Farmers National Banc (FMNB) 10-Q 2016 Q3 Quarterly report

UNITED STATES  

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

For the Quarterly period ended September 30, 2016

Commission file number 001-35296

FARMERS NATIONAL BANC CORP.

(Exact name of registrant as specified in its charter)

OHIO	34-1371693
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No)
20 South Broad Street Canfield, OH	44406
(Address of principal executive offices)	(Zip Code)

(330) 533-3341

(Registrant’s telephone number, including area code)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports 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.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

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

Large accelerated filer	☐	Accelerated filer	☒
Non-accelerated filer	☐	Smaller reporting company	☐

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

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

Class	Outstanding at October 31, 2016
Common Stock, No Par Value	27,047,664 shares

		Page Number
PART I - FINANCIAL INFORMATION
Item 1	Financial Statements (Unaudited)
	Included in Part I of this report:
	Farmers National Banc Corp. and Subsidiaries
	Consolidated Balance Sheets	2
	Consolidated Statements of Income	3
	Consolidated Statements of Comprehensive Income	4
	Consolidated Statement of Stockholders’ Equity	5
	Consolidated Statements of Cash Flows	6
	Notes to Unaudited Consolidated Financial Statements	7
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	37
Item 3	Quantitative and Qualitative Disclosures About Market Risk	47
Item 4	Controls and Procedures	48
PART II - OTHER INFORMATION		48
Item 1	Legal Proceedings	48
Item 1A	Risk Factors	48
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	48
Item 3	Defaults Upon Senior Securities	49
Item 4	Mine Safety Disclosures	49
Item 5	Other Information	49
Item 6	Exhibits	50
SIGNATURES		51
10-Q Certifications
Section 906 Certifications

1

CONSOLIDATED BALANCE SHEETS

FARMERS NATIONAL BANC CORP. AND SUBSIDIARIES

	(InThousands of Dollars)
(Unaudited)	September 30, 2016			December 31, 2015
ASSETS
Cash and due from banks	$	18,739		$	22,500
Federal funds sold and other		48,633			33,514
TOTAL CASH AND CASH EQUIVALENTS		67,372			56,014
Securities available for sale		368,729			394,312
Loans held for sale		2,148			1,769
Loans		1,395,620			1,296,865
Less allowance for loan losses		10,518			8,978
NET LOANS		1,385,102			1,287,887
Premises and equipment, net		23,502			24,190
Goodwill		36,939			35,090
Other intangibles		8,359			7,821
Bank owned life insurance		29,842			29,234
Other assets		39,015			33,585
TOTAL ASSETS	$	1,961,008		$	1,869,902
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest-bearing	$	352,441		$	314,650
Interest-bearing		1,139,724			1,094,397
TOTAL DEPOSITS		1,492,165			1,409,047
Short-term borrowings		216,525			225,832
Long-term borrowings		19,232			22,153
Other liabilities		17,649			14,823
TOTAL LIABILITIES		1,745,571			1,671,855
Commitments and contingent liabilities
Stockholders' Equity:
Common Stock - Authorized 35,000,000 shares; issued 27,713,811 in 2016 and 27,590,531 in 2015		178,027			176,287
Retained earnings		38,266			26,316
Accumulated other comprehensive income		4,001			133
Treasury stock, at cost; 666,147 shares in 2016 and 646,247 in 2015		(4,857	)		(4,689	)
TOTAL STOCKHOLDERS' EQUITY		215,437			198,047
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	1,961,008		$	1,869,902

See accompanying notes

2

CONSOLIDATED STATEMENTS OF INCOME

FARMERS NATIONAL BANC CORP. AND SUBSIDIARIES

	(In Thousands except Per Share Data)
	For the Three Months Ended				For the Nine Months Ended
(Unaudited)	Sept. 30, 2016		Sept. 30, 2015		Sept. 30, 2016		Sept. 30, 2015
INTEREST AND DIVIDEND INCOME
Loans, including fees	$	16,048	$	13,385	$	46,941	$	29,703
Taxable securities		1,160		1,369		3,885		4,421
Tax exempt securities		893		783		2,681		2,060
Dividends		177		48		403		142
Federal funds sold and other interest income		54		9		119		20
TOTAL INTEREST AND DIVIDEND INCOME		18,332		15,594		54,029		36,346
INTEREST EXPENSE
Deposits		858		909		2,358		2,675
Short-term borrowings		166		59		485		86
Long-term borrowings		115		88		357		306
TOTAL INTEREST EXPENSE		1,139		1,056		3,200		3,067
NET INTEREST INCOME		17,193		14,538		50,829		33,279
Provision for loan losses		1,110		1,220		2,880		2,520
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		16,083		13,318		47,949		30,759
NONINTEREST INCOME
Service charges on deposit accounts		1,057		929		2,979		2,204
Bank owned life insurance income		194		184		608		488
Trust fees		1,693		1,482		4,753		4,638
Insurance agency commissions		569		130		1,001		394
Security gains		31		3		72		48
Retirement plan consulting fees		561		423		1,546		1,705
Investment commissions		308		332		900		886
Net gains on sale of loans		1,063		415		2,005		694
Debit card interchange fees		653		506		1,936		1,196
Other operating income		356		281		1,368		878
TOTAL NONINTEREST INCOME		6,485		4,685		17,168		13,131
NONINTEREST EXPENSES
Salaries and employee benefits		8,366		7,244		23,660		18,449
Occupancy and equipment		1,587		1,368		4,867		3,680
State and local taxes		394		400		1,181		888
Professional fees		671		738		1,954		1,760
Merger related costs		31		2,499		544		4,656
Advertising		383		344		1,091		843
FDIC insurance		287		256		856		611
Intangible amortization		421		304		1,093		638
Core processing charges		738		643		1,956		1,406
Other operating expenses		2,347		1,725		7,250		4,428
TOTAL NONINTEREST EXPENSES		15,225		15,521		44,452		37,359
INCOME BEFORE INCOME TAXES		7,343		2,482		20,665		6,531
INCOME TAXES		1,967		625		5,471		1,651
NET INCOME	$	5,376	$	1,857	$	15,194	$	4,880
EARNINGS PER SHARE - basic and diluted	$	0.20	$	0.07	$	0.56	$	0.23

See accompanying notes

3

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FARMERS NATIONAL BANC CORP. AND SUBSIDIARIES

	(In Thousands of Dollars)
	For the Three Months Ended						For the Nine Months Ended
(Unaudited)	September 30, 2016			September 30, 2015			September 30, 2016			September 30, 2015
NET INCOME	$	5,376		$	1,857		$	15,194		$	4,880
Other comprehensive income (loss):
Net unrealized holding gains (losses) on available for sale securities		(2,350	)		3,557			6,021			421
Reclassification adjustment for (gains) realized in income		(31	)		(3	)		(72	)		(48	)
Net unrealized holding gains (losses)		(2,381	)		3,554			5,949			373
Income tax effect		833			(1,244	)		(2,081	)		(131	)
Other comprehensive income (loss), net of tax		(1,548	)		2,310			3,868			242
TOTAL COMPREHENSIVE INCOME	$	3,828		$	4,167		$	19,062		$	5,122

See accompanying notes

4

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

FARMERS NATIONAL BANC CORP. AND SUBSIDIARIES

	(InThousands of Dollars)
(Unaudited)	For the Nine Months Ended September 30, 2016
COMMON STOCK
Beginning balance	$	176,287
Issued 123,280 shares as part of business combination		1,138
Stock compensation expense for 383,222 unvested shares		602
Ending balance		178,027
RETAINED EARNINGS
Beginning balance		26,316
Net income		15,194
Dividends declared at $.12 per share		(3,244	)
Ending balance		38,266
ACCUMULATED OTHER COMPREHENSIVE INCOME
Beginning balance		133
Other comprehensive income		3,868
Ending balance		4,001
TREASURY STOCK, AT COST
Beginning balance		(4,689	)
Purchased 19,900 shares		(168	)
Ending balance		(4,857	)
TOTAL STOCKHOLDERS' EQUITY	$	215,437

See accompanying notes.

5

CONSOLIDATED STATEMENTS OF CASH FLOWS

FARMERS NATIONAL BANC CORP. AND SUBSIDIARIES

	(In Thousands of Dollars)
	Nine Months Ended
(Unaudited)	September 30, 2016			September 30, 2015
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	15,194		$	4,880
Adjustments to reconcile net income to net cash from operating activities:
Provision for loan losses		2,880			2,520
Depreciation and amortization		2,745			1,689
Net amortization of securities		1,677			1,510
Security gains		(72	)		(48	)
Gain on land and building sales, net		(238	)		0
Stock compensation expense		602			275
Loss on sale of other real estate owned		240			18
Earnings on bank owned life insurance		(608	)		(488	)
Origination of loans held for sale		(48,165	)		(12,295	)
Proceeds from loans held for sale		49,791			12,934
Net gains on sale of loans		(2,005	)		(694	)
Net change in other assets and liabilities		(8,221	)		(2,978	)
NET CASH FROM OPERATING ACTIVITIES		13,820			7,323
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturities and repayments of securities available for sale		46,483			44,047
Proceeds from sales of securities available for sale		11,480			58,240
Purchases of securities available for sale		(26,848	)		(41,346	)
Loan originations and payments, net		(100,396	)		(91,721	)
Proceeds from sale of other real estate owned		497			552
Purchase of bank owned life insurance		0			(6,000	)
Proceeds from land and building sales		479			0
Additions to premises and equipment		(512	)		(1,160	)
Net cash (paid) received in business combinations		(1,073	)		21,303
NET CASH FROM INVESTING ACTIVITIES		(69,890	)		(16,085	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits		83,118			(9,115	)
Net change in short-term borrowings		(9,307	)		38,756
Repayment of long-term borrowings		(2,971	)		(12,109	)
Cash dividends paid		(3,244	)		(1,876	)
Proceeds from reissuance of treasury shares		0			22
Repurchase of common shares		(168	)		0
NET CASH FROM FINANCING ACTIVITIES		67,428			15,678
NET CHANGE IN CASH AND CASH EQUIVALENTS		11,358			6,916
Beginning cash and cash equivalents		56,014			27,428
Ending cash and cash equivalents	$	67,372		$	34,344
Supplemental cash flow information:
Interest paid	$	3,196		$	2,955
Income taxes paid	$	6,800		$	1,780
Supplemental noncash disclosures:
Transfer of loans to other real estate	$	301		$	734
Security purchases not settled	$	1,176		$	0
Issuance of stock for business combinations	$	1,138		$	59,048

See accompanying notes

6

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Principles of Consolidation:

Farmers National Banc Corp. (“Company”) is a Financial Holding Company registered under the Bank Holding Company Act of 1956, as amended. The Company provides full banking services through its nationally chartered subsidiary, The Farmers National Bank of Canfield (“Bank”).  The Bank acquired Bowers Insurance Agency, Inc. (“Bowers”) and consolidated the activity of the Bowers with Farmers National Insurance (“Insurance”) during 2016.  The Company acquired First National Bank of Orrville (“First National Bank”) a subsidiary of National Bancshares Corporation (“NBOH”) and 1^st National Community Bank (“FNCB”) a subsidiary of Tri-State 1^st Banc, Inc. (“Tri-State”) during 2015 and consolidated all activity of both acquisitions within the Bank.  Farmers National Captive, Inc. (“Captive”) was formed during the third quarter of 2016 and is a wholly-owned insurance subsidiary of the Company that provides property and casualty insurance coverage to the Company and its subsidiaries.  The Captive pools resources with thirteen other similar insurance company subsidiaries of financial institutions to spread a limited amount of risk among themselves and to provide insurance where not currently available or economically feasible in today’s insurance market place.  The consolidated financial statements also include the accounts of the Farmers National Bank of Canfield’s subsidiaries; Farmers National Insurance and Farmers of Canfield Investment Co. (“Investments”).  The Company provides trust services through its subsidiary, Farmers Trust Company (“Trust”), retirement consulting services through National Associates, Inc. (“NAI”) and insurance services through the Bank’s subsidiary, Insurance.  The consolidated financial statements include the accounts of the Company, the Bank and its subsidiaries, along with the Trust, NAI and Captive. All significant intercompany balances and transactions have been eliminated in the consolidation.

Basis of Presentation:

The unaudited condensed consolidated financial statements have been prepared in conformity with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“U.S. GAAP”) for complete financial statements. The financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2015 Annual Report to Shareholders included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015. The interim consolidated financial statements include all adjustments (consisting of only normal recurring items) that, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the periods presented. The results of operations for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year. Certain items included in the prior period financial statements were reclassified to conform to the current period presentation. There was no effect on net income or total stockholders’ equity.

Estimates:

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Segments:

The Company provides a broad range of financial services to individuals and companies in northeastern Ohio.  Operations are managed and financial performance is primarily aggregated and reported in three lines of business, the Bank segment, the Trust segment and the Retirement Consulting segment.  

Comprehensive Income:

Comprehensive income(loss) consists of net income and other comprehensive income. Other comprehensive income(loss) consists of unrealized gains and losses on securities available for sale and changes in the funded status of the post-retirement health plan, which are recognized as separate components of equity, net of tax effects. For all periods presented there was no change in the funded status of the post-retirement health plan.

New Accounting Standards:

In June 2016, the FASB issued ASU 2016-13: Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.  The ASU requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts.  Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates.  Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of

7

expected credit losses.  Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances.  Additionally, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration.  ASU 2016-13 is effective for public companies for annual periods beginning after December 15, 2019, including interim periods within those fiscal years.  Entities will apply the standard's provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted.  The Company has not yet determined the impact the adoption of ASU 2016-13 will have on the Consolidated Financial Statements.

In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-09: Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The amendments in ASU 2016-09 simplify several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. ASU 2016-09 is effective for public companies for interim and annual reporting periods beginning after December 15, 2016, with early adoption permitted. The Company is currently assessing the impact of ASU 2016-02 on its Consolidated Financial Statements and disclosures.

In February 2016, FASB issued ASU 2016-02 (Topic 842): Leases. The main objective of ASU 2016-02 is to provide users with useful, transparent, and complete information about leasing transactions. ASU 2016-02 requires the rights and obligations associated with leasing arrangements be reflected on the balance sheet in order to increase transparency and comparability among organizations.  Under the updated guidance, lessees will be required to recognize a right-to-use asset and a liability to make a lease payment and disclose key information about leasing arrangements. ASU 2016-02 is effective for public companies for interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted. The Company does not expect the adoption of this ASU to have a material impact to its Consolidated Financial Statements.

In January 2016, FASB issued ASU 2016-01: Financial Instruments – Overall (Subtopic 825-10):  Recognition and Measurement of Financial Assets and Financial Liabilities.  The main objective of ASU 2016-01 is to enhance the reporting model for financial instruments to provide users of financial statements with more decision-useful information.  ASU 2016-01 addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments.  Some of the amendments in ASU 2016-01  include the following: 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 with changes in fair value recognized in net income; 2) Simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; 3) Require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; and 4) Require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value; among others.  The amendments of ASU 2016-01 are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.  The Company is currently evaluating the effects of ASU 2016-01 on its Consolidated Financial Statements.

Business Combinations:

On June 1, 2016, the Bank completed the acquisition of the Bowers Insurance Agency, Inc., and merged all activity of Bowers with Insurance, the Bank’s wholly-owned insurance agency subsidiary.  The Bowers group is engage in selling insurance including commercial, farm, home, and auto property/casualty insurance and will help to meet the needs of all the Company’s customers.  The transaction involved both cash and 123,280 shares of stock totaling $3.2 million, including up to $1.2 million of future payments, contingent upon Bowers meeting performance targets, with an estimated fair value at the acquisition date of $880 thousand. The acquisition is part of the Company’s plan to increase the levels of noninterest income and to complement the existing insurance services currently being offered.

