UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2022

☐ 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)

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, Par value $1.0 per share		CZFS		The Nasdaq Stock Market, LLC
Title of Each Class		Trading Symbol (s)		Name of Each Exchange on Which Registered

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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐

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

Large accelerated filer ☐	Accelerated filer ☐

Non-accelerated filer ☒	Smaller reporting company ☒

Emerging growth company ☐

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

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

The number of outstanding shares of the Registrant’s Common Stock, as of November 2, 2022, was 3,971,212.

CITIZENS FINANCIAL SERVICES, INC.

CONSOLIDATED BALANCE SHEET

(UNAUDITED)

(in thousands except share data)	September 30, 2022			December 31, 2021
ASSETS:
Cash and due from banks:
Noninterest-bearing	$	21,519		$	14,051
Interest-bearing		1,629			158,782
Total cash and cash equivalents		23,148			172,833
Interest bearing time deposits with other banks		6,055			11,026
Equity securities		2,257			2,270
Available-for-sale securities		445,222			412,402
Loans held for sale		1,280			4,554

Loans (net of allowance for loan losses:
2022 $18,291 and 2021, $17,304)		1,719,662			1,424,229

Premises and equipment		17,367			17,016
Accrued interest receivable		6,544			5,235
Goodwill		31,376			31,376
Bank owned life insurance		39,137			38,503
Other intangibles		1,371			1,627
Fair value of derivative instruments		17,674			4,011
Other assets		38,618			18,781
TOTAL ASSETS	$	2,349,711		$	2,143,863

LIABILITIES:
Deposits:
Noninterest-bearing	$	381,380		$	358,073
Interest-bearing		1,487,331			1,478,078
Total deposits		1,868,711			1,836,151
Borrowed funds		258,922			73,977
Accrued interest payable		922			711
Other liabilities		29,726			20,532
TOTAL LIABILITIES		2,158,281			1,931,371
STOCKHOLDERS' EQUITY:
Preferred Stock
$1.00 par value; authorized 3,000,000 shares at September 30, 2022 and December 31, 2021; none issued in 2022 or 2021		-			-
Common Stock
$1.00 par value; authorized 25,000,000 shares at September 30, 2022 and December 31, 2021; issued 4,427,687 at September 30, 2022 and 4,388,901 at December 31, 2021		4,428			4,389
Additional paid-in capital		80,869			78,395
Retained earnings		158,953			146,010
Accumulated other comprehensive loss		(35,855	)		(155	)
Treasury stock, at cost: 456,345 shares at September 30, 2022 and 444,481 shares at December 31, 2021		(16,965	)		(16,147	)
TOTAL STOCKHOLDERS' EQUITY		191,430			212,492
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	2,349,711		$	2,143,863

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

Index

CITIZENS FINANCIAL SERVICES, INC.

CONSOLIDATED STATEMENT OF INCOME

(UNAUDITED)

	Three Months Ended September 30,					Nine Months Ended September 30,
(in thousands, except share and per share data)	2022			2021		2022			2021
INTEREST INCOME:
Interest and fees on loans	$	19,396		$	16,505	$	52,436		$	49,569
Interest-bearing deposits with banks		61			118		333			335
Investment securities:
Taxable		1,514			1,074		4,050			2,865
Nontaxable		630			561		1,830			1,652
Dividends		182			84		356			291
TOTAL INTEREST INCOME		21,783			18,342		59,005			54,712
INTEREST EXPENSE:
Deposits		1,838			1,422		4,469			4,545
Borrowed funds		1,099			330		1,699			924
TOTAL INTEREST EXPENSE		2,937			1,752		6,168			5,469
NET INTEREST INCOME		18,846			16,590		52,837			49,243
Provision for loan losses		725			400		1,425			1,550
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		18,121			16,190		51,412			47,693
NON-INTEREST INCOME:
Service charges		1,509			1,210		4,081			3,479
Trust		187			182		620			674
Brokerage and insurance		446			408		1,428			1,190
Gains on loans sold		95			295		241			1,109
Equity security (losses) gains, net		(19	)		72		(198	)		288
Available for sale security (losses) gains, net		(6	)		162		(6	)		212
Earnings on bank owned life insurance		216			165		635			1,643
Other		264			358		626			1,198
TOTAL NON-INTEREST INCOME		2,692			2,852		7,427			9,793
NON-INTEREST EXPENSES:
Salaries and employee benefits		6,933			6,568		20,964			19,312
Occupancy		779			728		2,327			2,222
Furniture and equipment		122			123		416			407
Professional fees		588			310		1,321			1,153
FDIC insurance		160			129		440			387
Pennsylvania shares tax		339			339		1,017			856
Amortization of intangibles		40			48		120			146
Software expenses		370			336		1,069			1,003
ORE expenses (income)		122			130		(125	)		383
Other		2,161			1,689		5,496			4,798
TOTAL NON-INTEREST EXPENSES		11,614			10,400		33,045			30,667
Income before provision for income taxes		9,199			8,642		25,794			26,819
Provision for income taxes		1,655			1,578		4,609			4,645
NET INCOME	$	7,544		$	7,064	$	21,185		$	22,174

