secondqtr2007q.htm

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



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

For the quarterly period ended June 30, 2007

Or

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

For the transition period from_____________________ to ___________________

Commission file number 0-13222

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

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


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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  (See definition of “accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act)  Check one:

Large Accelerated File ____    Accelerated Filer ____    Non-accelerated Filer __X__


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

The number of shares outstanding of the Registrant's Common Stock, as of July 30, 2007, was 2,840,398 of Common Stock, par value $1.00.






 
Citizens Financial Services, Inc.
Form 10-Q

INDEX

   
PAGE
Part I
FINANCIAL INFORMATION
 
Item 1.
Financial Statements (unaudited):
 
 
Consolidated Balance Sheet as of June 30, 2007 and
December 31, 2006
1
 
Consolidated Statement of Income for the
Three Months and Six Months Ended June 30, 2007 and 2006
2
 
Consolidated Statement of Comprehensive Income for the
Three Months and Six Months Ended June 30, 2007 and 2006
3
 
Consolidated Statement of Cash Flows for the
Six Months Ended June 30, 2007 and 2006
4
 
Notes to Consolidated Financial Statements
5-7
Item 2.
Management’s Discussion and Analysis of Financial
Condition and Results of Operations
8-22
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
23
Item 4.
Controls and Procedures
23
     
Part II
OTHER INFORMATION
 
Item 1.
Legal Proceedings
24
Item 1A.
Risk Factors
24
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
24
Item 3.
Defaults upon Senior Securities
24
Item 4.
Submission of Matters to a Vote of Security Holders
24
Item 5.
Other Information
24
Item 6.
Exhibits
25-26
 
Signatures
27




CITIZENS FINANCIAL SERVICES, INC.
 
 
   
 
 
CONSOLIDATED BALANCE SHEET
 
 
   
 
 
(UNAUDITED)
 
 
   
 
 
 
 
 
   
 
 
 
 
June 30
   
December 31
 
(in thousands except share data)
 
2007
   
2006
 
ASSETS:
 
 
   
 
 
Cash and due from banks:
 
 
   
 
 
  Noninterest-bearing
  $
10,873
    $
10,007
 
  Interest-bearing
   
12
     
8
 
Total cash and cash equivalents
   
10,885
     
10,015
 
Available-for-sale securities
   
118,614
     
109,743
 
Loans (net of allowance for loan losses:
               
  2007, $4,107 and 2006, $3,876)
   
410,967
     
410,897
 
Premises and equipment
   
12,660
     
12,892
 
Accrued interest receivable
   
2,383
     
2,458
 
Goodwill
   
8,605
     
8,605
 
Bank owned life insurance
   
8,209
     
8,047
 
Other assets
   
8,958
     
9,511
 
 
               
TOTAL ASSETS
  $
581,281
    $
572,168
 
 
               
LIABILITIES:
               
Deposits:
               
  Noninterest-bearing
  $
50,753
    $
48,509
 
  Interest-bearing
   
417,189
     
398,006
 
Total deposits
   
467,942
     
446,515
 
Borrowed funds
   
62,382
     
75,775
 
Accrued interest payable
   
2,086
     
2,287
 
Other liabilities
   
4,531
     
4,091
 
TOTAL LIABILITIES
   
536,941
     
528,668
 
STOCKHOLDERS' EQUITY:
               
Common stock
               
  $1.00 par value; authorized 10,000,000 shares;
               
  issued  2,992,896 shares in 2007 and 2006, respectively
   
2,993
     
2,993
 
Additional paid-in capital
   
11,935
     
11,933
 
Retained earnings
   
35,892
     
34,007
 
Accumulated other comprehensive loss
    (2,551 )     (1,737 )
Unearned restricted stock:  3,074 shares for 2007 and 0 shares for 2006
    (72 )    
-
 
Treasury stock, at cost:  180,140 shares for
               
  2007, and 172,954 shares for 2006
    (3,857 )     (3,696 )
TOTAL STOCKHOLDERS' EQUITY
   
44,340
     
43,500
 
TOTAL LIABILITIES AND
               
   STOCKHOLDERS' EQUITY
  $
581,281
    $
572,168
 
 
               
The accompanying notes are an integral part of these unaudited consolidated financial statements.
         

 
1







CITIZENS FINANCIAL SERVICES, INC.
 
 
   
 
   
 
   
 
 
CONSOLIDATED STATEMENT OF INCOME
 
 
   
 
   
 
   
 
 
(UNAUDITED)
 
 
   
 
   
 
   
 
 
 
 
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(in thousands, except per share data)
 
2007
   
2006
   
2007
   
2006
 
INTEREST INCOME:
 
 
   
 
   
 
   
 
 
Interest and fees on loans
  $
7,539
    $
6,894
    $
14,896
    $
13,413
 
Investment securities:
                               
    Taxable
   
1,057
     
879
     
2,071
     
1,698
 
    Nontaxable
   
225
     
221
     
449
     
447
 
    Dividends
   
78
     
82
     
169
     
149
 
TOTAL INTEREST INCOME
   
8,899
     
8,076
     
17,585
     
15,707
 
INTEREST EXPENSE:
                               
Deposits
   
3,430
     
2,722
     
6,740
     
5,323
 
Borrowed funds
   
806
     
876
     
1,732
     
1,539
 
TOTAL INTEREST EXPENSE
   
4,236
     
3,598
     
8,472
     
6,862
 
NET INTEREST INCOME
   
4,663
     
4,478
     
9,113
     
8,845
 
Provision for loan losses
   
45
     
60
     
165
     
120
 
NET INTEREST INCOME AFTER
                               
    PROVISION FOR LOAN LOSSES
   
4,618
     
4,418
     
8,948
     
8,725
 
NON-INTEREST INCOME:
                               
Service charges
   
812
     
809
     
1,560
     
1,515
 
Trust
   
127
     
108
     
264
     
237
 
Brokerage
   
31
     
59
     
49
     
153
 
Investment securities gains (losses), net
   
-
     
5
     
-
      (1 )
Gains on loans sold
   
46
     
7
     
64
     
13
 
Gains on sales of foreclosed properties
   
373
     
34
     
396
     
47
 
Earnings on bank owned life insurance
   
82
     
74
     
162
     
146
 
Other
   
120
     
95
     
223
     
213
 
TOTAL NON-INTEREST INCOME
   
1,591
     
1,191
     
2,718
     
2,323
 
NON-INTEREST EXPENSES:
                               