Goodwill of $1.8 million, which is recorded on the balance sheet, arising from the acquisition consisted largely of synergies and the cost savings resulting from the combining of the companies.  The goodwill was determined not to be deductible for income tax purposes. The fair value of other intangible assets of $1.6 million is related to client relationships, company name and noncompetition agreements.

8

The following table summarizes the consideration paid for Bowers and the amounts of the assets acquired and liabilities assumed on the closing date of the acquisition.

(In Thousands of Dollars)
Consideration
Cash	$	1,137
Stock		1,138
Contingent consideration		880
Fair value of total consideration transferred	$	3,155
Fair value of assets acquired
Cash	$	64
Premises and equipment		290
Other assets		34
Total assets acquired		388
Fair value of liabilities assumed		124
Net assets acquired	$	264
Assets and liabilities arising from acquisition
Identified intangible assets		1,630
Deferred tax liability		(588	)
Goodwill created		1,849
Total net assets acquired	$	3,155

Valuation of some assets acquired or created including intangible assets and goodwill are preliminary and could be subject to change.

On October 1, 2015, the Company completed the acquisition of Tri-State, the parent company of FNCB.  The transaction involved both cash and 1,296,517 shares of stock totaling $14.3 million.  Pursuant to the terms of the merger agreement, common shareholders of Tri-State received 1.747 common shares, without par value, of the Company or $14.20 in cash, for each common share of Tri-State, subject to proration provisions specified in the merger agreement that provide for a targeted aggregate split of total consideration consisting of 75% shares of Farmers’ common stock and 25% cash.  Preferred shareholders of Tri-State received $13.60 in cash for each share of Series A Preferred Stock, without par value, of Tri-State.

Goodwill of $2.8 million, which is recorded on the balance sheet, arising from the acquisition consisted largely of synergies and the cost savings resulting from the combining of the companies.  The goodwill was determined not to be deductible for income tax purposes.  The fair value of other intangible assets of $1.2 million is related to core deposits.

On June 19, 2015, the Company completed the acquisition of all outstanding stock of NBOH, the parent company of First National Bank of Orrville.  The transaction involved both cash and 7,262,955 shares of stock totaling $74.8 million.  First National Bank of Orrville branches became branches of Farmers National Bank of Canfield.  Pursuant to the Agreement, each shareholder of NBOH received either $32.15 per share in cash or 4.034 shares of Farmers’ common stock, subject to an overall limitation of 80% of the shares of NBOH being exchanged for stock and 20% for cash.

Goodwill of $26.7 million, which is recorded on the balance sheet, arising from the acquisition consisted largely of synergies and the cost savings resulting from the combining of the companies.  The goodwill was determined not to be deductible for income tax purposes.  The fair value of other intangible assets of $4.4 million is related to core deposits.

The acquisitions provide an attractive mix of additional loans and deposits and helps the Company achieve additional operating scale that will drive earnings per share growth.  In addition to the financial benefits, the merger is a significant step in the Company’s strategy to expand its footprint.

9

The following table summarizes the consideration paid for Tri-State and NBOH and the amounts of the assets acquired and liabilities assumed on the closing date of each acquisition.

	(In Thousands of Dollars)
	Tri-State		NBOH
Consideration
Cash	$	3,607	$	15,732
Stock		10,733		59,048
Fair value of total consideration transferred	$	14,340	$	74,780
Fair value of assets acquired
Cash and due from financial institutions	$	13,553	$	37,035
Securities available for sale		48,300		51,340
Loans, net		66,374		430,035
Premises and equipment		1,935		6,105
Bank owned life insurance		3,274		2,891
Core deposit intangible		1,173		4,409
Other assets		1,329		7,996
Total assets		135,938		539,811
Fair value of liabilities assumed
Deposits		114,342		423,661
Short-term borrowings		0		65,537
Long-term borrowings		2,002		0
Accrued interest payable and other liabilities		8,072		2,514
Total liabilities		124,416		491,712
Net assets acquired	$	11,522	$	48,099
Goodwill created		2,818		26,681
Total net assets acquired	$	14,340	$	74,780

The fair value of net assets acquired includes fair value adjustments to certain receivables that were not considered impaired as of the acquisition date.  The fair value adjustments were determined using discounted contractual cash flows.  However, the Company believes that all contractual cash flows related to the financial instruments acquired from Tri-State will be collected.  As such, these receivables were not considered impaired at the acquisition date and were not subject to the guidance relating to purchased credit impaired loans.  Purchase credit impaired loans would have shown evidence of credit deterioration since origination.

The following table presents pro forma information as if the above three acquisitions that occurred during 2015 and 2016 actually took place at the beginning of 2015.  The pro forma information includes adjustments for merger related costs, amortization of intangibles arising from the transaction and the related income tax effects. The pro forma financial information is not necessarily indicative of the results of operations that would have occurred had the transactions been effective on the assumed date.

	For Three Months Ended Sept. 30,				For Nine Months Ended Sept. 30,
(In thousands of dollars except per share results)	2016		2015		2016		2015
Net interest income	$	17,193	$	15,621	$	50,829	$	46,065
Net income	$	5,376	$	4,523	$	15,214	$	10,060
Basic and diluted earnings per share	$	0.20	$	0.17	$	0.56	$	0.39

10

Securities:

The following table summarizes the amortized cost and fair value of the available-for-sale investment securities portfolio at September 30, 2016 and December 31, 2015 and the corresponding amounts of unrealized gains and losses recognized in accumulated other comprehensive income:

			Gross		Gross
(In Thousands of Dollars)	Amortized		Unrealized		Unrealized
	Cost		Gains		Losses			Fair Value
September 30, 2016
U.S. Treasury and U.S. government sponsored entities	$	5,876	$	92	$	0		$	5,968
State and political subdivisions		138,143		3,211		(71	)		141,283
Corporate bonds		1,344		19		(1	)		1,362
Mortgage-backed securities - residential		176,919		3,038		(303	)		179,654
Collateralized mortgage obligations - residential		22,377		78		(242	)		22,213
Small Business Administration		17,999		46		(59	)		17,986
Equity securities		127		138		(2	)		263
Totals	$	362,785	$	6,622	$	(678	)	$	368,729

			Gross		Gross
(In Thousands of Dollars)	Amortized		Unrealized		Unrealized
	Cost		Gains		Losses			Fair Value
December 31, 2015
U.S. Treasury and U.S. government sponsored entities	$	11,120	$	38	$	(52	)	$	11,106
State and political subdivisions		136,781		2,354		(412	)		138,723
Corporate bonds		1,134		5		(5	)		1,134
Mortgage-backed securities - residential		197,289		1,433		(2,135	)		196,587
Collateralized mortgage obligations - residential		28,035		0		(870	)		27,165
Small Business Administration		19,755		1		(457	)		19,299
Equity securities		203		127		(32	)		298
Totals	$	394,317	$	3,958	$	(3,963	)	$	394,312

Proceeds from the sale of portfolio securities were $2.3 million during the three and $11.5 million during the nine month period ended September 30, 2016.  Gross gains of $31 thousand and $224 thousand along with gross losses of $0 and $152 thousand were realized on these sales during the three and nine month periods ended September 30, 2016.  Proceeds from the sale of portfolio securities were $3.4 million during the three month period and $58.2 million during the nine month period ended September 30, 2015.  Gross gains were $30 thousand and $139 thousand along with gross losses of $27 thousand and $91 thousand during the same three and nine month periods ended September 30, 2015.

The amortized cost and fair value of the debt securities portfolio are shown by expected maturity.  Expected maturities may differ from contractual maturities if issuers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately.

	September 30, 2016
(In Thousands of Dollars)	Amortized Cost		Fair Value
Maturity
Within one year	$	8,345	$	8,385
One to five years		59,688		61,045
Five to ten years		69,008		70,709
Beyond ten years		8,322		8,474
Mortgage-backed, collateralized mortgage obligations and Small    Business Administration securities		217,295		219,853
Total	$	362,658	$	368,466

The following table summarizes the investment securities with unrealized losses at September 30, 2016 and December 31, 2015, aggregated by major security type and length of time in a continuous unrealized loss position.  Unrealized losses for U.S. Treasury and U.S. government sponsored entities for more than twelve months, rounded to less than $1 thousand in 2016.  

11

	Less than 12 Months					12 Months or Longer					Total
(In Thousands of Dollars)	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Loss			Value		Loss			Value		Loss
September 30, 2016
Available-for-sale
U.S. Treasury and U.S. government sponsored entities	$	0	$	0		$	508	$	0		$	508	$	0
State and political subdivisions		4,802		(67	)		297		(4	)		5,099		(71	)
Corporate bonds		103		(1	)		0		0			103		(1	)
Mortgage-backed securities - residential		5,827		(24	)		26,202		(279	)		32,029		(303	)
Collateralized mortgage obligations - residential		1,657		(3	)		11,758		(239	)		13,415		(242	)
Small Business Administration		3,914		(6	)		8,550		(53	)		12,464		(59	)
Equity securities		138		(2	)		0		0			138		(2	)
Total	$	16,441	$	(103	)	$	47,315	$	(575	)	$	63,756	$	(678	)

	Less than 12 Months					12 Months or Longer					Total
(In Thousands of Dollars)	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Loss			Value		Loss			Value		Loss
December 31, 2015
Available-for-sale
U.S. Treasury and U.S. government sponsored entities	$	6,044	$	(51	)	$	199	$	(1	)	$	6,243	$	(52	)
State and political subdivisions		22,016		(167	)		12,635		(245	)		34,651		(412	)
Corporate bonds		102		(1	)		478		(4	)		580		(5	)
Mortgage-backed securities - residential		79,301		(1,044	)		40,794		(1,091	)		120,095		(2,135	)
Collateralized mortgage obligations - residential		14,342		(169	)		12,695		(701	)		27,037		(870	)
Small Business Administration		0		0			19,237		(457	)		19,237		(457	)
Equity securities		88		(32	)		0		0			88		(32	)
Total	$	121,893	$	(1,464	)	$	86,038	$	(2,499	)	$	207,931	$	(3,963	)

Other-Than-Temporary-Impairment

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 an evaluation.  Investment securities are generally evaluated for OTTI under FASB Accounting Standards Codification (“ASC”) 320, Investments – Debt and Equity Securities.  Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, whether the market decline was affected by macroeconomic conditions and whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery.  In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, or U.S. government sponsored enterprises, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition.  The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment, and is based on the information available to management at a point in time.

When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis.  If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date.  The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.  For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income or loss.  The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.  For equity securities, the entire amount of impairment is recognized through earnings.

As of September 30, 2016, the Company’s security portfolio consisted of 467 securities, 43 of which were in an unrealized loss position.  The majority of the unrealized losses on the Company’s securities are related to its holdings of mortgage-backed securities, collateralized mortgage obligations, state and political subdivision securities, and Small Business Administration securities as discussed below.

12

Unrealized losses on debt securities issued by state and political subdivisions have not been recognized into income.  These securities have maintained their investment grade ratings and management does not have the intent and does not expect to be required to sell these securities before their anticipated recovery.  The fair value is expected to recover as the securities approach their maturity date.

All of the Company’s holdings of collateralized mortgage obligations and residential mortgage-backed securities were issued by U.S. government-sponsored entities.  Unrealized losses on these securities have not been recognized into income.  Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, the issues are guaranteed by the issuing entity which the U.S. government has affirmed its commitment to support, and because the Company does not have the intent to sell these residential mortgage-backed securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be OTTI.

Management does not believe any unrealized losses on Small Business Administration securities represent an other-than-temporary impairment.  The securities are issued and backed by the full faith and credit of the U.S. government and the Company does not have the intent and does not anticipate that it will be required to sell these securities before their anticipated recovery.  The fair value of these securities is expected to recover as they approach their maturity.

Loans:

Loan balances were as follows:

(In Thousands of Dollars)	September 30, 2016			December 31, 2015
Originated loans:
Commercial real estate
Owner occupied	$	137,086		$	113,160
Non-owner occupied		151,208			139,502
Other		62,609			50,855
Commercial		193,447			157,447
Residential real estate
1-4 family residential		213,620			179,657
Home equity lines of credit		56,053			41,171
Consumer
Indirect		150,436			127,335
Direct		23,976			17,325
Other		7,021			4,508
Subtotal	$	995,456		$	830,960
Net deferred loan costs		3,301			2,731
Total originated loans	$	998,757		$	833,691
Acquired loans:
Commercial real estate
Owner occupied	$	122,989		$	131,673
Non-owner occupied		26,773			28,045
Other		14,887			23,536
Commercial		54,395			73,621
Residential real estate
1-4 family residential		118,018			133,701
Home equity lines of credit		35,768			40,929
Consumer
Direct		23,802			31,465
Other		231			204
Total acquired loans	$	396,863		$	463,174
Allowance for loan losses		(10,518	)		(8,978	)
Net loans	$	1,385,102		$	1,287,887

13

Purchased credit impaired loans

As part of the NBOH acquisition the Company acquired various loans that displayed evidence of deterioration of credit quality since origination and which was probable that all contractually required payments would not be collected.  The carrying amounts and contractually required payments of these loans which are included in the loan balances above are summarized in the following tables:

(In Thousands of Dollars)	September 30, 2016		December 31, 2015
Commercial real estate
Owner occupied	$	899	$	986
Non-owner occupied		444		501
Commercial		1,233		1,576
Total outstanding balance	$	2,576	$	3,063
Carrying amount, net of allowance of $0 in 2016 and $31 in 2015	$	2,083	$	2,184

Accretable yield, or income expected to be collected, is shown in the table below:

	Nine Months Ended September 30, 2016
(In Thousands of Dollars)
Beginning balance	$	323
New loans purchased	0
Accretion of income		(56	)
Ending balance	$	267

The key assumptions considered include probability of default and the amount of actual prepayments after the acquisition date. Prepayments affect the estimated life of the loans and could change the amount of interest income and principal expected to be collected.  In reforecasting future estimated cash flows, credit loss expectations are adjusted as necessary.  There were no adjustments to forecasted cash flows that impacted the allowance for loan losses for the nine months ended September 30, 2016.

