thirdqtr10-q.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 September 30, 2009
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 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 the 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 __X__
(Do not check if a smaller reporting company)

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

The number of outstanding shares of the Registrant’s Common Stock, as of November 9, 2009, was 2,873,966.

 
 

 

 
 
Citizens Financial Services, Inc.
Form 10-Q

INDEX
 
 
   
PAGE
Part I
FINANCIAL INFORMATION
 
Item 1.
Financial Statements (unaudited):
 
 
Consolidated Balance Sheet as of September 30, 2009 and December 31, 2008
1
 
Consolidated Statement of Income for the Three Months and Nine Months Ended September 30, 2009 and 2008
2
 
Consolidated Statement of Comprehensive Income for the Three Months and Nine Months Ended September 30, 2009 and 2008
3
 
Consolidated Statement of Cash Flows for the Nine Months Ended September 30, 2009 and 2008
4
 
Notes to Consolidated Financial Statements
5-13
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
14-32
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
32
Item 4.
Controls and Procedures
32
     
Part II
OTHER INFORMATION
 
Item 1.
Legal Proceedings
33
Item 1A.
Risk Factors
33
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
33
Item 3.
Defaults upon Senior Securities
33
Item 4.
Submission of Matters to a Vote of Security Holders
33
Item 5.
Other Information
33
Item 6.
Exhibits
34
 
Signatures
35

 
 

 


CITIZENS FINANCIAL SERVICES, INC.
   
CONSOLIDATED BALANCE SHEET
   
(UNAUDITED)
   
     
 
September 30
December 31
(in thousands, except share and per share data)
2009
2008
ASSETS:
   
Cash and due from banks:
   
  Noninterest-bearing
 $           10,844
 $           9,692
  Interest-bearing
                 9,318
            10,164
Total cash and cash equivalents
               20,162
            19,856
     
Available-for-sale securities
            197,544
          174,139
 
   
Loans (net of allowance for loan losses:
   
  2009, $4,683 and 2008, $4,378)
            443,808
          428,436
 
   
Premises and equipment
               11,896
            12,762
Accrued interest receivable
                 3,544
              2,912
Goodwill
               10,256
            10,256
Bank owned life insurance
               12,539
            12,176
Other assets
                 7,465
              8,075
 
 
 
TOTAL ASSETS
 $         707,214
 $       668,612
 
 
 
LIABILITIES:
   
Deposits:
   
  Noninterest-bearing
 $           56,070
 $         55,545
  Interest-bearing
            523,777
          491,135
Total deposits
            579,847
          546,680
Borrowed funds
               57,790
            61,204
Accrued interest payable
                 2,075
              2,233
Other liabilities
                 6,395
              5,725
TOTAL LIABILITIES
            646,107
          615,842
STOCKHOLDERS' EQUITY:
   
Common stock
   
  $1.00 par value; authorized 10,000,000 shares; issued 3,076,253 shares
   
   at September 30, 2009 and 3,048,289 shares at December 31, 2008, respectively
                 3,076
              3,048
Additional paid-in capital
               13,455
            12,981
Retained earnings
               45,557
            41,034
Accumulated other comprehensive income
                 3,365
                    26
Treasury stock, at cost:  202,287 shares at September 30, 2009
   
  and 200,918 shares at December 31, 2008
               (4,346)
             (4,319)
TOTAL STOCKHOLDERS' EQUITY
               61,107
            52,770
TOTAL LIABILITIES AND
   
   STOCKHOLDERS' EQUITY
 $         707,214
 $       668,612
     
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
Nine Months Ended
 
September 30,
September 30,
(in thousands, except share and per share data)
2009
2008
2009
2008
INTEREST INCOME:
       
Interest and fees on loans
 $        7,581
 $      7,793
 $      22,616
 $    23,102
Interest-bearing deposits with banks
                 15
               28
                 27
               34
Investment securities:
 
 
 
 
    Taxable
           1,466
         1,142
           4,647
         3,391
    Nontaxable
               598
             359
           1,583
         1,048
    Dividends
                   7
               23
                 20
             164
TOTAL INTEREST INCOME
           9,667
         9,345
         28,893
       27,739
INTEREST EXPENSE:
       
Deposits
           2,777
         2,837
           8,555
         8,508
Borrowed funds
               500
             545
           1,519
         2,030
TOTAL INTEREST EXPENSE
           3,277
         3,382
         10,074
       10,538
NET INTEREST INCOME
           6,390
         5,963
         18,819
       17,201
Provision for loan losses
               400
             105
               700
             225
NET INTEREST INCOME AFTER
       
    PROVISION FOR LOAN LOSSES
           5,990
         5,858
         18,119
       16,976
NON-INTEREST INCOME:
       
Service charges
               958
             944
           2,664
         2,591
Trust
               121
             148
               397
             451
Brokerage and insurance
                 75
               58
               228
             176
Gains on loans sold
                 83
                 4
               292
               45
Investment securities gains (losses), net
                    -
        (4,089)
               118
        (4,089)
Earnings on bank owned life insurance
               128
               90
               364
             261
Other
                 87
             121
               278
             368
TOTAL NON-INTEREST INCOME (LOSS)
           1,452
        (2,724)
           4,341
           (197)
NON-INTEREST EXPENSES:
       
Salaries and employee benefits
           2,393
         2,196
           7,018
         6,510
Occupancy
               272
             271
               889
             866
Furniture and equipment
               102
             107
               336
             368
Professional fees
               164
             156
               459
             485
FDIC insurance
               277
               52
           1,030
             104
Other
           1,242
         1,250
           3,581
         3,552
TOTAL NON-INTEREST EXPENSES
           4,450
         4,032
         13,313
       11,885
Income (loss) before provision for income taxes
           2,992
           (898)
           9,147
         4,894
Provision for income taxes
               604
             154
           1,941
         1,479
NET INCOME (LOSS)
 $        2,388
 $     (1,052)
 $        7,206
 $      3,415
 
       
Earnings Per Share
 $          0.83
 $       (0.37)
 $          2.51
 $        1.19
Cash Dividends Paid Per Share
 $        0.245
 $      0.235
 $        0.730
 $      0.700
         
Weighted average number of shares outstanding
   2,873,966
  2,877,510
   2,873,520
  2,879,853
         
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
 Nine Months Ended
 
           September 30,
September 30,
(in thousands)
 
    2009
 
2008
 
2009
 
2008
Net income (loss)
 
 $   2,388
 
 $  (1,052)
 
 $     7,206
 
 $      3,415
Other comprehensive income:
               
      Unrealized gains (losses) on available for sale securities
       4,385
 
     (6,078)
 
        5,054
 
       (7,548)
 
      Change in unrealized gain (loss) on interest rate swap
        (115)
 
               -
 
           123
 
                 -
 
       Less:  Reclassification adjustment for loss (gain) included in net income
                -
 
       4,089
 
         (118)
 
         4,089
 
Other comprehensive income (loss) before tax
 
       4,270
 
     (1,989)
 
        5,059
 
       (3,459)
Income tax expense (benefit) related to other comprehensive income
 
       1,452
 
         (676)
 
        1,720
 
       (1,176)
Other comprehensive income (loss), net of tax
 
       2,818
 
     (1,313)
 
        3,339
 
       (2,283)
Comprehensive income (loss)
 
 $   5,206
 
 $  (2,365)
 
 $  10,545
 
 $      1,132
                 
The accompanying notes are an integral part of these unaudited consolidated financial statements.
           




 
3

 


CITIZENS FINANCIAL SERVICES, INC.
   