PER COMMON SHARE DATA:
Net Income - Basic	$	1.90		$	1.77	$	5.34		$	5.56
Net Income - Diluted	$	1.90		$	1.77	$	5.34		$	5.56
Cash Dividends Paid	$	0.480		$	0.465	$	1.421		$	1.377

Number of shares used in computation - basic		3,967,585			3,988,294		3,970,646			3,984,748
Number of shares used in computation - diluted		3,967,819			3,988,389		3,970,648			3,984,755

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

Index

CITIZENS FINANCIAL SERVICES, INC.

CONSOLIDATED STATEMENT OF COMPREHENSIVE (LOSS) INCOME

(UNAUDITED)

	Three Months Ended September 30,						Nine Months Ended, September 30,
(in thousands)	2022			2021			2022			2021
Net income	$	7,544		$	7,064		$	21,185		$	22,174
Other comprehensive (loss) income:
Change in unrealized losses on available for sale securities		(13,578	)		(924	)		(50,581	)		(3,577	)
Income tax effect		2,851			193			10,622			750
Change in unrecognized pension cost		24			81			72			254
Income tax effect		(5	)		(16	)		(15	)		(53	)
Change in unrealized gain on interest rate swaps		1,781			195			5,314			1,488
Income tax effect		(374	)		(42	)		(1,117	)		(313	)
Less: Reclassification adjustment for investment security gains included in net income		6			(162	)		6			(212	)
Income tax effect		(1	)		34			(1	)		45
Other comprehensive (loss) income, net of tax		(9,296	)		(641	)		(35,700	)		(1,618	)
Comprehensive (loss) income	$	(1,752	)	$	6,423		$	(14,515	)	$	20,556

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

Index

CITIZENS FINANCIAL SERVICES, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(UNAUDITED)

	Common Stock				Additional Paid-in			Retained			Accumulated Other Comprehensive			Treasury
(in thousands, except share data)	Shares		Amount		Capital			Earnings			Income (Loss)			Stock			Total

Balance, June 30, 2022		4,427,687		4,428		80,892			153,315			(26,559	)		(17,044	)		195,032

Comprehensive loss:
Net income									7,544									7,544
Net other comprehensive loss												(9,296	)					(9,296	)
Restricted stock, executive and Board of Director awards (769 shares)						(52	)								52			-
Restricted stock vesting						16												16
Sale of treasury stock to employees (540 shares)						5									35			40
Forfeited restricted stock (120 shares)						8									(8	)		-
Cash dividends, $0.480 per share									(1,906	)								(1,906	)
Balance, September 30, 2022		4,427,687	$	4,428	$	80,869		$	158,953		$	(35,855	)	$	(16,965	)	$	191,430

Balance, December 31, 2021		4,388,901	$	4,389	$	78,395		$	146,010		$	(155	)	$	(16,147	)	$	212,492

Comprehensive loss:
Net income									21,185									21,185
Net other comprehensive loss												(35,700	)					(35,700	)
Stock dividend		38,786		39		2,521			(2,560	)								-
Purchase of treasury stock (18,697 shares)															(1,279	)		(1,279	)
Restricted stock, executive and Board of Director awards (5,392 shares)						(221	)								365			144
Restricted stock vesting						158												158
Sale of treasury stock to employees (1,600 shares)						6									106			112
Forfeited restricted stock (159 shares)						10									(10	)		-
Cash dividends, $1.421 per share									(5,682	)								(5,682	)
Balance, September 30, 2022		4,427,687	$	4,428	$	80,869		$	158,953		$	(35,855	)	$	(16,965	)	$	191,430

Balance, June 30, 2021		4,388,901		4,389		78,412			135,714			1,610			(15,706	)		204,419