Salaries and employee benefits
   
2,033
     
1,987
     
4,126
     
4,023
 
Occupancy
   
308
     
276
     
609
     
584
 
Furniture and equipment
   
140
     
144
     
268
     
296
 
Professional fees
   
155
     
106
     
320
     
246
 
Amortization
   
36
     
36
     
72
     
180
 
Other
   
1,284
     
1,188
     
2,338
     
2,299
 
TOTAL NON-INTEREST EXPENSES
   
3,956
     
3,737
     
7,733
     
7,628
 
Income before provision for income taxes
   
2,253
     
1,872
     
3,933
     
3,420
 
Provision for income taxes
   
493
     
386
     
793
     
658
 
NET INCOME
  $
1,760
    $
1,486
    $
3,140
    $
2,762
 
                                 
Earnings Per Share
  $
0.63
    $
0.52
    $
1.11
    $
0.97
 
Cash Dividends Paid Per Share
  $
0.225
    $
0.215
    $
0.445
    $
0.425
 
 
                               
Weighted average number of shares outstanding
   
2,815,873
     
2,847,259
     
2,817,813
     
2,857,554
 
 
                               
The accompanying notes are an integral part of these unaudited consolidated financial statements.
                 


2



CITIZENS FINANCIAL SERVICES, INC.
 
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
 
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
(UNAUDITED)
 
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
 
 
Three Months Ended
   
Six Months Ended
 
 
 
June 30,
   
June 30,
 
(in thousands)
 
  2007
   
  2006
   
  2007
   
  2006
 
Net income
 
 
    $
1,760
   
 
    $
1,486
   
 
    $
3,140
   
 
    $
2,762
 
Other comprehensive income:
 
 
           
 
           
 
           
 
         
      Unrealized losses on available for
      sale securities
    (1,433 )             (624 )             (1,233 )             (1,239 )        
      Less:   Reclassification adjustment
      for gains (losses) included in net
      income
   
-
              (5 )            
-
             
1
         
Other comprehensive loss before tax
            (1,433 )             (629 )             (1,233 )             (1,238 )
Income tax benefit related to other comprehensive income
            (487 )             (214 )             (419 )             (421 )
Other comprehensive loss, net of tax
            (946 )             (415 )             (814 )             (817 )
Comprehensive income
          $
814
            $
1,071
            $
2,326
            $
1,945
 
 
                                                               
The accompanying notes are an integral part of these unaudited consolidated financial statements.
                                                         



3


CITIZENS FINANCIAL SERVICES, INC.
           
CONSOLIDATED STATEMENT OF CASH FLOWS
           
(UNAUDITED)
 
Six Months Ended
 
   
June 30,
 
(in thousands)
 
2007
   
2006
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
  Net income
  $
3,140
    $
2,762
 
  Adjustments to reconcile net income to net
               
   cash provided by operating activities:
               
    Provision for loan losses
   
165
     
120
 
    Depreciation and amortization
   
376
     
646
 
    Amortization and accretion of investment securities
   
93
     
238
 
    Deferred income taxes
    (12 )     (59 )
    Investment securities gains, net
   
-
     
1
 
    Realized gains on loans sold
    (64 )     (13 )
    Earnings on bank owned life insurance
    (162 )     (146 )
    Losses on premises and equipment
   
100
     
1
 
    Originations of loans held for sale
    (3,198 )     (1,172 )
    Proceeds from sales of loans held for sale
   
3,262
     
1,185
 
    Gains on sale of foreclosed assets held for sale
    (396 )     (47 )
    Decrease in accrued interest receivable
   
75
     
55
 
    Decrease in accrued interest payable
    (201 )     (123 )
    Other, net
   
339
      (107 )
      Net cash provided by operating activities
   
3,517
     
3,341
 
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
  Available-for-sale securities:
               
    Proceeds from sales of available-for-sale securities
   
-
     
9,791
 
    Proceeds from maturity and principal repayments of securities
   
5,848
     
8,130
 
    Purchase of securities
    (16,045 )     (19,411 )
  Proceeds from redemption of Regulatory Stock
   
1,395
     
889
 
  Purchase of Regulatory Stock
    (965 )     (1,788 )
  Net increase in loans
    (229 )     (19,186 )
  Purchase of premises and equipment
    (273 )     (269 )
  Proceeds from sale of foreclosed assets held for sale
   
1,075
     
256
 
      Net cash used in investing activities
    (9,194 )     (21,588 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
  Net increase in deposits
   
21,426
     
8,110
 
  Proceeds from long-term borrowings
   
6,638
     
2,444
 
  Repayments of long-term borrowings
    (3,500 )     (4,339 )
  Net increase (decrease) in short-term borrowed funds
    (16,531 )    
16,336
 
  Purchase of Treasury Stock
    (244 )     (778 )
  Reissuance of Treasury Stock
   
13
     
-
 
  Dividends paid
    (1,255 )     (1,204 )
      Net cash provided by financing activities
   
6,547
     
20,569
 
                 
          Net increase in cash and cash equivalents
   
870
     
2,322
 
                 
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
   
10,015
     
8,609
 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $
10,885
    $
10,931
 
                 
Supplemental Disclosures of Cash Flow Information:
               
    Interest paid
  $
8,673
    $
6,679
 
                 
    Income taxes paid
  $
410
    $
770
 
                 
    Loans transferred to foreclosed property
  $
61
    $
375
 
                 
The accompanying notes are an integral part of these unaudited consolidated financial statements.
 
 
 
4

 
CITIZENS FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Note 1 - Basis of Presentation

Citizens Financial Service, Inc., (individually and collectively with its direct and indirect subsidiaries, the “Company”) is a Pennsylvania corporation organized as the holding company of its wholly owned subsidiary, First Citizens National Bank (the “Bank”), and its subsidiary, First Citizens Insurance Agency, Inc.  All material inter-company balances and transactions have been eliminated in consolidation.

The accompanying consolidated financial statements have been prepared pursuant to rules and regulations of the Securities and Exchange Commission (SEC) and in conformity with U.S. generally accepted accounting principles.  Because this report is based on an interim period, certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted.

