabilities  12,642           8,441         
Total non-interest-bearing liabilities  157,806           109,306         
Stockholders' equity  122,741           102,453         
Total liabilities & stockholders' equity  1,189,914           938,936         
Net interest income      9,902           8,277     
Net interest spread (5)          3.53%          3.65%
Net interest income as a percentage                        
  of average interest-earning assets          3.62%          3.77%
Ratio of interest-earning assets                        
  to interest-bearing liabilities          121%          121%
                         
(1) Averages are based on daily averages.                     
(2) Includes loan origination and commitment fees.                     
(3) Tax exempt interest revenue is shown on a tax equivalent basis for proper comparison using         
a statutory federal income tax rate of 34%.             
(4) Income on non-accrual loans is accounted for on a cash basis, and the loan balances are included in interest-earning assets. 
(5) Interest rate spread represents the difference between the average rate earned on interest-earning assets     
and the average rate paid on interest-bearing liabilities.                 

 Analysis of Average Balances and Interest Rates (1)
  Three Months Ended
 June 30, 2015June 30, 2014
 Average AverageAverage Average
 Balance (1)InterestRateBalance (1)InterestRate
(dollars in thousands)$$%$$%
ASSETS      
Short-term investments:      
   Interest-bearing deposits at banks        19,879                100.19            6,122                    -0.03
Total short-term investments        19,879                100.19            6,122                    -0.03
Interest bearing time deposits at banks           5,960                291.97            2,480                 132.02
Investment securities:      
  Taxable      188,736              7991.69        212,143               9181.73
  Tax-exempt (3)        97,443           1,2124.98          96,282            1,2725.28
  Total investment securities      286,179           2,0112.87        308,425            2,1902.84
Loans:      
  Residential mortgage loans      183,251           2,5195.51        187,129            2,6545.69
  Construction           6,912                895.15            3,450                 414.77
  Commercial & farm loans      285,580           3,7305.24        272,525            3,7035.45
  Loans to state & political subdivisions        84,776              9364.43          66,335               8124.91
  Other loans           8,064              1607.94            8,716               1768.10
  Loans, net of discount (2)(3)(4)      568,583           7,4345.24        538,155            7,3865.50
Total interest-earning assets      880,601           9,4844.32        855,182            9,5894.50
Cash and due from banks           3,988              3,771  
Bank premises and equipment        12,611            11,174  
Other assets        41,736            31,121  
Total non-interest earning assets        58,335            46,066  
Total assets      938,936          901,248  
LIABILITIES AND STOCKHOLDERS' EQUITY��    
Interest-bearing liabilities:      
  NOW accounts      236,864              209             0.35        220,310               194              0.35
  Savings accounts      114,764                35             0.12        100,025                 27              0.11
  Money market accounts        94,609              109             0.46          85,869                 95              0.44
  Certificates of deposit      250,091              682             1.09        259,344               778              1.20
Total interest-bearing deposits      696,328           1,035             0.60        665,548            1,094              0.66
Other borrowed funds        30,849              172             2.24          39,990               145              1.45
Total interest-bearing liabilities      727,177           1,207             0.67        705,538            1,239              0.70
Demand deposits      100,865            91,798  
Other liabilities           8,441              6,924  
Total non-interest-bearing liabilities      109,306            98,722  
Stockholders' equity      102,453            96,988  
Total liabilities & stockholders' equity      938,936          901,248  
Net interest income            8,277              8,350 
Net interest spread (5)  3.65%  3.80%
Net interest income as a percentage      
  of average interest-earning assets  3.77%  3.92%
Ratio of interest-earning assets      
  to interest-bearing liabilities  121%  121%
       
(1) Averages are based on daily averages.     
(2) Includes loan origination and commitment fees.     
(3) Tax exempt interest revenue is shown on a tax equivalent basis for proper comparison using a statutory federal income tax rate of 34%.
(4) Income on non-accrual loans is accounted for on a cash basis, and the loan balances are included in interest-earning assets.
(5) Interest rate spread represents the difference between the average rate earned on interest-earning assets 
      and the average rate paid on interest-bearing liabilities.    

35
Tax exempt revenue is shown on a tax-equivalent basis for proper comparison using a statutory, federal income tax rate of 34%.  For purposes of the comparison, as well as the discussion that follows, this presentation facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Company’sCompany's 34% Federal statutory rate.  The following table represents the adjustment to convert net interest income to net interest income on a fully taxable equivalent basis for the periods ending June 30, 20152016 and 20142015 (in thousands):
40
 
    For the Three Months
 
    For the Six Months
 
    Ended June 30
 
    Ended June 30
 
    2015
    2014
 
    2015
    2014
Interest and dividend income from investment securities     
   and interest bearing deposits at banks (non-tax adjusted) $             1,639 $              1,771  $        3,371 $     3,564
Tax equivalent adjustment                   411                    432                849            866
Interest and dividend income from investment securities     
   and interest bearing deposits at banks (tax equivalent basis) $             2,050 $              2,203  $        4,220 $     4,430
      
Interest and fees on loans (non-tax adjusted) $             7,129 $              7,118  $      14,168 $   14,106
Tax equivalent adjustment                   305                    268                601            502
Interest and fees on loans (tax equivalent basis) $             7,434 $              7,386  $      14,769 $   14,608
      
Total interest income $             8,768 $              8,889  $      17,539 $   17,670
Total interest expense                1,207                 1,239             2,391        2,508
Net interest income                7,561                 7,650          15,148      15,162
Total tax equivalent adjustment                   716                    700             1,450        1,368
Net interest income (tax equivalent basis) $             8,277 $              8,350  $      16,598 $   16,530
  For the Three Months  For the Six Months 
  Ended June 30,  Ended June 30, 
  2016  2015  2016  2015 
Interest and dividend income from investment securities            
   and interest bearing deposits at banks (non-tax adjusted) $1,839  $1,639  $3,705  $3,371 
Tax equivalent adjustment  389   411   787   849 
Interest and dividend income from investment securities                
   and interest bearing deposits at banks (tax equivalent basis) $2,228  $2,050  $4,492  $4,220 
                 
Interest and fees on loans (non-tax adjusted) $8,587  $7,129  $17,183  $14,168 
Tax equivalent adjustment  342   305   717   601 
Interest and fees on loans (tax equivalent basis) $8,929  $7,434  $17,900  $14,769 
                 
Total interest income $10,426  $8,768  $20,888  $17,539 
Total interest expense  1,255   1,207   2,512   2,391 
Net interest income  9,171   7,561   18,376   15,148 
Total tax equivalent adjustment  731   716   1,504   1,450 
Net interest income (tax equivalent basis) $9,902  $8,277  $19,880  $16,598 

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

  Three months ended June 30, 2016 vs. 2015 (1)  Six months ended June 30, 2016 vs. 2015 (1) 
  Change in  Change  Total  Change in  Change  Total 
  Volume  in Rate  Change  Volume  in Rate  Change 
Interest Income:                  
Short-term investments:                  
  Interest-bearing deposits at banks $7  $13  $20  $26  $27  $53 
Interest bearing time deposits at banks  7   (2)  5   14   (2)  12 
Investment securities:                        
  Taxable  270   (49)  221   515   (123)  392 
  Tax-exempt  53   (121)  (68)  21   (206)  (185)
Total investments  323   (170)  153   536   (329)  207 
Loans:                        
  Residential mortgage loans  246   (100)  146   494   (214)  280 
  Construction  29   3   32   125   1   126 
  Commercial & agricultural loans  1,167   (32)  1,135   2,360   (110)  2,250 
  Loans to state & political subdivisions  167   (45)  122   437   (89)  348 
  Other loans  57   3   60   121   6   127 
Total loans, net of discount  1,666   (171)  1,495   3,537   (406)  3,131 
Total Interest Income  2,003   (330)  1,673   4,113   (710)  3,403 
Interest Expense:                        
Interest-bearing deposits:                        
  NOW accounts  53   (19)  34   102   (41)  61 
  Savings accounts  15   (4)  11   32   (6)  26 
  Money Market accounts  20   (3)  17   45   (7)  38 
  Certificates of deposit  86   (111)  (25)  350   (373)  (23)
Total interest-bearing deposits  174   (137)  37   529   (427)  102 
Other borrowed funds  28   (17)  11   46   (27)  19 
Total interest expense  202   (154)  48   575   (454)  121 
Net interest income $1,801  $(176) $1,625  $3,538  $(256) $3,282 
                         
(1) The portion of the total change attributable to both volume and rate changes, which can not be separated, has been allocated proportionally to the change due to volume and the change due to rate prior to allocation. 
Analysis of Changes in Net Interest Income on a Tax-Equivalent Basis (1)
  Three months ended June 30, 2015 vs. 2014 (1) Six months ended June 30, 2015 vs. 2014 (1)
  Change in Change Total Change in Change Total
  Volume in Rate Change Volume in Rate Change
Interest Income:      
Short-term investments:      
  Interest-bearing deposits at banks $                  3 $                  7 $          10 $             3 $             8 $           11
Interest bearing time deposits at banks                   17                    (1)   16              34               (1)              33
Investment securities:      
  Taxable                  (99)                  (20) (119)           (189)             (15)           (204)
  Tax-exempt                   16                  (76)  (60)            125           (175)             (50)
Total investments                  (83)                  (96) (179)             (64)           (190)           (254)
Loans:      
  Residential mortgage loans                  (54)                  (81) (135)             (81)           (146)           (227)
  Construction                   45                     3   48              23              14              37
  Commercial & agricultural loans                 141                (114)   27            247           (190)              57
  Loans to state & political subdivisions                 191                  (67)124            401             (70)            331
  Other loans                  (13)                    (3)  (16)             (30)               (7)             (37)
Total loans, net of discount                 310                (262)   48            560           (399)            161
Total Interest Income                 247                (352) (105)            533           (582)             (49)
Interest Expense:      
Interest-bearing deposits:      
  NOW accounts                   15                      -   15              22               (3)              19
  Savings accounts                     4                     4     8                8                4              12
  Money Market accounts                   10                     4   14              23                7              30
  Certificates of deposit                  (27)                  (69)  (96)             (70)           (146)           (216)
Total interest-bearing deposits                     2                  (61)  (59)             (17)           (138)           (155)
Other borrowed funds                  (20)                   47   27             (38)              76              38
Total interest expense                  (18)                  (14)  (32)             (55)             (62)           (117)
Net interest income $              265 $             (338) $       (73) $         588 $        (520) $           68
       