The following tables present the activity in the allowance for loan losses by portfolio segment for the three and nine month periods ended September 30, 2016 and 2015:

Three Months Ended September 30, 2016

(In Thousands of Dollars)	Commercial Real Estate			Commercial		Residential Real Estate			Consumer			Unallocated		Total
Allowance for loan losses
Beginning balance	$	3,210		$	1,634	$	2,081		$	2,444		$	351	$	9,720
Provision for loan losses		138			188		105			423			256		1,110
Loans charged off		(8	)		0		(87	)		(467	)		0		(562	)
Recoveries		1			0		48			201			0		250
Total ending allowance balance	$	3,341		$	1,822	$	2,147		$	2,601		$	607	$	10,518

Nine Months Ended September 30, 2016

(In Thousands of Dollars)	Commercial Real Estate			Commercial			Residential Real Estate			Consumer			Unallocated		Total
Allowance for loan losses
Beginning balance	$	3,127		$	1,373		$	1,845		$	2,160		$	473	$	8,978
Provision for loan losses		516			464			376			1,390			134		2,880
Loans charged off		(315	)		(37	)		(165	)		(1,442	)		0		(1,959	)
Recoveries		13			22			91			493			0		619
Total ending allowance balance	$	3,341		$	1,822		$	2,147		$	2,601		$	607	$	10,518

14

Three Months Ended September 30, 2015

(In Thousands of Dollars)	Commercial Real Estate		Commercial			Residential Real Estate			Consumer			Unallocated		Total
Allowance for loan losses
Beginning balance	$	2,633	$	1,280		$	1,548		$	1,825		$	0	$	7,286
Provision for loan losses		365		84			83			530			158		1,220
Loans charged off		0		(36	)		(46	)		(549	)		0		(631	)
Recoveries		103		8			60			248			0		419
Total ending allowance balance	$	3,101	$	1,336		$	1,645		$	2,054		$	158	$	8,294

Nine Months Ended September 30, 2015

(In Thousands of Dollars)	Commercial Real Estate			Commercial			Residential Real Estate			Consumer			Unallocated			Total
Allowance for loan losses
Beginning balance	$	2,676		$	1,420		$	1,689		$	1,663		$	184		$	7,632
Provision for loan losses		820			197			142			1,387			(26	)		2,520
Loans charged off		(520	)		(291	)		(287	)		(1,648	)		0			(2,746	)
Recoveries		125			10			101			652			0			888
Total ending allowance balance	$	3,101		$	1,336		$	1,645		$	2,054		$	158		$	8,294

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of September 30, 2016 and December 31, 2015. The recorded investment in loans includes the unpaid principal balance and unamortized loan origination fees and costs, but excludes accrued interest receivable, which is not considered to be material:

September 30, 2016

(In Thousands of Dollars)	Commercial Real Estate		Commercial		Residential Real Estate		Consumer		Unallocated		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	61	$	5	$	74	$	4	$	0	$	144
Collectively evaluated for impairment		3,251		1,722		2,073		2,597		607		10,250
Acquired loans		29		95		0		0		0		124
Acquired with deteriorated credit quality		0		0		0		0		0		0
Total ending allowance balance	$	3,341	$	1,822	$	2,147	$	2,601	$	607	$	10,518
Loans:
Loans individually evaluated for impairment	$	3,795	$	613	$	3,415	$	103	$	0	$	7,926
Loans collectively evaluated for impairment		346,730		192,710		265,825		186,398		0		991,663
Acquired loans		162,923		53,268		153,730		24,027		0		393,948
Acquired with deteriorated credit quality		1,174		909		0		0		0		2,083
Total ending loans balance	$	514,622	$	247,500	$	422,970	$	210,528	$	0	$	1,395,620

15

December 31, 2015

(In Thousands of Dollars)	Commercial Real Estate		Commercial		Residential Real Estate		Consumer		Unallocated		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	429	$	5	$	63	$	0	$	0	$	497
Collectively evaluated for impairment		2,698		1,337		1,782		2,160		473		8,450
Acquired loans		0		0		0		0		0		0
Acquired with deteriorated credit quality		0		31		0		0		0		31
Total ending allowance balance	$	3,127	$	1,373	$	1,845	$	2,160	$	473	$	8,978
Loans:
Loans individually evaluated for impairment	$	5,853	$	712	$	3,414	$	103	$	0	$	10,082
Loans collectively evaluated for impairment		296,866		156,415		217,023		153,305		0		823,609
Acquired loans		181,987		72,673		174,630		31,669		0		460,959
Acquired with deteriorated credit quality		1,267		948		0		0		0		2,215
Total ending loans balance	$	485,973	$	230,748	$	395,067	$	185,077	$	0	$	1,296,865

The following tables present information related to impaired loans by class of loans as of September 30, 2016 and December 31, 2015:

(In Thousands of Dollars)	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated
September 30, 2016
With no related allowance recorded:
Commercial real estate
Owner occupied	$	1,901	$	1,383	$	0
Non-owner occupied		334		333		0
Commercial		341		319		0
Residential real estate
1-4 family residential		2,517		2,271		0
Home equity lines of credit		190		174		0
Consumer		197		96		0
Subtotal		5,480		4,576		0
With an allowance recorded:
Commercial real estate
Owner occupied		948		946		57
Non-owner occupied		1,133		1,133		33
Commercial		296		294		100
Residential real estate
1-4 family residential		890		885		73
Home equity lines of credit		85		85		1
Consumer		7		7		4
Subtotal		3,359		3,350		268
Total	$	8,839	$	7,926	$	268

16

(In Thousands of Dollars)	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated
December 31, 2015
With no related allowance recorded:
Commercial real estate
Owner occupied	$	2,956	$	2,436	$	0
Non-owner occupied		343		342		0
Commercial		834		631		0
Residential real estate
1-4 family residential		2,575		2,310		0
Home equity lines of credit		283		268		0
Consumer		214		103		0
Subtotal		7,205		6,090		0
With an allowance recorded:
Commercial real estate
Owner occupied		1,597		1,595		379
Non-owner occupied		1,480		1,480		50
Commercial		81		81		5
Residential real estate
1-4 family residential		769		749		61
Home equity lines of credit		87		87		2
Subtotal		4,014		3,992		497
Total	$	11,219	$	10,082	$	497

The following tables present the average recorded investment in impaired loans by class and interest income recognized by loan class for the three and nine month periods ended September 30, 2016 and 2015:

	Average Recorded Investment				Interest Income Recognized
	For Three Months Ended September 30,				For Three Months Ended September 30,
(In Thousands of Dollars)	2016		2015		2016		2015
With no related allowance recorded:
Commercial real estate
Owner occupied	$	1,426	$	1,809	$	22	$	42
Non-owner occupied		333		374		0		10
Commercial		322		395		3		6
Residential real estate
1-4 family residential		2,250		2,267		37		41
Home equity lines of credit		238		270		2		4
Consumer		78		63		4		4
Subtotal		4,647		5,178		68		107
With an allowance recorded:
Commercial real estate
Owner occupied		694		2,324		9		12
Non-owner occupied		1,138		1,503		15		20
Commercial		149		336		1		1
Residential real estate
1-4 family residential		889		860		10		9
Home equity lines of credit		85		88		1		1
Consumer		5		0		0		0
Subtotal		2,960		5,111		36		43
Total	$	7,607	$	10,289	$	104	$	150

17

	Average Recorded Investment				Interest Income Recognized
	For Nine Months Ended September 30,				For Nine Months Ended September 30,
(In Thousands of Dollars)	2016		2015		2016		2015
With no related allowance recorded:
Commercial real estate
Owner occupied	$	1,666	$	2,115	$	60	$	87
Non-owner occupied		334		380		4		23
Commercial		422		422		13		17
Residential real estate
1-4 family residential		2,264		2,167		108		110
Home equity lines of credit		235		265		8		11
Consumer		93		78		10		11
Subtotal		5,014		5,427		203		259
With an allowance recorded:
Commercial real estate
Owner occupied		1,064		1,987		27		60
Non-owner occupied		1,336		1,520		53		60
Commercial		103		636		3		3
Residential real estate
1-4 family residential		828		917		30		29
Home equity lines of credit		86		89		3		3
Consumer		2		0		0		0
Subtotal		3,419		5,149		116		155
Total	$	8,433	$	10,576	$	319	$	414

Cash basis interest recognized during the three and nine month periods ended September 30, 2016 and 2015 was materially equal to interest income recognized.

Nonaccrual loans and loans past due 90 days or more still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

18

The following table presents the recorded investment in nonaccrual and loans past due 90 days or more still on accrual by class of loans as of September 30, 2016 and December 31, 2015:

	September 30, 2016				December 31, 2015
(In Thousands of Dollars)	Nonaccrual		Loans Past Due 90 Days or More Still Accruing		Nonaccrual		Loans Past Due 90 Days or More Still Accruing
Originated loans:
Commercial real estate
Owner occupied	$	1,050	$	0	$	3,313	$	0
Non-owner occupied		332		0		345		0
Commercial		525		0		541		73
Residential real estate
1-4 family residential		1,964		305		2,406		336
Home equity lines of credit		168		24		127		112
Consumer
Indirect		264		222		266		297
Direct		19		2		30		3
Other		0		20		0		24
Total originated loans	$	4,322	$	573	$	7,028	$	845
Acquired loans:
Commercial real estate
Owner occupied	$	490	$	0	$	126	$	18
Other		41		0		92		0
Commercial		1,193		0		1,068		0
Residential real estate
1-4 family residential		400		706		458		467
Home equity lines of credit		137		32		125		7
Consumer
Direct		80		29		161		50
Total acquired loans	$	2,341	$	767	$	2,030	$	542
Total loans	$	6,663	$	1,340	$	9,058	$	1,387

19

The following tables present the aging of the recorded investment in past due loans as of September 30, 2016 and December 31, 2015 by class of loans:

(In Thousands of Dollars)	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due and Nonaccrual		Total Past Due		Loans Not Past Due		Total
September 30, 2016
Originated loans:
Commercial real estate
Owner occupied	$	0	$	0	$	1,050	$	1,050	$	135,704	$	136,754
Non-owner occupied		16		0		332		348		150,497		150,845
Other		0		0		0		0		62,373		62,373
Commercial		28		40		525		593		192,513		193,106
Residential real estate
1-4 family residential		3,201		772		2,269		6,242		206,846		213,088
Home equity lines of credit		257		52		192		501		55,595		56,096
Consumer
Indirect		2,097		577		486		3,160		152,186		155,346
Direct		295		104		21		420		23,707		24,127
Other		29		79		20		128		6,894		7,022
Total originated loans:	$	5,923	$	1,624	$	4,895	$	12,442	$	986,315	$	998,757
Acquired loans:
Commercial real estate
Owner occupied	$	483	$	121	$	490	$	1,094	$	121,895	$	122,989
Non-owner occupied		0		0		0		0		26,773		26,773
Other		0		0		41		41		14,846		14,887
Commercial		178		37		1,193		1,408		52,987		54,395
Residential real estate
1-4 family residential		1,466		262		1,106		2,834		115,184		118,018
Home equity lines of credit		64		37		169		270		35,498		35,768
Consumer
Direct		660		132		109		901		22,901		23,802
Other		0		0		0		0		231		231
Total acquired loans	$	2,851	$	589	$	3,108	$	6,548	$	390,315	$	396,863
Total loans	$	8,774	$	2,213	$	8,003	$	18,990	$	1,376,630	$	1,395,620

20

(In Thousands of Dollars)	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due and Nonaccrual		Total Past Due		Loans Not Past Due		Total
December 31, 2015
Originated loans:
Commercial real estate
Owner occupied	$	34	$	0	$	3,313	$	3,347	$	109,532	$	112,879
Non-owner occupied		0		0		345		345		138,824		139,169
Other		112		0		0		112		50,559		50,671
Commercial		0		0		614		614		156,513		157,127
Residential real estate
1-4 family residential		1,694		402		2,742		4,838		174,376		179,214
Home equity lines of credit		62		5		239		306		40,917		41,223
Consumer
Indirect		2,059		525		563		3,147		128,280		131,427
Direct		311		5		33		349		17,124		17,473
Other		13		10		24		47		4,461		4,508
Total originated loans	$	4,285	$	947	$	7,873	$	13,105	$	820,586	$	833,691
Acquired loans:
Commercial real estate
Owner occupied	$	669	$	0	$	144	$	813	$	130,860	$	131,673
Non-owner occupied		0		0		0		0		28,045		28,045
Other		0		0		92		92		23,444		23,536
Commercial		276		2		1,068		1,346		72,275		73,621
Residential real estate
1-4 family residential		1,994		244		925		3,163		130,538		133,701
Home equity lines of credit		78		11		132		221		40,708		40,929
Consumer
Direct		567		56		211		834		30,631		31,465
Other		0		0		0		0		204		204
Total acquired loans	$	3,584	$	313	$	2,572	$	6,469	$	456,705	$	463,174
Total loans	$	7,869	$	1,260	$	10,445	$	19,574	$	1,277,291	$	1,296,865

Troubled Debt Restructurings:

Total troubled debt restructurings were $7.6 million and $9.3 million at September 30, 2016 and December 31, 2015, respectively.  The Company has allocated $143 thousand and $528 thousand of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of September 30, 2016 and December 31, 2015.  There were no commitments to lend additional amounts to borrowers with loans that were classified as troubled debt restructurings at September 30, 2016 and at December 31, 2015.

During the three and nine month periods ended September 30, 2016 and 2015, the terms of certain loans were modified as troubled debt restructurings.  The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; a deferral of principal payments; or a legal concession.  During the quarter ended September 30, 2016 only legal concessions were made to certain loans.  During the nine month period ended September 30, 2016, the terms of such loans included a reduction of the stated interest rate of the loan by 1.2% and an extension of the maturity date by 120 months.  During the same nine month period in 2015, loans modified as trouble debt restructurings had an extension of the maturity dates by 9 months.

21

The following table presents loans by class modified as troubled debt restructurings that occurred during the three and nine month periods ended September 30, 2016 and 2015:

			Pre-Modification		Post-Modification
Three Months Ended September 30, 2016	Number of		Outstanding Recorded		Outstanding Recorded
(In thousands of Dollars)	Loans		Investment		Investment
Originated loans:
Residential real estate
1-4 family residential		1	$	93	$	93
Indirect		7		41		41
Total originated loans		8	$	134	$	134
Acquired loans:
Residential real estate
Home equity lines of credit		1		18		18
Consumer		1		6		6
Total acquired loans		2	$	24	$	24
Total loans		10	$	158	$	158

			Pre-Modification		Post-Modification
Nine Months Ended September 30, 2016	Number of		Outstanding Recorded		Outstanding Recorded
(In Thousands of Dollars)	Loans		Investment		Investment
Originated loans:
Residential real estate
1-4 family residential		7	$	328	$	329
Indirect		20		155		155
Total originated loans		27	$	483	$	484
Acquired loans:
Residential real estate
1-4 family residential		2		68		68
Home equity lines of credit		1		18		18
Indirect
Consumer		2		39		39
Total acquired loans		5	$	125	$	125
Total loans		32	$	608	$	609

			Pre-Modification		Post-Modification
Three Months Ended September 30, 2015	Number of		Outstanding Recorded		Outstanding Recorded
(In thousands of Dollars)	Loans		Investment		Investment
Originated loans:
Residential real estate
1-4 family residential		5	$	153	$	153
Indirect		3		25		25
Total originated loans		8	$	178	$	178

22

			Pre-Modification		Post-Modification
	Number of		Outstanding Recorded		Outstanding Recorded
Nine Months Ended September 30, 2015	Loans		Investment		Investment
Troubled Debt Restructurings:
Commercial real estate
Owner occupied		2	$	801	$	801
Commercial		1		8		8
Residential real estate
1-4 family residential		10		700		700
Home equity lines of credit		1		50		50
Indirect		5		61		61
Total		19	$	1,620	$	1,620

There were $25 thousand and $353 thousand in charge offs during the three and nine month periods ended September 30, 2016, respectively.  There was a $25 thousand and a $36 thousand increase to the provision during the three and nine month period ended September 30, 2016, as a result of troubled debt restructurings.  There were $110 thousand in charge offs and a $85 thousand increase to the provision for loan losses during the nine month period ended September 30, 2015, as a result of troubled debt restructurings.

There were two commercial loans, one residential real estate loan and one home equity line of credit for which there was a payment default for both within twelve months following the modification of the troubled debt restructuring during the three month period and nine month period ended September 30, 2016.  The one home equity line of credit was past due at September 30, 2016.  There was no provision recorded as a result of the defaults during 2016.  A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms.

There was one commercial real estate loan modified as a troubled debt restructuring for which there was a payment default within the first twelve months following the modification during the three and nine month period ended September 30, 2015.  This loan was past due at September 30, 2015.  There was no provision recorded as a result of the default during 2015.