In the opinion of Management of the registrant, the accompanying interim financial statements for the quarters ended June 30, 2007 and 2006 include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the financial condition and the results of operations for the period.  In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. The financial performance reported for the Company for the six-month period ended June 30, 2007 is not necessarily indicative of the results to be expected for the full year.  This information should be read in conjunction with the Company’s Annual Report to shareholders and Form 10-K for the period ended December 31, 2006.

Note 2 - Earnings per Share

The following table sets forth the computation of earnings per share.  Earnings per share calculations give retroactive effect to stock dividends declared by the Company.  The Company has no dilutive securities.



 
Three months ended
Six months ended
 
June 30,
June 30,
 
2007
2006
2007
2006
 
 
 
 
 
Net income applicable to common stock
$1,760,000
$1,486,000
$3,140,000
$2,762,000
Weighted average common shares outstanding
2,815,873
2,847,259
2,817,813
2,857,554
 
 
 
 
 
Earnings per share
$0.63
$0.52
$1.11
$0.97

Note 3 - Income Tax Expense

Income tax expense is less than the amount calculated using the statutory tax rate, primarily the result of tax-exempt income earned from state and municipal securities, bank owned life insurance, and loans and investments in tax credits.

5

 
Note 4 - Employee Benefit Plans

For a detailed disclosure on the Company's pension and employee benefits plans, please refer to Note 10 of the Company's Consolidated Financial Statements included in the 2006 Annual Report on Form 10-K.

Defined Benefit Plan

The following sets forth the components of net periodic benefit costs of the noncontributory defined benefit plan for the three months and six months ended June 30, 2007 and 2006, respectively (in thousands):

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
 
 
2007
   
2006
   
2007
   
2006
 
                         
Service cost
  $
105
    $
87
    $
222
    $
178
 
Interest cost
   
102
     
84
     
214
     
166
 
Expected return on plan assets
    (117 )     (86 )     (246 )     (181 )
Net amortization and deferral
   
18
     
25
     
38
     
40
 
                                 
Net periodic benefit cost
  $
108
    $
110
    $
228
    $
203
 


 The Company expects to contribute $370,029 to its noncontributory defined benefit pension plan in 2007.  As of June 30, 2007, the Company has contributed $112,635.

Defined Contribution Plan

The Company also sponsors a defined contribution, 401(k) plan covering substantially all of its employees.  The Company contributes three percent of applicable salaries into the plan.  Contributions totaled $98,000 and $99,000 for the six months ended June 30, 2007 and 2006, respectively.

Note 5 – Recent Accounting Pronouncements

In February 2007, the FASB issued FAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115, which provides all entities with an option to report selected financial assets and liabilities at fair value. The objective of the FAS No. 159 is to improve financial reporting by providing entities with the opportunity to mitigate volatility in earnings caused by measuring related assets and liabilities differently without having to apply the complex provisions of hedge accounting.  FAS No. 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007.  Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007 provided the entity also elects to apply the provisions of FAS No. 157, Fair Value Measurements.  The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.

In March 2007, the FASB ratified Emerging Issues Task Force Issue No. 06-10 (“EITF 06-10”), Accounting for Collateral Assignment Split-Dollar Life Insurance Agreements. EITF 06-10 provides guidance for determining a liability for the postretirement benefit obligation as well as recognition and measurement of the associated asset on the basis of the terms of the collateral assignment agreement. EITF 06-10 is effective for fiscal years beginning after December 15, 2007. The Company is currently evaluating the impact the adoption of the EITF will have on the Company’s results of operations or financial condition.

In June 2007, the FASB ratified Emerging Issues Task Force Issue No. 06-11 (“EITF 06-11”), Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards. EITF 06-11 applies to share-based payment arrangements with dividend protection features that entitle employees to receive (a) dividends on equity-classified non-vested shares, (b) dividend equivalents on equity-classified non-vested share units, or (c) payments equal to the dividends paid on the underlying shares while an equity-classified share option is outstanding, when those dividends or dividend equivalents are charged to retained earnings under FAS No. 123R, Share-Based Payment, and result in an income tax deduction for the employer. A consensus was reached that a realized income tax benefit from dividends or dividend equivalents that are charged to retained earnings and are paid to employees for equity-classified non-vested equity shares, non-vested equity share units, and outstanding equity share options should be recognized as an increase in additional paid-in capital.  EITF 06-11 is effective for fiscal years beginning after December 15, 2007, and interim periods within those fiscal years. The Company is currently evaluating the impact the adoption of the EITF will have on the Company’s financial condition.

6

 
Note 6 – Comprehensive Income

For the three and six month periods ended June 30, 2007 and 2006, the components of other comprehensive income and total comprehensive income are presented in the Consolidated Statement of Comprehensive Income.  We had previously reported in our 2006 annual report to shareholders total comprehensive income for the year ended December 31, 2006 of $5,603, which consisted of net income, the change in net unrealized loss of securities available for sale, net of taxes, and the cumulative effect of change in accounting for pension obligation, net of tax benefit of $5,800, $655, and $(852), respectively.  The cumulative effect of change in accounting for pension obligations upon the initial adoption of Financial Accounting Standards Board Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, is required to be reported separately in accumulated other comprehensive income and not as part of comprehensive income for the period.  As such, we are revising our previously reported total comprehensive income to $6,689 for the year ended December 31, 2006.  The only other revision to the components of other comprehensive income consists of a reversal of a previously recognized minimum pension liability of $234, which is net of taxes of $121.  These revisions were also necessary to reflect the revised cumulative effect of change in accounting for pension obligation of $(1,086), which is net of a tax benefit of $560 as of December 31, 2006.

The Company intends to correct the Other Comprehensive Income presentation in its next Form 10-K filing.

