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


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

For the quarterly period ended June 30, 2016
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

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

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

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

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

Large accelerated filer ____                                                                                                                                 Accelerated filer _X__

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

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

The number of outstanding shares of the Registrant's Common Stock, as of July 26, 2016, was 3,349,753.


Citizens Financial Services, Inc.
Form 10-Q

INDEX

   
PAGE
Part I
FINANCIAL INFORMATION
 
Item 1.
Financial Statements (unaudited):
 
 
Consolidated Balance Sheet as of June 30,2016 and December 31, 2015
1
 
Consolidated Statement of Income for the Three and Six Months Ended June 30, 2016 and 2015
2
 
Consolidated Statement of Comprehensive Income for the Three and Six Months ended June 30, 2016 and 2015
3
 
Consolidated Statement of Cash Flows for the Six Months ended June 30, 2016 and 2015
4
 
Notes to Consolidated Financial Statements
5-34
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
35-57
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
57
Item 4.
Controls and Procedures
57
     
Part II
OTHER INFORMATION
 
Item 1.
Legal Proceedings
57
Item 1A.
Risk Factors
58
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
58
Item 3.
Defaults Upon Senior Securities
58
Item 4.
Mine Safety Disclosures
58
Item 5.
Other Information
58
Item 6.
Exhibits
58-59
 
Signatures
60



CITIZENS FINANCIAL SERVICES, INC.
           
CONSOLIDATED BALANCE SHEET
           
(UNAUDITED)
           
 
           
 
 
June 30
   
December 31
 
(in thousands except share data)
 
2016
   
2015
 
ASSETS:
           
Cash and due from banks:
           
  Noninterest-bearing
 
$
14,908
   
$
14,088
 
  Interest-bearing
   
11,914
     
10,296
 
Total cash and cash equivalents
   
26,822
     
24,384
 
Interest bearing time deposits with other banks
   
6,954
     
7,696
 
Available-for-sale securities
   
360,944
     
359,737
 
Loans held for sale
   
1,304
     
603
 
                 
Loans (net of allowance for loan losses:
               
  2016, $7,359 and 2015, $7,106)
   
701,756
     
687,925
 
                 
Premises and equipment
   
17,239
     
17,263
 
Accrued interest receivable
   
4,176
     
4,211
 
Goodwill
   
21,089
     
21,089
 
Bank owned life insurance
   
25,877
     
25,535
 
Other intangibles
   
2,183
     
2,437
 
Other assets
   
11,174
     
12,104
 
 
               
TOTAL ASSETS
 
$
1,179,518
   
$
1,162,984
 
 
               
LIABILITIES:
               
Deposits:
               
  Noninterest-bearing
 
$
142,327
   
$
150,960
 
  Interest-bearing
   
861,155
     
837,071
 
Total deposits
   
1,003,482
     
988,031
 
Borrowed funds
   
38,786
     
41,631
 
Accrued interest payable
   
644
     
734
 
Other liabilities
   
12,150
     
12,828
 
TOTAL LIABILITIES
   
1,055,062
     
1,043,224
 
STOCKHOLDERS' EQUITY:
               
Preferred Stock
               
  $1.00 par value; authorized 3,000,000 shares June 30, 2016 and December 31, 2015;
               
   none issued in 2016 or 2015
   
-
     
-
 
Common stock
               
  $1.00 par value; authorized 15,000,000 shares;  issued 3,704,375 at June 30, 2016 and
               
   3,671,751 at December 31, 2015
   
3,704
     
3,672
 
Additional paid-in capital
   
42,241
     
40,715
 
Retained earnings
   
87,753
     
85,790
 
Accumulated other comprehensive income (loss)
   
2,042
     
(236
)
Treasury stock, at cost:  358,921 shares at June 30, 2016
               
  and 335,876 shares at December 31, 2015
   
(11,284
)
   
(10,181
)
TOTAL STOCKHOLDERS' EQUITY
   
124,456
     
119,760
 
TOTAL LIABILITIES AND
               
   STOCKHOLDERS' EQUITY
 
$
1,179,518
   
$
1,162,984
 
 
               
The accompanying notes are an integral part of these unaudited consolidated financial statements.
         