Credit Quality Indicators:

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors.  The Company establishes a risk rating at origination for all commercial loan and commercial real estate relationships.  For relationships over $750 thousand, management monitors the loans on an ongoing basis for any changes in the borrower’s ability to service their debt.  Management also affirms the risk ratings for the loans and leases in their respective portfolios on an annual basis.  The Company uses the following definitions for risk ratings:

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.  Special mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  Substandard loans are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans.

23

As of September 30, 2016 and December 31, 2015, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

(In Thousands of Dollars)	Pass		Special Mention		Sub standard		Doubtful		Total
September 30, 2016
Originated loans:
Commercial real estate
Owner occupied	$	132,972	$	1,023	$	2,759	$	0	$	136,754
Non-owner occupied		147,800		567		2,478		0		150,845
Other		61,768		325		280		0		62,373
Commercial		190,620		1,454		1,032		0		193,106
Total originated loans	$	533,160	$	3,369	$	6,549	$	0	$	543,078
Acquired loans:
Commercial real estate
Owner occupied	$	119,466	$	556	$	2,967	$	0	$	122,989
Non-owner occupied		25,452		1,140		181		0		26,773
Other		14,257		469		161		0		14,887
Commercial		49,963		971		3,461		0		54,395
Total acquired loans	$	209,138	$	3,136	$	6,770	$	0	$	219,044
Total loans	$	742,298	$	6,505	$	13,319	$	0	$	762,122

(In Thousands of Dollars)	Pass		Special Mention		Sub standard		Doubtful		Total
December 31, 2015
Originated loans:
Commercial real estate
Owner occupied	$	107,222	$	1,069	$	4,588	$	0	$	112,879
Non-owner occupied		135,847		461		2,861		0		139,169
Other		50,376		0		295		0		50,671
Commercial		154,215		939		1,973		0		157,127
Total originated loans	$	447,660	$	2,469	$	9,717	$	0	$	459,846
Acquired loans:
Commercial real estate
Owner occupied	$	130,028	$	0	$	1,645	$	0	$	131,673
Non-owner occupied		26,141		1,340		564		0		28,045
Other		22,843		476		217		0		23,536
Commercial		69,674		635		3,312		0		73,621
Total acquired loans	$	248,686	$	2,451	$	5,738	$	0	$	256,875
Total loans	$	696,346	$	4,920	$	15,455	$	0	$	716,721

The Company considers the performance of the loan portfolio and its impact on the allowance for loan losses.  For residential, consumer indirect and direct loan classes, the Company also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity.  In the 1-4 family residential real estate portfolio at September 30, 2016 there were $381 thousand of other real estate owned properties and $445 thousand of properties in foreclosure.  Other real estate owned and foreclosure properties were $328 thousand and $857 thousand at December 31, 2015, respectively.

24

The following tables present the recorded investment in residential, consumer indirect and direct auto loans based on payment activity as of September 30, 2016 and December 31, 2015.  Nonperforming loans are loans past due 90 days or more and still accruing interest and nonaccrual loans.

	Residential Real Estate				Consumer
(In Thousands of Dollars)	1-4 Family Residential		Home Equity Lines of Credit		Indirect		Direct		Other
September 30, 2016
Originated loans:
Performing	$	210,819	$	55,904	$	154,860	$	24,106	$	7,002
Nonperforming		2,269		192		486		21		20
Total originated loans	$	213,088	$	56,096	$	155,346	$	24,127	$	7,022
Acquired loans:
Performing	$	116,912	$	35,599	$	0	$	23,693	$	231
Nonperforming		1,106		169		0		109		0
Total acquired loans		118,018		35,768		0		23,802		231
Total loans	$	331,106	$	91,864	$	155,346	$	47,929	$	7,253

	Residential Real Estate				Consumer
(In Thousands of Dollars)	1-4 Family Residential		Home Equity Lines of Credit		Indirect		Direct		Other
December 31, 2015
Originated loans:
Performing	$	176,472	$	40,984	$	130,864	$	17,440	$	4,484
Nonperforming		2,742		239		563		33		24
Total originated loans	$	179,214	$	41,223	$	131,427	$	17,473	$	4,508
Acquired loans:
Performing	$	132,776	$	40,797	$	0	$	31,254	$	204
Nonperforming		925		132		0		211		0
Total acquired loans		133,701		40,929		0		31,465		204
Total loans	$	312,915	$	82,152	$	131,427	$	48,938	$	4,712

Interest-Rate Swaps:

The Company uses a program that utilizes interest-rate swaps as part of its asset/liability management strategy.  The interest-rate swaps are used to help manage the Company’s interest rate risk position and not as derivatives for trading purposes.  The notional amount of the interest-rate swaps does not represent amounts exchanged by the parties.  The amount exchanged is determined by reference to the notional amount and the other terms of the individual interest-rate swap agreements.

The objective of the interest-rate swaps is to protect the related fixed rate commercial real estate loans from changes in fair value due to changes in interest rates.  The Company has a program whereby it lends to its borrowers at a fixed rate with the loan agreement containing a two-way yield maintenance provision, which will be invoked in the event of prepayment of the loan, and is expected to exactly offset the fair value of unwinding the swap.  The yield maintenance provision represents an embedded derivative which is bifurcated from the host loan contract and, as such, the swaps and embedded derivatives are not designated as hedges.  Accordingly, both instruments are carried at fair value and changes in fair value are reported in current period earnings.

Summary information about these interest-rate swaps at periods ended September 30, 2016 and December 31, 2015 is as follows:

	Sept. 30, 2016			December 31, 2015
Notional amounts (In thousands)	$	37,782		$	30,763
Weighted average pay rate on interest-rate swaps		4.30	%		4.25	%
Weighted average receive rate on interest-rate swaps		2.90	%		2.70	%
Weighted average maturity (years)		4.6			4.1
Fair value of combined interest-rate swaps (In thousands)	$	1,897		$	789

The fair value of the yield maintenance provisions and interest-rate swaps is recorded in other assets and other liabilities, respectively, in the consolidated balance sheets.  Changes in the fair value of the yield maintenance provisions and interest-rate swaps are reported

25

in earnings, as other noninterest income in the consolidated statements of income.  For the three month and nine month periods ended September 30, 2016 and 2015 there were no net gains or losses recognized in earnings.

Earnings Per Share:

The computation of basic and diluted earnings per share is shown in the following table:

	Three Months Ended Sept. 30,				Nine Months Ended Sept. 30,
	2016		2015		2016		2015
Basic EPS
Net income (In thousands)	$	5,376	$	1,857	$	15,194	$	4,880
Weighted average shares outstanding		27,260,584		25,710,795		27,167,720		21,204,754
Basic earnings per share	$	0.20	$	0.07	$	0.56	$	0.23
Diluted EPS
Net income (In thousands)	$	5,376	$	1,857	$	15,194	$	4,880
Weighted average shares outstanding for basic earnings per share		27,260,584		25,710,795		27,167,720		21,204,754
Dilutive effect of restricted stock awards		24,692		6,059		18,583		4,384
Weighted average shares for diluted earnings per share		27,285,276		25,716,854		27,186,303		21,209,138
Diluted earnings per share	$	0.20	$	0.07	$	0.56	$	0.23

There were no restricted stock awards that were considered anti-dilutive for the three and nine month periods ended September 30, 2016 and 2015.

Stock Based Compensation:

During 2012, the Company, with the approval of shareholders, created the 2012 Equity Incentive Plan (the “Plan”).  The Plan permits the award of up to 500 thousand shares to the Company’s directors and employees to promote the Company’s long-term financial success by motivating performance through long-term incentive compensation and to better align the interests of its employees with those of its shareholders.  There were 62,242 additional shares granted under the Plan during the nine month period ended September 30, 2016 as detailed in the table below.  Expense recognized for the Plan was $201 thousand and $602 thousand for the three and nine month periods ended September 30, 2016, respectively.  As of September 30, 2016, there was $1.6 million of total unrecognized compensation expense related to the nonvested shares granted under the Plan.  The remaining cost is expected to be recognized over 2.25 years. There was $159 thousand and $275 thousand of expense recognized for the Plan for the three and nine month periods ended September 30, 2015.  

Granted shares are earned upon meeting certain target performance metrics that are measured using extensive performance review scorecards.  The main metrics used include earnings per share, return on average assets and the efficiency ratio. The shares have forfeitable dividend rights; as such the shares do not meet the definition of participating shares.

The following is the activity under the Plan during the nine month periods ended September 30, 2016 and 2015:

	Nine Months Ended Sept. 30, 2016				Nine Months Ended Sept. 30, 2015
	Units		Weighted Average GrantDateFair Value		Units			Weighted Average GrantDateFair Value
Beginning balance		320,980	$	7.88		46,957		$	7.39
Granted		62,242		8.98		279,023			7.96
Vested		0		0		0			0
Forfeited		0		0		(5,000	)		7.88
Ending balance		383,222	$	8.06		320,980		$	7.88

26

Other Comprehensive Income:

The following table represents the detail of other comprehensive income for the three and nine month periods ended September 30, 2016 and 2015.

	Three Months Ended September 30, 2016
(In Thousands of Dollars)	Pre-tax			Tax		After-Tax
Unrealized holding gains on available-for-sale securities during the period	$	(2,350	)	$	823	$	(1,527	)
Reclassification adjustment for (gains) losses included in net income (1)		(31	)		10		(21	)
Net unrealized gains on available-for-sale securities	$	(2,381	)	$	833	$	(1,548	)

	Three Months Ended September 30, 2015
(In Thousands of Dollars)	Pre-tax			Tax			After-Tax
Unrealized holding gains on available-for-sale securities during the period	$	3,557		$	(1,245	)	$	2,312
Reclassification adjustment for (gains) losses included in net income (1)		(3	)		1			(2	)
Net unrealized gains on available-for-sale securities	$	3,554		$	(1,244	)	$	2,310

	Nine Months Ended September 30, 2016
(In Thousands of Dollars)	Pre-tax			Tax			After-Tax
Unrealized holding gains on available-for-sale securities during the period	$	6,021		$	(2,106	)	$	3,915
Reclassification adjustment for (gains) losses included in net income (1)		(72	)		25			(47	)
Net unrealized gains on available-for-sale securities	$	5,949		$	(2,081	)	$	3,868

	Nine Months Ended September 30, 2015
(In Thousands of Dollars)	Pre-tax			Tax			After-Tax
Unrealized holding gains on available-for-sale securities during the period	$	421		$	(148	)	$	273
Reclassification adjustment for (gains) losses included in net income (1)		(48	)		17			(31	)
Net unrealized gains on available-for-sale securities	$	373		$	(131	)	$	242

(1) Pre-tax reclassification adjustments relating to available-for-sale securities are reported in security gains and the tax impact is included in income tax expense on the consolidated statements of income.

Regulatory Capital Matters

Banks and bank holding companies are subject to various regulatory capital requirements administered by the federal banking agencies.  Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices.  The new minimum capital requirements associated with the Basel Committee on capital and liquidity regulation (Basel III) are being phased in and began on

January 1, 2015 and will continue through January 1, 2019.  Capital amounts and classifications are also subject to qualitative judgments by regulators.  Failure to meet capital requirements can initiate regulatory action by regulators that, if undertaken, could have a direct material effect on the financial statements.  Management believes as of September 30, 2016, the Company and the Bank meet all capital adequacy requirements to which they are subject.

The FDIC and other federal banking regulators revised the risk-based capital requirements applicable to financial holding companies and insured depository institutions, including the Company and the Bank, to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision (“Basel III”).

The common equity tier 1 capital, tier 1 capital and total capital ratios are calculated by dividing the respective capital amounts by risk-weighted assets.  The leverage ratio is calculated by dividing tier 1 capital by adjusted average total assets.

Basel III limits capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity tier 1 capital, tier 1 capital and total capital to risk-weighted assets in addition to the amount necessary to meet minimum risk-based capital requirements.  The capital conservation buffer phase in began January 1, 2016 and will increase each year until fully implemented at 2.5% on January 1, 2019.  Currently Basel III requires the

27

Company and the Bank to maintain (i) a minimum ratio of common equity tier 1 capital to risk-weighted assets of at least 4.5%, (ii) a minimum ratio of tier 1 capital to risk-weighted assets of at least 6.0%, (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0% and (iv) a minimum leverage ratio of at least 4.0%.

Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition.  If only adequately capitalized, regulatory approval is required to accept brokered deposits.  If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required.  At September 30, 2016 and December 31, 2015, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action.  There are no conditions or events since that notification that management believes have changed the institution’s category.

Actual and required capital amounts and ratios are presented below at September 30, 2016 and December 31, 2015:

	Actual					Requirement For Capital Adequacy Purposes:					To be Well Capitalized Under Prompt Corrective Action Provisions:
	Amount		Ratio			Amount		Ratio			Amount		Ratio
September 30, 2016
Common equity tier 1 capital ratio
Consolidated	$	175,963		11.67	%	$	67,872		4.5	%	N/A		N/A
Bank		167,147		11.12	%		67,651		4.5	%	$	97,718		6.5	%
Total risk based capital ratio
Consolidated		188,690		12.51	%		120,662		8.0	%	N/A		N/A
Bank		177,665		11.82	%		120,268		8.0	%		150,335		10.0	%
Tier I risk based capital ratio
Consolidated		178,111		11.81	%		90,497		6.0	%	N/A		N/A
Bank		167,147		11.12	%		90,201		6.0	%		120,268		8.0	%
Tier I leverage ratio
Consolidated		178,111		9.35	%		77,647		4.0	%	N/A		N/A
Bank		167,147		8.83	%		76,934		4.0	%		96,168		5.0	%
December 31, 2015
Common equity tier 1 capital ratio
Consolidated	$	165,451		11.59	%	$	64,245		4.5	%	N/A		N/A
Bank		157,396		11.08	%		63,938		4.5	%	$	92,354		6.5	%
Total risk based capital ratio
Consolidated		176,571		12.37	%		114,214		8.0	%	N/A		N/A
Bank		166,374		11.71	%		113,667		8.0	%		142,084		10.0	%
Tier I risk based capital ratio
Consolidated		167,550		11.74	%		85,660		6.0	%	N/A		N/A
Bank		157,396		11.08	%		85,250		6.0	%		113,667		8.0	%
Tier I leverage ratio
Consolidated		167,550		9.21	%		72,803		4.0	%	N/A		N/A
Bank		157,396		8.65	%		72,770		4.0	%		90,963		5.0	%

Fair Value:

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  There are three levels of inputs that may be used to measure fair values:

Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2 – Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

28

Level 3 – Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

Investment Securities: The Company uses a third party service to estimate fair value on available for sale securities on a monthly basis.  This service provider is considered a leading evaluation pricing service for U.S. domestic fixed income securities.  They subscribe to multiple third-party pricing vendors, and supplement that information with matrix pricing methods.  The fair values for investment securities are determined by quoted market prices in active markets, if available (Level 1).  For securities where quoted prices are not available, fair values are calculated based on quoted prices for similar assets in active markets, quoted prices for similar assets in markets that are not active or inputs other than quoted prices, which provide a reasonable basis for fair value determination.  Such inputs may include interest rates and yield curves, volatilities, prepayment speeds, credit risks and default rates.  Inputs used are derived principally from observable market data (Level 2).  For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).  The fair values of Level 3 investment securities are determined by using unobservable inputs to measure fair value of assets for which there is little, if any market activity at the measurement date, using reasonable inputs and assumptions based on the best information at the time, to the extent that inputs are available without undue cost and effort.  For the period ended September 30, 2016 and for the year ended December 31, 2015, the fair value of Level 3 investment securities was immaterial.

Derivative Instruments: The fair values of derivative instruments are based on valuation models using observable market data as of the measurement date (Level 2).