(1) The portion of the total change attributable to both volume and rate changes, which can not be separated, has been allocated proportionally to the change due to volume and the change due to rate prior to allocation.
36

Tax equivalent net interest income increased from $16,530,000 for the six month period ended June 30, 2014 to $16,598,000 for the six month period ended June 30, 2015 to $19,880,000 for the six month period ended June 30, 2016, an increase of $68,000.$3,282,000. The tax equivalent net interest margin decreased from 3.89%3.81% for the first six months of 20142015 to 3.81%3.62% for the comparable period in 2015.
2016.
Total tax equivalent interest income for the 20152016 six month period decreased $49,000increased $3,403,000 as compared to the 20142015 six month period. This decreaseincrease was primarily a result of a decreasean increase of $582,000$4,113,000 due to a change in rate,volume as interest bearing assets increased $226.8 million. This increase was offset by a decrease of $710,000 as a result of a decrease in the average yield on interest earning assets decreasedof 28 basis points from 4.48%4.36% to 4.36% or 12 basis points4.08% for the comparable periods. This decreaseThe Bank was offset by an increase of $533,000 asable to add a result of an increase in the average balancesignificant amount of interest earning assets as a result the acquisition of $19.8 million for the comparable periods. While the Bank has been able to add interest earning assets, the newFNB; however, these assets are priced at lower rates than assets that have matured duerates. In addition to the prolonged lowacquisition of FNB, the Company was able to grow loans in its historical markets during 2015 and 2016 and has experienced loan demand in its central Pennsylvania office, which contributed to the volume increase experienced in interest rate environment. Additionally, assets repriced at lower rates during the 2015 period.bearing assets.
41
Tax equivalent investment income for the six months ended June 30, 2015 decreased $254,0002016 increased $207,000 over the same period last year. The primary causescause of the decrease were a decreaseincrease was an increase in the average outstanding balance of taxable securities and a decrease in the yield earned on tax exempt securities.
·The average balance of taxable securities decreasedincreased by $22.3$68.2 million which resulted in a decreasean increase in investment income of $189,000.$515,000. The reason there was such a large decreaseincrease in the average balance of taxable securities was due to less than favorable investment opportunities.the acquisition of FNB and purchases made to utilize some of the excess liquidity acquired as part of the acquisition. The yield earned on taxable securities decreased 214 basis points from 1.69% to 1.55% as a result of purchases made in this low rate environment, which resulted in a further decrease in investment incomeincluded securities acquired as part of $15,000.the FNB acquisition.
·The yield on tax-exempt securities decreased 3241 basis points from 5.32%5.00% to 5.00%4.59%, which corresponds to a decrease in interest income of $175,000.$206,000. The yield decrease was due to the amount of purchases we made in the current low interest rate environment. For a discussion of the Company’sCompany's current investment strategy, see the “Financial"Financial Condition – Investments”Investments". Offsetting this decrease in yield, the average balance of tax-exempt securities increased $4.1 million$841,000 resulting in an increase in investment income of $125,000.$21,000.
The purchase of tax-exempt securities, along with municipal loans and investment tax credits, allows us to manage and reduce our effective tax rate as well as increase the overall after-tax yield on our interest earning assets.
Total loan interest income increased $161,000$3,131,000 for the six months ended June 30, 20152016 compared to the same period last year.
year, primarily as a result of the acquisition of FNB and loan growth that occurred in 2015 and 2016 in our historical markets and the new central Pennsylvania market.
·The average balance of statecommercial and political subdivisionagricultural loans increased $18.1$90.2 million from a year ago. This had a positive impact of $401,000 on total interest income due to volume. Offsetting this increase, the yield earned decreased 23 basis points to 4.50%, which decreased loan interest income $70,000.
·  The average balance of commercial and agricultural loans increased $10.5 million from a year ago. This had a positive impact of $247,000$2,360,000 on total interest income due to volume, which was offset by a decrease of $190,000$110,000 due to rate, as the yield earned decreased from 5.46%5.30% to 5.30%5.22% due to the continued low rate environment and increased competition.the assets acquired as part of the FNB acquisition, which have a lower yield than our historical portfolio.
·The average balance of state and political subdivision loans increased $20.7 million from a year ago as a result of the FNB acquisition. This had a positive impact of $437,000 on total interest income due to volume. Offsetting this increase, the yield decreased 23 basis points to 4.27%, which decreased loan interest income $89,000.
·Interest income on residential mortgage loans decreased $227,000.increased $280,000. The average balance of residential loans decreased $2.9increased $19.0 million from a year ago.ago due to the FNB acquisition. This resulted in a decreasean increase in loan interest income of $81,000. Additionally,$494,000. Offsetting the increase, the yield earned on residential loans decreased 1626 basis points compared to 2014,2015, which corresponds to a decrease in interest income of $146,000.$214,000.
37
Total interest expense decreased $117,000increased $121,000 for the six months ended June 30, 20152016 compared with last year. Ayear primarily as a result of an increase in deposits associated with the acquisition of FNB. Interest expense increased $575,000 as a result of volume as the average balance of interest bearing liabilities increased $185.6 million. Offsetting this increase was a decrease of $62,000 was the$454,000 due to rate as a result of a decrease in the average rate paid from 0.71%0.67% to 0.67%0.56%. The low interest rate environment prompted by the Federal Reserve had the effect of decreasing our rates paid on certificates of deposit. While the Company’sCompany's rates on deposit products are below its historical averages, we believe they are competitive with rates paid by other institutions in the marketplace. The average balance of interest bearing liabilities increased $12.7 million from June 30, 2014 to June 30, 2015. Increases were experienced in NOW accounts of $12.6 million, savings accounts of $14.3 million and money market accounts of $9.9 million. The cumulative effect of these increases was an increase in interest expense of $53,000. Certificates of deposit decreased $12.1 million, which resulted in a decrease in interest expense due to volume of $70,000. (see also “Financial Condition – Deposits”).
·Interest expense onThe average balance of interest bearing deposits increased $179.7 million from June 30, 2015 to June 30, 2016. Increases were experienced in NOW accounts of $72.2 million, savings accounts of $61.4 million, money market accounts of $20.0 million and certificates of deposits decreased $216,000 overdeposit of $26.1 million. The cumulative effect of these increases was an increase in interest expense of $529,000, which was primarily driven by the same period last year. FNB acquisition. (see also "Financial Condition – Deposits").
42
·There was a decrease in the average rate on certificates of deposit from 1.21%1.09% to 1.09%0.97% resulting in a decrease in interest expense of $146,000. Additionally, the average balance of certificates of deposit decreased $12.1 million causing a decrease in interest expense of $70,000.$373,000.
·  Interest expense on other borrowed funds increased $38,000 over the same period last year. The primary cause of the increase was the average rate on other borrowed funds increasing 71 basis points resulting in an increase in interest expense of $76,000. The increase in rate on the other borrowed funds is a result of the significant amount of overnight borrowings that were outstanding during the 2014 period compared to the 2015 period. In the current rate environment, overnight borrowings have a lower rate than longer term borrowings. The average balance of other borrowed funds decreased $12.0 million resulting in a decrease in interest expense due to volume of $38,000.
Tax equivalent net interest income for the three months ended June 30, 20152016 was $8,277,000$9,902,000 which compares to $8,350,000$8,277,000 for the same period last year.  This represents a decreasean increase of $73,000$1,625,000 or 0.9%19.6%.
The tax equivalent net interest margin decreased from 3.77% for the three months ended June 30, 2015 to 3.62% for the comparable period in 2016.
Total tax equivalent interest income was $9,484,000$11,157,000 for the three month period ended June 30,2015,30, 2016, compared with $9,589,000to $9,484,000 for the comparable period last year, a decreasean increase of $105,000. The$1,673,000. This primary driver of this increase was an increase of $2,003,000 due to a change in volume as interest bearing assets increased $219.6 million as a result of the FNB acquisition and growth in the north central and central Pennsylvania markets. . This increase was offset by a decrease wasof $330,000 as a result of a decrease in the average yield of 18 basis points on interest earning assets of 24 basis points from 4.50%4.32% to 4.32%:4.08% for the comparable periods.
·Total investment income decreasedincreased by $179,000$153,000 compared to same period last year.  ThisThe primary cause of the increase was duean increase of $69.5 million in the average outstanding balance of taxable securities, which equates to an increase of $270,000. Offsetting this increase, there was a 3047 point decrease in rate on tax exempt investments from 5.28%4.98% to 4.98%4.51%, which equates to a $76,000$121,000 decrease in income. In addition, there was a decrease in income of $99,000 as a result of a $23.4 million decrease in the average balance of taxable securities.
·Total loan interest income increased $48,000$1,495,000 compared to the same period last year. This was primarily due to an increase in volume of $25.4$132.8 million, which corresponds to a $310,000$1,666,000 increase in interest income. This was offset by a decrease in rate of 2612 points from 5.50%5.24% to 5.24%5.12%, which corresponds to a decrease in loan interest income of $262,000.$171,000.
Total interest expense decreased $32,000increased $48,000 for the three months ended June 30, 20152016 compared with last year as a result of a decreasethe increase in the average balance of interest bearing liabilities of $182.2 million, accounting for a $202,000 increase in interest expense. The average rate on interest-bearing liabilities of 3decreased 12 basis points from 0.70%0.67% to 0.67%0.55%, accounting for a $14,000 decrease inwhich reduced interest expense. Additionally, due to a $9.3 million decrease in the average balance of certificates of deposit, there was a $27,000 decrease in interest expense.
expense $154,000.

Provision for Loan Losses

For the six month period ending June 30, 2015,2016, we recorded a provision for loan losses of $240,000,$270,000, which represents a decreasean increase of $90,000$30,000 from the $330,000$240,000 provision recorded in the corresponding six months of last year. The provision was lowerhigher in 20152016 than 20142015 due to the improvementincrease in the credit quality of the loan portfolio.past due loans, special mention loans and substandard loans. see “Financial"Financial Condition – Allowance for Loan Losses and Credit Quality Risk”Risk").

38
For the three months ending June 30, 2015,2016, we recorded a provision of $120,000$135,000 compared to $150,000$120,000 in 2014.
2015.

