UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

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

For the quarterly period endedJune 30, ~~2017~~2018

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

¨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: 000-16084

CITIZENS & NORTHERN CORPORATION

(Exact name of Registrant as specified in its charter)

PENNSYLVANIA	23-2451943
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

90-92 MAIN STREET, WELLSBORO, PA 16901

(Address of principal executive offices) (Zip code)

570-724-3411

(~~Registrant’s~~Registrant's telephone number including area code)

Indicate by check mark whether the registrant (1) has filed all reports required 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. YesxNo¨

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

YesxNo¨

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

~~(Check~~ (Check one):

Large accelerated filer¨Accelerated filerxNon-accelerated filer¨Smaller reporting company¨

Emerging growth company¨

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes¨Nox

Indicate the number of shares outstanding of each of the ~~registrant’s~~registrant's classes of common stock, as of the latest practicable date.

Common Stock ($1.00 par value)

~~12,176,693~~12,281,924 Shares Outstanding on July ~~31, 2017~~30, 2018

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

CITIZENS & NORTHERN CORPORATION

Index

Part I. Financial Information

Item 1. Financial Statements

Consolidated Balance Sheets (Unaudited) – June 30, ~~2017~~2018 and December 31, ~~2016~~2017		Page 3

Consolidated Statements of Income (Unaudited) – Three-month and Six-month Periods Ended June 30, ~~2017~~2018 and ~~2016~~2017		Page 4

Consolidated Statements of Comprehensive Income (Unaudited) –- Three-month and Six-month Periods Ended June 30, ~~2017~~2018 and ~~2016~~2017		Page 5

Consolidated Statements of Cash Flows (Unaudited) – Six-month Periods Ended June 30, ~~2017~~2018 and ~~2016~~2017		Page 6

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) – ~~Six Months~~Six-month Periods Ended June 30, ~~2017~~2018 and ~~2016~~2017		Page 7

Notes to Unaudited Consolidated Financial Statements		Pages 8 – 3836

Item 2. ~~Management’s~~Management's Discussion and Analysis of ~~Financial Condition~~FinancialCondition and Results of Operations		Pages 3937 – 6061

Item 3. Quantitative and Qualitative Disclosures About Market Risk		Pages 6062 – 6163

Item 4. Controls and Procedures		Page 6264

Part II. Other Information		Pages 6365 – 6466

Signatures		Page 6567


Exhibit 31.1. Rule 13a-14(a)/15d-14(a) Certification –- Chief Executive Officer		~~Page 66~~

Exhibit 31.2. Rule 13a-14(a)/15d-14(a) Certification –- Chief Financial Officer		~~Page 67~~

Exhibit 32. Section 1350 Certifications		~~Page 68~~

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

ITEM 1. FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS

(In Thousands, Except Share and Per Share Data) (Unaudited)

	June 30,			December 31,			June 30,			December 31,
	2017			2016			2018			2017
ASSETS
Cash and due from banks:
Noninterest-bearing	$	21,645		$	17,551		$	19,720		$	25,664
Interest-bearing		12,998			14,558			31,755			14,580
Total cash and due from banks		34,643			32,109			51,475			40,244
Available-for-sale securities, at fair value		364,753			395,077
Available-for-sale debt securities, at fair value								348,044			355,937
Marketable equity security								948			971
Loans held for sale		1,708			142			177			765

Loans receivable		779,692			751,835			818,647			815,713
Allowance for loan losses		(8,635	)		(8,473	)		(8,831	)		(8,856	)
Loans, net		771,057			743,362			809,816			806,857

Bank-owned life insurance		19,888			19,704			18,835			20,083
Accrued interest receivable		3,808			3,963			4,042			4,048
Bank premises and equipment, net		15,510			15,397			15,017			15,432
Foreclosed assets held for sale		2,023			2,180			2,897			1,598
Deferred tax asset, net		3,942			5,117			4,304			3,289
Intangible assets – Goodwill and core deposit intangibles		11,957			11,959
Intangible assets - Goodwill and core deposit intangibles								11,952			11,954
Other assets		14,112			13,282			16,500			15,781
TOTAL ASSETS	$	1,243,401		$	1,242,292		$	1,284,007		$	1,276,959

LIABILITIES
Deposits:
Noninterest-bearing	$	236,932		$	224,175		$	248,502		$	241,214
Interest-bearing		760,330			759,668			792,397			767,235
Total deposits		997,262			983,843			1,040,899			1,008,449
Short-term borrowings		8,875			26,175			17,169			61,766
Long-term borrowings		38,321			38,454			27,054			9,189
Accrued interest and other liabilities		9,084			7,812			9,706			9,112
TOTAL LIABILITIES		1,053,542			1,056,284			1,094,828			1,088,516

STOCKHOLDERS’ EQUITY
STOCKHOLDERS' EQUITY
Preferred stock, $1,000 par value; authorized 30,000 shares; $1,000 liquidation preference per share; no shares issued		0			0			0			0
Common stock, par value $1.00 per share; authorized 20,000,000 shares; issued 12,655,171; outstanding 12,176,693 at June 30, 2017 and 12,113,228 December 31, 2016		12,655			12,655
Common stock, par value $1.00 per share; authorized 20,000,000 shares; issued 12,655,171; outstanding 12,280,538 at June 30, 2018 and 12,214,525 December 31, 2017								12,655			12,655
Paid-in capital		71,684			71,730			71,947			72,035
Retained earnings		114,066			112,790			118,012			113,608
Treasury stock, at cost; 478,478 shares at June 30, 2017 and 541,943 shares at December 31, 2016		(9,066	)		(10,269	)
Accumulated other comprehensive income (loss)		520			(898	)
TOTAL STOCKHOLDERS’ EQUITY		189,859			186,008
TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY	$	1,243,401		$	1,242,292
Treasury stock, at cost; 374,633 shares at June 30, 2018 and 440,646 shares at December 31, 2017								(7,096	)		(8,348	)
Accumulated other comprehensive loss								(6,339	)		(1,507	)
TOTAL STOCKHOLDERS' EQUITY								189,179			188,443
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY							$	1,284,007		$	1,276,959

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

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Consolidated Statements of Income

(In Thousands Except Per Share Data) (Unaudited)

	3 Months Ended					6 Months Ended				3 Months Ended					6 Months Ended
	June 30,		June 30,			June 30,		June 30,		June 30,			June 30,		June 30,			June 30,
	2017		2016			2017		2016		2018			2017		2018			2017
INTEREST INCOME
Interest and fees on loans:
Taxable	$	8,609	$	8,086		$	16,983	$	16,060	$	9,575		$	8,609	$	18,776		$	16,983
Tax-exempt		501		452			951		900		560			501		1,116			951
Interest on mortgages held for sale		6		8			10		14		4			6		6			10
Interest on balances with depository institutions		41		36			73		60		96			41		146			73
Income from available-for-sale securities:
Income from available-for-sale debt securities:
Taxable		1,352		1,490			2,755		3,045		1,381			1,352		2,744			2,755
Tax-exempt		826		847			1,670		1,743		712			826		1,425			1,670
Dividends		5		5			10		39
Dividends on marketable equity security											6			5		11			10
Total interest and dividend income		11,340		10,924			22,452		21,861		12,334			11,340		24,224			22,452
INTEREST EXPENSE
Interest on deposits		575		522			1,096		1,001		879			575		1,608			1,096
Interest on short-term borrowings		45		41			122		103		82			45		281			122
Interest on long-term borrowings		358		362			713		725		118			358		183			713
Total interest expense		978		925			1,931		1,829		1,079			978		2,072			1,931
Net interest income		10,362		9,999			20,521		20,032		11,255			10,362		22,152			20,521
Provision for loan losses		4		318			456		686
Net interest income after provision for loan losses		10,358		9,681			20,065		19,346
OTHER INCOME
Service charges on deposit accounts		1,094		1,164			2,178		2,302
Service charges and fees		104		123			201		217
(Credit) provision for loan losses											(20	)		4		272			456
Net interest income after (credit) provision for loan losses											11,275			10,358		21,880			20,065
NONINTEREST INCOME
Trust and financial management revenue		1,497		1,251			2,677		2,395		1,526			1,497		2,948			2,677
Brokerage revenue		208		180			364		353		271			208		483			364
Insurance commissions, fees and premiums		31		27			72		48		13			31		57			72
Service charges on deposit accounts											1,302			1,112		2,506			2,213
Service charges and fees											82			86		168			166
Interchange revenue from debit card transactions		568		487			1,088		950		641			568		1,220			1,088
Net gains from sale of loans		188		295			354		463		166			188		350			354
Loan servicing fees, net		55		(11	)		127		11		61			55		189			127
Increase in cash surrender value of life insurance		94		93			184		189		98			94		195			184
Other operating income		267		297			725		668
Other noninterest income											529			267		979			725
Sub-total		4,106		3,906			7,970		7,596		4,689			4,106		9,095			7,970
Realized gains on available-for-sale securities, net		107		122			252		505
Total other income		4,213		4,028			8,222		8,101
OTHER EXPENSES
Gain on restricted equity security											1,750			0		1,750			0
Realized (losses) gains on available-for-sale debt securities, net											(282	)		107		(282	)		252
Total noninterest income											6,157			4,213		10,563			8,222
NONINTEREST EXPENSE
Salaries and wages		3,972		3,913			7,840		7,800		4,193			3,972		8,317			7,840
Pensions and other employee benefits		1,144		1,002			2,674		2,439		1,200			1,137		2,810			2,661
Occupancy expense, net		600		560			1,178		1,169		613			600		1,250			1,178
Furniture and equipment expense		448		439			901		866		313			315		584			628
FDIC Assessments		96		155			190		297
Data processing expenses											694			615		1,335			1,190
Automated teller machine and interchange expense											319			305		641			599
Pennsylvania shares tax		336		323			672		645		336			336		672			672
Professional fees		254		282			481		571		279			188		555			375
Automated teller machine and interchange expense		305		267			599		516
Software subscriptions		291		251			571		492
Other operating expense		1,630		1,343			3,268		2,812
Total other expenses		9,076		8,535			18,374		17,607
Telecommunications											157			132		390			266
Directors' fees											168			186		352			371
Other noninterest expense											1,412			1,290		2,673			2,594
Total noninterest expense											9,684			9,076		19,579			18,374
Income before income tax provision		5,495		5,174			9,913		9,840		7,748			5,495		12,864			9,913
Income tax provision		1,374		1,303			2,358		2,396		1,377			1,374		2,118			2,358
NET INCOME	$	4,121	$	3,871		$	7,555	$	7,444	$	6,371		$	4,121	$	10,746		$	7,555
EARNINGS PER COMMON SHARE – BASIC	$	0.34	$	0.32		$	0.62	$	0.61
EARNINGS PER COMMON SHARE – DILUTED	$	0.34	$	0.32		$	0.62	$	0.61
EARNINGS PER COMMON SHARE - BASIC										$	0.52		$	0.34	$	0.88		$	0.62
EARNINGS PER COMMON SHARE - DILUTED										$	0.52		$	0.34	$	0.87		$	0.62

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

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Consolidated Statements of Comprehensive Income

(In Thousands) (Unaudited)

Three Months Ended Six Months Ended
June 30, June 30,
2017 2016 2017 2016
Net income $ 4,121 $ 3,871 $ 7,555 $ 7,444

Unrealized gains on available-for-sale securities:
Unrealized holding gains on available-for-sale securities 1,644 2,431 2,280 7,205
Reclassification adjustment for gains realized in income (107 ) (122 ) (252 ) (505 )
Other comprehensive gain on available-for-sale securities 1,537 2,309 2,028 6,700

Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses included in accumulated other comprehensive gain 0 0 166 26
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost (6 ) (5 ) (12 ) (10 )
Other comprehensive (loss) gain on unfunded retirement obligations (6 ) (5 ) 154 16

Other comprehensive income before income tax 1,531 2,304 2,182 6,716
Income tax related to other comprehensive income (536 ) (806 ) (764 ) (2,350 )

Net other comprehensive income 995 1,498 1,418 4,366

Comprehensive income $ 5,116 $ 5,369 $ 8,973 $ 11,810
Three Months Ended Six Months Ended
June 30, June 30,
2018 2017 2018 2017
Net income $ 6,371 $ 4,121 $ 10,746 $ 7,555

Unrealized (losses) gains on available-for-sale securities:
Unrealized holding (losses) gains on available-for-sale securities (1,292 ) 1,644 (6,131 ) 2,280
Reclassification adjustment for losses (gains) realized in income 282 (107 ) 282 (252 )
Other comprehensive (loss) gain on available-for-sale securities (1,010 ) 1,537 (5,849 ) 2,028

Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses  included in accumulated other comprehensive gain 0 0 93 166
Amortization of prior service cost and net actuarial  loss included in net periodic benefit cost (5 ) (6 ) (10 ) (12 )
Other comprehensive (loss )gain on unfunded retirement obligations (5 ) (6 ) 83 154

Other comprehensive (loss) income before income tax (1,015 ) 1,531 (5,766 ) 2,182
Income tax related to other comprehensive loss (income) 214 (536 ) 1,211 (764 )

Net other comprehensive (loss) income (801 ) 995 (4,555 ) 1,418

Comprehensive income $ 5,570 $ 5,116 $ 6,191 $ 8,973

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

5
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands) (Unaudited)

6 Months Ended 6 Months Ended
June 30, June 30, June 30, June 30,
2017 2016 2018 2017
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 7,555 $ 7,444 $ 10,746 $ 7,555
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 456 686 272 456
Realized gains on available-for-sale securities, net (252 ) (505 )
Realized losses (gains) on available-for-sale securities, net 282 (252 )
Unrealized loss on marketable equity security 23 0
Gain on restricted equity security (1,750 ) 0
Depreciation expense 826 787 850 826
Accretion and amortization on securities, net 583 660 512 583
Increase in cash surrender value of life insurance (184 ) (189 ) (195 ) (184 )
Stock-based compensation and other expense 322 325 338 322
Deferred income taxes 411 340 196 411
Decrease in fair value of servicing rights 78 179 26 78
Gains on sales of loans, net (354 ) (463 ) (350 ) (354 )
Origination of loans for sale (12,741 ) (12,698 ) (10,730 ) (12,741 )
Proceeds from sales of loans 11,434 12,953 11,571 11,434
Increase in accrued interest receivable and other assets (1,568 ) (708 ) (454 ) (1,568 )
Increase (decrease) in accrued interest payable and other liabilities 921 (296 )
Decrease in accrued interest payable and other liabilities 677 921
Other 104 65 193 104
Net Cash Provided by Operating Activities 7,591 8,580 12,207 7,591
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of certificates of deposit 348 100 820 348
Purchase of certificates of deposit (100 ) (340 ) (350 ) (100 )
Proceeds from sales of available-for-sale securities 14,373 19,387 0 14,373
Proceeds from calls and maturities of available-for-sale securities 27,529 37,009 23,605 27,529
Purchase of available-for-sale securities (9,376 ) (46,766 ) (22,355 ) (9,376 )
Redemption of Federal Home Loan Bank of Pittsburgh stock 4,054 2,642 4,020 4,054
Purchase of Federal Home Loan Bank of Pittsburgh stock (3,206 ) (1,600 ) (2,542 ) (3,206 )
Net increase in loans (28,753 ) (24,751 ) (5,712 ) (28,753 )
Proceeds from bank owned life insurance 0 1,442 1,443 0
Purchase of premises and equipment (939 ) (720 ) (687 ) (939 )
Proceeds from sale of foreclosed assets 644 292 1,243 644
Other 75 82 84 75
Net Cash Provided by (Used in) Investing Activities 4,649 (13,223 )
Net Cash (Used in) Provided by Investing Activities (431 ) 4,649
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 13,419 32,336 32,450 13,419
Net decrease in short-term borrowings (17,300 ) (27,794 ) (44,597 ) (17,300 )
Proceeds from long-term borrowings 18,000 0
Repayments of long-term borrowings (133 ) (152 ) (135 ) (133 )
Purchase of treasury stock 0 (3,723 )
Sale of treasury stock 81 100 65 81
Tax benefit from compensation plans 0 88
Common dividends paid (5,525 ) (5,557 ) (5,858 ) (5,525 )
Net Cash Used in Financing Activities (9,458 ) (4,702 ) (75 ) (9,458 )
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,782 (9,345 )
INCREASE IN CASH AND CASH EQUIVALENTS 11,701 2,782
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 28,621 33,313 37,004 28,621
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 31,403 $ 23,968 $ 48,705 $ 31,403

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Accrued purchase of available-for-sale securities $ 505 $ 0
Accrued purchase of certificates of deposit $ 0 $ 480
Assets acquired through foreclosure of real estate loans $ 608 $ 1,151 $ 2,486 $ 608
Accrued purchase of available-for-sale debt security $ 0 $ 505
Interest paid $ 1,926 $ 1,826 $ 2,011 $ 1,926
Income taxes paid $ 1,635 $ 1,485 $ 1,275 $ 1,635

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

6
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Consolidated Statements of Changes in ~~Stockholders’~~Stockholders' Equity
(In Thousands Except Share and Per Share Data)
(Unaudited)

Accumulated Accumulated
Other Other
Common Treasury Common Paid-in Retained Comprehensive Treasury Common Treasury Common Paid-in Retained Comprehensive Treasury
Shares Shares Stock Capital Earnings Income (Loss) Stock Total
Six Months Ended June 30, 2018
Balance, December 31, 2017 12,655,171 440,646 $ 12,655 $ 72,035 $ 113,608 ($ 1,507 ) ($ 8,348 ) $ 188,443
Impact of change in enacted income tax rate (a) 325 (325 ) 0
Impact of change in method of premium amortization of callable debt securities (b) (26 ) 26 0
Impact of change in method of accounting for marketable equity security (c) (22 ) 22 0
Net income 10,746 10,746
Other comprehensive loss, net (4,555 ) (4,555 )
Cash dividends declared on common stock, $0.54 per share (6,619 ) (6,619 )
Shares issued for dividend reinvestment Plan (31,572 ) 163 598 761
Shares issued from treasury and redeemed related to exercise of stock options (7,417 ) (75 ) 140 65
Restricted stock granted (34,552 ) (655 ) 655 0
Forfeiture of restricted stock 7,528 141 (141 ) 0
Stock-based compensation expense 338 338
Balance, June 30, 2018 12,655,171 374,633 $ 12,655 $ 71,947 $ 118,012 $ (6,339 ) $ (7,096 ) $ 189,179
Shares Shares Stock Capital Earnings (Loss) Income Stock Total
Six Months Ended June 30, 2017
Balance, December 31, 2016 12,655,171 541,943 $ 12,655 $ 71,730 $ 112,790 $ (898 ) $ (10,269 ) $ 186,008 12,655,171 541,943 $ 12,655 $ 71,730 $ 112,790 ($ 898 ) ($ 10,269 ) $ 186,008
Net income 7,555 7,555 7,555 7,555
Other comprehensive income, net 1,418 1,418 1,418 1,418
Cash dividends declared on common stock, $0.52 per share (6,279 ) (6,279 ) (6,279 ) (6,279 )
Shares issued for dividend reinvestment plan (31,913 ) 148 606 754
Shares issued for dividend reinvestment Plan (31,913 ) 148 606 754
Shares issued from treasury and redeemed related to exercise of stock options (4,578 ) (4 ) 85 81 (4,578 ) (4 ) 85 81
Restricted stock granted (30,782 ) (583 ) 583 0 (30,782 ) (583 ) 583 0
Forfeiture of restricted stock 3,808 71 (71 ) 0 3,808 71 (71 ) 0
Stock-based compensation expense 322 322 322 322
Balance, June 30, 2017 12,655,171 478,478 $ 12,655 $ 71,684 $ 114,066 $ 520 $ (9,066 ) $ 189,859 12,655,171 478,478 $ 12,655 $ 71,684 $ 114,066 $ 520 ($ 9,066 ) $ 189,859

Six Months Ended June 30, 2016
Balance, December 31, 2015 12,655,171 474,548 $ 12,655 $ 71,654 $ 109,454 $ 2,528 $ (8,804 ) $ 187,487
Net income 7,444 7,444
Other comprehensive income, net 4,366 4,366
Cash dividends declared on common stock, $0.52 per share (6,298 ) (6,298 )
Shares issued for dividend reinvestment plan (36,771 ) 48 693 741
Treasury stock purchased 187,075 (3,723 ) (3,723 )
Shares issued from treasury and redeemed related to exercise of stock options (5,556 ) (9 ) 109 100
Restricted stock granted (35,427 ) (658 ) 658 0
Forfeiture of restricted stock 1,107 20 (20 ) 0
Stock-based compensation expense 325 325
Tax effect of stock option exercises (1 ) (1 )
Tax benefit from dividends on restricted stock 12 12
Tax benefit from compensation plans 77 77
Balance, June 30, 2016 12,655,171 584,976 $ 12,655 $ 71,391 $ 110,677 $ 6,894 $ (11,087 ) $ 190,530
(a) As described in more detail in the Recent Accounting Pronouncements - Adopted section of Note 1, this reclassification resulted from adoption of Accounting Standards Update (ASU) 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, effective January 1, 2018.
(b) As described in more detail in the Recent Accounting Pronouncements - Adopted section of Note 1, this reclassification resulted from adoption of ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20), effective January 1, 2018.
(c) As described in more detail in the Recent Accounting Pronouncements - Adopted section of Note 1, this reclassification resulted from adoption of ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities, effective January 1, 2018.

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

7
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Notes to Unaudited Consolidated Financial Statements

1. BASIS OF INTERIM PRESENTATION AND STATUS OF RECENT ACCOUNTING PRONOUNCEMENTS
The consolidated financial statements include the accounts of Citizens & Northern Corporation and its subsidiaries, Citizens & Northern Bank (“C&N Bank”), Bucktail Life Insurance Company and Citizens & Northern Investment Corporation (collectively, “Corporation”), as well as C&N Bank’s wholly-owned subsidiary, C&N Financial Services Corporation. In December 2017, C&N Bank established a new entity, Northern Tier Holding LLC, for the purpose of acquiring, holding and disposing of real property acquired by the Bank. C&N Bank is the sole member of Northern Tier Holding LLC. All material intercompany balances and transactions have been eliminated in consolidation.

The consolidated financial information included herein, with the exception of the consolidated balance sheet dated December 31, ~~2016,~~2017, is unaudited. Such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations, comprehensive income, cash flows and changes in stockholders’ equity for the interim periods; however, the information does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for a complete set of financial statements. Certain ~~2016~~2017 information has been reclassified for consistency with the ~~2017~~2018 presentation.

Operating results reported for the three-month and six-month periods ended June 30, ~~2017~~2018 might not be indicative of the results for the year ending December 31, ~~2017.~~2018. The Corporation evaluates subsequent events through the date of filing with the Securities and Exchange Commission.

RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board (FASB) issues Accounting Standards Updates (ASUs) to the FASB Accounting Standards Codification (ASC). This section provides a summary description of recent ASUs that have significant implications (elected or required) within the consolidated financial statements, or that management expects may have a significant impact on financial statements issued in the near future.
Recent Accounting Pronouncements - Adopted
Effective January 1, 2018, the Corporation adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606).Under the ASU, as modified by subsequent ASUs, revenue is recognized when a customer obtains control of promised services in an amount that reflects the consideration the entity expects to receive in exchange for those services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.  The Corporation applied the five-step method outlined in the ASU to all revenue streams scoped-in by the ASU and elected the modified retrospective implementation method. Substantially all of the Corporation’s interest income and certain noninterest income were not impacted by the adoption of this ASU because the revenue from those contracts with customers is covered by other guidance in U.S. GAAP. The Corporation’s largest sources of noninterest revenue which are subject to the guidance include Trust and financial management revenue, service charges on deposit accounts and interchange revenue from debit card transactions. Adoption of ASU 2014-09 did not change the timing and pattern of the Corporation’s revenue recognition related to scoped-in noninterest income. New disclosures required by the ASU have been included in Note 13.
In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which permits, but does not require, entities to reclassify tax effects stranded in accumulated other comprehensive income resulting from the Tax Cuts and Jobs Act of 2017 to retained earnings. Companies that elect to reclassify these amounts must reclassify stranded tax effects for all items accounted for in accumulated other comprehensive income. The Corporation elected early adoption and adopted this standard update, effective January 1, 2018. The Corporation’s stranded tax effects were related to valuation of the net deferred tax asset attributable to items of accumulated other comprehensive income (loss), which are unrealized gains (losses) on available-for-sale securities and unfunded defined benefit plan obligations. Adoption resulted in a reclassification between two categories of stockholders’ equity at January 1, 2018, with an increase of $325,000 in retained earnings and a decrease in accumulated other comprehensive loss for the same amount (no net change in stockholders’ equity).
Effective January 1, 2018, the Corporation elected early adoption of ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20). This Update shortens the amortization period for certain callable debt securities held at a premium. Discounts will continue to be amortized to maturity. Adoption resulted in a reduction in retained earnings and corresponding increase in accumulated other comprehensive loss (no net change in stockholders’ equity) of $26,000 at January 1, 2018 for the cumulative after-tax impact of the change in accounting for debt securities held as of that date.
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
Effective January 1, 2018, the Corporation adopted ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities. The guidance affects the accounting for equity investments, financial liabilities under the fair value option and the presentation and disclosure requirements of financial instruments. ASU 2016-01 was effective for the Corporation on January 1, 2018 and resulted in the following changes:
· A marketable equity security previously included in available-for-sale securities on the consolidated balance sheets is presented as a separate asset.
· Changes in the fair value of the marketable equity security are captured in the consolidated statements of income.
· Retained earnings was reduced and a corresponding increase in accumulated other comprehensive loss was recognized (no net change in stockholders’ equity) of $22,000 at January 1, 2018 for the after-tax impact of the change in accounting for the unrealized loss on the marketable equity security.
· As described in more detail in Note 6, in the second quarter 2018, an unrealized gain of $866,000 (pre-tax) was recognized in the unaudited, consolidated statements of income on a restricted equity security (Visa Class B stock). As required by ASU 2016-01, the Corporation considered the pricing of observable transactions in determining the carrying value of this equity security that does not have a readily determinable fair value. Accordingly, the Corporation’s second quarter 2018 gain included the realized portion related to 10,000 shares sold in June 2018 and an unrealized portion based on the price per share of that sale. At June 30, 2018, the balance of other assets in the unaudited, consolidated balance sheet included a total of $1,750,000 associated with the Visa Cass B shares, including a receivable of $884,000 from the sale of 10,000 shares and $866,000 from the carrying value of the remaining 9,789 shares.
· Adoption of ASU 2016-01 also resulted in the use of an exit price to determine the fair value of financial instruments not measured at fair value in the consolidated balance sheets. Further information regarding valuation of financial instruments is provided in Note 5.
Recently Issued But Not Yet Effective Accounting Pronouncements
ASU 2016-02, Leases (Topic 842) changes current GAAP by requiring that lease assets and liabilities arising from operating leases be recognized on the balance sheet. In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842, Leases, amending narrow aspects of Topic 842. Topic 842 would not significantly change the recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee from current U.S. GAAP. For leases with a term of 12 months or less, a lessee would be permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and liabilities. Topic 842 will become effective for the Corporation for annual and interim periods beginning in the first quarter 2019. Adoption of Topic 842 is not expected to have a material impact on the Corporation’s consolidated financial statements. The Corporation leases certain properties and equipment under operating leases that will result in the recognition of lease assets and lease liabilities on the consolidated balance sheet under Topic 842; however, the majority of the Corporation’s properties and equipment are owned, not leased.
ASU 2016-13, Financial Instruments-Credit Losses (Topic 326), changes accounting for credit losses on loans receivable and debt securities from an incurred loss methodology to an expected credit loss methodology. Among other things, ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Accordingly, ASU 2016-13 requires the use of forward-looking information to form credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, though the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, ASU 2016-13 amends the accounting for credit losses on debt securities and purchased financial assets with credit deterioration. The amendments in ASU 2016-13 will be effective for the Corporation beginning in the first quarter 2020. Earlier adoption is permitted beginning in the first quarter 2019; however, the Corporation does not currently plan to early adopt the ASU. The Corporation has formed a cross functional management team that is assessing alternative loss estimation methodologies and the Corporation’s data and system needs in order to evaluate the impact that adoption of this standard will have on the Corporation’s financial condition and results of operations. The Corporation will record the effect of implementing this ASU through a cumulative-effect adjustment through retained earnings as of the beginning of the reporting period in which Topic 326 is effective.
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
ASU 2017-04, Intangibles – Goodwill and Other (Topic 350) simplifies the accounting for goodwill impairment. This guidance, among other things, removes step 2 of the goodwill impairment test thus eliminating the need to determine the fair value of individual assets and liabilities of the reporting unit. Upon adoption of this ASU, goodwill impairment will be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. This may result in more or less impairment being recognized than under current guidance. This Update will become effective for the Corporation’s annual and interim goodwill impairment tests beginning in the first quarter 2020. The Corporation does not expect adoption of this ASU to have a material impact on its consolidated financial statements.
2. PER SHARE DATA

Basic earnings per common share are calculated using the two-class method to determine income attributable to common shareholders. Unvested restricted stock awards that contain nonforfeitable rights to dividends are considered participating securities under the two-class method. Distributed dividends and an allocation of undistributed net income to participating securities reduce the amount of income attributable to common shareholders. Income attributable to common shareholders is then divided by weighted-average common shares outstanding for the period to determine basic earnings per common share.

Diluted earnings per common share are calculated under the more dilutive of either the treasury method or the two-class method. Diluted earnings per common share is computed using weighted-average common shares outstanding, plus weighted-average common shares available from the exercise of all dilutive stock options, less the number of shares that could be repurchased with the proceeds of stock option exercises based on the average share price of the ~~Corporation’s~~Corporation's common stock during the period.

3 Months Ended 6 Months Ended 3 Months Ended 6 Months Ended
June 30, June 30, June 30, June 30, June 30, June 30, June 30, June 30,
2017 2016 2017 2016 2018 2017 2018 2017
Basic
Net income $ 4,121,000 $ 3,871,000 $ 7,555,000 $ 7,444,000 $ 6,371,000 $ 4,121,000 $ 10,746,000 $ 7,555,000
Less: Dividends and undistributed earnings allocated to participating securities (21,000 ) (21,000 ) (39,000 ) (41,000 ) (32,000 ) (21,000 ) (55,000 ) (39,000 )
Net income attributable to common shares $ 4,100,000 $ 3,850,000 $ 7,516,000 $ 7,403,000 $ 6,339,000 $ 4,100,000 $ 10,691,000 $ 7,516,000
Basic weighted-average common shares outstanding 12,106,008 11,996,500 12,095,926 12,041,896 12,210,902 12,106,008 12,200,245 12,095,926
Basic earnings per common share (a) $ 0.34 $ 0.32 $ 0.62 $ 0.61 $ 0.52 $ 0.34 $ 0.88 $ 0.62

Diluted
Net income attributable to common shares $ 4,100,000 $ 3,850,000 $ 7,516,000 $ 7,403,000 $ 6,339,000 $ 4,100,000 $ 10,691,000 $ 7,516,000
Basic weighted-average common shares outstanding 12,106,008 11,996,500 12,095,926 12,041,896 12,210,902 12,106,008 12,200,245 12,095,926
Dilutive effect of potential common stock arising from stock options 38,698 21,540 42,263 21,158 37,243 38,698 36,273 42,263
Diluted weighted-average common shares outstanding 12,144,706 12,018,040 12,138,189 12,063,054 12,248,145 12,144,706 12,236,518 12,138,189
Diluted earnings per common share (a) $ 0.34 $ 0.32 $ 0.62 $ 0.61 $ 0.52 $ 0.34 $ 0.87 $ 0.62

Weighted-average nonvested restricted shares outstanding 61,172 62,080 63,175 63,633

(a) Basic and diluted earnings per share under the two-class method are determined on net income reported on the consolidated statements of income, ~~statement~~ less earnings allocated to nonvested restricted shares with nonforfeitable dividends (participating securities).

The weighted-average number of nonvested restricted shares outstanding was 62,080 shares in the three-month period ended June 30, 2017 and 65,876 shares in the three-month period ended June 30, 2016. The weighted-average number of nonvested restricted shares outstanding was 63,633 shares in the six-month period ended June 30, 2017 and 66,847 shares in the six-month period ended June 30, 2016.
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~~Stock~~Anti-dilutive stock options ~~that were anti-dilutive were~~are excluded from net income per share calculations. There were no anti-dilutive instruments in the three-month or six-month periods ended June 30, ~~2017. Weighted-average common shares available from anti-dilutive instruments totaled 47,139 shares in the second quarter 2016~~2018 and ~~47,224 shares in the six-month period ended June 30, 2016.~~2017.
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

3. COMPREHENSIVE INCOME

Comprehensive income is the total of (1) net income, and (2) all other changes in equity from non-stockholder sources, which are referred to as other comprehensive ~~income.~~income (loss). The components of other comprehensive income (loss), and the related tax effects, are as follows:

(In Thousands) Before-Tax Income Tax Net-of-Tax
Amount Effect Amount
Six Months Ended June 30, 2017
Unrealized gains on available-for-sale securities:
Unrealized holding gains on available-for-sale securities $ 2,280 $ (798 ) $ 1,482
Reclassification adjustment for (gains) realized in income (252 ) 88 (164 )
Other comprehensive income on available-for-sale securities 2,028 (710 ) 1,318

Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses included in other comprehensive income 166 (58 ) 108
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost (12 ) 4 (8 )
Other comprehensive income on unfunded retirement obligations 154 (54 ) 100

Total other comprehensive income $ 2,182 $ (764 ) $ 1,418
(In Thousands) Before-Tax Income Tax Net-of-Tax
Amount Effect Amount
Six Months Ended June 30, 2018
Unrealized losses on available-for-sale securities:
Unrealized holding losses on available-for-sale securities $ (6,131 ) $ 1,287 $ (4,844 )
Reclassification adjustment for losses realized in income 282 (59 ) 223
Other comprehensive loss on available-for-sale securities (5,849 ) 1,228 (4,621 )
Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses  included in other comprehensive income 93 (19 ) 74
Amortization of prior service cost and net  actuarial loss included in net periodic benefit cost (10 ) 2 (8 )
Other comprehensive income on unfunded retirement obligations 83 (17 ) 66

Total other comprehensive loss $ (5,766 ) $ 1,211 $ (4,555 )

(In Thousands) Before-Tax Income Tax Net-of-Tax Before-Tax Income Tax Net-of-Tax
Amount Effect Amount Amount Effect Amount
Six Months Ended June 30, 2016
Six Months Ended June 30, 2017
Unrealized gains on available-for-sale securities:
Unrealized holding gains on available-for-sale securities $ 7,205 $ (2,521 ) $ 4,684 $ 2,280 ($ 798 ) $ 1,482
Reclassification adjustment for (gains) realized in income (505 ) 177 (328 ) (252 ) 88 (164 )
Other comprehensive income on available-for-sale securities 6,700 (2,344 ) 4,356 2,028 (710 ) 1,318

Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses included in other comprehensive income 26 (9 ) 17 166 (58 ) 108
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost (10 ) 3 (7 )
Amortization of prior service cost and net actuarial loss included in net periodic benefit cost (12 ) 4 (8 )
Other comprehensive income on unfunded retirement obligations 16 (6 ) 10 154 (54 ) 100

Total other comprehensive income $ 6,716 $ (2,350 ) $ 4,366 $ 2,182 ($ 764 ) $ 1,418
(In Thousands) Before-Tax Income Tax Net-of-Tax
Amount Effect Amount
Three Months Ended June 30, 2018
Unrealized losses on available-for-sale securities:
Unrealized holding losses on available-for-sale securities $ (1,292 ) $ 272 $ (1,020 )
Reclassification adjustment for losses realized in income 282 (59 ) 223
Other comprehensive loss on available-for-sale securities (1,010 ) 213 (797 )
Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses  included in other comprehensive income 0 0 0
Amortization of prior service cost and net  actuarial loss included in net periodic benefit cost (5 ) 1 (4 )
Other comprehensive loss on unfunded retirement obligations (5 ) 1 (4 )

Total other comprehensive loss $ (1,015 ) $ 214 $ (801 )

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

(In Thousands) Before-Tax Income Tax Net-of-Tax
Amount Effect Amount
Three Months Ended June 30, 2017
Unrealized gains on available-for-sale securities:
Unrealized holding gains on available-for-sale securities $ 1,644 $ (575 ) $ 1,069
Reclassification adjustment for (gains) realized in income (107 ) 37 (70 )
Other comprehensive income on available-for-sale securities 1,537 (538 ) 999

Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses included in other comprehensive income 0 0 0
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost (6 ) 2 (4 )
Other comprehensive loss on unfunded retirement obligations (6 ) 2 (4 )

Total other comprehensive income $ 1,531 $ (536 ) $ 995
(In Thousands) Before-Tax Income Tax Net-of-Tax
Amount Effect Amount
Three Months Ended June 30, 2016
Unrealized gains on available-for-sale securities:
Unrealized holding gains on available-for-sale securities $ 2,431 $ (850 ) $ 1,581
Reclassification adjustment for (gains) realized in income (122 ) 43 (79 )
Other comprehensive income on available-for-sale securities 2,309 (807 ) 1,502

Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses included in other comprehensive income 0 0 0
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost (5 ) 1 (4 )
Other comprehensive loss on unfunded retirement obligations (5 ) 1 (4 )

Total other comprehensive income $ 2,304 $ (806 ) $ 1,498
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(In Thousands) Before-Tax Income Tax Net-of-Tax
Amount Effect Amount
Three Months Ended June 30, 2017
Unrealized gains on available-for-sale securities:
Unrealized holding gains on available-for-sale securities $ 1,644 ($ 575 ) $ 1,069
Reclassification adjustment for (gains) realized in income (107 ) 37 (70 )
Other comprehensive income on available-for-sale securities 1,537 (538 ) 999
Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses  included in other comprehensive income 0 0 0
Amortization of prior service cost and net  actuarial loss included in net periodic benefit cost (6 ) 2 (4 )
Other comprehensive loss on unfunded retirement obligations (6 ) 2 (4 )

Total other comprehensive income $ 1,531 $ (536 ) $ 995

Changes in the components of accumulated other comprehensive income (loss) are as follows and are presented net of tax:

(In Thousands) Unrealized Accumulated Unrealized Accumulated
Holding Gains Unfunded Other (Losses) Unfunded Other
(Losses) Retirement Comprehensive Gains Retirement Comprehensive
on Securities Obligations Income on Securities Obligations Income (Loss)
Six Months Ended June 30, 2018
Balance, beginning of period $ (1,566 ) $ 59 $ (1,507 )
Impact of change in enacted income tax rate (337 ) 12 (325 )
Impact of change in the method of premium amortization of callable debt securities 26 0 26
Impact of change in the method of accounting for marketable equity security 22 0 22
Other comprehensive (loss) income during six months ended June 30, 2018 (4,621 ) 66 (4,555 )
Balance, end of period $ (6,476 ) $ 137 $ (6,339 )

Six Months Ended June 30, 2017
Balance, beginning of period $ (949 ) $ 51 $ (898 ) $ (949 ) $ 51 $ (898 )
Change during six months ended June 30, 2017 1,318 100 1,418
Other comprehensive income during six months ended June 30, 2017 1,318 100 1,418
Balance, end of period $ 369 $ 151 $ 520 $ 369 $ 151 $ 520

Six Months Ended June 30, 2016
Three Months Ended June 30, 2018
Balance, beginning of period $ 2,493 $ 35 $ 2,528 $ (5,679 ) $ 141 $ (5,538 )
Change during six months ended June 30, 2016 4,356 10 4,366
Other comprehensive (loss) during three months ended June 30, 2018 (797 ) (4 ) (801 )
Balance, end of period $ 6,849 $ 45 $ 6,894 $ (6,476 ) $ 137 $ (6,339 )

Three Months Ended June 30, 2017
Balance, beginning of period $ (630 ) $ 155 $ (475 ) $ (630 ) $ 155 $ (475 )
Change during three months ended June 30, 2017 999 (4 ) 995
Other comprehensive income (loss) during three months ended June 30, 2017 999 (4 ) 995
Balance, end of period $ 369 $ 151 $ 520 $ 369 $ 151 $ 520

Three Months Ended June 30, 2016
Balance, beginning of period $ 5,347 $ 49 $ 5,396
Change during three months ended June 30, 2016 1,502 (4 ) 1,498
Balance, end of period $ 6,849 $ 45 $ 6,894
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Items reclassified out of each component of other comprehensive (loss) income are as follows:

~~For the Six Months Ended June 30, 2017~~
~~(In Thousands)~~
For the Six Months Ended June 30, 2018
(In Thousands)
Reclassified from
Details about Accumulated Other Accumulated Other Affected Line Item in the Consolidated
Comprehensive Loss Components Comprehensive Loss Statements of Income
Unrealized gains and losses on available-for-sale securities $ 282 Realized losses on available-for-sale debt securities, net
(59 ) Income tax provision
223 Net of tax
Amortization of defined benefit pension and postretirement items:
Prior service cost (16 ) Other noninterest expense
Actuarial loss 6 Other noninterest expense
(10 ) Total before tax
2 Income tax provision
(8 ) Net of tax
Total reclassifications for the period $ 215

For the Six Months Ended June 30, 2017
(In Thousands)
Reclassified from Reclassified from
Details about Accumulated Other Accumulated Other Affected Line Item in the Consolidated Accumulated Other Affected Line Item in the Consolidated
Comprehensive Income Components Comprehensive Income Statements of Income
Comprehensive Loss Components Comprehensive Loss Statements of Income
Unrealized gains and losses on available-for-sale securities $ (252 ) Realized gains on available-for-sale securities, net $ (252 ) Realized gains on available-for-sale debt securities, net
88 Income tax provision 88 Income tax provision
(164 ) Net of tax (164 ) Net of tax
Amortization of defined benefit pension and postretirement items:
Prior service cost (15 ) Pensions and other employee benefits (15 ) Other noninterest expense
Actuarial loss 3 Pensions and other employee benefits 3 Other noninterest expense
(12 ) Total before tax (12 ) Total before tax
4 Income tax provision 4 Income tax provision
(8 ) Net of tax (8 ) Net of tax
Total reclassifications for the period $ (172 ) $ (172 )
For the Three Months Ended June 30, 2018
(In Thousands)
Reclassified from
Details about Accumulated Other Accumulated Other Affected Line Item in the Consolidated
Comprehensive Loss Components Comprehensive Loss Statements of Income
Unrealized gains and losses on available-for-sale securities $ 282 Realized losses on available-for-sale debt securities, net
(59 ) Income tax provision
223 Net of tax
Amortization of defined benefit pension and postretirement items:
Prior service cost (8 ) Other noninterest expense
Actuarial loss 3 Other noninterest expense
(5 ) Total before tax
1 Income tax provision
(4 ) Net of tax
Total reclassifications for the period $ 219

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

~~For the Six Months Ended June 30, 2016~~
~~(In Thousands)~~
Reclassified from
Details about Accumulated Other Accumulated Other Affected Line Item in the Consolidated
Comprehensive Income Components Comprehensive Income Statements of Income
Unrealized gains and losses on available-for-sale Securities $ (505 ) Realized gains on available-for-sale securities, net
177 Income tax provision
(328 ) Net of tax
Amortization of defined benefit pension and postretirement items:
Prior service cost (15 ) Pensions and other employee benefits
Actuarial loss 5 Pensions and other employee benefits
(10 ) Total before tax
3 Income tax provision
(7 ) Net of tax
Total reclassifications for the period $ (335 )
~~For the Three Months Ended June 30, 2017~~
~~(In Thousands)~~
Reclassified from
Details about Accumulated Other Accumulated Other Affected Line Item in the Consolidated
Comprehensive Income Components Comprehensive Income Statements of Income
Unrealized gains and losses on available-for-sale Securities $ (107 ) Realized gains on available-for-sale securities, net
37 Income tax provision
(70 ) Net of tax
Amortization of defined benefit pension and postretirement items:
Prior service cost (7 ) Pensions and other employee benefits
Actuarial loss 1 Pensions and other employee benefits
(6 ) Total before tax
2 Income tax provision
(4 ) Net of tax
Total reclassifications for the period $ (74 )
~~For the Three Months Ended June 30, 2016~~
~~(In Thousands)~~
Reclassified from
Details about Accumulated Other Accumulated Other Affected Line Item in the Consolidated
Comprehensive Income Components Comprehensive Income Statements of Income
Unrealized gains and losses on available-for-sale Securities $ (122 ) Realized gains on available-for-sale securities, net
43 Income tax provision
(79 ) Net of tax
Amortization of defined benefit pension and postretirement items:
Prior service cost (7 ) Pensions and other employee benefits
Actuarial loss 2 Pensions and other employee benefits
(5 ) Total before tax
1 Income tax provision
(4 ) Net of tax
Total reclassifications for the period $ (83 )
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For the Three Months Ended June 30, 2017
(In Thousands)
Reclassified from
Details about Accumulated Other Accumulated Other Affected Line Item in the Consolidated
Comprehensive Loss Components Comprehensive Loss Statements of Income
Unrealized gains and losses on available-for-sale securities $ (107 ) Realized gains on available-for-sale debt securities, net
37 Income tax provision
(70 ) Net of tax
Amortization of defined benefit pension and postretirement items:
Prior service cost (7 ) Other noninterest expense
Actuarial loss 1 Other noninterest expense
(6 ) Total before tax
2 Income tax provision
(4 ) Net of tax
Total reclassifications for the period $ (74 )

4. CASH AND DUE FROM BANKS

Cash and due from banks at June 30, ~~2017~~2018 and December 31, ~~2016~~2017 include the following:

(In thousands) June 30, Dec. 31, June 30, Dec. 31,
2017 2016 2018 2017
Cash and cash equivalents $ 31,403 $ 28,621 $ 48,705 $ 37,004
Certificates of deposit 3,240 3,488 2,770 3,240
Total cash and due from banks $ 34,643 $ 32,109 $ 51,475 $ 40,244

Certificates of deposit are issues by U.S. banks with original maturities greater than three months. Each certificate of deposit is fully FDIC-insured. The Corporation maintains cash and cash equivalents with certain financial institutions in excess of the FDIC insurance limit.