Comprehensive income:
Net income									7,064									7,064
Net other comprehensive income (loss)												(641	)					(641	)
Purchase of treasury stock (727 shares)															(45	)		(45	)
Restricted stock, executive and Board of Director awards (1,234 shares)						(42	)								70			28
Cash dividends, $0.465 per share									(1,858	)								(1,858	)
Balance, September 30, 2021		4,388,901	$	4,389	$	78,370		$	140,920		$	969		$	(15,681	)	$	208,967

Balance, December 31, 2020		4,350,342		4,350		75,908			126,627			2,587			(15,213	)		194,259

Comprehensive income:
Net income									22,174									22,174
Net other comprehensive income (loss)												(1,618	)					(1,618	)
Stock dividend		38,559		39		2,313			(2,352	)								-
Purchase of treasury stock (15,483 shares)															(894	)		(894	)
Restricted stock, executive and Board of Director awards (6,653 shares)						(257	)								429			172
Restricted stock vesting						403												403
Forfeited restricted stock						3									(3	)		-
Cash dividends, $1.377 per share									(5,529	)								(5,529	)
Balance, September 30, 2021		4,388,901	$	4,389	$	78,370		$	140,920		$	969		$	(15,681	)	$	208,967

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

Index

CITIZENS FINANCIAL SERVICES, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

	Nine Months Ended September 30,
(in thousands)	2022			2021
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	21,185		$	22,174
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		1,425			1,550
Depreciation and amortization		773			840
Amortization and accretion of loans and other assets		(1,386	)		(3,376	)
Amortization and accretion of investment securities		1,467			1,637
Deferred income taxes		86			964
Investment and equity securities losses (gains), net		204			(500	)
Earnings on bank owned life insurance		(635	)		(1,643	)
Vesting of restricted stock		158			403
Originations of loans held for sale		(9,447	)		(35,458	)
Proceeds from sales of loans held for sale		12,864			47,648
Realized gains on loans sold		(241	)		(1,109	)
(Increase) decrease in accrued interest receivable		(1,309	)		767
(Gain) loss on sale of foreclosed assets held for sale		(481	)		25
Increase (decrease) in accrued interest payable		211			(194	)
Other, net		(536	)		(1,350	)
Net cash provided by operating activities		24,338			32,378
CASH FLOWS FROM INVESTING ACTIVITIES:
Available-for-sale securities:
Proceeds from sales		4,492			29,198
Proceeds from maturity and principal repayments		28,553			40,734
Purchase of securities		(117,913	)		(177,000	)
Purchase of equity securities		(218	)		-
Proceeds from sale of equity securities		33			-
Purchase of interest bearing time deposits with other banks		(3,720	)		-
Proceeds from sale of interest bearing time deposits with other banks		2,733			-
Proceeds from matured interest bearing time deposits with other banks		5,954			2,484
Proceeds from life insurance		-			3,714
Proceeds from redemption of regulatory stock		3,811			3,957
Purchase of regulatory stock		(12,081	)		(2,896	)
Net increase in loans		(295,059	)		(34,401	)
Purchase of premises and equipment		(1,150	)		(1,043	)
Investments in low income housing partnerships		(949	)		-
Proceeds from sale of foreclosed assets held for sale		845			1,095
Net cash used in investing activities		(384,669	)		(134,158	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits		32,559			152,111
Proceeds from long-term borrowings		-			9,869
Repayments of long-term borrowings		(4,725	)		(21,800	)
Net (decrease) increase in short-term borrowed funds		189,661			1,287
Purchase of treasury and restricted stock		(1,279	)		(894	)
Sale of treasury stock to employees		112			-
Dividends paid		(5,682	)		(5,529	)
Net cash provided by financing activities		210,646			135,044
Net (decrease) increase in cash and cash equivalents		(149,685	)		33,264
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		172,833			68,707
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	23,148		$	101,971

Supplemental Disclosures of Cash Flow Information:
Interest paid	$	5,957		$	5,663
Income taxes paid	$	4,600		$	4,000
Loans transferred to foreclosed property	$	61		$	552
Right of use asset and liability	$	1,518		$	487
Stock Dividend	$	2,560		$	2,352

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

Index

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 and its wholly owned subsidiary is CZFS Acquisition Company, LLC. CZFS Acquisition Company, LLC is the holding company of its wholly owned subsidiary, First Citizens Community Bank (the “Bank”), and of the Bank’s wholly owned subsidiaries, First Citizens Insurance Agency, Inc. (“First Citizens Insurance”) and 1^st Realty of PA LLC (“Realty”).