Non-interest Income

The following table shows the breakdown of non-interest income for the three and six months ended June 30, 2016 and 2015 and 2014 (in(dollars in thousands):

  Six months ended June 30,  Change 
  2016  2015  Amount  % 
Service charges $2,230  $2,004  $226   11.3 
Trust  378   374   4   1.1 
Brokerage and insurance  367   382   (15)  (3.9)
Gains on loans sold  116   98   18   18.4 
Investment securities gains, net  155   301   (146)  (48.5)
Earnings on bank owned life insurance  342   306   36   11.8 
Other  311   218   93   42.7 
Total $3,899  $3,683  $216   5.9 
 
    Six months ended June 30,
    Change
 
    2015
    2014
    Amount
    %
Service charges $                 2,004 $               2,141 $               (137)                (6.4)
Trust                       374                     377                      (3)                (0.8)
Brokerage and insurance                       382                     257                   125               48.6
Gains on loans sold                         98                       70                     28               40.0
Investment securities gains, net                       301                     246                     55               22.4
Earnings on bank owned life insurance                       306                     242                     64               26.4
Other                       218                     209                       9                 4.3
Total $                 3,683 $               3,542 $                141                 4.0
     
 
    Three months ended June 30,
Change
 
    2015
    2014
    Amount
    %
Service charges $                 1,028 $               1,102 $                 (74)                (6.7)
Trust                       180                     186                      (6)                (3.2)
Brokerage and insurance                       255                     137                   118               86.1
Gains on loans sold                         60                       30                     30             100.0
Investment securities gains, net                       175                       75                   100             133.3
Earnings on bank owned life insurance                       154                     121                     33               27.3
Other                       103                     104                      (1)                (1.0)
Total $                 1,955 $               1,755 $                200               11.4
43
  Three months ended June 30,  Change 
  2016  2015  Amount  % 
Service charges $1,128  $1,028  $100   9.7 
Trust  182   180   2   1.1 
Brokerage and insurance  158   255   (97)  (38.0)
Gains on loans sold  70   60   10   16.7 
Investment securities gains, net  128   175   (47)  (26.9)
Earnings on bank owned life insurance  172   154   18   11.7 
Other  145   103   42   40.8 
Total $1,983  $1,955  $28   1.4 

Non-interest income for the six months ended June 30, 20152016 totaled $3,683,000,$3,899,000, an increase of $141,000$216,000 when compared to the same period in 2014.2015. During the first six months of 2014,2016, net investment securitysecurities gains amounted to $301,000$155,000 compared to gains of $246,000$301,000 last year. We sold two US treasury securities and one agency security for gains totaling $27,000 and $48,000, respectively, as a result of interest rates at the time of the sale. We also sold four municipal securities for gains totaling $80,000. In 2015, we sold three agency securities for gains totaling $100,000, one mortgage backed security in government sponsored entities for a gain of $37,000, seven municipal bonds for gains totaling $99,000, a financial institution equity holding for a gain of $76,000 and a US Treasury note for a loss of $11,000 in orderdue to take advantage of certain market conditions. In 2014, we sold five agency securities for gains totaling $95,000, three mortgage backed securities in government sponsored entities for gains totaling $78,000, and a portion of a financial institution equity holding for a gain of $73,000.

For the first six months of 2015,2016, account service charges totaled $2,004,000, a decrease$2,230,000, an increase of $137,000$226,000 or 6.4%11.3%, when compared to the same period in 2014.2015. The primary decreaseincrease was associated with a $109,000 decrease$41,000 increase attributable to fees charged to customers for non-sufficient funds.  Thisfunds, an $159,000 increase in interchange revenue source has been negatively impacted and will continuea $26,000 increase in ATM income. Each of these increases was primarily attributable to be negatively impacted by changes in regulations implemented as partthe acquisition of Dodd-Frank.FNB. The increase in earnings on bank owned life insurancesinsurance of $64,000$36,000 is due to purchasesadditional insurance obtained as part of an additional $5.0 million of insurance made late in the fourth quarter of 2014.FNB acquisition. The increase in brokerageother income is attributable to the acquisition and insurance revenues of $125,000includes increases in the current six months is primarily due to sales to a new customer, with a large brokerage balance. The increase in gains on loans sold is due to an increase of 36.0% in the amount of loans sold in 2015 compared to 2014. During the first six months of 2015, the Company received proceeds of $6.9 million from the sale of conforming loans compared to $5.1 million of proceeds for the comparable 2014 period.safe deposit rents and loan servicing fees.

39
For the three month period ended June 30, 2015,2016, the changes experienced from the prior year related to service charges, earnings on bank owned life insurance and other income correspond to the changes experienced for the six month period.period, which was the result of the acquisition. The decrease in revenue associated with non-sufficient funds continued intobrokerage and insurance revenues of $97,000 was due to sales to a new customer in the second quarter while increases related to brokerage, and earnings on bank owned life insurance continue and are consistent with year to date changes.
of 2015.

Non-interest Expense

The following tables reflect the breakdown of non-interest expense for the three and six months ended June 30, 2016 and 2015 and 2014 (in(dollars in thousands):
    Six months ended
   Six months ended       
    June 30,
    Change
  June 30,  Change    
    2015
    2014
    Amount
    %
 2016  2015  Amount  % 
Salaries and employee benefits $                 6,049 $               5,810 $                 239                   4.1 $7,782  $6,049  $1,733   28.6 
Occupancy                       717                     654                      63                   9.6  900   717   183   25.5 
Furniture and equipment                       215                     194                      21                 10.8  328   215   113   52.6 
Professional fees                       412                     442                    (30)                 (6.8)  553   412   141   34.2 
FDIC insurance                       232                     229                        3                   1.3  317   232   85   36.6 
Pennsylvania shares tax                       401                     384                      17                   4.4  390   401   (11)  (2.7)
Amortization of intangibles  164   -   164  NA 
ORE expenses                       358                     137                    221               161.3  305   358   (53)  (14.8)
Other                    2,379                  2,241                    138                   6.2  3,474   2,379   1,095   46.0 
Total $               10,763 $             10,091 $                 672                   6.7 $14,213  $10,763  $3,450   32.1 
   
    Three months ended
  
    June 30,
    Change
 
    2015
    2014
    Amount
    %
Salaries and employee benefits $                 2,993 $               2,893 $                 100                   3.5
Occupancy                       348                     304                      44                 14.5
Furniture and equipment                         87                       94                      (7)                 (7.4)
Professional fees                       180                     208                    (28)               (13.5)
FDIC insurance                       116                     116                        -                      -
Pennsylvania shares tax                       200                     191                        9                   4.7
ORE expenses                       240                       47                    193               410.6
Other                    1,264                  1,147                    117                 10.2
Total $                 5,428 $               5,000 $                 428                   8.6
 

44
  Three months ended       
  June 30,  Change    
  2016  2015  Amount  % 
Salaries and employee benefits $3,900  $2,993  $907   30.3 
Occupancy  455   348   107   30.7 
Furniture and equipment  171   87   84   96.6 
Professional fees  266  180   86   47.8 
FDIC insurance  160   116   44   37.9 
Pennsylvania shares tax  240   200   40   20.0 
Amortization of intangibles  82   -   82  NA 
ORE expenses  212   357   (145)  (40.6)
Other  1,815   1,147   668   58.2 
Total $7,301  $5,428  $1,873   34.5 
Non-interest expenses increased $672,000$3,450,000 for the six months ended June 30, 20152016 compared to the same period in 2014.2015, with the primary driver being the acquisition of FNB, which resulted in the Bank acquiring seven new branches and the associated employee base. Salaries and employee benefits increased $239,000$1,733,000 or 4.1%28.6%. Merit increases effective at the beginning of 20152016 and an increase in full time equivalent employees of 56.3 as parta result of implementing the Bank’s strategic plan,acquisition and the hiring of the agricultural loan team accounted for an increase in salaries and employee benefits of approximately $179,000. Insurance$1,324,000. Health insurance related expenses increased $48,000$223,000 as a result of an increasecovering additional employees obtained as part of the acquisition. Retirement and profit sharing plan expenses, which include pension plans, profit sharing, SERP and salary continuation plans increased $181,000 in claims experience. Due to actuarial changes, pension expense has increased $78,000 in 20152016 compared to the 20142015 six month period.  As a result ofA second agricultural team was hired July 1, 2016 to service the increase in brokerageLebanon and insurance revenues, commission expense has increased $41,000. Profit sharing expenses have decreased $99,000 compared to the comparable period of 2014.Lancaster County markets.

The primary cause of the increases in occupancy and furniture and fixtures is the opening of the Mill Hall branch in the first quarter of 2015. The increase in ORE expenses in 2015 is the result of a $109,000 write-down on one OREO property taken in the second quarter of 2015 due to an updated appraisal and expenses related to OREO proceedings.the acquisition of FNB. The largest driver of the increase in other expenses is fees relatedwas driven primarily by three items. The first was a general expense increase due to the pending merger withacquisition of FNB and its seven branches. The First National Banksecond was an increase in contributions of Fredericksburg, which is expected$100,000 made as part of the Pennsylvania Educational Improvement Tax Credit Program. The contribution was to closebe made in the fourth quarter of 2015.2015, but due to the Pennsylvania budget impasse, the contribution was delayed until the first quarter of 2016. The final increase of $350,000 was associated with charges as a result of customers' accounts being compromised and experiencing fraudulent charges. The increase in professional fees is associated with legal fees as the Company looks to exit certain contracts and has closed a branch in 2016 and consulting fees associated with system upgrades, which include the issuances of new debit cards, which will occur in the third quarter of 2016, that include additional security features, which we anticipate will reduce our fraudulent card experience.

40
For the three months ended, June 30, 2015,2016, non-interest expenses increased $428,000$1,873,000 when compared to the same period in 2014. ORE expenses increased $193,000 primarily due to2015. The increases for the $109,000 ORE write downquarter are consistent with the increases for the six month period and fees related to OREO court proceedings. The increase in other expenses isare primarily driven as a resultby the acquisition of fees associated with the pending merger.
FNB.

Provision for Income Taxes

The provision for income taxes was $1,519,000$1,478,000 for the six month period ended June 30, 20152016 compared to $1,742,000$1,519,000 for the same period in 2014.2015.  The decrease is attributable to athe decrease in income before the provision for income taxes of $455,000 and an increase in tax-exempt income as a proportion of total interest income. Through management of our municipal loan and bond portfolios, management is focused on minimizing our effective tax rate.  Our effective tax rate was 19.4%19.0% and 21.0%19.4% for the first six months of 20152016 and 2014,2015, respectively, compared to the statutory rate of 34%.