 
7

 
ITEM 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Cautionary Statement
 
Forward-looking statements may prove inaccurate. We have made forward-looking statements in this document, and in documents that we incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of operations of Citizens Financial Services, Inc., First Citizens National Bank, First Citizens Insurance Agency, Inc. or the combined company. When we use such words as "believes," "expects,” "anticipates," or similar expressions, we are making forward-looking statements.  For a variety of reasons, actual results could differ materially from those contained in or implied by forward-looking statements.  The Company would like to caution readers that the following important factors, among others, may have affected and could in the future affect the Company’s actual results and could cause the Company’s actual results for subsequent periods to differ materially from those expressed in any forward looking statement:
 
·  
Interest rates could change more rapidly or more significantly than we expect.
·  
The economy could change significantly in an unexpected way, which would cause the demand for new loans and the ability of borrowers to repay outstanding loans to change in ways that our models do not anticipate.
·  
The stock and bond markets could suffer a significant disruption, which may have a negative effect on our financial condition and that of our borrowers, and on our ability to raise money by issuing new securities.
·  
It could take us longer than we anticipate implementing strategic initiatives designed to increase revenues or manage expenses, or we may be unable to implement those initiatives at all.
·  
Acquisitions and dispositions of assets could affect us in ways that management has not anticipated.
·  
We may become subject to new legal obligations or the resolution of litigation may have a negative effect on our financial condition.
·  
We may become subject to new and unanticipated accounting, tax, or regulatory practices, regulations or requirements, including the costs of compliance with such changes.
·  
We could experience greater loan delinquencies than anticipated, adversely affecting our earnings and financial condition.  We could also experience greater losses than expected due to the ever increasing volume of information theft and fraudulent scams impacting our customers and the banking industry.
·  
We could lose the services of some or all of our key personnel, which would negatively impact our business because of their business development skills, financial expertise, lending experience, technical expertise and market area knowledge.

     Except as required by applicable law and regulation, we assume no obligation to update or revise any forward-looking statements after the date on which they are made.

Introduction

The following is management's discussion and analysis of the significant changes in the results of operations, capital resources and liquidity presented in its accompanying consolidated financial statements for Citizens Financial Service, Inc., a bank holding company and its subsidiary (the Company).  Our Company's consolidated financial condition and results of operations consist almost entirely of our wholly owned subsidiary’s (First Citizens National Bank) financial conditions and results of operations. Management’s discussion and analysis should be read in conjunction with the preceding June 30, 2007 financial information. The results of operations for the three months and six months ended June 30, 2007 and 2006 are not necessarily indicative of the results you may expect for the full year.

Our Company currently engages in the general business of banking throughout our service area of Potter, Tioga and Bradford counties in North Central Pennsylvania and Allegany, Steuben, Chemung and Tioga counties in Southern New York. We maintain our central office in Mansfield, Pennsylvania. Presently we operate 16 banking facilities.  In Pennsylvania, these offices are located in Mansfield, Blossburg, Ulysses, Genesee, Wellsboro, Troy, Sayre, Canton, Gillett, Millerton, LeRaysville, Towanda, the Wellsboro Weis Market store, and the Mansfield Wal-Mart Super Center.  In New York, we have a branch office in Wellsville, Allegany County.

8

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

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

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

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

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

Readers should carefully review the risk factors described in other documents our Company files from time to time with the Securities and Exchange Commission, including the Annual Report for the year ended December 31, 2006, filed by our Company and any current reports on Form 8-K filed by us.

We face strong competition in the communities that we serve from other commercial banks, savings banks, and savings and loan associations, some of which are substantially larger institutions than our subsidiary. In addition, insurance companies, investment-counseling firms, and other business firms and individuals offer personal and corporate trust services. We also compete with credit unions, issuers of money market funds, securities brokerage firms, consumer finance companies, mortgage brokers and insurance companies. These entities are strong competitors for virtually all types of financial services.  The financial services industry continues to experience tremendous change to competitive barriers between bank and non-bank institutions. We must compete not only with traditional financial institutions, but in addition, with other business corporations that have begun to deliver competing financial services, and banking services that are easily accessible through the internet. Competition for banking services is based on price, nature of product, quality of service, and in the case of certain activities, convenience of location.

Trust and Investment Services

Our Investment and Trust Services Department is committed to helping our customers meet their financial goals.  The Trust Department offers professional trust administration, investment management services, estate planning and administration, and custody of securities.  We also help the members of our communities prepare for retirement by providing retirement plans for local employers and by managing individual IRA accounts.  Assets held by the Company in a fiduciary or agency capacity for its customers are not included in the consolidated financial statements since such items are not assets of the Company.  As of June 30, 2007 and December 31, 2006, the Trust Department had $91.5 million and $82.6 million of assets under management, respectively.

Our Investment Representatives offer full service brokerage services throughout the Bank’s market area, and appointments can be made at any First Citizens National Bank branch. The Investment Representatives provide financial planning and help our customers achieve their financial goals with their choice of mutual funds, annuities, health and life insurance.  These products are made available through our insurance subsidiary, First Citizens Insurance Agency, Inc.
 
9

 
Results of Operations

Overview of the Income Statement

       The Company had net income of $3,140,000 for the first six months of 2007 compared with earnings of $2,762,000 for last year’s comparable period, an increase of $378,000 or 13.7%. Earnings per share for the first six months of 2007 were $1.11, compared to $.97 last year representing a 14.4% increase.  Annualized return on assets and return on equity for the six months of 2007 was 1.10% and 13.68%, respectively, compared with 1.02% and 12.75% for last year’s comparable period.

Net income for the three months ended June 30, 2007 totaled $1,760,000 compared with $1,486,000 for the comparable period last year, an increase of $274,000 or 18.4%.  Earnings per share for the three months ended June 30, 2007 and 2006 were $.63 and $.52 per share, respectively. Annualized return on assets and return on equity for the quarter ended June 30, 2007 was 1.23% and 15.24%, respectively, compared with 1.09% and 13.55% for last year’s comparable period.

Details of the reasons for this change are discussed on the following pages.

Net Interest Income

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

Net interest income, for the first half of 2007, was $9,113,000, an increase of $268,000 compared to the same period in 2006.  For the first six months of 2007, the provision for loan losses totaled $165,000 compared to $120,000 for the first six months of 2006.  Consequently, net interest income after the provision for loan losses was $8,948,000, an increase of $223,000 over the first six months of 2006.

For the three months ended June 30, 2007, net interest income was $4,663,000, which was $185,000 or 4.1% higher than the comparable period last year.  The provision for loan losses was $45,000 for the three months ended June 30, 2007 compared with $60,000 the same period last year. As such, net interest income after the provision for loan losses was $4,618,000 compared with $4,418,000 for the quarters ended June 30, 2007 and 2006, respectively.