CONSOLIDATED STATEMENT OF CASH FLOWS
   
(UNAUDITED)
Nine Months Ended
 
September 30,
(in thousands)
2009
2008
CASH FLOWS FROM OPERATING ACTIVITIES:
   
  Net income
 $        7,206
 $         3,415
  Adjustments to reconcile net income to net
   
   cash provided by operating activities:
   
    Provision for loan losses
               700
                225
    Depreciation and amortization
               476
                474
    Amortization and accretion of investment securities
               277
                    8
    Deferred income taxes
               155
              (396)
    Investment securities (gains) losses, net
             (118)
            4,089
    Realized gains on loans sold
             (292)
                (46)
    Earnings on bank owned life insurance
             (364)
              (261)
    Originations of loans held for sale
       (17,546)
           (3,823)
    Proceeds from sales of loans held for sale
         17,838
            3,869
    Loss (gain) on sale of foreclosed assets held for sale
                 40
                (24)
    Increase in accrued interest receivable
             (632)
              (255)
    Decrease in accrued interest payable
             (159)
              (151)
    Other, net
                 95
              (761)
      Net cash provided by operating activities
            7,676
            6,363
     
CASH FLOWS FROM INVESTING ACTIVITIES:
   
  Available-for-sale securities:
   
    Proceeds from sales of available-for-sale-securities
            6,778
                162
    Proceeds from maturity and principal repayments of securities
         35,143
          11,621
    Purchase of securities
       (60,548)
         (26,766)
  Proceeds from redemption of regulatory stock
                    -
            4,953
  Purchase of regulatory stock
             (586)
           (3,187)
  Net increase in loans
       (16,287)
           (6,485)
  Purchase of premises and equipment
         (1,063)
              (249)
  Proceeds from sale of premises and equipment
            1,406
                213
  Proceeds from sale of foreclosed assets held for sale
               313
                109
      Net cash used in investing activities
       (34,844)
         (19,629)
     
CASH FLOWS FROM FINANCING ACTIVITIES:
   
  Net increase in deposits
         33,168
          58,924
  Proceeds from long-term borrowings
         10,545
          21,312
  Repayments of long-term borrowings
       (14,050)
         (17,493)
  Net increase (decrease) in short-term borrowed funds
                 91
         (31,542)
  Purchase of treasury stock
             (192)
              (244)
  Dividends paid
         (2,088)
           (1,988)
      Net cash  provided by financing activities
         27,474
          28,969
     
          Net increase in cash and cash equivalents
               306
          15,703
     
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
         19,856
          10,389
CASH AND CASH EQUIVALENTS AT END OF PERIOD
 $      20,162
 $       26,092
     
Supplemental Disclosures of Cash Flow Information:
   
    Interest paid
 $      10,233
 $       10,689
     
    Income taxes paid
 $        2,025
 $         2,015
     
    Loans transferred to foreclosed property
 $            410
 $             747
   
 
The accompanying notes are an integral part of these unaudited consolidated financial statements.
 
 
4

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


Note 1 - Basis of Presentation

Citizens Financial Services, Inc., (individually and collectively with its direct and indirect subsidiaries, the “Company”) is a Pennsylvania corporation organized as the holding company of its wholly owned subsidiary, First Citizens National Bank (the “Bank”), and the Bank’s subsidiary, First Citizens Insurance Agency, Inc. (“First Citizens Insurance”).

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.  Certain of the prior year amounts have been reclassified to conform with the current year presentation.  Such reclassifications had no effect on net income or stockholders’ equity.  All material inter-company balances and transactions have been eliminated in consolidation.

In the opinion of management of the Company, the accompanying interim financial statements for the quarters ended September 30, 2009 and 2008 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 nine-month period ended September 30, 2009 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 on Form 10-K for the year ended December 31, 2008.

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
Nine months ended
 
September 30,
September 30,
 
2009
2008
2009
2008
 
       
Net income (loss) applicable to common stock
$2,388,000
($1,052,000)
$7,206,000
$3,415,000
Weighted average common shares outstanding
2,873,966
2,877,510
2,873,520
2,879,853
         
Earnings per share
$0.83
($0.37)
$2.51
$1.19
 
 

Note 3 - Income Tax Expense

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


Note 4 – Investments

The amortized cost and estimated fair value of investment securities at September 30, 2009 and December 31, 2008 were as follows (in thousands):
 
5


   
Gross
Gross
Estimated
 
Amortized
Unrealized
Unrealized
Fair
September 30, 2009
Cost
Gains
Losses
Value
Available-for-sale securities:
       
  U.S. Agency securities
 $      52,717
 $         1,223
 $               (9)
 $       53,931
  Obligations of state and
       
    political subdivisions
         58,061
            2,798
                (11)
          60,848
  Corporate obligations
           5,969
               193
                (24)
            6,138
  Mortgage-backed securities
         72,651
            3,417
                    -
          76,068
  Equity securities
              431
               129
                  (1)
               559
Total available-for-sale securities
 $    189,829
 $         7,760
 $             (45)
 $     197,544
         
   
Gross
Gross
Estimated
 
Amortized
Unrealized
Unrealized
Fair
December 31, 2008
Cost
Gains
Losses
Value
Available-for-sale securities:
       
  U.S. Agency securities
 $      27,628
 $         1,314
 $                 -
 $       28,942
  Obligations of state and
       
    political subdivisions
         44,188
               424
              (480)
          44,132
  Corporate obligations
           5,964
                    -
              (668)
            5,296
  Mortgage-backed securities
         93,037
            2,437
                (67)
          95,407
  Equity securities
              545
                 20
              (203)
               362
Total available-for-sale securities
 $    171,362
 $         4,195
 $        (1,418)
 $     174,139

 
The following table shows the Company’s gross unrealized losses and estimated fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time, that the individual securities have been in a continuous unrealized loss position, at September 30, 2009 and December 31, 2008 (in thousands). As of September 30, 2009 and December 31, 2008, the Company owned 7 and 47 securities whose estimated fair value was less than their cost basis, respectively.
 

September 30, 2009
Less than Twelve Months
Twelve Months or Greater
Total
   
Estimated
Gross
Estimated
Gross
Estimated
Gross
   
Fair
Unrealized
Fair
Unrealized
Fair
Unrealized
   
Value
Losses
Value
Losses
Value
Losses
U.S. Agency securities
 $          4,893
 $                 9
 $                  -
 $                  -
 $          4,893
 $                 9
Obligations of states and
           
     political subdivisions
                     -
                     -
                870
                  11
                870
                  11
Corporate obligations
                     -
                     -
             1,002
                  24
             1,002
                  24
Mortgage-backed securities
                     -
                     -
                     -
                     -
                     -
                     -
 
Total debt securities
             4,893
                    9
             1,872
                  35
             6,765
                  44
Equity securities
                   -
                    1
                   -
                   -
                     -
                    1
               
    Total securities
 $          4,893
 $               10
 $          1,872
 $               35
 $          6,765
 $               45
               
 
6

               
               
December 31, 2008
Less than Twelve Months
Twelve Months or Greater
Total
   
Estimated
Gross
Estimated
Gross
Estimated
Gross
   
Fair
Unrealized
Fair
Unrealized
Fair
Unrealized
   
Value
Losses
Value
Losses
Value
Losses
U.S. Agency securities
 $                  -
 $                  -
 $                  -
 $                  -
 $                  -
 $                  -
Obligations of states and
           
     political subdivisions
           16,910
                463
             1,348
                  17
           18,258
                480
Corporate obligations
             1,874
                135
             3,421
                533
             5,295
                668
Mortgage-backed securities
             9,413
                  67
                     -
                     -
             9,413
                  67
 
Total debt securities
           28,197
                665
             4,769
                550
           32,966
             1,215
Equity securities
                231
                203
                   -
                   -
                231
                203
               
    Total securities
 $        28,428
 $             868
 $          4,769
 $             550
 $        33,197
 $          1,418


The Company’s investment securities portfolio contains unrealized losses on U.S. Agency securities issued or backed by the full faith and credit of the U.S. government or are generally viewed as having the implied guarantee of the U.S. government.  For fixed maturity investments with unrealized losses due to interest rates where the Company does not intend to sell these investments and it is not more likely than not that the Company will be required to sell the investment before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired.  For equity securities where the fair value has been significantly below cost for one year, the Company’s policy is to recognize an impairment loss unless sufficient evidence is available that the decline is not other than temporary and a recovery period can be predicted.  The Company has concluded that any impairment of its investment securities portfolio outlined in the above table is not other than temporary and is not credit related. Rather, it is the result of interest rate changes, sector credit rating changes, or company-specific rating changes that are not expected to result in the non-collection of principal and interest during the period.