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 consolidated financial statements at September 30, 2022 and for the periods ended September 30, 2022 and 2021 include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the financial condition and the results of operations at the dates and for the periods presented. 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 of revenues and expenses for the periods covered by the Consolidated Statement of Income. The financial performance reported for the Company for the three and nine month periods ended September 30, 2022 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, 2021, as amended.

Note 2 – Revenue Recognition

In accordance with ASC 606, Management determined that the primary sources of revenue emanating from interest and dividend income on loans and investments along with noninterest revenue resulting from investment security gains, loan servicing, gains on loans sold and earnings on bank owned life insurances are not within the scope of ASC 606. The main types of noninterest income within the scope of the standard are as follows:

•

Service charges on deposit accounts – The Company has contracts with its deposit customers where fees are charged if certain parameters are not met. These agreements can be cancelled at any time by either the Company or the deposit customer. Revenue from these transactions is recognized on a monthly basis as the Company has an unconditional right to the fee consideration. The Company also has transaction fees related to specific transactions or activities resulting from a customer request or activity that include overdraft fees, online banking fees, interchange fees, ATM fees and other transaction fees. All of these fees are attributable to specific performance obligations of the Company where the revenue is recognized at a defined point in time upon the completion of the requested service/transaction.

Index

•

Trust fees – Typical contracts for trust services are based on a fixed percentage of the assets earned ratably over a defined period and billed on a monthly basis. Fees charged to customers’ accounts are recognized as revenue over the period during which the Company fulfills its performance obligation under the contract (i.e., holding client asset in a managed fiduciary trust account). For these accounts, the performance obligation of the Company is typically satisfied by holding and managing the customer’s assets over time. Other fees related to specific customer requests are attributable to specific performance obligations of the Company where the revenue is recognized at a defined point in time, upon completion of the requested service/transaction.

•

Gains and losses on sale of other real estate owned – Gains and losses are recognized at the completion of the property sale when the buyer obtains control of the real estate and all of the performance obligations of the Company have been satisfied. Evidence of the buyer obtaining control of the asset include transfer of the property title, physical possession of the asset, and the buyer obtaining control of the risks and rewards related to the asset. In situations where the Company agrees to provide financing to facilitate the sale, additional analysis is performed to ensure that the contract for sale identifies the buyer and seller, the asset to be transferred, payment terms, and that the contract has a true commercial substance and that collection of amounts due from the buyer are reasonable. In situations where financing terms are not reflective of current market terms, the transaction price is discounted impacting the gain/loss and the carrying value of the asset.

•

Brokerage and insurance – Fees includes commissions from the sales of investments and insurance products recognized on a trade date basis as the performance obligation is satisfied at the point in time in which the trade is processed. Additional fees are based on a percentage of the market value of customer accounts and billed on a monthly or quarterly basis. The Company’s performance obligation under the contracts with certain customers is generally satisfied through the passage of time as the Company monitors and manages the assets in the customer’s portfolio and is not dependent on certain return or performance level of the customer’s portfolio. Fees for these services are billed monthly and are recorded as revenue at the end of the month for which the wealth management service has been performed. Other performance obligations (such as the delivery of account statements to customers) are generally considered immaterial to the overall transaction price.

The following table depicts the disaggregation of revenue derived from contracts with customers to depict the nature, amount, timing, and uncertainty of revenue and cash flows for the three and nine months ended September 30, 2022 and 2021 (in thousands). All revenue in the table below relates to goods and services transferred at a point in time.

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
Revenue stream	2022		2021		2022		2021
Service charges on deposit accounts
Overdraft fees	$	374	$	302	$	993	$	807
Statement fees		51		57		158		169
Interchange revenue		953		691		2,495		2,034
ATM income		39		100		194		299
Other service charges		92		60		241		170
Total Service Charges		1,509		1,210		4,081		3,479
Trust		187		182		620		674
Brokerage and insurance		446		408		1,428		1,190
Other		125		139		387		367
Total	$	2,267	$	1,939	$	6,516	$	5,710

Index

Note 3 – Earnings per Share

The following table sets forth the computation of earnings per share.