The Corporation is required to maintain reserves against deposit liabilities in the form of cash and balances with the Federal Reserve Bank of Philadelphia. The reserves are based on deposit levels, account activity, and other services provided by the Federal Reserve Bank. Required reserves were ~~$12,812,000~~$14,232,000 at June 30, ~~2017~~2018 and ~~$16,654,000~~$17,178,000 at December 31, ~~2016.~~2017.

5. FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS

The Corporation measures certain assets at fair value. Fair value is defined as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date. FASB Accounting Standards Codification (ASC) topic 820, “Fair Value Measurements and Disclosures” establishes a framework for measuring fair value that includes a hierarchy used to classify the inputs used in measuring fair value. The hierarchy prioritizes the inputs used in determining valuations into three levels. The level in the fair value hierarchy within which the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement. The levels of the fair value hierarchy are as follows:

Level 1 – Fair value is based on unadjusted quoted prices in active markets that are accessible to the Corporation for identical assets. These generally provide the most reliable evidence and are used to measure fair value whenever available.

Level 2 – Fair value is based on significant inputs, other than Level 1 inputs, that are observable either directly or indirectly for substantially the full term of the asset through corroboration with observable market data. Level 2 inputs include quoted market prices in active markets for similar assets, quoted market prices in markets that are not active for identical or similar assets and other observable inputs.

Level 3 – Fair value is based on significant unobservable inputs. Examples of valuation methodologies that would result in Level 3 classification include option pricing models, discounted cash flows and other similar techniques.

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
The Corporation monitors and evaluates available data relating to fair value measurements on an ongoing basis and recognizes transfers among the levels of the fair value hierarchy as of the date of an event or change in circumstances that affects the valuation method chosen. Examples of such changes may include the market for a particular asset becoming active or inactive, changes in the availability of quoted prices, or changes in the availability of other market data.

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At June 30, ~~2017~~2018 and December 31, ~~2016,~~2017, assets measured at fair value and the valuation methods used are as follows:

June 30, 2017 June 30, 2018
Quoted Prices Other Quoted Prices Other
in Active Observable Unobservable Total in Active Observable Unobservable Total
Markets Inputs Inputs Fair Markets Inputs Inputs Fair
(In Thousands) (Level 1) (Level 2) (Level 3) Value (Level 1) (Level 2) (Level 3) Value

Recurring fair value measurements
AVAILABLE-FOR-SALE SECURITIES:
AVAILABLE-FOR-SALE DEBT SECURITIES:
Obligations of U.S. Government agencies $ 0 $ 9,591 $ 0 $ 9,591 $ 0 $ 7,779 $ 0 $ 7,779
Obligations of states and political subdivisions:
Tax-exempt 0 116,338 0 116,338 0 101,700 0 101,700
Taxable 0 28,452 0 28,452 0 26,066 0 26,066
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities 0 47,405 0 47,405 0 58,330 0 58,330
Residential collateralized mortgage obligations 0 128,248 0 128,248 0 121,933 0 121,933
Commercial mortgage-backed securities 0 33,742 0 33,742 0 32,236 0 32,236
Total debt securities 0 363,776 0 363,776
Marketable equity securities 977 0 0 977
Total available-for-sale securities 977 363,776 0 364,753
Total available-for-sale debt securities 0 348,044 0 348,044
Marketable equity security 948 0 0 948
Restricted equity security 0 0 866 866
Servicing rights 0 0 1,279 1,279 0 0 1,370 1,370
Total recurring fair value measurements $ 977 $ 363,776 $ 1,279 $ 366,032 $ 948 $ 348,044 $ 2,236 $ 351,228

Nonrecurring fair value measurements
Impaired loans with a valuation allowance $ 0 $ 0 $ 3,293 $ 3,293 $ 0 $ 0 $ 3,652 $ 3,652
Valuation allowance 0 0 (1,083 ) (1,083 ) 0 0 (1,095 ) (1,095 )
Impaired loans, net 0 0 2,210 2,210 0 0 2,557 2,557
Foreclosed assets held for sale 0 0 2,023 2,023 0 0 2,897 2,897
Total nonrecurring fair value measurements $ 0 $ 0 $ 4,233 $ 4,233 $ 0 $ 0 $ 5,454 $ 5,454

1415
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

December 31, 2016 December 31, 2017
Quoted Prices Other Quoted Prices Other
in Active Observable Unobservable Total in Active Observable Unobservable Total
Markets Inputs Inputs Fair Markets Inputs Inputs Fair
(In Thousands) (Level 1) (Level 2) (Level 3) Value (Level 1) (Level 2) (Level 3) Value

Recurring fair value measurements
AVAILABLE-FOR-SALE SECURITIES:
AVAILABLE-FOR-SALE DEBT SECURITIES:
Obligations of U.S. Government agencies $ 0 $ 9,541 $ 0 $ 9,541 $ 0 $ 7,873 $ 0 $ 7,873
Obligations of states and political subdivisions:
Tax-exempt 0 119,037 0 119,037 0 105,111 0 105,111
Taxable 0 30,297 0 30,297 0 25,573 0 25,573
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities 0 58,404 0 58,404 0 52,347 0 52,347
Residential collateralized mortgage obligations 0 146,608 0 146,608 0 131,814 0 131,814
Commercial mortgage-backed securities 0 30,219 0 30,219 0 33,219 0 33,219
Total debt securities 0 394,106 0 394,106
Marketable equity securities 971 0 0 971
Total available-for-sale securities 971 394,106 0 395,077
Total available-for-sale debt securities 0 355,937 0 355,937
Marketable equity security 971 0 0 971
Servicing rights 0 0 1,262 1,262 0 0 1,299 1,299
Total recurring fair value measurements $ 971 $ 394,106 $ 1,262 $ 396,339 $ 971 $ 355,937 $ 1,299 $ 358,207

Nonrecurring fair value measurements
Impaired loans with a valuation allowance $ 0 $ 0 $ 3,372 $ 3,372 $ 0 $ 0 $ 3,776 $ 3,776
Valuation allowance 0 0 (674 ) (674 ) 0 0 (1,183 ) (1,183 )
Impaired loans, net 0 0 2,698 2,698 0 0 2,593 2,593
Foreclosed assets held for sale 0 0 2,180 2,180 0 0 1,598 1,598
Total nonrecurring fair value measurements $ 0 $ 0 $ 4,878 $ 4,878 $ 0 $ 0 $ 4,191 $ 4,191

Management’s evaluation and selection of valuation techniques and the unobservable inputs used in determining the fair values of assets valued using Level 3 methodologies include sensitive assumptions. Other market participants might use substantially different assumptions, which could result in calculations of fair values that would be substantially different than the amount calculated by management.

At June 30, ~~2017~~2018 and December 31, ~~2016,~~2017, quantitative information regarding significant techniques and inputs used for assets measured on a recurring basis using unobservable inputs (Level 3 methodologies) are as follows:

Fair Value at Fair Value at
6/30/17 Valuation Unobservable Method or Value As of 6/30/18 Valuation Unobservable Method or Value As of
Asset (In Thousands) Technique Input(s) 6/30/17 (In Thousands) Technique Input(s) 6/30/18
Servicing rights $ 1,279 Discounted cash flow Discount rate 13.00 % Rate used through modeling period $ 1,370 Discounted cash flow Discount rate 13.00 % Rate used through modeling period
Loan prepayment speeds 137.00 % Weighted-average PSA Loan prepayment speeds 119.00 % Weighted-average PSA
Servicing fees 0.25 % of loan balances Servicing fees 0.25 % of loan balances
4.00 % of payments are late 4.00 % of payments are late
5.00 % late fees assessed 5.00 % late fees assessed
$ 1.94 Miscellaneous fees per account per month $ 1.94 Miscellaneous fees per account per month
Servicing costs $ 6.00 Monthly servicing cost per account Servicing costs $ 6.00 Monthly servicing cost per account
$ 24.00 Additional monthly servicing cost per loan on loans more than 30 days delinquent $ 24.00 Additional monthly servicing cost per loan on loans more than 30 days delinquent
1.50 % of loans more than 30 days delinquent 1.50 % of loans more than 30 days delinquent
3.00 % annual increase in servicing costs 3.00 % annual increase in servicing costs

1516
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Fair Value at Fair Value at Method or Value As of
12/31/16 Valuation Unobservable Method or Value As of 12/31/17 Valuation Unobservable 12/31/17
Asset (In Thousands) Technique Input(s) 12/31/16 (In Thousands) Technique Input(s)
Servicing rights $ 1,262 Discounted cash flow Discount rate 13.00 % Rate used through modeling period $ 1,299 Discounted cash flow Discount rate 13.00 % Rate used through modeling period
Loan prepayment speeds 138.00 % Weighted-average PSA Loan prepayment speeds 140.00 % Weighted-average PSA
Servicing fees 0.25 % of loan balances Servicing fees 0.25 % of loan balances
4.00 % of payments are late 4.00 % of payments are late
5.00 % late fees assessed 5.00 % late fees assessed
$ 1.94 Miscellaneous fees per account per month $ 1.94 Miscellaneous fees per account per month
Servicing costs $ 6.00 Monthly servicing cost per account Servicing costs $ 6.00 Monthly servicing cost per account
$ 24.00 Additional monthly servicing cost per loan on loans more than 30 days delinquent $ 24.00 Additional monthly servicing cost per loan on loans more than 30 days delinquent
1.50 % of loans more than 30 days delinquent 1.50 % of loans more than 30 days delinquent
3.00 % annual increase in servicing costs 3.00 % annual increase in servicing costs

The fair value of servicing rights is affected by expected future interest rates. Increases (decreases) in future expected interest rates tend to increase (decrease) the fair value of the Corporation’s servicing rights because of changes in expected prepayment behavior by the borrowers on the underlying loans. Unrealized gains (losses) in fair value of servicing rights are included in Loan servicing fees, net, in the unaudited consolidated statements of income.

Following is a reconciliation of activity for Level 3 assets measured at fair value on a recurring basis:

(In Thousands) Three Months Ended Six Months Ended
June 30,
2017 June 30,
2016 June 30,
2017 June 30,
2016
Servicing rights balance, beginning of period $ 1,278 $ 1,261 $ 1,262 $ 1,296
Issuances of servicing rights 49 71 95 107
Unrealized losses included in earnings (48 ) (108 ) (78 ) (179 )
Servicing rights balance, end of period $ 1,279 $ 1,224 $ 1,279 $ 1,224
(In Thousands) Three Months Ended June 30, 2018 Six Months Ended June 30, 2018
Restricted
Equity Security Servicing
Rights Total Restricted
Equity Security Servicing
Rights Total
Balance, beginning of period $ 0 $ 1,369 $ 1,369 $ 0 $ 1,299 $ 1,299
Issuances of servicing rights 0 47 $ 47 0 97 $ 97
Unrealized gains (losses) included in earnings 866 (46 ) $ 820 866 (26 ) $ 840
Balance, end of period $ 866 $ 1,370 $ 2,236 $ 866 $ 1,370 $ 2,236
(In Thousands) Three Months Ended June 30, 2017 Six Months Ended June 30, 2017
Restricted
Equity Security Servicing
Rights Total Restricted
Equity Security Servicing
Rights Total
Balance, beginning of period $ 0 $ 1,278 $ 1,278 $ 0 $ 1,262 $ 1,262
Issuances of servicing rights 0 49 $ 49 0 95 $ 95
Unrealized gains (losses) included in earnings 0 (48 ) ($ 48 ) 0 (78 ) ($ 78 )
Balance, end of period $ 0 $ 1,279 $ 1,279 $ 0 $ 1,279 $ 1,279

Loans are classified as impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Foreclosed assets held for sale consist of real estate acquired by foreclosure. For impaired commercial loans secured by real estate and foreclosed assets held for sale, estimated fair values are determined primarily using values from third-party appraisals. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property. For commercial and industrial and agricultural loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging data or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.
17
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

At June 30, ~~2017~~2018 and December 31, ~~2016,~~2017, quantitative information regarding significant techniques and inputs used for nonrecurring fair value measurements using unobservable inputs (Level 3 methodologies) are as follows:

(In Thousands, Except Weighted-
Percentages) Valuation Average
Balance at Allowance at Fair Value at Valuation Unobservable Discount at
Asset 6/30/17 6/30/17 6/30/17 Technique Inputs 6/30/17

Impaired loans:
Commercial:
Commercial loans secured by real estate $ 2,718 $ 958 $ 1,760 Sales comparison Discount to appraised value 16 %
Commercial and industrial 75 75 0 Sales comparison Discount to appraised value 100 %
Loans secured by farmland 500 50 450 Sales comparison Discount to appraised value 53 %
Total impaired loans $ 3,293 $ 1,083 $ 2,210
Foreclosed assets held for sale - real estate:
Residential (1-4 family) $ 879 $ 0 $ 879 Sales comparison Discount to appraised value 33 %
Land 646 0 646 Sales comparison Discount to appraised value 34 %
Commercial real estate 498 0 498 Sales comparison Discount to appraised value 49 %
Total foreclosed assets held for sale $ 2,023 $ 0 $ 2,023
(In Thousands, Except Weighted-
Percentages) Valuation Average)
Balance at Allowance at Fair Value at Valuation Unobservable Discount at
Asset 6/30/18 6/30/18 6/30/18 Technique Inputs 6/30/18

Impaired loans:
Residential mortgage loans - first liens $ 512 $ 120 $ 392 Sales comparison Discount to appraised value 26 %
Commercial:
Commercial loans secured by real estate 2,573 850 1,723 Sales comparison Discount to appraised value 16 %
Commercial and industrial 75 75 0 Sales comparison Discount to appraised value 100 %
Loans secured by farmland 492 50 442 Sales comparison Discount to appraised value 56 %
Total impaired loans $ 3,652 $ 1,095 $ 2,557
Foreclosed assets held for sale - real estate:
Residential (1-4 family) $ 412 $ 0 $ 412 Sales comparison Discount to appraised value 31 %
Land 120 0 120 Sales comparison Discount to appraised value 57 %
Commercial real estate 2,365 0 2,365 Sales comparison Discount to appraised value 34 %
Total foreclosed assets held for sale $ 2,897 $ 0 $ 2,897

16

(In Thousands, Except Weighted- Weighted-
Percentages) Valuation Average Valuation Average
Balance at Allowance at Fair Value at Valuation Unobservable Discount at Balance at Allowance at Fair Value at Valuation Unobservable Discount at
Asset 12/31/16 12/31/16 12/31/16 Technique Inputs 12/31/16 12/31/17 12/31/17 12/31/17 Technique Inputs 12/31/17

Impaired loans:
Residential mortgage loans - first liens $ 515 $ 122 $ 393 Sales comparison Discount to appraised value 26 %
Commercial:
Commercial loans secured by real estate $ 2,773 $ 528 $ 2,245 Sales comparison Discount to appraised value 7 % 2,641 919 1,722 Sales comparison Discount to appraised value 16 %
Commercial and industrial 95 95 0 Sales comparison Discount to appraised value 100 % 126 92 34 Sales comparison Discount to appraised value 72 %
Loans secured by farmland 504 51 453 Sales comparison Discount to appraised value 55 % 494 50 444 Sales comparison Discount to appraised value 53 %
Total impaired loans $ 3,372 $ 674 $ 2,698 $ 3,776 $ 1,183 $ 2,593
Foreclosed assets held for sale - real estate:
Residential (1-4 family) $ 1,102 $ 0 $ 1,102 Sales comparison Discount to appraised value 35 % $ 721 $ 0 $ 721 Sales comparison Discount to appraised value 37 %
Land 650 0 650 Sales comparison Discount to appraised value 33 % 632 0 632 Sales comparison Discount to appraised value 35 %
Commercial real estate 428 0 428 Sales comparison Discount to appraised value 50 % 245 0 245 Sales comparison Discount to appraised value 71 %
Total foreclosed assets held for sale $ 2,180 $ 0 $ 2,180 $ 1,598 $ 0 $ 1,598

Certain of the Corporation’s financial instruments are not measured at fair value in the consolidated financial statements. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from disclosure requirements. Therefore, the aggregate fair value amounts presented may not represent the underlying fair value of the Corporation.

~~The Corporation used the following methods and assumptions in estimating fair value disclosures for financial instruments:~~
~~CASH AND CASH EQUIVALENTS -~~ ~~The carrying amounts of cash and short-term instruments approximate fair values.~~
~~CERTIFICATES OF DEPOSIT -~~ ~~Fair values for certificates of deposit, included in cash and due from banks in the consolidated balance sheet, are based on quoted market prices for certificates of similar remaining maturities.~~
~~SECURITIES -~~ Fair values for securities, excluding restricted equity securities, are based on quoted market prices or other methods as described above. The carrying value of restricted equity securities approximates fair value based on applicable redemption provisions.
~~LOANS HELD FOR SALE -~~ ~~Fair values of loans held for sale are determined based on applicable sale prices available under the Federal Home Loan Banks’ MPF Xtra and MPF Original programs.~~
~~LOANS -~~ Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, commercial real estate, residential mortgage and other consumer. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories. The fair value of performing loans is calculated by discounting contractual cash flows, adjusted for estimated prepayments based on historical experience, using estimated market discount rates that reflect the credit and interest rate risk inherent in the loans. Fair value of nonperforming loans is based on recent appraisals or estimates prepared by the Corporation’s lending officers.
~~SERVICING RIGHTS -~~ The fair value of servicing rights, included in other assets in the consolidated balance sheet, is determined through a discounted cash flow valuation. Significant inputs include expected net servicing income, the discount rate and the expected prepayment speeds of the underlying loans.
~~DEPOSITS -~~ The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, money market and interest checking accounts, is (by definition) equal to the amount payable on demand at June 30, 2017 and December 31, 2016. The fair value of time deposits, such as certificates of deposit and Individual Retirement Accounts, 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 fair value estimates of deposits 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.
1718
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

~~BORROWED FUNDS -~~The estimated fair ~~value of borrowings is estimated using discounted cash flow analyses based on rates currently available to the Corporation for similar types of borrowing arrangements.~~
~~ACCRUED INTEREST -~~ ~~The~~values, and related carrying amounts, of ~~accrued interest receivable and payable approximate~~the Corporation’s financial instruments that are not recorded at fair ~~values.~~value are as follows:

(In Thousands) Fair Value June 30, 2018 December 31, 2017
Hierarchy Carrying Fair Carrying Fair
Level Amount Value Amount Value
Financial assets:
Cash and cash equivalents Level 1 $ 48,705 $ 48,705 $ 37,004 $ 37,004
Certificates of deposit Level 2 2,770 2,755 3,240 3,234
Restricted equity securities (included in Other Assets) Level 2 5,078 5,078 6,556 6,556
Loans, net Level 3 809,816 807,330 806,857 789,891
Accrued interest receivable Level 2 4,042 4,042 4,048 4,048

Financial liabilities:
Deposits with no stated maturity Level 2 801,332 801,332 794,778 794,778
Time deposits Level 2 239,567 239,718 213,671 213,734
Short-term borrowings Level 2 17,169 16,954 61,766 61,643
Long-term borrowings Level 2 27,054 27,075 9,189 9,256
Accrued interest payable Level 2 107 107 46 46
~~OFF-BALANCE SHEET COMMITMENTS -~~
The Corporation has commitments to extend credit and has issued standby letters of credit. Standby letters of credit are conditional guarantees of performance by a customer to a third party. Estimates of the fair value of these off-balance sheet items were not made because of the short-term nature of these arrangements and the credit standing of the counterparties.

~~The estimated fair values, and related carrying amounts, of the Corporation’s financial instruments are as follows:~~
(In Thousands) Valuation June 30, 2017 December 31, 2016
Method(s) Carrying Fair Carrying Fair
Used Amount Value Amount Value
Financial assets:
Cash and cash equivalents Level 1 $ 31,403 $ 31,403 $ 28,621 $ 28,621
Certificates of deposit Level 2 3,240 3,236 3,488 3,481
Available-for-sale securities See Above 364,753 364,753 395,077 395,077
Restricted equity securities (included in Other Assets) Level 2 3,578 3,578 4,426 4,426
Loans held for sale Level 1 1,708 1,708 142 142
Loans, net Level 3 771,057 757,201 743,362 725,787
Accrued interest receivable Level 2 3,808 3,808 3,963 3,963
Servicing rights Level 3 1,279 1,279 1,262 1,262

Financial liabilities:
Deposits with no stated maturity Level 2 779,842 779,842 771,625 771,625
Time deposits Level 2 217,420 217,556 212,218 212,274
Short-term borrowings Level 2 8,875 8,762 26,175 26,024
Long-term borrowings Level 2 38,321 38,716 38,454 39,062
Accrued interest payable Level 2 70 70 65 65
18
6. SECURITIES

Amortized cost and fair value of available-for-sale debt securities at June 30, ~~2017~~2018 and December 31, ~~2016~~2017 are summarized as follows:

June 30, 2017
Gross Gross
Unrealized Unrealized
Amortized Holding Holding Fair
(In Thousands) Cost Gains Losses Value

Obligations of U.S. Government agencies $ 9,678 $ 0 $ (87 ) $ 9,591
Obligations of states and political subdivisions:
Tax-exempt 114,095 2,899 (656 ) 116,338
Taxable 28,162 344 (54 ) 28,452
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities 47,767 111 (473 ) 47,405
Residential collateralized mortgage obligations 129,372 360 (1,484 ) 128,248
Commercial mortgage-backed securities 34,112 37 (407 ) 33,742
Total debt securities 363,186 3,751 (3,161 ) 363,776
Marketable equity securities 1,000 0 (23 ) 977
Total $ 364,186 $ 3,751 $ (3,184 ) $ 364,753
December 31, 2016 June 30, 2018
Gross Gross Gross Gross
Unrealized Unrealized Unrealized Unrealized
Amortized Holding Holding Fair Amortized Holding Holding Fair
(In Thousands) Cost Gains Losses Value Cost Gains Losses Value

Obligations of U.S. Government agencies $ 9,671 $ 5 $ (135 ) $ 9,541 $ 7,779 $ 0 $ 0 $ 7,779
Obligations of states and political subdivisions:
Tax-exempt 118,140 2,592 (1,695 ) 119,037 101,956 1,504 (1,760 ) 101,700
Taxable 30,073 303 (79 ) 30,297 26,248 60 (242 ) 26,066
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities 58,922 306 (824 ) 58,404 60,130 59 (1,859 ) 58,330
Residential collateralized mortgage obligations 147,915 408 (1,715 ) 146,608 126,457 22 (4,546 ) 121,933
Commercial mortgage-backed securities 30,817 0 (598 ) 30,219 33,671 0 (1,435 ) 32,236
Total debt securities 395,538 3,614 (5,046 ) 394,106
Marketable equity securities 1,000 0 (29 ) 971
Total $ 396,538 $ 3,614 $ (5,075 ) $ 395,077
Total available-for-sale-debt securities $ 356,241 $ 1,645 $ (9,842 ) $ 348,044

19
CITIZENS & NORTHERN CORPORATION – FORM 10-Q
December 31, 2017
Gross Gross
Unrealized Unrealized
Amortized Holding Holding Fair
(In Thousands) Cost Gains Losses Value

Obligations of U.S. Government agencies $ 8,026 $ 0 ($ 153 ) $ 7,873
Obligations of states and political subdivisions:
Tax-exempt 103,673 2,291 (853 ) 105,111
Taxable 25,431 226 (84 ) 25,573
Mortgage-backed securities issued or guaranteed  by U.S. Government agencies or sponsored  agencies:
Residential pass-through securities 52,992 79 (724 ) 52,347
Residential collateralized mortgage obligations 134,314 110 (2,610 ) 131,814
Commercial mortgage-backed securities 33,881 4 (666 ) 33,219
Total available-for-sale debt securities $ 358,317 $ 2,710 ($ 5,090 ) $ 355,937

The following table presents gross unrealized losses and fair value of available-for-sale debt securities with unrealized loss positions that are not deemed to be other-than-temporarily impaired, aggregated by length of time that individual securities have been in a continuous unrealized loss position at June 30, ~~2017~~2018 and December 31, ~~2016:~~2017:

June 30, 2017 Less Than 12 Months 12 Months or More Total
June 30, 2018 Less Than 12 Months 12 Months or More Total
(In Thousands) Fair Unrealized Fair Unrealized Fair Unrealized Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses Value Losses Value Losses Value Losses

Obligations of U.S. Government agencies $ 7,943 $ (87 ) $ 0 $ 0 $ 7,943 $ (87 )
Obligations of states and political subdivisions:
Tax-exempt 32,129 (557 ) 3,698 (99 ) 35,827 (656 ) $ 27,053 $ (410 ) $ 15,981 $ (1,350 ) $ 43,034 $ (1,760 )
Taxable 7,558 (54 ) 0 0 7,558 (54 ) 14,749 (183 ) 2,237 (59 ) 16,986 (242 )
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities 33,600 (473 ) 0 0 33,600 (473 ) 27,123 (733 ) 24,818 (1,126 ) 51,941 (1,859 )
Residential collateralized mortgage obligations 67,281 (891 ) 20,176 (593 ) 87,457 (1,484 ) 57,687 (1,583 ) 60,666 (2,963 ) 118,353 (4,546 )
Commercial mortgage-backed securities 24,948 (262 ) 4,793 (145 ) 29,741 (407 ) 18,795 (651 ) 14,092 (784 ) 32,887 (1,435 )
Total debt securities 173,459 (2,324 ) 28,667 (837 ) 202,126 (3,161 )
Marketable equity securities 1,000 (23 ) 0 0 1,000 (23 )
Total temporarily impaired available-for-sale securities $ 174,459 $ (2,347 ) $ 28,667 $ (837 ) $ 203,126 $ (3,184 )
Total temporarily impaired available-for-sale debt securities $ 145,407 $ (3,560 ) $ 117,794 $ (6,282 ) $ 263,201 $ (9,842 )

December 31, 2016 Less Than 12 Months 12 Months or More Total
December 31, 2017 Less Than 12 Months 12 Months or More Total
(In Thousands) Fair Unrealized Fair Unrealized Fair Unrealized Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses Value Losses Value Losses Value Losses

Obligations of U.S. Government agencies $ 7,899 $ (135 ) $ 0 $ 0 $ 7,899 $ (135 ) $ 0 $ 0 $ 7,873 $ (153 ) $ 7,873 $ (153 )
Obligations of states and political subdivisions:
Tax-exempt 54,479 (1,676 ) 1,278 (19 ) 55,757 (1,695 ) 19,050 (135 ) 24,391 (718 ) 43,441 (853 )
Taxable 9,594 (79 ) 0 0 9,594 (79 ) 9,279 (45 ) 2,116 (39 ) 11,395 (84 )
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities 48,674 (824 ) 0 0 48,674 (824 ) 25,255 (242 ) 22,549 (482 ) 47,804 (724 )
Residential collateralized mortgage obligations 85,198 (1,124 ) 16,073 (591 ) 101,271 (1,715 ) 50,812 (589 ) 68,558 (2,021 ) 119,370 (2,610 )
Commercial mortgage-backed securities 30,219 (598 ) 0 0 30,219 (598 ) 14,713 (173 ) 14,569 (493 ) 29,282 (666 )
Total debt securities 236,063 (4,436 ) 17,351 (610 ) 253,414 (5,046 )
Marketable equity securities 1,000 (29 ) 0 0 1,000 (29 )
Total temporarily impaired available-for-sale securities $ 237,063 $ (4,465 ) $ 17,351 $ (610 ) $ 254,414 $ (5,075 )
Total temporarily impaired available-for-sale debt securities $ 119,109 $ (1,184 ) $ 140,056 $ (3,906 ) $ 259,165 $ (5,090 )
20
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Gross realized gains and losses from available-for-sale securities were as follows:

(In Thousands) 3 Months Ended 6 Months Ended
June 30, June 30, June 30, June 30,
2017 2016 2017 2016
Gross realized gains from sales $ 107 $ 123 $ 268 $ 506
Gross realized losses from sales 0 (1 ) (16 ) (1 )
Net realized gains $ 107 $ 122 $ 252 $ 505
20
(In Thousands) 3 Months Ended 6 Months Ended
June 30, June 30, June 30, June 30,
2018 2017 2018 2017
Gross realized gains from sales $ 0 $ 107 $ 0 $ 268
Gross realized losses from sales 0 0 0 (16 )
Losses from other-than-temporary impairment (282 ) 0 (282 ) 0
Net realized gains $ (282 ) $ 107 $ (282 ) $ 252

The amortized cost and fair value of available-for-sale debt securities by contractual maturity are shown in the following table as of June 30, ~~2017.~~2018. Actual maturities may differ from contractual maturities because counterparties may have the right to call or prepay obligations with or without call or prepayment penalties.

Amortized Fair Amortized Fair
(In Thousands) Cost Value Cost Value

Due in one year or less $ 18,759 $ 18,808 $ 19,947 $ 20,174
Due from one year through five years 70,742 72,143 61,054 61,171
Due from five years through ten years 38,086 38,288 34,534 33,663
Due after ten years 24,348 25,142 20,448 20,537
Sub-total 151,935 154,381 135,983 135,545
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities 47,767 47,405 60,130 58,330
Residential collateralized mortgage obligations 129,372 128,248 126,457 121,933
Commercial mortgage-backed securities 34,112 33,742 33,671 32,236
Total $ 363,186 $ 363,776 $ 356,241 $ 348,044

The Corporation’s mortgage-backed securities have stated maturities that may differ from actual maturities due to borrowers’ ability to prepay obligations. Cash flows from such investments are dependent upon the performance of the underlying mortgage loans and are generally influenced by the level of interest rates. In the table above, mortgage-backed securities and collateralized mortgage obligations are shown in one period.

Investment securities carried at ~~$223,562,000~~$216,367,000 at June 30, ~~2017~~2018 and ~~$230,803,000~~$217,925,000 at December 31, ~~2016~~2017 were pledged as collateral for public deposits, trusts and certain other deposits as provided by law. See Note 8 for information concerning securities pledged to secure borrowing arrangements.

Management evaluates securities for other-than-temporary impairment (OTTI) at least on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether the Corporation intends to sell the security or more likely than not will be required to sell the security before its anticipated recovery.

In the second quarter 2018, the Corporation recorded a pre-tax impairment loss on available-for-sale debt securities of $282,000. The loss represents the unrealized loss at June 30, 2018 on securities that were sold in July 2018. The securities sold included obligations of U.S. Government agencies and states and political subdivisions. The realized losses on the sales totaled $329,000, including $282,000 recorded in the second quarter 2018. Proceeds from the sales totaling $17,858,000 were reinvested in residential collateralized mortgage obligations.
A summary of information management considered in evaluating debt and equity securities for other-than-temporary impairment (“OTTI”) at June 30, ~~2017~~2018 is provided below.
21
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Debt Securities

At June 30, ~~2017,~~2018, management performed an assessment for possible OTTI of the Corporation’s debt securities on an issue-by-issue basis, relying on information obtained from various sources, including publicly available financial data, ratings by external agencies, brokers and other sources. The extent of individual analysis applied to each security depended on the size of the Corporation’s investment, as well as management’s perception of the credit risk associated with each security. Based on the results of the assessment, management believes impairment of debt securities except for the securities for which an impairment loss was recognized in the second quarter 2018 at June 30, 2018 and December 31, 2017 to be temporary.

Equity Securities

The Corporation’s marketable equity ~~securities~~security, with a carrying value of $948,000 at June 30, ~~2017~~2018 and $971,000 at December 31, ~~2016~~2017, consisted exclusively of one mutual fund. ~~At June 30, 2017, there~~There was an unrealized loss on the mutual fund of ~~$23,000,~~$52,000 at June 30 2018 and $29,000 at December 31, ~~2016 there was an~~2017. The increase in the unrealized loss of ~~$29,000. Management determined an OTTI charge was not required on this security at June 30, 2017 and December 31, 2016.~~
~~The Corporation had no realized gains or losses from the sale of equity securities~~$8,000 in the ~~first~~second quarter of 2018 and $23,000 in the six months ~~of 2017. The Corporation realized gains from sales of bank stocks totaling $28,000 in the three-month period~~ ended June 30, ~~2016 and $277,000 during~~2018 is included in other noninterest income in the ~~first six months~~consolidated statements of ~~2016.~~income.
21

C&N Bank is a member of the Federal Home Loan Bank of Pittsburgh (FHLB-Pittsburgh), which is one of 11 regional Federal Home Loan Banks. As a member, C&N Bank is required to purchase and maintain stock in FHLB-Pittsburgh. There is no active market for FHLB-Pittsburgh stock, and it must ordinarily be redeemed by FHLB-Pittsburgh in order to be liquidated. C&N Bank’s investment in FHLB-Pittsburgh stock, included in Other Assets in the consolidated balance sheet, was ~~$3,448,000~~$4,948,000 at June 30, ~~2017~~2018 and ~~$4,296,000~~$6,426,000 at December 31, ~~2016.~~2017. The Corporation evaluated its holding of FHLB-Pittsburgh stock for impairment and deemed the stock to not be impaired at June 30, ~~2017~~2018 and December 31, ~~2016.~~2017. In making this determination, management concluded that recovery of total outstanding par value, which equals the carrying value, is expected. The decision was based on review of financial information that FHLB-Pittsburgh has made publicly available.

In the second quarter 2018, the Corporation recorded a pre-tax gain on a restricted equity security (Visa Class B stock) of $1,750,000. The Corporation had received 19,789 shares of Visa Class B stock pursuant to Visa’s 2007 initial public offering. Until the second quarter 2018, the carrying value of the shares was $0, which represented the Corporation’s cost basis. Class B shares are subject to restrictions on transfer, essentially limiting their transferability to other owners of Class B shares. In June 2018, the Corporation sold 10,000 of the shares for a price of $88.43 per share in a transaction that settled in July 2018. As required by ”U.S. GAAP”, companies must consider the pricing of observable transactions in determining the carrying value of equity securities that do not have readily determinable fair values. Accordingly, the Corporation’s second quarter 2018 gain was based on the price per share of the sale initiated in June 2018, applied to the total of 19,789 shares. At June 30, 2018, the balance of other assets in the unaudited, consolidated balance sheet included a total of $1,750,000 from the Visa Class B shares, including a receivable of $884,000 from the sale of 10,000 shares and $866,000 from the carrying value of the remaining 9,789 shares.
A summary of the realized and unrealized gains and losses recognized on equity securities is as follows:
(In Thousands)
3 Months Ended 6 Months Ended
June 30, June 30, June 30, June 30,
2018 2017 2018 2017
Net gain and losses recognized during the period on equity securities $ 1,742 $ 0 $ 1,727 $ 0
Less: net gains recognized during the period on equity securities sold during the period (884 ) 0 (884 ) 0

Unrealized gains recognized during the period on equity securities still held at the reporting date $ 858 $ 0 $ 843 $ 0
22
CITIZENS & NORTHERN CORPORATION – FORM 10-Q
7. LOANS

The loans receivable portfolio is segmented into residential mortgage, commercial and consumer loans. Loans outstanding at June 30, ~~2017~~2018 and December 31, ~~2016~~2017 are summarized by segment, and by classes within each segment, as follows:

Summary of Loans by Type
(In Thousands) June 30, Dec. 31, June 30, Dec. 31,
2017 2016 2018 2017
Residential mortgage:
Residential mortgage loans - first liens $ 342,603 $ 334,102 $ 361,592 $ 359,987
Residential mortgage loans - junior liens 24,150 23,706 26,594 25,325
Home equity lines of credit 37,159 38,057 34,852 35,758
1-4 Family residential construction 26,067 24,908 26,722 26,216
Total residential mortgage 429,979 420,773 449,760 447,286

Commercial:
Commercial loans secured by real estate 155,158 150,468 159,392 159,266
Commercial and industrial 82,815 83,854 88,499 88,276
Political subdivisions 51,495 38,068 56,690 59,287
Commercial construction and land 15,201 14,287 13,066 14,527
Loans secured by farmland 7,432 7,294 7,397 7,255
Multi-family (5 or more) residential 7,497 7,896 7,860 7,713
Agricultural loans 4,454 3,998 5,622 6,178
Other commercial loans 11,038 11,475 14,455 10,986
Total commercial 335,090 317,340 352,981 353,488

Consumer 14,623 13,722 15,906 14,939

Total 779,692 751,835 818,647 815,713
Less: allowance for loan losses (8,635 ) (8,473 ) (8,831 ) (8,856 )

Loans, net $ 771,057 $ 743,362 $ 809,816 $ 806,857

The Corporation grants loans to individuals as well as commercial and tax-exempt entities. Commercial, residential and personal loans are made to customers geographically concentrated in the Pennsylvania and New York counties that comprise the market serviced by Citizens & Northern Bank. Although the Corporation has a diversified loan portfolio, a significant portion of its debtors’ ability to honor their contracts is dependent on the local economic conditions within the region. There is no concentration of loans to borrowers engaged in similar businesses or activities that exceed 10% of total loans at either June 30, ~~2017~~2018 or December 31, ~~2016.~~2017.

The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and recorded as a reduction of the investment in loans. The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Corporation’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available. In the process of evaluating the loan portfolio, management also considers the Corporation’s exposure to losses from unfunded loan commitments. As of June 30, ~~2017~~2018 and December 31, ~~2016,~~2017, management determined that no allowance for credit losses related to unfunded loan commitments was required.