Proceeds from sales of securities available-for-sale for the nine months ended September 30, 2009 and 2008 were $6,778,000 and $162,000, respectively.  For the three months ended September 30, 2009 and 2008, proceeds from sales of securities available-for-sale were $0 and $162,000, respectively.  The gross gains and losses were as follows (in thousands):

 
Three Months Ended
Nine Months Ended
 
 September 30,
September 30,
 
          2009
          2008
          2009
          2008
Gross gains
 $                -
 $              43
 $            209
 $              43
Gross losses
                   -
            4,132
                 91
            4,132
Net gains (losses)
 $                -
 $        (4,089)
 $            118
 $        (4,089)

 
    Investment securities with an approximate carrying value of $143,211,000 and $106,669,000 at September 30, 2009 and December 31, 2008, respectively, were pledged to secure public funds and certain other deposits as provided by law.
 
    Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.   The amortized cost and estimated fair value of debt securities at September 30, 2009, by contractual maturity, are shown below (in thousands):

7


 
 
Amortized
 
Estimated
 
Cost
 
Fair Value
Available-for-sale debt securities:
     
  Due in one year or less
 $        2,799
 
 $         2,851
  Due after one year through five years
         18,265
 
          18,826
  Due after five years through ten years
         35,217
 
          36,468
  Due after ten years
       133,117
 
        138,840
Total
 $    189,398
 
 $     196,985


Note 5 - 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 2008 Annual Report on Form 10-K.

Noncontributory Defined Benefit Pension Plan

The Bank sponsors a noncontributory defined benefit pension plan (“Pension Plan”) covering substantially all employees and officers.  The Bank’s funding policy is to make annual contributions, if needed, based upon the funding formula developed by the plan’s actuary.

The Pension Plan was amended, effective January 1, 2008, to cease eligibility for employees with a hire date of January 1, 2008 or later.  In lieu of the Pension Plan, employees with a hire date of January 1, 2008 or later are eligible to receive, after meeting certain length of service requirements, an annual discretionary 401(k) plan contribution from the Bank equal to a percentage of an employee’s base compensation.  The contribution amount, if any, is placed in a separate account within the 401(k) plan and is subject to a vesting requirement.

The Pension Plan was also amended, effective January 1, 2008, for employees who are still eligible to participate.  The amended Pension Plan requires benefits to be paid to eligible employees based primarily upon age and compensation rates during employment.  Upon retirement or other termination of employment, employees can elect either an annuity benefit or a lump sum distribution of vested benefits in the Pension Plan.

The following sets forth the components of net periodic benefit costs of the Pension Plan for the three and nine months ended September 30, 2009 and 2008, respectively (in thousands):

 
       Three Months Ended
 
    Nine Months Ended
 
       September  30,
 
     September 30,
 
       2009
       2008
 
    2009
    2008
           
Service cost
 $                 90
 $                 24
 
 $             240
 $             300
Interest cost
                  116
                    30
 
                309
                378
Expected return on plan assets
               (113)
                   (37)
 
              (302)
               (466)
Net amortization and deferral
                    37
                      1
 
                99
                  16
           
Net periodic benefit cost
 $              130
 $                 18
 
 $             346
 $             228

 
 The Company expects to contribute, and has contributed, $500,000 to the Pension Plan in 2009.


8



Defined Contribution Plan

The Company sponsors a voluntary 401(k) savings plan (“401(k) Plan”) which eligible employees can elect to contribute up to the maximum amount allowable not to exceed the limits of IRS Code Sections 401(k).  The 401(k) Plan was amended, effective January 1, 2008. Under the amended 401(k) Plan, the Company’s contributions are no longer required, but are dependent upon the contributions of the eligible employees.  The Company’s contributions vest immediately.  Contributions by the Company totaled $159,000 and $156,000 for the nine months ended September 30, 2009 and 2008, respectively.

Directors’ Deferred Compensation Plan

The Company’s directors may elect to defer all or portions of their fees until their retirement or termination from service.  Amounts deferred under the plan earn interest based upon the highest current rate offered to certificate of deposit customers.  Amounts deferred under the plan are not guaranteed and represent a general liability of the Company.  Amounts included in interest expense on the deferred amounts totaled $28,000 and $29,000 for the nine months ended September 30, 2009 and 2008, respectively.

Restricted Stock Plan
 
        Effective April 18, 2006, shareholders of the Company approved the 2006 Restricted Stock Plan (the “Plan”).  Employees and non-employee corporate directors are eligible to receive awards of restricted stock based upon performance related requirements.  Awards granted under the Plan are in the form of the Company’s common stock and are subject to certain vesting requirements including continuous employment or service with the Company.  100,000 shares of the Company’s common stock have been authorized under the Plan, which terminates April 18, 2016.  The Plan assists the Company in attracting, retaining and motivating employees to make substantial contributions to the success of the Company and to increase the emphasis on the use of equity as a key component of compensation.

For the nine months ended September 30, 2009 and 2008, 7,526 and 4,993 shares of restricted stock were awarded and 2,517 and 1,133 shares were vested, respectively.  Compensation cost related to restricted stock is recognized based on the market price of the stock at the grant date over the vesting period. Compensation expense related to restricted stock was $72,000 and $37,000 for the nine months ended September 30, 2009 and 2008, respectively.


Note 6 – Fair Value Measurements


Effective January 1, 2008, the Company adopted FASB ASC Topic 820, Fair Value Measurements and Disclosures, which, among other things, requires enhanced disclosures about assets and liabilities carried at fair value. FASB ASC Topic 820 establishes a hierarchal disclosure framework associated with the level of pricing observability utilized in measuring assets and liabilities at fair value. The three broad levels defined by FASB ASC Topic 820 hierarchy are as follows:
 
 
                 Level I:
Quoted prices are available in active markets for identical assets or liabilities as of the reported date.
 
                 Level II:
Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but traded less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed.
   
                 Level III:
Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.
 
 
 
9

The following tables present the assets reported on the consolidated statements of financial condition at their fair value as of September 30, 2009 and December 31, 2008 by level within the fair value hierarchy. As required by FASB ASC Topic 820, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
 

(In thousands)
 
September 30, 2009
   
Level 1
 
Level II
 
Level III
   
Total
 Fair value measurements on a recurring basis:
                 
Securities available for sale:
                 
     U.S. Agency securities
     
 $ 53,931
       
 $ 53,931
     Obligations of state and
                 
       political subdivisions
     
 $ 60,848
       
 $ 60,848
     Corporate obligations
     
 $  6,138
       
 $  6,138
     Mortgage-backed securities
     
 $ 76,068
       
 $ 76,068
     Equity securities
 
 $  559
           
 $    559
                   
   Trust Preferred Interest Rate Swap
     
 $   (221)
       
 $   (221)
                   
 Fair value measurements on a non-recurring basis:
                 
Impaired Loans
     
 $    724
       
 $    724
                   
                   
(In thousands)
 
December 31, 2008
   
Level 1
 
Level II
 
Level III
   
Total
 Fair value measurements on a recurring basis:
                 
Securities available for sale:
                 
     U.S. Agency securities
     
 $ 28,942
       
 $ 28,942
     Obligations of state and
                 
       political subdivisions
     
 $ 44,132
       
 $ 44,132
     Corporate obligations
     
 $  5,296
       
 $  5,296
     Mortgage-backed securities
     
 $ 95,407
       
 $ 95,407
     Equity securities
 
 $  362
           
 $    362
                   
   Trust Preferred Interest Rate Swap
     
 $   (330)
       