For the three months ended June 30, 2015,2016, the provision for income taxes was $779,000$687,000 compared to $890,000$779,000 for the same period in 2014.2015. The decrease is attributable to the decrease in income before the provision for income taxes of $287,000 and an increase in tax-exempt income as a proportion of total interest income.$250,000. Our effective tax rate was 19.6%18.5% and 20.9%19.6% for the three months ended June 30, 20152016 and 2014,2015, respectively, compared to the statutory rate of 34%.

We have invested in four limited partnership agreements that established low-income housing projects in our market areas. We anticipate recognizing an aggregate of $1.1 million$945,000 of tax credits over the next seven6.5 years, with an additional $99,000 anticipated to be recognized during 2015.2016.

45
Financial Condition

Total assets were $942.5 million$1.180 billion at June 30, 2015,2016, an increase of $17.5$16.5 million, or 1.9%1.4% from $925.0 million$1.163 billion at December 31, 2014.2015.  Cash and cash equivalents decreased $511,000 or 4.5%increased $2.4 million to $10.9$26.8 million. Investment securities decreased to $304.8increased $1.2 million and net loans increased 3.2% to $564.7$701.8 million at June 30, 2015.2016.  Total deposits increased $18.0$15.5 million to $791.9 million$1.003 billion since year-end 2014,2015, while borrowed funds decreased $2.6$2.8 million to $39.2$38.8 million.

Cash and Cash Equivalents
Cash and cash equivalents totaled $10.9$26.8 million at June 30, 20152016 compared to $11.4$24.4 million at December 31, 2014, a decrease2015, an increase of $0.5$2.4 million. Management actively measures and evaluates its liquidity position through our Asset–Liability Committee and believes its liquidity needs are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources including the Bank’sBank's core deposits, Federal Home Loan Bank financing, federal funds lines with correspondent banks, brokered certificates of deposit and the portion of the investment and loan portfolios that mature within one year.  Management expects that these sources of funds will permit us to meet cash obligations and off-balance sheet commitments as they come due.
Investments

The following table shows the composition of the investment portfolio as of June 30 201530, 2016 and December 31, 20142015 (dollars in thousands):

  June 30, 2016  December 31, 2015 
  Amount  %  Amount  % 
Available-for-sale:            
  U. S. Agency securities $205,819   57.0  $199,591   55.5 
  U. S. Treasury notes  5,053   1.4   10,082   2.8 
  Obligations of state & political                
     subdivisions  104,472   28.9   102,863   28.6 
  Corporate obligations  11,480   3.2   14,565   4.0 
  Mortgage-backed securities in                
    government sponsored entities  31,606   8.8   30,204   8.4 
  Equity securities in financial                
     institutions  2,514   0.7   2,432   0.7 
Total $360,944   100.0  $359,737   100.0 
                 
  June 30, 2016/         
  December 31, 2015         
  Change         
  Amount  %         
Available-for-sale:                
  U. S. Agency securities $6,228   3.1         
  U. S. Treasury notes  (5,029)  (49.9)        
  Obligations of state & political                
     subdivisions  1,609   1.6         
  Corporate obligations  (3,085)  (21.2)        
  Mortgage-backed securities in                
    government sponsored entities  1,402   4.6         
  Equity securities in financial                
     institutions  82   3.4         
Total $1,207   0.3         
 June 30, 2015December 31, 2014
 Amount%Amount%
Available-for-sale:    
  U. S. Agency securities $              167,580             55.0 $        150,885          49.3
  U. S. Treasury notes                             -                  -               4,849            1.6
  Obligations of state & political subdivisions                   96,282             31.6           105,036          34.3
  Corporate obligations                   12,805               4.2             13,958            4.6
  Mortgage-backed securities in government sponsored entities                   26,350               8.6             29,728            9.6
  Equity securities in financial institutions                     1,775               0.6               1,690            0.6
Total $              304,792           100.0 $        306,146        100.0
41
 June 30, 2015/ December 31, 2014
         Change
 Amount%
Available-for-sale:  
  U. S. Agency securities $                16,695             11.1
  U. S. Treasury notes                    (4,849)         (100.0)
  Obligations of state & political subdivisions                    (8,754)             (8.3)
  Corporate obligations                    (1,153)             (8.3)
  Mortgage-backed securities in government sponsored entities                    (3,378)           (11.4)
  Equity securities in financial institutions                          85               5.0
Total $                 (1,354)             (0.4)

Our investment portfolio decreasedincreased by $1.4$1.2 million, or 0.4%0.3%, from December 31, 20142015 to June 30, 2015.2016.  During 2015,2016, we purchased approximately $38.9$18.6 million of U.S. agency obligations, $10.5$9.8 million of state and local obligations and $218,000$4.1 million of equitythe mortgage backed securities in financial institutions,government sponsored entities, which helped offset the $2.8$2.9 million of principal repayments and $28.3$18.7 million of calls and maturities that occurred during the six month period. We also sold $18.4$12.1 million of various securities at a gain of $301,000.$155,000. Excluding our short-term investments consisting of monies held primarily at the Federal Reserve for liquidity purposes, our investment portfolio for the six month period ended June 30, 20152016 yielded 2.81%2.39%, which is the same ascompared to 2.81% in the comparable period in 20142015 on a tax equivalent basis.

During
46
With the first six monthsadditional liquidity obtained as part of 2015, there were significant swingsthe acquisition of FNB, and volatility in the yieldinterest rate market, purchases in 2016 have focused on investments as a result of economic indicators, comments made by the Federal Reservecash flow and purchasing securities that have indicated a potential rise in ratesfill positions in the near future and turbulence in foreign markets.  As a result of this volatility, we have monitoredCompany's investment cashflow ladder for the next four years. We continually monitor interest rate trading ranges for various investment products and have triedtry to limitfocus purchases to times when yieldsrates are in the top third of the trading range. Additionally, for the purchases made, the investment strategyOur primary focus in 2015 has beeninvestments continues to be to purchase agency securities with maturities of less than five years and high quality municipal bonds with high coupons. The Bank believes itits investment strategy has appropriately mitigated its interest rate risk exposure in the event of rising interest rates if they occur. Additionally, high coupon municipal bonds have less price volatility in rising rate scenarios than similar lower coupon bonds. We believe this strategy will enable uswhile providing sufficient cashflows to reinvest cash flows infund loan growth expected as a result of the next two to five years whenacquisition and if investment opportunities improve.
other lending growth initiatives.

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

Loans

The following table shows the composition of the loan portfolio as of June 30, 20152016 and December 31, 20142015 (dollars in thousands):

June 30,December 31, June 30,  December 31, 
20152014 2016  2015 
Amount%Amount% Amount  %  Amount  % 
Real estate:                
Residential $          181,566           31.8 $         185,438           33.5 $203,980   28.8  $203,407   29.3 
Commercial             193,727           33.9            190,945           34.5  246,895   34.8   237,542   34.2 
Agricultural               30,723             5.4              24,639             4.4  62,392   8.8   57,822   8.3 
Construction                 8,025             1.4                6,353             1.1  10,481   1.5   15,011   2.2 
Consumer                 8,374             1.5                8,497             1.5  11,439   1.6   11,543   1.7 
Other commercial and agricultural loans               64,506           11.3              58,516           10.6  74,089   10.4   71,206   10.2 
State & political subdivision loans               84,730           14.7              79,717           14.4  99,839   14.1   98,500   14.1 
Total loans             571,651         100.0            554,105         100.0  709,115   100.0   695,031   100.0 
Less allowance for loan losses                 6,959                 6,815   7,359       7,106     
Net loans $          564,692  $         547,290  $701,756      $687,925     
                
 June 30, 2016/         
 December 31, 2015         
 Change         
 Amount  %         
Real estate:                
Residential $573   0.3         
Commercial  9,353   3.9         
Agricultural  4,570   7.9         
Construction  (4,530)  (30.2)        
Consumer  (104)  (0.9)        
Other commercial and agricultural loans  2,883   4.0         
State & political subdivision loans  1,339   1.4         
Total loans $14,084   2.0         

42
 June 30, 2015/
  December 31, 2014
 Change
 Amount%
Real estate:  
  Residential $            (3,872)           (2.1)
  Commercial                 2,782             1.5
  Agricultural                 6,084           24.7
  Construction                 1,672           26.3
Consumer                  (123)           (1.4)
Other commercial and agricultural loans                 5,990           10.2
State & political subdivision loans                 5,013             6.3
Total loans $            17,546   ��         3.2
The Company’sBank's lending isefforts have historically focused in theon north central Pennsylvania market and the southern tier of New York. The compositionWith the acquisition of our loan portfolio consists principallyFNB, this focus now includes opportunities in the Lebanon, Lancaster, Schuylkill and Berks County markets of retail lending, which includes single-family residential mortgages and other consumer lending, and commercial lendingsouth central, Pennsylvania. In addition, in 2016, we opened an office in Winfield Pennsylvania that focuses on agricultural customers in central Pennsylvania. We have also received regulatory approval in the third quarter of 2016 to establish a branch in Mount Joy, Pennsylvania. We originate loans primarily to locally owned small businesses and area municipalities.  New loans are primarilythrough direct loans to our existing customer base, with new customers generated by referrals from real estate brokers, building contractors, attorneys, accountants, corporate and advisory board members, existing customers and the efforts and expertiseBank's website.  The Bank offers a variety of loans although historically most of our business development officers.lending has focused on real estate loans including residential, commercial, agricultural, and construction loans.  All lending is governed by a lending policy that is developed and administered by management and approved by the Board of Directors.
47
During the first six months of 2015,2016, the Company experiencedprimary driver of growth in the loan portfolio was in commercial and agricultural interests and was primarily driven by the agricultural team hired for the Winfield location. The increase in state and political subdivision loans which increased $5.0 million or 6.3%, other commercial and agricultural loans, which increased $6.0 million or 10.2%, commercial real estate, which increased $2.8 million or 1.5%, agricultural real estate loans, which increased $6.1 million or 24.7% and construction loans, which increased $1.7 million, or 26.3%. The increase in state and political loans, other commercial and agricultural, commercial real estate and agricultural real estate loans reflects on the Company’s experienced lenders and their abilityis due to identify and meet the needs of our customers while providing growth opportunities for the Company’s loan portfolio.  We also look at commercial relationships as a way to obtain deposits from farmers, small businesses and municipalities throughout our market area. We continue to experience growth in the Mill Hall branch that opened in February 2015. Commercial loan demand is subject to significant competitive pressures, the yield curve, the strength of the overall regional and national economy and the local economy. The local economy has been impacted significantly by natural gas exploration activities, which are impacted by regulations and changes in the market price of natural gas. Due to the low price for natural gas exploration activities remained curtailed. We workus working closely with local municipalities and school districts to meet their needs that otherwise would be provided by the municipal bond market. We look at commercial relationships as a way to grow our loan portfolio and obtain deposits from farmers, small businesses and municipalities throughout our market area, and the addition of the central Pennsylvania agricultural team has resulted in an increase in demand for agricultural loans that will be recorded in the third and fourth quarters. Commercial loan demand is subject to significant competitive pressures, the yield curve, and the strength of the overall national, regional and local economies.
Activity associated with exploration for natural gas remains limited in 2016 due to the low price of natural gas produced in our area. While the Bank has loaned to companies that service the exploration activities, the Bank has not originated any loans to companies performing the actual drilling and exploration activities. Loans made by the Company were to service industry customers which included trucking companies, stone quarries and other support businesses. We also have originated loans to businesses and individuals for restaurants, hotels and apartment rentals that have been developed and expanded to meet the housing and living needs of the gas workers. Due to our understanding of the industry and its cyclical nature, the loans made for natural gas-related activities were originated in accordance with specific policies and procedures for lending to these entities, which included lower loan to value thresholds, shortened amortization periods, and expansion of our monitoring of loan concentrations associated with this activity.
Residential real estate loans decreased $3.9 millionincreased $573,000 during the first six months of 2015.2016. Loan demand for conforming mortgages, which the Company typically sells on the secondary market has increased slightly in 20152016 when compared to 2014. During2015, some of which is attributable to the first six monthsacquisition of 2015, $7.5 million of loans were originated, which compares to $5.3 million originated during the same period in 2014.FNB. For loans sold on the secondary market, the Company recognizes fee income for servicing these sold loans, which is included in non-interest income.  Management continues to build technologies which make it easier and more efficient for customers to choose the Company for their mortgage needs.