The following table sets forth the average balances of, and the interest earned or incurred on, each principal category of assets, liabilities and stockholders’ equity, the related rates, net interest income and rate “spread” created for the six months ended June 30, 2007, 2006 and 2005:


10



     
Analysis of Average Balances and Interest Rates (1)
   
               
 
Six Months Ended
Six Months Ended
Six Months Ended
 
June 30, 2007
June 30, 2006
June 30, 2005
 
Average
 
Average
Average
 
Average
Average
 
Average
 
Balance (1)
Interest
Rate
Balance (1)
Interest
Rate
Balance (1)
Interest
Rate
(dollars in thousands)
$
$
%
$
$
%
$
$
%
ASSETS
                 
Short-term investments:
                 
   Interest-bearing deposits at banks
                 3
              -
          -
              5
             -
          -
            30
             -
0.01
Total short-term investments
                 3
              -
 -
              5
             -
          -
            30
             -
0.01
Investment securities:
                 
  Taxable
      93,630
     2,260
4.83
    85,976
      1,872
4.35
    87,232
     1,670
3.83
  Tax-exempt (3)
      22,607
         680
6.02
    22,500
         677
6.02
    11,643
         366
6.29
  Total investment securities
    116,237
     2,940
5.06
  108,476
      2,549
4.70
    98,875
     2,036
4.12
Loans:
                 
  Residential mortgage loans
    211,803
     7,737
7.37
  204,995
      7,083
6.97
  198,403
     6,728
6.84
  Commercial & farm loans
    145,762
     5,692
7.87
  130,163
      4,894
7.58
  116,322
     3,980
6.90
  Loans to state & political subdivisions
      44,911
     1,344
6.03
    43,289
      1,283
5.98
    38,704
     1,150
5.99
  Other loans
      12,135
         555
9.22
    12,950
         567
8.83
    12,432
         544
8.82
  Loans, net of discount (2)(3)(4)
    414,611
   15,328
7.46
  391,397
    13,827
7.12
  365,861
   12,402
6.84
Total interest-earning assets
    530,851
   18,268
6.94
  499,878
    16,376
6.61
  464,766
   14,438
6.26
Cash and due from banks
         9,213
   
      8,770
   
      8,529
   
Bank premises and equipment
      12,904
   
    12,228
   
    11,907
   
Other assets
      19,007
 
 
    18,484
 
 
    18,667
 
 
Total non-interest earning assets
      41,124
   
    39,482
   
    39,103
   
Total assets
    571,975
 
 
  539,360
 
 
  503,869
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Interest-bearing liabilities:
                 
  NOW accounts
      89,466
         925
      2.08
    83,558
         727
    1.75
    69,165
         259
    0.76
  Savings accounts
      38,280
           65
      0.34
    39,509
62
    0.32
    40,652
57
    0.28
  Money market accounts
      48,562
         877
      3.64
    44,476
         638
    2.89
    45,841
         366
    1.61
  Certificates of deposit
    233,334
     4,873
      4.21
  210,391
      3,896
    3.73
  213,729
     3,742
    3.53
Total interest-bearing deposits
    409,642
     6,740
      3.32
  377,934
      5,323
    2.84
  369,387
     4,424
    2.42
Other borrowed funds
      62,656
     1,732
      5.57
    63,536
      1,539
    4.88
    43,387
         758
    3.52
Total interest-bearing liabilities
    472,298
     8,472
      3.62
  441,470
      6,862
    3.13
  412,774
     5,182
    2.53
Demand deposits
      48,458
   
    49,061
   
    45,511
   
Other liabilities
         6,413
   
      5,722
   
      4,370
   
Total non-interest-bearing liabilities
      54,871
 
 
    54,783
 
 
    49,881
 
 
Stockholders' equity
      44,806
   
    43,107
   
    41,214
   
Total liabilities & stockholders' equity
    571,975
 
 
  539,360
 
 
  503,869
 
 
Net interest income
 
     9,796
 
 
      9,514
 
 
     9,256
 
Net interest spread (5)
   
3.32%
   
3.48%
   
3.73%
Net interest income as a percentage
                 
  of average interest-earning assets
   
3.72%
   
3.84%
   
4.02%
Ratio of interest-earning assets
                 
  to interest-bearing liabilities
   
1.12
   
1.13
   
1.12
                   
(1) Averages are based on daily averages.
               
(2) Includes loan origination and commitment fees.
               
(3) Tax exempt interest revenue is shown on a tax equivalent basis for proper comparison using
       
       a statutory federal income tax rate of 34%.
           
(4) Income on non-accrual loans is accounted for on a cash basis, and the loan balances are included in interest-earning assets.
 
(5) Interest rate spread represents the difference between the average rate earned on interest-earning assets
   
      and the average rate paid on interest-bearing liabilities.
             
 
 
11

 
Tax exempt revenue is shown on a tax-equivalent basis for proper comparison using a statutory, federal income tax rate of 34%.  For purposes of the comparison, as well as the discussion that follows, this presentation facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Company’s 34% Federal statutory rate.  The following table represents the adjustment to convert net interest income to net interest income on a fully taxable equivalent basis for the periods ending June 30, 2007, 2006 and 2005:
 

   
For the Six Months
 
   
Ended June 30,
 
In thousands:
 
2007
   
2006
   
2005
 
                   
Total interest income
  $
17,585
    $
15,707
    $
13,913
 
Total interest expense
   
8,472
     
6,862
     
5,182
 
                         
Net interest income
   
9,113
     
8,845
     
8,731
 
Tax equivalent adjustment
   
683
     
669
     
525
 
                         
Net interest income (fully taxable equivalent)
  $
9,796
    $
9,514
    $
9,256
 

           The following table shows the tax-equivalent effect of changes in volume and rate on interest income and expense.