 $   (330)
                   
 Fair value measurements on a non-recurring basis:
                 
Impaired Loans
     
 $    830
       
 $    830

10


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

 
        September 30
 
        December 31
 
          2009
 
          2008
 
Carrying
Estimated
 
Carrying
Estimated
 
Amount
Fair Value
 
Amount
Fair Value
Financial assets:
         
Cash and cash equivalents
 $ 20,162
 $ 20,162
 
 $  19,856
 $ 19,856
Available-for-sale securities
  197,544
  197,544
 
   174,139
  174,139
Net loans
  443,808
  460,760
 
   428,436
  445,571
Bank owned life insurance
   12,539
   12,539
 
    12,176
   12,176
Regulatory stock
    3,956
    3,956
 
     3,371
    3,371
Accrued interest receivable
    3,544
    3,544
 
     2,912
    2,912
           
           
Financial liabilities:
         
Deposits
 $579,847
 $587,748
 
 $ 546,680
 $555,089
Borrowed funds
   57,790
   54,516
 
    61,204
   60,823
Accrued interest payable
    2,075
    2,075
 
     2,233
    2,233


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

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

Cash and Cash Equivalents:

The carrying amounts for cash and due from banks approximate fair value because they mature within one year and do not present unanticipated credit concerns.

Accrued Interest Receivable and Payable:

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

Available-For-Sale Securities:

The fair values of available-for-sale securities are based on quoted market prices as of the balance sheet date.  For certain instruments, fair value is estimated by obtaining quotes from independent dealers.

11

Loans:

Fair values are estimated for portfolios of loans with similar financial characteristics.  The fair value of performing loans has been estimated by discounting expected future cash flows. The discount rate used in these calculations is derived from the Treasury yield curve adjusted for credit quality, operating expense and prepayment option price, and is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Company’s historical experience with repayments for each loan classification, modified as required by an estimate of the effect of current economic and lending conditions.
Fair value for significant nonperforming loans is based on recent external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discount rates are judgmentally determined using available market information and specific borrower information.

Bank Owned Life Insurance:

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

Regulatory Stock:

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


Deposits:

The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings and NOW accounts, and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.  The deposits’ fair value estimates do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market, commonly referred to as the core deposit intangible.

Borrowed Funds:

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


Note 7 – Recent Accounting Pronouncements

    In June 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2009-01, Topic 105 - Generally Accepted Accounting Principles - FASB Accounting Standards Codification™ and the Hierarchy of Generally Accepted Accounting Principles. The Codification is the single source of authoritative nongovernmental U.S. generally accepted accounting principles (GAAP).  The Codification does not change current GAAP, but is intended to simplify user access to all authoritative GAAP by providing all the authoritative literature related to a particular topic in one place.  Rules and interpretive releases of the SEC under federal securities laws are also sources of authoritative GAAP for SEC registrants. The Company adopted this standard for the interim reporting period ending September 30, 2009.  The adoption of this standard did not have a material impact on the Company’s results of operations or financial position.

    In June 2009, the FASB issued an accounting standard related to the accounting for transfers of financial assets, which is effective for fiscal years beginning after November 15, 2009, and interim periods within those fiscal years.  This standard enhances reporting about transfers of financial assets, including securitizations, and where companies have continuing exposure to the risks related to transferred financial assets. This standard eliminates the concept of a “qualifying special-purpose entity” and changes the requirements for derecognizing financial assets. This standard also requires additional disclosures about all continuing involvements with transferred financial assets including information about gains and losses resulting from transfers during the period.  This accounting standard was subsequently codified into ASC Topic 860.  The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.

12

In June 2009, the FASB issued FAS No. 167, Amendments to FASB Interpretation No. 46(R). FAS 167, which amends FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, (FIN 46(R)). Under FASB’s Codification at ASC 105-10-65-1-d, FAS No. 167 will remain authoritative until integrated into the FASB Codification.  This statement prescribes a qualitative model for identifying whether a company has a controlling financial interest in a variable interest entity (VIE) and eliminates the quantitative model prescribed by FIN 46(R). The new model identifies two primary characteristics of a controlling financial interest: (1) provides a company with the power to direct significant activities of the VIE, and (2) obligates a company to absorb losses of and/or provides rights to receive benefits from the VIE. FAS No. 167 requires a company to reassess on an ongoing basis whether it holds a controlling financial interest in a VIE. A company that holds a controlling financial interest is deemed to be the primary beneficiary of the VIE and is required to consolidate the VIE. This statement is effective for fiscal years beginning after November 15, 2009, and interim periods within those fiscal years. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.

       In August 2009, the FASB issued ASU No. 2009-05, Fair Value Measurements and Disclosures (Topic 820) – Measuring Liabilities at Fair Value.  This ASU provides amendments for fair value measurements of liabilities.  It provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more techniques.  ASU 2009-05 also clarifies that when estimating a fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability.  ASU 2009-05 is effective for the first reporting period (including interim periods) beginning after issuance or fourth quarter 2009.  The Company is currently evaluating the impact of this standard on the Company’s financial condition, results of operations, and disclosures.

Note 8 – Branch Acquisition

  On November 21, 2008, the Company acquired the Mansfield branch of the Elmira Savings Bank located in Mansfield, Pennsylvania.  The acquisition included retail deposits of $16,889,000 and loans of $267,000.  Land, building and certain other fixed assets were acquired with an appropriate fair market value of $296,000.  The Company also recorded goodwill of $1,651,000 and $67,000 of core deposit intangible.  Upon completion of the acquisition, the Bank had approximately 40% of the deposit market share in Tioga County.  

Note 9 - Subsequent Events

The Company assessed events occurring subsequent to September 30, 2009 through November 12, 2009 for potential recognition and disclosure in the consolidated financial statements. No events have occurred that would require adjustment to or disclosure in the consolidated financial statements which were issued on November 12, 2009.

13


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

 
Cautionary Statement
 
 
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 words such 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 to implement strategic initiatives designed to increase revenues or manage expenses, or we may not be able 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.

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


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 the Company.  Our Company's consolidated financial condition and results of operations consist almost entirely of the Bank’s financial condition and results of operations. Management’s discussion and analysis should be read in conjunction with the preceding financial statements presented under Part I.  The results of operations for the three months and nine months ended September 30, 2009 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 17 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 November 2008, we completed the acquisition of another Mansfield location from The Elmira Savings Bank, FSB (see Footnote 7 to the Consolidated Financial Statements).  In New York, we have a branch office in Wellsville, Allegany County.

14


Risk Management

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


Competition

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 the Bank. 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 also 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 primarily based on price, nature of product, quality of service, and convenience of location.


Trust and Investment Services

Our Investment and Trust Services Department offers professional trust administration, investment management services, estate planning and administration, and custody of securities.  Assets held by the Company in a fiduciary or agency capacity for its customers are not included in the consolidated financial statements since such items are not assets of the Company.  Revenues and fees of the Trust Department are reflected in the Company’s financial statements.  As of September 30, 2009 and December 31, 2008, the Trust Department had $83.2 and $74.3 million of assets under management, respectively.  The $8.9 million increase is primarily attributable to a recovery in market values of trust assets since the end of last year.

15

Our Investment Representatives offer full service brokerage services and financial planning throughout the Bank’s market area.  Products such as mutual funds, annuities, health and life insurance are made available through our insurance subsidiary, First Citizens Insurance.  Fee income from the sale of these products is reflected in the Company’s financial statements as a component of non-interest income in the Consolidated Statement of Income.


Results of Operations

Overview of the Income Statement

         The Company had net income of $7,206,000 for the first nine months of 2009 compared to earnings of $3,415,000 for last year’s comparable period, an increase of $3,791,000 or 111.0%. Earnings per share for the first nine months of 2009 were $2.51, compared to $1.19 last year, representing a 110.9% increase.  Annualized return on assets and return on equity for the nine months of 2009 were 1.39% and 17.46%, respectively, compared with 0.76% and 8.93% for last year’s comparable period.