	Three months ended September 30,				Nine months ended September 30,
	2022		2021		2022		2021
Net income applicable to common stock	$	7,544,000	$	7,064,000	$	21,185,000	$	22,174,000

Basic earnings per share computation
Weighted average common shares outstanding		3,967,585		3,988,294		3,970,646		3,984,748
Earnings per share - basic	$	1.90	$	1.77	$	5.34	$	5.56

Diluted earnings per share computation
Weighted average common shares outstanding for basic earnings per share		3,967,585		3,988,294		3,970,646		3,984,748
Add: Dilutive effects of restricted stock		234		95		2		7
Weighted average common shares outstanding for dilutive earnings per share		3,967,819		3,988,389		3,970,648		3,984,755
Earnings per share - diluted	$	1.90	$	1.77	$	5.34	$	5.56

For the three months ended September 30, 2022 and 2021, there were 356 and 4,977 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 per share prices ranging from $57.36-$74.27 for the three month period ended September 30, 2022 and per share prices ranging from $57.39-$63.19 for the three month period ended September 30, 2021. For the nine months ended September 30, 2022 and 2021, 5,811 and 6,000 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 $44.93-$74.27 for the nine month period ended September 30, 2022 and prices ranging from $51.14-$63.19 for the nine month period ended September 30, 2021.

Note 4 – Investments

The amortized cost, gross unrealized gains and losses, and fair value of investment securities at September 30, 2022 and December 31, 2021 were as follows (in thousands):

September 30, 2022	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available-for-sale securities:
U.S. agency securities	$	81,546	$	-	$	(7,564	)	$	73,982
U.S. treasury securities		162,172		-		(14,328	)		147,844
Obligations of state and political subdivisions		123,230		10		(12,790	)		110,450
Corporate obligations		10,346		-		(908	)		9,438
Mortgage-backed securities in government sponsored entities		118,118		19		(14,629	)		103,508
Total available-for-sale securities	$	495,412	$	29	$	(50,219	)	$	445,222

December 31, 2021
Available-for-sale securities:
U.S. agency securities	$	73,803	$	976	$	(834	)	$	73,945
U.S. treasury securities		116,743		63		(1,459	)		115,347
Obligations of state and political subdivisions		109,367		2,706		(52	)		112,021
Corporate obligations		10,378		39		(84	)		10,333
Mortgage-backed securities in government sponsored entities		101,727		597		(1,568	)		100,756
Total available-for-sale securities	$	412,018	$	4,381	$	(3,997	)	$	412,402

Index

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 September 30, 2022 and December 31, 2021 (in thousands). As of September 30, 2022, the Company owned 343 securities whose fair value was less than their cost basis.

September 30, 2022	Less than Twelve Months					Twelve Months or Greater					Total
	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
U.S. agency securities	$	48,992	$	(2,443	)	$	24,990	$	(5,121	)	$	73,982	$	(7,564	)
U.S. treasury securities		65,232		(3,667	)		82,612		(10,661	)		147,844		(14,328	)
Obligations of state and political subdivisions		94,880		(11,086	)		8,892		(1,704	)		103,772		(12,790	)
Corporate obligations		4,474		(372	)		3,964		(536	)		8,438		(908	)
Mortgage-backed securities in government sponsored entities		43,787		(4,476	)		50,030		(10,153	)		93,817		(14,629	)
Total securities	$	257,365	$	(22,044	)	$	170,488	$	(28,175	)	$	427,853	$	(50,219	)

December 31, 2021
U.S. agency securities	$	26,754	$	(387	)	$	7,542	$	(447	)	$	34,296	$	(834	)
U.S. treasury securities		106,794		(1,459	)		-		-			106,794		(1,459	)
Obligations of states and political subdivisions		10,744		(26	)		2,899		(26	)		13,643		(52	)
Corporate obligations		6,922		(84	)		-		-			6,922		(84	)
Mortgage-backed securities in government sponsored entities		60,182		(1,305	)		7,975		(263	)		68,157		(1,568	)
Total securities	$	211,396	$	(3,261	)	$	18,416	$	(736	)	$	229,812	$	(3,997	)

As of September 30, 2022 and December 31, 2021, the Company’s investment securities portfolio contained unrealized losses on U.S. Treasuries, 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, corporate obligations and mortgage backed securities in government sponsored entities. 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 fair 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. 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 market 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.