 
 Six Months Ended June 30, 2007 vs. 2006 (1)
Six Months Ended June 30, 2006 vs. 2005 (1)
 
 Change in
 Change
 Total
 Change in
 Change
 Total
 
 Volume
 in Rate
 Change
 Volume
 in Rate
 Change
Interest Income:
           
Short-term investments:
           
  Interest-bearing deposits at banks
 $             -
 $             -
 $             -
 $              -
 $              -
 $              -
Investment securities:
           
  Taxable
              85
           303
           388
             (24)
            226
            202
  Tax-exempt
                3
                 -
                3
            327
             (16)
            311
Total investments
              88
           303
           391
            303
            210
            513
Loans:
           
  Residential mortgage loans
           217
           437
           654
            233
            122
            355
  Commercial & farm loans
           620
           178
           798
            750
            164
            914
  Loans to state & political subdivisions
              49
              12
              61
            136
               (3)
            133
  Other loans
           (37)
              25
           (12)
              23
                 -
              23
Total loans, net of discount
           849
           652
        1,501
         1,142
            283
         1,425
Total Interest Income
           937
           955
        1,892
         1,445
            493
         1,938
Interest Expense:
           
Interest-bearing deposits:
           
  NOW accounts
              45
           153
           198
              41
            427
            468
  Savings accounts
              (2)
                5
                3
               (2)
                7
                5
  Money Market accounts
              50
           189
           239
             (11)
            283
            272
  Certificates of deposit
           110
           867
           977
             (59)
            213
            154
Total interest-bearing deposits
           203
        1,214
        1,417
             (31)
            930
            899
Other borrowed funds
           (21)
           214
           193
         1,163
           (382)
            781
Total interest expense
           182
        1,428
        1,610
         1,132
            548
         1,680
Net interest income
 $        755
 $      (473)
 $        282
 $         313
 $          (55)
 $         258
             
(1) The portion of the total change attributable to both volume and rate changes during the year has been allocated
      to volume and rate components based upon the absolute dollar amount of the change in each component prior to allocation.
 

12

 
As can be seen from the preceding tables, we continue to experience a compression of our net interest margin.  Due to the inversion of the yield curve, the net interest spread has decreased from 3.48% for the first six months of 2006 to 3.32% for the first six months of 2007.  The Federal Reserve increased the Federal Funds rate 425 basis points from June 2004 to June 2006.  During that period, as well as through June 2007, long-term rates have not increased proportionally.  This has resulted in a flat to inverted yield curve.  As such, our cost of funds (interest paid on deposits and borrowings) has increased while the rates earned on interest bearing assets have not increased accordingly.  That flatness or inversion of the yield curve has remained in place for the first six months of 2007.  We expect our interest margin to improve when, and if, the normal steepness of the yield curve returns.  We continue to review various pricing and investment strategies in an attempt to maintain or improve upon our current interest margin.  Low cost deposits continue to be our focus and are key in improving the interest margin on a go forward basis.
 
Tax equivalent net interest income improved  from $9,514,000 in 2006 to $9,796,000, in 2007. In the period ending June 30, 2007, net interest income increased $282,000 on a tax equivalent basis over the same period in 2006.  The increase in interest-earning assets of $31.0 million generated an increase in interest income of $1,892,000, with $937,000 due to volume, and $955,000 of the increase attributable to a change in rate.  The yield on interest earning assets has increased 33 basis points going from 6.61% to 6.94%.  Interest-bearing liabilities increased $30.8 million resulting in an increase of $1,610,000 of interest expense predominately attributable to a change in rate.  Comparing the first half of 2007 with 2006, the average interest rate on interest-bearing liabilities increased 49 basis points, from 3.13% to 3.62%.
 
Provision For Loan Losses

           For the six-month period ending June 30, 2007, we recorded $165,000 to the provision as a result of our quarterly review of the allowance for loan losses. Management's quarterly review of the allowance for loan losses is based on the following information: migration analysis of delinquent and non-accrual loans, impaired loans, estimated future losses on loans, recent review of large problem credits, local and national economic conditions, historical loss experience, OCC qualitative adjustments, actual and expected loan growth and peer comparisons (see also “Financial Condition – Allowance for Loan Losses).

Non-interest Income

Non-interest income as detailed below increased $395,000 or 17.0%, for the first six months of 2007 when compared to the same period in 2006.  Gains on sales of foreclosed properties increased by $349,000 due to a large pre-tax gain of $381,000 realized during the second quarter from the sale of a commercial property.  Service charge income increased $45,000, or 3%, mainly derived from customers’ usage of their debit cards.  This usage amounted to over $231,000 for the first six months of 2007, an improvement of 16.5% over 2006.  Trust income increased $27,000 or 11.4% due to our ongoing success in growing our trust assets under management.  Gains on loans sold also increased $51,000 due to more volume of secondary mortgages compared to last year.  These increases were offset by brokerage income that decreased $104,000 as we have transitioned over the last several months to a new broker-dealer.  We continue to emphasize the successful transition to the new broker-dealer and anticipate continued improvement over the remainder of the year.

For the three months ended June 30, 2007, non-interest income totaled $1,591,000, which is an increase of $400,000 over the comparable period last year.  Most of the increase is attributable to an increase of $349,000 in gains on sales of foreclosed assets due to a large pre-tax gain of $381,000 realized during the second quarter of 2007 from the sale of a commercial property.

The following table shows the breakdown of non-interest income for the three months and six months ended June 30, 2007 and 2006:


13


 

 
Three months ended June 30,
Change
 
2007
2006
Amount
%
Service charges
 $              812
 $             809
 $                 3
                 0.4
Trust
                  127
                108
                  19
               17.6
Brokerage
                    31
                  59
                 (28)
             (47.5)
Investment securities gains (losses), net
                       -
                    5
                   (5)
           (100.0)
Gains on loans sold
                    46
                    7
                  39
             557.1
Gains on sales of foreclosed properties
                  373
                  34
                339
             997.1
Earnings on bank owned life insurance
                    82
                  74
                    8
               10.8
Other
                  120
                  95
                  25
               26.3
Total
 $           1,591
 $          1,191
 $             400
               33.6
 
   
 
 
 
 
 
 
 
 
 
 
 
 
 
Six months ended June 30,
Change
 
2007
2006
Amount
%
Service charges
 $           1,560
 $          1,515
 $               45
                 3.0
Trust
                  264
                237
                  27
               11.4
Brokerage
                    49
                153
               (104)
             (68.0)
Investment securities gains (losses), net
                       -
                   (1)
                    1
           (100.0)
Gains on loans sold
                    64
                  13
                  51
             392.3
Gains on sales of foreclosed properties
                  396
                  47
                349
             742.6
Earnings on bank owned life insurance
                  162
                146
                  16
               11.0
Other
                  223
                213
                  10
                 4.7
Total
 $           2,718
 $          2,323
 $             395
               17.0

 
Non-interest Expense

Total non-interest expense, as detailed below, increased $105,000 or 1.4%, for the first six months of 2007, compared to the same period in 2006.  The increase is primarily due to a $100,000 write-down of one of our bank properties.  The increase in salaries and employee benefits of $103,000 is due mainly to annual merit increases.  Other professional fees have increased $74,000 over last year due to various consulting arrangements including an evaluation of our pension plan.  Furniture and equipment costs decreased due to decreased depreciation expense from assets becoming fully depreciated.  Amortization expense decreased $108,000 due to a core deposit intangible from a previous acquisition that became fully amortized in March 2006.  There has been a slight overall increase in other operating expenses of $39,000, or 1.7%, over the first six months of 2007.  Excluding the write-down of the bank property, expenses would have only increased by $5,000 over 2006.