Net income for the three month’s ended September 30, 2009 was $2,388,000 compared to a net loss of $1,052,000 in the comparable 2008 period, an increase of $3,440,000. Earnings (loss) per share for the three months ended September 30, 2009 and 2008 were $0.83 and $(0.37) per share, respectively.  Annualized return on assets and return on equity for the quarter ended September 30, 2009 was 1.35% and 16.84%, respectively, compared with -0.69% and -8.01% for the same 2008 period.

The comparison to last year’s results is significantly impacted by the $4.1 million other than temporary impairment charge recorded in the third quarter of last year related to investments in Freddie Mac preferred stock and a Lehman Brothers corporate bond.  The after tax impact for the three months and nine months ended September 30, 2008 was approximately $3.5 million. As a result of the Emergency Economic Stabilization Act of 2008 (EESA) being signed into law on October 3, 2008, a provision in the new bill allowed the Freddie Mac preferred stock to be treated as an ordinary loss, allowing a tax benefit of approximately $1,000,000. However, since the EESA was not signed until after September 30, 2008, accounting rules did not allow us to recognize the $1,000,000 tax benefit until the fourth quarter of 2008.  As such, the after-tax impact for 2008 earnings was approximately $2.5 million, after recognition in the fourth quarter of 2008 for the additional tax benefit.

Net Interest Income

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

Net interest income for the first nine months of 2009 was $18,819,000, an increase of $1,618,000, or 9.4%, compared to the same period in 2008.  For the first nine months of 2009, the provision for loan losses totaled $700,000, an increase of $475,000 over the comparable period in 2008.  Consequently, net interest income after the provision for loan losses was $18,119,000 compared to $16,976,000 during the first nine months of 2008.

For the three months ended September 30, 2009, net interest income was $6,390,000 compared to $5,963,000, an increase of $427,000, or 7.2% over the comparable period in 2008. The provision for loan losses this quarter was $400,000 compared to $105,000 last year.  Consequently, net interest income after the provision for loan losses was $5,990,000 for the quarter ended compared to $5,858,000 in 2008.
 
 
16

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 nine months and three months ended September 30, 2009 and 2008:




 
Analysis of Average Balances and Interest Rates (1)
 
Nine Months Ended
 
          September 30, 2009
       September 30, 2008
 
Average
 
Average
Average
 
Average
 
Balance (1)
Interest
Rate
Balance (1)
Interest
Rate
(dollars in thousands)
       $
          $
          %
        $
          $
          %
ASSETS
           
Short-term investments:
           
   Interest-bearing deposits at banks
       19,894
               27
0.18
          2,543
                34
1.79
Total short-term investments
       19,894
               27
0.18
          2,543
                34
1.79
Investment securities:
           
  Taxable
     131,218
         4,668
4.74
        94,719
          3,571
5.03
  Tax-exempt (3)
       49,726
         2,398
6.43
        34,356
          1,588
6.16
  Total investment securities
     180,944
         7,066
5.21
      129,075
          5,159
5.33
Loans:
           
  Residential mortgage loans
     204,144
       11,112
7.28
      212,161
        11,798
7.43
  Commercial & farm loans
     178,301
         9,284
6.96
      156,134
          8,971
7.67
  Loans to state & political subdivisions
       46,439
         2,144
6.17
        47,568
          2,240
6.29
  Other loans
       11,436
             761
8.89
        11,981
              818
9.12
  Loans, net of discount (2)(3)(4)
     440,320
       23,301
7.08
      427,844
        23,827
7.44
Total interest-earning assets
     641,158
       30,394
6.34
      559,462
        29,020
6.93
Cash and due from banks
         9,476
   
          9,576
   
Bank premises and equipment
       11,813
   
        12,385
   
Other assets
       27,496
   
        19,193
   
Total non-interest earning assets
       48,785
   
        41,154
   
Total assets
     689,943
   
      600,616
   
LIABILITIES AND STOCKHOLDERS' EQUITY
         
Interest-bearing liabilities:
           
  NOW accounts
     120,999
             732
            0.81
      104,866
          1,037
            1.32
  Savings accounts
       46,216
             110
            0.32
        40,717
              114
            0.37
  Money market accounts
       41,513
             262
            0.84
        45,350
              681
            2.01
  Certificates of deposit
     302,617
         7,450
            3.29
      231,081
          6,676
            3.86
Total interest-bearing deposits
     511,345
         8,554
            2.24
      422,014
          8,508
            2.69
Other borrowed funds
       58,175
         1,520
            3.49
        67,786
          2,030
            4.00
Total interest-bearing liabilities
     569,520
       10,074
            2.36
      489,800
        10,538
            2.87
Demand deposits
       56,564
   
        53,587
   
Other liabilities
         8,830
   
          6,233
   
Total non-interest-bearing liabilities
       65,394
   
        59,820
   
Stockholders' equity
       55,029
   
        50,996
   
Total liabilities & stockholders' equity
     689,943
   
      600,616
   
Net interest income
 
       20,320
   
        18,482
 
Net interest spread (5)
   
3.97%
   
4.06%
Net interest income as a percentage
           
  of average interest-earning assets
   
4.24%
   
4.41%
Ratio of interest-earning assets
           
  to interest-bearing liabilities
   
            1.13
   
            1.14
             
(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.
       
 
17

 

 
 
Analysis of Average Balances and Interest Rates (1)
 
 Three Months Ended
 
          September 30, 2009
       September 30, 2008
 
Average
 
Average
Average
 
Average
 
Balance (1)
Interest
Rate
Balance (1)
Interest
Rate
(dollars in thousands)
       $
          $
          %
       $
          $
             %
ASSETS
           
Short-term investments:
           
   Interest-bearing deposits at banks
           22,956
                  15
0.27
                    6,173
                         27
1.74
Total short-term investments
           22,956
                  15
0.27
                    6,173
                         27
1.74
Investment securities:
           
  Taxable
         135,243
             1,473
4.36
                 96,360
                     1,162
4.82
  Tax-exempt (3)
           55,926
                905
6.47
                 35,324
                       545
6.17
  Total investment securities
           191,169
             2,378
4.98
                131,684
                    1,707
5.19
Loans:
           
  Residential mortgage loans
         201,992
             3,649
7.17
                211,252
                   3,939
7.42
  Commercial & farm loans
         185,403
              3,191
6.83
               158,404
                    3,071
7.71
  Loans to state & political subdivisions
           46,472
                706
6.03
                  48,915
                       768
6.25
  Other loans
             11,751
                260
8.74
                   11,539
                       266
9.17
  Loans, net of discount (2)(3)(4)
         445,618
             7,806
6.95
                430,110
                   8,044
7.44
Total interest-earning assets
         659,743
            10,199
6.13
              567,967
                   9,778
6.85
Cash and due from banks
             9,067
   
                  10,423
   
Bank premises and equipment
            11,896
   
                  12,283
   
Other assets
           27,533
   
                  19,653
   
Total non-interest earning assets
           48,496
   
                 42,359
   
Total assets
         708,239
   
               610,326
   
LIABILITIES AND STOCKHOLDERS' EQUITY
         
Interest-bearing liabilities:
           
  NOW accounts
         123,265
                234
               0.75
                110,434
                       327
                        1.18
  Savings accounts
           47,609
                  37
               0.31
                 42,602
                          41
                      0.38
  Money market accounts
           41,996
                  78
               0.74
                  43,714
                        186
                       1.69
  Certificates of deposit
         312,898
             2,427
               3.08
              244,496
                   2,283
                       3.71
Total interest-bearing deposits
         525,768
             2,776
               2.09
               441,246
                   2,837
                      2.56
Other borrowed funds
           58,959
                501
               3.37
                  53,221
                       545
                      4.07
Total interest-bearing liabilities
         584,727
             3,277
               2.22
              494,467
                   3,382
                      2.72
Demand deposits
           58,080
   