Impaired Loans: At the time loans are considered impaired, collateral dependent impaired loans are valued at the lower of cost or fair value and non-collateral dependent loans are valued based on discounted cash flows.  Impaired loans carried at fair value generally receive specific allocations of the allowance for loan losses.  For collateral dependent loans fair value is commonly based on recent real estate appraisals.  These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.  Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available.  Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.  Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification.  Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Other Real Estate Owned: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis.  These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair values are commonly based on recent real estate appraisals.  These appraisals may use a single valuation approach or a combination of approaches including comparable sales and the income approach.  Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available.  Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers (for commercial and commercial real estate properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company.  Once received, a member of the Appraisal Department reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics.  On an annual basis, the Company compares the actual selling price of collateral that has been sold to the most recent appraised value to determine what adjustments should be made to appraisals to arrive at fair value.

29

Assets measured at fair value on a recurring basis are summarized below:

	Fair Value Measurements at September 30, 2016 Using:
(In Thousands of Dollars)	Carrying Value		Quoted Prices in Active Markets forIdentical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial Assets
Investment securities available-for sale
U.S. Treasury and U.S. government sponsored entities	$	5,968	$	0	$	5,968	$	0
State and political subdivisions		141,283		0		140,670		613
Corporate bonds		1,362		0		1,362		0
Mortgage-backed securities-residential		179,654		0		179,641		13
Collateralized mortgage obligations		22,213		0		22,213		0
Small Business Administration		17,986		0		17,986		0
Equity securities		263		263		0		0
Total investment securities	$	368,729	$	263	$	367,840	$	626
Yield maintenance provisions	$	1,897	$	0	$	1,897	$	0
Financial Liabilities
Interest rate swaps	$	1,897	$	0	$	1,897	$	0

	Fair Value Measurements at December 31, 2015 Using:
(In Thousands of Dollars)	Carrying Value		Quoted Prices  in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial Assets
Investment securities available-for sale
U.S. Treasury and U.S. government sponsored entities	$	11,106	$	0	$	11,106	$	0
State and political subdivisions		138,723		0		138,723		0
Corporate bonds		1,134		0		1,134		0
Mortgage-backed securities-residential		196,587		0		196,572		15
Collateralized mortgage obligations		27,165		0		27,165		0
Small Business Administration		19,299		0		19,299		0
Equity securities		298		298		0		0
Total investment securities	$	394,312	$	298	$	393,999	$	15
Yield maintenance provisions	$	789	$	0	$	789	$	0
Financial Liabilities
Interest rate swaps	$	789	$	0	$	789	$	0

There were no significant transfers between Level 1 and Level 2 during the three and nine month periods ended September 30, 2016 and 2015.  For additional information related to yield maintenance provisions and interest rate swaps see Interest –Rate Swaps note.

The table below presents a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3):

	Three Months ended September 30,						Nine Months ended September 30,
(In Thousands of Dollars)	2016			2015			2016			2015
Beginning Balance	$	1,820		$	16		$	15		$	10
Total unrealized gains or losses:
Included in other comprehensive income		0			0			0			0
Transfers from level 2		0			0			1,806			0
Repayments, calls and maturities		(1,194	)		(1	)		(1,195	)		(1	)
Acquired and/or purchased		0			0			0			6
Ending Balance	$	626		$	15		$	626		$	15

30

Assets measured at fair value on a non-recurring basis are summarized below:

	Fair Value Measurements at September 30, 2016 Using:
(In Thousands of Dollars)	Carrying Value		Quoted Prices  in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial Assets
Impaired loans
Commercial real estate
Owner occupied	$	31	$	0	$	0	$	31
1–4 family residential		47		0		0		47
Consumer		3		0		0		3

	Fair Value Measurements at December 31, 2015 Using:
(In Thousands of Dollars)	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial Assets
Impaired loans
Commercial real estate
Owner occupied	$	1,448	$	0	$	0	$	1,448
Commercial		1,514		0		0		1,514
1–4 family residential		42		0		0		42
Consumer		13		0		0		13

Impaired loans that are measured for impairment using the fair value of the collateral for collateral dependent loans, had a principal balance of $95 thousand with a valuation allowance of $14 thousand at September 30, 2016, resulting in $139 thousand in additional provision for loan losses for the three and nine month periods.  At December 31, 2015, impaired loans had a principal balance of $3.4 million, with a valuation allowance of $383 thousand.  Loans measured at fair value at September 30, 2015 resulted in an additional provision for loan losses of $567 thousand and $777 thousand for the three and nine month periods, respectively.  Excluded from the fair value of impaired loans, at September 30, 2016 and December 31, 2015, discussed above are $2.7 million and $2.9 million of loans classified as troubled debt restructurings and measured using the present value of cash flows, which is not considered an exit price.

Impaired commercial real estate loans, both owner-occupied and non-owner occupied are valued by independent external appraisals.  These external appraisals are prepared using the sales comparison approach and income approach valuation techniques.  Management makes subsequent unobservable adjustments to the impaired loan appraisals.  Impaired loans other than commercial real estate and other real estate owned are not considered material.

The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at the periods ended September 30, 2016 and December 31, 2015:

September 30, 2016	Fair value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
Impaired loans
Commercial real estate	$	31	Sales Comparison	Adjustment for differences between comparable sales	(24.02%)
Residential		47	Sales comparison	Adjustment for differences between comparable sales	(12.97%) - 14.22% (3.38%)
Consumer		3	Sales comparison	Adjustment for differences between comparable sales	(14.66%) - 14.66% 0.00%

31

December 31, 2015	Fair value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
Impaired loans
Commercial real estate	$	701	Income approach	Adjustment for differences between earning multiplier	(49.42%) - 40.89% 35.33%
		747	Quoted price for loan relationship	Offer price	1.01%
Commercial		252	Quoted price for loan relationship	Offer price	(3.01%)
		1,262	Income approach	Adjustment for differences between earning multiplier	(29.77%)
Residential		42	Sales comparison	Adjustment for differences between comparable sales	(18.32%) - 24.16% (14.02%)
Consumer		13	Sales comparison	Adjustment for differences between comparable sales	(12.86%) - 11.97% (5.79%)

The carrying amounts and estimated fair values of financial instruments not previously disclosed at September 30, 2016 and December 31, 2015 are as follows:

			Fair Value Measurements at September 30, 2016 Using:
(In Thousands of Dollars)	CarryingAmount		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	67,372	$	18,739	$	48,633	$	0	$	67,372
Restricted stock		9,584	n/a		n/a		n/a		n/a
Loans held for sale		2,148		0		2,207		0		2,207
Loans, net		1,385,102		0		0		1,392,618		1,392,618
Mortgage servicing rights		733		0		733		0		733
Accrued interest receivable		5,379		0		1,967		3,412		5,379
Financial liabilities
Deposits		1,492,165		1,247,392		244,962		0		1,492,354
Short-term borrowings		216,525		0		216,525		0		216,525
Long-term borrowings		19,232		0		19,396		0		19,396
Accrued interest payable		449		28		421		0		449

			Fair Value Measurements at December 31, 2015 Using:
(In Thousands of Dollars)	Carrying Amount		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	56,014	$	22,500	$	33,514	$	0	$	56,014
Restricted stock		9,384	n/a		n/a		n/a		n/a
Loans held for sale		1,769		0		1,813		0		1,813
Loans, net		1,287,887		0		0		1,296,075		1,296,075
Mortgage servicing rights		453		0		453		0		453
Accrued interest receivable		5,158		0		2,011		3,147		5,158
Financial liabilities
Deposits		1,409,047		1,164,506		241,909		0		1,406,415
Short-term borrowings		225,832		0		225,832		0		225,832
Long-term borrowings		22,153		0		22,306		0		22,306
Accrued interest payable		445		26		419		0		445

32

The methods and assumptions used to estimate fair value, not previously described, are described as follows:

Cash and Cash Equivalents: The carrying amounts of cash and short-term instruments approximate fair values and are classified as either Level 1 or Level 2.  The Company has determined that cash on hand and non-interest bearing due from bank accounts are Level 1 whereas interest bearing federal funds sold and other are Level 2.

Restricted Stock: It is not practical to determine the fair value of restricted stock due to restrictions placed on its transferability.

Loans: Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification.  Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification.  Impaired loans are valued at the lower of cost or fair value as described previously.  The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

Loans held for sale: The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

Accrued Interest Receivable/Payable: The carrying amounts of accrued interest receivable and payable approximate fair value resulting in a Level 1, Level 2 or Level 3 classification.  The classification is the result of the association with securities, loans and deposits.

Deposits: The fair values disclosed for demand deposits – interest and non-interest checking, passbook savings, and money market accounts – are, by definition, equal to the amount payable on demand at the reporting date resulting in a Level 1 classification.  The carrying amounts of variable rate certificates of deposit approximate their fair values at the reporting date resulting in a Level 2 classification.  Fair value for fixed rate certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

Short-term Borrowings: The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings, generally maturing within ninety days, approximate their fair values resulting in a Level 2 classification.

Long-term Borrowings: The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.

Off-balance Sheet Instruments: The fair value of commitments is not considered material.

Segment Information:

The reportable segments are determined by the products and services offered, primarily distinguished between banking, trust and retirement consulting operations.  They are also distinguished by the level of information provided to the chief operating decision makers in the Company, who use such information to review performance of various components of the business, which are then aggregated.  Loans, investments, and deposits provide the revenues in the banking operation.  All operations are domestic. Significant segment totals are reconciled to the financial statements as follows:

33

(In Thousands of Dollars)	Trust Segment		Bank Segment		Retirement Consulting Segment			Eliminations and Others			Consolidated Totals
September 30, 2016
Goodwill and other intangibles	$	4,754	$	38,272	$	2,919		$	(646	)	$	45,299
Total assets	$	11,058	$	1,943,647	$	3,461		$	2,842		$	1,961,008
(In Thousands of Dollars)	Trust Segment		Bank Segment		Retirement Consulting Segment			Eliminations and Others			Consolidated Totals
December 31, 2015
Goodwill and other intangibles	$	4,967	$	35,412	$	3,178		$	(646	)	$	42,911
Total assets	$	11,078	$	1,854,306	$	4,127		$	391		$	1,869,902
(In Thousands of Dollars)	Trust Segment		Bank Segment		Retirement Consulting Segment			Eliminations and Others			Consolidated Totals
For Three Months Ended September 30, 2016
Net interest income	$	27	$	17,187	$	0		$	(21	)	$	17,193
Provision for loan losses		0		1,110		0			0			1,110
Service fees, security gains and other noninterest income		1,718		4,276		561			(70	)		6,485
Noninterest expense		1,152		12,622		336			267			14,377
Amortization and depreciation expense		76		666		90			16			848
Income before taxes		517		7,065		135			(374	)		7,343
Income taxes		188		1,900		48			(169	)		1,967
Net Income	$	329	$	5,165	$	87		$	(205	)	$	5,376
(In Thousands of Dollars)	Trust Segment		Bank Segment		Retirement Consulting Segment			Eliminations and Others			Consolidated Totals
For Nine Months Ended September 30, 2016
Net interest income	$	69	$	50,829	$	0		$	(69	)	$	50,829
Provision for loan losses		0		2,880		0			0			2,880
Service fees, security gains and other noninterest income		4,831		11,020		1,546			(229	)		17,168
Noninterest expense		3,465		36,312		1,060			1,256			42,093
Amortization and depreciation expense		228		1,845		269			17			2,359
Income before taxes		1,207		20,812		217			(1,571	)		20,665
Income taxes		423		5,501		76			(529	)		5,471
Net Income	$	784	$	15,311	$	141		$	(1,042	)	$	15,194
(In Thousands of Dollars)	Trust Segment		Bank Segment		Retirement Consulting Segment			Eliminations and Others			Consolidated Totals
For Three Months Ended September 30, 2015
Net interest income	$	16	$	14,525	$	0		$	(3	)	$	14,538
Provision for loan losses		0		1,220		0			0			1,220
Service fees, security gains and other noninterest income		1,505		2,824		423			(67	)		4,685
Noninterest expense		1,161		11,909		381			1,264			14,715
Amortization and depreciation expense		84		632		90			0			806
Income before taxes		276		3,588		(48	)		(1,334	)		2,482
Income taxes		95		783		(16	)		(237	)		625
Net Income	$	181	$	2,805	$	(32	)	$	(1,097	)	$	1,857

34

(In Thousands of Dollars)	Trust Segment		Bank Segment		Retirement Consulting Segment		Eliminations and Others			Consolidated Totals
For Nine Months Ended September 30, 2015
Net interest income	$	46	$	33,243	$	0	$	(10	)	$	33,279
Provision for loan losses		0		2,520		0		0			2,520
Service fees, security gains and other noninterest income		4,708		6,917		1,705		(199	)		13,131
Noninterest expense		3,598		26,924		1,143		3,841			35,506
Amortization and depreciation expense		255		1,328		270		0			1,853
Income before taxes		901		9,388		292		(4,050	)		6,531
Income taxes		307		2,005		100		(761	)		1,651
Net Income	$	594	$	7,383	$	192	$	(3,289	)	$	4,880

The Bank segment includes Farmers National Insurance and Farmers of Canfield Investment Co.

Goodwill and Intangible Assets:

Goodwill associated with the Bank’s purchase of the Bowers group in June 2016 and the Company’s purchase of NBOH in June 2015, Tri-State in October 2015, NAI in July of 2013 and Trust in 2009 totaled $36.9 million at September 30, 2016 and $35.1 million at December 31, 2015.  The Bowers group, NBOH and Tri-State acquisitions are more fully described in the Business Acquisitions footnote.  Impairment exists when a reporting unit’s carrying value of goodwill exceeds its fair value, which is determined through a two-step impairment test. Management performs goodwill impairment testing on an annual basis as of September 30.  No goodwill impairment has been identified as of September 30, 2016.  The fair value of the reporting unit is determined based on a discounted cash flow model.  

Acquired Intangible Assets

Acquired intangible assets were as follows:

	September 30, 2016					December 31, 2015
(In Thousands of Dollars)	Gross Carrying Amount		Accumulated Amortization			Gross Carrying Amount		Accumulated Amortization
Amortized intangible assets:
Customer relationship intangibles	$	7,210	$	(4,089	)	$	5,970	$	(3,585	)
Non-compete contracts		430		(349	)		370		(325	)
Trade name		520		(95	)		190		(65	)
Core deposit intangible		5,582		(850	)		5,582		(316	)
Total	$	13,742	$	(5,383	)	$	12,112	$	(4,291	)

Aggregate amortization expense was $421 thousand and $1.1 million for the three and nine month periods ended September 30, 2016.  Amortization expense was $304 thousand and $638 for the three and nine months ended September 30, 2015.

Estimated amortization expense for each of the next five periods and thereafter:

2016 (Three months)	$	373
2017		1,467
2018		1,341
2019		1,231
2020		1,127
Thereafter		2,820
TOTAL	$	8,359

Short-term borrowings:

There were $120 million in short-term Federal Home Loan Bank Advances at September 30, 2016 with a weighted average interest rate of 0.46%.  Short-term Federal Home Loan Bank Advances were $150 million at December 31, 2015.  In addition, the Company

35

had no Fed funds purchased and has a $350 thousand balance on business lines of credit with one lending institution at September 30, 2016 and December 31, 2015.

The following table provides a disaggregation of the obligation by the class of collateral pledged for short-term financing obtained through the sales of repurchase agreements:

(In Thousands of Dollars)	September 30, 2016		December 31, 2015
Overnight and continuous repurchase agreements
U.S. Treasury and U.S. government sponsored entities	$	8,081	$	5,276
State and political subdivisions		14,797		2,640
Mortgage-backed securities - residential		65,112		60,391
Collateralized mortgage obligations - residential		8,185		7,175
Total repurchase agreements	$	96,175	$	75,482

Management believes the risks associated with the agreements are minimal and, in the case of collateral decline, the Company has additional investment securities available to adequately pledge as guarantees for the repurchase agreements.  