 
1

CITIZENS FINANCIAL SERVICES, INC.
                       
CONSOLIDATED STATEMENT OF INCOME
                       
(UNAUDITED)
                       
 
 
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(in thousands, except share and per share data)
 
2016
   
2015
   
2016
   
2015
 
INTEREST INCOME:
                       
Interest and fees on loans
 
$
8,587
   
$
7,129
   
$
17,183
   
$
14,168
 
Interest-bearing deposits with banks
   
64
     
39
     
135
     
70
 
Investment securities:
                               
`    Taxable
   
959
     
765
     
1,903
     
1,519
 
    Nontaxable
   
755
     
801
     
1,526
     
1,649
 
    Dividends
   
61
     
34
     
141
     
133
 
TOTAL INTEREST INCOME
   
10,426
     
8,768
     
20,888
     
17,539
 
INTEREST EXPENSE:
                               
Deposits
   
1,072
     
1,035
     
2,146
     
2,044
 
Borrowed funds
   
183
     
172
     
366
     
347
 
TOTAL INTEREST EXPENSE
   
1,255
     
1,207
     
2,512
     
2,391
 
NET INTEREST INCOME
   
9,171
     
7,561
     
18,376
     
15,148
 
Provision for loan losses
   
135
     
120
     
270
     
240
 
NET INTEREST INCOME AFTER
                               
    PROVISION FOR LOAN LOSSES
   
9,036
     
7,441
     
18,106
     
14,908
 
NON-INTEREST INCOME:
                               
Service charges
   
1,128
     
1,028
     
2,230
     
2,004
 
Trust
   
182
     
180
     
378
     
374
 
Brokerage and insurance
   
158
     
255
     
367
     
382
 
Gains on loans sold
   
70
     
60
     
116
     
98
 
Investment securities gains, net
   
128
     
175
     
155
     
301
 
Earnings on bank owned life insurance
   
172
     
154
     
342
     
306
 
Other
   
145
     
103
     
311
     
218
 
TOTAL NON-INTEREST INCOME
   
1,983
     
1,955
     
3,899
     
3,683
 
NON-INTEREST EXPENSES:
                               
Salaries and employee benefits
   
3,900
     
2,993
     
7,782
     
6,049
 
Occupancy
   
455
     
348
     
900
     
717
 
Furniture and equipment
   
171
     
87
     
328
     
215
 
Professional fees
   
266
     
180
     
553
     
412
 
FDIC insurance
   
160
     
116
     
317
     
232
 
Pennsylvania shares tax
   
240
     
200
     
390
     
401
 
Amortization of other intangibles
   
82
     
-
     
164
     
-
 
ORE expenses
   
212
     
357
     
305
     
358
 
Other
   
1,815
     
1,147
     
3,474
     
2,379
 
TOTAL NON-INTEREST EXPENSES
   
7,301
     
5,428
     
14,213
     
10,763
 
Income before provision for income taxes
   
3,718
     
3,968
     
7,792
     
7,828
 
Provision for income taxes
   
687
     
779
     
1,478
     
1,519
 
NET INCOME
 
$
3,031
   
$
3,189
   
$
6,314
   
$
6,309
 
                                 
PER COMMON SHARE DATA:
                               
Net Income - Basic
 
$
0.91
   
$
1.04
   
$
1.88
   
$
2.06
 
Net Income - Diluted
 
$
0.91
   
$
1.04
   
$
1.88
   
$
2.06
 
Cash Dividends Paid
 
$
0.419
   
$
0.402
   
$
0.829
   
$
0.802
 
 
                               
Number of shares used in computation - basic
   
3,343,254
     
3,052,285
     
3,349,913
     
3,055,569
 
Number of shares used in computation - diluted
   
3,343,663
     
3,053,349
     
3,350,118
     
3,056,103
 
 
                               
The accompanying notes are an integral part of these unaudited consolidated financial statements.
                 