                  56,715
   
Other liabilities
             8,697
   
                   6,566
   
Total non-interest-bearing liabilities
           66,777
   
                  63,281
   
Stockholders' equity
           56,735
   
                 52,578
   
Total liabilities & stockholders' equity
         708,239
   
               610,326
   
Net interest income
 
             6,922
   
                   6,396
 
Net interest spread (5)
   
3.91%
   
4.13%
Net interest income as a percentage
           
  of average interest-earning assets
   
4.16%
   
4.48%
Ratio of interest-earning assets
           
  to interest-bearing liabilities
   
                1.13
   
                        1.15
             
(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
   
 

 
18

 
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 September 30, 2009 and 2008:
 

 
For the Three Months
 
For the Nine Months
(dollars in thousands)
Ended September 30
 
Ended September 30
 
2009
2008
 
2009
2008
Interest and dividend income from investment securities
         
   and interest bearing deposits at banks (non-tax adjusted)
 $             2,086
 $              1,552
 
 $        6,277
 $          4,637
Tax equivalent adjustment
                   307
                    182
 
               816
                556
Interest and dividend income from investment securities
         
   and interest bearing deposits at banks (tax equivalent basis)
 $             2,393
 $              1,734
 
 $        7,093
 $          5,193
           
           
           
Interest and fees on loans (non-tax adjusted)
 $             7,581
 $              7,793
 
 $      22,616
 $        23,102
Tax equivalent adjustment
                   225
                    251
 
               685
                725
Interest and fees on loans (tax equivalent basis)
 $             7,806
 $              8,044
 
 $      23,301
 $        23,827
           
           
           
Total interest income
 $             9,667
 $              9,345
 
 $      28,893
 $        27,739
Total interest expense
                3,277
                 3,382
 
         10,074
           10,538
Net interest income
                6,390
                 5,963
 
         18,819
           17,201
Total tax equivalent adjustment
                   532
                    433
 
            1,501
             1,281
Net interest income (tax equivalent basis)
 $             6,922
 $              6,396
 
 $      20,320
 $        18,482


19

 

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

Analysis of Changes in Net Interest Income on a Tax-Equivalent Basis (1)
             
 
 Three months ended September 30, 2009 vs. 2008 (1)
 Nine months ended September 30, 2009 vs. 2008 (1)
 
 Change in
 Change
 Total
 Change in
 Change
 Total
 (in thousands)
 Volume
 in Rate
 Change
 Volume
 in Rate
 Change
Interest Income:
           
Short-term investments:
           
  Interest-bearing deposits at banks
 $             26
 $           (38)
 $           (12)
 $             (8)
 $               1
 $             (7)
Investment securities:
           
  Taxable
              432
            (121)
              311
           1,285
            (188)
           1,097
  Tax-exempt
              335
                25
              360
              738
                72
              810
Total investments
              767
              (96)
              671
           2,023
            (116)
           1,907
Loans:
           
  Residential mortgage loans
            (137)
            (153)
            (290)
            (451)
            (235)
            (686)
  Commercial & farm loans
              497
            (377)
              120
              922
            (609)
              313
  Loans to state & political subdivisions
              (32)
              (30)
              (62)
              (54)
              (42)
              (96)
  Other loans
                  6
              (12)
                (6)
              (37)
              (20)
              (57)
Total loans, net of discount
              334
            (572)
            (238)
              380
            (906)
            (526)
Total Interest Income
           1,127
            (706)
              421
           2,395
         (1,021)
           1,374
Interest Expense:
           
Interest-bearing deposits:
           
  NOW accounts
                36
            (129)
              (93)
              200
            (505)
            (305)
  Savings accounts
                  5
                (9)
                (4)
                39
              (43)
                (4)
  Money Market accounts
                (7)
            (101)
            (108)
              (54)
            (365)
            (419)
  Certificates of deposit
              578
            (434)
              144
           1,480
            (706)
              774
Total interest-bearing deposits
              612
            (673)
              (61)
           1,665
         (1,619)
                46
Other borrowed funds
                56
            (100)
              (44)
            (270)
            (240)
            (510)
Total interest expense
              668
            (773)
            (105)
           1,395
         (1,859)
            (464)
Net interest income
 $           459
 $             67
 $           526
 $        1,000
 $           838
 $        1,838
             
(1) The portion of the total change attributable to both volume and rate changes, which can not be separated, has been
      allocated proportionally to the change due to volume and the change due to rate prior to allocation.
 
 
 
Tax equivalent net interest income increased from $18,482,000 for the 2008 nine month period to $20,320,000 in the 2009 nine month period, an increase of $1,838,000 for the nine months ended September 30, 2009.  The tax equivalent net interest margin decreased from 4.41% for the first nine months of 2008 to 4.24% in 2009.
 
 
Total interest income for the nine month periods increased $1,374,000.  This increase is primarily a result of a $2,395,000 increase due to volume as the average balance of interest earning assets increased by $81.7 million.  There was a decrease of $1,021,000 due to change in rate, as the yield on interest earning assets decreased 59 basis points from 6.93% to 6.34%.  Investment income for the nine months ended September 30, 2009 increased $1,907,000 over the same period last year.  The average balance of total investment securities at September 30, 2009 increased by $51.9 million from December 31, 2009 due to investment opportunities and investing excess cash, primarily the result of increased deposits.  The average balance of taxable securities increased by $36.5 million while tax-exempt securities increased by $15.4 million, which had the effect of increasing interest income by $1,285,000 and $738,000, respectively, due to volume.  The purchase of tax-exempt securities, along with municipal loans, allows us to manage our effective tax rate as well as the overall yield on our interest earning assets.
 
 
Total loan interest income decreased $526,000 for the nine months ended September 30, 2009 compared to the same period last year.  Interest income on residential mortgage loans decreased $686,000 of which $451,000 was due to volume and $235,000 was due to a decrease in rate.  The current economic recession, higher unemployment rates and other negative economic factors have resulted in lower loan demand for non-conforming residential mortgages and home equity loans.  The average balance of commercial and farm loans increased $22.2 million from a year ago primarily due to our emphasis to grow this segment of the loan portfolio.  This had a positive impact of $922,000 on total interest income due to volume.  Offsetting this, a decrease of 71 basis points earned on commercial and farm loans had the effect of decreasing interest income by $609,000.
 
20

 
Total interest expense decreased $464,000 for the nine months ended September 30, 2009 compared with last year.  This decrease is primarily due to a change in rate, accounting for a $1,859,000 decrease in our interest expense.  The average interest rate on interest-bearing liabilities decreased 51 basis points, from 2.87% to 2.36%.  The actions of the Federal Reserve and current economic downturn had the effect of decreasing our short-term borrowing costs as well as rates on deposit products, including shorter-term certificates of deposit and rate sensitive NOW and money market accounts.   Offsetting this, the average balance of interest-bearing liabilities increased $79.7 million resulting in an increase in interest expense of $1,395,000 (see also “Financial Condition – Deposits”).  The average balance of certificates of deposit increased $71.5 million causing an increase in interest expense of $1,480,000.  Offsetting the increase in average balance was a decrease in the rate on certificates of deposit from 3.86% to 3.29% resulting in a decrease of $706,000.  The average balance of NOW accounts also increased $16.1 million accounting for an increase of $200,000 in interest expense. The change in rate from 132 basis points to 81 basis points, contributed to an offset in interest expense of $505,000 resulting in an overall decrease of $305,000.  The average balance of borrowed funds decreased by $9.6 million resulting in a decrease in interest expense of $270,000.  The average interest rate paid on borrowed funds also decreased by 51 basis points accounting for a decrease in interest expense of $240,000 due to rate.
 