2223
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Transactions within the allowance for loan losses, summarized by segment and class, for the three-month and six-month periods ended June 30, ~~2017~~2018 and ~~2016~~2017 were as follows:

Three Months Ended June 30, 2017 March 31, June 30,
Three Months Ended June 30, 2018 March 31, June 30,
(In Thousands) 2017
Balance Charge-offs Recoveries Provision
(Credit) 2017
Balance 2018
Balance Charge-offs Recoveries Provision
(Credit) 2018
Balance
Allowance for Loan Losses:
Residential mortgage:
Residential mortgage loans - first liens $ 3,125 $ (99 ) $ 12 $ 14 $ 3,052 $ 3,067 $ (34 ) $ 1 $ 21 $ 3,055
Residential mortgage loans - junior liens 256 (16 ) 1 20 261 351 0 2 0 353
Home equity lines of credit 338 0 0 (6 ) 332 286 (12 ) 0 18 292
1-4 Family residential construction 240 0 0 11 251 239 0 0 8 247
Total residential mortgage 3,959 (115 ) 13 39 3,896 3,943 (46 ) 3 47 3,947
Commercial:
Commercial loans secured by real estate 2,685 0 0 (75 ) 2,610 2,635 0 0 (22 ) 2,613
Commercial and industrial 906 (1 ) 1 4 910 1,036 (133 ) 1 69 973
Commercial construction and land 169 0 0 (7 ) 162 137 0 0 (2 ) 135
Loans secured by farmland 111 0 0 (4 ) 107 102 0 0 4 106
Multi-family (5 or more) residential 236 0 0 (67 ) 169 169 0 0 5 174
Agricultural loans 39 0 0 3 42 205 0 0 (159 ) 46
Other commercial loans 109 0 0 (4 ) 105 149 0 0 (15 ) 134
Total commercial 4,255 (1 ) 1 (150 ) 4,105 4,433 (133 ) 1 (120 ) 4,181
Consumer 132 (19 ) 8 13 134 174 (32 ) 9 53 204
Unallocated 398 0 0 �� 102 500 499 0 0 0 499
Total Allowance for Loan Losses $ 8,744 $ (135 ) $ 22 $ 4 $ 8,635 $ 9,049 $ (211 ) $ 13 $ (20 ) $ 8,831

Three Months Ended June 30, 2016 March 31, June 30,
Three Months Ended June 30, 2017 March 31, June 30,
(In Thousands) 2016
Balance Charge-offs Recoveries Provision
(Credit) 2016
Balance
2017
Balance
Charge-offs Recoveries Provision
(Credit) 2017
Balance
Allowance for Loan Losses:
Residential mortgage:
Residential mortgage loans - first liens $ 2,722 $ (42 ) $ 0 $ 150 $ 2,830 $ 3,125 $ (99 ) $ 12 $ 14 $ 3,052
Residential mortgage loans - junior liens 228 0 0 11 239 256 (16 ) 1 20 261
Home equity lines of credit 351 0 0 8 359 338 0 0 (6 ) 332
1-4 Family residential construction 200 0 0 22 222 240 0 0 11 251
Total residential mortgage 3,501 (42 ) 0 191 3,650 3,959 (115 ) 13 39 3,896
Commercial:
Commercial loans secured by real estate 2,027 0 1 55 2,083 2,685 0 0 (75 ) 2,610
Commercial and industrial 976 0 0 62 1,038 906 (1 ) 1 4 910
Commercial construction and land 84 0 0 21 105 169 0 0 (7 ) 162
Loans secured by farmland 108 0 0 (5 ) 103 111 0 0 (4 ) 107
Multi-family (5 or more) residential 256 0 0 (8 ) 248 236 0 0 (67 ) 169
Agricultural loans 44 0 0 3 47 39 0 0 3 42
Other commercial loans 112 0 0 7 119 109 0 0 (4 ) 105
Total commercial 3,607 0 1 135 3,743 4,255 (1 ) 1 (150 ) 4,105
Consumer 126 (21 ) 12 21 138 132 (19 ) 8 13 134
Unallocated 427 0 0 (29 ) 398 398 0 0 102 500
Total Allowance for Loan Losses $ 7,661 $ (63 ) $ 13 $ 318 $ 7,929 $ 8,744 $ (135 ) $ 22 $ 4 $ 8,635

2324
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Six Months Ended June 30, 2017 Dec. 31, June 30,
Six Months Ended June 30, 2018 Dec. 31, June 30,
(In Thousands) 2016
Balance Charge-offs Recoveries Provision
(Credit) 2017
Balance 2017
Balance Charge-offs Recoveries Provision
(Credit) 2018
Balance
Allowance for Loan Losses:
Residential mortgage:
Residential mortgage loans - first liens $ 3,033 $ (162 ) $ 14 $ 167 $ 3,052 $ 3,200 $ (87 ) $ 2 $ (60 ) $ 3,055
Residential mortgage loans - junior liens 258 (16 ) 2 17 261 224 0 3 126 353
Home equity lines of credit 350 0 0 (18 ) 332 296 (12 ) 0 8 292
1-4 Family residential construction 249 0 0 2 251 243 0 0 4 247
Total residential mortgage 3,890 (178 ) 16 168 3,896 3,963 (99 ) 5 78 3,947
Commercial:
Commercial loans secured by real estate 2,380 (96 ) 0 326 2,610 2,584 (21 ) 0 50 2,613
Commercial and industrial 999 (1 ) 2 (90 ) 910 1,065 (133 ) 3 38 973
Commercial construction and land 162 0 0 0 162 150 0 0 (15 ) 135
Loans secured by farmland 110 0 0 (3 ) 107 105 0 0 1 106
Multi-family (5 or more) residential 241 0 0 (72 ) 169 172 0 0 2 174
Agricultural loans 40 0 0 2 42 57 0 0 (11 ) 46
Other commercial loans 115 0 0 (10 ) 105 102 0 0 32 134
Total commercial 4,047 (97 ) 2 153 4,105 4,235 (154 ) 3 97 4,181
Consumer 138 (60 ) 23 33 134 159 (73 ) 21 97 204
Unallocated 398 0 0 102 500 499 0 0 0 499
Total Allowance for Loan Losses $ 8,473 $ (335 ) $ 41 $ 456 $ 8,635 $ 8,856 $ (326 ) $ 29 $ 272 $ 8,831

Six Months Ended June 30, 2016 Dec. 31, June 30,
Six Months Ended June 30, 2017 Dec. 31, June 30,
(In Thousands) 2015
Balance Charge-offs Recoveries Provision
(Credit) 2016
Balance 2016
Balance Charge-offs Recoveries Provision (Credit) 2017
Balance
Allowance for Loan Losses:
Residential mortgage:
Residential mortgage loans - first liens $ 2,645 $ (42 ) $ 0 $ 227 $ 2,830 $ 3,033 $ (162 ) $ 14 $ 167 $ 3,052
Residential mortgage loans - junior liens 219 0 0 20 239 258 (16 ) 2 17 261
Home equity lines of credit 347 0 0 12 359 350 0 0 (18 ) 332
1-4 Family residential construction 207 0 0 15 222 249 0 0 2 251
Total residential mortgage 3,418 (42 ) 0 274 3,650 3,890 (178 ) 16 168 3,896
Commercial:
Commercial loans secured by real estate 1,939 0 2 142 2,083 2,380 (96 ) 0 326 2,610
Commercial and industrial 981 0 1 56 1,038 999 (1 ) 2 (90 ) 910
Commercial construction and land 58 0 0 47 105 162 0 0 0 162
Loans secured by farmland 106 0 0 (3 ) 103 110 0 0 (3 ) 107
Multi-family (5 or more) residential 675 (595 ) 0 168 248 241 0 0 (72 ) 169
Agricultural loans 45 0 0 2 47 40 0 0 2 42
Other commercial loans 118 0 0 1 119 115 0 0 (10 ) 105
Total commercial 3,922 (595 ) 3 413 3,743 4,047 (97 ) 2 153 4,105
Consumer 122 (39 ) 27 28 138 138 (60 ) 23 33 134
Unallocated 427 0 0 (29 ) 398 398 0 0 102 500
Total Allowance for Loan Losses $ 7,889 $ (676 ) $ 30 $ 686 $ 7,929 $ 8,473 $ (335 ) $ 41 $ 456 $ 8,635

In the evaluation of the loan portfolio, management determines two major components for the allowance for loan losses – (1) a specific component based on an assessment of certain larger relationships, mainly commercial purpose loans, on a loan-by-loan basis; and (2) a general component for the remainder of the portfolio based on a collective evaluation of pools of loans with similar risk characteristics. The general component is assigned to each pool of loans based on both historical net charge-off experience, and an evaluation of certain qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the above methodologies for estimating specific and general losses in the portfolio.

2425
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

In determining the larger loan relationships for detailed assessment under the specific allowance component, the Corporation uses an internal risk rating system. Under the risk rating system, the Corporation classifies problem or potential problem loans as “Special Mention,” “Substandard,” or “Doubtful” on the basis of currently existing facts, conditions and values. Substandard loans include those characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected. Loans classified as Doubtful have all the weaknesses inherent in those classified as Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans that do not currently expose the Corporation to sufficient risk to warrant classification as Substandard or Doubtful, but possess weaknesses that deserve management’s close attention, are deemed to be Special Mention. Risk ratings are updated any time that conditions or the situation warrants. Loans not classified are included in the “Pass” column in the table ~~below.~~that follows.

The following tables summarize the aggregate credit quality classification of outstanding loans by risk rating as of June 30, ~~2017~~2018 and December 31, ~~2016:~~2017:

June 30, 2017
June 30, 2018
(In Thousands) Special Special
Pass Mention Substandard Doubtful Total Pass Mention Substandard Doubtful Total
Residential Mortgage:
Residential mortgage loans - first liens $ 333,881 $ 331 $ 8,335 $ 56 $ 342,603 $ 353,020 $ 290 $ 8,230 $ 52 $ 361,592
Residential mortgage loans - junior liens 23,856 110 184 0 24,150 26,051 98 445 0 26,594
Home equity lines of credit 36,562 62 535 0 37,159 34,196 60 596 0 34,852
1-4 Family residential construction 26,067 0 0 0 26,067 26,722 0 0 0 26,722
Total residential mortgage 420,366 503 9,054 56 429,979 439,989 448 9,271 52 449,760
Commercial:
Commercial loans secured by real estate 146,316 1,533 7,309 0 155,158 152,847 788 5,757 0 159,392
Commercial and Industrial 76,416 4,034 2,354 11 82,815 82,590 4,726 1,172 11 88,499
Political subdivisions 51,495 0 0 0 51,495 56,690 0 0 0 56,690
Commercial construction and land 15,055 66 80 0 15,201 12,990 0 76 0 13,066
Loans secured by farmland 5,433 594 1,391 14 7,432 5,394 619 1,372 12 7,397
Multi-family (5 or more) residential 6,896 0 601 0 7,497 7,468 0 392 0 7,860
Agricultural loans 3,621 84 749 0 4,454 4,858 84 680 0 5,622
Other commercial loans 10,964 0 74 0 11,038 14,383 0 72 0 14,455
Total commercial 316,196 6,311 12,558 25 335,090 337,220 6,217 9,521 23 352,981
Consumer 14,422 0 201 0 14,623 15,860 0 46 0 15,906
Totals $ 750,984 $ 6,814 $ 21,813 $ 81 $ 779,692 $ 793,069 $ 6,665 $ 18,838 $ 75 $ 818,647

2526
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

December 31, 2016
December 31, 2017
(In Thousands) Special Special
Pass Mention Substandard Doubtful Total Pass Mention Substandard Doubtful Total
Residential Mortgage:
Residential mortgage loans - first liens $ 324,377 $ 408 $ 9,258 $ 59 $ 334,102 $ 350,609 $ 307 $ 9,019 $ 52 $ 359,987
Residential mortgage loans - junior liens 23,274 132 300 0 23,706 24,795 104 426 0 25,325
Home equity lines of credit 37,360 123 574 0 38,057 35,233 61 464 0 35,758
1-4 Family residential construction 24,820 0 88 0 24,908 26,216 0 0 0 26,216
Total residential mortgage 409,831 663 10,220 59 420,773 436,853 472 9,909 52 447,286
Commercial:
Commercial loans secured by real estate 139,358 3,092 8,018 0 150,468 150,806 936 7,524 0 159,266
Commercial and Industrial 79,202 4,180 461 11 83,854 82,724 3,896 1,645 11 88,276
Political subdivisions 38,068 0 0 0 38,068 59,287 0 0 0 59,287
Commercial construction and land 14,136 70 81 0 14,287 14,449 0 78 0 14,527
Loans secured by farmland 5,745 129 1,404 16 7,294 5,283 581 1,379 12 7,255
Multi-family (5 or more) residential 7,277 0 619 0 7,896 7,130 0 583 0 7,713
Agricultural loans 3,208 0 790 0 3,998 5,203 270 705 0 6,178
Other commercial loans 11,401 0 74 0 11,475 10,913 0 73 0 10,986
Total commercial 298,395 7,471 11,447 27 317,340 335,795 5,683 11,987 23 353,488
Consumer 13,546 0 176 0 13,722 14,853 0 86 0 14,939
Totals $ 721,772 $ 8,134 $ 21,843 $ 86 $ 751,835 $ 787,501 $ 6,155 $ 21,982 $ 75 $ 815,713

The general component of the allowance for loan losses covers pools of loans including commercial loans not considered individually impaired, as well as smaller balance homogeneous classes of loans, such as residential real estate, home equity lines of credit and other consumer loans. Accordingly, the Corporation generally does not separately identify individual consumer and residential loans for impairment disclosures, unless such ~~loans are~~a loan: (1) is subject to a restructuring ~~agreement.~~agreement, or (2) has an outstanding balance of $400,000 or more and a credit grade of Special Mention, Substandard or Doubtful. The pools of loans are evaluated for loss exposure based upon average historical net charge-off rates for each loan class, adjusted for qualitative factors (described in the following paragraphs). The time period used in determining the average historical net charge-off rate for each loan class is based on management’s evaluation of an appropriate time period that captures an historical loss experience relevant to the current portfolio. ~~Throughout 2016 and at March 31, 2017, a three-year average net charge-off rate was used for all loan classes.~~ At June 30, 2018 and December 31, 2017, a five-year average net charge-off rate was used for commercial loans secured by real estate and for multi-family residential loans, while a three-year average net charge-off rate was used for all other loan classes.

Qualitative risk factors are evaluated for the impact on each of the three segments (residential mortgage, commercial and consumer) within the loan portfolio. Each qualitative factor is assigned a value to reflect improving, stable or declining conditions based on management’s judgment using relevant information available at the time of the evaluation. The adjustment for qualitative factors is applied as an increase or decrease to the average net charge-off rate for each loan class within each segment.

The qualitative factors used in the general component calculations are designed to address credit risk characteristics associated with each segment. The Corporation’s credit risk associated with all of the segments is significantly impacted by these factors, which include economic conditions within its market area, the Corporation’s lending policies, changes or trends in the portfolio, risk profile, competition, regulatory requirements and other factors. Further, the residential mortgage segment is significantly affected by the values of residential real estate that provide collateral for the loans. The majority of the Corporation’s commercial segment loans (approximately ~~55%~~53% at June 30, ~~2017)~~2018) is secured by real estate, and accordingly, the Corporation’s risk for the commercial segment is significantly affected by commercial real estate values. The consumer segment includes a wide mix of loans for different purposes, primarily secured loans, including loans secured by motor vehicles, manufactured housing and other types of collateral.
27
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Loans are classified as impaired, when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial loans, by the fair value of the collateral (if the loan is collateral dependent), by future cash flows discounted at the loan’s effective rate or by the loan’s observable market price.

26
The scope of loans reviewed individually each quarter to determine if they are impaired include all commercial loan relationships greater than $200,000 and any residential mortgage or consumer loans of $400,000 or more for which there is at least one extension of credit graded Special Mention, Substandard or Doubtful. Loans that are individually reviewed, but which are determined to not be impaired, are combined with all remaining loans that are not reviewed on a specific basis, and such loans are included within larger pools of loans based on similar risk and loss characteristics for purposes of determining the general component of the allowance. The loans that have been individually reviewed, but which have been determined to not be impaired, are included in the “Collectively Evaluated” column in the table summarizing the allowance and associated loan balances as of June 30, ~~2017~~2018 and December 31, ~~2016.~~2017. All loans classified as troubled debt restructurings (discussed in more detail below) and all commercial loan relationships less than $200,000 or other loan relationships less than $400,000 in the aggregate, but with an estimated loss of $100,000 or more, are individually evaluated for impairment.

The following tables present a summary of loan balances and the related allowance for loan losses summarized by portfolio segment and class for each impairment method used as of June 30, ~~2017~~2018 and December 31, ~~2016:~~2017:

June 30, 2017 Loans: Allowance for Loan Losses:
June 30, 2018 Loans: Allowance for Loan Losses:
(In Thousands)
Individually Collectively Individually Collectively Individually Collectively Individually Collectively
Evaluated Evaluated Totals Evaluated Evaluated Totals Evaluated Evaluated Totals Evaluated Evaluated Totals
Residential mortgage:
Residential mortgage loans - first liens $ 732 $ 341,871 $ 342,603 $ 0 $ 3,052 $ 3,052 $ 959 $ 360,633 $ 361,592 $ 0 $ 3,055 $ 3,055
Residential mortgage loans - junior liens 63 24,087 24,150 0 261 261 296 26,298 26,594 120 233 353
Home equity lines of credit 0 37,159 37,159 0 332 332 0 34,852 34,852 0 292 292
1-4 Family residential construction 0 26,067 26,067 0 251 251 0 26,722 26,722 0 247 247
Total residential mortgage 795 429,184 429,979 0 3,896 3,896 1,255 448,505 449,760 120 3,827 3,947
Commercial:
Commercial loans secured by real estate 5,953 149,205 155,158 958 1,652 2,610 4,128 155,264 159,392 850 1,763 2,613
Commercial and industrial 159 82,656 82,815 75 835 910 167 88,332 88,499 75 898 973
Political subdivisions 0 51,495 51,495 0 0 0 0 56,690 56,690 0 0 0
Commercial construction and land 0 15,201 15,201 0 162 162 0 13,066 13,066 0 135 135
Loans secured by farmland 1,379 6,053 7,432 50 57 107 1,358 6,039 7,397 50 56 106
Multi-family (5 or more) residential 392 7,105 7,497 0 169 169 392 7,468 7,860 0 174 174
Agricultural loans 12 4,442 4,454 0 42 42 680 4,942 5,622 0 46 46
Other commercial loans 0 11,038 11,038 0 105 105 0 14,455 14,455 0 134 134
Total commercial 7,895 327,195 335,090 1,083 3,022 4,105 6,725 346,256 352,981 975 3,206 4,181
Consumer 21 14,602 14,623 0 134 134 18 15,888 15,906 0 204 204
Unallocated 500 499

Total $ 8,711 $ 770,981 $ 779,692 $ 1,083 $ 7,052 $ 8,635 $ 7,998 $ 810,649 $ 818,647 $ 1,095 $ 7,237 $ 8,831

2728
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

December 31, 2016 Loans: Allowance for Loan Losses:
December 31, 2017 Loans: Allowance for Loan Losses:

(In Thousands) Individually Collectively Individually Collectively
Individually Collectively Individually Collectively
Evaluated Evaluated Totals Evaluated Evaluated Totals Evaluated Evaluated Totals Evaluated Evaluated Totals
Residential mortgage:
Residential mortgage loans - first liens $ 753 $ 333,349 $ 334,102 $ 0 $ 3,033 $ 3,033 $ 984 $ 359,003 $ 359,987 $ 0 $ 3,200 $ 3,200
Residential mortgage loans - junior liens 68 23,638 23,706 0 258 258 302 25,023 25,325 122 102 224
Home equity lines of credit 0 38,057 38,057 0 350 350 0 35,758 35,758 0 296 296
1-4 Family residential construction 0 24,908 24,908 0 249 249 0 26,216 26,216 0 243 243
Total residential mortgage 821 419,952 420,773 0 3,890 3,890 1,286 446,000 447,286 122 3,841 3,963
Commercial:
Commercial loans secured by real estate 8,005 142,463 150,468 528 1,852 2,380 5,873 153,393 159,266 919 1,665 2,584
Commercial and industrial 212 83,642 83,854 95 904 999 568 87,708 88,276 188 877 1,065
Political subdivisions 0 38,068 38,068 0 0 0 0 59,287 59,287 0 0 0
Commercial construction and land 0 14,287 14,287 0 162 162 0 14,527 14,527 0 150 150
Loans secured by farmland 1,394 5,900 7,294 51 59 110 1,365 5,890 7,255 50 55 105
Multi-family (5 or more) residential 392 7,504 7,896 0 241 241 392 7,321 7,713 0 172 172
Agricultural loans 13 3,985 3,998 0 40 40 7 6,171 6,178 0 57 57
Other commercial loans 0 11,475 11,475 0 115 115 0 10,986 10,986 0 102 102
Total commercial 10,016 307,324 317,340 674 3,373 4,047 8,205 345,283 353,488 1,157 3,078 4,235
Consumer 23 13,699 13,722 0 138 138 20 14,919 14,939 0 159 159
Unallocated 398 499

Total $ 10,860 $ 740,975 $ 751,835 $ 674 $ 7,401 $ 8,473 $ 9,511 $ 806,202 $ 815,713 $ 1,279 $ 7,078 $ 8,856

Summary information related to impaired loans at June 30, ~~2017~~2018 and December 31, ~~2016~~2017 is as follows:

(In Thousands) June 30, 2017 December 31, 2016 June 30, 2018 December 31, 2017
Unpaid Unpaid Unpaid Unpaid
Principal Recorded Related Principal Recorded Related Principal Recorded Related Principal Recorded Related
Balance Investment Allowance Balance Investment Allowance Balance Investment Allowance Balance Investment Allowance
With no related allowance recorded:
Residential mortgage loans - first liens $ 762 $ 732 $ 0 $ 783 $ 753 $ 0 $ 717 $ 688 $ 0 $ 740 $ 711 $ 0
Residential mortgage loans - junior liens 63 63 0 68 68 0 56 56 0 60 60 0
Commercial loans secured by real estate 3,235 3,235 0 6,975 5,232 0 1,554 1,554 0 3,230 3,230 0
Commercial and industrial 84 84 0 117 117 0 92 92 0 119 119 0
Loans secured by farmland 879 879 0 890 890 0 866 866 0 871 871 0
Multi-family (5 or more) residential 987 392 0 987 392 0 987 392 0 987 392 0
Agricultural loans 12 12 0 13 13 0 680 680 0 8 8 0
Consumer 21 21 0 23 23 0 18 18 0 20 20 0
Total with no related allowance recorded 6,043 5,418 0 9,856 7,488 0 4,970 4,346 0 6,035 5,411 0

With a related allowance recorded:
Residential mortgage loans - first liens 272 272 0 273 273 0
Residential mortgage loans - junior liens 240 240 120 242 242 122
Commercial loans secured by real estate 2,718 2,718 958 2,773 2,773 528 2,573 2,573 850 2,641 2,641 919
Commercial and industrial 75 75 75 95 95 95 75 75 75 449 449 188
Loans secured by farmland 500 500 50 504 504 51 492 492 50 495 495 50
Total with a related allowance recorded 3,293 3,293 1,083 3,372 3,372 674 3,652 3,652 1,095 4,100 4,100 1,279
Total $ 9,336 $ 8,711 $ 1,083 $ 13,228 $ 10,860 $ 674 $ 8,622 $ 7,998 $ 1,095 $ 10,135 $ 9,511 $ 1,279

2829
CITIZENS & NORTHERN CORPORATION – FORM 10-Q
In the table immediately above, two loans to one borrower are presented under the Residential mortgage loans – first liens and Residential mortgage loans – junior liens classes. These loans are collateralized by one property, and the allowance associated with these loans was determined based on an analysis of the total amounts of the Corporation’s exposure in comparison to the estimated net proceeds if the Corporation were to sell the property.

The average balance of impaired loans and interest income recognized on impaired loans is as follows:

Interest Income Recognized on Interest Income Recognized on
Average Investment in Impaired Loans Impaired Loans on a Cash Basis Average Investment in Impaired Loans Impaired Loans on a Cash Basis
(In Thousands) 3 Months Ended 6 Months Ended 3 Months Ended 6 Months Ended 3 Months Ended 6 Months Ended 3 Months Ended 6 Months Ended
June 30, June 30, June 30, June 30, June 30, June 30, June 30, June 30,
2017 2016 2017 2016 2017 2016 2017 2016 2018 2017 2018 2017 2018 2017 2018 2017
Residential mortgage:
Residential mortgage loans - first lien $ 738 $ 833 $ 743 $ 847 $ 8 $ 12 $ 17 $ 22 $ 1,108 $ 738 $ 1,077 $ 743 $ 11 $ 8 $ 30 $ 17
Residential mortgage loans - junior lien 65 71 66 72 1 1 2 2 299 65 300 66 4 1 7 2
Total residential mortgage 803 904 809 919 9 13 19 24 1,407 803 1,377 809 15 9 37 19
Commercial:
Commercial loans secured by real estate 6,219 5,892 6,554 6,026 35 81 91 191 4,592 6,219 5,237 6,554 35 35 70 91
Commercial and industrial 235 754 241 661 4 7 7 10 280 235 394 241 1 4 7 7
Commercial construction and land 0 0 0 0 0 0 0 0
Loans secured by farmland 1,382 1,413 1,386 1,418 14 17 22 38 1,360 1,382 1,362 1,386 10 14 16 22
Multi-family (5 or more) residential 392 490 392 590 0 0 0 0 392 392 392 392 0 0 0 0
Agricultural loans 12 15 12 15 0 0 1 1 568 12 457 12 7 0 18 1
Total commercial 8,240 8,564 8,585 8,710 53 105 121 240 7,192 8,240 7,842 8,585 53 53 111 121
Consumer 25 18 29 15 0 0 0 0 19 25 19 29 0 0 0 0
Total $ 9,068 $ 9,486 $ 9,423 $ 9,644 $ 62 $ 118 $ 140 $ 264 $ 8,618 $ 9,068 $ 9,238 $ 9,423 $ 68 $ 62 $ 148 $ 140

Loans are placed on nonaccrual status for all classes of loans when, in the opinion of management, collection of interest is doubtful. Any unpaid interest previously accrued on those loans is reversed from income. Interest income is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on loans for which the risk of further loss is greater than remote are applied as a reduction of the loan principal balance. Interest income on other nonaccrual loans, including impaired loans, is recognized only to the extent of interest payments received. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectability of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans receivable is determined based on contractual due dates for loan payments. Also, the amortization of deferred loan fees is discontinued when a loan is placed on nonaccrual status.

The breakdown by portfolio segment and class of nonaccrual loans and loans past due ninety days or more and still accruing is as follows:

(In Thousands) June 30, 2017 December 31, 2016 June 30, 2018 December 31, 2017
Past Due Past Due Past Due Past Due
90+ Days and 90+ Days and 90+ Days and 90+ Days and
Accruing Nonaccrual Accruing Nonaccrual Accruing Nonaccrual Accruing Nonaccrual
Residential mortgage:
Residential mortgage loans - first liens $ 1,936 $ 3,680 $ 3,022 $ 3,770 $ 1,848 $ 4,518 $ 2,340 $ 5,131
Residential mortgage loans - junior liens 0 0 114 0 30 240 105 242
Home equity lines of credit 78 45 320 11 98 55 203 44
Total residential mortgage 2,014 3,725 3,456 3,781 1,976 4,813 2,648 5,417
Commercial:
Commercial loans secured by real estate 0 5,761 2,774 3,080 274 3,808 175 5,645
Commercial and industrial 261 159 286 119 713 167 603 517
Commercial construction and land 113 0 0 0 0 52 26 52
Loans secured by farmland 274 1,318 219 1,331 212 1,304 271 1,308
Multi-family (5 or more) residential 0 392 0 392 0 392 0 392
Agricultural loans 0 12 0 13 0 680 0 7
Total commercial 648 7,642 3,279 4,935 1,199 6,403 1,075 7,921
Consumer 18 137 103 20 20 14 1 66

Totals $ 2,680 $ 11,504 $ 6,838 $ 8,736 $ 3,195 $ 11,230 $ 3,724 $ 13,404

2930
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

The amounts shown in the table immediately above include loans classified as troubled debt restructurings (described in more detail below), if such loans are past due ninety days or more or nonaccrual.

The table below presents a summary of the contractual aging of loans as of June 30, ~~2017~~2018 and December 31, ~~2016:~~2017:

As of June 30, 2017 As of December 31, 2016 As of June 30, 2018 As of December 31, 2017
Current & Current & Current & Current &
(In Thousands) Past Due Past Due Past Due Past Due Past Due Past Due Past Due Past Due Past Due Past Due Past Due Past Due
Less than 30-89 90+ Less than 30-89 90+ Less than 30-89 90+ Less than 30-89 90+
30 Days Days Days Total 30 Days Days Days Total 30 Days Days Days Total 30 Days Days Days Total
Residential mortgage:
Residential mortgage loans - first liens $ 335,563 $ 3,639 $ 3,401 $ 342,603 $ 321,670 $ 6,695 $ 5,737 $ 334,102 $ 353,568 $ 4,230 $ 3,794 $ 361,592 $ 347,032 $ 7,967 $ 4,988 $ 359,987
Residential mortgage loans - junior liens 24,081 69 0 24,150 23,268 324 114 23,706 26,441 123 30 26,594 25,133 87 105 25,325
Home equity lines of credit 36,741 305 113 37,159 37,603 134 320 38,057 34,152 565 135 34,852 34,789 732 237 35,758
1-4 Family residential construction 25,802 265 0 26,067 24,567 341 0 24,908 26,722 0 0 26,722 25,667 549 0 26,216
Total residential mortgage 422,187 4,278 3,514 429,979 407,108 7,494 6,171 420,773 440,883 4,918 3,959 449,760 432,621 9,335 5,330 447,286

Commercial:
Commercial loans secured by real estate 152,173 92 2,893 155,158 147,464 82 2,922 150,468 157,813 201 1,378 159,392 155,917 311 3,038 159,266
Commercial and industrial 82,410 85 320 82,815 83,364 185 305 83,854 87,702 20 777 88,499 87,306 303 667 88,276
Political subdivisions 51,495 0 0 51,495 38,068 0 0 38,068 56,690 0 0 56,690 59,287 0 0 59,287
Commercial construction and land 15,024 64 113 15,201 14,199 88 0 14,287 12,980 34 52 13,066 14,400 49 78 14,527
Loans secured by farmland 6,262 92 1,078 7,432 6,181 83 1,030 7,294 5,884 544 969 7,397 6,226 12 1,017 7,255
Multi-family (5 or more) residential 7,105 0 392 7,497 7,439 65 392 7,896 7,446 22 392 7,860 7,321 0 392 7,713
Agricultural loans 4,389 53 12 4,454 3,981 4 13 3,998 5,615 1 6 5,622 6,114 57 7 6,178
Other commercial loans 11,038 0 0 11,038 11,475 0 0 11,475 14,455 0 0 14,455 10,986 0 0 10,986
Total commercial 329,896 386 4,808 335,090 312,171 507 4,662 317,340 348,585 822 3,574 352,981 347,557 732 5,199 353,488
Consumer 14,390 78 155 14,623 13,446 153 123 13,722 15,770 112 24 15,906 14,760 123 56 14,939

Totals $ 766,473 $ 4,742 $ 8,477 $ 779,692 $ 732,725 $ 8,154 $ 10,956 $ 751,835 $ 805,238 $ 5,852 $ 7,557 $ 818,647 $ 794,938 $ 10,190 $ 10,585 $ 815,713

Nonaccrual loans are included in the contractual aging in the immediately preceding table. A summary of the contractual aging of nonaccrual loans at June 30, ~~2017~~2018 and December 31, ~~2016~~2017 is as follows:

Current &
(In Thousands) Past Due Past Due Past Due
Less than 30-89 90+
30 Days Days Days Total
June 30, 2017 Nonaccrual Totals $ 4,714 $ 993 $ 5,797 $ 11,504
December 31, 2016 Nonaccrual Totals $ 4,199 $ 419 $ 4,118 $ 8,736
Current &
(In Thousands) Past Due Past Due Past Due
Less than 30-89 90+
30 Days Days Days Total
June 30, 2018 Nonaccrual Totals $ 4,937 $ 1,931 $ 4,362 $ 11,230
December 31, 2017 Nonaccrual Totals $ 5,802 $ 741 $ 6,861 $ 13,404

Loans whose terms are modified are classified as Troubled Debt Restructurings (TDRs) if the Corporation grants such borrowers concessions, and it is deemed that those borrowers are experiencing financial difficulty. Loans classified as TDRs are designated as impaired. The outstanding balance of loans subject to TDRs, as well as contractual aging information at June 30, ~~2017~~2018 and December 31, ~~2016~~2017 is as follows:

Current &
(In Thousands) Past Due Past Due Past Due
Less than 30-89 90+
30 Days Days Days Nonaccrual Total
June 30, 2017 Totals $ 679 $ 50 $ 241 $ 2,818 $ 3,788
December 31, 2016 Totals $ 5,453 $ 350 $ 0 $ 2,874 $ 8,677
Current &
(In Thousands) Past Due Past Due Past Due
Less than 30-89 90+
30 Days Days Days Nonaccrual Total
June 30, 2018 Totals $ 651 $ 102 $ 0 $ 2,951 $ 3,704
December 31, 2017 Totals $ 636 $ 0 $ 0 $ 3,027 $ 3,663

3031
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

At June 30, ~~2017~~2018 and December 31, ~~2016,~~2017, there were no commitments to loan additional funds to borrowers whose loans have been classified as TDRs.

There were no TDRs that occurred during the three-month periods ended June 30, 2018 and 2017. TDRs that occurred during the six-month periods ended June 30, ~~2017~~2018 and ~~2016~~2017 are as follows:

(Balances in Thousands) Three Months Ended Three Months Ended
June 30, 2017 June 30, 2016
Post- Post-
Number Modification Number Modification
of Recorded of Recorded
Loans Investment Loans Investment
Commercial and industrial,
Extended maturity with interest rate reduction 0 $ 0 1 $ 102
Six Months Ended Six Months Ended
June 30, 2017 June 30, 2016
Post- Post-
Number Modification Number Modification
of Recorded of Recorded
Loans Investment Loans Investment
Commercial and industrial:
Extended maturity with interest rate increase 0 $ 0 1 $ 5
Extended maturity with interest rate reduction 0 0 1 102
Total 0 $ 0 2 $ 107
(Balances in Thousands) Six Months Ended Six Months Ended
June 30, 2018 June 30, 2017
Post- Post-
Number Modification Number Modification
of Recorded of Recorded
Loans Investment Loans Investment
Residential mortgage - first liens,
Reduced monthly payments for a six-month period 1 $ 80 0 $ 0
Commercial loans secured by real estate,
Extended interest only payments for a six-month period 2 36 0 0
Commercial and industrial,
Extended interest only payments for a six-month period 1 46 0 0
Total 4 $ 162 0 $ 0

In the ~~three-month and~~ six-month periods ended June 30, 2018 and 2017, ~~and 2016,~~there were no defaults on loans for which modifications considered to be TDRs were entered into within the previous 12 ~~months are summarized as follows:~~months.
(Balances in Thousands) Three Months Ended Three Months Ended
June 30, 2017 June 30, 2016
Number Number
of Recorded of Recorded
Loans Investment Loans Investment
Residential mortgage - first liens 0 $ 0 1 $ 242
Residential mortgage - junior liens 0 0 1 30
Consumer 0 0 1 28
Total 0 $ 0 3 $ 300
Six Months Ended Six Months Ended
June 30, 2017 June 30, 2016
Number Number
of Recorded of Recorded
Loans Investment Loans Investment
Residential mortgage - first liens 0 $ 0 2 $ 273
Residential mortgage - junior liens 0 0 1 30
Commercial and industrial 0 0 1 5
Consumer 0 0 1 28
Total 0 $ 0 5 $ 336
31

The carrying amount of foreclosed residential real estate properties held as a result of obtaining physical possession (included in Foreclosed assets held for sale in the unaudited ~~Consolidated Balance Sheet)~~consolidated balance sheets) is as follows:

(In Thousands) June 30, Dec. 31, June 30, Dec. 31,
2017 2016 2018 2017
Foreclosed residential real estate $ 879 $ 1,102 $ 412 $ 721

The recorded investment of consumer mortgage loans secured by residential real properties for which formal foreclosure proceedings were in process is as follows:

(In Thousands) June 30, Dec. 31, June 30, Dec. 31,
2017 2016 2018 2017
Residential real estate in process of foreclosure $ 1,646 $ 2,738 $ 1,150 $ 1,789

8. BORROWED FUNDS

Short-term borrowings (initial maturity within one year) include the following:

(In Thousands) June 30, Dec. 31, June 30, Dec. 31,
2017 2016 2018 2017
FHLB-Pittsburgh borrowings $ 4,000 $ 21,000 $ 12,000 $ 58,000
Customer repurchase agreements 4,875 5,175 5,169 3,766
Total short-term borrowings $ 8,875 $ 26,175 $ 17,169 $ 61,766

The FHLB-Pittsburgh loan facilities are collateralized by qualifying loans secured by real estate with a book value totaling ~~$490,474,000~~$493,749,000 at June 30, ~~2017~~2018 and ~~$471,454,000~~$488,889,000 at December 31, ~~2016.~~2017. Also, the FHLB-Pittsburgh loan facilities require the Corporation to invest in established amounts of FHLB-Pittsburgh stock. The carrying values of the Corporation’s holdings of FHLB-Pittsburgh stock (included in Other Assets) were ~~$3,448,000~~$4,948,000 at June 30, ~~2017~~2018 and ~~$4,296,000~~$6,426,000 at December 31, ~~2016.~~2017.
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

At June 30, 2018, the short-term borrowings from FHLB-Pittsburgh consisted of 4 advances of $3,000,000 each maturing monthly from July to October 2018, with a weighted average interest rate of 1.85%. At December 31, 2017, the short-term ~~borrowing~~borrowings from FHLB-Pittsburgh of ~~$4,000,000 was~~$58,000,000 included an overnight borrowing of $29,000,000 with an interest rate of ~~1.24%. At December 31, 2016, the~~1.54% and other short-term ~~borrowing from FHLB-Pittsburgh of $21,000,000 was an overnight borrowing~~advances totaling $29,000,000 with ~~an interest~~a weighted average rate of ~~0.74%~~1.69%.

The Corporation engages in repurchase agreements with certain commercial customers. These agreements provide that the Corporation sells specified investment securities to the customers on an overnight basis and repurchases them on the following business day. The weighted average interest rate paid by the Corporation on customer repurchase agreements was 0.10% at June 30, ~~2017~~2018 and December 31, ~~2016.~~2017. The carrying value of the underlying securities was $10,770,000 at June 30, 2018 and $12,158,000 at December 31, 2017.
~~Long-term borrowings are as follows:~~
(In Thousands) June 30, Dec. 31,
2017 2016
FHLB-Pittsburgh borrowings $ 11,321 $ 11,454
Repurchase agreement 27,000 27,000
Total long-term borrowings $ 38,321 $ 38,454

Long-term borrowings from FHLB-Pittsburgh are as follows:

(In Thousands) June 30, Dec. 31,
2017 2016
Loan matured in June 2017 with a rate of 6.83% $ 0 $ 4
Loan maturing in September 2017 with a rate of 3.81% 10,000 10,000
Loan maturing in April 2020 with a rate of 4.79% 556 646
Loan maturing in June 2025 with a rate of 4.91% 765 804
Total long-term FHLB-Pittsburgh borrowings $ 11,321 $ 11,454
~~The repurchase agreement included in long-term borrowings has an interest rate of 3.595% and an effective maturity date in December 2017.~~
32
~~The “Repurchase Date,” as defined in the Master Repurchase Agreement between the Corporation and the broker-dealer, occurs quarterly on or about the 20~~^th of each March, June, September and December until the “Final Repurchase Date” (as defined) on December 20, 2017. The Corporation pays interest, and the borrowing is putable by the issuer, on each Repurchase Date. The Final Repurchase Date is the effective maturity date of the borrowing.
Securities sold under repurchase agreements were delivered to the broker-dealer who is the counter-party to the transactions. The broker-dealer may have sold, loaned or otherwise disposed of such securities to other parties in the normal course of their operations, and has agreed to resell to the Corporation substantially identical securities at the maturities of the agreements. The Master Repurchase Agreement provides that the Agreement constitutes a “netting contract,” as defined; however, the Corporation and the broker-dealer have no other obligations to one another and accordingly, no netting has occurred.
~~The carrying value of the underlying securities was $32,858,000 at June 30, 2017 and $31,494,000 at December 31, 2016, detailed in the following table:~~
(In Thousands) June 30, Dec. 31,
2017 2016
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities $ 14,673 $ 18,181
Residential collateralized mortgage obligations 18,185 13,313
Total $ 32,858 $ 31,494
~~Two of the more significant risks associated with the repurchase agreement with the broker-dealer are as follows:~~
· The borrowings are putable at quarterly intervals by the issuer. Accordingly, if interest rates were to rise to a sufficient level, the issuer would be expected to require the Corporation to pay off the borrowing. In this circumstance, the Corporation would be required to obtain a new borrowing at a higher interest rate than the existing repurchase agreement or utilize cash from other sources to pay off the borrowing. If sales of available-for-sale securities were used to generate cash to pay off the borrowing, the value of such securities would be expected to have fallen, which could result in the Corporation recognizing a loss.
· As principal pay-downs of mortgage backed securities and CMOs occur, the Corporation must have available, unencumbered assets or purchase a sufficient amount of assets with credit quality suitable to the broker-dealer to replace the amounts being paid off. Since pre-payments of mortgages typically increase as interest rates fall, the Corporation may be required to purchase additional assets at times when market rates are lower than the rates paid on the borrowing.
The Corporation manages these risks by maintaining sufficient available assets of acceptable credit quality, as well as maintaining other borrowing facilities, to meet ongoing collateral maintenance requirements or pay off the borrowing if required. In particular, the Corporation had unused borrowing capacity available from the FHLB-Pittsburgh of $338,020,000 at June 30, 2017.
(In Thousands) June 30, Dec. 31,
2018 2017
Loan maturing in November 2018 with a rate of 1.63% $ 3,000 $ 3,000
Loan maturing in December 2018 with a rate of 1.35% 3,000 3,000
Loan maturing in January 2019 with a rate of 1.83% 2,000 2,000
Loan maturing in February 2019 with a rate of 1.95% 3,000 0
Loan maturing in March 2019 with a rate of 2.15% 3,000 0
Loan maturing in April 2019 with a rate of 2.24% 3,000 0
Loan maturing in May 2019 with a rate of 2.30% 3,000 0
Loan maturing in June 2019 with a rate of 2.42% 3,000 0
Loan maturing in July 2019 with a rate of 2.41% 3,000 0
Loan maturing in April 2020 with a rate of 4.79% 368 463
Loan maturing in June 2025 with a rate of 4.91% 686 726
Total long-term FHLB-Pittsburgh borrowings $ 27,054 $ 9,189

9. DEFINED BENEFIT PLANS

The Corporation sponsors a defined benefit health care plan that provides postretirement medical benefits and life insurance to employees who meet certain age and length of service requirements. Full-time employees no longer accrue service time toward the Corporation-subsidized portion of the medical benefits. The plan contains a cost-sharing feature which causes participants to pay for all future increases in costs related to benefit coverage. Accordingly, actuarial assumptions related to health care cost trend rates do not significantly affect the liability balance at June 30, ~~2017~~2018 and December 31, ~~2016,~~2017, and are not expected to significantly affect the ~~Corporation’s~~Corporation's future expenses. The Corporation uses a December 31 measurement date for the postretirement plan.
33

In an acquisition in 2007, the Corporation assumed the Citizens Trust Company Retirement Plan, a defined benefit pension plan. This plan covers certain employees who were employed by Citizens Trust Company on December 31, 2002, when the plan was amended to discontinue admittance of any future participant and to freeze benefit accruals. Information related to the Citizens Trust Company Retirement Plan has been included in the tables that follow. The Corporation uses a December 31 measurement date for this plan.

The components of net periodic benefit costs from these defined benefit plans are as follows:

Defined Benefit Plans
(In Thousands) Pension Postretirement Pension Postretirement
Six Months Ended Six Months Ended Six Months Ended Six Months Ended
June 30, June 30, June 30, June 30,
2017 2016 2017 2016 2018 2017 2018 2017
Service cost $ 0 $ 0 $ 18 $ 18 $ 0 $ 0 $ 20 $ 18
Interest cost 12 13 28 31 13 12 26 28
Expected return on plan assets (15 ) (13 ) 0 0 (10 ) (15 ) 0 0
Amortization of prior service cost 0 0 (15 ) (15 ) 0 0 (16 ) (15 )
Recognized net actuarial loss 3 5 0 0 6 3 0 0
Net periodic benefit cost $ 0 $ 5 $ 31 $ 34 $ 9 $ 0 $ 30 $ 31

Defined Benefit Plans
(In Thousands) Pension Postretirement
Three Months Ended Three Months Ended
June 30, June 30,
2017 2016 2017 2016
Service cost $ 0 $ 0 $ 9 $ 9
Interest cost 6 6 14 15
Expected return on plan assets (7 ) (6 ) 0 0
Amortization of prior service cost 0 0 (7 ) (7 )
Recognized net actuarial loss 1 2 0 0
Net periodic benefit cost $ 0 $ 2 $ 16 $ 17
33
CITIZENS & NORTHERN CORPORATION – FORM 10-Q
Defined Benefit Plans
(In Thousands) Pension Postretirement
Three Months Ended Three Months Ended
June 30, June 30,
2018 2017 2018 2017
Service cost $ 0 $ 0 $ 10 $ 9
Interest cost 7 6 13 14
Expected return on plan assets (5 ) (7 ) 0 0
Amortization of prior service cost 0 0 (8 ) (7 )
Recognized net actuarial loss 3 1 0 0
Net periodic benefit cost $ 5 $ 0 $ 15 $ 16
Service cost, interest cost and expected return on plan assets are included in pensions and other employee benefits expense in the consolidated statements of income in the first six months 2018 and 2017. Amortization of prior service cost and the recognized net actuarial loss are included in other noninterest expense in the consolidated statements of income in the first six months 2018 and 2017.