Index

Proceeds from sales of securities available-for-sale for the nine months ended September 30, 2022 and 2021 were $4,492,000 and $29,198,000, respectively. Proceeds from sales of securities available-for-sale for the three months ended September 30, 2022 and 2021 were $4,492,000 and $24,153,000, respectively. The gross gains and losses were as follows (in thousands):

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2022			2021			2022			2021
Gross gains on available for sale securities	$	-		$	252		$	-		$	302
Gross losses on available for sale securities		(6	)		(90	)		(6	)		(90	)
Net gains	$	(6	)	$	162		$	(6	)	$	212

The following table presents the net gains (losses) on the Company’s equity investments recognized in earnings during the three and nine month periods ended September 30, 2022 and 2021, and the portion of unrealized gains for the period that relates to equity investments held at September 30, 2022 and 2021 (in thousands):

	Three Months Ended September 30,					Nine Months Ended September 30,
Equity securities	2022			2021		2022			2021
Net (losses) gains recognized in equity securities during the period	$	(19	)	$	72	$	(198	)	$	288
Less: Net gains realized on the sale of equity securities during the period		4			-		4			-
Net unrealized (losses) gains	$	(23	)	$	72	$	(202	)	$	288

Investment securities with an approximate carrying value of $302.2 million and $295.0 million at September 30, 2022 and December 31, 2021, respectively, were pledged to secure public funds, certain other deposits and borrowing lines.

Actual maturities may 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 (excludes equity securities) at September 30, 2022, by contractual maturity, are shown below (in thousands):

	Amortized Cost		Fair Value
Available-for-sale debt securities:
Due in one year or less	$	14,108	$	13,996
Due after one year through five years		199,749		184,858
Due after five years through ten years		110,505		97,613
Due after ten years		171,050		148,755
Total	$	495,412	$	445,222

Note 5 – Loans

The Company grants commercial, industrial, agricultural, residential, and consumer loans primarily to customers throughout north central, central and south central Pennsylvania, southern New York and Wilmington and Dover, Delaware. Although the Company had a diversified loan portfolio at September 30, 2022 and December 31, 2021, 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 September 30, 2022 and December 31, 2021 (in thousands):

September 30, 2022	Total Loans		Individually evaluated for impairment		Loans acquired with deteriorated credit quality		Collectively evaluated for impairment
Real estate loans:
Residential	$	203,673	$	344	$	9	$	203,320
Commercial		857,314		5,736		1,902		849,676
Agricultural		317,761		5,174		1,523		311,064
Construction		79,154		-		-		79,154
Consumer		124,375		4		-		124,371
Other commercial loans		66,241		135		-		66,106
Other agricultural loans		29,509		801		-		28,708
State and political subdivision loans		59,926		-		-		59,926
Total		1,737,953		12,194		3,434		1,722,325
Allowance for loan losses		18,291		107		-		18,184
Net loans	$	1,719,662	$	12,087	$	3,434	$	1,704,141

Index

December 31, 2021	Total Loans		Individually evaluated for impairment		Loans acquired with deteriorated credit quality		Collectively evaluated for impairment
Real estate loans:
Residential	$	201,097	$	620	$	14	$	200,463
Commercial		687,338		8,381		2,145		676,812
Agricultural		312,011		5,355		1,643		305,013
Construction		55,036		-		-		55,036
Consumer		25,858		-		-		25,858
Other commercial loans		74,585		186		-		74,399
Other agricultural loans		39,852		991		-		38,861
State and political subdivision loans		45,756		-		-		45,756
Total		1,441,533		15,533		3,802		1,422,198
Allowance for loan losses		17,304		121		-		17,183
Net loans	$	1,424,229	$	15,412	$	3,802	$	1,405,015

During 2022 the Company continued its participation in the Paycheck Protection Program (“PPP”), administered directly by the U.S. Small Business Administration (the “SBA”) through the processing of forgiveness of PPP loans. During 2021, the Company originated $24.3 million of PPP loans. There were no outstanding principal balances of PPA loans as of September 30, 2022. As of December 31, 2021, the Company had outstanding principal balances of $6.8 million of PPP loans that were included in other commercial loans. As of September 30, 2022, all PPP loans had either been forgiven or repaid. The PPP loans were fully guaranteed by the SBA and were eligible for forgiveness by the SBA to the extent that the proceeds are used to cover eligible payroll costs, interest costs, rent, and utility costs over a period of up to 24 weeks after the loan was made as long as certain conditions were met regarding employee retention and compensation levels. PPP loans deemed eligible for forgiveness by the SBA were repaid by the SBA to the Company. The SBA issued guidance for forgiveness with a streamlined approach for loans of $150,000 or less.