 
Tax equivalent net interest income for the three months ended September 30, 2009 was $6,922,000 which compares to $6,396,000 for the same period last year.  This represents an increase of $526,000 or 8.2%.  Total tax equivalent interest income was $10,199,000 compared with $9,778,000 for the comparable period last year, an increase of $421,000.  Of this amount, $1,127,000 was due to an increase in volume and $706,000 was due to a decrease in rate.  Total investment income increased by $671,000 compared to last year.  This was predominantly due to a change in volume of $59.5 million in investment securities.  Total interest expense decreased $105,000 for the three months ended September 30, 2009 compared with last year. $668,000 is attributable to an increase in volume mostly due to a $68.4 million increase in certificates of deposit.  Conversely, $773,000 is due to a decrease in rate as the average rate on interest-bearing liabilities decreased 50 basis points from 2.72% to 2.22%.
 

Provision For Loan Losses
 
       For the nine-month period ending September 30, 2009, we recorded a provision for loan losses of $700,000, which represents an increase of $475,000 over the same time period in 2008.  This is the result of current economic conditions and an increase in non-performing loans as of September 30, 2009, which have impacted management's quarterly review of the allowance for loan losses.  The quarterly review 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, actual and expected loan growth and peer comparisons (see also “Financial Condition – Allowance for Loan Losses”).

For the three months ending September 30, 2009, we recorded a provision of $400,000 compared to $105,000 in 2008.


Non-interest Income

Non-interest income for the nine months ended September 30, 2009 totaled $4,341,000, an increase of $4,538,000 when compared to the same period in 2008.  $4,207,000 of the increase is attributable primarily to the investment securities losses recorded in the third quarter of 2008 related to other than temporary impairment charges on Freddie Mac preferred stock and a Lehman Brothers corporate bond.  During the first nine months of 2009, investment securities gains amounted to $118,000.  We sold an agency bond at a gain of $32,000 that was likely to be called in 2009.  We also elected to sell several higher coupon mortgage-backed securities that were prepaying very quickly realizing total gains of $157,000.  This was offset with a $16,000 loss on the sale of bank equity shares as well as an other than temporary impairment charge of $54,000 on our Freddie Mac preferred stock.

21

Service charge income increased by $73,000 and continues to be the Company’s primary source of non-interest income.  For the first nine months of 2009, account service charges totaled $2,664,000 compared to $2,591,000 last year.  Approximately $42,000 of the increase is attributable to customers’ usage of their debit cards, $19,000 is due to an increase in fees charged to customers for non-sufficient funds, and an additional $15,000 is due to an increase in statement service charges.

Brokerage and insurance income increased $52,000 as we continue to increase the principal amounts invested through us by our customers.  We continue to grow and develop this segment of business with our customers.  Gains on loans sold also increased $247,000 compared to last year as a result of the amount of refinancing due to favorable rates in the secondary markets during the economic downturn.  Earnings on bank owned life insurance (BOLI) increased from $261,000 in 2008 to $364,000 for the nine months ended September 30, 2009.  In the fourth quarter of 2008, we invested an additional $3.4 million based upon an analysis of new employees and updated future employee benefit costs, resulting in additional BOLI income.  Trust income is down slightly by $54,000 through nine months compared to 2008 due to the economy’s downturn and the affect it has had on the values of trust assets under management for most of 2009.

For reasons previously mentioned above, service charges increased by $14,000 for the three months ended September 30, 2009 compared to the same period in 2008.  Gains on loans sold increased by $79,000 compared to last year’s three months ended due to significantly higher refinancing activity in the secondary market.  Investment securities gains amounted to $0 for the quarter compared to a loss of $4,089,000 last year.  Earnings on bank owned life insurance also increased $38,000 for the quarter ended September 30, 2009 compared to 2008 due to the increase in the BOLI investment.  Brokerage and insurance increased $17,000 for the comparable period mainly due to some recent activity done in 2009.  Trust income, as mentioned above, declined by $27,000 comparing the last three months to the comparable 2008 period.
 
 
The following table shows the breakdown of non-interest income for the three and nine months ended September 30, 2009 and 2008:


 
Nine months ended September 30,
Change
 
2009
2008
Amount
%
Service charges
 $               2,664
 $              2,591
 $                  73
                 2.8
Trust
                      397
                     451
                    (54)
             (12.0)
Brokerage and insurance
                      228
                     176
                     52
               29.5
Gains on loans sold
                      292
                       45
                   247
             548.9
Investment securities gains (losses), net
                      118
                (4,089)
                4,207
                    -
Earnings on bank owned life insurance
                      364
                     261
                   103
               39.5
Other
                      278
                     368
                    (90)
             (24.5)
Total
 $               4,341
 $                (197)
 $             4,538
        (2,303.6)
         
 
Three months ended September 30,
Change
 
2009
2008
Amount
%
Service charges
 $                   958
 $                  944
 $                  14
                 1.5
Trust
                      121
                     148
                    (27)
             (18.2)
Brokerage and insurance
                        75
                       58
                     17
               29.3
Gains on loans sold
                        83
                         4
                     79
          1,975.0
Investment securities losses, net
                           -
                (4,089)
                4,089
                    -
Earnings on bank owned life insurance
                      128
                       90
                     38
               42.2
Other
                        87
                     121
                    (34)
             (28.1)
Total
 $               1,452
 $             (2,724)
 $             4,176
           (153.3)



22

Non-interest Expense

Non-interest expenses increased $1,428,000 or 12.0%, through September 30, 2009 compared to the same period in 2008.  The increase in salaries and employee benefits of $508,000 is due mainly to annual merit increases, increased employee insurance premiums, pension expenses and the implementation of a Supplemental Executive Retirement Plan (SERP) late in 2008.

FDIC Insurance increased by $926,000 for the nine months ended September 30, 2009 primarily due to an increase in our FDIC deposit insurance assessments.  Through the first nine months of this year, we have expensed $1,030,000 for FDIC assessments compared to only $104,000 last year.  In 2008 we recognized approximately $209,000 in credits as a result of the Federal Deposit Insurance Reform Act of 2005.  Credits related to this legislation were fully utilized by the end of 2008.  Due to the recent strain on the FDIC deposit insurance fund related to the continuing failing of many banks across the nation, the FDIC increased their rates and charged a five basis point special assessment based on assets as of June 30, 2009. The impact of this special assessment was approximately $325,000.  In lieu of an additional special assessment in the fourth quarter of 2009, the FDIC has announced that they will require assessments for the following three years, 2010 – 2012, be prepaid in order to increase the monies available in the insurance fund.  These prepayments will be recognized as a charge to operations over the applicable three year period.

Professional fees decreased $26,000 due to non-recurring costs in 2008 surrounding branch expansion activities.  The $32,000 decrease in furniture and equipment is due to assets becoming fully depreciated.

For the three months ended, September 30, 2009, salaries and employee benefits increased by $197,000 due to merit increases, higher employee insurance premiums, increased pension expense and SERP benefits.  As mentioned above, FDIC insurance also increased by $225,000 compared to the same period last year.