43
Allowance for Loan Losses

The allowance for loan losses is maintained at a level which in management’smanagement's judgment is adequate to absorb probable future loan losses inherent in the loan portfolio.  The provision for loan losses is charged against current income.  Loans deemed not collectable are charged-off against the allowance while subsequent recoveries increase the allowance.  The following table presents an analysis of the allowance for loan losses and non-performing loans and assets as of and for the six months ended June 30, 20152016 and for the years ended December 31, 2015, 2014, 2013 2012 and 20112012 (dollars in thousands):
 June 30,December 31,
 20152014201320122011
Balance     
  at beginning of period $          6,815 $          7,098 $          6,784 $          6,487 $          5,915
Charge-offs:     
  Real estate:     
     Residential                  34                  97                  17                  95                101
     Commercial                  56                516                  62                    2                  29
     Agricultural                     -                     -                     -                     -                     -
  Consumer                  24                  47                  54                  54                  71
  Other commercial and agricultural loans                    1                250                    1                  21                    6
Total loans charged-off                115                910                134                172                207
Recoveries:     
  Real estate:     
     Residential                     -                     -                    5                     -                     -
     Commercial                    7                  15                    5                    9                  15
     Agricultural                     -                     -                     -                     -                     -
  Consumer                  12                  27                  33                  33                  57
  Other commercial and agricultural loans                     -                     -                     -                    7                  32
Total loans recovered                  19                  42                  43                  49                104
Net loans charged-off                  96                868                  91                123                103
Provision charged to expense                240                585                405                420                675
Balance at end of period $          6,959 $          6,815 $          7,098 $          6,784 $          6,487
      
Loans outstanding at end of period $      571,651 $      554,105 $      540,612 $      502,463 $      487,509
Average loans outstanding, net $      562,138 $      540,541 $      516,748 $      496,822 $      474,972
Non-performing assets:     
    Non-accruing loans $          6,567 $          6,599 $          8,097 $          8,067 $          9,165
    Accrual loans - 90 days or more past due                826                836                697                506                275
      Total non-performing loans $          7,393 $          7,435 $          8,794 $          8,573 $          9,440
    Foreclosed assets held for sale             1,815             1,792             1,360                616                860
      Total non-performing assets $          9,208 $          9,227 $        10,154 $          9,189 $        10,300
Annualized net charge-offs to average loans0.03%0.16%0.02%0.02%0.02%
Allowance to total loans1.22%1.23%1.31%1.35%1.33%
Allowance to total non-performing loans94.13%91.66%80.71%79.13%68.72%
Non-performing loans as a percent of loans     
   net of unearned income1.29%1.34%1.63%1.71%1.94%
Non-performing assets as a percent of loans    
  net of unearned income1.61%1.67%1.88%1.83%2.11%

4448
  June 30,  December 31, 
  2016  2015  2014  2013  2012 
Balance               
  at beginning of period $7,106  $6,815  $7,098  $6,784  $6,487 
Charge-offs:                    
  Real estate:                    
     Residential  43   66   97   17   95 
     Commercial  -   84   516   62   2 
     Agricultural  -   -   -   -   - 
  Consumer  38   47   47   54   54 
  Other commercial and agricultural loans  18   41   250   1   21 
Total loans charged-off  99   238   910   134   172 
Recoveries:                    
  Real estate:                    
     Residential  -   -   -   5   - 
     Commercial  8   14   15   5   9 
     Agricultural  -   -   -   -   - 
  Consumer  68   33   27   33   33 
  Other commercial and agricultural loans  6   2   -   -   7 
Total loans recovered  82   49   42   43   49 
                     
Net loans charged-off  17   189   868   91   123 
Provision charged to expense  270   480   585   405   420 
Balance at end of year $7,359  $7,106  $6,815  $7,098  $6,784 
                     
Loans outstanding at end of period $709,115  $695,031  $554,105  $540,612  $502,463 
Average loans outstanding, net $699,896  $577,992  $540,541  $516,748  $496,822 
Non-performing assets:                    
    Non-accruing loans $10,206  $6,531  $6,599  $8,097  $8,067 
    Accrual loans - 90 days or more past due  1,104   623   836   697   506 
      Total non-performing loans $11,310  $7,154  $7,435  $8,794  $8,573 
    Foreclosed assets held for sale  1,558   1,354   1,792   1,360   616 
      Total non-performing assets $12,868  $8,508  $9,227  $10,154  $9,189 
                     
Annualized net charge-offs to average loans  0.00%  0.03%  0.16%  0.02%  0.02%
Allowance to total loans  1.04%  1.02%  1.23%  1.31%  1.35%
Allowance to total non-performing loans  65.07%  99.33%  91.66%  80.71%  79.13%
Non-performing loans as a percent of loans                    
   net of unearned income  1.59%  1.03%  1.34%  1.63%  1.71%
Non-performing assets as a percent of loans                 
  net of unearned income  1.81%  1.22%  1.67%  1.88%  1.83%

Management believes it uses the best information available when estimating the allowance for loan losses and that the allowance for loan losses is adequate as of June 30, 2015.2016.  However, future adjustments could be required if circumstances differ substantially from assumptions and estimates used in making the initial determination.  A prolonged downturn in the economy, high unemployment rates, significant changes in the value of collateral and delays in receiving financial information from borrowers could result in increased levels of non-performing assets, charge-offs, loan loss provisions and reduction in income. Additionally, bank regulatory agencies periodically examine the Bank’sBank's allowance for loan losses.  The banking agencies could require the recognition of additions to the allowance for loan losses based upon their judgment of information available to them at the time of their examination.

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

49
The balance in the allowance for loan losses was $6,959,000$7,359,000 or 1.22%1.04% of total loans as of June 30, 20152016 as compared to $6,815,000$7,106,000 or 1.23%1.02% of loans as of December 31, 2014.2015. The $144,000decrease as a percent of loans compared to year end 2014, 2013 and 2012 is attributable to the increase in loans as part of the acquisition of FNB and the associated purchase accounting adjustments that were applied to the FNB loan portfolio.  The $253,000 increase is a result of a $240,000$270,000 provision for the first six months offset byand net charge-offs of $96,000.loans of $17,000. The following table shows the distribution of the allowance for loan losses and the percentage of loans compared to total loans by loan category (dollars in thousands) as of June 30, 20152016 and December 31, 2015, 2014, 2013 and 2012 and 2011:(dollars in thousands):

  June 30,  December 31 
  2016  2015     2014     2013  2012 
  Amount  %  Amount  %  Amount  %  Amount  %  Amount  % 
Real estate loans:                              
  Residential $990   28.8  $905   29.3  $878   33.5  $946   34.6  $875   35.4 
  Commercial, agricultural  3,919   43.6   3,785   42.5   3,870   38.9   4,558   39.8   4,437   38.8 
  Construction  18   1.5   24   2.2   26   1.1   50   1.7   38   2.4 
Consumer  104   1.6   102   1.7   84   1.5   105   1.7   119   2.1 
Other commercial and agricultural loans  1,564   10.4   1,305   10.2   1,224   10.6   942   10.0   728   9.5 
State & political subdivision loans  764   14.1   593   14.1   545   14.4   330   12.2   271   11.8 
Unallocated  -   N/A  392   N/A  188   N/A  167   N/A  316   N/A
Total allowance for loan losses $7,359   100.0  $7,106   100.0  $6,815   100.0  $7,098   100.0  $6,784   100.0 
 June 30December 31
 20152014201320122011
 Amount%Amount%Amount%Amount%Amount%
Real estate loans:          
  Residential $    931    31.8 $    878    33.5 $    946    34.6 $    875    35.4 $    805    37.7
  Commercial, agricultural    3,679    39.3    3,870    38.9    4,558    39.8    4,437    38.8    4,132    37.9
  Construction         14      1.4         26      1.1         50      1.7         38      2.4         15      1.7
Consumer         89      1.5         84      1.5       105      1.7       119      2.1       111      2.2
Other commercial and agricultural loans    1,502    11.3    1,224    10.6       942    10.0       728      9.5       674      9.1
State & political subdivision loans       568    14.7       545    14.4       330    12.2       271    11.8       235    11.4
Unallocated       176 N/A       188 N/A       167 N/A       316 N/A       515 N/A
Total allowance for loan losses $ 6,959  100.0 $ 6,815  100.0 $ 7,098  100.0 $ 6,784  100.0 $ 6,487  100.0

As a result of previous loss experiences and other risk factors utilized in determining the allowance, the Bank’sBank's allocation of the allowance does not directly correspond to the actual balances of the loan portfolio. While commercial and agricultural real estate total 39.3%43.6% of the loan portfolio, 52.9%53.3% of the allowance is assigned to this segment of the loan portfolio as these loans have more inherent risks than residential real estate or loans to state and political subdivisions.