2

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

 

3

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


4


 CITIZENS FINANCIAL SERVICES, INC.
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 Community Bank (the "Bank"), and the Bank's wholly owned subsidiary, First Citizens Insurance Agency, Inc. ("First Citizens Insurance"). On December 11, 2015, the Company completed its acquisition of The First National Bank of Fredericksburg (FNB) by merging FNB into the Bank.

The accompanying consolidated financial statements have been prepared pursuant to rules and regulations of the Securities and Exchange Commission ("SEC") 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 at June 30, 2016 and for the periods ended June 30, 2016 and 2015 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 periods.  In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. The financial performance reported for the Company for the six month period ended June 30, 2016 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, 2015.

Note 2 - Earnings per Share

The following table sets forth the computation of earnings per share. Earnings per share calculations give retroactive effect to stock dividends declared by the Company.

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

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

5

Note 3 - Income Tax Expense

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

Investments in Qualified Affordable Housing Projects

As of June 30, 2016 and December 31, 2015, the Company was invested in four partnerships that provide affordable housing. The balance of the investments, which is included within other assets in the Consolidated Balance Sheet, was $829,000 and $959,000 as of June 30, 2016 and December 31, 2015, respectively. Investments purchased prior to January 1, 2015, are accounted for utilizing the effective yield method. As of June 30, 2016, the Company has $945,000 of tax credits remaining that will be recognized over 6.4 years. Tax credits of $49,000 were recognized as a reduction of tax expense during the three months ended June 30, 2016 and 2015. Tax credits of $99,000 were recognized as a reduction of tax expense during the six months ended June 30, 2016 and 2015.

Note 4 – Investments

The amortized cost, gross unrealized gains and losses, and fair value of investment securities at June 30, 2016 and December 31, 2015 were as follows (in thousands):

         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
June 30, 2016
 
Cost
   
Gains
   
Losses
   
Value
 
Available-for-sale securities:
                       
  U.S. agency securities
 
$
203,461
   
$
2,359
   
$
(1
)
 
$
205,819
 
  U.S. treasury securities
   
5,046
     
7
     
-
     
5,053
 
  Obligations of state and
                               
    political subdivisions
   
101,144
     
3,338
     
(10
)
   
104,472
 
  Corporate obligations
   
11,430
     
50
     
-
     
11,480
 
  Mortgage-backed securities in
                               
    government sponsored entities
   
31,190
     
456
     
(40
)
   
31,606
 
  Equity securities in financial
                               
     Institutions
   
2,001
     
518
     
(5
)
   
2,514
 
Total available-for-sale securities
 
$
354,272
   
$
6,728
   
$
(56
)
 
$
360,944
 
                                 
                                 
December 31, 2015
                               
Available-for-sale securities:
                               
  U.S. agency securities
 
$
199,749
   
$
369
   
$
(527
)
 
$
199,591
 
  U.S. treasury securities
   
10,103
     
-
     
(21
)
   
10,082
 
  Obligations of state and
                               
    political subdivisions
   
99,856
     
3,080
     
(73
)
   
102,863
 
  Corporate obligations
   
14,583
     
68
     
(86
)
   
14,565
 
  Mortgage-backed securities in
                               
    government sponsored entities
   
30,107
     
186
     
(89
)
   
30,204
 
  Equity securities in financial institutions
   
2,001
     
436
     
(5
)
   
2,432
 
Total available-for-sale securities
 
$
356,399
   
$
4,139
   
$
(801
)
 
$
359,737
 

The following table shows the Company's gross unrealized losses and 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, which individual securities have been in a continuous unrealized loss position, at June 30, 2016 and December 31, 2015 (in thousands). As of June 30, 2016, the Company owned 17 securities whose fair value was less than their cost basis.