36

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements

Discussions in this report that are not statements of historical fact (including statements that include terms such as “will,” “may,” “should,” “believe,” “expect,” “anticipate,” “estimate,” “project,” “intend,” and “plan”) are forward-looking statements that involve risks and uncertainties.  Any forward-looking statement is not a guarantee of future performance and actual future results could differ materially from those contained in forward-looking information.  Factors that could cause or contribute to such differences include, without limitation, risks and uncertainties detailed from time to time in the Company’s filings with the Securities and Exchange Commission (the “Commission”), including without limitation, the risk factors disclosed in Item 1A, “Risk Factors,” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

Many of these factors are beyond the Company’s ability to control or predict, and readers are cautioned not to put undue reliance on those forward-looking statements.  The following list, which is not intended to be an all-encompassing list of risks and uncertainties affecting the Company, summarizes several factors that could cause the Company’s actual results to differ materially from those anticipated or expected in these forward-looking statements:

• general economic conditions in market areas where we conduct business, which could materially impact credit quality trends;

• business conditions in the banking industry;

• the regulatory environment;

• fluctuations in interest rates;

• demand for loans in the market areas where we conduct business;

• rapidly changing technology and evolving banking industry standards;

• competitive factors, including increased competition with regional and national financial institutions;

• new service and product offerings by competitors and price pressures; and other like items.

Other factors not currently anticipated may also materially and adversely affect the Company’s results of operations, cash flows and financial position.  There can be no assurance that future results will meet expectations.  While the Company believes that the forward-looking statements in this report are reasonable, the reader should not place undue reliance on any forward-looking statement.  In addition, these statements speak only as of the date made.  The Company does not undertake, and expressly disclaims, any obligation to update or alter any statements whether as a result of new information, future events or otherwise, except as may be required by applicable law.

Overview

The Captive, which was formed during the third quarter of 2016, is a wholly-owned insurance subsidiary of the Company that provides property and casualty insurance coverage to the Company and its affiliates.  The Captive provides insurance to thirteen other third party insurance captives for which insurance may not be currently available or economically feasible in today’s insurance marketplace.  The entity was created to spread a limited amount of risk among all members of the captive pool.

On June 1, 2016, the Bank completed the acquisition of the Bowers group, and merged the Bowers group with Insurance, the Bank’s wholly-owned insurance agency subsidiary. Bowers will continue to operate out of its Cortland, Ohio location and will enhance the Company’s current product line up, and offer broader options of commercial, farm, home, and auto property/casualty insurance carriers to meet all the needs of all the Company’s customers.  The transaction involved both cash and 123,280 shares of stock totaling $3.2 million, including up to $1.2 million of future payments, contingent upon Bowers meeting performance targets.  Goodwill of $1.8 million, which is recorded on the balance sheet, arising from the acquisition consisted largely of synergies and the cost savings resulting from the combining of the companies.  The goodwill was determined not to be deductible for income tax purposes.  The fair value of other intangible assets of $1.6 million is related to client relationships, company name and noncompetition agreements.

On June 19, 2015, Farmers completed the merger of NBOH, the holding company for the First National Bank of Orrville.  Immediately following the merger, First National Bank was merged into the Bank.  This transaction resulted in the addition of $540 million in assets and 14 branch locations in Wayne, Medina and Stark counties in Ohio.  On October 1, 2015, Farmers completed the acquisition of Tri-State and the merger of Tri-State’s wholly-owned subsidiary, First National Community Bank, which operates 5 banking locations in Columbiana County in Ohio and Western Pennsylvania into the Bank.  At closing, Tri-State had $136 million in assets.  They also had $54.3 million of demand deposits with an overall cost of deposits of 0.19%.  Both acquisitions provide the Company the opportunity to expand into new markets and develop efficiencies of scale to drive future profits.  

37

Net income for the three months ended September 30, 2016 was $5.4 million, or $0.20 per diluted share, which compares to $1.9 million, or $0.07 per diluted share, for the three months ended September 30, 2015.  Excluding expenses related to acquisition activities, net income for the two periods was $5.4 million or $0.20 per diluted share and $3.7 million or $0.14 per diluted share, respectively.  The Company believes that this non-GAAP financial measure provides both management and investors a more complete understanding of the underlying operational results and trends.

Net income for the nine months ended September 30, 2016 was $15.2 million, or $0.56 per diluted share, compared to $4.9 million or $0.23 per diluted share for same nine month period in 2015. Annualized return on average assets and return on average equity were 1.06% and 9.74%, respectively, for the nine month period ending September 30, 2016, compared to 0.48% and 4.31% for the same period in 2015.  Excluding expenses related to acquisition activities, net income for the two nine month periods was $15.6 million, or $0.58 per share and $8.6 million or $0.40 per share, respectively, and the annualized return on average assets and return on average equity were 1.09% and 10.0% in 2016, compared to 0.83% and 7.41% in 2015, respectively.

Annualized return on average assets and return on average equity were 1.10% and 9.97%, respectively, for the three month period ending September 30, 2016, compared to 0.43% and 3.97% for the same period in 2015.  Excluding expenses related to acquisition activities, the annualized return on average assets and return on average equity for the quarter ended September 30, 2016 were 1.10% and 10.02% compared to 0.87% and 7.97% for the same quarter in 2015.

Annualized return on average assets and return on average equity were 1.06% and 9.74%, respectively, for the nine month period ending September 30, 2016, compared to 0.48% and 4.31% for the same nine month period in 2015.

Net income excluding merger related costs is a non-U.S. GAAP financial measure and should be considered in addition to, not asubstitute for or superior to, financial measures determined in accordance with U.S. GAAP.  With respect to the calculation of the actual unaudited net income excluding costs related to acquisition activities for the three and nine month periods ended September 30, 2016 and 2015, reconciliations are displayed in the below table.

	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
(In Thousands of Dollars)		2016		2015		2016		2015
Reconciliation of Net Income, Excluding Costs Related to Acquisition Activities
Income before income taxes - Reported	$	7,343	$	2,482	$	20,665	$	6,531
Acquisition Costs		31		2,499		544		4,656
Income before income taxes - Adjusted		7,374		4,981		21,209		11,187
Income tax expense		1,973		1,255		5,618		2,626
Net income - Adjusted	$	5,401	$	3,726	$	15,591	$	8,561

Total loans were $1.40 billion at September 30, 2016, compared to $1.30 billion at December 31, 2015, representing an annualized growth of 10.2%.  The increase in loans is a direct result of Farmers’ focus on loan growth utilizing a talented lending and credit team, while adhering to a sound underwriting discipline. Most of the increase in loans has occurred in the commercial real estate, commercial and industrial, residential real estate and consumer loan portfolios.  Loans now comprise 76.5% of the Bank's third quarter average earning assets at September 30, 2016, an improvement compared to 73.8% at the same time in 2015.  This improvement along with the growth in earning assets organically and through merger activity has resulted in a 20% increase in tax equated loan income from the third quarter of 2015 to the same quarter in 2016.

Non-performing assets to total assets remain at a safe level, currently at 0.43%.  Early stage delinquencies also continue to remain at low levels, at $11.0 million, or 0.79% of total loans, at September 30, 2016.  Net charge-offs for the current quarter were $312 thousand, up $101 thousand compared to $211 thousand in the same quarter in 2015.  It is important to note that annualized net charge-offs as a percentage of average net loans outstanding decreased from 0.10% for the 3 months ended September 30, 2015 to 0.09% for the same period in 2016.  Lending to the energy sector is insignificant and less than 1% of the loan portfolio.

The net interest margin for the three months ended September 30, 2016 was 3.97%, a 13 basis points increase from the quarter ended September 30, 2015.  In comparing the third quarter of 2016 to the same period in 2015, asset yields increased 13 basis points, while the cost of interest-bearing liabilities decreased 2 basis points.  Another key contributor to the increase in net interest margin was the shift in the mix of earning assets from securities to loans. The increased margin is also partially due to the additional accretion as a result of the discounted loan portfolios acquired in the NBOH and Tri-State mergers. Excluding the amortization of premium on time deposits and Federal Home Loan Bank of Cincinnati (“FHLB”) advances along with the accretion of the acquired loan discount, the net interest margin would have been 8 basis points lower or 3.89% for the quarter ended September 30, 2016.

38

The net interest margin for the nine months ended September 30, 2016 was 4.04%, a 32 basis points increase from the nine month period ended September 30, 2015.  Excluding the amortization of premium on time deposits and FHLB advances along with the accretion of the loan portfolio discount, the net interest margin would have been 9 basis points lower or 3.95% for the nine month period ended September 30, 2016.

Noninterest income increased 38.4% to $6.5 million for the quarter ended September 30, 2016 compared to $4.7 million in 2015.  Deposit account income increased $128 thousand, or 14%, in the current year’s quarter compared to the same quarter in 2015 which was mainly due to the increased number of deposit accounts added from the two acquisitions in 2015. Gains on the sale of mortgage loans increased $648 thousand, or 156%, in comparing the same two quarters.  Insurance agency commissions increased $439 thousand and debit card interchange fees also increased $147 thousand or 29% in comparing the third quarter of 2015 to the same quarter in 2016.

The Company has remained committed to managing the level of noninterest expenses.  Total noninterest expenses for the third quarter of 2016 were $15.2 million compared to $15.5 million in the same quarter in 2015.  Excluding merger related costs, total noninterest expenses for the three month period ended September 30 2015 would have been $13.0 million compared to $15.2 million for the third quarter in 2016.  The primary reasons for the increase was the increased salaries and employee benefits related to the acquisition of the Bowers group on June 1, 2016 and increased incentive compensation resulting from improved corporate profitability.  Annualized noninterest expenses measured as a percentage of quarterly average assets increased slightly from 3.06% in the third quarter of 2015 to 3.12% in the third quarter of 2016.  These same ratios excluding merger related expenses increased from 3.04% in the third quarter of 2015 to 3.11% in the third quarter of 2016.

The efficiency ratio for the quarter ended September 30 2016 improved to 60.9% compared to 76.6% for the same quarter in 2015.  Excluding expenses related to acquisition activities, the efficiency ratios for the same periods were 60.7% and 66.5%, respectively.  The main factors leading to the improvement in the efficiency ratio was the increase in net interest income and noninterest income, along with the stabilized level of noninterest expenses relative to average assets.

Results of Operations

The following is a comparison of selected financial ratios and other results at or for the nine month periods ended September 30, 2016 and 2015:

	At or for the Three Months Ended September 30,						At or for the Nine Months Ended September 30,
(In Thousands, except Per Share Data)	2016			2015			2016			2015
Total Assets	$	1,961,008		$	1,707,797		$	1,961,008		$	1,707,797
Net Income	$	5,376		$	1,857		$	15,194		$	4,880
Basic and Diluted Earnings Per Share	$	0.20		$	0.07		$	0.56		$	0.23
Return on Average Assets (Annualized)		1.10	%		0.43	%		1.06	%		0.48	%
Return on Average Equity (Annualized)		9.97	%		3.97	%		9.74	%		4.31	%
Efficiency Ratio (tax equivalent basis) (1)		60.85	%		76.55	%		62.00	%		76.27	%
Equity to Asset Ratio		10.99	%		10.90	%		10.99	%		10.90	%
Tangible Common Equity Ratio (2)		8.88	%		8.80	%		8.88	%		8.80	%
Dividends to Net Income		20.13	%		41.46	%		21.34	%		38.42	%
Net Loans to Assets		70.63	%		68.79	%		70.63	%		68.79	%
Loans to Deposits		93.53	%		88.93	%		93.53	%		88.93	%

(1) The ratio is calculated by dividing noninterest expenses by the sum of net interest income and noninterest income.  The Company strives for a lower efficiency ratio.  This efficiency ratio measure is not required by any regulatory agency but provides meaningful information to management and investors since a lower ratio indicates the Company is using their assets more effectively to generate profits.  

39

(2) The tangible common equity ratio is calculated by dividing total common stockholders’ equity by total assets, after reducing both amounts by intangible assets.  The tangible common equity ratio is not required by U.S. GAAP or by applicable bank regulatory requirements, but is a metric used by management to evaluate the adequacy of the Company’s capital levels.  Since there is no authoritative requirement to calculate the tangible common equity ratio, the Company’s tangible common equity ratio is not necessarily comparable to similar capital measures disclosed or used by other companies in the financial services industry.  Tangible common equity and tangible assets are non-U.S. GAAP financial measures and should be considered in addition to, not as a substitute for or superior to, financial measures determined in accordance with U.S. GAAP.  With respect to the calculation of the actual unaudited tangible common equity ratio as of September 30, 2016 and 2015, reconciliations of tangible common equity to U.S. GAAP total common stockholders’ equity and tangible assets to U.S. GAAP total assets are set forth below:

	September 30,		December 31,		September 30,
(In Thousands of Dollars)		2016		2015		2015
Reconciliation of Common Stockholders' Equity to Tangible Common Equity
Stockholders' Equity	$	215,437	$	198,047	$	186,151
Less Goodwill and Other Intangibles		45,299		42,911		39,265
Tangible Common Equity		170,138		155,136		146,886
Period End Outstanding Shares		27,048		26,944		25,674
Tangible Book Value	$	6.29	$	5.76	$	5.72

	September 30,		December 31,		September 30,
(In Thousands of Dollars)		2016		2015		2015
Reconciliation of Total Assets to Tangible Assets
Total Assets	$	1,961,008	$	1,869,902	$	1,707,797
Less Goodwill and Other Intangibles		45,299		42,911		39,265
Tangible Assets	$	1,915,709	$	1,826,991	$	1,668,532

Net Interest Income. The following schedule details the various components of net interest income for the periods indicated.  All asset yields are calculated on a tax-equivalent basis where applicable.  Security yields are based on amortized cost.

40

Average Balance Sheets and Related Yields and Rates

(Dollar Amounts in Thousands)

	Three Months Ended								Three Months Ended
	September 30, 2016								September 30, 2015
	AVERAGE								AVERAGE
	BALANCE			INTEREST		RATE (1)			BALANCE			INTEREST		RATE (1)
EARNING ASSETS
Loans (3) (5) (6)	$	1,365,637		$	16,212		4.72	%	$	1,151,899		$	13,530		4.66	%
Taxable securities (4)		229,630			1,160		2.01			265,416			1,369		2.05
Tax-exempt securities (4) (6)		131,714			1,365		4.12			116,581			1,196		4.07
Equity securities (2)		9,607			177		7.33			7,593			48		2.51
Federal funds sold and other		47,850			54		0.45			19,615			9		0.18
TOTAL EARNING ASSETS		1,784,438			18,968		4.23			1,561,104			16,152		4.10
NONEARNING ASSETS
Cash and due from banks		29,046								26,690
Premises and equipment		23,956								23,500
Allowance for loan losses		(9,939	)							(7,452	)
Unrealized gains (losses) on securities		8,035								221
Other assets (3)		113,668								95,808
TOTAL ASSETS	$	1,949,204							$	1,699,871
INTEREST-BEARING LIABILITIES
Time deposits	$	250,268		$	490		0.78	%	$	257,822		$	616		0.95	%
Savings deposits		552,037			191		0.14			512,288			144		0.11
Demand deposits		322,511			177		0.22			267,700			149		0.22
Short term borrowings		215,859			166		0.31			109,795			59		0.21
Long term borrowings		19,404			115		2.36			51,651			88		0.68
TOTAL INTEREST-BEARING LIABILITIES		1,360,079			1,139		0.33			1,199,256			1,056		0.35
NONINTEREST-BEARING LIABILITIES AND STOCKHOLDERS' EQUITY
Demand deposits		359,291								303,188
Other liabilities		15,350								11,974
Stockholders' equity		214,484								185,453
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	1,949,204							$	1,699,871
Net interest income and interest rate spread				$	17,829		3.90	%				$	15,096		3.57	%
Net interest margin							3.97	%							3.84	%

(1) Rates are calculated on an annualized basis.