The following table identifies amounts of loans contractually past due 30 to 89 days and non-performing loans by loan category, as well as the change from December 31, 20142015 to June 30,201530, 2016 in non-performing loans(dollars in thousands). Non-performing loans include thoseaccruing loans that are contractually past due 90 days or more and non-accrual loans. Interest does not accrue on non-accrual loans.  Subsequent cash payments received are applied to the outstanding principal balance or recorded as interest income, depending upon management's assessment of its ultimate ability to collect principal and interest.

  June 30, 2016  December 31, 2015 
     Non-Performing Loans     Non-Performing Loans 
  30 - 89 Days           30 - 89 Days          
  Past Due  90 Days Past  Non-  Total Non-  Past Due  90 Days Past  Non-  Total Non- 
(in thousands) Accruing  Due Accruing  accrual  Performing  Accruing  Due Accruing  accrual  Performing 
Real estate:                        
  Residential $1,817  $219  $1,385  $1,604  $1,273  $394  $1,008  $1,402 
  Commercial  1,402   461   4,711   5,172   859   60   4,422   4,482 
  Agricultural  251   165   29   194   344   -   34   34 
  Construction  -   -   -   -   -   -   -   - 
Consumer  243   9   39   48   262   9   55   64 
Other commercial and                                
   agricultural loans  218   250   4,042   4,292   319   160   1,012   1,172 
Total nonperforming loans $3,931  $1,104  $10,206  $11,310  $3,057  $623  $6,531  $7,154 
 

4550
June 30, 2015 December 31, 2014
 Non-Performing Loans  Non-Performing Loans
30 - 89 Days    30 - 89 Days    Change in Non-Performing Loans June 30, 2016/ 
Past Due90 Days PastNon-Total Non- Past Due90 Days PastNon-Total Non- December 31, 2015 
(in thousands) AccruingDue AccruingaccrualPerforming  AccruingDue AccruingaccrualPerforming Amount  % 
Real estate:              
Residential $        1,038 $           460 $    849 $       1,309  $       1,089 $             346 $       828 $       1,174 $202   14.4 
Commercial             59              1044,5474,651             147               3105,0105,320  690   15.4 
Agricultural           209                   -            -                  -                 -                   -              -                  -  160   470.6 
Construction  -   N/A
Consumer             38                  1         5354               75                   6            47               53  (16)  (25.0)
Other commercial and                
agricultural loans           365              2611,1181,379             761               174714888  3,120   266.2 
Total nonperforming loans $       1,709 $           826 $ 6,567 $       7,393  $     2,072 $           836 $   6,599 $       7,435 $4,156   58.1 

 Change in Non-Performing Loans
  June 30, 2015 /December 31, 2014
(in thousands)Amount%
Real estate:  
  Residential $        135             11.5
  Commercial          (669)            (12.6)
  Agricultural                - N/A
  Construction                - N/A
Consumer               1               1.9
Other commercial and  
   agricultural loans           491             55.3
Total nonperforming loans $         (42)              (0.6)
For the six month period endingended June 30, 2015,2016, we recorded a provision for loan losses of $240,000,$270,000, which compares to $330,000$240,000 for the same time period in 2014.2015. Non-performing loans decreased $42,000increased $4.2 million or 0.6%58.1%, from December 31, 20142015 to June 30, 2015.2016, primarily due to one commercial relationship with a balance of $3.7 million that was placed on non-accrual status in the second quarter of 2016. Approximately 60.0%68.1% of the Bank’sBank's non-performing loans at June 30, 2016 are associated with the following threefour customer relationships:

·
A commercial customer with a total loan relationship of $3.7 million secured by undeveloped land, stone quarries and equipment was on non-accrual status as of June 30, 2016. The slowdown in the exploration for natural gas has significantly impacted the cash flows of the customer, who provided excavation services and stone for pad construction related to these activities. Management reviewed the collateral and determined that no specific reserve was required as of June 30, 2016.
·A commercial customer with a total loan relationship of $3.4$3.1 million secured by 164approximately 160 residential properties was consideredon non-accrual status as of June 30, 2015.2016. In the first quarter of 2011, the Company and borrower entered into a forbearance agreement to restructure the debt. In July of 2013, the customer filed for bankruptcy under Chapter 11 and a Trustee was appointed in January of 2014. In 2015, the Trustee has decreased the loan payments below what was agreed to in the forbearance agreement. This decrease is currently being litigated in bankruptcy court. As a result of the decrease, the relationship has become more than 90 days past due. In the second quarter of 2015, 252016, the Company began the process of appraising the underlying collateral. As of June 30, 2016, approximately 75% of the appraisals were completed and management observed an additional 20 properties. These items did not note any significant changeordered have been received. The appraisals received have indicated a slight decrease in collateral values.values compared to the appraisals ordered for the loan origination, however, the loan is still considered well secured on a loan to value basis. We continue to monitor the bankruptcy proceedings to identify potential changes in the customer’scustomer's operations and the impact these would have on the loan payments for our loans to the customer and the underlying collateral that supports these loans. As of June 30, 2016, there is no specific reserve for this relationship.
·A commercial customer with a relationship of approximately $435,000 after a charge-off of $463,000 during the second quarter of 2014, secured by commercial real estate was consideredon non-accrual status as of June 30, 2015.2016. The current economic conditions have significantly impacted the cash flows from the customer’scustomer's activities. Management reviewed the collateral and in the second quarter of 2014 charged-off of a portion of the balance associated with this customer, which was based on the appraised value of collateral and as a result there is no specific reserve as of June 30, 2015.2016. The customer is currently working with another financial institution to refinance the loan, which is expected to close in the third quarter of 2016.
·A commercial customer with a relationship of approximately $583,000$420,000 secured by vacant real estate equipment and accounts receivable was consideredon non-accrual status as of June 30, 2015.2016. The slowdown in the exploration for natural gas has significantly impacted the cash flows of the customer.customer, who provided trucking services related to these activities. Management reviewed the collateral and there isdetermined that a specific reserve of $56,000$197,000 was required as of June 30, 2015.2016.

4651
Management of the Bank believes that the allowance for loan losses is adequate as of June 30, 2016, which is based on the following factors:
·OneTwo loan relationshiprelationships comprises 46.2%60.6% of the non-performing loan balance, whose debt is well collateralized as of June 30, 2015.2016.
·Net and gross charge-offs have returned to their low historical rate of .03% on an annualized basis in the first half of 2015.2015 and have remained low in 2016.
·Real estate values in the Bank’sBank's primary market areaareas have remained stable. Additionally, our primaryonly decreased slightly with the decrease in the market area is predominately centered in aprice for natural gas exploration and drilling area, and while the activities associated with this exploration are cyclical, it has provided a positive impact on the value of local real estate.gas.

Bank Owned Life Insurance

The Company purchasedholds bank owned life insurance policies to offset future employee benefit costs. As of June 30, 2015, the cash surrender value of this life insurance is $20,615,000, which has resulted in income recognized in the first six months of 2015 of $306,000 compared to $242,000 during the comparable period in 2014. The use of life insuranceThese policies providesprovide the Bank with an asset that will generategenerates earnings to partially offset the current costs of benefits, and eventually (at the death of the individuals) providesinsureds) provide partial recovery of cash outflows associated with the benefits.
Effective January 1,  As of June 30, 2016 and December 31, 2015, the cash surrender value of the life insurance was $25.9 million and $25.5 million, respectively.  The change in cash surrender value, net of purchases and amounts acquired through acquisitions, is recognized in the results of operations.  The amounts recorded as non-interest income totaled $342,000 and $306,000 for the six month periods ended June 30, 2016 and 2015, respectively. The Company restructuredevaluates annually the risks associated with the life insurance policies, including limits on the amount of coverage and an evaluation of the various carriers' credit ratings.
The Company agreements that were purchased directly from insurance companies are structured so that any death benefits received from a policy while the insured person is an active employee of the Bank will be split with the beneficiary of the policy.  Under the restructuredthese agreements, the employee’semployee's beneficiary will be entitled to receive 50% of the net amount at risk from the proceeds.  The net amount at risk is the total death benefit payable less the cash surrender value of the policy as of the date of death. The policies acquired as part of the acquisition of FNB provide a fixed split-dollar benefit for the beneficiaries estate, which is dependent on several factors including whether the covered individual was a Director of FNB or an employee of FNB and their salary level.

Premises and Equipment

Premises and equipment increaseddecreased $24,000 to $17.2 million as of June 30, 2016 from $12.4 million at December 31, 2014 to $12.6 million at June 30, 2015. This occurred primarily as a result of costs associated withnormal depreciation expense recorded in the constructionfirst six months of our branch in Mill Hall, which opened in February 2015.2016.

Deposits

The following table shows the composition of deposits as of June 30, 20152016 and December 31, 20142015 (dollars in thousands):

  June 30,  December 31, 
  2016  2015 
  Amount  %  Amount  % 
Non-interest-bearing deposits $142,327   14.2  $150,960   15.3 
NOW accounts  299,130   29.8   279,655   28.3 
Savings deposits  169,990   16.9   170,277   17.2 
Money market deposit accounts  123,146   12.3   105,229   10.7 
Certificates of deposit  268,889   26.8   281,910   28.5 
Total $1,003,482   100.0  $988,031   100.0 
 June 30December 31,
 20152014
 Amount%Amount%
Non-interest-bearing deposits $                    100,46912.7 $          95,526          12.3
NOW accounts                       236,54529.9           226,038          29.2
Savings deposits                       116,20114.7           108,252          14.0
Money market deposit accounts                         91,61511.6             95,350          12.3
Certificates of deposit                       247,05731.1           248,767          32.2
Total $                    791,887100.0 $        773,933        100.0
   
 June 30,  2015/
  December 31, 2014
         Change
 Amount%
Non-interest-bearing deposits $                        4,9435.2
NOW accounts                         10,5074.6
Savings deposits                           7,9497.3
Money market deposit accounts                          (3,735) (3.9)
Certificates of deposit                          (1,710) (0.7)
Total $                      17,9542.3


4752
  June 30, 2016/ 
  December 31, 2015 
  Change 
  Amount  % 
Non-interest-bearing deposits $(8,633)  (5.7)
NOW accounts  19,475   7.0 
Savings deposits  (287)  (0.2)
Money market deposit accounts  17,917   17.0 
Certificates of deposit  (13,021)  (4.6)
Total $15,451   1.6 

Deposits increased $18.0$15.5 million since December 31, 2014.2015. The biggestlargest driver of this increase was in NOW accounts, which increased $10.5 million, followed closely by the increase in savings deposit accounts of $7.9 million and non-interest bearing deposits of $4.9 million. The primary drivers of the increase in NOW accounts and Savings accounts is the result ofdue to deposits from local government customers and gas related depositsmunicipalities, as they increased $42.4 million across various product types. This growth was driven by the Pennsylvania budget impasse for customers2015 being resolved during the first quarter of 2016, which resulted in the Potter County market. The decrease in Money market accounts was attributablefunds flowing to a decrease inour local school district deposits. Similarand municipalities from the Commonwealth. Certificates of deposits decreased $13.0 million in 2016. During 2016 the Company continued to pay historically low rates on certificates of deposits which are less attractive to the prior year,Company's customers. Certain customers who typically utilize certificate of deposits as CD’s mature, some customersa means of generating income or as a longer term investment option, are convertingmoving funds into money market that still paid interest in order to maintain flexibility for potentially rising interest rates. The rates paid on certificates of deposit by the balances to other deposits accounts atCompany remain competitive with rates paid by our competition. As of June 30, 2016, the bank. This is occurring as customers are seeking more liquidity during this low rate environment. The Bank currently doesdid not have any outstanding brokered certificates of deposit.