In the first six months of ~~2017,~~2018, the Corporation funded postretirement contributions totaling $24,000, with estimated annual postretirement contributions of ~~$62,000~~$60,000 expected in ~~2017~~2018 for the full year. ~~Based upon preliminary actuarial information, no~~No defined benefit pension contributions are required in ~~2017,~~2018, though the Corporation may make discretionary contributions.

10. STOCK-BASED COMPENSATION PLANS

The Corporation has a Stock Incentive Plan for a selected group of officers and an Independent Directors Stock Incentive Plan. In the first quarter ~~2017,~~2018, the Corporation awarded ~~22,312~~25,466 shares of restricted stock under the Stock Incentive Plan and ~~8,470~~9,086 shares of restricted stock under the Independent Directors Stock Incentive Plan. The ~~2017~~2018 restricted stock awards under the Stock Incentive Plan vest ratably over three years, and vesting for one-half of the ~~14,897~~16,578 restricted shares awarded to Executive Officers depends on the Corporation meeting a return on average equity (“ROAE”) target each year. The ~~2017~~2018 restricted stock issued under the Independent Directors Stock Incentive Plan vests over one year.

Compensation cost related to restricted stock is recognized based on the ~~market price~~fair value of the stock at the grant date over the vesting ~~period.~~period, adjusted for estimated and actual forfeitures. Management has estimated restricted stock expense in the first six months of ~~2017~~2018 based on an assumption that the ROAE target for awards to Executive Officers in 2016, 2017 and ~~2017~~2018 will not be met, resulting in forfeiture of the restricted stock.

Total annual stock-based compensation for the year ending December 31, ~~2017~~2018 is estimated to total ~~$652,000.~~$714,000. If the ROAE targets for awards to Executive Officers in 2016, 2017 and ~~2017~~2018 are met or exceeded, total annual stock-based compensation would increase by approximately ~~$123,000.~~$190,000. Total stock-based compensation expense attributable to restricted stock awards amounted to $155,000 in the second quarter 2018 and $338,000 in the six-month period ended June 30, 2018. Total stock-based compensation expense attributable to restricted stock awards amounted to $154,000 in the second quarter 2017 and $322,000 in the six-month period ended June 30, 2017. ~~Total stock-based compensation expense attributable to restricted stock awards amounted to $163,000 in the second quarter 2016 and $325,000 in the six-month period ended June 30, 2016.~~

34
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

11. INCOME TAXES

The net deferred tax asset at June 30, ~~2017~~2018 and December 31, ~~2016~~2017 represents the following temporary difference components:

June 30, December 31, June 30, December 31,
(In Thousands) 2017 2016 2018 2017
Deferred tax assets:
Unrealized holding losses on securities $ 0 $ 512
Unrealized holding losses on available-for-sale securities:
Included in accumulated other comprehensive loss $ 1,721 $ 843
Included in retained earnings 0 (337 )
Allowance for loan losses 3,055 2,998 1,889 1,894
Other deferred tax assets 2,353 2,658 1,813 1,726
Total deferred tax assets 5,408 6,168 5,423 4,126

Deferred tax liabilities:
Unrealized holding gains on securities 198 0
Defined benefit plans - ASC 835 81 27
Defined benefit plans - ASC 835:
Included in accumulated other comprehensive loss 36 31
Included in retained earnings 0 (12 )
Bank premises and equipment 1,076 913 834 751
Core deposit intangibles 5 6 2 3
Other deferred tax liabilities 106 105 247 64
Total deferred tax liabilities 1,466 1,051 1,119 837
Deferred tax asset, net $ 3,942 $ 5,117 $ 4,304 $ 3,289
In December 2017, the Corporation recognized an adjustment in the carrying value of the net deferred tax asset as a result of a reduction in the federal corporate income tax rate to 21%, effective January 1, 2018, from the 35% marginal rate that had previously been in effect. At December 31, 2017, the portion of the adjustment attributable to items of accumulated other comprehensive income (loss) were stranded in retained earnings, including components related to unrealized losses on securities and defined benefit plans. As described in Note 1, the Corporation elected early adoption of ASU 2018-02, resulting in a reclassification between two categories of stockholders’ equity at January 1, 2018, with an increase of $325,000 in retained earnings and a decrease in accumulated other comprehensive loss for the same amount. Management believes the Corporation’s accounting for the effects of the reduction in the federal income tax rate is materially complete at June 30, 2018.

The provision for income tax for the three-month and ~~six month~~six-month periods ended June 30, ~~2017~~2018 and ~~2016~~2017 is based on the Corporation’s estimate of the effective tax rate expected to be applicable for the full year. The effective tax rates for the Corporation are as follows:

Three Months Ended Six Months Ended Three Months Ended Six Months Ended
(Dollars In thousands) June 30, June 30, June 30, June 30,
2017 2016 2017 2016 2018 2017 2018 2017
Income before income tax provision $ 5,495 $ 5,174 $ 9,913 $ 9,840 $ 7,748 $ 5,495 $ 12,864 $ 9,913
Income tax provision 1,374 1,303 2,358 2,396 1,377 1,374 2,118 2,358
Effective tax rate 25.00 % 25.18 % 23.79 % 24.35 % 17.77 % 25.00 % 16.46 % 23.79 %

The effective tax rate for each period presented differs from the statutory rate of 21% for the period ended June 30, 2018 and 35% for the period ended June 30, 2017 principally because of the effects of tax-exempt interest income.

The Corporation has investments in three limited partnerships that manage affordable housing projects that have qualified for the federal low-income housing tax credit. The Corporation’s expected return from these investments is based on the receipt of tax credits and tax benefits from deductions of operating losses. The Corporation uses the effective yield method to account for these investments, with the benefits recognized as a reduction of the provision for income taxes. For two of the three limited partnership investments, the tax credits have been received in full in prior years, and the Corporation has fully realized the benefits of the credits and amortized its initial investments in the partnerships. The most recent affordable housing project was completed in 2013, and the Corporation received tax credits in 2013 through ~~2016~~2017 and expects to continue to receive tax credits annually through 2022. The carrying amount of the Corporation’s investment is ~~$660,000~~$553,000 at June 30, ~~2017~~2018 and ~~$713,000~~$608,000 at December 31, ~~2016~~2017 (included in Other Assets in the consolidated balance sheets). For the year ending December 31, ~~2017,~~2018, the estimated amount of tax credits and other tax benefits to be received is ~~$157,000~~$150,000 and the estimated amount to be recognized as a reduction of the provision for income taxes is ~~$73,000.~~$54,000. The total reduction in the provision for income taxes resulting from this investment is $13,000 in the second quarter 2018 and $27,000 for the six months ended June 30, 2018, and $19,000 in the second quarter ~~2017~~2016 and $37,000 for the six months ended June 30, ~~2017, and $19,000 in the second quarter 2016 and $38,000 for the six months ended June 30, 2016.~~2017.
35
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

The Corporation has no unrecognized tax benefits, nor pending examination issues related to tax positions taken in preparation of its income tax returns. With limited exceptions, the Corporation is no longer subject to examination by the Internal Revenue Service for years prior to ~~2013.~~2014.
35

12. CONTINGENCIES

In the normal course of business, the Corporation may be subject to pending and threatened lawsuits in which claims for monetary damages could be asserted. In management’s opinion, the Corporation’s financial position and results of operations would not be materially affected by the outcome of such pending legal proceedings.

13. ~~RECENT ACCOUNTING PRONOUNCEMENTS~~REVENUE RECOGNITION

~~The FASB issues Accounting Standards Updates (ASUs) to~~As disclosed in Note 1, as of January 1, 2018, the FASB ASC. This section provides a summary description of recent ASUs that have significant implications (elected or required) within the consolidated financial statements, or that management expects may have a significant impact on financial statements issued in the near future.
~~In May 2014, the FASB issued~~Corporation adopted ASU 2014-09, Revenue from Contracts with Customers ~~which provides a principles-based framework for revenue recognition~~(Topic 606), as well as subsequent ASUs that ~~supersedes virtually all previously issued revenue recognition guidance under U.S. GAAP. Additionally,~~modified ASC 606. The Company has elected to apply the ASU ~~requires improved disclosures to help users of financial statements better understand~~and all related ASUs using the ~~nature, amount, timing, and uncertainty of revenue that is recognized.~~modified retrospective implementation method. The ~~core principle~~implementation of the five-step revenue recognition framework is that an entity should recognize revenue to depict the transfer of promised 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. Additional ASUs related to revenue recognition include the following:
· In August 2015 the FASB issued ASU 2015-14, which deferred the effective date of the revenue recognition standard by a year, making it applicable for the Corporation in the first quarter 2018 and for the annual period ending December 31, 2018.
· ~~In April 2016, the FASB issued ASU 2016-10, which provides clarifying information related to identifying performance obligations and licensing.~~
· ~~In May 2016, the FASB issued ASU 2016-12 and in December 2016, the FASB issued ASU 2016-20, which provide clarifying guidance in a few narrow areas and adds some practical expedients to the guidance.~~
· ~~In February 2017, the FASB issued ASU 2017-05, which provides guidance on the accounting for gains and losses on the derecognition of nonfinancial assets.~~
The amendments should be applied either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the amendments recognized at the date of initial application. Initial adoption of this ASU is not expected to have a significantguidance had no material impact on the ~~Corporation, as~~measurement or recognition of ~~interest income~~revenue of prior periods. The Corporation generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the ~~larger~~transaction prices are typically fixed; charged either on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.
Additional disclosures related to the Corporation’s largest sources of noninterest income inwithin the ~~Corporation’s current business model would not be impacted by the ASU.~~consolidated statements of income that are subject to ASC 606 are as follows:

~~In January 2016, the FASB issued ASU 2016-01, Recognition~~Trust and ~~Measurement of Financial Assets and Liabilities. This makes significant changes in U.S. GAAP related to certain aspects of recognition, measurement, presentation and disclosure~~financial management revenue– C&N Bank’s trust division provides a wide range of financial ~~instruments.~~services, including wealth management services for individuals, businesses and retirement funds, administration of 401(k) and other retirement plans, retirement planning, estate planning and estate settlement services. Trust clients are located primarily within the Corporation’s geographic markets. Assets held in a fiduciary capacity by C&N Bank are not the Corporation’s assets and are therefore not included in the consolidated balance sheets. The changes provided for in this Update that are applicable to the Corporation are as follows: (1) require 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 of trust assets under management was approximately $927,089,000 at June 30, 2018 and $916,580,000 at December 31, 2017. Trust and financial management revenue is included within noninterest income in the consolidated statements of income.
Trust revenue is recorded on a cash basis, which is not materially different from the accrual basis. The majority (approximately 81%, based on annual 2017 results) of trust revenue is earned and collected monthly, with changes in fair value recognized in net income; however, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the ~~identical or~~amount determined based on a ~~similar investment~~percentage of the same issuer; (2) for equity investments without readily determinable fair values, require a qualitative assessment to identify impairment, and if a qualitative assessment indicates that impairment exists, requiring an entity to measure the investment at fair value; (3) eliminate 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; (4) require public business entities to use the exit price notion when measuring the fair value of ~~financial instruments for disclosure purposes; (5) require an entity~~the trust assets under management. Wealth management fees are contractually agreed with each customer, and fee levels vary based mainly on the size of assets under management. The services provided under such a contract represent a single performance obligation under the ASU because it embodies a series of distinct goods or services that are substantially the same and have the same pattern of transfer to ~~present separately in other comprehensive income~~ the ~~portion~~customer. None of the ~~total change~~contracts with trust customers provide for incentive-based fees. In addition to wealth management fees, trust revenue includes fees for provision of services, including employee benefit plan administration, tax return preparation and estate planning and settlement. Fees for such services are billed based on contractual arrangements or established fee schedules, and are typically billed upon completion of providing such services. The costs of acquiring trust customers are incremental and recognized within noninterest expense in the ~~fair value~~consolidated statements of ~~a liability resulting from a change~~income.
Service charges on deposit accounts - Deposits are included as liabilities in the ~~instrument-specific credit risk~~consolidated balance sheets. Service charges on deposit accounts include: overdraft fees, which are charged when customers overdraw their accounts beyond available funds; automated teller machine (ATM) fees charged for withdrawals by deposit customers from other financial institutions’ ATMs; and a variety of other monthly or transactional fees for services provided to retail and business customers, mainly associated with checking accounts. All deposit liabilities are considered to have one-day terms and therefore related fees are recognized in income at the time when the ~~entity has elected~~services are provided to ~~measure~~ the ~~liability~~customers. Incremental costs of obtaining deposit contracts are not significant and are recognized as expense when incurred within noninterest expense in the consolidated statements of income.
Interchange revenue from debit card transactions– The Corporation issues debit cards to consumer and business customers with checking, savings or money market deposit accounts. Debit card and ATM transactions are processed via electronic systems that involve several parties. The Corporation’s debit card and ATM transaction processing is executed via contractual arrangements with payment processing networks, a processor and a settlement bank. As described above, all deposit liabilities are considered to have one-day terms and therefore interchange revenue from customers’ use of their debit cards to initiate transactions are recognized in income at ~~fair value~~the time when the services are provided and related fees received in ~~accordance~~the Corporation’s deposit account with the ~~fair value option for financial instruments (at June 30, 2017~~settlement bank. Incremental costs associated with ATM and December 31, 2016, the Corporation has no liabilities for which the fair value measurement option has been elected); (6) require 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 (7) clarify 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. The amendments in this Update will become effective for the Corporation for annual and interim periods beginninginterchange processing are recognized as expense when incurred within noninterest expense in the ~~first quarter 2018. With limited exceptions, early adoption~~consolidated statements of the amendments in this Update is not permitted. Amendments are to be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values should be applied prospectively. Initial adoption of this ASU is not expected to have a significant impact on the Corporation’s financial position; however, the method for determining the fair value of loans and other financial instruments for disclosure purposes will be affected.income.

36
CITIZENS & NORTHERN CORPORATION – FORM 10-Q
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases. Specifically, a lessee should recognize on the balance sheet 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. For leases with a term of 12 months or less, a lessee would be permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and liabilities. Topic 842 would not significantly change the recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee from current U.S. GAAP; however, the principal change from current GAAP is that lease assets and liabilities arising from operating leases would be recognized on the balance sheet. Topic 842 provides several other changes or clarifications to existing GAAP, and will require qualitative disclosures, along with quantitative disclosures, so that financial statement users can understand more about the nature of an entity’s leasing activities. In transition, Topic 842 provides that lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach, including optional practical expedients. An entity that elects to apply the practical expedients will, in effect, continue to account for leases that commence before the effective date in accordance with previous GAAP unless the lease is modified, except that lessees will be required to recognize a right-of-use asset and a lease liability for all operating leases at each reporting date based on the present value of the remaining minimum rental payments that were tracked and disclosed under previous GAAP. Topic 842 will become effective for the Corporation for annual and interim periods beginning in the first quarter 2019. The Corporation is in the early stages of evaluating the potential impact of adopting this amendment.
In March 2016, the FASB issued ASU No. 2016-07, Investments – Equity Method and Joint Ventures. This ASU eliminates the requirement that when an investment qualifies for the equity method as a result of an increase in the level of ownership interest or influence, an investor must adjust the investment, results of operations and retained earnings retroactively as if the equity method had been in effect during all previous periods the investment had been held. The ASU requires the equity method investor to add the cost of acquiring an additional interest in the investee to the basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for the equity method. The ASU further requires that an entity that has an available-for-sale equity security that becomes qualified for the equity method recognize through earnings the unrealized 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 were effective for the Corporation for annual and interim periods beginning in the first quarter 2017. Initial adoption of this ASU in 2017 did not have a significant impact on the Corporation.
In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation. This ASU changes several aspects of accounting for share-based payment transactions, and includes some changes that apply only to nonpublic companies. This Update includes amendments that currently apply, or may apply in the future, to the Corporation related to the following: (1) accounting for the difference between the deduction for tax purposes and the amount of compensation cost recognized for financial reporting purposes; (2) classification of excess tax benefits on the statement of cash flows; (3) accounting for forfeitures; (4) accounting for awards partially settled in cash in excess of the employer’s minimum statutory tax withholding requirements; and (5) classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax-withholding purposes. The amendments in this Update were effective for the Corporation for annual and interim periods beginning in the first quarter 2017. The ASU provides separate transition provisions for each of the amendments. Initial adoption of this ASU in 2017 did not have a significant impact on the Corporation.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326). This ASU will result in significant changes in the Corporation’s accounting for credit losses related to loans receivable and investment securities. A summary of significant provisions of this ASU is as follows:
· The ASU requires that a financial asset (or a group of financial assets) measured at amortized cost basis be presented, net of a valuation allowance for credit losses, at an amount expected to be collected on the financial asset(s), and that the income statement include the measurement of credit losses for newly recognized financial assets as well as changes in expected losses on previously recognized financial assets. The provisions of this ASU require measurement of expected credit losses based on relevant information including past events, historical experience, current conditions, and reasonable and supportive forecasts that affect the collectability of the asset. The provisions of this ASU differ from current U.S. GAAP in that current U.S. GAAP generally delays recognition of the full amount of credit losses until the loss is probable of occurring.
37
· The amendments in the Update retain many of the disclosure requirements related to credit quality in current U.S. GAAP, updated to reflect the change from an incurred loss methodology to an expected credit loss methodology.
· In addition, the Update requires that disclosure of credit quality indicators in relation to the amortized cost of financing receivables, a current requirement, be further disaggregated by year of origination.
· This ASU requires that credit losses on available-for-sale debt securities be presented as an allowance rather than as a write-down, and limits the amount of the allowance for credit losses to the amount by which the fair value is below amortized cost. For purchased available-for-sale securities with a more-than-insignificant amount of credit deterioration since origination, the ASU requires an allowance be determined in a manner similar to other available-for-sale debt securities; however, the initial allowance would be added to the purchase price, with only subsequent changes in the allowance recorded in credit loss expense, and interest income recognized at the effective rate excluding the discount embedded in the purchase price related to estimated credit losses at acquisition.
· This ASU will be effective for the Corporation for interim and annual periods beginning in the first quarter of 2020. Earlier adoption is permitted beginning in the first quarter of 2019. The entity will record the effect of implementing this ASU through a cumulative-effect adjustment through retained earnings as of the beginning of the reporting period in which Topic 326 is effective.
~~The Corporation is in the early stages of evaluating the potential impact of adopting this amendment.~~
In June 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) – Classification of Certain Cash Receipts and Cash Payments. This Update provides clarification regarding eight specific cash flow issues with the objective of reducing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. For the Corporation, the amendments in this Update are effective beginning in the first quarter 2018. The amendments in this Update should be applied using a retroactive transition method to each period presented. The Corporation anticipates there will be no adjustments to the Consolidated Statements of Cash Flows, as previously reported, as a result of the clarifications provided in the Update.
In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350) to simplify the accounting for goodwill impairment. This guidance, among other things, removes step 2 of the goodwill impairment test thus eliminating the need to determine the fair value of individual assets and liabilities of the reporting unit. Upon adoption of this ASU, goodwill impairment will be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. This may result in more or less impairment being recognized than under current guidance. This Update will become effective for the Corporation’s annual and interim goodwill impairment tests beginning in the first quarter of 2020.
In March 2017, the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20). This Update will shorten the amortization period for certain callable debt securities held at a premium. Under current U.S. GAAP, entities generally amortize the premium over the contractual life of the instrument. Discounts will continue to be amortized to maturity. The amendments in this Update are effective for the Corporation for annual and interim periods beginning in the first quarter 2019. An entity should apply the amendments in this Update through a cumulative-effect adjustment directly to retained earnings as of the beginning of the year of adoption. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The Corporation does not expect adoption of the amendments to have a significant impact on its financial position and does not expect to early adopt the amendments.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Certain statements in this section and elsewhere in this quarterly report on Form 10-Q are forward-looking statements. Citizens & Northern Corporation and its wholly-owned subsidiaries (collectively, the Corporation) intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995. Forward-looking statements, which are not historical facts, are based on certain assumptions and describe future plans, business objectives and expectations, and are generally identifiable by the use of words such as, ~~“should”~~"should", “likely”, ~~“expect”~~"expect", “plan”, ~~“anticipate”~~"anticipate", “target”, “forecast”, and “goal”. These forward-looking statements are subject to risks and uncertainties that are difficult to predict, may be beyond management’s control and could cause results to differ materially from those expressed or implied by such forward-looking statements. Factors which could have a material, adverse impact on the operations and future prospects of the Corporation include, but are not limited to, the following:

· changes in monetary and fiscal policies of the Federal Reserve Board and the U. S. Government, particularly related to changes in interest rates
· changes in general economic conditions
· legislative or regulatory changes
· downturn in demand for loan, deposit and other financial services in the Corporation’s market area
· increased competition from other banks and non-bank providers of financial services
· technological changes and increased technology-related costs
· changes in accounting principles, or the application of generally accepted accounting principles.

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

EARNINGS OVERVIEW

~~Second quarter 2017 net~~Net income was ~~$0.34~~$0.52 per ~~basic and~~ diluted share ~~as compared to $0.28~~in the second quarter 2018, up from $0.36 in the first quarter ~~2017~~2018 and ~~$0.32~~$0.34 in the second quarter ~~2016.~~2017. Second quarter 2018 earnings included a net benefit of $0.10 per diluted share from a gain on a restricted equity security (Visa Inc. Class B stock) and a loss on available-for-sale debt securities. For the six months ended June 30, ~~2017,~~2018, net income was $0.87 per ~~basic and~~ diluted share, including a net benefit of $0.09 per diluted share from the gain on Visa Class B stock and the loss on available-for-sale debt securities. In comparison, net income was $0.62 ~~as compared to $0.61~~per diluted share for the ~~first~~ six months ended June 30, 2017, including a benefit of ~~2016.~~$0.01 per diluted share from a gain on available-for-sale debt securities.
In the second quarter 2018, the Corporation recorded a pre-tax gain on Visa Class B stock of $1,750,000. The ~~return~~Corporation had received 19,789 shares of Visa Class B stock pursuant to Visa’s 2007 initial public offering. Until the second quarter 2018, the carrying value of the shares was $0, which represented the Corporation’s cost basis. Class B shares are subject to restrictions on transfer, essentially limiting their transferability to other owners of Class B shares. In June 2018, the Corporation received an offer and agreed to sell 10,000 of the shares for a price of $88.43 per share. This transaction settled in July 2018. Under current accounting guidance, public companies must consider the pricing of observable transactions in determining the carrying value of equity securities that do not have readily determinable fair values. Accordingly, the total second quarter 2018 gains (realized and unrealized) was based on the price per share of the recent sale, applied to the total of 19,789 shares.
At June 30, 2018, the Corporation recorded a pre-tax impairment loss on available-for-sale debt securities of $282,000. The loss represents the unrealized loss at June 30, 2018 on securities that were sold in July 2018. The securities sold included obligations of U.S. Government agencies and states and political subdivisions. The realized losses on the sales totaled $329,000, including $282,000 recorded in the second quarter 2018. Proceeds from the sales totaling $17.8 million were reinvested in fixed rate mortgage-backed securities issued by U.S. Government agencies (CMOs). The recent fully taxable equivalent yield on the securities sold was 1.73%, while the estimated average ~~assets for~~yield on the ~~first six months~~CMOs purchased (at current market rates) is 3.36%.
The table below provides a reconciliation of second quarter and June 30, 2018 year-to-date unaudited earnings results to the comparative 2017 ~~was 1.22%,~~results excluding the gain on Visa Class B stock and ~~the return~~gains and losses on ~~average equity was 8.07%. Highlights~~available-for-sale debt securities.
37
CITIZENS & NORTHERN CORPORATION – FORM 10-Q
(Dollars In Thousands, Except Per Share Data)
(Unaudited) 2nd Quarter 2018 2nd Quarter 2017
Income Diluted Income Diluted
Before Income Earnings Before Income Earnings
Income Tax per Income Tax per
Tax Provision Net Common Tax Provision Net Common
Provision (1) Income Share Provision (1) Income Share
Results as Presented Under U.S. GAAP $ 7,748 $ 1,377 $ 6,371 $ 0.52 $ 5,495 $ 1,374 $ 4,121 $ 0.34
Less: Gain on Restricted Equity Security (1,750 ) (368 ) (1,382 ) 0 0 0
Net Losses (Gains) on Available-for-sale Debt Securities 282 59 223 (107 ) (37 ) (70 )
Earnings Information, Excluding Effect of Gain on Restricted Equity Security and Net Gains and Losses on Available-for-sale Debt Securities $ 6,280 $ 1,068 $ 5,212 $ 0.42 $ 5,388 $ 1,337 $ 4,051 $ 0.33
6 Months Ended June 30, 2018 6 Months Ended June 30, 2017
Income Diluted Income Diluted
Before Income Earnings Before Income Earnings
Income Tax Per Income Tax per
Tax Provision Net Common Tax Provision Net Common
Provision (1) Income Share Provision (1) Income Share
Results as Presented Under U.S. GAAP $ 12,864 $ 2,118 $ 10,746 $ 0.87 $ 9,913 $ 2,358 $ 7,555 $ 0.62
Less: Gain on Restricted Equity Security (1,750 ) (368 ) (1,382 ) 0 0 0
Net Losses (Gains) on Available-for-sale Debt Securities 282 59 223 (252 ) (88 ) (164 )
Earnings Information, Excluding Effect of Gain on Restricted Equity Security and Net Gains and Losses on Available-for-sale Debt Securities $ 11,396 $ 1,809 $ 9,587 $ 0.78 $ 9,661 $ 2,270 $ 7,391 $ 0.61
(1) Income tax has been allocated to the gain on restricted equity security and net losses (gains) on available-for-sale debt securities based on marginal income tax rates of 21% for 2018 and 35% for 2017.
Additional highlights related to the Corporation’s earnings results for the comparative periods are presented below.

Second Quarter 2018 as Compared to Second Quarter 2017
Net income ~~was $4,121,000~~of $6,371,000 in the second quarter ~~2017, an increase of $250,000 (6.5%)~~2018 was up $2,250,000 over the second quarter ~~2016~~2017 amount. ~~Some~~Excluding the after-tax impact of the ~~more~~gain on Visa Class B stock and net (losses) gains on available-for-sale debt securities as described above, adjusted second quarter 2018 net income of $5,212,000 exceeded adjusted second quarter 2017 net income of $4,051,000 by $1,161,000 (28.7%). The marginal federal income tax rate in effect in 2018 is 21%, down from the 2017 marginal rate of 35%. Accordingly, the effective tax rate of 17.8% for the second quarter 2018 was significantly lower than the second quarter 2017 effective tax rate of 25.0%. Pre-tax income, excluding the gain on Visa Class B stock and net (losses) gains on available-for-sale debt securities, totaled $6,280,000 in the second quarter 2018, an increase of $892,000 (16.6%) over adjusted pre-tax income of $5,388,000 in the second quarter 2017. Other significant ~~fluctuations in revenues and expenses between the three-month period ended June 30, 2017 and the corresponding period in 2016~~earnings-related variances were as follows:

· Net interest income increased ~~$363,000 (3.6%~~$893,000 (8.6%) in the second quarter ~~2017 as compared to~~2018 over the second quarter ~~2016.~~2017 amount. Total interest and dividend income increased $994,000, while interest expense increased $101,000. The net interest margin of ~~3.83%~~3.87% for the second quarter ~~2017~~2018 was 0.04% higher than the second quarter ~~2016 level of 3.76%.~~2017 level. Despite the decrease in fully taxable-equivalent yields on municipal securities and loans resulting from the reduced corporate tax rate, the average yield on earning assets increased to 4.23% in the second quarter 2018 from 4.17% in the second quarter 2017. The improvement in ~~the margin~~average yield included the impact of an increase in average yield on taxable loans, reflecting the effects of recent increases in interest rates, along with a favorable change in the mix of earning assets ~~including~~with growth in loans and a reduction in securities. Average total loans outstanding were higher by ~~$59.5~~$54.1 million ~~(8.4%~~(7.0%) in the second quarter ~~2017~~2018 as compared to the second quarter ~~2016,~~2017, while average total available-for-sale debt securities were lower by ~~$35.5~~$19.2 million. Average total deposits were ~~$11.4~~$48.6 million ~~(1.2%~~(5.0%) higher in the second quarter ~~2017~~2018 as compared to the second quarter ~~2016.~~2017. In the second quarter 2018, average brokered deposits (CDs) totaled $1,813,000, while there were no brokered deposits in the second quarter 2017. The average rate paid on interest-bearing liabilities was 0.52% in the second quarter 2018, up 0.04% as compared to the second quarter 2017. The average rate paid on deposits was up 0.14% in the second quarter 2018 as compared to the second quarter 2017, while the average cost of borrowed funds dropped to 1.75% from 2.71% as a result of the pay-off of higher-cost borrowings that matured in the latter portion of 2017.
38
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

· The ~~second quarter 2017 provision~~credit for loan losses ~~of $4,000~~(reduction in expense) was ~~$314,000 lower than~~$20,000 in the second quarter ~~2016 amount. In~~2018 as compared to a provision of $4,000 in the second quarter 2017. As noted above, the credit recognized in the second quarter 2018 included a credit of $78,000 from a net reduction in specific allowances on loans, as adjusted for net charge-offs during the period, partially offset by a provision of $58,000 attributable mainly to loan growth. In comparison, the second quarter 2017 ~~the~~ provision included $315,000 related to the change in total specific allowances on impaired loans, as adjusted for net charge-offs during the period and a $102,000 increase in the unallocated portion of the ~~allowance. Offsetting a significant portion of the provision was~~allowance, offset by a $413,000 reduction in the collectively determined portion of the allowance for loan losses. The reduction in the collectively determined allowance included the effects of a 4 basis point improvement (reduction) in the Corporation’s aggregate net charge-off experience, along with a 4 basis point reduction in the qualitative factors used to estimate the allowance as of the end of the quarter. The reductions in the qualitative factors were determined by a management committee that noted improvements in loan delinquency levels along with a reduction in the unemployment rate over the previous 12 months throughout most of the Corporation’s market area. The net increase in specific allowances in the second quarter 2017 included an increase of $205,000 in the allowance related to one real estate secured commercial loan. In comparison, the second quarter 2016 provision included a $3,000 reduction in total specific allowances on impaired loans, as adjusted for net charge-offs during the period and a $29,000 decrease in the unallocated portion of the allowance, with a $350,000 increase in the collectively determined portion of the allowance. The increase in the collectively determined portion of the allowance in the second quarter 2016 resulted from growth in outstanding loans and the use of slightly higher qualitative factors to estimate the required allowance.at June 30, 2017.
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· Noninterest ~~revenue~~income increased ~~$200,000 (5.1%~~$583,000 (14.2%) in the second quarter ~~2017~~2018 over the second quarter ~~2016~~2017 amount. ~~Trust and financial management revenue (which is recognized~~Service charges on ~~a cash basis)~~deposit accounts increased ~~$246,000, including $215,000 from a change in the frequency of billings that was implemented~~$190,000 (17.1%) in the second quarter ~~2017. Interchange revenue~~2018 over the second quarter 2017 total, mainly due to increased fees from ~~debit card transactions~~the overdraft privilege program and reflecting the benefit of operational improvements to the program that were instituted early in 2018. Other noninterest income increased $81,000 (16.6%), reflecting benefits from a consulting project in 2016 that identified opportunities for improvements in card-related volumes and processing. Loan servicing fees, net, increased $66,000, as the fair value of mortgage servicing rights decreased by $48,000$262,000 in the second quarter ~~2017 as compared to a reduction of $108,000 in the first quarter 2016. Net gains from sales of loans decreased $107,000 in the second quarter 2017~~2018 as compared to the second quarter ~~2016 due~~2017, including an increase of $154,000 in state tax credits related to ~~a lower average profit margin as well as a reduction~~donation of the real estate used at the Towanda, Pennsylvania banking location (described in ~~volume. Service charges on deposit accounts decreased $70,000 (6.0%), as revenue from consumer overdrafts declined due to lower volume.~~more detail below).

· Total noninterest ~~expenses~~expense increased ~~$541,000 (6.3%~~$608,000 (6.7%) in the second quarter ~~2017~~2018 over the second quarter ~~2016~~2017 amount. ~~Other operating~~Salaries and wages expense increased ~~$287,000,~~$221,000 (5.6%), including ~~increases~~the effects of ~~$77,000~~annual performance-based salary adjustments for a majority of employees along with an increase of $73,000 in estimated cash and stock-based compensation expense and an increase in the average number of full-time equivalent employees (FTEs) to 297 in the second quarter 2018 from 292 in the second quarter 2017. Other noninterest expense increased $122,000, including an increase in donations expense of $226,000 resulting mainly from the donation of the Towanda real estate to a nonprofit organization. In June 2018, the Corporation donated the real estate for its existing Towanda banking facility, and entered into a 12-month lease with the nonprofit organization, with a 6-month renewal option, allowing banking operations to continue until a new location in the Towanda market can be obtained and prepared for use. Also, in the second quarter 2018, the Corporation received refunds of sales and use taxes totaling $37,000, which were recorded as a reduction in other noninterest expense; in comparison, sales and use tax audit assessments totaling $65,000 were paid and recognized as other noninterest expense in the second quarter 2017. Over the last half of 2017 and early 2018, the Corporation installed a new telephone system throughout most locations and implemented a new loan ~~collection expenses, $70,000 in losses and expenses~~origination system. Costs associated with ~~other real estate and $65,000 related~~these projects contributed to ~~a sales tax audit. Pensions~~increases in professional fees, data processing and other ~~employee benefits~~noninterest expense ~~increased $142,000, including~~in the ~~effect of higher health care expenses on~~second quarter 2018 as compared to the Corporation’s partially self-insured plan. Software subscriptions increased $40,000, including costs associated with new applications as well as annual licensing increases. Automated teller machine and interchange expense increased $38,000, including costs associated with issuing new debit cards with EMV functionality. FDIC assessments expense decreased $59,000, reflecting a lower assessment level.second quarter 2017.

~~Net~~Six Months Ended June 30, 2018 as Compared to Six Months Ended June 30, 2017
For the six months ended June 30, 2018, net income of $10,746,000 exceeded the corresponding amount for the first six months of 2017 by $3,191,000. Excluding the after-tax impact of the gain on Visa Class B stock and net (losses) gains on available-for-sale debt securities as described above, adjusted year-to-date 2018 net income of $9,587,000 exceeded adjusted net income for the first six months of 2017 of $7,391,000 by $2,196,000 (29.7%). As a result of the lower marginal federal income tax rate in effect in 2018, the effective tax rate was ~~$7,555,000, an increase of 1.5% over net income~~16.5% for the first six months of ~~2016~~2018, down from 23.8% for the first six months of ~~$7,444,000. Some~~2017. Pre-tax income, excluding the gain on Visa Class B stock and net (losses) gains on available-for-sale debt securities, totaled $11,396,000 for the first six months of 2018, an increase of $1,735,000 (18.0%) over adjusted pre-tax income of $9,661,000 for the ~~more~~first six months of 2017. Other significant ~~fluctuations in revenues and expenses between the six-month period ended June 30, 2017 and the corresponding period in 2016~~earnings-related variances were as follows:

· Net interest income was ~~$489,000 (2.4%~~up $1,631,000 (8.0%) for the first six months of 2018 over the amount for the first six months of 2017. Trends for the first six months of 2018 as compared to the first six months of 2017 were similar to those described in the comparison of quarterly results above. The net interest margin was 3.86% for the first six months of 2018, up from 3.81% for the first six months of 2017. The average yield on earning assets was 4.21% in the first six months of 2018, up from 4.14% in the first six months of 2017, reflecting an increase in average yield on loans of 0.10% and a favorable change in the mix of earning assets with growth in loans and a reduction in securities. Average total loans outstanding were higher by $55.8 million (7.3%) for the first six months of 2018 as compared to the first six months of 2017, while average total available-for-sale debt securities were lower by $27.0 million. Average total deposits were $39.5 million (4.0%) higher for the first six months of ~~2017~~2018 as compared to 2017. In the first six months of ~~2016. The net interest margin was 3.81% for the first six months of 2017, up from 3.79% for the first six months of 2016. Average total loans outstanding~~2018, average brokered deposits (CDs) totaled $912,000, while there were ~~up $58.6 million (8.3%)~~no brokered deposits in the first six months of ~~2017 as compared to the first six months of 2016, while~~2017. The average ~~total available-for-sale securities were lower by $29.0 million. Average total deposits were $17.0 million (1.8%) higher~~rate paid on interest-bearing liabilities was 0.51% in the first six months of ~~2017~~2018, up 0.03% as compared to 2017. The average rate paid on deposits was up 0.12% in the first six months of ~~2016.~~2018 as compared to 2017, while the average cost of borrowed funds dropped to 1.69% from 2.42% as a result of the pay-off of higher-cost borrowings that matured in the latter portion of 2017.
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

· The provision for loan losses ~~of $456,000~~was $272,000 for the first six months of ~~2017 was $230,000 lower than~~2018 as compared to $456,000 in 2017. The provision in 2018 included $113,000 from a net increase in specific allowances on loans, as adjusted for net charge-offs during the ~~amount for~~period, and $159,000 attributable mainly to loan growth. In comparison, the ~~first six months of 2016. In~~provision in 2017 ~~the provision~~ included $703,000 related to the change in total specific allowances on
· impaired loans, as adjusted for net charge-offs during the period and a $102,000 increase in the unallocated portion of the allowance, with a reduction in the provision of $349,000 related to ~~the~~a reduction in the collectively determined allowance for loan losses. As described in more detail above, the reduction in the collectively determined allowance included the effects of an improvement in the Corporation’s aggregate net charge-off experience and a reduction in the qualitative factors used to estimate the allowance as of June 30, 2017. The net increase in specific allowances in the first six months of 2017 included an increase in the allowance related to one real estate secured commercial loan of $430,000 to $958,000 at June 30, 2017 as compared to $528,000 at December 31, 2016. The increase in the specific allowance for this loan was based on an updated appraisal. In comparison, the provision for the first six months of 2016 included $79,000 related to the change in total specific allowances on impaired loans, as adjusted for net charge-offs during the period, a $29,000 decrease in the unallocated portion of the allowance and an increase in the provision of $636,000 related to an increase in the collectively determined allowance for loan losses. The increase in the collectively determined portion of the allowance at June 30, 2016 as compared to the end of the preceding year resulted from loan growth and slight increases in the net charge-off and qualitative factors used to estimate the allowance.

· Noninterest ~~revenue~~income, excluding the gain on Visa Class B stock and net (losses) gains on available-for-sale debt securities, increased ~~$374,000 (4.9%~~$1,125,000 (14.1%) infor the first six months of ~~2017 as compared to~~2018 over the amount for the first six months of ~~2016.~~2017. Service charges on deposit accounts increased $293,000 (13.2%), mainly due to increased fees from the overdraft privilege program and reflecting the benefit of operational improvements to the program that were instituted early in 2018. Trust and financial management revenue increased ~~$282,000,~~$271,000 (10.1%), reflecting growth in assets under management resulting from market appreciation and new business. Other noninterest income increased $254,000, including an increase in tax credits of $131,000 resulting from the ~~effects of changing~~state tax credit related to the ~~frequency of billings as noted~~real estate donation described above. Interchange revenue from debit card transactions and brokerage revenue also increased ~~$138,000 (14.5%),~~by significant amounts, reflecting ~~improvements~~increases in card-related volumes and processing. Loan servicing fees, net, increased $116,000, as the fair value of mortgage servicing rights decreased by $78,000 in the first six months of 2017 as compared to a reduction of $179,000 in the first six months of 2016. Service charges on deposit accounts decreased $124,000 (5.4%), as revenue from consumer overdrafts declined due to lower volume. Net gains from sales of loans were $109,000 lower for the first six months of 2017 as compared to 2016, due to a lower average profit margin as well as a reduction in sales volume.
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· Total noninterest ~~expenses~~expense increased ~~$767,000 (4.4%~~$1,205,000 (6.6%) for the first six months of ~~2017 as compared to~~2018 over the amount for the first six months of ~~2016. Other operating~~2017. Salaries and wages expense increased ~~$456,000. Within other operating~~$477,000 (6.1%), including the effects of annual performance-based salary adjustments for a majority of employees along with an increase of $159,000 in estimated cash and stock-based compensation expense and an increase in the ~~largest variances included increases~~average number of ~~$169,000~~full-time equivalent employees (FTEs) to 295 in ~~loan collection expenses, $70,000~~2018 from 290 in ~~losses and expenses associated with other real estate and $65,000 related to a sales tax audit.~~2017. Pensions and other employee benefits expense increased ~~$235,000, primarily as a result~~$149,000 (5.6%), consistent with the increase in salaries and wages and including an increase of ~~higher~~$113,000 (12.5%) in health ~~care expenses~~insurance expense from the Corporation’s partially self-insured plan. ~~Automated teller machine and interchange expense increased $83,000, including costs associated with issuing new debit cards with EMV functionality. Software subscriptions increased $79,000, including~~As noted above, costs associated with new ~~applications as well as annual licensing increases. FDIC assessments~~telephone and loan origination systems contributed to increases in professional fees, data processing and other noninterest expense ~~decreased $107,000, reflecting a lower assessment level. Professional fees expense decreased $90,000, reflecting a reduction~~ in ~~information technology and sales and service-related consulting expense.~~2018.