The Company evaluated whether loans acquired as part of the MidCoast acquisition were within the scope of ASC 310-30, Receivables-Loans and Debt Securities Acquired with Deteriorated Credit Quality. Purchased credit-impaired (“PCI”) 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. One loan was upgraded and cashflows for the loan were expected to increase during the quarter. For the other loans, there were no material increases or decreases in the expected cash flows of these loans between April 17, 2020 (the “acquisition date”) and September 30, 2022. The fair value of PCI 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 as a result of the MidCoast acquisition was $3,171,000 at September 30, 2022.

Changes in the accretable yield for PCI loans were as follows for the three and nine months ended September 30, 2022 and 2021 (in thousands):

	Three months ended September 30,						Nine months ended September 30,
	2022			2021			2022			2021
Balance at beginning of period	$	278		$	584		$	370		$	788
Acquisition of Midcoast		-			-			-			-
Reclassification of non-accretable discount		774			29			1,002			29
Accretion		(105	)		(135	)		(425	)		(339	)
Balance at end of period	$	947		$	478		$	947		$	478

Index

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

	September 30, 2022		December 31, 2021
Outstanding balance	$	6,207	$	6,159
Carrying amount		3,434		3,802

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, commercial or agricultural real estate used during the construction phase of residential, commercial or agricultural 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 other 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 to the allowance for loan losses or a charge-off to the allowance for loan losses.

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

September 30, 2022	Unpaid Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Total Recorded Investment		Related Allowance
Real estate loans:
Mortgages	$	430	$	248	$	41	$	289	$	5
Home Equity		73		40		15		55		1
Commercial		6,850		5,372		364		5,736		60
Agricultural		5,637		4,986		188		5,174		24
Consumer		4		-		4		4		4
Other commercial loans		798		62		73		135		13
Other agricultural loans		1,159		801		-		801		-
Total	$	14,951	$	11,509	$	685	$	12,194	$	107

December 31, 2021
Real estate loans:
Mortgages	$	697	$	495	$	45	$	540	$	6
Home Equity		97		37		43		80		6
Commercial		9,330		8,096		285		8,381		61
Agricultural		5,694		5,167		188		5,355		14
Other commercial loans		813		92		94		186		34
Other agricultural loans		1,274		991		-		991		-
Total	$	17,905	$	14,878	$	655	$	15,533	$	121

Index

The following tables includes the average balance of impaired loan receivables by class and the income recognized on these receivables for the three and nine month periods ended September 30, 2022 and 2021 (in thousands):

	For the Nine Months Ended
	September 30, 2022						September 30, 2021
	Average Recorded Investment		Interest Income Recognized		Interest Income Recognized Cash Basis		Average Recorded Investment		Interest Income Recognized		Interest Income Recognized Cash Basis
Real estate loans:
Mortgages	$	466	$	9	$	-	$	727	$	12	$	-
Home Equity		68		2		-		106		4		-
Commercial		6,372		141		6		8,902		211		23
Agricultural		5,253		90		-		4,513		64		-
Consumer		-		-		-		1		-		-
Other commercial loans		313		2		-		876		2		-
Other agricultural loans		886		3		-		1,069		3		-
Total	$	13,358	$	247	$	6	$	16,194	$	296	$	23

	For the Three Months Ended
	September 30, 2022						September 30, 2021
	Average Recorded Investment		Interest Income Recognized		Interest Income Recognized Cash Basis		Average Recorded Investment		Interest Income Recognized		Interest Income Recognized Cash Basis
Real estate loans:
Mortgages	$	321	$	4	$	-	$	613	$	4	$	-
Home Equity		50		1		-		84		1		-
Commercial		5,778		43		3		8,688		77		8
Agricultural		5,194		33		-		4,454		21		-
Consumer		1		-		-		-		-		-
Other commercial loans		157		1		-		486		-		-
Other agricultural loans		822		1		-		1,022		1		-
Total	$	12,323	$	83	$	3	$	15,347	$	104	$	8

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 and assess 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.

Index

•

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.