Borrowed Funds

Borrowed funds decreased $2.6$2.8 million during the first six months of 2015.2016. The decrease was the result of repaying $10.3$1.6 million of overnight borrowingsadvances from the FHLB. The repayments were offset by borrowing $4.7 million from the FHLB on a long term basis and $4.0 million on a short term basis. Additionally, there was a decrease of approximately $1.1$1.2 million in the balances outstanding under repurchase agreements. The Bank’sBank's current strategy for borrowings is to consider terms and structures to manage interest rate risk and liquidity in a potential rising interest rate environment. The Company's daily cash requirements or short-term investments are primarily met by using the financial instruments available through the Federal Home Loan Bank of Pittsburgh.

In December 2003, the Company formed a special purpose entity, Citizens Financial Statutory Trust I (“("the Entity”Entity"), to issue $7,500,000 of floating rate obligated mandatory redeemable securities as part of a pooled offering.  The rate is determined quarterly based on the 3 month LIBOR, plus 2.80%.  The Entity may redeem them,the securities, in whole or in part, at face value at any time.  The Company borrowed the proceeds of the issuance from the Entity in December 2003 in the form of a $7,500,000 note payable, which is included within “Borrowed Funds”"Borrowed Funds" in the liabilities section of the Company’sCompany's balance sheet. Under current accounting rules, the Company’sCompany's minority interest in the Entity was recorded at the initial investment amount and is included in the other assets section of the balance sheet.  The Entity is not consolidated as part of the Company’sCompany's Consolidated Financial Statements.

Stockholders’Stockholders' Equity

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

Total stockholders’stockholders' equity was $103.2$124.5 million at June 30, 20152016 compared to $100.5$119.8 million at December 31, 2014,2015, an increase of $2.7$4.7 million or 2.7%3.9%.  Excluding accumulated other comprehensive income (loss) stockholders’stockholders' equity increased $3.3$2.4 million, or 3.37%2.0%. The Company purchased 18,78830,914 shares of treasury stock at a weighted average cost of $52.59$47.90 per share. The Company reissued 3,9561,608 shares as part of the dividend reinvestment program at a weighted average cost of $52.90, 3,340$47.40 per share, 3,650 shares as part of the restricted stock program at a weighted average cost of $52.42$47.84 per share and 1,2061,016 shares as part of an incentive program at a weighted average cost of $52.90.$47.65 per share. The Company reissued 372 shares as services awards for Company employees, at a weighted average cost of $47.95 per share. The Company reissued 1,223 shares through the employee stock ownership plan, at a weighted average cost of $48.51. In the first six months of 2015,2016, the Company had net income of $6.3 million and declared cash dividends of $2.5$2.8 million, or $0.81$0.829 per shares,share, representing a cash dividend payout ratio of 38.8%44.0%. We also issued a one percent stock dividend to the Company's shareholders, which had a market value of $1.6 million at its issuance.

53
All of the Company’sCompany's investment securities are classified as available-for-sale, making this portion of the Company’sCompany's balance sheet more sensitive to the changing market value of investments. As a result of changes in the interest rate environment, accumulated other comprehensive income (loss) associated with the change in investment securities decreased $663,000increased $2.2 million from December 31, 2014 and accounts for the majority of the total decrease in accumulated other comprehensive income (loss) of $596,000.2015.

48
The Company has complied with standards of being well capitalized mandatedand Bank are subject to various regulatory capital requirements administered by the federal banking regulators. The Company’s primary regulators have established “risk-based”agencies. Failure to meet minimum capital requirements designed to measurecan initiate certain mandatory-and possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy.  Risk-based capital ratios reflectadequacy guidelines and the relative risks associated with various assets entities hold in their portfolios.  A weight category of 0% (lowest risk assets), 20%, 50%, or 150% (highest risk assetsregulatory framework for prompt corrective action, the Company and Bank)Bank must meet specific capital guidelines that involve quantitative measures of the Company and Bank's assets, liabilities, and certain off-balance-sheet items as calculated under U.S. GAAP, regulatory reporting requirements, and regulatory capital standards. The Company and Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulatory capital standards to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios  of total and Tier 1 capital (as defined) to risk-weighted assets (as defined), is assignedcommon equity Tier 1 capital (as defined) to each asset ontotal risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of June 30, 2016 and December 31, 2015, that the balance sheet. The Company’s computedCompany and Bank meet all capital adequacy requirements to which they are subject.

As of June 30, 2016 and December 31, 2015, the Company and Bank are categorized as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company must maintain minimum total risk-based capital, Tier 1 risk-based capital, common equity Tier 1 risk-based capital, and Tier 1 leverage ratios as set forth in the table.There are as follows (dollars in thousands):
no conditions or events since that notification that management believes have changed the institution's category.
 June 30,December 31,
 20152014
Total capital (to risk-weighted assets)Amount RatioAmount Ratio
Company $            110,485 19.06% $      106,891 18.55%
For capital adequacy purposes                 46,367 8.00%           46,105 8.00%
To be well capitalized                 57,959 10.00%           57,631 10.00%
Tier I capital (to risk-weighted assets)      
Company $            103,185 17.80% $        99,692 17.30%
For capital adequacy purposes                 34,775 6.00%           23,053 4.00%
To be well capitalized                 46,367 8.00%           34,579 6.00%
Community Equity Tier I capital (to risk-weighted assets)      
Company $              95,685 16.51% N/A  N/A
For capital adequacy purposes                 26,082 4.50% N/A  N/A
To be well capitalized                 37,673 6.50% N/A  N/A
Tier I capital (to average assets)      
Company $            103,185 11.08% $        99,692 10.99%
For capital adequacy purposes                 37,259 4.00%           36,272 4.00%
To be well capitalized                 46,574 5.00%           45,341 5.00%

The Bank’sCompany and Bank's computed risk-basedrisk‑based capital ratios are as follows (dollars in thousands):

 June 30,December 31,
 20152014
Total capital (to risk-weighted assets)Amount RatioAmount Ratio
Bank $            101,796 17.62% $        97,498 16.97%
For capital adequacy purposes                 46,217 8.00%           45,969 8.00%
To be well capitalized                 57,772 10.00%           57,462 10.00%
Tier I capital (to risk-weighted assets)      
Bank $              94,656 16.38% $        90,500 15.75%
For capital adequacy purposes                 34,663 6.00%           22,985 4.00%
To be well capitalized                 46,217 8.00%           34,477 6.00%
Community Equity Tier I capital (to risk-weighted assets)      
Bank $              94,656 16.38% N/A  N/A
For capital adequacy purposes                 41,848 4.50% N/A  N/A
To be well capitalized                 60,447 6.50% N/A  N/A
Tier I capital (to average assets)      
Bank $              94,656 10.18% $        90,500 10.00%
For capital adequacy purposes                 37,198 4.00%           36,218 4.00%
To be well capitalized                 46,497 5.00%           45,273 5.00%
  Actual  For Capital Adequacy Purposes  
To Be Well Capitalized
Under Prompt Corrective
Action Provisions
 
June 30, 2016 Amount  Ratio  Amount  Ratio  Amount  Ratio 
Total Capital (to Risk Weighted Assets):
 
Company $117,683   16.16% $58,248   8.00% $72,810   10.00%
  Bank $112,026   15.43% $58,077   8.00% $72,596   10.00%
                         
Tier 1 Capital (to Risk Weighted Assets):
 
Company $109,928   15.10% $43,686   6.00% $58,248   8.00%
  Bank $104,450   14.39% $43,558   6.00% $58,077   8.00%
                         
Common Equity Tier 1 Capital (to Risk Weighted Assets):
 
Company $102,428   14.07% $32,765   4.50% $47,327   6.50%
  Bank $104,450   14.39% $32,668   4.50% $47,188   6.50%
                         
Tier 1 Capital (to Average Assets):
 
Company $109,928   9.40% $46,793   4.00% $58,491   5.00%
  Bank $104,450   8.95% $46,691   4.00% $58,364   5.00%

4954

  Actual  For Capital Adequacy Purposes  
To Be Well Capitalized Under Prompt Corrective
Action Provisions
 
December 31, 2015 Amount  Ratio  Amount  Ratio  Amount  Ratio 
Total Capital (to Risk Weighted Assets):
 
Company $114,886   16.23% $56,630   8.00% $70,787   10.00%
  Bank $108,232   15.34% $56,443   8.00% $70,554   10.00%
                         
Tier 1 Capital (to Risk Weighted Assets):
 
Company $107,612   15.20% $42,472   6.00% $56,630   8.00%
  Bank $100,958   14.31% $42,332   6.00% $56,443   8.00%
                         
Common Equity Tier 1 Capital (to Risk Weighted Assets):
 
Company $100,112   14.14% $31,854   4.50% $46,012   6.50%
  Bank $100,958   14.31% $31,749   4.50% $45,860   6.50%
                         
Tier 1 Capital (to Average Assets):
 
Company $107,612   11.01% $39,083   4.00% $48,854   5.00%
  Bank $100,958   10.35% $39,006   4.00% $48,757   5.00%

Off Balance Sheet Activities

Some financial instruments, such as loan commitments, credit lines, and letters of credit, are issued to meet customer financing needs.  The contractual amount of financial instruments with off-balance sheet risk was as follows at June 30, 20152016 and December 31, 20142015 (in thousands):

  June 30, 2016  December 31, 2015 
Commitments to extend credit $186,943  $143,134 
Standby letters of credit  13,884   13,751 
  $200,827  $156,885 
 
       June 30, 2015
          December 31, 2014
Commitments to extend credit $       118,876 $  108,951
Standby letters of credit10,02410,389
  $       128,900 $      119,340

We also offer limited overdraft protection as a non-contractual courtesy which is available to demand deposit accounts in good standing. Overdraft charges as a result of ATM withdrawals and one time point of sale (non-recurring) transactions require prior approval of the customer. The non-contractual amount of financial instruments with off-balance sheet risk at June 30, 20152016 and December 31, 20142015 was $12,373,000$12,606,000 and $12,360,000,$12,485,000, respectively. The Company reserves the right to discontinue this service without prior notice.