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

TABLE I - QUARTERLY FINANCIAL DATA
(In Thousands, Except Per Share Data) (Unaudited) For the Three Months Ended:
June 30, Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31,
Table I – QUARTERLY FINANCIAL DATA
(Dollars In Thousands, Except Per Share Data) For the Three Months Ended:
(Unaudited) June 30, March 31, Dec. 31, Sept. 30, June 30, March 31,
2017 2017 2016 2016 2016 2016 2018 2018 2017 2017 2017 2017
Interest income $ 11,340 $ 11,112 $ 11,106 $ 11,131 $ 10,924 $ 10,937 $ 12,334 $ 11,890 $ 11,785 $ 11,626 $ 11,340 $ 11,112
Interest expense 978 953 920 944 925 904 1,079 993 999 985 978 953
Net interest income 10,362 10,159 10,186 10,187 9,999 10,033 11,255 10,897 10,786 10,641 10,362 10,159
Provision (credit) for loan losses 4 452 (3 ) 538 318 368
Net interest income after provision (credit) for loan losses 10,358 9,707 10,189 9,649 9,681 9,665
Other income 4,106 3,864 4,031 3,884 3,906 3,690
Net gains on available-for-sale securities 107 145 69 584 122 383
Other expenses 9,076 9,298 8,558 8,579 8,535 9,072
(Credit) provision for loan losses (20 ) 292 23 322 4 452
Net interest income after (credit) provision for loan losses 11,275 10,605 10,763 10,319 10,358 9,707
Noninterest income 4,689 4,406 4,117 4,066 4,106 3,864
Net gains on securities 1,468 0 0 5 107 145
Noninterest expense 9,684 9,895 9,401 9,192 9,076 9,298
Income before income tax provision 5,495 4,418 5,731 5,538 5,174 4,666 7,748 5,116 5,479 5,198 5,495 4,418
Income tax provision 1,374 984 1,500 1,451 1,303 1,093 1,377 741 3,536 1,262 1,374 984
Net income $ 4,121 $ 3,434 $ 4,231 $ 4,087 $ 3,871 $ 3,573 $ 6,371 $ 4,375 $ 1,943 $ 3,936 $ 4,121 $ 3,434
Net income attributable to common shares $ 4,100 $ 3,416 $ 4,209 $ 4,065 $ 3,850 $ 3,553 $ 6,339 $ 4,352 $ 1,933 $ 3,916 $ 4,100 $ 3,416
Basic earnings per common share $ 0.34 $ 0.28 $ 0.35 $ 0.34 $ 0.32 $ 0.29 $ 0.52 $ 0.36 $ 0.16 $ 0.32 $ 0.34 $ 0.28
Diluted earnings per common share $ 0.34 $ 0.28 $ 0.35 $ 0.34 $ 0.32 $ 0.29 $ 0.52 $ 0.36 $ 0.16 $ 0.32 $ 0.34 $ 0.28
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

CRITICAL ACCOUNTING POLICIES

The presentation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect many of the reported amounts and disclosures. Actual results could differ from these estimates.

A material estimate that is particularly susceptible to significant change is the determination of the allowance for loan losses. Management believes the allowance for loan losses is adequate and reasonable. Analytical information related to the Corporation’s aggregate loans and the related allowance for loan losses is summarized by loan segment and classes of loans in Note 7 to the unaudited consolidated financial statements. Additional discussion of the Corporation’s allowance for loan losses is provided in a separate section later in Management’s Discussion and Analysis. Given the very subjective nature of identifying and valuing loan losses, it is likely that well-informed individuals could make materially different assumptions, and could, therefore calculate a materially different allowance value. While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.

Another material estimate is the calculation of fair values of the Corporation’s debt securities. For most of the Corporation’s debt securities, the Corporation receives estimated fair values of debt securities from an independent valuation service, or from brokers. In developing fair values, the valuation service and the brokers use estimates of cash flows, based on historical performance of similar instruments in similar interest rate environments. Based on experience, management is aware that estimated fair values of debt securities tend to vary among brokers and other valuation services.

41
As described in Note 6 to the unaudited consolidated financial statements, management evaluates securities for other-than-temporary impairment (OTTI). In making that evaluation, consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether the Corporation intends to sell the security or more likely than not will be required to sell the security before its anticipated recovery. Management’s assessments of the likelihood and potential for recovery in value of securities are subjective and based on sensitive assumptions.

NET INTEREST INCOME

The Corporation’s primary source of operating income is net interest income, which is equal to the difference between the amounts of interest income and interest expense. Tables II, III and IV include information regarding the Corporation’s net interest income for the three-month and six-month periods ended June 30, ~~2017~~2018 and ~~June 30, 2016.~~2017. In each of these tables, the amounts of interest income earned on tax-exempt securities and loans have been adjusted to a fully taxable-equivalent basis. Accordingly, the net interest income amounts reflected in these tables exceed the amounts presented in the consolidated financial statements. The discussion that follows is based on amounts in the related Tables.

Six-Month Periods Ended June 30, ~~2017~~2018 and ~~2016~~2017

For the six-month periods, fully taxable equivalent net interest income was ~~$21,903,000~~$22,812,000 in ~~2017, $475,000 (2.2%~~2018, $909,000 (4.2%) higher than in ~~2016.~~2017. Interest income was ~~$577,000~~$1,050,000 higher in ~~2017~~2018 as compared to ~~2016;~~2017, while interest expense was ~~also~~ higher by ~~$102,000~~$141,000 in comparing the same periods. As presented in Table III, the Net Interest Margin was ~~3.81%~~3.86% in ~~2017~~2018 as compared to ~~3.79%~~3.81% in ~~2016,~~2017, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) was 3.70% in 2018, up from 3.66% in ~~each of the six-month periods ended June 30, 2017 and 2016.~~2017.

INTEREST INCOME AND EARNING ASSETS

Interest income totaled ~~$23,834,000~~$24,884,000 in ~~2017,~~2018, an increase of ~~2.5%~~4.4% from ~~2016.~~2017. Interest and fees on loans receivable increased ~~$1,000,000,~~$1,747,000, or ~~5.7%.~~9.5%, to $20,182,000 in 2018 from $18,435,000 in 2017. Table IV shows the increase in interest on loans includes $1,332,000 attributable to an increase in volume and $415,000 related to an increase in average rate. The average balance of ~~gross~~ loans receivable increased ~~$58,649,000, or 8.3%,~~$55,817,000 (7.3%) to $821,225,000 in 2018 from $765,408,000 in ~~2017 from $706,759,000~~2017. The increase in ~~2016. The Corporation experienced~~average balance reflects the Corporation’s significant growth in both commercial and residential mortgage loans ~~outstanding.~~in 2017. The ~~Corporation’s~~ average rate on taxable loans in 2018 was 5.09% compared to 4.89% in 2017 as current rates on variable rate loans and rates on recent new loan originations have increased, consistent with increases in market interest rates. The yield on tax-exempt loans receivable ~~declined~~decreased to ~~4.86%~~3.69% in ~~2017 from 4.96%~~2018 compared to 4.51% in ~~2016 as average interest rates~~2017. This decrease reflects the reduced tax benefit on new loans have been lower than the average rates on loans that have been fully or partially paid off. More recently, interest rates on floating-rate loans such as commercial and home equity lines of credit have increased, which has caused the overall yield on loans receivable to increase slightly, to 4.87% in the second quarter 2017tax-exempt assets as compared to ~~4.84%~~taxable assets resulting from the marginal tax rate being reduced to 21% in ~~the first quarter~~2018 from 35% in 2017.

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
Interest income on available-for-sale debt securities totaled $4,539,000 in 2018, a reduction of $767,000 from the total for 2017. As indicated in Table III, average available-for-sale debt securities (at amortized cost) totaled ~~$379,789,000~~$351,807,000 in ~~2017,~~2018, a decrease of ~~$28,984,000~~$26,982,000 (7.1%) from ~~2016.~~2017. Proceeds from maturities and calls of securities have been used to help fund loan growth and decrease borrowings over the course of 2017 and first six months of 2018. The ~~net decrease~~average yield on available-for-sale debt securities decreased to 2.60% in 2018 from 2.82% in 2017. The reduction in yield on available-for-sale debt securities includes the impact of a reduced tax benefit on tax-exempt municipal bonds as a result of the reduction in the Corporation’s available-for-sale securities portfolio consisted of decreases in all categories of securities with the exception of commercial mortgage-backed securities. The Corporation’s yield on securities was 2.83% in 2017, which was comparable to 2.82% in 2016.federal income tax rate.

INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES

Interest expense increased ~~$102,000,~~$141,000, or ~~5.6%~~7.3%, to $2,072,000 in 2018 from $1,931,000 in ~~2017 from $1,829,000 in 2016.~~2017. Table III shows that the overall cost of funds on interest-bearing liabilities increased to 0.51% in 2018 from 0.48% in ~~2017 from 0.45% in 2016.~~2017.

Total average ~~deposits~~deposit balances (interest-bearing and noninterest-bearing) increased ~~1.8%~~4.1%, to $1,013,113,000 in 2018 from $973,640,000 in ~~2017 from $956,602,000 in 2016.~~2017. Increases in the average balances of demand deposits, ~~savings and~~certificates of deposit, interest checking ~~accounts~~and savings were partially offset by ~~decreases~~reductions in money market and Individual Retirement ~~Accounts, money market accounts and~~Accounts.
Interest expense on deposits increased $512,000 in 2018 over 2017. The average rate on interest-bearing deposits increased to 0.42% in 2018 from 0.30% in 2017. Interest expense on certificates of ~~deposit.~~deposit increased $232,000 in 2018 of which $167,000 is from an increase in average rate and $65,000 due to an increase in volume. Interest expense on interest checking accounts increased $211,000 in 2018 to $394,000 from $183,000 in 2017. This increase is primarily due to an increase in the average rate paid on qualifying accounts.

Interest expense on borrowed funds decreased $371,000 in 2018 as compared to 2017, including a reduction in interest expense on long-term borrowings partially offset by an increase in interest expense on short-term borrowings. Total average borrowed funds ~~increased $1,485,000~~decreased $14,109,000 to $55,517,000 in 2018 from $69,626,000 in ~~2017 from $68,141,000 in 2016.~~2017. The average rate on total borrowed funds was 1.69% in 2018 compared to 2.42% in 2017.
Interest expense on short-term borrowings in 2018 exceeded interest expense in the same period of 2017 by $159,000 as result of a series of advances from FHLB-Pittsburgh that mature in monthly amounts of $3,000,000 through October 2018, as well as an increase in short-term interest rates. These short-term advances were originated in the third and fourth quarters of 2017 to pay off a portion of a total of $37,000,000 in long-term borrowings that matured during that time period. Average short-term borrowings totaled $37,878,000 for the first six months of 2018, an increase of $6,638,000 over 2017. The weighted-average rate on short-term borrowings was 1.50% in 2018 as compared to ~~2.44%~~0.79% in ~~2016.~~2017.
Interest expense on long-term debt decreased $530,000 in 2018 as compared to 2017, mainly from repayment of the $37 million in higher-cost borrowings (weighted-average rate of 3.65%) in the third and fourth quarters of 2017 as referred to above. Borrowings are classified as long-term within the Tables based on their term at origination. The average balance of long-term borrowings in 2018 of $17,639,000 consisted mainly of FHLB advances maturing in early to mid-2019, and had a weighted-average rate of 2.09%. In comparison, average long-term borrowings in the same period of 2017 totaled $38,386,000, with an average rate of 3.75%.

Three-Month Periods Ended June 30, ~~2017~~2018 and ~~2016~~2017

For the three-month periods, fully taxable equivalent net interest income was ~~$11,062,000~~$11,586,000 in ~~2017,~~2018, which was ~~$378,000 (3.5%~~$524,000 (4.7%) higher than in ~~2016.~~2017. Interest income was ~~$431,000~~$625,000 higher in ~~2017~~2018 as compared to ~~2016,~~2017, while interest expense was higher by ~~$53,000~~$101,000 in comparing the same periods. As presented in Table III, the Net Interest Margin was ~~3.83%~~3.87% in ~~2017~~2018 as compared to ~~3.76%~~3.83% in ~~2016,~~2017, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) was ~~3.69%~~3.71% in ~~2017~~2018 as compared to ~~3.63%~~3.69% in ~~2016.~~2017.
42

Interest income totaled ~~$12,040,000~~$12,665,000 in ~~2017,~~2018, an increase of ~~$431,000 (3.7%~~$625,000 (5.2%) from ~~2016.~~2017. Interest and fees from loans receivable increased ~~$597,000,~~$908,000, or ~~6.8%~~9.7%, in ~~2017~~2018 as compared to ~~2016,~~2017, while income from available-for-sale securities decreased ~~$169,000 (6.1%~~$337,000 (12.9%). As indicated in Table III, for the three-month periods, the average balance of gross loans receivable increased ~~8.4%~~7.0% to $825,505,000 in 2018 from $771,372,000 in ~~2017 from $711,882,000 in 2016.~~2017. The average rate of return on loans was 5.00% in 2018, up from 4.87% in ~~2017, down from 4.96% in 2016.~~2017. Total average available-for-sale securities (at amortized cost) in ~~2017~~2018 decreased to ~~$370,799,000~~$350,610,000 from ~~$406,260,000~~$369,799,000 in ~~2016.~~2017. The average rate of return on available-for-sale securities was ~~2.83%~~2.61% for ~~2017, up~~2018, down from ~~2.76%~~2.84% in ~~2016.~~2017. The reduction in average rate of return on available-for-sale securities is a result of a reduced tax benefit on tax exempt municipal bonds due to the marginal tax rate decreasing to 21% in 2018 from 35% in 2017.
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

For the three-month periods, interest expense increased ~~$53,000,~~$101,000, or ~~5.7%~~10.3%, to $1,079,000 in 2018 from $978,000 in ~~2017 from $925,000 in 2016. All of this increase was in interest paid~~2017. Interest expense on deposits increased $304,000, as the average rate paid on deposits increased ~~0.02%,~~to 0.45% in 2018 from 0.31% in 2017, including increases of ~~0.07%~~0.33% on certificates of deposit and ~~0.06%~~0.18% on interest checking. ~~As presented in Table III, the overall cost of funds on interest-bearing liabilities increased to 0.48% in 2017 from 0.46% in 2016.~~ Total average deposits (interest-bearing and noninterest-bearing) amounted to ~~$979,986,000~~$1,028,539,000 in the second quarter ~~2017,~~of 2018, an increase of ~~$11,381,000 (1.2%~~$48,553,000 (5.0%) ~~from~~over the second quarter ~~2016~~2017 total. The increase in total average deposits included an increase in interest bearing deposits of $27,859,000 and an increase in noninterest-bearing demand deposits of $20,694,000.

Interest expense on total borrowed funds ~~was unchanged from 2016~~decreased $203,000 in 2018 as compared to 2017. Interest expense on short-term borrowings increased ~~$4,000~~$37,000 while interest expense on long-term borrowings decreased by ~~the same amount from 2016~~$240,000 in 2018 as compared to 2017. The average balance of total borrowed funds decreased to $45,784,000 in the second quarter 2018 from $59,558,000 in the second quarter 2017, ~~from $61,874,000 in the second quarter 2016,~~ while the average rate on borrowed funds ~~increased~~decreased to 1.75% in the second quarter 2018 from 2.71% in the second quarter ~~2017 from 2.62% in the second quarter 2016.~~2017.

~~The average balance of~~Interest expense on short-term borrowings ~~decreased~~increased $37,000 to ~~$21,205,000~~$82,000 in 2018 from $45,000 in 2017. The increase in interest expense on short-term borrowings reflects the ~~second quarter~~impact of higher short-term interest rates in 2018 as compared to 2017 ~~from $23,225,000 in 2016, and~~as the average rate on short-term borrowings increased to 1.39% in 2018 from 0.85% in ~~2017 from 0.71% in 2016.~~2017. The ~~increase in~~ average ~~rate on~~balance of short-term borrowings ~~reflects increases in overnight borrowing rates, consistent with increases~~increased to $23,610,000 in the ~~Fed Funds rate totaling 0.75% rate over~~second quarter 2018 from $21,205,000 in the ~~past several months, including separate 0.25% Fed Funds increases in December 2016, March 2017 and June~~second quarter 2017.

The average balance of long-term borrowings was ~~$38,353,000~~$22,174,000 in the second quarter ~~2017,~~2018, at an average rate of ~~3.74%~~2.13%, down ~~slightly~~ from an average balance of ~~$38,649,000~~$38,353,000 at an average rate of ~~3.77%~~3.74% in the second quarter ~~2016. Borrowings are classified as~~2017. As described above, the reduction in average balance and rate on long-term ~~within~~borrowings reflects the ~~Tables based on their term at origination; however, within this category,~~repayment of higher cost borrowings totaling $37,000,000 in the third and fourth quarters of 2017, with ~~a total balance~~long-term borrowings in 2018 consisting mainly of ~~$37,000,000 at June 30, 2017 mature within the year ending December 31, 2017. The two largest borrowings within the long-term category that mature~~FHLB advances maturing in 2017 include a $10 million advance from FHLB-Pittsburgh with a 3.81% interest rate that matures in September and a $27 million repurchase agreement with a rate of 3.595% and an effective maturity in December 2017.early to mid-2019.

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

TABLE II - ANALYSIS OF INTEREST INCOME AND EXPENSE

Three Months Ended Six Months Ended Three Months Ended Six Months Ended
June 30, Increase/ June 30, Increase/ June 30, Increase/ June 30, Increase/
(In Thousands) 2017 2016 (Decrease) 2017 2016 (Decrease) 2018 2017 (Decrease) 2018 2017 (Decrease)

INTEREST INCOME
Available-for-sale securities:
Available-for-sale debt securities:
Taxable $ 1,357 $ 1,495 $ (138 ) $ 2,765 $ 3,084 $ (319 ) $ 1,381 $ 1,352 $ 29 $ 2,744 $ 2,755 ($ 11 )
Tax-exempt 1,263 1,294 (31 ) 2,551 2,664 (113 ) 897 1,263 (366 ) 1,795 2,551 (756 )
Total available-for-sale securities 2,620 2,789 (169 ) 5,316 5,748 (432 )
Total available-for-sale debt securities 2,278 2,615 (337 ) 4,539 5,306 (767 )
Dividends on marketable equity security 6 5 1 11 10 1
Interest-bearing due from banks 41 36 5 73 60 13 96 41 55 146 73 73
Loans held for sale 6 8 (2 ) 10 14 (4 ) 4 6 (2 ) 6 10 (4 )
Loans receivable:
Taxable 8,609 8,086 523 16,983 16,060 923 9,575 8,609 966 18,776 16,983 1,793
Tax-exempt 764 690 74 1,452 1,375 77 706 764 (58 ) 1,406 1,452 (46 )
Total loans receivable 9,373 8,776 597 18,435 17,435 1,000 10,281 9,373 908 20,182 18,435 1,747
Total Interest Income 12,040 11,609 431 23,834 23,257 577 12,665 12,040 625 24,884 23,834 1,050

INTEREST EXPENSE
Interest-bearing deposits:
Interest checking 106 74 32 183 132 51 213 106 107 394 183 211
Money market 89 86 3 170 165 5 122 89 33 215 170 45
Savings 36 33 3 70 65 5 38 36 2 75 70 5
Certificates of deposit 238 220 18 462 422 40 389 238 151 694 462 232
Individual Retirement Accounts 106 109 (3 ) 211 217 (6 ) 117 106 11 230 211 19
Other time deposits 0 0 0 0 0 0
Total interest-bearing deposits 575 522 53 1,096 1,001 95 879 575 304 1,608 1,096 512
Borrowed funds:
Short-term 45 41 4 122 103 19 82 45 37 281 122 159
Long-term 358 362 (4 ) 713 725 (12 ) 118 358 (240 ) 183 713 (530 )
Total borrowed funds 403 403 0 835 828 7 200 403 (203 ) 464 835 (371 )
Total Interest Expense 978 925 53 1,931 1,829 102 1,079 978 101 2,072 1,931 141

Net Interest Income $ 11,062 $ 10,684 $ 378 $ 21,903 $ 21,428 $ 475 $ 11,586 $ 11,062 $ 524 $ 22,812 $ 21,903 $ 909

Note: Interest income from tax-exempt securities and loans has been adjusted to a fully tax-equivalent basis, using the Corporation’s marginal federal income tax rate of 21% for 2018 and 35%. for 2017.

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

TABLE III - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES
(Dollars in Thousands)
3 Months 3 Months 6 Months 6 Months 3 Months 3 Months 6 Months 6 Months
Ended Rate of Ended Rate of Ended Rate of Ended Rate of Ended Rate of Ended Rate of Ended Rate of Ended Rate of
6/30/2017 Return/ 6/30/2016 Return/ 6/30/2017 Return/ 6/30/2016 Return/ 6/30/2018 Return/ 6/30/2017 Return/ 6/30/2018 Return/ 6/30/2017 Return/
Average Cost of Average Cost of Average Cost of Average Cost of Average Cost of Average Cost of Average Cost of Average Cost of
Balance Funds % Balance Funds % Balance Funds % Balance Funds % Balance Funds % Balance Funds % Balance Funds % Balance Funds %
EARNING ASSETS
Available-for-sale securities,
at amortized cost:
Available-for-sale debt securities, at amortized cost:
Taxable $ 255,806 2.13 % $ 297,608 2.02 % $ 263,486 2.12 % $ 301,744 2.06 % $ 247,809 2.24 % $ 254,806 2.13 % $ 248,819 2.22 % $ 262,486 2.12 %
Tax-exempt 114,993 4.41 % 108,652 4.79 % 116,303 4.42 % 107,029 5.01 % 102,801 3.50 % 114,993 4.41 % 102,988 3.51 % 116,303 4.42 %
Total available-for-sale securities 370,799 2.83 % 406,260 2.76 % 379,789 2.82 % 408,773 2.83 %
Total available-for-sale debt securities 350,610 2.61 % 369,799 2.84 % 351,807 2.60 % 378,789 2.82 %
Marketable equity security 952 2.53 % 1,000 2.01 % 957 2.32 % 1,000 2.02 %
Interest-bearing due from banks 14,873 1.11 % 24,250 0.60 % 14,898 0.99 % 22,299 0.54 % 22,286 1.73 % 14,873 1.11 % 18,231 1.61 % 14,898 0.99 %
Loans held for sale 499 4.82 % 540 5.96 % 351 5.75 % 496 5.68 % 267 6.01 % 499 4.82 % 218 5.55 % 351 5.75 %
Loans receivable:
Taxable 702,933 4.91 % 650,213 5.00 % 700,501 4.89 % 645,586 5.00 % 747,889 5.14 % 702,933 4.91 % 744,292 5.09 % 700,501 4.89 %
Tax-exempt 68,439 4.48 % 61,669 4.50 % 64,907 4.51 % 61,173 4.52 % 77,616 3.65 % 68,439 4.48 % 76,933 3.69 % 64,907 4.51 %
Total loans receivable 771,372 4.87 % 711,882 4.96 % 765,408 4.86 % 706,759 4.96 % 825,505 5.00 % 771,372 4.87 % 821,225 4.96 % 765,408 4.86 %
Total Earning Assets 1,157,543 4.17 % 1,142,932 4.09 % 1,160,446 4.14 % 1,138,327 4.11 % 1,199,620 4.23 % 1,157,543 4.17 % 1,192,438 4.21 % 1,160,446 4.14 %
Cash 17,276 16,522 16,648 16,055 18,010 17,276 17,445 16,648
Unrealized gain/loss on securities 689 7,737 (130 ) 7,396 (8,242 ) 689 (6,893 ) (130 )
Allowance for loan losses (8,901 ) (7,756 ) (8,748 ) (7,844 ) (9,161 ) (8,901 ) (9,082 ) (8,748 )
Bank premises and equipment 15,714 15,390 15,713 15,424 15,425 15,714 15,438 15,713
Intangible Assets 11,957 11,967 11,958 11,969 11,952 11,957 11,953 11,958
Other assets 41,322 38,938 42,594 38,734 41,575 41,322 42,174 42,594
Total Assets $ 1,235,600 $ 1,225,730 $ 1,238,481 $ 1,220,061 $ 1,269,179 $ 1,235,600 $ 1,263,473 $ 1,238,481

INTEREST-BEARING LIABILITIES
Interest-bearing deposits:
Interest checking $ 203,256 0.21 % $ 196,918 0.15 % $ 202,194 0.18 % $ 196,030 0.14 % $ 217,607 0.39 % $ 203,256 0.21 % $ 215,307 0.37 % $ 202,194 0.18 %
Money market 190,703 0.19 % 200,896 0.17 % 190,902 0.18 % 196,205 0.17 % 180,667 0.27 % 190,703 0.19 % 180,297 0.24 % 190,902 0.18 %
Savings 142,978 0.10 % 132,353 0.10 % 140,903 0.10 % 131,178 0.10 % 152,663 0.10 % 142,978 0.10 % 151,149 0.10 % 140,903 0.10 %
Certificates of deposit 116,450 0.82 % 117,825 0.75 % 115,051 0.81 % 115,618 0.73 % 135,429 1.15 % 116,450 0.82 % 129,733 1.08 % 115,051 0.81 %
Individual Retirement Accounts 98,004 0.43 % 104,030 0.42 % 98,513 0.43 % 104,796 0.42 % 92,899 0.51 % 98,004 0.43 % 93,601 0.50 % 98,513 0.43 %
Other time deposits 1,107 0.00 % 1,140 0.00 % 950 0.00 % 972 0.00 % 1,092 0.00 % 1,107 0.00 % 933 0.00 % 950 0.00 %
Total interest-bearing deposits 752,498 0.31 % 753,162 0.28 % 748,513 0.30 % 744,799 0.27 % 780,357 0.45 % 752,498 0.31 % 771,020 0.42 % 748,513 0.30 %
Borrowed funds:
Short-term 21,205 0.85 % 23,225 0.71 % 31,240 0.79 % 29,454 0.70 % 23,610 1.39 % 21,205 0.85 % 37,878 1.50 % 31,240 0.79 %
Long-term 38,353 3.74 % 38,649 3.77 % 38,386 3.75 % 38,687 3.77 % 22,174 2.13 % 38,353 3.74 % 17,639 2.09 % 38,386 3.75 %
Total borrowed funds 59,558 2.71 % 61,874 2.62 % 69,626 2.42 % 68,141 2.44 % 45,784 1.75 % 59,558 2.71 % 55,517 1.69 % 69,626 2.42 %
Total Interest-bearing Liabilities 812,056 0.48 % 815,036 0.46 % 818,139 0.48 % 812,940 0.45 % 826,141 0.52 % 812,056 0.48 % 826,537 0.51 % 818,139 0.48 %
Demand deposits 227,488 215,443 225,127 211,803 248,182 227,488 242,093 225,127
Other liabilities 7,573 8,304 7,866 7,841 8,848 7,573 8,859 7,866
Total Liabilities 1,047,117 1,038,783 1,051,132 1,032,584 1,083,171 1,047,117 1,077,489 1,051,132
Stockholders’ equity, excluding other comprehensive income/loss 187,882 181,882 187,289 182,629
Stockholders' equity, excluding other comprehensive income/loss 192,375 187,882 191,258 187,289
Accumulated other comprehensive income/loss 601 5,065 60 4,848 (6,367 ) 601 (5,274 ) 60
Total Stockholders’ Equity 188,483 186,947 187,349 187,477
Total Liabilities and Stockholders’ Equity $ 1,235,600 $ 1,225,730 $ 1,238,481 $ 1,220,061
Total Stockholders' Equity 186,008 188,483 185,984 187,349
Total Liabilities and Stockholders' Equity $ 1,269,179 $ 1,235,600 $ 1,263,473 $ 1,238,481
Interest Rate Spread 3.69 % 3.63 % 3.66 % 3.66 % 3.71 % 3.69 % 3.70 % 3.66 %
Net Interest Income/Earning Assets 3.83 % 3.76 % 3.81 % 3.79 % 3.87 % 3.83 % 3.86 % 3.81 %

Total Deposits (Interest-bearing and Demand) $ 979,986 $ 968,605 $ 973,640 $ 956,602 $ 1,028,539 $ 979,986 $ 1,013,113 $ 973,640

(1) Annualized rates of return on tax-exempt securities and loans are presented on a fully taxable-equivalent basis, using the Corporation’s marginal federal income tax rate of 21% in 2018 and 35% in 2017.
(2) Nonaccrual loans have been included with loans for the purpose of analyzing net interest earnings.
(3) Rates of return on earning assets and costs of funds are presented on an annualized basis.

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

TABLE IV - ANALYSIS OF VOLUME AND RATE CHANGES

(In Thousands) 3 Months Ended 6/30/17 vs. 6/30/16 6 Months Ended 6/30/17 vs. 6/30/16 3 Months Ended 6/30/18 vs. 6/30/17 6 Months Ended 6/30/18 vs. 6/30/17
Change in Change in Total Change in Change in Total Change in Change in Total Change in Change in Total
Volume Rate Change Volume Rate Change Volume Rate Change Volume Rate Change
EARNING ASSETS
Available-for-sale securities:
Available-for-sale debt securities:
Taxable $ (214 ) $ 76 $ (138 ) $ (406 ) $ 87 $ (319 ) $ (38 ) $ 67 $ 29 $ (147 ) $ 136 $ (11 )
Tax-exempt 73 (104 ) (31 ) 215 (328 ) (113 ) (125 ) (241 ) (366 ) (271 ) (485 ) (756 )
Total available-for-sale securities (141 ) (28 ) (169 ) (191 ) (241 ) (432 )
Total available-for-sale debt securities (163 ) (174 ) (337 ) (418 ) (349 ) (767 )
Marketable equity security 0 1 1 0 1 1
Interest-bearing due from banks (18 ) 23 5 (25 ) 38 13 21 34 55 19 54 73
Loans held for sale 0 (2 ) (2 ) (4 ) 0 (4 ) (3 ) 1 (2 ) (4 ) 0 (4 )
Loans receivable:
Taxable 664 (141 ) 523 1,303 (380 ) 923 566 400 966 1,088 705 1,793
Tax-exempt 77 (3 ) 74 80 (3 ) 77 94 (152 ) (58 ) 244 (290 ) (46 )
Total loans receivable 741 (144 ) 597 1,383 (383 ) 1,000 660 248 908 1,332 415 1,747
Total Interest Income 582 (151 ) 431 1,163 (586 ) 577 515 110 625 929 121 1,050

INTEREST-BEARING LIABILITIES
Interest-bearing deposits:
Interest checking 2 30 32 4 47 51 8 99 107 13 198 211
Money market (4 ) 7 3 (4 ) 9 5 (5 ) 38 33 (10 ) 55 45
Savings 3 0 3 5 0 5 2 0 2 5 0 5
Certificates of deposit (2 ) 20 18 (2 ) 42 40 44 107 151 65 167 232
Individual Retirement Accounts (6 ) 3 (3 ) (14 ) 8 (6 ) (6 ) 17 11 (11 ) 30 19
Other time deposits 0 0 0 0 0 0
Total interest-bearing deposits (7 ) 60 53 (11 ) 106 95 43 261 304 62 450 512
Borrowed funds:
Short-term (4 ) 8 4 6 13 19 6 31 37 30 129 159
Long-term (2 ) (2 ) (4 ) (7 ) (5 ) (12 ) (121 ) (119 ) (240 ) (292 ) (238 ) (530 )
Total borrowed funds (6 ) 6 0 (1 ) 8 7 (115 ) (88 ) (203 ) (262 ) (109 ) (371 )
Total Interest Expense (13 ) 66 53 (12 ) 114 102 (72 ) 173 101 (200 ) 341 141

Net Interest Income $ 595 $ (217 ) $ 378 $ 1,175 $ (700 ) $ 475 $ 587 $ (63 ) $ 524 $ 1,129 $ (220 ) $ 909

(1) Changes in income on tax-exempt securities and loans are presented on a fully tax-equivalent basis, using the Corporation’s marginal federal income tax rate of 21% for 2018 and 35%. for 2017.

(2) The change in interest due to both volume and rates has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amount of the change in each.

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
NONINTEREST INCOME
TABLE V - COMPARISON OF NONINTEREST INCOME
(Dollars in Thousands)
6 Months Ended
June 30, $ %
2018 2017 Change Change
Trust and financial management revenue $ 2,948 $ 2,677 $ 271 10.1
Brokerage revenue 483 364 119 32.7
Insurance commissions, fees and premiums 57 72 (15 ) (20.8 )
Service charges on deposit accounts 2,506 2,213 293 13.2
Service charges and fees 168 166 2 1.2
Interchange revenue from debit card transactions 1,220 1,088 132 12.1
Net gains from sales of loans 350 354 (4 ) (1.1 )
Loan servicing fees, net 189 127 62 48.8
Increase in cash surrender value of life insurance 195 184 11 6.0
Other noninterest income 979 725 254 35.0
Total noninterest income, excluding gains (losses) on securities, net $ 9,095 $ 7,970 $ 1,125 14.1

Table V excludes ~~realized~~the gain on a restricted equity security (Visa Class B stock) and net (losses) gains on available-for-sale debt securities, which are discussed in the “Earnings Overview” section of Management’s Discussion and Analysis. Total noninterest income shown in Table V increased ~~$374,000 (4.9%~~$1,125,000 (14.1%) in the first six months of ~~2017~~2018 over the first six months of ~~2016~~2017 amount. The most significant variances include the following:

TABLE V - COMPARISON OF NONINTEREST INCOME
(Dollars In Thousands)
6 Months Ended
June 30, $ %
2017 2016 Change Change
Service charges on deposit accounts $ 2,178 $ 2,302 $ (124 ) (5.4 )
Service charges and fees 201 217 (16 ) (7.4 )
Trust and financial management revenue 2,677 2,395 282 11.8
Brokerage revenue 364 353 11 3.1
Insurance commissions, fees and premiums 72 48 24 50.0
Interchange revenue from debit card transactions 1,088 950 138 14.5
Net gains from sales of loans 354 463 (109 ) (23.5 )
Loan servicing fees, net 127 11 116 1054.5
Increase in cash surrender value of life insurance 184 189 (5 ) (2.6 )
Other operating income 725 668 57 8.5
Total noninterest income before realized gains on available-for-sale securities, net $ 7,970 $ 7,596 $ 374 4.9
· Service charges on deposit accounts increased $293,000 (13.2%), mainly due to increased fees from the overdraft privilege program and reflecting the benefit of operational improvements to the program that were instituted early in 2018.

· Trust and financial management revenue increased ~~$282,000 (11.8%~~$271,000 (10.1%). The increase in revenue included the impact of a change in the frequency of billings for many accounts from a quarterly billing cycle to monthly, resulting in additional fees of $215,000 more than would otherwise have been recognized in the first six months of 2017. (Trust revenue is recognized on a cash basis, which would not ordinarily vary significantly from an amount determined on an accrual basis.) The increase also included the effects of a mid-year 2017 increase in fee levels and an increase in the value of assets under management to ~~$894,669,000~~$927,089,000 at June 30, ~~2017,~~2018, up ~~5.6%~~3.6% from one year earlier. The increase in value of Trust assets under management resulted ~~mainly~~ from appreciation in equity ~~values.~~values and new business.

· Interchange revenue from debit card transactions increased ~~$138,000 (14.5%~~$132,000 (12.1%), reflecting ~~improvements~~an increase in ~~card-related volumes and processing.~~volume of transactions.
· As a result of increased volume, broker-dealer revenue increased $119,000 (32.7%).

· Loan servicing fees, net, increased ~~$116,000.~~$62,000. This category includes fees received from servicing residential mortgage loans that have been originated and sold, adjusted for changes in the fair value of servicing rights. The fair value of mortgage servicing rights decreased by ~~$78,000~~$26,000 in the first six months of ~~2017~~2018 as compared to a reduction of ~~$178,000~~$78,000 in the same period of ~~2016.~~2017.

· ~~Service charges~~Other noninterest income increased $254,000, including an increase of $131,000 in state tax benefits from tax credits, primarily as a result of the donation of the Towanda building. Also, dividends on ~~deposit accounts decreased $124,000 (5.4%), as~~FHLB-Pittsburgh stock increased $70,000 and interchange revenue from ~~consumer overdrafts declined due to lower volume.~~
· Net gains from sales of loans were $109,000 lower for the first six months of 2017 as compared to 2016, due to a lower average profit margin as well as a reduction in sales volume. The total cost basis of residential mortgage loans sold in the first six months of 2017 was $11.1 million as compared to $12.5 million in the first six months of 2016, a reduction of 11.3%. In total, gains from sales of loans were 3.19% of the total cost basis of loans sold in the first six months of 2017, down from 3.71% in the first six months of 2016. The reduction in average profit margin resulted from competitive pricing pressures.credit card transactions increased $48,000.

47
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

TABLE VI - COMPARISON OF NONINTEREST INCOME
(Dollars Inin Thousands)
3 Months Ended
June 30, $ %
2017 2016 Change Change
Service charges on deposit accounts $ 1,094 $ 1,164 $ (70 ) (6.0 )
Service charges and fees 104 123 (19 ) (15.4 )
Trust and financial management revenue 1,497 1,251 246 19.7
Brokerage revenue 208 180 28 15.6
Insurance commissions, fees and premiums 31 27 4 14.8
Interchange revenue from debit card transactions 568 487 81 16.6
Net gains from sales of loans 188 295 (107 ) (36.3 )
Loan servicing fees, net 55 (11 ) 66 (600.0 )
Increase in cash surrender value of life insurance 94 93 1 1.1
Other operating income 267 297 (30 ) (10.1 )
Total noninterest income before realized gains on available-for-sale securities, net $ 4,106 $ 3,906 $ 200 5.1
3 Months Ended
June 30, $ %
2018 2017 Change Change
Trust and financial management revenue $ 1,526 $ 1,497 $ 29 1.9
Brokerage revenue 271 208 63 30.3
Insurance commissions, fees and premiums 13 31 (18 ) (58.1 )
Service charges on deposit accounts 1,302 1,112 190 17.1
Service charges and fees 82 86 (4 ) (4.7 )
Interchange revenue from debit card transactions 641 568 73 12.9
Net gains from sales of loans 166 188 (22 ) (11.7 )
Loan servicing fees, net 61 55 6 10.9
Increase in cash surrender value of life insurance 98 94 4 4.3
Other noninterest income 529 267 262 98.1
Total noninterest income, excluding gains (losses) on securities, net $ 4,689 $ 4,106 $ 583 14.2

Table VI excludes ~~realized~~the gain on a restricted equity security (Visa Class B stock) and net (losses) gains on available-for-sale debt securities, which are discussed in the “Earnings Overview” section of Management’s Discussion and Analysis. Total noninterest income shown in Table VI increased ~~$200,000 (5.1%~~$583,000 (14.2%) in the ~~first six months~~second quarter 2018 over the second quarter of 2017 ~~over the first six months of 2016~~ amount. The most significant variances include the following:

· ~~Trust and financial management revenue~~Service charges on deposit accounts increased ~~$246,000, including $215,000~~$190,000 (17.1%) in the second quarter 2018 over the second quarter 2017 total, mainly due to increased fees from the ~~effects~~overdraft privilege program and reflecting the benefit of ~~changing~~operational improvements to the ~~frequency of billings as described above.~~program that were instituted early in 2018.

· Interchange revenue from debit card transactions increased ~~$81,000 (16.6%~~$73,000 (12.9%), reflecting ~~benefits from a consulting project~~an increase in ~~2016 that identified opportunities for improvements in card-related volumes and processing.~~volume of transactions.

· ~~Loan servicing fees, net,~~As a result of increased ~~$66,000, as the fair value of mortgage servicing rights decreased by $48,000~~volume, broker-dealer revenue increased $63,000 (30.3%).
· Other noninterest income increased $262,000 in the second quarter ~~2017 as compared to a reduction of $108,000 in the second quarter 2016.~~
· ~~Net gains from sales of loans decreased $107,000 in the second quarter 2017~~2018 as compared to the second quarter ~~2016, due to a lower average profit margin~~2017, including an increase of $154,000 in state tax benefits from tax credits resulting from the second quarter 2018 donation of the Towanda building. Also, dividends on FHLB-Pittsburgh stock increased $40,000 and ~~a reduction in sales volume.~~
· ~~Service charges on deposit accounts decreased $70,000 (6.0%), as~~interchange revenue from ~~consumer overdrafts declined due to lower volume.~~credit card transactions increased $26,000.
~~TABLE VII - COMPARISON OF NONINTEREST EXPENSE~~
~~(Dollars In Thousands)~~
6 Months Ended
June 30, $ %
2017 2016 Change Change
Salaries and wages $ 7,840 $ 7,800 $ 40 0.5
Pensions and other employee benefits 2,674 2,439 235 9.6
Occupancy expense, net 1,178 1,169 9 0.8
Furniture and equipment expense 901 866 35 4.0
FDIC Assessments 190 297 (107 ) (36.0 )
Pennsylvania shares tax 672 645 27 4.2
Professional fees 481 571 (90 ) (15.8 )
Automated teller machine and interchange expense 599 516 83 16.1
Software subscriptions 571 492 79 16.1
Other operating expense 3,268 2,812 456 16.2
Total noninterest expense $ 18,374 $ 17,607 $ 767 4.4

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
NONINTEREST EXPENSE
TABLE VII - COMPARISON OF NONINTEREST EXPENSE
(Dollars In Thousands)
Six Months Ended
June 30, $ %
2018 2017 Change Change
Salaries and wages $ 8,317 $ 7,840 $ 477 6.1
Pensions and other employee benefits 2,810 2,661 149 5.6
Occupancy expense, net 1,250 1,178 72 6.1
Furniture and equipment expense 584 628 (44 ) (7.0 )
Data processing expenses 1,335 1,190 145 12.2
Automated teller machine and interchange expense 641 599 42 7.0
Pennsylvania shares tax 672 672 0 0.0
Professional fees 555 375 180 48.0
Telecommunications 390 266 124 46.6
Directors' fees 352 371 (19 ) (5.1 )
Other noninterest expense 2,673 2,594 79 3.0

Total noninterest expense $ 19,579 $ 18,374 $ 1,205 6.6

As shown in Table VII, total noninterest expense increased ~~$767,000 (4.4%~~$1,205,000 (6.6%) in the first six months of ~~2017~~2018 as compared to the first six months of ~~2016.~~2017. The most significant variances include the following:

· ~~Other operating~~Salaries and wages expense increased ~~$456,000. Within other operating~~$477,000 (6.1%), including the effects of annual performance-based salary adjustments for a majority of employees along with an increase of $159,000 in estimated cash and stock-based compensation expense and an increase in the ~~largest variances~~average number of FTEs to 295 in the first six months of 2018 from 290 in the first six months of 2017.
· Professional fees were $180,000 higher in 2018 than in 2017. The increase in professional fees included ~~increases~~expenses in the first six months of ~~$169,000 in loan collection expenses, $70,000 in losses and expenses associated with other real estate and $65,000~~2018 related to implementation of a ~~sales tax audit.~~new mortgage loan origination system, completion of a consulting project related to Board governance and committee structure, assistance with implementation of new accounting standards, certification of a compliance-related software system and other corporate projects.

· Pensions and other employee benefits expense increased ~~$235,000, primarily as a result~~$149,000, including an increase of ~~higher~~$131,000 in health care expenses due to higher claims on the ~~Corporation’s~~ partially self-insured plan.

· ~~Automated teller machine and interchange expense~~Data processing expenses increased ~~$83,000,~~$145,000, including costs associated with ~~issuing~~the new ~~debit cards with EMV functionality.~~mortgage loan origination system.

· ~~Software subscriptions~~Telecommunications expense increased ~~$79,000, including~~$124,000 as a result of additional costs ~~associated~~related to a new telephone system, along with ~~new applications as well as annual licensing increases.~~costs from the prior legacy system during the transition period.

· ~~FDIC assessments expense decreased $107,000, reflecting a lower assessment level.~~Occupancy costs increased $72,000, primarily due to increases in fuel and maintenance costs.