(2) Equity securities include restricted stock, which is included in other assets on the consolidated balance sheets.

(3) Non-accrual loans and overdraft deposits are included in other assets.

(4) Includes unamortized discounts and premiums.  Average balance and yield are computed using the average historical amortized cost.

(5) Interest on loans includes fee income of $1.0 million and $834 thousand for 2016 and 2015, respectively, and is reduced by amortization of $638 thousand and $640 thousand for 2016 and 2015, respectively.

(6) For 2016, adjustments of $164 thousand and $472 thousand, respectively, are made to tax equate income on tax exempt loans and tax exempt securities. For 2015, adjustments of $145 thousand and $413 thousand, respectively, are made to tax equate income on tax exempt loans and tax exempt securities.  These adjustments are based on a marginal federal income tax rate of 35%, less disallowances.

41

Average Balance Sheets and Related Yields and Rates

(Dollar Amounts in Thousands)

	Nine Months Ended September 30, 2016								Nine Months Ended September 30, 2015
	AVERAGE BALANCE			INTEREST		RATE (1)			AVERAGE BALANCE			INTEREST		RATE (1)
EARNING ASSETS
Loans (3) (5) (6)	$	1,326,536		$	47,429		4.78	%	$	852,094		$	30,129		4.73	%
Taxable securities (4)		245,578			3,885		2.11			278,538			4,421		2.12
Tax-exempt securities (4) (6)		130,010			4,098		4.21			93,874			3,149		4.48
Equity securities (2) (6)		9,601			403		5.61			5,564			142		3.41
Federal funds sold and other		33,625			119		0.47			21,071			20		0.13
TOTAL EARNING ASSETS		1,745,350			55,934		4.28			1,251,141			37,861		4.05
NONEARNING ASSETS
Cash and due from banks		33,088								18,063
Premises and equipment		24,093								19,558
Allowance for loan losses		(9,437	)							(7,553	)
Unrealized gains (losses) on securities		5,311								1,698
Other assets (3)		111,095								70,834
TOTAL ASSETS	$	1,909,500							$	1,353,741
INTEREST-BEARING LIABILITIES
Time deposits	$	247,327		$	1,371		0.74	%	$	221,576		$	2,120		1.28	%
Savings deposits		541,746			501		0.12			444,161			371		0.11
Demand deposits		321,302			486		0.20			184,057			184		0.13
Short term borrowings		213,341			485		0.30			80,721			86		0.14
Long term borrowings		20,719			357		2.30			39,449			306		1.04
TOTAL INTEREST-BEARING LIABILITIES		1,344,435			3,200		0.32			969,964			3,067		0.42
NONINTEREST-BEARING LIABILITIES AND STOCKHOLDERS' EQUITY
Demand deposits		342,673								221,555
Other liabilities		14,111								10,727
Stockholders' equity		208,281								151,495
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	1,909,500							$	1,353,741
Net interest income and interest rate spread				$	52,734		3.96	%				$	34,794		3.63	%
Net interest margin							4.04	%							3.72	%

(1) Rates are calculated on an annualized basis.

(2) Equity securities include restricted stock, which is included in other assets on the consolidated balance sheets.

(3) Non-accrual loans and overdraft deposits are included in other assets.

(4) Includes unamortized discounts and premiums.  Average balance and yield are computed using the average historical amortized cost.

(5) Interest on loans includes fee income of $3.0 million and $2.1 million for 2016 and 2015, respectively, and is reduced by amortization of $1.8 million and $1.7 million for 2016 and 2015, respectively.

(6) For 2016, adjustments of $488 thousand and $1.4 million, respectively, are made to tax equate income on tax exempt loans and tax exempt securities.  For 2015, adjustments of $426 thousand and $1.1 million, respectively, are made to tax equate income on tax exempt loans and tax exempt securities.  These adjustments are based on a marginal federal income tax rate of 35%, less disallowances.

Net Interest Income.  Tax equivalent net interest income was $17.8 million for the third quarter of 2016 compared to $15.1 million for the same period in 2015.  The net interest margin to average earning assets on a fully taxable equivalent basis increased 13 basis points to 3.97% for the three months ended September 30, 2016, compared to 3.84% for the same three month period in the prior year.  In

42

comparing the quarters ended September 30, 2016 and 2015, yields on earning assets increased 13 basis points, while the cost of interest bearing liabilities decreased 2 basis points.  The increased margin is partially due to the additional accretion of the discount on the 2015 acquired loan portfolios, the higher mix of loans to assets on the balance sheet and maturing time deposits with higher interest rates being moved to products with lower interest rates or leaving the Bank.  Excluding the amortization of premium on time deposits and FHLB advances along with the accretion of the loan portfolio discount, the net interest margin would have been 8 basis points lower or 3.89% for the quarter ended September 30, 2016.

Tax equivalent net interest income was $52.7 million for the nine month period ended September 30, 2016, compared to $34.8 million for the same period in 2015.  The annualized net interest margin to average earning assets on a fully taxable equivalent basis increased 32 basis points to 4.04% for the nine months ended September 30, 2016, compared to 3.72% for the same nine month period in the prior year.  The increase is primarily a result of factors similar to the three month results previously stated in the above paragraph.

Noninterest Income.  Noninterest income increased 38.4% to $6.5 million for the quarter ended September 30, 2016 compared to $4.7 million in 2015.  Insurance agency commissions increased $439 thousand for the three month period ended September 30, 2016 compared to the three month period in 2015.  Most of this increase is related to the acquisition, in June of 2016, of the Bowers group insurance agency.  Gains on the sale of mortgage loans increased $648 thousand or 156% and deposit account income increased $128 thousand or 13.8% in comparing the same two quarters.  The increased fees related to deposit accounts are mainly the result of additional volume provided by the Tri-State merger that occurred on October 1, 2015.  In addition, debit card interchange fees also supplied a boost in the second quarter of 2016 compared to the same time period in 2015, increasing 29% or $147 thousand.

Noninterest income for the nine months ended September 30, 2016 was $17.2 million, compared to $13.1 million during the same period in 2015. The increase was the result of many of the same factors affecting the quarterly numbers.  Gains on the sale of mortgage loans increased from $694 thousand for the nine month period ended September 30, 2015 to $2.0 million for the current year nine month period ended September 30, 2016.  Most of the gains on sale increase can be attributed to the acquisition of NBOH and their established secondary mortgage team that was able to provide the added noninterest income compared to the same prior year period.  Debit card fee income increased $740 thousand for the nine month period ended September 30, 2016 compared to the same period in 2015.  Other operating income increased by $490 thousand or 55.8% compared to the same nine month period in 2015.  Most of the additional income came from the investment in a Small Business Investment Company fund (“SBIC”).  Conversely, retirement plan consulting fees decreased by $159 thousand or 9.3% compared to $1.7 million recorded during the nine month period ended September 30, 2015.  The decrease is mainly due to several infrequently occurring projects that occurred in the 2015 period.

Noninterest Expense.  Noninterest expense totaled $15.2 million for the three month period ended September 30, 2016, which was $296 thousand or 1.9% less than the $15.5 million during the same quarter in 2015.  Excluding merger related expense in the three month periods ended September 30, 2016 and 2015, noninterest expenses would have increased $2.2 million in the current year quarter.  The increase is primarily the result of increased levels of expense due to the increased size of the Company after the late 2015 acquisition of Tri-State and the Bowers group on June 1, 2016.  Although the costs to operate the larger entity were spread over most expense categories, salaries and employee benefits increased 15.5%, or $1.1 million, during the current quarter compared to the same quarter in 2015, as a result of the additional employees.  Annualized salaries and employee benefits as a percent of quarterly average assets increase slightly from 1.70% in the third quarter of 2015 to 1.72% in the third quarter of 2016.  At September 30, 2015, before the acquisitions of Tri-State and Bowers, the Full Time Equivalents were at 408.  Post acquisitions at September 30, 2016 there were 434 Full Time Equivalents.  Management continues to monitor Full Time Equivalents as part of the ongoing effort to maintain efficient levels.

Noninterest expenses for the nine months ended September 30, 2016 were $44.5 million, compared to $37.4 million for the same period in 2015, representing an increase of $7.1 million, or 19%. The increase is the result of the $5.2 million increase in salaries and employee benefits as mentioned above, an increase of $1.2 million in occupancy and equipment costs, $550 thousand in core processing charges and a $2.8 million increase in other operating expense.

The Company’s tax equivalent efficiency ratio for the three month period ended September 30, 2016 was 60.9% compared to 76.6% for the same period in 2015.  The positive change in the efficiency ratio was the result of cost efficiencies being realized with the increased size of the Company, supplemented by the improvements to net interest income and noninterest income.

The tax equivalent efficiency ratio for the nine month period ended September 30, 2016 was 62.0% compared to 76.3% for the nine month period ended September 30, 2015.  Excluding the merger costs the ratio was 60.7% and 66.5% for the nine month periods ended September 30, 2016 and 2015, respectively. Management has continued to focus on increasing the levels of noninterest income and reducing the level of noninterest expenses.

Income Taxes.  Income tax expense totaled $2.0 million for the quarter ended September 30, 2016 and $625 thousand for the quarter ended September 30, 2015.  As discussed in previous paragraphs the increased volume of the larger company impacted net income therefore increasing the overall tax expense for the period.  The effective tax rate for the three month period ended September 30,

43

2016 was 26.8% compared to the effective tax rate of 25.2% for the same period in 2015.  The increased effective tax rate in the three month period ended September 30, 2016 was a result of changes to the non-taxable municipal securities portfolio and the increased tax rate as a result of net income exceeding the $10 million threshold.  

Income tax expense was $5.5 million for the first nine months of 2016 and $1.7 million for the first nine months of 2015.  The effective tax rate for the nine month period of 2016 was 26.5%, compared to 25.3% for the same period in 2015.

Other Comprehensive Income.  For the quarter ended September 30, 2016, the change in net unrealized gains or losses on securities, net of reclassifications, resulted in an unrealized loss, net of tax, of $1.5 million, compared to an unrealized gain of $2.3 million for the same period in 2015.  The decrease in fair value of securities for the three month period ended September 30, 2016 compared to 2015 is the result of normal market interest rate fluctuations.

For the nine months of 2016, the change in net unrealized gains on securities, net of reclassifications, resulted in an unrealized gain, net of tax, of $3.9 million, compared to an unrealized gain of $242 thousand for the same period in 2015. The increase in fair value of securities for the nine month period ended September 30, 2016 is the result of the market’s reaction to projected long term interest rates.

Financial Condition

Cash and Cash Equivalents.  Cash and cash equivalents increased $11.4 million during the first nine months of 2016 from $56.0 million to $67.4 million.  The increase in the cash balance is part of the normal fluctuations on the Company’s $1.961 billion balance sheet. The Company expects these levels to remain relatively steady over the next few months.

Securities.  Securities available-for-sale decreased by $25.6 million since December 31, 2015.  The Company used proceeds from repayments and maturities of the securities portfolio to help fund the loan portfolio growth during the first nine months of 2016.

Loans.  Gross loans increased $98.8 million since December 31, 2015.  Most of the increase in loans has occurred in the commercial real estate, commercial and industrial, residential real estate loan portfolios and consumer loan portfolios.  The Bank utilized a talented lending and credit team while adhering to sound underwriting discipline to increase the loan portfolio.  The increase in loan balances was enough to overcome the continued low interest rate environment and help the current quarter’s tax equated loan income to improve by $2.7 million compared to the same quarter in 2015.  

The average tax equivalent interest rate on the loan portfolio was 4.78% for the nine month period ended September 30, 2016 compared to 4.73% for the same period in 2015.  On a fully tax equivalent basis, loans contributed $47.4 million of total interest income during the nine month period ended September 30, 2016 compared to $30.1 million for the same period in 2015.

 Allowance for Loan Losses.  The following table indicates key asset quality ratios that management evaluates on an ongoing basis. The unpaid principal balance of non-performing loans and non-performing assets was used in the calculation of amounts and ratios on the table below for quarters prior to the current quarter ended September 30, 2016.  For the current quarter, recorded investment amounts were used in the calculations.

Asset Quality History

(In Thousands of Dollars)

	9/30/2016			6/30/2016			3/31/2016			12/31/2015			9/30/2015
Nonperforming loans	$	8,003		$	8,360		$	9,710		$	10,445		$	9,620
Nonperforming loans as a % of total loans		0.57	%		0.62	%		0.74	%		0.81	%		0.81	%
Loans delinquent 30-89 days	$	10,987		$	11,371		$	10,072		$	9,130		$	6,974
Loans delinquent 30-89 days as a % of total loans		0.79	%		0.84	%		0.77	%		0.70	%		0.59	%
Allowance for loan losses	$	10,518		$	9,720		$	9,390		$	8,978		$	8,294
Allowance for loan losses as a % of loans		0.75	%		0.72	%		0.71	%		0.69	%		0.70	%
Allowance for loan losses as a % of non-acquired loans		1.05	%		1.04	%		1.08	%		1.08	%		1.08	%
Allowance for loan losses as a % of nonperforming loans		131.43	%		116.27	%		96.70	%		85.96	%		86.22	%
Annualized net charge-offs to average net loans outstanding		0.09	%		0.20	%		0.11	%		0.09	%		0.10	%
Non-performing assets	$	8,509		$	8,932		$	10,265		$	11,387		$	10,672
Non-performing assets as a % of total assets		0.43	%		0.46	%		0.55	%		0.61	%		0.62	%
Net charge-offs for the quarter	$	312		$	660		$	368		$	296		$	211

44

For the three months ended September 30, 2016, management recorded a $1.1 million provision for loan losses, compared to providing $1.2 million over the same three month period in the prior year.  The larger provision for the prior year quarter was mainly a result of higher than normal charge-offs due to one owner-occupied commercial real estate loan relationship.  For the nine month periods ended September 30, 2016 and 2015 the provision recorded was $2.9 million and $2.5 million, respectively.  The larger provision recorded for the nine month period ended September 30, 2016 was primarily a result of a larger loan portfolio.  Loan growth over the first nine months of 2016 was 10.2% on an annualized basis.  The allowance for loan losses as a percentage of the total loan portfolio was 0.75% at September 30, 2016 compared to 0.70% at September 30, 2015.  The loan portfolios acquired at fair market value during the NBOH and Tri-State mergers were recorded without an associated allowance for loan losses during 2015.  When the acquired loans are excluded the ratio of allowance for loan losses to total non-acquired loans is 1.05% at September 30, 2016 compared to 1.08% at September 30, 2015.  Even though early stage delinquencies as a percentage of total loans increased from 0.59% at September 30, 2015 to 0.79% at September 30, 2016, non-performing loans as a percentage of total loans decreased from .81% at September 30, 2015 to .57% at September 30, 2016.  Even with the reduction in the percentage of non-performing loans to total loans as compared to September 30, 2015 the percentage of the allowance for loan losses to non-performing loans increased from 86.22% at September 30, 2015 to 131.43% at September 30, 2016.