The following tables reflect the breakdown of non-interest expense and professional fees for the three and nine months ended September 30, 2009 and 2008:

 
Nine months ended September 30,
Change
 
2009
2008
Amount
%
Salaries and employee benefits
 $               7,018
 $              6,510
 $                 508
                   7.8
Occupancy
                      889
                     866
                      23
                   2.7
Furniture and equipment
                      336
                     368
                    (32)
                 (8.7)
Professional fees
                      459
                     485
                    (26)
                 (5.4)
FDIC Insurance
                   1,030
                     104
                    926
               890.4
Other
                   3,581
                 3,552
                      29
                   0.8
Total
 $             13,313
 $            11,885
 $             1,428
                 12.0
         
 
Nine months ended September 30,
Change
 
2009
2008
Amount
%
Other professional fees
 $                   215
 $                  245
 $                 (30)
               (12.2)
Legal fees
                        70
                       89
                    (19)
               (21.3)
Examinations and audits
                      174
                     151
                      23
                 15.2
Total
 $                   459
 $                  485
 $                 (26)
                 (5.4)
         

23


 
 
Three months ended September 30,
           Change
 
             2009
             2008
           Amount
          %
Salaries and employee benefits
 $               2,393
 $              2,196
 $                 197
                   9.0
Occupancy
                      272
                     271
                        1
                   0.4
Furniture and equipment
                      102
                     107
                      (5)
                 (4.7)
Professional fees
                      164
                     156
                        8
                   5.1
FDIC Insurance
                      277
                       52
                    225
               432.7
Other
                   1,242
                 1,250
                      (8)
                 (0.6)
Total
 $               4,450
 $              4,032
 $                 418
                 10.4
         
 
Three months ended September 30,
            Change
 
             2009
             2008
            Amount
          %
Other professional fees
 $                     69
 $                    67
 $                     2
                   3.0
Legal fees
                        33
                       42
                      (9)
               (21.4)
Examinations and audits
                        62
                       47
                      15
                 31.9
Total
 $                   164
 $                  156
 $                     8
                   5.1


Provision For Income Taxes

The provision for income taxes was $1,941,000 for the nine-month period ended September 30, 2009 compared to $1,479,000 for the same period in 2008.  The increase is attributable to an increase in income before provision for income taxes of $4,253,000 and primarily due to a decrease in our effective tax rate compared to last year.   Through management of our municipal loan and bond portfolios, management is focused on minimizing our effective tax rate.  Our effective tax rate was 21.2% and 30.2% for the first nine months of 2009 and 2008, respectively, compared to the statutory rate of 34%.  Our effective tax rate in 2008 was attributable to the accounting treatment required on the write-down of our Freddie Mac Preferred stock recorded in the third quarter of 2008.

For the three-months ended September 30, 2009 the provision for income taxes was $604,000, resulting in an effective tax rate of 20.2%.  This compares to a provision for income taxes of $154,000 for the comparable period last year, which was primarily impacted by the accounting treatment required on the write-down of the Freddie Mac preferred stock.
 
        We invest 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 $822,000 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 $298,000 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 $158,000 out of a total $574,000 of tax credits.  We anticipate recognizing $594,000 of tax credits over the next eight years.

Financial Condition

Total assets were $707.2 million at September 30, 2009, an increase of $38.6 million, or 5.8% from $668.6 million at December 31, 2008.  Net loans increased 3.6% to $443.8 million and investment securities increased 13.4% to $197.5 million at September 30, 2009.  Total deposits increased $33.2 million or 6.1% to $579.8 million since year-end 2008. Borrowed funds have decreased $3.4 million to $57.8 million compared with $61.2 million at year-end.


24


Cash and Cash Equivalents

Cash and cash equivalents totaled $20.2 million at September 30, 2009 compared to $19.9 million at December 31, 2008, an increase of $.3 million.  Non-interest-bearing cash increased $1.2 million since year-end 2008, while interest-bearing cash decreased $.9 million during that same period.  The increase in deposits has had a direct correlation to the increase in cash and cash equivalents and has contributed greatly in strengthening our liquidity position during this recessionary 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 as they come due.

Investments

Our investment portfolio increased by $23.4 million or 13.4% from December 31, 2008 to September 30, 2009.  During 2009 we purchased approximately $37.7 million of U.S. agency obligations, $7.4 million of mortgage backed securities and $15.4 million of state and local obligations which help offset the $23.4 million of principal repayments and $11.7 million of calls that occurred during the year. We also selectively sold $6.8 million of bonds and equities at a net gain of $118,000.  The overall market value of our investment portfolio increased approximately $4.9 million due to market fluctuations since year end.  Significant market recoveries were seen in our mortgage backed securities, state and local obligations, and our corporate bonds since year end.  Excluding our short-term investments consisting of monies held primarily at the Federal Reserve for liquidity purposes, our investment portfolio is currently yielding 5.21% compared to 5.33% a year ago on a tax equivalent basis.

As mentioned above, due to the economic downturn and the lowering of interest rates, we have experienced significant prepayments of our mortgage backed securities and calls on our agency bonds.  Due to the amount of cash flow from the investment portfolio as well as an increase in deposits, our strategy has been to reinvest funds mainly in short-term agency bonds and longer-term municipal bonds.

 
 
Estimated Fair Market Value of Investment Portfolio
 
September 30, 2009
December 31, 2008
(dollars in thousands)
Amount
%
Amount
%
Available-for-sale:
       
  U. S. Agency securities
 $    53,931
    27.3
 $  28,942
  16.6
  Obligations of state & political
       
     subdivisions
      60,847
    30.8
    44,132
  25.3
  Corporate obligations
       6,138
     3.1
     5,296
   3.0
  Mortgage-backed securities
      76,068
    38.5
    95,407
  54.8
  Equity securities
         560
     0.3
       362
   0.3
Total
 $   197,544
   100.0
 $ 174,139
 100.0
         
 
 
September 30,  2009/
 
 December 31, 2008
 
        Change
(dollars in thousands)
Amount
%
Available-for-sale:
   
  U. S. Agency securities
 $    24,989
    86.3
  Obligations of state & political
   
     subdivisions
      16,715
    37.9
  Corporate obligations
         842
    15.9
  Mortgage-backed securities
     (19,339)
   (20.3)
  Equity securities
         198
    54.7
Total
 $    23,405
    13.4
 
25

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

Loans

The 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.

Total loans increased approximately $15.7 million or 3.6% during the first nine months of 2009.  Commercial real estate, agricultural, and commercial and other loans increased $20.0 million, $2.0 million and $3.7 million, respectively.  Residential real estate, construction, and municipal loans have decreased $2.4 million, $6.2 million, and $1.7 million, respectively.

There has been a decrease in loan demand for residential real estate, construction and consumer loans due to several economic factors.  Recessionary pressures, higher unemployment, and a depressed housing market have had a negative impact on nonconforming, residential real estate mortgage and home equity loan growth.  Conversely, loan demand for conforming mortgages, which the Company sells on the secondary market, has increased dramatically during the first nine months of 2009.  Through September 30, 2009, we have sold $17.5 million of loans in the secondary market compared to just $3.8 million through this time last year.  Residential mortgage lending is a principal business activity and our Company continues to offer a variety of competitively priced conforming, nonconforming and home equity mortgages.

The growth in commercial real estate, agricultural and other commercial loans, despite the recession, reflects the Company’s focus on commercial lending as a means to increase loan growth and obtain deposits from farmers and small businesses throughout our market area.  We believe we have a strong team of experienced professionals that enable us to meet the needs of these customers within our service area.

 
September 30,
December 31,
 
2009
2008
(in thousands)
Amount
%
Amount
%
Real estate:
       
  Residential
 $ 196,709
   43.8
 $ 199,118
   46.0
  Commercial
   127,697
   28.5
   107,740
   24.9
  Agricultural
    19,017
    4.2
    17,066
    3.9
  Construction
     4,944
    1.1
    11,118
    2.6
Loans to individuals
       
  for household, family and other purchases
    12,012
    2.7
    11,651
    2.7
Commercial and other loans
    41,666
    9.3
    37,968
    8.8
State & political subdivision loans
    46,446
   10.4
    48,153
   11.1
Total loans
   448,491
  100.0
   432,814
  100.0
Less allowance for loan losses
     4,683
 
     4,378
 
Net loans
 $ 443,808
 
 $ 428,436
 
         
 
 
September 30, 2009/
 
 December 31, 2008
 
Change
(in thousands)
Amount
%
Real estate:
   
  Residential
 $  (2,409)
   (1.2)
  Commercial
    19,957
   18.5
  Agricultural
     1,951
   11.4
  Construction
    (6,174)
  (55.5)
Loans to individuals
   
  for household, family and other purchases