· ~~Professional fees~~Other noninterest expense ~~decreased $90,000, reflecting~~increased $79,000. Within this category, the most significant fluctuations between 2018 and comparative 2017 were as follows:
Ø The donation of the Towanda property was completed in June 2018, resulting in recognition of expense of $250,000 based on the net book value of the real estate. Accordingly, donation expense in the first six months of 2018 exceeded the 2017 total by $227,000.
Ø Credit card processing and rewards redemption expense increased $51,000.
Ø Collection expense, net of reimbursements, was $105,000 lower in 2018.
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
Ø Recoveries of sales and use tax previously paid totaled $40,000 in the first six months of 2018, resulting in a reduction in ~~information technology and~~expense. In comparison, expense associated with sales and ~~service-related consulting expense.~~use tax assessments totaling $65,000 was recognized in the first six months of 2017.

TABLE VIII - COMPARISON OF NONINTEREST EXPENSE
(Dollars In Thousands)

3 Months Ended Three Months Ended
June 30, $ % June 30, $ %
2017 2016 Change Change 2018 2017 Change Change
Salaries and wages $ 3,972 $ 3,913 $ 59 1.5 $ 4,193 $ 3,972 $ 221 5.6
Pensions and other employee benefits 1,144 1,002 142 14.2 1,200 1,137 63 5.5
Occupancy expense, net 600 560 40 7.1 613 600 13 2.2
Furniture and equipment expense 448 439 9 2.1 313 315 (2 ) (0.6 )
FDIC Assessments 96 155 (59 ) (38.1 )
Data processing expenses 694 615 79 12.8
Automated teller machine and interchange expense 319 305 14 4.6
Pennsylvania shares tax 336 323 13 4.0 336 336 0 0.0
Professional fees 254 282 (28 ) (9.9 ) 279 188 91 48.4
Automated teller machine and interchange expense 305 267 38 14.2
Software subscriptions 291 251 40 15.9
Other operating expense 1,630 1,343 287 21.4
Telecommunications 157 132 25 18.9
Directors' fees 168 186 (18 ) (9.7 )
Other noninterest expense 1,412 1,290 122 9.5
Total noninterest expense $ 9,076 $ 8,535 $ 541 6.3 $ 9,684 $ 9,076 $ 608 6.7

As shown in Table VIII, total noninterest expense increased ~~$541,000 (6.3%~~$608,000 (6.7%) in the second quarter ~~2017~~2018 as compared to the second quarter ~~2016.~~2017. The most significant variances include the following:

· ~~Other operating~~Salaries and wages expense increased ~~$287,000,~~$221,000 (5.6%), including ~~increases~~the effects of ~~$77,000~~annual performance-based salary adjustments for a majority of employees along with an increase of $73,000 in ~~loan collection~~estimated cash and stock-based compensation expense and an increase in the average number of FTEs to 297 in the second quarter 2018 from 292 in the second quarter 2017.
· Professional fees were $91,000 higher in the second quarter 2018 than in the second quarter 2017, including expenses ~~$65,000~~in the second quarter 2018 related to implementation of the new mortgage loan origination system, assistance with implementation of new accounting standards, certification of a ~~sales tax audit~~compliance-related software system and ~~$52,000 in losses~~other corporate projects.
· Data processing expenses increased $79,000, including costs associated with ~~other real estate.~~the new mortgage loan origination system.

· Pensions and other employee benefits expense increased ~~$142,000,~~$63,000, including ~~the effect~~an increase of ~~higher~~$32,000 in health care expenses due to higher claims on the ~~Corporation’s~~ partially self-insured plan.

· ~~Occupancy~~Other noninterest expense increased ~~$40,000 (7.1%),~~$122,000. Within this category, donations expense increased $226,000, including ~~approximately $11,000~~the second quarter 2018 expense of $250,000 from donation of the ~~new loan processing office~~Towanda real estate as described above. Recoveries of sales and use tax previously paid totaled $37,000 in ~~Elmira, NY, which opened~~the second quarter 2018, resulting in ~~March 2017.~~a reduction in expense, while second quarter 2017 expense included sales and use tax assessments totaling $65,000.

· ~~Software subscriptions increased $40,000, including costs associated with new applications as well as annual licensing increases.~~
INCOME TAXES

· ~~Automated teller machine and interchange expense increased $38,000, including costs associated with issuing new debit cards with EMV functionality.~~
The income tax provision in interim periods is based on the Corporation’s estimate of the effective tax rate expected to be applicable for the full year. The income tax provision for the first six months of 2018 was $2,118,000, or 16.5% of pre-tax earnings, which was $240,000 lower than the provision for the first six months of 2017 of $2,358,000, or 23.8% of pre-tax income. The Corporation benefited from the reduction in the federal corporate income tax rate to 21%, effective January 1, 2018, from the 35% marginal tax rate in effect throughout 2017. The Corporation’s effective tax rates differ from the statutory rate of 21% in the first six months of 2018 and 35% for the first six months of 2017 principally because of the effects of tax-exempt interest income.
· ~~FDIC assessments expense decreased $59,000, reflecting a lower assessment level.~~

4950
CITIZENS & NORTHERN CORPORATION – FORM 10-Q
The Corporation recognizes deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax basis of assets and liabilities. At June 30, 2018 the net deferred tax asset was $4,304,000, up from $3,289,000 at December 31, 2017. The most significant change in temporary difference components was a net increase of $1,215,000 related to unrealized losses on available-for-sale securities. At June 30, 2018, the net deferred tax asset associated with the unrealized loss was $1,721,000, while at December 31, 2017, the deferred tax asset associated with the unrealized loss was $506,000, including $843,000 recorded as an offset to the pre-tax unrealized loss within accumulated other comprehensive loss, partially offset by $337,000 charged against retained earnings.
The Corporation regularly reviews deferred tax assets for recoverability based on history of earnings, expectations for future earnings and expected timing of reversals of temporary differences. Realization of deferred tax assets ultimately depends on the existence of sufficient taxable income, including taxable income in prior carryback years, as well as future taxable income.
Management believes the recorded net deferred tax asset at June 30, 2018 is fully realizable; however, if management determines the Corporation will be unable to realize all or part of the net deferred tax asset, the Corporation would adjust the deferred tax asset, which would negatively impact earnings.
Additional information related to income taxes is presented in Note 11 to the unaudited, consolidated financial statements.

FINANCIAL CONDITION

This section includes information regarding the Corporation’s lending activities or other significant changes or exposures that are not otherwise addressed in Management’s Discussion and Analysis. Significant changes in the average balances of the Corporation’s earning assets and interest-bearing liabilities are described in the “Net Interest Income” section of Management’s Discussion and Analysis. Other significant balance sheet items, including the allowance for loan losses and stockholders’ equity, are discussed in separate sections of Management’s Discussion and Analysis. There are no significant concerns that have arisen related to the Corporation’s off-balance sheet loan commitments or outstanding standby letters of credit at June 30, ~~2017,~~2018, and management does not expect capital expenditures to have a material, detrimental effect on the Corporation’s financial condition in ~~2017.~~2018.

Gross loans outstanding (excluding mortgage loans held for sale) were $818,647,000 at June 30, 2018, up 0.4% from $815,713,000 at December 31, 2017 and 5.0% from $779,692,000 at June 30, ~~2017, up 3.7% from $751,835,000 at December 31, 2016 and up 7.1 % from $727,842 at June 30, 2016.~~2017. Total outstanding mortgages and other consumer real estate loans were ~~$9,206,000 (2.2%~~$2,474,000 (0.6%) higher at June 30, ~~2017~~2018 as compared to December 31, ~~2016;~~2017 and increased ~~$31,334,000 (7.9%) compared to June 30, 2016. Total outstanding commercial loans were higher by $17,750,000 (5.6%) at June 30, 2017 as compared to December 31, 2016 and $18,027,000 (5.7%~~$19,781,000 (4.6%) as compared to June 30, ~~2016.~~2017. Total outstanding commercial loans were lower by $507,000 (0.1%) at June 30, 2018 as compared to December 31, 2017 and $17,891,000 (5.3%) higher compared to June 30, 2017. The reduction in outstanding commercial loans at June 30, 2018 reflected pay-offs totaling approximately $13,000,000 from a few large loans that occurred late in the second quarter. Average loans outstanding in the first six months of ~~2017~~2018 of ~~$765,408,000~~$821,225,000 were ~~$58,649,000 (8.3%~~$55,817,000 (7.3%) higher than the corresponding total in the first six months of 2016. The increase in loans outstanding over the last two quarters of 2016 and first two quarters 2017 have included significant increases in mortgages and other consumer real estate loans as well as commercial loans.2017.

While the Corporation’s lending activities are primarily concentrated in its market area, a portion of the Corporation’s commercial loan segment consists of participation loans. Participation loans represent portions of larger commercial transactions for which other institutions are the “lead banks”. Although not the lead bank, the Corporation conducts detailed underwriting and monitoring of participation loan opportunities. Participation loans are included in the “Commercial and industrial,” “Commercial loans secured by real estate”, “Political subdivisions” and ~~“Political subdivisions”~~“Other commercial” classes in the loan tables presented in this Form 10-Q. Total participation loans outstanding amounted to $62,949,000 at June 30, 2018, up from $61,245,000 at December 31, 2017 and $42,876,000 at June 30, ~~2017, down from $47,508,000 at December 31, 2016 and down from $47,055,000 at June 30, 2016.~~2017. At June 30, ~~2017,~~2018, the balance of participation loans outstanding includes a total of ~~$31,682,000~~$52,681,000 to businesses located outside of the Corporation’s market area, including ~~$10,515,000~~$9,684,000 from participations in loans originated through the Corporation’s membership in a network that originates loans throughout the U.S. The Corporation’s participation loans originated through the network consist of loans to businesses that are larger than the Corporation’s typical commercial customer base. The loans originated through the network are considered “leveraged loans,” meaning the businesses typically have minimal tangible book equity and the extent of collateral available is limited, though at the time of origination the businesses have demonstrated strong cash flow performance in their recent histories. Total leveraged participation loans, including loans originated through the network and two loans originated through another lead institution, totaled ~~$12,359,000~~$13,944,000 at June 30, ~~2017, $15,207,000~~2018 and $15,328,000 at December 31, ~~2016 and $12,199,000 at June 30, 2016.~~2017.

Since 2009, the Corporation has originated and sold residential mortgage loans to the secondary market through the MPF Xtra program administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Residential mortgages originated and sold through the MPF Xtra program consist primarily of conforming, prime loans sold to the Federal National Mortgage Association (Fannie Mae), a quasi-government entity. In 2014, the Corporation began to originate and sell residential mortgage loans to the secondary market through the MPF Original program, which is also administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Residential mortgages originated and sold through the MPF Original program consist primarily of conforming, prime loans sold to the Federal Home Loan Bank of Pittsburgh.

51
CITIZENS & NORTHERN CORPORATION – FORM 10-Q
For loan sales originated under the MPF Xtra and Original programs, the Corporation provides customary representations and warranties to investors that specify, among other things, that the loans have been underwritten to the standards established by the investor. The Corporation may be required to repurchase a loan and reimburse a portion of fees received, or reimburse the investor for a credit loss incurred on a loan, if it is determined that the representations and warranties have not been met. Such repurchases or reimbursements generally result from an underwriting or documentation deficiency. At June 30, ~~2017,~~2018, the total outstanding balance of loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to ~~$1,828,000,~~$1,780,000, and the corresponding total outstanding balance repurchased at December 31, ~~2016~~2017 was ~~$1,852,000.~~$1,805,000.
50

At June 30, 2018, outstanding balances of loans sold and serviced through the two programs totaled $171,543,000, including loans sold through the MPF Xtra program of $102,533,000 and loans sold through the Original program of $69,010,000. At December 31, 2017, outstanding balances of loans sold and serviced through the two programs totaled ~~$165,789,000,~~$169,725,000, including loans sold through the MPF Xtra program of ~~$112,184,000~~$107,117,000 and loans sold through the Original program of $53,605,000. At December 31, 2016, outstanding balances of loans sold and serviced through the two programs totaled $163,296,000, including loans sold through the MPF Xtra program of $116,978,000 and loans sold through the Original program of $46,318,000.$62,608,000. Based on the fairly limited volume of required repurchases to date, no allowance has been established for representation and warranty exposures as of June 30, ~~2017~~2018 and December 31, ~~2016.~~2017.

For loans sold under the Original program, the Corporation provides a credit enhancement whereby the Corporation would assume credit losses in excess of a defined First Loss Account (“FLA”) balance, up to specified amounts. The FLA is funded by the Federal Home Loan Bank of Pittsburgh based on a percentage of the outstanding balance of loans sold. At June 30, ~~2017,~~2018, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $3,623,000, and the Corporation has recorded ana related allowance ~~in the amount of $227,000~~ for credit losses ~~on loans sold under the MPF Original Program~~of $300,000 which is included in “Accrued interest and other liabilities” in the accompanying consolidated balance ~~sheet. The corresponding recorded allowance at~~sheets. At December 31, ~~2016~~2017, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was ~~$196,000.~~$5,742,000, and the related allowance for credit losses was $260,000. The Corporation does not provide a credit enhancement for loans sold through the Xtra program.

PROVISION AND ALLOWANCE FOR LOAN LOSSES

The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction of the investment in loans. Note 7 to the unaudited consolidated financial statements provides an overview of the process management uses for evaluating and determining the allowance for loan losses.

While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.

The allowance for loan losses was ~~$8,635,000~~$8,831,000 at June 30, ~~2017, up~~2018, down from ~~$8,473,000~~$8,856,000 at December 31, ~~2016.~~2017. Table X shows total specific allowances on impaired loans ~~increased $409,000~~decreased $184,000 to ~~$1,083,000~~$1,095,000 at June 30, ~~2017~~2018 from ~~$674,000~~$1,279,000 at December 31, ~~2016.~~2017. The ~~net increase in~~largest individual loan balance for which a specific ~~allowances in the first half of 2017 included an increase of $430,000 in the~~ allowance ~~related to one~~has been recorded is a real estate secured commercial ~~loan. The increase in the specific allowance for this~~ loan ~~was based on~~with an ~~updated appraisal. At June 30, 2017, the~~ outstanding balance of ~~this loan was $2,718,000,~~$2,573,000 and ~~the related~~a specific allowance ~~was $958,000.~~
~~Table X also shows that the collectively determined portion~~ of ~~the allowance related to commercial loans decreased $51,000, to $3,022,000~~$850,000 at June 30, ~~2017~~2018, down from ~~$3,373,000~~an outstanding balance of $2,641,000 and a specific allowance of $919,000 at December 31, 2016. The decrease in the collectively determined allowance on commercial loans resulted from an aggregate improvement (reduction) in the net charge-off experience and qualitative factors used to value the allowance on commercial loans, partially offset by the impact of an increase in outstanding loans. The aggregate net charge-off experience factor used in the allowance calculation on commercial loans was 0.09% lower at June 30, 2017 as compared to December 31, 2016. The Corporation’s aggregate net charge-off rate on commercial loans has been improving over the past several quarters, as the effects on the overall rate of a large ($1,486,000) charge-off in 2014 on a commercial loan secured by real estate has gradually diminished. The qualitative factors used in the allowance calculation for commercial loans were 0.05% lower at June 30, 2017 as compared to December 31, 2016, reflecting a pattern of overall improvement in loan delinquency levels and a reduction in the unemployment rate throughout most of the Corporation’s market area over the previous twelve months.
Throughout 2016 and at March 31, 2017, a rolling three-year average net charge-off rate was used for all loan classes. At June 30, 2017, a five-year average net charge-off rate was used for commercial loans secured by real estate and for multi-family residential loans, while a three-year average net charge-off rate was used for all other loan classes. The change in time period for these two loan classes was based on management’s evaluation of an appropriate time period that captures an historical loss experience relevant to the current portfolio. The impact of this change was to increase the allowance for loan losses at June 30, 2017 and resulting provision for the second quarter and six months ended June 30, 2017 by $189,000.2017.

5152
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

The provision for loan losses by segment in the three-month and six-month period ended June 30, ~~2017~~2018 and ~~2016~~2017 is as follows:

(In Thousands) 3 Months Ended 6 Months Ended 3 Months Ended 6 Months Ended
June 30, June 30, June 30, June 30, June 30, June 30, June 30, June 30,
2017 2016 2017 2016 2018 2017 2018 2017
Residential mortgage $ 39 $ 191 $ 168 $ 274 $ 47 $ 39 $ 78 $ 168
Commercial (150 ) 135 153 413 (120 ) (150 ) 97 153
Consumer 13 21 33 28 53 13 97 33
Unallocated 102 (29 ) 102 (29 ) 0 102 0 102

Total $ 4 $ 318 $ 456 $ 686 $ (20 ) $ 4 $ 272 $ 456

The ~~overall decreases in the~~ provision for loan losses is further detailed as follows:
3 Months 3 Months 6 Months 6 Months
Residential mortgage segment Ended Ended Ended Ended
(In thousands) June 30, June 30, June 30, June 30,
2018 2017 2018 2017
Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs $ 41 $ 102 $ 92 $ 162

Increase (decrease) in collectively determined portion of the allowance attributable to:
Loan growth 43 11 23 48
Changes in historical loss experience factors (37 ) 7 (37 ) 39
Changes in qualitative factors 0 (81 ) 0 (81 )
Total provision for loan losses - Residential mortgage segment $ 47 $ 39 $ 78 $ 168
3 Months 3 Months 6 Months 6 Months
Commercial segment Ended Ended Ended Ended
(In thousands) June 30, June 30, June 30, June 30,
2018 2017 2018 2017
(Decrease) increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs $ (142 ) $ 202 $ (31 ) $ 504

(Decrease) increase in collectively determined portion of the allowance attributable to:
Loan (reduction) growth (18 ) 32 35 45
Changes in historical loss experience factors 40 (305 ) 93 (262 )
Changes in qualitative factors 0 (79 ) 0 (134 )
Total (credit) provision for loan losses - Commercial segment $ (120 ) $ (150 ) $ 97 $ 153
53
CITIZENS & NORTHERN CORPORATION – FORM 10-Q
3 Months 3 Months 6 Months 6 Months
Consumer segment Ended Ended Ended Ended
(In thousands) June 30, June 30, June 30, June 30,
2018 2017 2018 2017
Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs $ 23 $ 11 $ 52 $ 37

Increase (decrease) in collectively determined portion of the allowance attributable to:
Loan growth 5 5 9 7
Changes in historical loss experience factors 16 (2 ) 26 (9 )
Changes in qualitative factors 9 (1 ) 10 (2 )
Total provision for loan losses - Consumer segment $ 53 $ 13 $ 97 $ 33
3 Months 3 Months 6 Months 6 Months
Total - All segments Ended Ended Ended Ended
(In thousands) June 30, June 30, June 30, June 30,
2018 2017 2018 2017
(Decrease) increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs $ (78 ) $ 315 $ 113 $ 703

Increase (decrease) in collectively determined portion of the allowance attributable to:
Loan growth 30 48 67 100
Changes in historical loss experience factors 19 (300 ) 82 (232 )
Changes in qualitative factors 9 (161 ) 10 (217 )
Sub-total (20 ) (98 ) 272 354
Unallocated 0 102 0 102
Total (credit) provision for loan losses - All segments $ (20 ) $ 4 $ 272 $ 456
For the periods shown in the tables immediately above, the provision related to increases or decreases in specific allowances on impaired loans was affected by changes in the results of management’s assessment of the amount of probable or actual (charged-off) losses associated with a small number of larger, individual loans. This line item also includes net charge-offs or recoveries from smaller loans that had not been individually evaluated for impairment prior to charge-off. In the second quarter ~~and first six months~~2018, the credit for the commercial segment included the benefit of ~~2017 as compared to the corresponding periods~~reversing a specific allowance of ~~2016 reflect, in part, increases~~$158,000 that had been previously established. The reversal of this specific allowance resulted from an improvement in the ~~provision due to changes in specific allowances offset by decreases~~Corporation’s collateral position.
In the tables immediately above, the portion of the net change in the collectively determined allowance ~~for~~attributable to loan ~~losses including a reduction in~~growth was determined by applying the historical loss experience and qualitative factors used ~~to determine~~in the allowance calculation at the end of the preceding period to the net increase in loans outstanding (excluding loans specifically evaluated for impairment) for the period.
The effect on the provision of changes in historical loss experience and qualitative factors, as ~~well as a reduction~~shown in the ~~historical average~~tables above, was determined by: (1) calculating the net ~~charge-offs~~change in each factor used in determining the allowance at the end of the period as ~~a percentage of outstanding loans as described above. More detail related~~compared to the ~~largest segments, residential mortgage~~preceding period, and ~~commercial, is as follows:~~(2) applying the net change in each factor to the outstanding balance of loans at the end of the preceding period (excluding loans specifically evaluated for impairment).
· The provision for the residential mortgage segment in the second quarter 2017 included $102,000 related to net charge-offs during the period, partially offset by a reduction of $63,000 in the collectively determined portion of the allowance. The second quarter 2017 reduction in the collectively determined portion of the allowance on residential mortgage loans resulted from a 0.03% reduction in qualitative factors, reflecting improvements in delinquencies and a reduction in the unemployment rate in the Corporation’s market area over the previous twelve months, partially offset by the effects of an increase in outstanding mortgage loans. In comparison, the provision for the residential mortgage segment in the second quarter 2016 included $42,000 related to net charge-offs during the period and an increase of $149,000 in the collectively determined portion of the allowance. The increase in the collectively determined portion of the allowance in the second quarter 2016 resulted mainly from growth in outstanding loans.
· For the first six months of 2017, the provision for the residential mortgage segment included net charge-offs totaling $162,000 and a net increase in the collectively determined allowance of $6,000. The net increase in the collectively determined portion of the allowance for residential mortgage loans included the effects of an increase in loans outstanding, partially offset by a 0.03% reduction in qualitative factors used to calculate the allowance at June 30, 2017 as compared to December 31, 2016. For the first six months of 2016, the provision for the residential mortgage segment included net charge-offs totaling $42,000 and a net increase in the collectively determined allowance of $232,000.
· The provision for the commercial segment in the second quarter 2017 included $202,000 related to the change in total specific allowances on impaired loans, as adjusted for net charge-offs during the period offset by a decrease of $352,000 in the collectively determined allowance for loan losses. The increase in specific allowances on commercial loans in the second quarter 2017 included an increase of $205,000 related to the commercial loan mentioned above. As noted above, the reduction in the collectively determined allowance on commercial loans included the effects of reductions in net charge-off experience and qualitative factors used in calculating the allowance. In the second quarter 2016, the provision for the commercial segment included a net reduction of $54,000 related to the change in total specific allowances on impaired loans, as adjusted for net charge-offs during the period and an increase of $189,000 in the collectively determined allowance for loan losses. The second quarter 2016 increase in the collectively determined allowance on commercial loans included the effects of growth in outstanding loans and a 0.03% aggregate increase in qualitative factors used in calculating the value of the allowance.
· The provision for the commercial segment for the first six months of 2017 included $504,000 related to the change in total specific allowances on impaired loans, as adjusted for net charge-offs during the period offset by a decrease of $351,000 in the collectively determined allowance for loan losses. The increase in specific allowances on commercial loans in the first six months of 2017 included an increase of $430,000 related to the commercial loan mentioned above. As noted above, the reduction in the collectively determined allowance on commercial loans included the effects of reductions in net charge-off experience and qualitative factors used in calculating the allowance. For the first six months of 2016, the provision for the commercial segment included $25,000 related to the change in total specific allowances on impaired loans, as adjusted for net charge-offs during the period and an increase of $388,000 in the collectively determined allowance for loan losses.

5254
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Table XI presents information related to past due and impaired loans, and loans that have been modified under terms that are considered troubled debt restructurings (TDRs). Total nonperforming loans as a percentage of outstanding loans was ~~1.82%~~1.76% at June 30, ~~2017,~~2018, down from ~~2.07%~~2.10% at December 31, ~~2016,~~2017, and nonperforming assets as a percentage of total assets was ~~1.30%~~1.35% at June 30, ~~2017,~~2018, down from ~~1.43%~~1.47% at December 31, ~~2016.~~2017. Table XI presents data at June 30, ~~2017~~2018 and at the end of each of the years ended December 31, ~~2012~~2013 through ~~2016.~~2017. For the range of dates presented in Table XI, total nonperforming loans as a percentage of loans has ranged from a low of ~~1.41%~~1.76% at ~~December 31, 2012~~June 30, 2018 to a high of 2.80% at December 31, 2013, and total nonperforming assets as a percentage of assets have ranged from a low of ~~0.82%~~1.31% at December 31, ~~2012~~2015 to a high of 1.53% at December 31, 2013.

The balance of loans subject to troubled debt restructurings (TDRs) was $3,788,000 at June 30, 2017, which was $4,889,000 lower than the corresponding total at December 31, 2016, mainly due to removal of one commercial relationship from TDR status. At June 30, 2017, the outstanding contractual balances of loans to this borrower total $6,481,000, and the recorded investments total $4,731,000. In 2014, the Corporation entered into a forbearance agreement with this commercial borrower which was extended for two additional twelve-month periods, most recently in July 2016. The Corporation recorded a charge-off of $1,486,000 in the second quarter 2014, as the payment amounts based on the forbearance agreement were not sufficient to fully amortize the contractual amount of principal outstanding on the loans. In December 2016, the Corporation and the borrower entered into a modification agreement, terminating the forbearance agreement and establishing loan terms with essentially the same interest rate and monthly payment amounts as had been in effect under the forbearance agreement. The interest rates provided for in the modification agreement were equal to or greater than rates the Corporation would be willing to accept for loans with comparable terms to borrowers with a comparable risk profile at the time of the modification. The borrower has made all required payments on the loans in accordance with the terms of the forbearance agreement, as extended, and the modification agreement. Accordingly, the loans were restored to full accrual status at December 31, 2016 and are no longer included in the amounts reported as TDRs at June 30, 2017.
Total impaired loans of ~~$8,711,000~~$7,998,000 at June 30, ~~2017~~2018 are down ~~$2,149,000~~$1,513,000 from the corresponding amount at December 31, ~~2016~~2017 of ~~$10,860,000, including~~$9,511,000, while foreclosed assets held for sale increased $1,299,000 to a ~~decrease in impaired loans without~~balance of $2,897,000 at June 30, 2018. In the second quarter 2018, the Corporation acquired two properties that had secured a valuation allowance of $2,070,000. This net decrease in impaired loans is the result of: (1) removal from impairment status of the loans with the modification agreement noted in the previous paragraph, partially offset by (2) the addition of one commercial loan, ~~secured by real estate~~recording the acquisition at an estimated fair value of $2,293,000 with anno gain or loss recognized. Table XI shows that the total outstanding balance of ~~approximately $2.8 million~~impaired loans of $7,998,000 at June 30, ~~2017. This commercial loan was reviewed in~~2018 is lower than the ~~second quarter~~year-end balances from 2013 – 2017, ~~to determine if a specific allowance~~while the balance of foreclosed assets held for ~~loan losses would be required, and it was determined that no allowance was required at June 30, 2017 based on~~sale is higher than the ~~estimated net realizable value of~~year-end amounts for the ~~related collateral.~~previous five years.

Total nonperforming assets of ~~$16,207,000~~$17,322,000 at June 30, ~~2017~~2018 are ~~$1,547,000~~$1,404,000 lower than the corresponding amount at December 31, ~~2016,~~2017, summarized as follows:

· Total nonaccrual loans at June 30, ~~2017~~2018 of ~~$11,504,000~~$11,230,000 was ~~$2,768,000 higher~~$2,174,000 lower than the corresponding December 31, ~~2016~~2017 total of $13,404,000, including the effect of ~~classifying~~reducing nonaccrual loans due to the acquisition of the commercial properties as ~~nonaccrual the real estate secured commercial loan with a balance of approximately $2.8 million noted~~described above.

· Total loans past due 90 days or more and still accruing interest amounted to ~~$2,680,000~~$3,195,000 at June 30, ~~2017,~~2018, a decrease of ~~$4,158,000~~$529,000 from the total at December 31, 2016. The decrease in 2017 in the balance of loans past due 90 days or more and still accruing interest included the effects of moving the previously noted commercial loan with a balance of $2.8 million to nonaccrual status at June 30, 2017. The reduction in loans past due 90 days or more ~~also~~ included a reduction in residential mortgage loans of $672,000 and an increase in ~~that aging category.~~commercial loans of $124,000. The Corporation reviews the status of loans past due 90 days or more each quarter to determine if it is appropriate to continue to accrue interest, and has determined the loans included in this category are well secured and that ultimate collection of all principal and interest is probable.

· Foreclosed assets held for sale consisted of real estate, and totaled ~~$2,023,000~~$2,897,000 at June 30, ~~2017, a decrease~~2018, an increase of ~~$157,000~~$1,299,000 from ~~$2,180,000~~$1,598,000 at December 31, ~~2016.~~2017. At June 30, ~~2017,~~2018, the Corporation held 1513 such properties for sale, with total carrying values of ~~$879,000~~$412,000 related to residential real estate, ~~$646,000~~$120,000 of land and ~~$498,000~~$2,365,000 related to commercial real estate. At December 31, ~~2016,~~2017, the Corporation held 1916 such properties for sale, with total carrying values of ~~$1,102,000~~$721,000 related to residential real estate, ~~$650,000~~$632,000 of land and ~~$428,000~~$245,000 related to commercial real estate. The Corporation evaluates the carrying values of foreclosed assets each quarter based on the most recent market activity or appraisals for each property.

53
Over the period ~~2012-2016~~2013-2017 and the first six months of ~~2017,~~2018, each period includes a few large commercial relationships that have required significant monitoring and workout efforts. As a result, a limited number of relationships may significantly impact the total amount of allowance required on impaired loans, and may significantly impact the amount of total charge-offs reported in any one period.

Management believes it has been conservative in its decisions concerning identification of impaired loans, estimates of loss, and nonaccrual status; however, the actual losses realized from these relationships could vary materially from the allowances calculated as of June 30, ~~2017.~~2018. Management continues to closely monitor its commercial loan relationships for possible credit losses, and will adjust its estimates of loss and decisions concerning nonaccrual status, if appropriate.

Tables IX through XII present historical data related to loans and the allowance for loan losses.

55
CITIZENS & NORTHERN CORPORATION – FORM 10-Q
TABLE IX - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
(Dollars In Thousands)
6 Months Ended
June 30, June 30, Years Ended December 31,
2017 2016 2016 2015 2014 2013 2012
Balance, beginning of year $ 8,473 $ 7,889 $ 7,889 $ 7,336 $ 8,663 $ 6,857 $ 7,705
Charge-offs:
Residential mortgage (178 ) (42 ) (73 ) (217 ) (327 ) (95 ) (552 )
Commercial (97 ) (595 ) (597 ) (251 ) (1,715 ) (459 ) (498 )
Consumer (60 ) (39 ) (87 ) (94 ) (97 ) (117 ) (171 )
Total charge-offs (335 ) (676 ) (757 ) (562 ) (2,139 ) (671 ) (1,221 )
Recoveries:
Residential mortgage 16 0 3 1 25 24 18
Commercial 2 3 35 214 264 348 8
Consumer 23 27 82 55 47 58 59
Total recoveries 41 30 120 270 336 430 85
Net charge-offs (294 ) (646 ) (637 ) (292 ) (1,803 ) (241 ) (1,136 )
Provision for loan losses 456 686 1,221 845 476 2,047 288
Balance, end of period $ 8,635 $ 7,929 $ 8,473 $ 7,889 $ 7,336 $ 8,663 $ 6,857
Net charge-offs as a % of average loans 0.04 % 0.09 % 0.09 % 0.04 % 0.29 % 0.04 % 0.16 %
Six Months Ended
June 30, June 30, Years Ended December 31,
2018 2017 2017 2016 2015 2014 2013
Balance, beginning of year $ 8,856 $ 8,473 $ 8,473 $ 7,889 $ 7,336 $ 8,663 $ 6,857
Charge-offs:
Residential mortgage (99 ) (178 ) (197 ) (73 ) (217 ) (327 ) (95 )
Commercial (154 ) (97 ) (132 ) (597 ) (251 ) (1,715 ) (459 )
Consumer (73 ) (60 ) (150 ) (87 ) (94 ) (97 ) (117 )
Total charge-offs (326 ) (335 ) (479 ) (757 ) (562 ) (2,139 ) (671 )
Recoveries:
Residential mortgage 5 16 19 3 1 25 24
Commercial 3 2 4 35 214 264 348
Consumer 21 23 38 82 55 47 58
Total recoveries 29 41 61 120 270 336 430
Net charge-offs (297 ) (294 ) (418 ) (637 ) (292 ) (1,803 ) (241 )
Provision for loan losses 272 456 801 1,221 845 476 2,047
Balance, end of period $ 8,831 $ 8,635 $ 8,856 $ 8,473 $ 7,889 $ 7,336 $ 8,663
Net charge-offs as a % of average loans 0.04 % 0.04 % 0.05 % 0.09 % 0.04 % 0.29 % 0.04 %

TABLE X - COMPONENTS OF THE ALLOWANCE FOR LOAN LOSSES
(In Thousands)
June 30, As of December 31,
2017 2016 2015 2014 2013 2012
ASC 310 - Impaired loans $ 1,083 $ 674 $ 820 $ 769 $ 2,333 $ 623
ASC 450 - Collective segments:
Commercial 3,022 3,373 3,103 2,732 2,583 2,594
Residential mortgage 3,896 3,890 3,417 3,295 3,156 3,011
Consumer 134 138 122 145 193 188
Unallocated 500 398 427 395 398 441
Total Allowance $ 8,635 $ 8,473 $ 7,889 $ 7,336 $ 8,663 $ 6,857
June 30, As of December 31,
2018 2017 2016 2015 2014 2013
ASC 310 - Impaired loans $ 1,095 $ 1,279 $ 674 $ 820 $ 769 $ 2,333
ASC 450 - Collective segments:
Commercial 3,206 3,078 3,373 3,103 2,732 2,583
Residential mortgage 3,827 3,841 3,890 3,417 3,295 3,156
Consumer 204 159 138 122 145 193
Unallocated 499 499 398 427 395 398
Total Allowance $ 8,831 $ 8,856 $ 8,473 $ 7,889 $ 7,336 $ 8,663

5456
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

TABLE XI - PAST DUE AND IMPAIRED LOANS, NONPERFORMING ASSETS
AND TROUBLED DEBT RESTRUCTURINGS (TDRs)
(Dollars In Thousands) As of
June 30, As of December 31,
2017 2016 2015 2014 2013 2012
Impaired loans with a valuation allowance $ 3,293 $ 3,372 $ 1,933 $ 3,241 $ 9,889 $ 2,710
Impaired loans without a valuation allowance 5,418 7,488 8,041 9,075 6,432 4,719
Total impaired loans $ 8,711 $ 10,860 $ 9,974 $ 12,316 $ 16,321 $ 7,429
Total loans past due 30-89 days and still accruing $ 3,749 $ 7,735 $ 7,057 $ 7,121 $ 8,305 $ 7,756

Nonperforming assets:
Total nonaccrual loans $ 11,504 $ 8,736 $ 11,517 $ 12,610 $ 14,934 $ 7,353
Total loans past due 90 days or more and still accruing 2,680 6,838 3,229 2,843 3,131 2,311
Total nonperforming loans 14,184 15,574 14,746 15,453 18,065 9,664
Foreclosed assets held for sale (real estate) 2,023 2,180 1,260 1,189 892 879
Total nonperforming assets $ 16,207 $ 17,754 $ 16,006 $ 16,642 $ 18,957 $ 10,543

Loans subject to troubled debt restructurings (TDRs):
Performing $ 729 $ 5,803 $ 1,186 $ 1,807 $ 3,267 $ 906
Nonperforming 3,059 2,874 5,178 5,388 908 1,155
Total TDRs $ 3,788 $ 8,677 $ 6,364 $ 7,195 $ 4,175 $ 2,061

Total nonperforming loans as a % of loans 1.82 % 2.07 % 2.09 % 2.45 % 2.80 % 1.41 %
Total nonperforming assets as a % of assets 1.30 % 1.43 % 1.31 % 1.34 % 1.53 % 0.82 %
Allowance for loan losses as a % of total loans 1.11 % 1.13 % 1.12 % 1.16 % 1.34 % 1.00 %
Allowance for loan losses as a % of nonperforming loans 60.88 % 54.40 % 53.50 % 47.47 % 47.95 % 70.95 %
(Dollars In Thousands)

June 30, As of December 31,
2018 2017 2016 2015 2014 2013
Impaired loans with a valuation allowance $ 3,652 $ 4,100 $ 3,372 $ 1,933 $ 3,241 $ 9,889
Impaired loans without a valuation allowance 4,346 5,411 7,488 8,041 9,075 6,432
Total impaired loans $ 7,998 $ 9,511 $ 10,860 $ 9,974 $ 12,316 $ 16,321
Total loans past due 30-89 days and still accruing $ 3,921 $ 9,449 $ 7,735 $ 7,057 $ 7,121 $ 8,305
Nonperforming assets:
Total nonaccrual loans $ 11,230 $ 13,404 $ 8,736 $ 11,517 $ 12,610 $ 14,934
Total loans past due 90 days or more and still accruing 3,195 3,724 6,838 3,229 2,843 3,131
Total nonperforming loans 14,425 17,128 15,574 14,746 15,453 18,065
Foreclosed assets held for sale (real estate) 2,897 1,598 2,180 1,260 1,189 892
Total nonperforming assets $ 17,322 $ 18,726 $ 17,754 $ 16,006 $ 16,642 $ 18,957
Loans subject to troubled debt restructurings (TDRs):
Performing $ 753 $ 636 $ 5,803 $ 1,186 $ 1,807 $ 3,267
Nonperforming 2,951 3,027 2,874 5,178 5,388 908
Total TDRs $ 3,704 $ 3,663 $ 8,677 $ 6,364 $ 7,195 $ 4,175
Total nonperforming loans as a % of loans 1.76 % 2.10 % 2.07 % 2.09 % 2.45 % 2.80 %
Total nonperforming assets as a % of assets 1.35 % 1.47 % 1.43 % 1.31 % 1.34 % 1.53 %
Allowance for loan losses as a % of total loans 1.08 % 1.09 % 1.13 % 1.12 % 1.16 % 1.34 %
Allowance for loan losses as a % of nonperforming loans 61.22 % 51.70 % 54.40 % 53.50 % 47.47 % 47.95 %
~~TABLE XII - SUMMARY OF LOANS BY TYPE~~
~~Summary of Loans by Type~~
TABLE XII - SUMMARY OF LOANS BY TYPE TABLE XII - SUMMARY OF LOANS BY TYPE
Summary of Loans by Type Summary of Loans by Type
(In Thousands) June 30, As of December 31, June 30, As of December 31,
2017 2016 2015 2014 2013 2012 2018 2017 2016 2015 2014 2013
Residential mortgage:
Residential mortgage loans - first liens $ 342,603 $ 334,102 $ 304,783 $ 291,882 $ 299,831 $ 311,627 $ 361,592 $ 359,987 $ 334,102 $ 304,783 $ 291,882 $ 299,831
Residential mortgage loans - junior liens 24,150 23,706 21,146 21,166 23,040 26,748 26,594 25,325 23,706 21,146 21,166 23,040
Home equity lines of credit 37,159 38,057 39,040 36,629 34,530 33,017 34,852 35,758 38,057 39,040 36,629 34,530
1-4 Family residential construction 26,067 24,908 21,121 16,739 13,909 12,842 26,722 26,216 24,908 21,121 16,739 13,909
Total residential mortgage 429,979 420,773 386,090 366,416 371,310 384,234 449,760 447,286 420,773 386,090 366,416 371,310

Commercial:
Commercial loans secured by real estate 155,158 150,468 154,779 145,878 147,215 158,413 159,392 159,266 150,468 154,779 145,878 147,215
Commercial and industrial 82,815 83,854 75,196 50,157 42,387 48,442 88,499 88,276 83,854 75,196 50,157 42,387
Political subdivisions 51,495 38,068 40,007 17,534 16,291 31,789 56,690 59,287 38,068 40,007 17,534 16,291
Commercial construction and land 15,201 14,287 5,122 6,938 17,003 28,200 13,066 14,527 14,287 5,122 6,938 17,003
Loans secured by farmland 7,432 7,294 7,019 7,916 10,468 11,403 7,397 7,255 7,294 7,019 7,916 10,468
Multi-family (5 or more) residential 7,497 7,896 9,188 8,917 10,985 6,745 7,860 7,713 7,896 9,188 8,917 10,985
Agricultural loans 4,454 3,998 4,671 3,221 3,251 3,053 5,622 6,178 3,998 4,671 3,221 3,251
Other commercial loans 11,038 11,475 12,152 13,334 14,631 362 14,455 10,986 11,475 12,152 13,334 14,631
Total commercial 335,090 317,340 308,134 253,895 262,231 288,407 352,981 353,488 317,340 308,134 253,895 262,231

Consumer 14,623 13,722 10,656 10,234 10,762 11,269 15,906 14,939 13,722 10,656 10,234 10,762
Total 779,692 751,835 704,880 630,545 644,303 683,910 818,647 815,713 751,835 704,880 630,545 644,303
Less: allowance for loan losses (8,635 ) (8,473 ) (7,889 ) (7,336 ) (8,663 ) (6,857 ) (8,831 ) (8,856 ) (8,473 ) (7,889 ) (7,336 ) (8,663 )

Loans, net $ 771,057 $ 743,362 $ 696,991 $ 623,209 $ 635,640 $ 677,053 $ 809,816 $ 806,857 $ 743,362 $ 696,991 $ 623,209 $ 635,640

5557
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

LIQUIDITY

Liquidity is the ability to quickly raise cash at a reasonable cost. An adequate liquidity position permits the Corporation to pay creditors, compensate for unforeseen deposit fluctuations and fund unexpected loan demand. At June 30, ~~2017,~~2018, the Corporation maintained overnight interest-bearing deposits with the Federal Reserve Bank of Philadelphia and other correspondent banks totaling ~~$9,758,000.~~$28,985,000.

The Corporation maintains overnight borrowing facilities with several correspondent banks that provide a source of day-to-day liquidity. Also, the Corporation maintains borrowing facilities with the Federal Home Loan Bank of Pittsburgh, secured by various mortgage loans.

The Corporation has a line of credit with the Federal Reserve Bank of Philadelphia’s Discount Window. Management intends to use this line of credit as a contingency funding source. As collateral for the line, the Corporation has pledged available-for-sale securities with a carrying value of ~~$17,188,000~~$15,481,000 at June 30, ~~2017.~~2018.