6


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

As of June 30, 2016, the Company's investment securities portfolio contained unrealized losses on agency securities issued or backed by the full faith and credit of the United States government or are generally viewed as having the implied guarantee of the U.S. government, obligations of states and political subdivisions, mortgage backed securities issued by government sponsored entities, and equity securities in financial institutions. For fixed maturity investments management considers whether the present value of cash flows expected to be collected are less than the security's amortized cost basis (the difference defined as the credit loss), the magnitude and duration of the decline, the reasons underlying the decline and the Company's intent to sell the security or whether it is more likely than not that the Company would be required to sell the security before its anticipated recovery in market value, to determine whether the loss in value is other than temporary. Once a decline in value is determined to be other than temporary, if the Company does not intend to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of the security's amortized cost basis, the charge to earnings is limited to the amount of credit loss. Any remaining difference between fair value and amortized cost (the difference defined as the non-credit portion) is recognized in other comprehensive income, net of applicable taxes. Otherwise, the entire difference between fair value and amortized cost is charged to earnings. For equity securities where the fair value has been significantly below cost for one year, the Company's policy is to recognize an impairment loss unless sufficient evidence is available that the decline is not other than temporary and a recovery period can be predicted.  The Company has concluded that any impairment of its investment securities portfolio outlined in the above table is not other than temporary and is the result of interest rate changes, sector credit rating changes, or issuer-specific rating changes that are not expected to result in the non-collection of principal and interest during the period.

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

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

Investment securities with an approximate carrying value of $221.9 million and $203.8 million at June 30, 2016 and December 31, 2015, respectively, were pledged to secure public funds and certain other deposits.

7

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

   
Amortized
       
 
 
Cost
   
Fair Value
 
Available-for-sale debt securities:
           
  Due in one year or less
 
$
41,555
   
$
41,758
 
  Due after one year through five years
   
190,450
     
193,673
 
  Due after five years through ten years
   
41,023
     
42,092
 
  Due after ten years
   
79,243
     
80,907
 
Total
 
$
352,271
   
$
358,430
 

Note 5 – Loans

The Company grants loans primarily to customers throughout north central, central and south central Pennsylvania and the southern tier New York.  Although the Company had a diversified loan portfolio at June 30, 2016 and December 31, 2015, a substantial portion of its debtors' ability to honor their contracts is dependent on the economic conditions within these regions. The following table summarizes the primary segments of the loan portfolio and how those segments are analyzed within the allowance for loan losses as of June 30, 2016 and December 31, 2015 (in thousands):

June 30, 2016
 
Total Loans
   
Individually
evaluated for impairment
   
Loans acquired
with deteriorated
credit quality
   
Collectively
evaluated for impairment
 
Real estate loans:
                       
     Residential
 
$
203,980
   
$
518
   
$
34
   
$
203,428
 
     Commercial and agricultural
   
309,287
     
6,404
     
2,753
     
300,130
 
     Construction
   
10,481
     
-
     
-
     
10,481
 
Consumer
   
11,439
     
-
     
6
     
11,433
 
Other commercial and agricultural loans
   
74,089
     
5,682
     
876
     
67,531
 
State and political subdivision loans
   
99,839
     
-
     
-
     
99,839
 
Total
   
709,115
     
12,604
     
3,669
     
692,842
 
Allowance for loan losses
   
7,359
     
587
     
-
     
6,772
 
Net loans
 
$
701,756
   
$
12,017
   
$
3,669
   
$
686,070
 

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

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

8

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

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

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

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

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

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

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

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

9

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

 
       
Recorded
   
Recorded
             
 
 
Unpaid
   
Investment
   
Investment
   
Total
       
 
 
Principal
   
With No
   
With
   
Recorded
   
Related
 
June 30, 2016
 
Balance
   
Allowance
   
Allowance
   
Investment
   
Allowance
 
Real estate loans:
                             
     Mortgages
 
$
502
   
$
114
   
$
345
   
$
459
   
$
35
 
     Home Equity
   
59
     
-
     
59
     
59
     
11
 
     Commercial
   
8,888
     
5,944
     
295
     
6,239
     
126
 
     Agricultural
   
165
     
165
     
-
     
165
     
-
 
     Construction
   
-
     
-
     
-
     
-
     
-
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other commercial loans
   
5,717
     
4,547
     
1,031
     
5,578
     
415
 
Other agricultural loans
   
104
     
104
     
-
     
104
     
-
 
State and political subdivision loans
   
-
     
-
     
-
     
-
     
-
 
Total
 
$
15,435
   
$
10,874
   
$
1,730
   
$
12,604
   
$
587
 
 
                                       