Non-interest expenses totaled $3,956,000 for the three months ended June 30, 2007 compared with $3,737,000 for the comparable period last year.  This is an increase of $219,000, or 5.9%.  Most of the increase is attributable to a $100,000 write-down of one of our bank properties.  Excluding the write-down, non-interest expenses would have increased $119,000, or 3.2% for the three months ended June 30, 2007 compared with the same period last year.  Professional fees increased $$49,000 due to various consulting arrangements.  Occupancy expenses increased $32,000 primarily due to additional depreciation expense related to our new branch facility in Wellsville, New York.

The following tables reflect the breakdown of non-interest expense and professional fees for the three months and six months ended June 30, 2007 and 2006:


14






 
Three months ended June 30,
Change
 
2007
2006
Amount
%
Salaries and employee benefits
 $          2,033
 $         1,987
 $              46
                   2.3
Occupancy
                 308
               276
                 32
                 11.6
Furniture and equipment
                 140
               144
                  (4)
                 (2.8)
Professional fees
                 155
               106
                 49
                 46.2
Amortization
                   36
                 36
                    -
                      -
Other
             1,284
            1,188
                 96
                   8.1
Total
 $          3,956
 $         3,737
 $            219
                   5.9
 
 
 
 
 
 
Three months ended June 30,
Change
 
2007
2006
Amount
%
Other professional fees
 $                72
 $              60
 $              12
                 20.0
Legal fees
                   42
                 10
                 32
               320.0
Examinations and audits
                   41
                 36
                   5
                 13.9
Total
 $             155
 $            106
 $              49
                 46.2




 
Six months ended June 30,
Change
 
2007
2006
Amount
%
Salaries and employee benefits
 $          4,126
 $         4,023
 $            103
                   2.6
Occupancy
                 609
               584
                 25
                   4.3
Furniture and equipment
                 268
               296
                (28)
                 (9.5)
Professional fees
                 320
               246
                 74
                 30.1
Amortization
                   72
               180
              (108)
               (60.0)
Other
             2,338
            2,299
                 39
                   1.7
Total
 $          7,733
 $         7,628
 $            105
                   1.4
 
 
 
 
 
 
Six months ended June 30,
Change
 
2007
2006
Amount
%
Other professional fees
 $             188
 $            147
 $              41
                 27.9
Legal fees
                   55
                 29
                 26
                 89.7
Examinations and audits
                   77
                 70
                   7
                 10.0
Total
 $             320
 $            246
 $              74
                 30.1


Provision For Income Taxes

The provision for income taxes was $793,000 for the six-month period ended June 30, 2007 compared to $658,000 for the same period in 2006.  Through management of our municipal loan and bond portfolios, we have achieved an effective tax rate of 20.17% for the first six months this year versus 19.24% for the first six months of 2006.

We are involved in three limited partnership agreements that established low-income housing projects in our market areas. As a result of these agreements, for tax purposes we have recognized $616,000 out of a total $913,000 of tax credits from one project in the Towanda area that began in October of 2000. We have recognized $212,000 out of a total $385,000 of tax credits on the second project in the Wellsboro market which was completed in November 2001.  In 2005, we entered into a third limited liability partnership for a low-income housing project for senior citizens in our Sayre market area.  Beginning in 2007, we have recognized $29,000 out of a total $574,000 of tax credits.  We anticipate recognizing $1,015,000 of tax credits over the next ten years.

15

 
Financial Condition

Total assets (shown in the Consolidated Balance Sheet) of $581.3 million have increased 1.6% since year-end 2006’s balance of $572.2 million.  Net loans have increased .1% to $411.0 million at June 30, 2007.  Investment securities increased 8.1% to $118.6 million since year-end 2006.  Total deposits increased $21.4 million or 4.8% to $467.9 million since year-end 2006. Borrowed funds have decreased $13.4 million to $62.4 million compared with $75.8 million at year-end.  Explanations of variances will be described within the following appropriate sections.

Cash and Cash Equivalents

Cash and cash equivalents totaled $10,885,000 at June 30, 2007 compared to $10,015,000 on December 31, 2006.  Non-interest-bearing cash increased temporarily $866,000 since year-end 2006, while interest-bearing cash increased $4,000 during that same period.  We believe the liquidity needs of the Company are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources, and the portion of the investment and loan portfolios that mature within one year.  These sources of funds will enable the Company to meet cash obligations and off-balance sheet commitments.

Investments

As shown in the table below, our investment portfolio increased by $8,871,000 or 8.1% from December 31, 2006 to June 30, 2007.  During the first two quarters of 2007 we purchased approximately $7.8 million of U.S. agency obligations, $6.7 million of mortgage-backed securities, and $1.4 million of municipal bonds offsetting the $5.7 million of principal repayments that occurred during the same time period.  We continue to receive monthly principal repayments allowing us to purchase at current market yields.  We have increased our investment portfolio during the second quarter primarily due to opportunities related to increases in the treasury curve.  The overall market value of our investment portfolio has decreased approximately $1.2 million due to increases in interest rates since year end.  Our investment portfolio is currently yielding 5.06% compared to 4.70% a year ago, on a tax equivalent basis.