The Corporation’s outstanding, available, and total credit facilities at June 30, ~~2017~~2018 and December 31, ~~2016~~2017 are as follows:

Outstanding Available Total Credit Outstanding Available Total Credit
(In Thousands) June 30, Dec. 31, June 30, Dec. 31, June 30, Dec. 31, June 30, Dec. 31, June 30, Dec. 31, June 30, Dec. 31,
2017 2016 2017 2016 2017 2016 2018 2017 2018 2017 2018 2017
Federal Home Loan Bank of Pittsburgh $ 15,321 $ 32,454 $ 338,019 $ 306,767 $ 353,340 $ 339,221 $ 39,054 $ 67,189 $ 324,880 $ 295,441 $ 363,934 $ 362,630
Federal Reserve Bank Discount Window 0 0 15,896 15,636 15,896 15,636 0 0 15,079 15,877 15,079 15,877
Other correspondent banks 0 0 45,000 45,000 45,000 45,000 0 0 45,000 45,000 45,000 45,000
Total credit facilities $ 15,321 $ 32,454 $ 398,915 $ 367,403 $ 414,236 $ 399,857 $ 39,054 $ 67,189 $ 384,959 $ 356,318 $ 424,013 $ 423,507

At June 30, 2018, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of short-term borrowings of $12,000,000 and long-term borrowings of $27,054,000. At December 31, 2017, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowings of ~~$4,000,000~~$29,000,000, short-term borrowings of $29,000,000 and long-term borrowings ~~with a total amount~~ of $11,321,000. At December 31, 2016, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowings of $21,000,000 and long-term borrowings with a total amount of $11,454,000.$9,189,000. Additional information regarding borrowed funds is included in Note 8 ofto the unaudited consolidated financial statements.

Additionally, the Corporation uses ~~repurchase agreements placed with brokers to borrow funds secured by investment assets and~~ “RepoSweep” arrangements to borrow funds from commercial banking customers on an overnight basis. If required to raise cash in an emergency situation, the Corporation could sell available-for-sale securities to meet its ~~obligations.~~obligations or use repurchase agreements placed with brokers to borrow funds secured by investment assets. At June 30, ~~2017,~~2018, the carrying value of available-for-sale securities in excess of amounts required to meet pledging or repurchase agreement obligations was ~~$172,788,000.~~$172,786,000.

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

STOCKHOLDERS’ EQUITY AND CAPITAL ADEQUACY

The Corporation and C&N Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Details concerning capital ratios at June 30, ~~2017~~2018 and December 31, ~~2016~~2017 are presented below. Management believes, as of June 30, ~~2017~~2018 and December 31, ~~2016,~~2017, that the Corporation and C&N Bank meet all capital adequacy requirements to which they are subject and maintain capital conservation buffers (described in more detail below) that allow the Corporation and C&N Bank to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. Further, as reflected in the table below, the Corporation’s and C&N Bank’s capital ratios at June 30, ~~2017~~2018 and December 31, ~~2016~~2017 exceed the Corporation’s policy threshold levels.

5658
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

(Dollars in Thousands) Minimum To Be Well Minimum To Be Well
Minimum To Maintain Capitalized Under Minimum To Meet Minimum Minimum To Maintain Capitalized Under Minimum To Meet
Minimum Capital Conservation Prompt Corrective the Corporation’s Capital Capital Conservation Prompt Corrective the Corporation's
Actual Capital
Requirement Buffer at
Reporting Date Action
Provisions Policy
Thresholds Actual Requirement Buffer at Reporting Date Action Provisions Policy Thresholds
Amount Ratio Amount Ratio Amount Ratio Amount Ratio Amount Ratio Amount Ratio Amount Ratio Amount Ratio Amount Ratio Amount Ratio
June 30, 2017:
June 30, 2018:
Total capital to risk-weighted assets:
Consolidated $ 186,238 23.57 % $ 63,213 ³8% $ 73,090 ³9.25% $ 79,016 ³10% $ 82,967 ³10.5% $ 192,699 23.82 % $ 64,705 ³8% $ 79,870 ³9.875% $ 80,881 ³10% $ 84,925 ³10.5%
C&N Bank 164,739 20.97 % 62,856 ³8% 72,677 ³9.25% 78,569 ³10% 82,498 ³10.5% 170,389 21.18 % 64,358 ³8% 79,442 ³9.875% 80,447 ³10% 84,470 ³10.5%
Tier 1 capital to risk-weighted assets:
Consolidated 177,376 22.45 % 47,410 ³6% 57,287 ³7.25% 63,213 ³8% 67,164 ³8.5% 183,568 22.70 % 48,529 ³6% 63,694 ³7.875% 64,705 ³8% 68,749 ³8.5%
C&N Bank 155,877 19.84 % 47,142 ³6% 56,963 ³7.25% 62,856 ³8% 66,784 ³8.5% 161,258 20.05 % 48,268 ³6% 63,352 ³7.875% 64,358 ³8% 68,380 ³8.5%
Common equity tier 1 capital to risk-weighted assets:
Consolidated 177,376 22.45 % 35,557 ³4.5% 45,434 ³5.75% 51,361 ³6.5% 55,311 ³7% 183,568 22.70 % 36,397 ³4.5% 51,562 ³6.375% 52,573 ³6.5% 56,617 ³7%
C&N Bank 155,877 19.84 % 35,356 ³4.5% 45,177 ³5.75% 51,070 ³6.5% 54,999 ³7% 161,258 20.05 % 36,201 ³4.5% 51,285 ³6.375% 52,291 ³6.5% 56,313 ³7%
Tier 1 capital to average assets:
Consolidated 177,376 14.49 % 48,962 ³4% N/A N/A 61,202 ³5% 61,202 ³5% 183,568 14.52 % 50,582 ³4% N/A N/A 63,227 ³5% 63,227 ³5%
C&N Bank 155,877 12.89 % 48,365 ³4% N/A N/A 60,456 ³5% 60,456 ³5% 161,258 12.90 % 49,993 ³4% N/A N/A 62,491 ³5% 62,491 ³5%

December 31, 2016:
December 31, 2017:
Total capital to risk-weighted assets:
Consolidated $ 183,597 23.60 % $ 62,245 ³8% $ 67,108 ³8.625% $ 77,806 ³10% $ 81,697 ³10.5% $ 187,097 23.07 % $ 64,872 ³8% $ 75,008 ³9.25% $ 81,090 ³10% $ 85,144 ³10.5%
C&N Bank 162,705 21.03 % 61,894 ³8% 66,730 ³8.625% 77,368 ³10% 81,236 ³10.5% 165,142 20.47 % 64,528 ³8% 74,611 ³9.25% 80,661 ³10% 84,694 ³10.5%
Tier 1 capital to risk-weighted assets:
Consolidated 174,928 22.48 % 46,684 ³6% 51,547 ³6.625% 62,245 ³8% 66,135 ³8.5% 177,981 21.95 % 48,654 ³6% 58,790 ³7.25% 64,872 ³8% 68,926 ³8.5%
C&N Bank 154,036 19.91 % 46,421 ³6% 51,256 ³6.625% 61,894 ³8% 65,762 ³8.5% 156,026 19.34 % 48,396 ³6% 58,479 ³7.25% 64,528 ³8% 68,561 ³8.5%
Common equity tier 1 capital to risk-weighted assets:
Consolidated 174,928 22.48 % 35,013 ³4.5% 39,876 ³5.125% 50,574 ³6.5% 54,464 ³7% 177,981 21.95 % 36,490 ³4.5% 46,626 ³5.75% 52,708 ³6.5% 56,763 ³7%
C&N Bank 154,036 19.91 % 34,815 ³4.5% 39,651 ³5.125% 50,289 ³6.5% 54,157 ³7% 156,026 19.34 % 36,297 ³4.5% 46,380 ³5.75% 52,429 ³6.5% 56,462 ³7%
Tier 1 capital to average assets:
Consolidated 174,928 14.27 % 49,026 ³4% N/A N/A 61,282 ³5% 61,282 ³5% 177,981 14.23 % 50,023 ³4% N/A N/A 62,529 ³5% 62,529 ³5%
C&N Bank 154,036 12.73 % 48,404 ³4% N/A N/A 60,506 ³5% 60,506 ³5% 156,026 12.63 % 49,418 ³4% N/A N/A 61,772 ³5% 61,772 ³5%

Management expects the Corporation and C&N Bank to maintain capital levels that exceed the regulatory standards for well-capitalized institutions and the applicable capital conservation buffers for the next 12 months and for the foreseeable future.

Future dividend payments will depend upon maintenance of a strong financial condition, future earnings and capital and regulatory requirements. As described in more detail below, the Corporation and C&N Bank are subject to restrictions on the amount of dividends that may be paid without approval of banking regulatory authorities.

In July 2013, the federal regulatory authorities issued a new capital rule based, in part, on revisions developed by the Basel Committee on Banking Supervision to the Basel capital framework (Basel III). The Corporation and C&N Bank became subject to the new rule effective January 1, 2015. Generally, the new rule implemented higher minimum capital requirements, revised the definition of regulatory capital components and related calculations, added a new common equity tier 1 capital ratio, implemented a new capital conservation buffer, increased the risk weighting for past due loans and provided a transition period for several aspects of the new rule.

5759
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

The current (new) capital rule provides that, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of common equity tier 1 capital above its minimum risk-based capital requirements. The buffer is measured relative to risk-weighted assets. The current and remaining transition schedule for ~~new~~capital ratios, including the capital conservation buffer, is as follows:

As of January 1: As of January 1:
2015 2016 2017 2018 2019 2018 2019
Minimum common equity tier 1 capital ratio 4.5 % 4.5 % 4.5 % 4.5 % 4.5 % 4.5 % 4.5 %
Common equity tier 1 capital conservation buffer N/A 0.625 % 1.25 % 1.875 % 2.5 % 1.875 % 2.5 %
Minimum common equity tier 1 capital ratio plus capital conservation buffer 4.5 % 5.125 % 5.75 % 6.375 % 7.0 % 6.375 % 7.0 %
Phase-in of most deductions from common equity tier 1 capital 40 % 60 % 80 % 100 % 100 % 100 % 100 %
Minimum tier 1 capital ratio 6.0 % 6.0 % 6.0 % 6.0 % 6.0 % 6.0 % 6.0 %
Minimum tier 1 capital ratio plus capital conservation buffer N/A 6.625 % 7.25 % 7.875 % 8.5 % 7.875 % 8.5 %
Minimum total capital ratio 8.0 % 8.0 % 8.0 % 8.0 % 8.0 % 8.0 % 8.0 %
Minimum total capital ratio plus capital conservation buffer N/A 8.625 % 9.25 % 9.875 % 10.5 % 9.875 % 10.5 %

As fully phased in, a banking organization with a buffer greater than 2.5% would not be subject to additional limits on dividend payments or discretionary bonus payments; however, a banking organization with a buffer less than 2.5% would be subject to increasingly stringent limitations as the buffer approaches zero. The new rule also prohibits a banking organization from making dividend payments or discretionary bonus payments if its eligible retained income is negative in that quarter and its capital conservation buffer ratio was less than 2.5% as of the beginning of that quarter. Eligible net income is defined as net income for the four calendar quarters preceding the current calendar quarter, net of any distributions and associated tax effects not already reflected in net income. A summary of payout restrictions based on the capital conservation buffer is as follows:

Capital Conservation Buffer Maximum Payout
(as a % of risk-weighted assets) (as a % of eligible retained income)
Greater than 2.5% No payout limitation applies
≤2.5% and >1.875% 60 %60%
≤1.875% and >1.25% 40 %40%
≤1.25% and >0.625% 20 %20%
≤0.625% 0 %0%

At June 30, ~~2017,~~2018, the Corporation’s Capital Conservation Buffer, determined based on the minimum total capital ratio, was ~~15.57%~~15.82%. C&N Bank’s Capital Conservation Buffer (also determined based on the minimum total capital ratio) was ~~12.97%~~13.18%.

The Corporation’s total stockholders’ equity is affected by fluctuations in the fair values of available-for-sale securities. The difference between amortized cost and fair value of available-for-sale debt securities, net of deferred income tax, is included in Accumulated Other Comprehensive Income (Loss) within stockholders’ equity. The balance in Accumulated Other Comprehensive Income (Loss) related to unrealized ~~losses~~gains (losses) on available-for-sale securities, net of deferred income tax, amounted to ~~$369,000~~($6,476,000) at June 30, ~~2017~~2018 and ($~~949,000)~~1,566,000) at December 31, ~~2016.~~2017. Changes in accumulated other comprehensive income (loss) are excluded from earnings and directly increase or decrease stockholders’ equity. If available-for-sale securities are deemed to be other-than-temporarily impaired, unrealized losses are recorded as a charge against earnings, and amortized cost for the affected securities is reduced. Note 6 to the unaudited consolidated financial statements provides additional information concerning management’s evaluation of available-for-sale securities for other-than-temporary impairment at June 30, ~~2017.~~2018.

5860
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Stockholders’ equity is also affected by the underfunded or overfunded status of defined benefit pension and postretirement plans. The balance in Accumulated Other Comprehensive Income (Loss) related to defined benefit plans, net of deferred income tax, was ~~$151,000~~$137,000 at June 30, ~~2017~~2018 and ~~$51,000~~$59,000 at December 31, ~~2016.~~2017.

COMPREHENSIVE INCOME

Comprehensive Income is the total of (1) net income, and (2) all other changes in equity from non-stockholder sources, which are referred to as Other Comprehensive Income. Changes in the components of Accumulated Other Comprehensive Income (Loss) are included in Other Comprehensive Income, and for the Corporation, consist of changes in unrealized gains or losses on available-for-sale securities and changes in underfunded or overfunded defined benefit plans. Fluctuations in interest rates significantly affect fair values of available-for-sale securities, and accordingly have an effect on Other Comprehensive Income (Loss) in each period.

Comprehensive Income totaled ~~$5,116,000~~$5,570,000 for the three months ended June 30, ~~2017~~2018 as compared to ~~$5,369,000~~$5,116,000 in the second quarter ~~2016.~~2017. For the three months ended June 30, ~~2017,~~2018, Comprehensive Income included: (1) Net Income of ~~$4,121,000,~~$6,371,000, which was ~~$250,000~~$2,250,000 higher than in the second quarter ~~2016;~~2017; (2) Other Comprehensive ~~Income~~Loss from ~~an increase~~a decrease in net unrealized ~~gains~~losses on available-for-sale securities of ~~$999,000~~($797,000) as compared to Other Comprehensive Income of ~~$1,502,000~~$999,000 from ~~an increase in~~ net unrealized gains on available-for-sale securities in the second quarter ~~2016;~~2017; and (3) Other Comprehensive Loss from defined benefit plans of ($4,000) for the second quarter ~~2017~~2018 and ~~2016.~~for the second quarter 2017.

~~Comprehensive Income totaled $8,973,000 for~~For the six months ended June 30, ~~2017~~2018, Comprehensive Income totaled $6,191,000 as compared to ~~$11,810,000~~$8,973,000 for the first six months of 2017. For the six months ended June 30, ~~2016. In the six months ended June 30, 2017,~~2018, Comprehensive Income included: (1) Net Income of ~~$7,555,000, which was $111,000 higher than in~~$10,746,000, up $3,191,000 from net income for the first six months of ~~2016;~~2017; (2) Other Comprehensive ~~Income~~Loss from ~~an increase~~a decrease in net unrealized ~~gains~~losses on available-for-sale securities ~~net~~ of ~~deferred income tax, of $1,318,000~~($4,621,000) as compared to Other Comprehensive Income of ~~$4,356,000~~$1,318,000 from net unrealized gains on available-for-sale securities in the first six months of ~~2016;~~2017; and (3) Other Comprehensive Income from defined benefit plans of ~~$100,000~~$66,000 for the six months ended June 30, 2018 as compared to Other Comprehensive Income of ~~$10,000 in the first six months of 2016.~~
~~INCOME TAXES~~
~~The income tax provision in interim periods is based on the Corporation’s estimate of the effective tax rate expected to be applicable for the full year. The income tax provision~~$100,000 for the first six months of 2017 was $2,358,000, or 23.8% of pre-tax earnings, slightly lower than the provision for the first six months of 2016 of $2,396,000, or 24.4% of pre-tax income. The Corporation’s effective tax rates differ from the statutory rate of 35% principally because of the effects of tax-exempt interest income.2017.
The Corporation recognizes deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax basis of assets and liabilities. At June 30, 2017 the net deferred tax asset was $3,942,000, down from $5,117,000 at December 31, 2016. The most significant change in temporary difference components was a net reduction of $710,000 related to unrealized gains and losses on available-for-sale securities. At June 30, 2017, the net deferred tax liability associated with the unrealized gain was $198,000, while at December 31, 2016, the deferred tax asset associated with the unrealized loss was $512,000.
The Corporation uses currently enacted tax rates to value deferred tax assets and liabilities. The Trump Administration and the U.S. Congress are in the process of evaluating possible tax changes which may include a reduction in U.S. corporate income tax rates. If corporate tax rates were reduced, management expects the Corporation would record an initial charge against earnings to lower the carrying amount of the net deferred tax asset, and then would record a lower tax provision going forward on an ongoing basis.
The Corporation regularly reviews deferred tax assets for recoverability based on history of earnings, expectations for future earnings and expected timing of reversals of temporary differences. Realization of deferred tax assets ultimately depends on the existence of sufficient taxable income, including taxable income in prior carryback years, as well as future taxable income. Further, as discussed above, realization of deferred tax assets would be impacted if income tax rates are lowered from currently enacted levels.
Management believes the recorded net deferred tax asset at June 30, 2017 is fully realizable; however, if management determines the Corporation will be unable to realize all or part of the net deferred tax asset, the Corporation would adjust the deferred tax asset, which would negatively impact earnings.
~~Additional information related to income taxes is presented in Note 11 to the unaudited, consolidated financial statements.~~
59

INFLATION

The Corporation is significantly affected by the Federal Reserve Board’s efforts to control inflation through changes in short-term interest rates. Since September 2007, the Federal Reserve has maintained the fed funds target rate at extremely low levels by historical standards. Further, throughout the period of low interest rates, the Federal Reserve has injected massive amounts of liquidity into the nation’s monetary system through a variety of programs. Since late 2015, the Federal Reserve has begun to move its fed funds target rate higher, in an effort to re-establish a more normalized level by historical standards, with seven separate 0.25% increases infrom December 2015 ~~and 2016, March 2017 and~~through June ~~2017,~~2018, resulting in the current range of 1%1.75% to ~~1.25%~~2.00%. Inflation has remained subdued, measured ~~for most of 2016~~through 2017 and the first ~~half~~six months of ~~2017~~2018 at levels at or below the Federal Open Market Committee’s 2% longer run ~~objective, though there have been some reports of wage pressure~~objective. The FOMC noted in its latest statement that the labor market continues to strengthen and that economic activity continues to rise at a solid rate with household spending picking up and business fixed investment growing. The Committee continues to suggest that as market conditions continue to improve, further gradual increases in the ~~U.S. employment picture has gradually improved over the past several years.~~federal funds rate will be warranted.

Although management cannot predict future changes in the rates of inflation, management monitors the impact of economic trends, including any indicators of inflationary pressures, in managing interest rate and other financial risks.
RECENT LEGISLATIVE DEVELOPMENTS
On May 24, 2018, President Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Act”), which was designed to ease certain restrictions imposed by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Most of the changes made by the new Act can be grouped into five general areas: mortgage lending; certain regulatory relief for “community” banks; enhanced consumer protections in specific areas, including subjecting credit reporting agencies to additional requirements; certain regulatory relief for large financial institutions, including increasing the threshold at which institutions are classified as systemically important financial institutions (from $50 billion to $250 billion) and therefore subject to stricter oversight, and revising the rules for larger institution stress testing; and certain changes to federal securities regulations designed to promote capital formation. Some of the key provisions of the Act as it relates to community banks and bank holding companies include, but are not limited to: (i) designating mortgages held in portfolio as “qualified mortgages” for banks with less than $10 billion in assets, subject to certain documentation and product limitations; (ii) exempting banks with less than $10 billion in assets from Volcker Rule requirements relating to proprietary trading; (iii) simplifying capital calculations for banks with less than $10 billion in assets by requiring federal banking agencies to establish a community bank leverage ratio of tangible equity to average consolidated assets of not less than 8% or more than 10%, and provide that banks that maintain tangible equity in excess of such ratio will be deemed to be in compliance with risk-based capital and leverage requirements; (iv) assisting smaller banks with obtaining stable funding by providing an exception for reciprocal deposits from FDIC restrictions on acceptance of brokered deposits; (v) raising the eligibility for use of short-form Call Reports from $1 billion to $5 billion in assets; and (vi) clarifying definitions pertaining to high volatility commercial real estate loans (HVCRE), which require higher capital allocations, so that only loans with increased risk are subject to higher risk weightings. The Corporation continues to analyze the changes implemented by the Act, but does not believe that such changes will materially impact the Corporation’s business, operations, or financial results.
61
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

MARKET RISK

Market risk is the risk of loss arising from adverse changes in market rates and prices of the Corporation’s financial instruments. In addition to the effects of interest rates, the market prices of the Corporation’s debt securities within the available-for-sale securities portfolio are affected by fluctuations in the risk premiums (amounts of spread over risk-free rates) demanded by investors. Management attempts to limit the risk that economic conditions would force the Corporation to sell securities for realized losses by maintaining a strong capital position (discussed in the “Stockholders’ Equity and Capital Adequacy” section of Management’s Discussion and Analysis) and ample sources of liquidity (discussed in the “Liquidity” section of Management’s Discussion and Analysis).

The Corporation’s major category of market risk, interest rate risk, is discussed in the following section.

INTEREST RATE RISK

Business risk arising from changes in interest rates is an inherent factor in operating a bank. A significant portion of the Corporation’s assets are long-term, fixed-rate loans and debt securities. Funding for these assets comes principally from shorter-term deposits and borrowed funds. Accordingly, there is an inherent risk of lower future earnings or decline in fair value of the Corporation’s financial instruments when interest rates change.

The Corporation uses a simulation model to calculate the potential effects of interest rate fluctuations on net interest income and the market value of portfolio equity. For purposes of these calculations, the market value of portfolio equity includes the fair values of financial instruments, such as securities, loans, deposits and borrowed funds, and the book values of nonfinancial assets and liabilities, such as premises and equipment and accrued expenses. The model measures and projects the amount of potential changes in net interest income, and calculates the discounted present value of anticipated cash flows of financial instruments, assuming an immediate increase or decrease in interest rates. Management ordinarily runs a variety of scenarios within a range of plus or minus 100-400 basis points of current rates.

The model makes estimates, at each level of interest rate change, regarding cash flows from principal repayments on loans and mortgage-backed securities and call activity on other investment securities. Actual results could vary significantly from these estimates, which could result in significant differences in the calculations of projected changes in net interest income and market value of portfolio equity. Also, the model does not make estimates related to changes in the composition of the deposit portfolio that could occur due to rate competition, and the table does not necessarily reflect changes that management would make to realign the portfolio as a result of changes in interest rates.

The Corporation’s Board of Directors has established policy guidelines for acceptable levels of interest rate risk, based on an immediate increase or decrease in interest rates. The policy limits acceptable fluctuations in net interest income from the baseline (flat rates) one-year scenario and variances in the market value of portfolio equity from the baseline values based on current rates.

Table XIII, which follows this discussion, is based on the results of calculations performed using the simulation model as of ~~April~~June 30, ~~2017~~2018 and December 31, ~~2016.~~2017. The table shows that as of the respective dates, the changes in net interest income and changes in market value were within the policy limits in all scenarios.

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

TABLE XIXIII - THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES

April 30, 2017 Data
June 30, 2018 Data
(Dollars In Thousands) Period Ending April 30, 2018 Period Ending June 30, 2019

Basis Point Interest Interest Net Interest NII NII Interest Interest Net Interest NII NII
Change in Rates Income Expense Income (NII) % Change Risk Limit Income Expense Income (NII) % Change Risk Limit
+400 $ 54,806 $ 22,388 $ 32,418 -18.8 % 25.0 % $ 60,391 $ 19,673 $ 40,718 -8.8 % 25.0 %
+300 52,065 17,689 34,376 -13.9 % 20.0 % 57,690 15,948 41,742 -6.5 % 20.0 %
+200 49,331 13,002 36,329 -9.0 % 15.0 % 55,020 12,222 42,798 -4.1 % 15.0 %
+100 46,567 8,329 38,238 -4.2 % 10.0 % 52,271 8,497 43,774 -1.9 % 10.0 %
0 43,721 3,789 39,932 0.0 % 0.0 % 49,417 4,778 44,639 0.0 % 0.0 %
-100 40,705 2,777 37,928 -5.0 % 10.0 % 46,175 3,123 43,052 -3.6 % 10.0 %
-200 38,867 2,621 36,246 -9.2 % 15.0 % 43,160 2,627 40,533 -9.2 % 15.0 %
-300 38,369 2,553 35,816 -10.3 % 20.0 % 41,520 2,439 39,081 -12.5 % 20.0 %
-400 38,172 2,553 35,619 -10.8 % 25.0 % 41,237 2,439 38,798 -13.1 % 25.0 %

Market Value of Portfolio Equity at April 30, 2017 Market Value of Portfolio Equity at June 30, 2018

Present Present Present Present Present Present
Basis Point Value Value Value Value Value Value
Change in Rates Equity % Change Risk Limit Equity % Change Risk Limit
+400 $ 174,874 -22.8 % 50.0 % $ 200,729 -15.8 % 40.0 %
+300 186,137 -17.9 % 45.0 % 208,792 -12.5 % 30.0 %
+200 198,978 -12.2 % 35.0 % 219,045 -8.2 % 25.0 %
+100 212,539 -6.2 % 25.0 % 228,463 -4.2 % 15.0 %
0 226,643 0.0 % 0.0 % 238,490 0.0 % 0.0 %
-100 228,853 1.0 % 25.0 % 240,239 0.7 % 15.0 %
-200 229,466 1.2 % 35.0 % 238,693 0.1 % 25.0 %
-300 254,165 12.1 % 45.0 % 239,087 0.3 % 30.0 %
-400 292,933 29.2 % 50.0 % 275,020 15.3 % 40.0 %

December 31, 2016 Data
(In Thousands) Period Ending December 31, 2017
December 31, 2017 Data December 31, 2017 Data
(Dollars in Thousands) Period Ending December 31, 2018

Basis Point Interest Interest Net Interest NII NII Interest Interest Net Interest NII NII
Change in Rates Income Expense Income (NII) % Change Risk Limit Income Expense Income (NII) % Change Risk Limit
+400 $ 53,712 $ 22,315 $ 31,397 -20.5 % 25.0 % $ 57,619 $ 19,730 $ 37,889 -10.8 % 25.0 %
+300 51,128 17,545 33,583 -15.0 % 20.0 % 54,978 15,852 39,126 -7.9 % 20.0 %
+200 48,500 12,809 35,691 -9.6 % 15.0 % 52,334 11,974 40,360 -5.0 % 15.0 %
+100 45,845 8,102 37,743 -4.4 % 10.0 % 49,620 8,095 41,525 -2.2 % 10.0 %
0 43,132 3,643 39,489 0.0 % 0.0 % 46,717 4,243 42,474 0.0 % 0.0 %
-100 40,581 2,978 37,603 -4.8 % 10.0 % 43,581 2,781 40,800 -3.9 % 10.0 %
-200 38,881 2,949 35,932 -9.0 % 15.0 % 41,290 2,216 39,074 -8.0 % 15.0 %
-300 38,269 2,936 35,333 -10.5 % 20.0 % 40,463 2,191 38,272 -9.9 % 20.0 %
-400 38,104 2,936 35,168 -10.9 % 25.0 % 40,194 2,191 38,003 -10.5 % 25.0 %

Market Value of Portfolio Equity at December 31, 2016 Market Value of Portfolio Equity at December 31, 2017

Present Present Present Present Present Present
Basis Point Value Value Value Value Value Value
Change in Rates Equity % Change Risk Limit Equity % Change Risk Limit
+400 $ 168,600 -24.6 % 50.0 % $ 195,385 -16.8 % 40.0 %
+300 180,500 -19.3 % 45.0 % 203,648 -13.3 % 30.0 %
+200 194,471 -13.1 % 35.0 % 213,689 -9.0 % 25.0 %
+100 208,830 -6.7 % 25.0 % 224,389 -4.4 % 15.0 %
0 223,744 0.0 % 0.0 % 234,759 0.0 % 0.0 %
-100 227,806 1.8 % 25.0 % 236,030 0.5 % 15.0 %
-200 229,602 2.6 % 35.0 % 234,863 0.0 % 25.0 %
-300 252,118 12.7 % 45.0 % 252,464 7.5 % 30.0 %
-400 290,792 30.0 % 50.0 % 292,124 24.4 % 40.0 %

6163
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

ITEM 4. CONTROLS AND PROCEDURES

The Corporation’s management, under the supervision of and with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, has carried out an evaluation of the design and effectiveness of the Corporation’s disclosure controls and procedures as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Securities Exchange Act of 1934 as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Corporation’s disclosure controls and procedures are effective to ensure that all material information required to be disclosed in reports the Corporation files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.

~~There~~During the quarter ended June 30, 2018, the Corporation completed the implementation of a new loan origination system for residential mortgages and consumer loans and revised certain loan processing procedures for residential mortgages, consumer loans and commercial loans. These changes included restructuring of the loan processing department and reassignment of responsibilities within that department. Management’s internal control oversight and assessment include consideration of these changes. Except as previously described, there were no significant changes in the Corporation’s internal control over financial reporting that occurred during the period covered by this report that have materially affected, or that are reasonably likely to affect, our internal control over financial reporting.

6264
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

PART II – OTHER INFORMATION

Item 1. Legal Proceedings
The Corporation and C&N Bank are involved in various legal proceedings incidental to their business. Management believes the aggregate liability, if any, resulting from such pending and threatened legal proceedings will not have a material, adverse effect on the Corporation’s financial condition or results of operations.
The Corporation and C&N Bank are involved in various legal proceedings incidental to their business.  Management believes the aggregate liability, if any, resulting from such pending and threatened legal proceedings will not have a material, adverse effect on the Corporation’s financial condition or results of operations.
Item 1A. Risk Factors
There have been no material changes from the risk factors previously disclosed in Item 1A of the Corporation’s Form 10-K filed February 15, 2018.
~~There have been no material changes from the risk factors previously disclosed in Item 1A of the Corporation’s Form 10-K filed February 16, 2017.~~
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
~~Issuer Purchases of Equity Securities~~
~~The following table sets forth a summary of the purchases by the Corporation, on the open market, of its equity securities during the second quarter 2017:~~

Period Total Number
of Shares
Purchased Average
Price Paid
per Share Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs Maximum Number of
Shares that May Yet
be Purchased Under
the Plans or Programs
April 1 - 30, 2017 0 $ 0 0 600,000
May 1 - 31, 2017 0 $ 0 0 600,000
June 1 - 30, 2017 0 $ 0 0 600,000
Issuer Purchases of Equity Securities
The following table sets forth a summary of the purchases by the Corporation, on the open market, of its equity securities during the second quarter 2018:
Period Total Number
of Shares
Purchased Average
Price Paid
per Share Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs Maximum Number of
Shares that May Yet
be Purchased Under
the Plans or
Programs
April 1 - 30, 2018 0 $ 0 0 600,000
May 1 - 31, 2018 0 $ 0 0 600,000
June 1 - 30, 2018 0 $ 0 0 600,000
Note to Table: Effective April 21, 2016, the Corporation’s Board of Directors approved a treasury stock repurchase program. Under this stock repurchase program, the Corporation is authorized to repurchase up to 600,000 shares of the Corporation's common stock or slightly less than 5% of the Corporation's issued and outstanding shares at April 19, 2016. The Board of Directors’ April 21, 2016 authorization provides that: (1) the new treasury stock repurchase program shall be effective when publicly announced and shall continue thereafter until suspended or terminated by the Board of Directors, in its sole discretion; and (2) all shares of common stock repurchased pursuant to the new program shall be held as treasury shares and be available for use and reissuance for purposes as and when determined by the Board of Directors including, without limitation, pursuant to the Corporation’s Dividend Reinvestment and Stock Purchase Plan and its equity compensation program. To date, no purchases have been made under this repurchase program.

Note to Table:  Effective April 21, 2016, the Corporation’s Board of Directors approved a treasury stock repurchase program.  Under this stock repurchase program, the Corporation is authorized to repurchase up to 600,000 shares of the Corporation’s common stock or slightly less than 5% of the Corporation’s issued and outstanding shares at April 19, 2016.  The Board of Directors’ April 21, 2016 authorization provides that: (1) the new treasury stock repurchase program shall be effective when publicly announced and shall continue thereafter until suspended or terminated by the Board of Directors, in its sole discretion; and (2) all shares of common stock repurchased pursuant to the new program shall be held as treasury shares and be available for use and reissuance for purposes as and when determined by the Board of Directors including, without limitation, pursuant to the Corporation’s Dividend Reinvestment and Stock Purchase Plan and its equity compensation program.  To date, no purchases have been made under this repurchase program.
Item 3. Defaults Upon Senior Securities
None
~~None~~
Item 4. Mine Safety Disclosures
Not applicable
~~Not applicable~~
Item 5. Other Information
~~None~~
None

6365
CITIZENS & NORTHERN CORPORATION – FORM 10-Q
~~Item 6.~~ ~~Exhibits~~
Item 6. Exhibits

2. Plan of acquisition, reorganization, arrangement, liquidation or succession Not applicable

3. (i) Articles of Incorporation ~~Articles of Incorporation~~ Incorporated by reference to Exhibit 3.1 of the ~~Corporation’s~~Corporation's Form 8-K filed September 21, 2009

3. (ii) By-laws ~~By-laws~~ Incorporated by reference to Exhibit 3.1 of the ~~Corporation’s~~Corporation's Form 8-K filed April 19, 2013

4. Instruments defining the rights of Security holders, including Indentures Not applicable

10. Material contracts:
~~10.~~10.1 Form of Indemnification Agreements dated May 24, 2018 between the Corporation and Directors Bobbi J. Kilmer, Terry L. Lehman, Frank G. Pellegrino and Aaron K. Singer ~~Material contracts~~ ~~Not applicable~~Filed herewith

11. Statement re: computation of per share earnings Information concerning the computation of
earnings per share is provided in Note 2
to the unaudited consolidated financial
statements, which is included in Part I,
Item 1 of Form 10-Q

15. Letter re: unaudited interim information Not applicable

18. Letter re: change in accounting principles Not applicable

19. Report furnished to security holders Not applicable

22. Published report regarding matters submitted to vote of security holders Not applicable

23. Consents of experts and counsel Not applicable

24. Power of attorney Not applicable

31. Rule 13a-14(a)/15d-14(a) certifications:
31.1 Certification of Chief Executive Officer Filed herewith
31.2 Certification of Chief Financial Officer Filed herewith
32. Section 1350 certifications Filed herewith
99. Additional exhibits Not applicable
100. XBRL-related documents Not applicable
101. Interactive data file Filed herewith

~~32.~~ ~~Section 1350 certifications~~ ~~Filed herewith~~
~~99.~~ ~~Additional exhibits~~ ~~Not applicable~~
~~100.~~ ~~XBRL-related documents~~ ~~Not applicable~~
~~101.~~ ~~Interactive data file~~ ~~Filed herewith~~

6466
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

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 & NORTHERN CORPORATION

August ~~3, 2017~~6, 2018 By: ~~/s/~~ /s/ J. Bradley Scovill
Date President and Chief Executive Officer

August ~~3, 2017~~6, 2018 By: ~~/s/~~ /s/ Mark A. Hughes
Date Treasurer and Chief Financial Officer

6567

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2017			2016			2017			2016
Net income	$	4,121		$	3,871		$	7,555		$	7,444

Unrealized gains on available-for-sale securities:
Unrealized holding gains on available-for-sale securities		1,644			2,431			2,280			7,205
Reclassification adjustment for gains realized in income		(107	)		(122	)		(252	)		(505	)
Other comprehensive gain on available-for-sale securities		1,537			2,309			2,028			6,700

Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses included in accumulated other comprehensive gain		0			0			166			26
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost		(6	)		(5	)		(12	)		(10	)
Other comprehensive (loss) gain on unfunded retirement obligations		(6	)		(5	)		154			16

Other comprehensive income before income tax		1,531			2,304			2,182			6,716
Income tax related to other comprehensive income		(536	)		(806	)		(764	)		(2,350	)

Net other comprehensive income		995			1,498			1,418			4,366

Comprehensive income	$	5,116		$	5,369		$	8,973		$	11,810

														Accumulated																						Accumulated
														Other																						Other
	Common		Treasury			Common		Paid-in			Retained			Comprehensive			Treasury						Common		Treasury			Common		Paid-in			Retained			Comprehensive			Treasury
																							Shares		Shares			Stock		Capital			Earnings			Income (Loss)			Stock			Total
Six Months Ended June 30, 2018
Balance, December 31, 2017																								12,655,171		440,646		$	12,655	$	72,035		$	113,608		($	1,507	)	($	8,348	)	$	188,443
Impact of change in enacted income tax rate (a)																																		325			(325	)					0
Impact of change in method of premium amortization of callable debt securities (b)																																		(26	)		26						0
Impact of change in method of accounting for marketable equity security (c)																																		(22	)		22						0
Net income																																		10,746									10,746
Other comprehensive loss, net																																					(4,555	)					(4,555	)
Cash dividends declared on common stock, $0.54 per share																																		(6,619	)								(6,619	)
Shares issued for dividend reinvestment Plan																										(31,572	)				163									598			761
Shares issued from treasury and redeemed related to exercise of stock options																										(7,417	)				(75	)								140			65
Restricted stock granted																										(34,552	)				(655	)								655			0
Forfeiture of restricted stock																										7,528					141									(141	)		0
Stock-based compensation expense																															338												338
Balance, June 30, 2018																								12,655,171		374,633		$	12,655	$	71,947		$	118,012		$	(6,339	)	$	(7,096	)	$	189,179
	Shares		Shares			Stock		Capital			Earnings			(Loss) Income			Stock			Total
Six Months Ended June 30, 2017
Balance, December 31, 2016		12,655,171		541,943		$	12,655	$	71,730		$	112,790		$	(898	)	$	(10,269	)	$	186,008			12,655,171		541,943		$	12,655	$	71,730		$	112,790		($	898	)	($	10,269	)	$	186,008
Net income												7,555									7,555													7,555									7,555
Other comprehensive income, net															1,418						1,418																1,418						1,418
Cash dividends declared on common stock, $0.52 per share												(6,279	)								(6,279	)												(6,279	)								(6,279	)
Shares issued for dividend reinvestment plan				(31,913	)				148									606			754
Shares issued for dividend reinvestment Plan																										(31,913	)				148									606			754
Shares issued from treasury and redeemed related to exercise of stock options				(4,578	)				(4	)								85			81					(4,578	)				(4	)								85			81
Restricted stock granted				(30,782	)				(583	)								583			0					(30,782	)				(583	)								583			0
Forfeiture of restricted stock				3,808					71									(71	)		0					3,808					71									(71	)		0
Stock-based compensation expense									322												322										322												322
Balance, June 30, 2017		12,655,171		478,478		$	12,655	$	71,684		$	114,066		$	520		$	(9,066	)	$	189,859			12,655,171		478,478		$	12,655	$	71,684		$	114,066		$	520		($	9,066	)	$	189,859

Six Months Ended June 30, 2016
Balance, December 31, 2015		12,655,171		474,548		$	12,655	$	71,654		$	109,454		$	2,528		$	(8,804	)	$	187,487
Net income												7,444									7,444
Other comprehensive income, net															4,366						4,366
Cash dividends declared on common stock, $0.52 per share												(6,298	)								(6,298	)
Shares issued for dividend reinvestment plan				(36,771	)				48									693			741
Treasury stock purchased				187,075														(3,723	)		(3,723	)
Shares issued from treasury and redeemed related to exercise of stock options				(5,556	)				(9	)								109			100
Restricted stock granted				(35,427	)				(658	)								658			0
Forfeiture of restricted stock				1,107					20									(20	)		0
Stock-based compensation expense									325												325
Tax effect of stock option exercises									(1	)											(1	)
Tax benefit from dividends on restricted stock									12												12
Tax benefit from compensation plans												77									77
Balance, June 30, 2016		12,655,171		584,976		$	12,655	$	71,391		$	110,677		$	6,894		$	(11,087	)	$	190,530

(In Thousands)	Before-Tax			Income Tax			Net-of-Tax
	Amount			Effect			Amount
Six Months Ended June 30, 2017
Unrealized gains on available-for-sale securities:
Unrealized holding gains on available-for-sale securities	$	2,280		$	(798	)	$	1,482
Reclassification adjustment for (gains) realized in income		(252	)		88			(164	)
Other comprehensive income on available-for-sale securities		2,028			(710	)		1,318

Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses included in other comprehensive income		166			(58	)		108
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost		(12	)		4			(8	)
Other comprehensive income on unfunded retirement obligations		154			(54	)		100

Total other comprehensive income	$	2,182		$	(764	)	$	1,418

(In Thousands)	Unrealized						Accumulated			Unrealized						Accumulated
	Holding Gains			Unfunded			Other			(Losses)			Unfunded			Other
	(Losses)			Retirement			Comprehensive			Gains			Retirement			Comprehensive
	on Securities			Obligations			Income			on Securities			Obligations			Income (Loss)
Six Months Ended June 30, 2018
Balance, beginning of period										$	(1,566	)	$	59		$	(1,507	)
Impact of change in enacted income tax rate											(337	)		12			(325	)
Impact of change in the method of premium amortization of callable debt securities											26			0			26
Impact of change in the method of accounting for marketable equity security											22			0			22
Other comprehensive (loss) income during six months ended June 30, 2018											(4,621	)		66			(4,555	)
Balance, end of period										$	(6,476	)	$	137		$	(6,339	)

Six Months Ended June 30, 2017
Balance, beginning of period	$	(949	)	$	51		$	(898	)	$	(949	)	$	51		$	(898	)
Change during six months ended June 30, 2017		1,318			100			1,418
Other comprehensive income during six months ended June 30, 2017											1,318			100			1,418
Balance, end of period	$	369		$	151		$	520		$	369		$	151		$	520

Six Months Ended June 30, 2016
Three Months Ended June 30, 2018
Balance, beginning of period	$	2,493		$	35		$	2,528		$	(5,679	)	$	141		$	(5,538	)
Change during six months ended June 30, 2016		4,356			10			4,366
Other comprehensive (loss) during three months ended June 30, 2018											(797	)		(4	)		(801	)
Balance, end of period	$	6,849		$	45		$	6,894		$	(6,476	)	$	137		$	(6,339	)

Three Months Ended June 30, 2017
Balance, beginning of period	$	(630	)	$	155		$	(475	)	$	(630	)	$	155		$	(475	)
Change during three months ended June 30, 2017		999			(4	)		995
Other comprehensive income (loss) during three months ended June 30, 2017											999			(4	)		995
Balance, end of period	$	369		$	151		$	520		$	369		$	151		$	520

Three Months Ended June 30, 2016
Balance, beginning of period	$	5,347		$	49		$	5,396
Change during three months ended June 30, 2016		1,502			(4	)		1,498
Balance, end of period	$	6,849		$	45		$	6,894