Based on the evaluation of the adequacy of the allowance for loan losses, management believes that the allowance for loan losses at September 30, 2016 is adequate and reflects probable incurred losses in the portfolio.  The provision for loan losses is based on management’s judgment after taking into consideration all factors connected with the collectability of the existing loan portfolio.  Management evaluates the loan portfolio in light of economic conditions, changes in the nature and volume of the loan portfolio, industry standards and other relevant factors.  Specific factors considered by management in determining the amounts charged to operating expenses include previous credit loss experience, the status of past due interest and principal payments, the quality of financial information supplied by loan customers and the general condition of the industries in the community to which loans have been made.

Deposits.  Total deposits increased $83.1 million from December 31, 2015 to September 30, 2016, for a balance of $1.5 billion.  The increase in deposits is the result of the Company’s efforts to increase deposits without causing a significant negative impact to the net interest margin during the first nine months of 2016.  Non-interest bearing demand deposits and interest bearing deposits both had large increases between December 31, 2015 and September 30, 2016.  Non-interest bearing deposits increased by $37.8 million or 12.0% during the nine month period and interest bearing deposits increased $35.7 million or 11.1%.  Money market index accounts also increased, at December 31, 2015 the balance was $288.1 million and at September 30, 2016 it increased to $308.3 million, an increase of 7.0%.  The Company’s strategy is to grow deposit balances, to help supply the needs of the growing loan portfolio, while pricing deposit rates to remain competitive within the market.  At September 30, 2016, core deposits, which include, savings and money market accounts, time deposits less than $250 thousand, demand deposits and interest bearing demand deposits represented approximately 97.2% of total deposits.

Borrowings.  Total borrowing balances decreased 4.9% from $247.9 million at December 31, 2015 to $235.8 million at September 30, 2016.  During the nine month period ended September 30, 2016 the Company repaid $30.0 million in short-term FHLB advances while adding $20.7 million in securities sold under repurchase agreements.  The decrease in borrowings is a direct result of the growth in deposits over that same period.

Capital Resources.  Total stockholders’ equity increased $17.4 million, or 8.8%, during the nine month period ended September 30, 2016.  The increase is due to the net income addition to retained earnings less the amount of dividends paid.  Also contributing to the overall equity increase was the $1.2 million of stock issued as part of the purchase price of the Bowers group. The increase of $3.9 million in accumulated other comprehensive income, which is the result of a change in the mark to market adjustment to the securities available for sale portfolio, helped increase equity as well.  Shareholders received $0.04 per share in cash dividends in each of the first three quarters of 2016, which is a 33% increase over the $0.03 paid during each quarter in 2015.  Book value per share increased from $7.35 per share at December 31, 2015 to $7.96 per share at September 30, 2016.  The Company’s tangible book value per share also increased, from $5.76 per share at December 31, 2015 to $6.29 per share at September 30, 2016.  The increases in book value and tangible book value per share were also the result of the mark to market adjustments to the securities available for sale portfolio and the increase to retained earnings from profit retention.

The capital management function is a regular process that consists of providing capital for both the current financial position and the anticipated future growth of the Company.  New minimum capital requirements associated with the Basel Committee on capital and liquidity regulation (Basel III) are being phased in beginning on January 1, 2015 through January 1, 2019.  At September 30, 2016 the Company is required to maintain 4.5% common equity tier 1 to risk weighted assets.  As of September 30, 2016 the Company’s common equity tier 1 to risk weighted assets was 11.67%, total risk-based capital ratio stood at 12.51%, and the Tier I risk-based capital ratio and Tier I leverage ratio were at 11.81% and 9.35%, respectively.  Management believes that the Company and the Bank meet all capital adequacy requirements to which they are subject, as of September 30, 2016.

45

Critical Accounting Policies

The Company follows financial accounting and reporting policies that are in accordance with U.S. GAAP. These policies are presented in Note 1 of the consolidated audited financial statements in the Company’s Annual Report to Shareholders included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.  Critical accounting policies are those policies that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.  The Company has identified two accounting policies that are critical accounting policies and an understanding of these policies is necessary to understand the Company’s financial statements.  These policies relate to determining the adequacy of the allowance for loan losses and other-than-temporary impairment of securities.  Additional information regarding these policies is included in the notes to the aforementioned 2015 consolidated financial statements, Note 1 (Summary of Significant Accounting Policies), Note 3 (Securities), Note 4 (Loans), and the sections captioned “Investment Securities” and “Loan Portfolio.”

Management believes that the accounting for goodwill and other intangible assets also involves a higher degree of judgment than most other significant accounting policies.  U.S. GAAP establishes standards for the amortization of acquired intangible assets and the impairment assessment of goodwill.  Goodwill arising from business combinations represents the value attributable to unidentifiable intangible assets in the business acquired.  The Company’s goodwill relates to the value inherent in the banking industry and that value is dependent upon the ability of the Company’s subsidiaries to provide quality, cost-effective services in a competitive marketplace.  The goodwill value is supported by revenue that is in part driven by the volume of business transacted.  A decrease in earnings resulting from a decline in the customer base or the inability to deliver cost-effective services over sustained periods can lead to impairment of goodwill that could adversely impact earnings in future periods.  U.S. GAAP requires an annual evaluation of goodwill for impairment, or more frequently if events or changes in circumstances indicate that the asset might be impaired.  The fair value of the goodwill is estimated by reviewing the past and projected operating results for the subsidiaries and comparable industry information.

Liquidity

The Company maintains, in the opinion of management, liquidity sufficient to satisfy depositors’ requirements and meet the credit needs of customers.  The Company depends on its ability to maintain its market share of deposits as well as acquiring new funds.  The Company’s ability to attract deposits and borrow funds depends in large measure on its profitability, capitalization and overall financial condition.  The Company’s objective in liquidity management is to maintain the ability to meet loan commitments, purchase securities or to repay deposits and other liabilities in accordance with their terms without an adverse impact on current or future earnings.  Principal sources of liquidity for the Company include assets considered relatively liquid, such as federal funds sold, cash and due from banks, as well as cash flows from maturities and repayments of loans, and securities.

Along with its liquid assets, the Bank has additional sources of liquidity available which help to ensure that adequate funds are available as needed.  These other sources include, but are not limited to, loan repayments, the ability to obtain deposits through the adjustment of interest rates and the purchasing of federal funds and borrowings on approved lines of credit at major domestic banks.  At September 30, 2016, these lines of credit totaled $25 million of which the Bank had not borrowed against.  In addition, the Company has two revolving lines of credit with correspondent banks totaling $6.5 million.  The outstanding balance at September 30, 2016 was $350 thousand.  Management feels that its liquidity position is adequate and continues to monitor the position on a monthly basis.  As of September 30, 2016, the Bank had outstanding balances with the FHLB of $137.1 million with additional borrowing capacity of approximately $141.7 million with the FHLB, as well as access to the Federal Reserve Discount Window, which provides an additional source of funds.  The Bank views its membership in the FHLB as a solid source of liquidity.  

The primary investing activities of the Company are originating loans and purchasing securities. During the first nine months of 2016, net cash used by investing activities amounted to $69.9 million, compared to $16.1 million used in the same period in 2015.  Loan originations were robust and used $100.4 million during the first nine months of 2016 compared to the $91.7 million used during the same period in 2015. The cash used in investing activities during this period can be attributed to the strong lending activity in most all of the loan portfolios. Proceeds from the sale of securities available for sale were down to $11.5 million from $58.2 million during the first nine months of 2015.  Conversely, purchases of securities available for sale amounted to $26.8 million used during the first nine months of 2016 compared to $41.3 million used during the same period in 2015.  The acquisition of NBOH in the first nine months of 2015 provided $21.3 million in cash while the acquisition of the Bowers group in 2016 used $1.1 million.  The Company also used $6.0 million to purchase additional bank owned life insurance in 2015 and none in 2016.  

The primary financing activities of the Company are obtaining deposits, repurchase agreements and other borrowings.  Net cash provided by financing activities amounted to $67.4 million for the period ended September 30, 2016, compared to $15.7 million provided in financing activities for the same period in 2015. There were large swings in two line items during the nine month period ended September 30, 2016 compared to the same period last year. Deposits provided $83.1 million compared to $9.1 million used during the nine month periods ended June 30, 2016 and 2015, respectively. Changes in short term borrowings used $9.3 million in the nine month period ended September 30, 2016 compared to providing $38.8 million during the nine month period ended September 30,

46

2015.  There was also $12.1 million used from long-term borrowing repayments in the nine month period ended September 30, 2015 compared to $3.0 million used in the same period this year.  

Off-Balance Sheet Arrangements

In the normal course of business, to meet the financial needs of our customers, we are a party to financial instruments with off-balance sheet risk.  These financial instruments generally include commitments to originate mortgage, commercial and consumer loans, and involve to varying degrees, elements of credit and interest rate risk in excess of amounts recognized in the Consolidated Balance Sheets.  The Bank’s maximum exposure to credit loss in the event of nonperformance by the borrower is represented by the contractual amount of those instruments.  Because some commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The same credit policies are used in making commitments as are used for on-balance sheet instruments.  Collateral is required in instances where deemed necessary.  Undisbursed balances of loans closed include funds not disbursed but committed for construction projects.  Unused lines of credit include funds not disbursed, but committed for, home equity, commercial and consumer lines of credit.  Financial standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party.  Those guarantees are primarily used to support public and private borrowing arrangements.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.  Total unused commitments were $312.9 million at September 30, 2016 and $274.2 at December 31, 2015.  Additionally, the Company has committed up to a $5 million subscription in SBIC investment funds.  At September 30, 2016 the Company had invested $3.1 million in these funds.

Recent Market and Regulatory Developments

Various legislation affecting financial institutions and the financial industry will likely continue to be introduced in Congress, and such legislation may further change banking statutes and the operating environment of the Company in substantial and unpredictable ways, and could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance depending upon whether any of this potential legislation will be enacted, and if enacted, the effect that it or any implementing regulations, would have on the financial condition or results of operations of the Company or any of its subsidiaries.  With the enactment of the Dodd-Frank Act, the nature and extent of future legislative and regulatory changes affecting financial institutions remains very unpredictable at this time.

Also, such statutes, regulations and policies are continually under review by Congress and state legislatures and federal and state regulatory agencies and are subject to change at any time, particularly in the current economic and regulatory environment.  Any such change in statutes, regulations or regulatory policies applicable to the Company could have a material effect on the business of the Company.

Item  3. Quantitative and Qualitative Disclosures About Market Risk

The Company’s ability to maximize net income is dependent, in part, on management’s ability to plan and control net interest income through management of the pricing and mix of assets and liabilities.  Because a large portion of assets and liabilities of the Company are monetary in nature, changes in interest rates and monetary or fiscal policy affect its financial condition and can have significant impact on the net income of the Company.  Additionally, the Company’s balance sheet is slightly asset sensitive and in the low interest rate environment that exists today, the Company’s net interest margin should maintain relatively stable levels throughout the near future.  

47

The Company considers the primary market exposure to be interest rate risk.  Simulation analysis is used to monitor the Company’s exposure to changes in interest rates, and the effect of the change to net interest income.  The following table shows the effect on net interest income and the net present value of equity in the event of a sudden and sustained 300 basis point increase or 100 basis point decrease in market interest rates:

Changes In Interest Rate (basis points)	September 30, 2016 Result			December31, 2015 Result			ALCO Guidelines
Net Interest Income Change
+300		3.7	%		-1.3	%		15	%
+200		2.9	%		-0.6	%		10	%
+100		1.8	%		-0.2	%		5	%
-100		-3.6	%		-2.8	%		5	%
Net Present Value Of Equity Change
+300		8.2	%		-8.4	%		20	%
+200		8.0	%		-4.5	%		15	%
+100		5.7	%		-1.3	%		10	%
-100		-10.3	%		-3.5	%		10	%

It should be noted that the change in the net present value of equity exceeded policy when the simulation model assumed a sudden decrease in rates of 100 basis points (1%).  This is primarily due to the positive impact on the fair value of assets not being as great as the negative impact on the fair value of certain liabilities.  Specifically, because core deposits typically bear relatively low interest rates, their fair value would be negatively impacted as the rates could not be adjusted by the full extent of the sudden decrease in rates.  Management does not believe that a 100 basis rate decline is realistic in the current interest rate environment. The results of the other simulations indicate that in an environment where interest rates rise 100, 200 and 300 basis points over a 12 month period, using September 30, 2016 amounts as a base case, comply with internal limits established by the Company.  A report on interest rate risk is presented to the Board of Directors and the Asset/Liability Committee on a quarterly basis.  The Company has no market risk sensitive instruments held for trading purposes, nor does it hold derivative financial instruments, and does not plan to purchase these instruments in the near future.

Item  4. Controls and Procedures

Based on their evaluation, as of the end of the period covered by this Quarterly Report on Form 10-Q, the Company’s Chief Executive Officer and Chief Financial Officer have concluded the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) are effective.  There were no changes in the Company’s internal controls over financial reporting (as defined in Rule 13a–15(f) under the Exchange Act) that occurred during the fiscal quarter ended September 30, 2016, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

In the opinion of management there are no outstanding legal actions that will have a material adverse effect on the Company’s financial condition or results of operations.

Item 1A. Risk Factors

There have been no material changes to the Company’s risk factors from those disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015.

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

Purchases of equity securities by the issuer.

On September 28, 2012, the Company announced that its Board of Directors approved a stock repurchase program that authorizes the repurchase of up to 920,000 shares of its outstanding common stock in the open market or in privately negotiated transactions. There were no shares purchased during the three month period ended September 30, 2016.  There are 245,866 shares that may still be repurchased under this program.  

48

During the acquisition of the Bowers group there were 123,280 shares issued as part of the transaction that was completed on June 1, 2016.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

49

Item 6. Exhibits

The following exhibits are filed or incorporated by reference as part of this report:

3.1	Articles of Incorporation of Farmers National Banc Corp., as amended (incorporated by reference from Exhibit 4.1 to the Company’s Registration Statement on Form S-3 filed with the Commission on October 3, 2001 (File No. 333-70806)).
3.2	Amendment to Articles of Incorporation of Farmers National Banc Corp., as amended (incorporated by reference from Exhibit 3.1 to the Company’s Current Report on Form 8-K filed with the Commission on May 1, 2013).
3.3	Amended Code of Regulations of Farmers National Banc Corp. (incorporated by reference from Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2011 filed with the Commission on August 9, 2011).
31.1	Rule 13a-14(a)/15d-14(a) Certification of Kevin J. Helmick, President and Chief Executive Officer of the Company (filed herewith).
31.2	Rule 13a-14(a)/15d-14(a) Certification of Carl D. Culp, Executive Vice President, Chief Financial Officer and Treasurer of the Company (filed herewith).
32.1	Certification pursuant to 18 U.S.C. Section 1350 of Kevin J. Helmick, President and Chief Executive Officer of the Company (filed herewith).
32.2	Certification pursuant to 18 U.S.C. Section 1350 of Carl D. Culp, Executive Vice President, Chief Financial Officer and Treasurer of the Company (filed herewith).
101	The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2016, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets; (ii) the Consolidated Statements of Income; (iii) the Consolidated Statements of Comprehensive Income; (iv) the Consolidated Statements of Cash Flows; and (v) Notes to Unaudited Consolidated Financial Statements, tagged as blocks of text.

*  Constitutes a management contract or compensatory plan or arrangement.

50

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.

FARMERS NATIONAL BANC CORP.

Dated: November 8, 2016

/s/ Kevin J. Helmick

Kevin J. Helmick
President and Chief Executive Officer

Dated: November 8, 2016

/s/ Carl D. Culp

Carl D. Culp
Executive Vice President and Treasurer

51