December 31, 2015
                                       
Real estate loans:
                                       
     Mortgages
 
$
281
   
$
114
   
$
129
   
$
243
   
$
26
 
     Home Equity
   
61
     
-
     
61
     
61
     
11
 
     Commercial
   
8,654
     
5,843
     
225
     
6,068
     
62
 
     Agricultural
   
167
     
167
     
-
     
167
     
-
 
     Construction
   
-
     
-
     
-
     
-
     
-
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other commercial loans
   
5,535
     
4,653
     
987
     
5,640
     
256
 
Other agricultural loans
   
105
     
105
     
-
     
105
     
-
 
State and political subdivision loans
   
-
     
-
     
-
     
-
     
-
 
Total
 
$
14,803
   
$
10,882
   
$
1,402
   
$
12,284
   
$
355
 

The following tables includes the average balance of impaired financing receivables by class and the income recognized on impaired loans for the three and six month periods ended June 30, 2016 and 2015(in thousands):

10

 
 
 
For the Six Months ended
 
 
 
June 30, 2016
   
June 30, 2015
 
 
             
Interest
               
Interest
 
 
 
Average
   
Interest
   
Income
   
Average
   
Interest
   
Income
 
 
 
Recorded
   
Income
   
Recognized
   
Recorded
   
Income
   
Recognized
 
 
 
Investment
   
Recognized
   
Cash Basis
   
Investment
   
Recognized
   
Cash Basis
 
Real estate loans:
                                   
     Mortgages
 
$
425
   
$
9
   
$
-
   
$
224
   
$
4
   
$
5
 
     Home Equity
   
60
     
2
     
-
     
114
     
2
     
-
 
     Commercial
   
6,142
     
52
     
-
     
5,862
     
32
     
-
 
     Agricultural
   
165
     
5
     
-
     
-
     
-
     
-
 
     Construction
   
-
     
-
     
-
     
-
     
-
     
-
 
Consumer
   
-
     
-
     
-
     
-
     
-
     
-
 
Other commercial loans
   
5,942
     
134
     
3
     
2,678
     
49
     
3
 
Other agricultural loans
   
104
     
3
     
-
     
-
     
-
     
-
 
State and political
                                               
   subdivision loans
   
-
     
-
     
-
     
-
     
-
     
-
 
Total
 
$
12,838
   
$
205
   
$
3
   
$
8,878
   
$
87
   
$
8
 
 
                                               
 
 
For the Three Months Ended
 
 
 
June 30, 2016
   
June 30, 2015
 
Real estate loans:
                                               
     Mortgages
 
$
460
   
$
5
   
$
-
   
$
259
   
$
2
   
$
5
 
     Home Equity
   
59
     
1
     
-
     
103
     
1
     
-
 
     Commercial
   
6,158
     
26
     
-
     
5,700
     
19
     
-
 
     Agricultural
   
165
     
3
     
-
     
-
     
-
     
-
 
     Construction
   
-
     
-
     
-
     
-
     
-
     
-
 
Consumer
   
-
     
-
     
-
     
-
     
-
     
-
 
Other commercial loans
   
5,933
     
68
     
2
     
2,629
     
24
     
2
 
Other agricultural loans
   
104
     
2
     
-
     
-
     
-
     
-
 
State and political
                                               
   subdivision loans
   
-
     
-
     
-
     
-
     
-
     
-
 
Total
 
$
12,879
   
$
105
   
$
2
   
$
8,691
   
$
46
   
$
7
 

Credit Quality Information

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

11

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

The following tables represent credit exposures by internally assigned grades as of June 30, 2016 and December 31, 2015 (in thousands):

June 30, 2016
 
Pass
   
Special Mention
   
Substandard
   
Doubtful
   
Loss
   
Ending Balance
 
Real estate loans:
                                   