For the Six Months Ended June 30, 2018
(In Thousands)
	Reclassified from
Details about Accumulated Other	Accumulated Other			Affected Line Item in the Consolidated
Comprehensive Loss Components	Comprehensive Loss			Statements of Income
Unrealized gains and losses on available-for-sale securities	$	282		Realized losses on available-for-sale debt securities, net
		(59	)	Income tax provision
		223		Net of tax
Amortization of defined benefit pension and postretirement items:
Prior service cost		(16	)	Other noninterest expense
Actuarial loss		6		Other noninterest expense
		(10	)	Total before tax
		2		Income tax provision
		(8	)	Net of tax
Total reclassifications for the period	$	215

For the Six Months Ended June 30, 2017
(In Thousands)
	Reclassified from				Reclassified from
Details about Accumulated Other	Accumulated Other			Affected Line Item in the Consolidated	Accumulated Other			Affected Line Item in the Consolidated
Comprehensive Income Components	Comprehensive Income			Statements of Income
Comprehensive Loss Components					Comprehensive Loss			Statements of Income
Unrealized gains and losses on available-for-sale securities	$	(252	)	Realized gains on available-for-sale securities, net	$	(252	)	Realized gains on available-for-sale debt securities, net
		88		Income tax provision		88		Income tax provision
		(164	)	Net of tax		(164	)	Net of tax
Amortization of defined benefit pension and postretirement items:
Prior service cost		(15	)	Pensions and other employee benefits		(15	)	Other noninterest expense
Actuarial loss		3		Pensions and other employee benefits		3		Other noninterest expense
		(12	)	Total before tax		(12	)	Total before tax
		4		Income tax provision		4		Income tax provision
		(8	)	Net of tax		(8	)	Net of tax
Total reclassifications for the period	$	(172	)		$	(172	)

For the Three Months Ended June 30, 2018
(In Thousands)
	Reclassified from
Details about Accumulated Other	Accumulated Other			Affected Line Item in the Consolidated
Comprehensive Loss Components	Comprehensive Loss			Statements of Income
Unrealized gains and losses on available-for-sale securities	$	282		Realized losses on available-for-sale debt securities, net
		(59	)	Income tax provision
		223		Net of tax
Amortization of defined benefit pension and postretirement items:
Prior service cost		(8	)	Other noninterest expense
Actuarial loss		3		Other noninterest expense
		(5	)	Total before tax
		1		Income tax provision
		(4	)	Net of tax
Total reclassifications for the period	$	219

For the Three Months Ended June 30, 2017
(In Thousands)
	Reclassified from
Details about Accumulated Other	Accumulated Other			Affected Line Item in the Consolidated
Comprehensive Loss Components	Comprehensive Loss			Statements of Income
Unrealized gains and losses on available-for-sale securities	$	(107	)	Realized gains on available-for-sale debt securities, net
		37		Income tax provision
		(70	)	Net of tax
Amortization of defined benefit pension and postretirement items:
Prior service cost		(7	)	Other noninterest expense
Actuarial loss		1		Other noninterest expense
		(6	)	Total before tax
		2		Income tax provision
		(4	)	Net of tax
Total reclassifications for the period	$	(74	)

(In thousands)	June 30,		Dec. 31,		June 30,		Dec. 31,
	2017		2016		2018		2017
Cash and cash equivalents	$	31,403	$	28,621	$	48,705	$	37,004
Certificates of deposit		3,240		3,488		2,770		3,240
Total cash and due from banks	$	34,643	$	32,109	$	51,475	$	40,244

	June 30, 2017												June 30, 2018
	Quoted Prices		Other								Quoted Prices		Other
	in Active		Observable		Unobservable			Total			in Active		Observable		Unobservable			Total
	Markets		Inputs		Inputs			Fair			Markets		Inputs		Inputs			Fair
(In Thousands)	(Level 1)		(Level 2)		(Level 3)			Value			(Level 1)		(Level 2)		(Level 3)			Value

Recurring fair value measurements
AVAILABLE-FOR-SALE SECURITIES:
AVAILABLE-FOR-SALE DEBT SECURITIES:
Obligations of U.S. Government agencies	$	0	$	9,591	$	0		$	9,591		$	0	$	7,779	$	0		$	7,779
Obligations of states and political subdivisions:
Tax-exempt		0		116,338		0			116,338			0		101,700		0			101,700
Taxable		0		28,452		0			28,452			0		26,066		0			26,066
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities		0		47,405		0			47,405			0		58,330		0			58,330
Residential collateralized mortgage obligations		0		128,248		0			128,248			0		121,933		0			121,933
Commercial mortgage-backed securities		0		33,742		0			33,742			0		32,236		0			32,236
Total debt securities		0		363,776		0			363,776
Marketable equity securities		977		0		0			977
Total available-for-sale securities		977		363,776		0			364,753
Total available-for-sale debt securities												0		348,044		0			348,044
Marketable equity security												948		0		0			948
Restricted equity security												0		0		866			866
Servicing rights		0		0		1,279			1,279			0		0		1,370			1,370
Total recurring fair value measurements	$	977	$	363,776	$	1,279		$	366,032		$	948	$	348,044	$	2,236		$	351,228

Nonrecurring fair value measurements
Impaired loans with a valuation allowance	$	0	$	0	$	3,293		$	3,293		$	0	$	0	$	3,652		$	3,652
Valuation allowance		0		0		(1,083	)		(1,083	)		0		0		(1,095	)		(1,095	)
Impaired loans, net		0		0		2,210			2,210			0		0		2,557			2,557
Foreclosed assets held for sale		0		0		2,023			2,023			0		0		2,897			2,897
Total nonrecurring fair value measurements	$	0	$	0	$	4,233		$	4,233		$	0	$	0	$	5,454		$	5,454

	December 31, 2016												December 31, 2017
	Quoted Prices		Other								Quoted Prices		Other
	in Active		Observable		Unobservable			Total			in Active		Observable		Unobservable			Total
	Markets		Inputs		Inputs			Fair			Markets		Inputs		Inputs			Fair
(In Thousands)	(Level 1)		(Level 2)		(Level 3)			Value			(Level 1)		(Level 2)		(Level 3)			Value

Recurring fair value measurements
AVAILABLE-FOR-SALE SECURITIES:
AVAILABLE-FOR-SALE DEBT SECURITIES:
Obligations of U.S. Government agencies	$	0	$	9,541	$	0		$	9,541		$	0	$	7,873	$	0		$	7,873
Obligations of states and political subdivisions:
Tax-exempt		0		119,037		0			119,037			0		105,111		0			105,111
Taxable		0		30,297		0			30,297			0		25,573		0			25,573
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities		0		58,404		0			58,404			0		52,347		0			52,347
Residential collateralized mortgage obligations		0		146,608		0			146,608			0		131,814		0			131,814
Commercial mortgage-backed securities		0		30,219		0			30,219			0		33,219		0			33,219
Total debt securities		0		394,106		0			394,106
Marketable equity securities		971		0		0			971
Total available-for-sale securities		971		394,106		0			395,077
Total available-for-sale debt securities												0		355,937		0			355,937
Marketable equity security												971		0		0			971
Servicing rights		0		0		1,262			1,262			0		0		1,299			1,299
Total recurring fair value measurements	$	971	$	394,106	$	1,262		$	396,339		$	971	$	355,937	$	1,299		$	358,207

Nonrecurring fair value measurements
Impaired loans with a valuation allowance	$	0	$	0	$	3,372		$	3,372		$	0	$	0	$	3,776		$	3,776
Valuation allowance		0		0		(674	)		(674	)		0		0		(1,183	)		(1,183	)
Impaired loans, net		0		0		2,698			2,698			0		0		2,593			2,593
Foreclosed assets held for sale		0		0		2,180			2,180			0		0		1,598			1,598
Total nonrecurring fair value measurements	$	0	$	0	$	4,878		$	4,878		$	0	$	0	$	4,191		$	4,191

	Fair Value at								Fair Value at
	6/30/17		Valuation	Unobservable	Method or Value As of				6/30/18		Valuation	Unobservable				Method or Value As of
Asset	(In Thousands)		Technique	Input(s)	6/30/17				(In Thousands)		Technique	Input(s)				6/30/18
Servicing rights	$	1,279	Discounted cash flow	Discount rate		13.00	%	Rate used through modeling period	$	1,370	Discounted cash flow	Discount rate		13.00	%	Rate used through modeling period
				Loan prepayment speeds		137.00	%	Weighted-average PSA				Loan prepayment speeds		119.00	%	Weighted-average PSA
				Servicing fees		0.25	%	of loan balances				Servicing fees		0.25	%	of loan balances
						4.00	%	of payments are late						4.00	%	of payments are late
						5.00	%	late fees assessed						5.00	%	late fees assessed
					$	1.94		Miscellaneous fees per account per month					$	1.94		Miscellaneous fees per account per month
				Servicing costs	$	6.00		Monthly servicing cost per account				Servicing costs	$	6.00		Monthly servicing cost per account
					$	24.00		Additional monthly servicing cost per loan on loans more than 30 days delinquent					$	24.00		Additional monthly servicing cost per loan on loans more than 30 days delinquent
						1.50	%	of loans more than 30 days delinquent						1.50	%	of loans more than 30 days delinquent
						3.00	%	annual increase in servicing costs						3.00	%	annual increase in servicing costs

(In Thousands, Except									Weighted-
Percentages)			Valuation						Average
	Balance at		Allowance at		Fair Value at		Valuation	Unobservable	Discount at
Asset	6/30/17		6/30/17		6/30/17		Technique	Inputs	6/30/17

Impaired loans:
Commercial:
Commercial loans secured by real estate	$	2,718	$	958	$	1,760	Sales comparison	Discount to appraised value		16	%
Commercial and industrial		75		75		0	Sales comparison	Discount to appraised value		100	%
Loans secured by farmland		500		50		450	Sales comparison	Discount to appraised value		53	%
Total impaired loans	$	3,293	$	1,083	$	2,210
Foreclosed assets held for sale - real estate:
Residential (1-4 family)	$	879	$	0	$	879	Sales comparison	Discount to appraised value		33	%
Land		646		0		646	Sales comparison	Discount to appraised value		34	%
Commercial real estate		498		0		498	Sales comparison	Discount to appraised value		49	%
Total foreclosed assets held for sale	$	2,023	$	0	$	2,023

(In Thousands)	Fair Value	June 30, 2018				December 31, 2017
	Hierarchy	Carrying		Fair		Carrying		Fair
	Level	Amount		Value		Amount		Value
Financial assets:
Cash and cash equivalents	Level 1	$	48,705	$	48,705	$	37,004	$	37,004
Certificates of deposit	Level 2		2,770		2,755		3,240		3,234
Restricted equity securities (included in Other Assets)	Level 2		5,078		5,078		6,556		6,556
Loans, net	Level 3		809,816		807,330		806,857		789,891
Accrued interest receivable	Level 2		4,042		4,042		4,048		4,048

Financial liabilities:
Deposits with no stated maturity	Level 2		801,332		801,332		794,778		794,778
Time deposits	Level 2		239,567		239,718		213,671		213,734
Short-term borrowings	Level 2		17,169		16,954		61,766		61,643
Long-term borrowings	Level 2		27,054		27,075		9,189		9,256
Accrued interest payable	Level 2		107		107		46		46

	June 30, 2017
			Gross		Gross
			Unrealized		Unrealized
	Amortized		Holding		Holding			Fair
(In Thousands)	Cost		Gains		Losses			Value

Obligations of U.S. Government agencies	$	9,678	$	0	$	(87	)	$	9,591
Obligations of states and political subdivisions:
Tax-exempt		114,095		2,899		(656	)		116,338
Taxable		28,162		344		(54	)		28,452
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities		47,767		111		(473	)		47,405
Residential collateralized mortgage obligations		129,372		360		(1,484	)		128,248
Commercial mortgage-backed securities		34,112		37		(407	)		33,742
Total debt securities		363,186		3,751		(3,161	)		363,776
Marketable equity securities		1,000		0		(23	)		977
Total	$	364,186	$	3,751	$	(3,184	)	$	364,753

June 30, 2017	Less Than 12 Months					12 Months or More					Total
June 30, 2018																Less Than 12 Months					12 Months or More					Total
(In Thousands)	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized			Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses			Value		Losses			Value		Losses			Value		Losses

Obligations of U.S. Government agencies	$	7,943	$	(87	)	$	0	$	0		$	7,943	$	(87	)
Obligations of states and political subdivisions:
Tax-exempt		32,129		(557	)		3,698		(99	)		35,827		(656	)	$	27,053	$	(410	)	$	15,981	$	(1,350	)	$	43,034	$	(1,760	)
Taxable		7,558		(54	)		0		0			7,558		(54	)		14,749		(183	)		2,237		(59	)		16,986		(242	)
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities		33,600		(473	)		0		0			33,600		(473	)		27,123		(733	)		24,818		(1,126	)		51,941		(1,859	)
Residential collateralized mortgage obligations		67,281		(891	)		20,176		(593	)		87,457		(1,484	)		57,687		(1,583	)		60,666		(2,963	)		118,353		(4,546	)
Commercial mortgage-backed securities		24,948		(262	)		4,793		(145	)		29,741		(407	)		18,795		(651	)		14,092		(784	)		32,887		(1,435	)
Total debt securities		173,459		(2,324	)		28,667		(837	)		202,126		(3,161	)
Marketable equity securities		1,000		(23	)		0		0			1,000		(23	)
Total temporarily impaired available-for-sale securities	$	174,459	$	(2,347	)	$	28,667	$	(837	)	$	203,126	$	(3,184	)
Total temporarily impaired available-for-sale debt securities																$	145,407	$	(3,560	)	$	117,794	$	(6,282	)	$	263,201	$	(9,842	)

Summary of Loans by Type
(In Thousands)	June 30,			Dec. 31,			June 30,			Dec. 31,
	2017			2016			2018			2017
Residential mortgage:
Residential mortgage loans - first liens	$	342,603		$	334,102		$	361,592		$	359,987
Residential mortgage loans - junior liens		24,150			23,706			26,594			25,325
Home equity lines of credit		37,159			38,057			34,852			35,758
1-4 Family residential construction		26,067			24,908			26,722			26,216
Total residential mortgage		429,979			420,773			449,760			447,286

Commercial:
Commercial loans secured by real estate		155,158			150,468			159,392			159,266
Commercial and industrial		82,815			83,854			88,499			88,276
Political subdivisions		51,495			38,068			56,690			59,287
Commercial construction and land		15,201			14,287			13,066			14,527
Loans secured by farmland		7,432			7,294			7,397			7,255
Multi-family (5 or more) residential		7,497			7,896			7,860			7,713
Agricultural loans		4,454			3,998			5,622			6,178
Other commercial loans		11,038			11,475			14,455			10,986
Total commercial		335,090			317,340			352,981			353,488

Consumer		14,623			13,722			15,906			14,939

Total		779,692			751,835			818,647			815,713
Less: allowance for loan losses		(8,635	)		(8,473	)		(8,831	)		(8,856	)

Loans, net	$	771,057		$	743,362		$	809,816		$	806,857

Three Months Ended June 30, 2017	March 31,											June 30,
Three Months Ended June 30, 2018														March 31,										June 30,
(In Thousands)	2017 Balance		Charge-offs			Recoveries			Provision (Credit)			2017 Balance		2018 Balance		Charge-offs			Recoveries		Provision (Credit)			2018 Balance
Allowance for Loan Losses:
Residential mortgage:
Residential mortgage loans - first liens	$	3,125	$	(99	)	$	12		$	14		$	3,052	$	3,067	$	(34	)	$	1	$	21		$	3,055
Residential mortgage loans - junior liens		256		(16	)		1			20			261		351		0			2		0			353
Home equity lines of credit		338		0			0			(6	)		332		286		(12	)		0		18			292
1-4 Family residential construction		240		0			0			11			251		239		0			0		8			247
Total residential mortgage		3,959		(115	)		13			39			3,896		3,943		(46	)		3		47			3,947
Commercial:
Commercial loans secured by real estate		2,685		0			0			(75	)		2,610		2,635		0			0		(22	)		2,613
Commercial and industrial		906		(1	)		1			4			910		1,036		(133	)		1		69			973
Commercial construction and land		169		0			0			(7	)		162		137		0			0		(2	)		135
Loans secured by farmland		111		0			0			(4	)		107		102		0			0		4			106
Multi-family (5 or more) residential		236		0			0			(67	)		169		169		0			0		5			174
Agricultural loans		39		0			0			3			42		205		0			0		(159	)		46
Other commercial loans		109		0			0			(4	)		105		149		0			0		(15	)		134
Total commercial		4,255		(1	)		1			(150	)		4,105		4,433		(133	)		1		(120	)		4,181
Consumer		132		(19	)		8			13			134		174		(32	)		9		53			204
Unallocated		398		0			0	��		102			500		499		0			0		0			499
Total Allowance for Loan Losses	$	8,744	$	(135	)	$	22		$	4		$	8,635	$	9,049	$	(211	)	$	13	$	(20	)	$	8,831

June 30, 2017	Loans:						Allowance for Loan Losses:
June 30, 2018													Loans:						Allowance for Loan Losses:
(In Thousands)
	Individually		Collectively				Individually		Collectively				Individually		Collectively				Individually		Collectively
	Evaluated		Evaluated		Totals		Evaluated		Evaluated		Totals		Evaluated		Evaluated		Totals		Evaluated		Evaluated		Totals
Residential mortgage:
Residential mortgage loans - first liens	$	732	$	341,871	$	342,603	$	0	$	3,052	$	3,052	$	959	$	360,633	$	361,592	$	0	$	3,055	$	3,055
Residential mortgage loans - junior liens		63		24,087		24,150		0		261		261		296		26,298		26,594		120		233		353
Home equity lines of credit		0		37,159		37,159		0		332		332		0		34,852		34,852		0		292		292
1-4 Family residential construction		0		26,067		26,067		0		251		251		0		26,722		26,722		0		247		247
Total residential mortgage		795		429,184		429,979		0		3,896		3,896		1,255		448,505		449,760		120		3,827		3,947
Commercial:
Commercial loans secured by real estate		5,953		149,205		155,158		958		1,652		2,610		4,128		155,264		159,392		850		1,763		2,613
Commercial and industrial		159		82,656		82,815		75		835		910		167		88,332		88,499		75		898		973
Political subdivisions		0		51,495		51,495		0		0		0		0		56,690		56,690		0		0		0
Commercial construction and land		0		15,201		15,201		0		162		162		0		13,066		13,066		0		135		135
Loans secured by farmland		1,379		6,053		7,432		50		57		107		1,358		6,039		7,397		50		56		106
Multi-family (5 or more) residential		392		7,105		7,497		0		169		169		392		7,468		7,860		0		174		174
Agricultural loans		12		4,442		4,454		0		42		42		680		4,942		5,622		0		46		46
Other commercial loans		0		11,038		11,038		0		105		105		0		14,455		14,455		0		134		134
Total commercial		7,895		327,195		335,090		1,083		3,022		4,105		6,725		346,256		352,981		975		3,206		4,181
Consumer		21		14,602		14,623		0		134		134		18		15,888		15,906		0		204		204
Unallocated												500												499

Total	$	8,711	$	770,981	$	779,692	$	1,083	$	7,052	$	8,635	$	7,998	$	810,649	$	818,647	$	1,095	$	7,237	$	8,831

									Interest Income Recognized on																Interest Income Recognized on
	Average Investment in Impaired Loans								Impaired Loans on a Cash Basis								Average Investment in Impaired Loans								Impaired Loans on a Cash Basis
(In Thousands)	3 Months Ended				6 Months Ended				3 Months Ended				6 Months Ended				3 Months Ended				6 Months Ended				3 Months Ended				6 Months Ended
	June 30,				June 30,				June 30,				June 30,				June 30,				June 30,				June 30,				June 30,
	2017		2016		2017		2016		2017		2016		2017		2016		2018		2017		2018		2017		2018		2017		2018		2017
Residential mortgage:
Residential mortgage loans - first lien	$	738	$	833	$	743	$	847	$	8	$	12	$	17	$	22	$	1,108	$	738	$	1,077	$	743	$	11	$	8	$	30	$	17
Residential mortgage loans - junior lien		65		71		66		72		1		1		2		2		299		65		300		66		4		1		7		2
Total residential mortgage		803		904		809		919		9		13		19		24		1,407		803		1,377		809		15		9		37		19
Commercial:
Commercial loans secured by real estate		6,219		5,892		6,554		6,026		35		81		91		191		4,592		6,219		5,237		6,554		35		35		70		91
Commercial and industrial		235		754		241		661		4		7		7		10		280		235		394		241		1		4		7		7
Commercial construction and land		0		0		0		0		0		0		0		0
Loans secured by farmland		1,382		1,413		1,386		1,418		14		17		22		38		1,360		1,382		1,362		1,386		10		14		16		22
Multi-family (5 or more) residential		392		490		392		590		0		0		0		0		392		392		392		392		0		0		0		0
Agricultural loans		12		15		12		15		0		0		1		1		568		12		457		12		7		0		18		1
Total commercial		8,240		8,564		8,585		8,710		53		105		121		240		7,192		8,240		7,842		8,585		53		53		111		121
Consumer		25		18		29		15		0		0		0		0		19		25		19		29		0		0		0		0
Total	$	9,068	$	9,486	$	9,423	$	9,644	$	62	$	118	$	140	$	264	$	8,618	$	9,068	$	9,238	$	9,423	$	68	$	62	$	148	$	140

	As of June 30, 2017								As of December 31, 2016								As of June 30, 2018								As of December 31, 2017
	Current &								Current &								Current &								Current &
(In Thousands)	Past Due		Past Due		Past Due				Past Due		Past Due		Past Due				Past Due		Past Due		Past Due				Past Due		Past Due		Past Due
	Less than		30-89		90+				Less than		30-89		90+				Less than		30-89		90+				Less than		30-89		90+
	30 Days		Days		Days		Total		30 Days		Days		Days		Total		30 Days		Days		Days		Total		30 Days		Days		Days		Total
Residential mortgage:
Residential mortgage loans - first liens	$	335,563	$	3,639	$	3,401	$	342,603	$	321,670	$	6,695	$	5,737	$	334,102	$	353,568	$	4,230	$	3,794	$	361,592	$	347,032	$	7,967	$	4,988	$	359,987
Residential mortgage loans - junior liens		24,081		69		0		24,150		23,268		324		114		23,706		26,441		123		30		26,594		25,133		87		105		25,325
Home equity lines of credit		36,741		305		113		37,159		37,603		134		320		38,057		34,152		565		135		34,852		34,789		732		237		35,758
1-4 Family residential construction		25,802		265		0		26,067		24,567		341		0		24,908		26,722		0		0		26,722		25,667		549		0		26,216
Total residential mortgage		422,187		4,278		3,514		429,979		407,108		7,494		6,171		420,773		440,883		4,918		3,959		449,760		432,621		9,335		5,330		447,286

Commercial:
Commercial loans secured by real estate		152,173		92		2,893		155,158		147,464		82		2,922		150,468		157,813		201		1,378		159,392		155,917		311		3,038		159,266
Commercial and industrial		82,410		85		320		82,815		83,364		185		305		83,854		87,702		20		777		88,499		87,306		303		667		88,276
Political subdivisions		51,495		0		0		51,495		38,068		0		0		38,068		56,690		0		0		56,690		59,287		0		0		59,287
Commercial construction and land		15,024		64		113		15,201		14,199		88		0		14,287		12,980		34		52		13,066		14,400		49		78		14,527
Loans secured by farmland		6,262		92		1,078		7,432		6,181		83		1,030		7,294		5,884		544		969		7,397		6,226		12		1,017		7,255
Multi-family (5 or more) residential		7,105		0		392		7,497		7,439		65		392		7,896		7,446		22		392		7,860		7,321		0		392		7,713
Agricultural loans		4,389		53		12		4,454		3,981		4		13		3,998		5,615		1		6		5,622		6,114		57		7		6,178
Other commercial loans		11,038		0		0		11,038		11,475		0		0		11,475		14,455		0		0		14,455		10,986		0		0		10,986
Total commercial		329,896		386		4,808		335,090		312,171		507		4,662		317,340		348,585		822		3,574		352,981		347,557		732		5,199		353,488
Consumer		14,390		78		155		14,623		13,446		153		123		13,722		15,770		112		24		15,906		14,760		123		56		14,939

Totals	$	766,473	$	4,742	$	8,477	$	779,692	$	732,725	$	8,154	$	10,956	$	751,835	$	805,238	$	5,852	$	7,557	$	818,647	$	794,938	$	10,190	$	10,585	$	815,713

(Balances in Thousands)	Six Months Ended				Six Months Ended
	June 30, 2018				June 30, 2017
			Post-				Post-
	Number		Modification		Number		Modification
	of		Recorded		of		Recorded
	Loans		Investment		Loans		Investment
Residential mortgage - first liens,
Reduced monthly payments for a six-month period		1	$	80		0	$	0
Commercial loans secured by real estate,
Extended interest only payments for a six-month period		2		36		0		0
Commercial and industrial,
Extended interest only payments for a six-month period		1		46		0		0
Total		4	$	162		0	$	0

Defined Benefit Plans
(In Thousands)	Pension						Postretirement						Pension						Postretirement
	Six Months Ended						Six Months Ended						Six Months Ended						Six Months Ended
	June 30,						June 30,						June 30,						June 30,
	2017			2016			2017			2016			2018			2017			2018			2017
Service cost	$	0		$	0		$	18		$	18		$	0		$	0		$	20		$	18
Interest cost		12			13			28			31			13			12			26			28
Expected return on plan assets		(15	)		(13	)		0			0			(10	)		(15	)		0			0
Amortization of prior service cost		0			0			(15	)		(15	)		0			0			(16	)		(15	)
Recognized net actuarial loss		3			5			0			0			6			3			0			0
Net periodic benefit cost	$	0		$	5		$	31		$	34		$	9		$	0		$	30		$	31

(Dollars In Thousands, Except Per Share Data)
(Unaudited)	2nd Quarter 2018											2nd Quarter 2017
	Income									Diluted		Income									Diluted
	Before			Income						Earnings		Before			Income						Earnings
	Income			Tax						per		Income			Tax						per
	Tax			Provision			Net			Common		Tax			Provision			Net			Common
	Provision			(1)			Income			Share		Provision			(1)			Income			Share
Results as Presented Under U.S. GAAP	$	7,748		$	1,377		$	6,371		$	0.52	$	5,495		$	1,374		$	4,121		$	0.34
Less: Gain on Restricted Equity Security		(1,750	)		(368	)		(1,382	)				0			0			0
Net Losses (Gains) on Available-for-sale Debt Securities		282			59			223					(107	)		(37	)		(70	)
Earnings Information, Excluding Effect of Gain on Restricted Equity Security and Net Gains and Losses on Available-for-sale Debt Securities	$	6,280		$	1,068		$	5,212		$	0.42	$	5,388		$	1,337		$	4,051		$	0.33

	6 Months Ended June 30, 2018											6 Months Ended June 30, 2017
	Income									Diluted		Income									Diluted
	Before			Income						Earnings		Before			Income						Earnings
	Income			Tax						Per		Income			Tax						per
	Tax			Provision			Net			Common		Tax			Provision			Net			Common
	Provision			(1)			Income			Share		Provision			(1)			Income			Share
Results as Presented Under U.S. GAAP	$	12,864		$	2,118		$	10,746		$	0.87	$	9,913		$	2,358		$	7,555		$	0.62
Less: Gain on Restricted Equity Security		(1,750	)		(368	)		(1,382	)				0			0			0
Net Losses (Gains) on Available-for-sale Debt Securities		282			59			223					(252	)		(88	)		(164	)
Earnings Information, Excluding Effect of Gain on Restricted Equity Security and Net Gains and Losses on Available-for-sale Debt Securities	$	11,396		$	1,809		$	9,587		$	0.78	$	9,661		$	2,270		$	7,391		$	0.61

TABLE I - QUARTERLY FINANCIAL DATA
(In Thousands, Except Per Share Data) (Unaudited)	For the Three Months Ended:
	June 30,		Mar. 31,		Dec. 31,			Sept. 30,		June 30,		Mar. 31,
Table I – QUARTERLY FINANCIAL DATA
(Dollars In Thousands, Except Per Share Data)														For the Three Months Ended:
(Unaudited)														June 30,			March 31,		Dec. 31,		Sept. 30,		June 30,		March 31,
	2017		2017		2016			2016		2016		2016		2018			2018		2017		2017		2017		2017
Interest income	$	11,340	$	11,112	$	11,106		$	11,131	$	10,924	$	10,937	$	12,334		$	11,890	$	11,785	$	11,626	$	11,340	$	11,112
Interest expense		978		953		920			944		925		904		1,079			993		999		985		978		953
Net interest income		10,362		10,159		10,186			10,187		9,999		10,033		11,255			10,897		10,786		10,641		10,362		10,159
Provision (credit) for loan losses		4		452		(3	)		538		318		368
Net interest income after provision (credit) for loan losses		10,358		9,707		10,189			9,649		9,681		9,665
Other income		4,106		3,864		4,031			3,884		3,906		3,690
Net gains on available-for-sale securities		107		145		69			584		122		383
Other expenses		9,076		9,298		8,558			8,579		8,535		9,072
(Credit) provision for loan losses															(20	)		292		23		322		4		452
Net interest income after (credit) provision for loan losses															11,275			10,605		10,763		10,319		10,358		9,707
Noninterest income															4,689			4,406		4,117		4,066		4,106		3,864
Net gains on securities															1,468			0		0		5		107		145
Noninterest expense															9,684			9,895		9,401		9,192		9,076		9,298
Income before income tax provision		5,495		4,418		5,731			5,538		5,174		4,666		7,748			5,116		5,479		5,198		5,495		4,418
Income tax provision		1,374		984		1,500			1,451		1,303		1,093		1,377			741		3,536		1,262		1,374		984
Net income	$	4,121	$	3,434	$	4,231		$	4,087	$	3,871	$	3,573	$	6,371		$	4,375	$	1,943	$	3,936	$	4,121	$	3,434
Net income attributable to common shares	$	4,100	$	3,416	$	4,209		$	4,065	$	3,850	$	3,553	$	6,339		$	4,352	$	1,933	$	3,916	$	4,100	$	3,416
Basic earnings per common share	$	0.34	$	0.28	$	0.35		$	0.34	$	0.32	$	0.29	$	0.52		$	0.36	$	0.16	$	0.32	$	0.34	$	0.28
Diluted earnings per common share	$	0.34	$	0.28	$	0.35		$	0.34	$	0.32	$	0.29	$	0.52		$	0.36	$	0.16	$	0.32	$	0.34	$	0.28

	3 Months						3 Months						6 Months						6 Months						3 Months						3 Months						6 Months						6 Months
	Ended			Rate of			Ended			Rate of			Ended			Rate of			Ended			Rate of			Ended			Rate of			Ended			Rate of			Ended			Rate of			Ended			Rate of
	6/30/2017			Return/			6/30/2016			Return/			6/30/2017			Return/			6/30/2016			Return/			6/30/2018			Return/			6/30/2017			Return/			6/30/2018			Return/			6/30/2017			Return/
	Average			Cost of			Average			Cost of			Average			Cost of			Average			Cost of			Average			Cost of			Average			Cost of			Average			Cost of			Average			Cost of
	Balance			Funds %			Balance			Funds %			Balance			Funds %			Balance			Funds %			Balance			Funds %			Balance			Funds %			Balance			Funds %			Balance			Funds %
EARNING ASSETS
Available-for-sale securities,
at amortized cost:
Available-for-sale debt securities, at amortized cost:
Taxable	$	255,806			2.13	%	$	297,608			2.02	%	$	263,486			2.12	%	$	301,744			2.06	%	$	247,809			2.24	%	$	254,806			2.13	%	$	248,819			2.22	%	$	262,486			2.12	%
Tax-exempt		114,993			4.41	%		108,652			4.79	%		116,303			4.42	%		107,029			5.01	%		102,801			3.50	%		114,993			4.41	%		102,988			3.51	%		116,303			4.42	%
Total available-for-sale securities		370,799			2.83	%		406,260			2.76	%		379,789			2.82	%		408,773			2.83	%
Total available-for-sale debt securities																										350,610			2.61	%		369,799			2.84	%		351,807			2.60	%		378,789			2.82	%
Marketable equity security																										952			2.53	%		1,000			2.01	%		957			2.32	%		1,000			2.02	%
Interest-bearing due from banks		14,873			1.11	%		24,250			0.60	%		14,898			0.99	%		22,299			0.54	%		22,286			1.73	%		14,873			1.11	%		18,231			1.61	%		14,898			0.99	%
Loans held for sale		499			4.82	%		540			5.96	%		351			5.75	%		496			5.68	%		267			6.01	%		499			4.82	%		218			5.55	%		351			5.75	%
Loans receivable:
Taxable		702,933			4.91	%		650,213			5.00	%		700,501			4.89	%		645,586			5.00	%		747,889			5.14	%		702,933			4.91	%		744,292			5.09	%		700,501			4.89	%
Tax-exempt		68,439			4.48	%		61,669			4.50	%		64,907			4.51	%		61,173			4.52	%		77,616			3.65	%		68,439			4.48	%		76,933			3.69	%		64,907			4.51	%
Total loans receivable		771,372			4.87	%		711,882			4.96	%		765,408			4.86	%		706,759			4.96	%		825,505			5.00	%		771,372			4.87	%		821,225			4.96	%		765,408			4.86	%
Total Earning Assets		1,157,543			4.17	%		1,142,932			4.09	%		1,160,446			4.14	%		1,138,327			4.11	%		1,199,620			4.23	%		1,157,543			4.17	%		1,192,438			4.21	%		1,160,446			4.14	%
Cash		17,276						16,522						16,648						16,055						18,010						17,276						17,445						16,648
Unrealized gain/loss on securities		689						7,737						(130	)					7,396						(8,242	)					689						(6,893	)					(130	)
Allowance for loan losses		(8,901	)					(7,756	)					(8,748	)					(7,844	)					(9,161	)					(8,901	)					(9,082	)					(8,748	)
Bank premises and equipment		15,714						15,390						15,713						15,424						15,425						15,714						15,438						15,713
Intangible Assets		11,957						11,967						11,958						11,969						11,952						11,957						11,953						11,958
Other assets		41,322						38,938						42,594						38,734						41,575						41,322						42,174						42,594
Total Assets	$	1,235,600					$	1,225,730					$	1,238,481					$	1,220,061					$	1,269,179					$	1,235,600					$	1,263,473					$	1,238,481

INTEREST-BEARING LIABILITIES
Interest-bearing deposits:
Interest checking	$	203,256			0.21	%	$	196,918			0.15	%	$	202,194			0.18	%	$	196,030			0.14	%	$	217,607			0.39	%	$	203,256			0.21	%	$	215,307			0.37	%	$	202,194			0.18	%
Money market		190,703			0.19	%		200,896			0.17	%		190,902			0.18	%		196,205			0.17	%		180,667			0.27	%		190,703			0.19	%		180,297			0.24	%		190,902			0.18	%
Savings		142,978			0.10	%		132,353			0.10	%		140,903			0.10	%		131,178			0.10	%		152,663			0.10	%		142,978			0.10	%		151,149			0.10	%		140,903			0.10	%
Certificates of deposit		116,450			0.82	%		117,825			0.75	%		115,051			0.81	%		115,618			0.73	%		135,429			1.15	%		116,450			0.82	%		129,733			1.08	%		115,051			0.81	%
Individual Retirement Accounts		98,004			0.43	%		104,030			0.42	%		98,513			0.43	%		104,796			0.42	%		92,899			0.51	%		98,004			0.43	%		93,601			0.50	%		98,513			0.43	%
Other time deposits		1,107			0.00	%		1,140			0.00	%		950			0.00	%		972			0.00	%		1,092			0.00	%		1,107			0.00	%		933			0.00	%		950			0.00	%
Total interest-bearing deposits		752,498			0.31	%		753,162			0.28	%		748,513			0.30	%		744,799			0.27	%		780,357			0.45	%		752,498			0.31	%		771,020			0.42	%		748,513			0.30	%
Borrowed funds:
Short-term		21,205			0.85	%		23,225			0.71	%		31,240			0.79	%		29,454			0.70	%		23,610			1.39	%		21,205			0.85	%		37,878			1.50	%		31,240			0.79	%
Long-term		38,353			3.74	%		38,649			3.77	%		38,386			3.75	%		38,687			3.77	%		22,174			2.13	%		38,353			3.74	%		17,639			2.09	%		38,386			3.75	%
Total borrowed funds		59,558			2.71	%		61,874			2.62	%		69,626			2.42	%		68,141			2.44	%		45,784			1.75	%		59,558			2.71	%		55,517			1.69	%		69,626			2.42	%
Total Interest-bearing Liabilities		812,056			0.48	%		815,036			0.46	%		818,139			0.48	%		812,940			0.45	%		826,141			0.52	%		812,056			0.48	%		826,537			0.51	%		818,139			0.48	%
Demand deposits		227,488						215,443						225,127						211,803						248,182						227,488						242,093						225,127
Other liabilities		7,573						8,304						7,866						7,841						8,848						7,573						8,859						7,866
Total Liabilities		1,047,117						1,038,783						1,051,132						1,032,584						1,083,171						1,047,117						1,077,489						1,051,132
Stockholders’ equity, excluding other comprehensive income/loss		187,882						181,882						187,289						182,629
Stockholders' equity, excluding other comprehensive income/loss																										192,375						187,882						191,258						187,289
Accumulated other comprehensive income/loss		601						5,065						60						4,848						(6,367	)					601						(5,274	)					60
Total Stockholders’ Equity		188,483						186,947						187,349						187,477
Total Liabilities and Stockholders’ Equity	$	1,235,600					$	1,225,730					$	1,238,481					$	1,220,061
Total Stockholders' Equity																										186,008						188,483						185,984						187,349
Total Liabilities and Stockholders' Equity																									$	1,269,179					$	1,235,600					$	1,263,473					$	1,238,481
Interest Rate Spread					3.69	%					3.63	%					3.66	%					3.66	%					3.71	%					3.69	%					3.70	%					3.66	%
Net Interest Income/Earning Assets					3.83	%					3.76	%					3.81	%					3.79	%					3.87	%					3.83	%					3.86	%					3.81	%

Total Deposits (Interest-bearing and Demand)	$	979,986					$	968,605					$	973,640					$	956,602					$	1,028,539					$	979,986					$	1,013,113					$	973,640

(In Thousands)	3 Months Ended 6/30/17 vs. 6/30/16									6 Months Ended 6/30/17 vs. 6/30/16									3 Months Ended 6/30/18 vs. 6/30/17									6 Months Ended 6/30/18 vs. 6/30/17
	Change in			Change in			Total			Change in			Change in			Total			Change in			Change in			Total			Change in			Change in			Total
	Volume			Rate			Change			Volume			Rate			Change			Volume			Rate			Change			Volume			Rate			Change
EARNING ASSETS
Available-for-sale securities:
Available-for-sale debt securities:
Taxable	$	(214	)	$	76		$	(138	)	$	(406	)	$	87		$	(319	)	$	(38	)	$	67		$	29		$	(147	)	$	136		$	(11	)
Tax-exempt		73			(104	)		(31	)		215			(328	)		(113	)		(125	)		(241	)		(366	)		(271	)		(485	)		(756	)
Total available-for-sale securities		(141	)		(28	)		(169	)		(191	)		(241	)		(432	)
Total available-for-sale debt securities																				(163	)		(174	)		(337	)		(418	)		(349	)		(767	)
Marketable equity security																				0			1			1			0			1			1
Interest-bearing due from banks		(18	)		23			5			(25	)		38			13			21			34			55			19			54			73
Loans held for sale		0			(2	)		(2	)		(4	)		0			(4	)		(3	)		1			(2	)		(4	)		0			(4	)
Loans receivable:
Taxable		664			(141	)		523			1,303			(380	)		923			566			400			966			1,088			705			1,793
Tax-exempt		77			(3	)		74			80			(3	)		77			94			(152	)		(58	)		244			(290	)		(46	)
Total loans receivable		741			(144	)		597			1,383			(383	)		1,000			660			248			908			1,332			415			1,747
Total Interest Income		582			(151	)		431			1,163			(586	)		577			515			110			625			929			121			1,050

INTEREST-BEARING LIABILITIES
Interest-bearing deposits:
Interest checking		2			30			32			4			47			51			8			99			107			13			198			211
Money market		(4	)		7			3			(4	)		9			5			(5	)		38			33			(10	)		55			45
Savings		3			0			3			5			0			5			2			0			2			5			0			5
Certificates of deposit		(2	)		20			18			(2	)		42			40			44			107			151			65			167			232
Individual Retirement Accounts		(6	)		3			(3	)		(14	)		8			(6	)		(6	)		17			11			(11	)		30			19
Other time deposits		0			0			0			0			0			0
Total interest-bearing deposits		(7	)		60			53			(11	)		106			95			43			261			304			62			450			512
Borrowed funds:
Short-term		(4	)		8			4			6			13			19			6			31			37			30			129			159
Long-term		(2	)		(2	)		(4	)		(7	)		(5	)		(12	)		(121	)		(119	)		(240	)		(292	)		(238	)		(530	)
Total borrowed funds		(6	)		6			0			(1	)		8			7			(115	)		(88	)		(203	)		(262	)		(109	)		(371	)
Total Interest Expense		(13	)		66			53			(12	)		114			102			(72	)		173			101			(200	)		341			141

Net Interest Income	$	595		$	(217	)	$	378		$	1,175		$	(700	)	$	475		$	587		$	(63	)	$	524		$	1,129		$	(220	)	$	909

TABLE V - COMPARISON OF NONINTEREST INCOME
(Dollars In Thousands)
	6 Months Ended
	June 30,				$			%
	2017		2016		Change			Change
Service charges on deposit accounts	$	2,178	$	2,302	$	(124	)		(5.4	)
Service charges and fees		201		217		(16	)		(7.4	)
Trust and financial management revenue		2,677		2,395		282			11.8
Brokerage revenue		364		353		11			3.1
Insurance commissions, fees and premiums		72		48		24			50.0
Interchange revenue from debit card transactions		1,088		950		138			14.5
Net gains from sales of loans		354		463		(109	)		(23.5	)
Loan servicing fees, net		127		11		116			1054.5
Increase in cash surrender value of life insurance		184		189		(5	)		(2.6	)
Other operating income		725		668		57			8.5
Total noninterest income before realized gains on available-for-sale securities, net	$	7,970	$	7,596	$	374			4.9

	June 30,		As of December 31,
	2017		2016		2015		2014		2013		2012
ASC 310 - Impaired loans	$	1,083	$	674	$	820	$	769	$	2,333	$	623
ASC 450 - Collective segments:
Commercial		3,022		3,373		3,103		2,732		2,583		2,594
Residential mortgage		3,896		3,890		3,417		3,295		3,156		3,011
Consumer		134		138		122		145		193		188
Unallocated		500		398		427		395		398		441
Total Allowance	$	8,635	$	8,473	$	7,889	$	7,336	$	8,663	$	6,857