Liquidity

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

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

The Company's use of funds is shown in the investing activity section of the Consolidated Statement of Cash Flows, where the net loan activity is presented.  Other significant uses of funds include purchasing stock from the Federal Home Loan Bank (FHLB) of Pittsburgh, as well as capital expenditures.  Capital expenditures (including software purchases), during the first six months of 20152016 were $514,000, primarily related to our Mill Hall branch,$398,000 compared to $145,000$514,000 during the same time period in 2014.2015.

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Short-term debt from the FHLB supplements the Bank’sBank's availability of funds.  The Bank achieves liquidity primarily from temporary or short-termshort‑term investments in the Federal Reserve and the FHLB.  The Bank has a maximum borrowing capacity at the FHLB of approximately $263.1$310.4 million, of which $26.9$16.5 million was outstanding at June 30, 2015.2016. Additionally, we have a Federal funds line totaling $10.0 million from a third party bank at market rates.  This line is not drawn upon. We also have a borrower in custody line with the Federal Reserve Bank of approximately $8.7$3.9 million, which also is not drawn upon as of June 30, 2015.2016. The Company continues to evaluate its liquidity needs and as necessary finds additional sources.

Citizens Financial Services, Inc. is a separate legal entity from the Bank and must provide for its own liquidity.  In addition to its operating expenses, Citizens Financial is responsible for paying any dividends declared to its shareholders.  Citizens Financial also has repurchased shares of its common stock.  Citizens Financial’sFinancial's primary source of income is dividends received from the Bank.  Both federal and state laws impose restrictions on the ability of the Bank to pay dividends. In particular, the Bank may not, as a state-chartered bank which is a member of the Federal Reserve System, declare a dividend without approval of the Federal Reserve, unless the dividend to be declared by the Bank’sBank's Board of Directors does not exceed the total of:  (i) the Bank’sBank's net profits for the current year to date, plus (ii) its retained net profits for the preceding two current years, less any required transfers to surplus.  The Federal Reserve Board and the FDIC have formal and informal policies which provide that insured banks and bank holding companies should generally pay dividends only out of current operating earnings, with some exceptions.  The Prompt Corrective Action Rules, described above, further limit the ability of banks to pay dividends, because banks which are not classified as well capitalized or adequately capitalized may not pay dividends and no dividend may be paid which would make the Bank undercapitalized after the dividend.  At June 30, 2015,2016, Citizens Financial Services, Inc.Financial(on an unconsolidated basis) had liquid assets of $7.3$3.7 million.

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Interest Rate and Market Risk Management

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

Because of the nature of our operations, we are not subject to foreign currency exchange or commodity price risk and, since our Company hasbecause we have no trading portfolio, it iswe are not subject to trading risk. Currently, ourthe Company has equity securities that represent only 0.6%0.7% of ourits investment portfolio and, therefore, equity risk is not significant.

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

Gap analysis, one of the methods used by us to analyze interest rate risk, does not necessarily show the precise impact of specific interest rate movements on our Company's net interest income because the re-pricing of certain assets and liabilities is discretionary and is subject to competitive and other pressures.  In addition, assets and liabilities within the same period may, in fact, be repaid at different times and at different rate levels.  We have not experienced the kind of earnings volatility that might be indicated from gap analysis.

The BankCompany currently uses a computer simulation model to better measure the impact of interest rate changes on net interest income. We use the model as part of our risk management and asset liability management processes that we believe will effectively identify, measure, and monitor the Bank’sCompany's risk exposure.  In this analysis, the BankCompany examines the results of movements in interest rates with additional assumptions made concerning prepayment speeds on mortgage loans and mortgage securities.   Shock scenarios, which assume a parallel shift in interest rates and is instantaneous, typically have the greatest impact on net interest income. The following is a rate shock analysis and the impact on net interest income as of June 30, 20152016 (dollars in thousands):

    Change In % Change In
   Prospective One-Year  Prospective Prospective
Changes in Rates  Net Interest Income Net Interest Income Net Interest Income
      
-100 Shock  $                        29,428  $                        (267)                        (0.90)
Base                            29,695                                  -                              -
+100 Shock                            28,707                            (988)                        (3.33)
+200 Shock                            27,910                         (1,785)                        (6.01)
+300 Shock                            27,045                         (2,650)                        (8.92)
+400 Shock                            26,061                         (3,634)                      (12.24)
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     Change In  % Change In 
  Prospective One-Year  Prospective  Prospective 
Changes in Rates Net Interest Income  Net Interest Income  Net Interest Income 
          
-100 Shock $35,090  $(757)  (2.11)
Base  35,847   -   - 
+100 Shock  35,293   (554)  (1.55)
+200 Shock  34,816   (1,031)  (2.88)
+300 Shock  34,157   (1,690)  (4.71)
+400 Shock  33,400   (2,447)  (6.83)

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

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Item 3-Quantitative and Qualitative Disclosure about Market Risk

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

Item 4-Control and Procedures

(a) Disclosure Controls and Procedures

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

(b) Changes to Internal Control over Financial Reporting

There were no changes in the Company’sCompany's internal control over financial reporting during the quarter ended June 30, 20152016 that have materially affected, or are reasonable likely to materially affect, the Company’sCompany's internal control over financial reporting.

PART II -‑ OTHER INFORMATION

Item 1 -‑ Legal Proceedings

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

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Item 1A – Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item"Item 1.A. Risk Factors”Factors" in our Annual Report on Form 10-K for the year ended December 31, 2014,2015, which could materially affect our business, financial condition or future results. At June 30, 20152016 the risk factors of the Company have not changed materially from those reported in our Annual Report on Form 10-K.  However, the risks described in our Annual Report on Form 10-K are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

ISSUER PURCHASES OF EQUITY SECURITIESISSUER PURCHASES OF EQUITY SECURITIESISSUER PURCHASES OF EQUITY SECURITIES 
            
Period
Total Number of
Shares (or units
Purchased)
Average Price
Paid per Share
(or Unit)
Total Number of Shares (or Units)
Purchased as Part of Publicly
Announced Plans of Programs
Maximum Number (or Approximate Dollar
Value) of Shares (or Units) that May Yet Be
Purchased Under the Plans or Programs (1)
 Total Number of Shares (or units Purchased)  Average Price Paid per Share (or Unit)  Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans of Programs  Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs (1) 
    
4/1/15 to 4/30/15---54,577
5/1/15 to 5/31/15364$48.5036454,213
6/1/15 to 6/30/15---54,213
4/1/16 to 4/30/16  29  $47.00   29   155,610 
5/1/16 to 5/31/16  7,271  $47.78   7,271   148,339 
6/1/16 to 6/30/16  5,717  $47.65   5,717   142,622 
Total364$48.5036454,577  13,017  $47.72   13,017   142,622 

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(1)On January 17, 2012,October 20, 2015, the Company announced that the Board of Directors authorized the Company to repurchase up to an additional 140,000150,000 shares.  The repurchases will be conducted through open-market purchases or privately negotiated transactions and will be made from time to time depending on market conditions and other factors.  No time limit was placed on the duration of the share repurchase program.  Any repurchased shares will be held as treasury stock and will be available for general corporate purposes.

Item 3 -‑ Defaults Upon Senior Securities

Not applicable.

Item 4 – Mine Safety Disclosure

Not applicable.

Item 5 -‑ Other Information

None.None

Item 6 -‑ Exhibits

(a)  The following documents are filed as a part of this report:
   
2.1
Agreement and Plan of Merger by and among Citizens Financial Services, Inc., First Citizens Community Bank and The First National Bank of Fredericksburg, dated as of June 30, 2015(1)
 3.1 
Articles of Incorporation of Citizens Financial Services, Inc., as amended (2)(1)
 
 3.2 
Bylaws of Citizens Financial Services, Inc.(3)(2)
 
 4.1 
Form of Common Stock Certificate.(4)(3)
 
 31.1 
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
 
 31.2 
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
 
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 32.1 
Section 1350 Certification of Chief Executive Officer and Chief Financial Officer
 101 ** The following materials from the Company’sCompany's Quarterly Report on Form 10-Q for the period ended June 30,2015,30, 2016, formatted in XBRL (Extensible Business Reporting Language): (i) The Consolidated Balance Sheet (unaudited), (ii) the Consolidated Statement of Income (unaudited), (iii) the Consolidated Statement of Comprehensive Income (unaudited), (iv) the Consolidated Statement of Cash Flows (unaudited) and (v) related notes (unaudited).
 
 
(1) Incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K, as filed with the Commission on July 1, 2015.
(2)    Incorporated by reference to Exhibit 3.1 to the Company’sCompany's Quarterly Report on Form 10-Q for the quarter ended March 31, 2010, as filed with the Commission on May 12, 2010.

(2)(3)Incorporated by reference to Exhibit 3.2 to the Company’sCompany's Current Report on Form 8-K, as filed with the Commission on December 24, 2009.

(3)(4)Incorporated by reference to Exhibit 4 to the Company’sCompany's Annual Report on Form 10-K for the fiscal year ended December 31, 2005, as filed with the Commission on March 14, 2006.

** Furnished, not filed.


5359
Signatures


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

 
Citizens Financial Services, Inc.
(Registrant)
 
    
August 6, 20154, 2016By:/s/ Randall E. Black 
  Randall E. Black 
  
President and Chief Executive Officer
(Principal Executive Officer)
 
    

  
    
August 6, 20154, 2016By:/s/ Mickey L. Jones 
  Mickey L. Jones 
  
Chief Financial Officer
(Principal Accounting Officer)
 
    


 



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