     Commercial
 
$
228,452
   
$
3,619
   
$
14,796
   
$
28
   
$
-
   
$
246,895
 
     Agricultural
   
53,701
     
5,951
     
2,740
     
-
     
-
     
62,392
 
     Construction
   
10,481
     
-
     
-
     
-
     
-
     
10,481
 
Other commercial loans
   
48,344
     
2,148
     
5,061
     
133
     
-
     
55,686
 
Other agricultural loans
   
14,454
     
2,320
     
1,629
     
-
     
-
     
18,403
 
State and political
                                               
   subdivision loans
   
91,639
     
8,200
     
-
     
-
     
-
     
99,839
 
Total
 
$
447,071
   
$
22,238
   
$
24,226
   
$
161
   
$
-
   
$
493,696
 
 
                                               
December 31, 2015
                                               
Real estate loans:
                                               
     Commercial
 
$
217,544
   
$
4,150
   
$
15,816
   
$
32
   
$
-
   
$
237,542
 
     Agricultural
   
53,695
     
2,865
     
1,262
     
-
     
-
     
57,822
 
     Construction
   
14,422
     
589
     
-
     
-
     
-
     
15,011
 
Other commercial loans
   
51,297
     
446
     
5,669
     
137
     
-
     
57,549
 
Other agricultural loans
   
13,318
     
234
     
105
     
-
     
-
     
13,657
 
State and political
                                               
   subdivision loans
   
98,500
     
-
     
-
     
-
     
-
     
98,500
 
Total
 
$
448,776
   
$
8,284
   
$
22,852
   
$
169
   
$
-
   
$
480,081
 

For residential real estate mortgages, home equity and consumer loans, credit quality is monitored based on whether the loan is performing or non-performing, which is typically based on the aging status of the loan and payment activity, unless a specific action, such as bankruptcy, repossession, death or significant delay in payment occurs to raise awareness of a possible credit event. Non-performing loans include those loans that are considered nonaccrual, described in more detail below, and all loans past due 90 or more days and still accruing. The following table presents the recorded investment in those loan classes based on payment activity as of June 30, 2016 and December 31, 2015 (in thousands):

June 30, 2016
 
Performing
   
Non-performing
   
PCI
   
Total
 
Real estate loans:
                       
     Mortgages
 
$
142,633
   
$
1,474
   
$
34
   
$
144,141
 
     Home Equity
   
59,709
     
130
     
-
     
59,839
 
Consumer
   
11,385
     
48
     
6
     
11,439
 
Total
 
$
213,727
   
$
1,652
   
$
40
   
$
215,419
 
 
12



December 31, 2015
 
Performing
   
Non-performing
   
PCI
   
Total
 
Real estate loans:
                       
     Mortgages
 
$
139,734
   
$
1,270
   
$
35
   
$
141,039
 
     Home Equity
   
62,236
     
132
     
-
   
$
62,368
 
Consumer
   
11,470
     
64
     
9
   
$
11,543
 
Total
 
$
213,440
   
$
1,466
   
$
44
   
$
214,950
 

Aging Analysis of Past Due Financing Receivables

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following table includes an aging analysis of the recorded investment of past due financing receivables as of June 30, 2016 and December 31, 2015 (in thousands):

 
                                     
Total
   
90 Days or
 
 
 
30-59 Days
   
60-89 Days
   
90 Days
   
Total Past
               
Financing
   
Greater and
 
June 30, 2016
 
Past Due
   
Past Due
   
Or Greater
   
Due
   
Current
   
PCI
   
Receivables
   
Accruing
 
Real estate loans:
                                               
     Mortgages
 
$
1,564
   
$
25
   
$
704
   
$
2,293
   
$
141,814
   
$
34
   
$
144,141
   
$
195
 
     Home Equity
   
478
     
74
     
77
     
629
     
59,210
     
-
     
59,839
     
24
 
     Commercial
   
1,257
     
958
     
4,147
     
6,362
     
238,517
     
2,016
     
246,895