Estimated Fair Market Value of Investment Portfolio
 
June 30,
December 31,
 
2007
2006
(dollars in thousands)
Amount
%
Amount
%
Available-for-sale:
       
  U. S. Agency securities
 $    24,268
    20.5
 $  16,651
  15.2
  Obligations of state & political
       
     subdivisions
      23,573
    19.9
    22,562
  20.5
  Corporate obligations
       7,757
     6.5
     7,997
   7.3
  Mortgage-backed securities
      60,369
    50.9
    59,875
  54.6
  Equity securities
       2,647
     2.2
     2,658
   2.4
Total
 $   118,614
   100.0
 $ 109,743
 100.0

 
   
 
June 30,  2007/
 
 December 31, 2006
 
        Change
(dollars in thousands)
Amount
%
Available-for-sale:
   
  U. S. Agency securities
 $     7,617
    45.7
  Obligations of state & political
   
     subdivisions
       1,011
     4.5
  Corporate obligations
        (240)
    (3.0)
  Mortgage-backed securities
         494
     0.8
  Equity securities
         (11)
    (0.4)
Total
 $     8,871
     8.1
 

 
16

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

Loans

The Company’s lending is focused in the north central Pennsylvania market and the southern tier of New York.  The composition of our loan portfolio consists principally of retail lending, which includes single-family residential mortgages and other consumer lending, and commercial lending primarily to locally owned small businesses.  New loans are generated primarily from direct loans to our existing customer base, with new customers generated by referrals from real estate brokers, building contractors, attorneys, accountants and existing customers.

As shown in the tables below (dollars in thousands), total loans increased approximately $301,000 or .1% during the first half of 2007.  The increase in commercial real estate loans of $3.7 million was offset by a $3.6 million decrease in residential real estate loans with minimal change in the other loan categories.

We have experienced an overall decrease in loan demand during the first six months of 2007. Our focus continues to be on loan quality and customer relationships, which has impacted our growth during the first six months due to local and regional economic conditions.   The Company’s focus remains on commercial lending as a means to increase loan growth as well as obtain deposits from farmers and small businesses throughout our market area.  We have a strong team of dedicated, experienced professionals that enable us to meet the needs of commercial and agricultural customers within our service area.  Residential mortgage lending is a principal business activity and one our Company continues to provide by offering a full menu of competitively priced conforming, nonconforming and home equity mortgages.  We emphasize branch office personnel training and focus on providing flexibility and fast “turn around time” that will aid in growing our loan portfolio.

 
June 30,
December 31,
 
2007
2006
(dollars in thousands)
Amount
%
Amount
%
Real estate:
       
  Residential
 $ 202,417
   48.7
 $ 206,059
   49.7
  Commercial
    97,855
   23.6
    94,122
   22.7
  Agricultural
    17,029
    4.1
    17,054
    4.1
  Construction
     6,478
    1.6
     7,027
    1.7
Loans to individuals
       
  for household, family and other purchases
    12,565
    3.0
    12,482
    3.0
Commercial and other loans
    33,099
    8.0
    32,766
    7.9
State & political subdivision loans
    45,631
   11.0
    45,263
   10.9
Total loans
   415,074
  100.0
   414,773
  100.0
Less allowance for loan losses
     4,107
 
     3,876
 
Net loans
 $ 410,967
 
 $ 410,897
 

 
 
 
 
June 30, 2007/
 
 December 31, 2006
 
Change
(dollars in thousands)
Amount
%
Real estate:
   
  Residential
 $  (3,642)
   (1.8)
  Commercial
     3,733
    4.0
  Agricultural
       (25)
   (0.1)
  Construction
      (549)
   (7.8)
Loans to individuals
   
  for household, family and other purchases
        83
    0.7
Commercial and other loans
       333
    1.0
State & political subdivision loans
       368
    0.8
Total loans
 $     301
    0.1


17

 
Allowance For Loan Losses

As shown in the table below, the Allowance for Loan Losses as a percentage of loans increased from .93% at December 31, 2006 to .99% at June 30, 2007.  The dollar amount of the reserve increased $231,000 since year-end 2006.  The increase is a result of a $165,000 provision for the first six months, losses of $58,000, and recoveries of $124,000, which includes $79,000 from one large commercial relationship.



   
June 30,
   
December 31,
 
(dollars in thousands)
 
2007
   
2006
   
2005
   
2004
   
2003
 
Balance, at beginning of period
  $
3,876
    $
3,664
    $
3,919
    $
3,620
    $
3,621
 
  Provision charged to income
   
165
     
330
     
60
     
-
     
435
 
  Increase related to acquisition
   
-
     
-
     
-
     
290
     
-
 
  Recoveries on loans previously
                                       
    charged against the allowance
   
124
     
172
     
57
     
324
     
116
 
     
4,165
     
4,166
     
4,036
     
4,234
     
4,172
 
  Loans charged against the allowance
    (58 )     (290 )     (372 )     (315 )     (552 )
Balance, at end of year
  $
4,107
    $
3,876
    $
3,664
    $
3,919
    $
3,620
 
                                         
Allowance for loan losses as a percent
                                       
  of total loans
    0.99 %     0.93 %     0.96 %     1.09 %     1.14 %
 
                                       
Allowance for loan losses as a percent
                                       
  of non-performing loans
    157.12 %     115.43 %     163.94 %     176.53 %     134.62 %


The adequacy of the allowance for loan losses is subject to a formal analysis by management of the Company.  Management deems the allowance to be adequate to absorb inherent losses probable in the portfolio, as of June 30, 2007.  The Company has disclosed in its annual report on Form 10-K for the year ended December 31, 2006 the process and methodology supporting the loan loss provision.

Credit Quality Risk

The following table identifies amounts of loan losses and non-performing loans.  Past due loans are those that were contractually past due 90 days or more as to interest or principal payments (dollars in thousands).

 
 
June 30,
   
December 31,
 
(dollars in thousands)
 
2007
   
2006
   
2005
   
2004
   
2003
 
Non-performing loans:
                             
  Non-accruing loans
  $
328
    $
478
    $
867
    $
722
    $
578
 
  Impaired loans
   
1,920
     
1,190
     
1,031
     
1,061
     
1,926
 
  Accrual loans - 90 days or
                                       
    more past due
   
366
     
1,690
     
337
     
437
     
185
 
Total non-performing loans
   
2,614
     
3,358
     
2,235
     
2,220
     
2,689
 
Foreclosed assets held for sale
   
140
     
758
     
619
     
712
     
305
 
Total non-performing assets
  $
2,754
    $
4,116
    $
2,854
    $
2,932
    $
2,994
 
Non-performing loans as a percent of loans
                                       
   net of unearned income
    0.63 %     0.81 %     0.58 %     0.62 %     0.85 %
Non-performing assets as a percent of loans
                                       
   net of unearned income
    0.66 %     0.99 %     0.75 %     0.82 %