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, agricultural and state and political relationships over $500,000 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 50% of the dollar volume of the commercial, agricultural and municipal loan portfolios on an annual basis, 2) review a sample of new loans originated for over $1.0 million in the last year, 3) review a sample 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 September 30, 2022 and December 31, 2021 (in thousands):

September 30, 2022	Pass		Special Mention		Substandard		Doubtful		Loss		Ending Balance
Real estate loans:
Commercial	$	816,081	$	34,150	$	7,083	$	-	$	-	$	857,314
Agricultural		302,861		10,342		4,558		-		-		317,761
Construction		73,330		5,824		-		-		-		79,154
Other commercial loans		62,915		3,015		279		32		-		66,241
Other agricultural loans		27,820		1,304		385		-		-		29,509
State and political subdivision loans		59,926		-		-		-		-		59,926
Total	$	1,342,933	$	54,635	$	12,305	$	32	$	-	$	1,409,905

December 31, 2021
Real estate loans:
Commercial	$	646,137	$	35,332	$	5,869	$	-	$	-	$	687,338
Agricultural		291,537		15,105		5,369		-		-		312,011
Construction		55,036		-		-		-		-		55,036
Other commercial loans		70,932		3,289		316		48		-		74,585
Other agricultural loans		37,800		1,351		701		-		-		39,852
State and political subdivision loans		45,588		168		-		-		-		45,756
Total	$	1,147,030	$	55,245	$	12,255	$	48	$	-	$	1,214,578

Index

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 September 30, 2022 and December 31, 2021 (in thousands):

September 30, 2022	Performing		Non-performing		PCI		Total
Real estate loans:
Mortgages	$	155,163	$	570	$	9	$	155,742
Home Equity		47,902		29		-		47,931
Consumer		124,375		-		-		124,375
Total	$	327,440	$	599	$	9	$	328,048

December 31, 2021	Performing		Non-performing		PCI		Total
Real estate loans:
Mortgages	$	150,320	$	608	$	14	$	150,942
Home Equity		50,122		33		-		50,155
Consumer		25,858		-		-		25,858
Total	$	226,300	$	641	$	14	$	226,955

Aging Analysis of Past Due Loan 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 loan receivables as of September 30, 2022 and December 31, 2021 (in thousands):

September 30, 2022	30-59 Days Past Due		60-89 Days Past Due		90 Days Or Greater		Total Past Due		Current		PCI		Total Loans Receivables		90 Days or Greater and Accruing
Real estate loans:
Mortgages	$	1,495	$	77	$	229	$	1,801	$	153,932	$	9	$	155,742	$	21
Home Equity		71		-		29		100		47,831		-		47,931		-
Commercial		548		185		2,181		2,914		852,498		1,902		857,314		72
Agricultural		-		-		1,367		1,367		314,871		1,523		317,761		-
Construction		-		-		-		-		79,154		-		79,154		-
Consumer		98		10		-		108		124,267		-		124,375		-
Other commercial loans		107		-		62		169		66,072		-		66,241		-
Other agricultural loans		-		199		-		199		29,310		-		29,509		-
State and political subdivision loans		-		-		-		-		59,926		-		59,926		-
Total	$	2,319	$	471	$	3,868	$	6,658	$	1,727,861	$	3,434	$	1,737,953	$	93

Loans considered non-accrual	$	41	$	133	$	3,775	$	3,949	$	3,169	$	-	$	7,118
Loans still accruing		2,278		338		93		2,709		1,724,692		3,434		1,730,835
Total	$	2,319	$	471	$	3,868	$	6,658	$	1,727,861	$	3,434	$	1,737,953

Index

December 31, 2021	30-59 Days Past Due		60-89 Days Past Due		90 Days Or Greater		Total Past Due		Current		PCI		Total Loans Receivables		90 Days or Greater and Accruing
Real estate loans:
Mortgages	$	220	$	170	$	209	$	599	$	150,329	$	14	$	150,942	$	13
Home Equity		103		-		33		136		50,019		-		50,155		33
Commercial		127		115		1,969		2,211		682,982		2,145		687,338		-
Agricultural		31		-		1,367		1,398		308,970		1,643		312,011		-
Construction		-		-		-		-		55,036		-		55,036		-
Consumer		163		1		-		164		25,694		-		25,858		-
Other commercial loans		17		10		92		119		74,466		-		74,585		-
Other agricultural loans		10		-		-		10		39,842		-		39,852		-
State and political subdivision loans		-		-		-		-		45,756		-		45,756		-
Total	$	671	$	296	$	3,670	$	4,637	$	1,433,094	$	3,802	$	1,441,533	$	46

Loans considered non-accrual	$	-	$	-	$	3,624	$	3,624	$	3,992	$	-	$	7,616
Loans still accruing		671		296		46		1,013		1,429,102		3,802		1,433,917
Total	$	671	$	296	$	3,670	$	4,637	$	1,433,094	$	3,802	$	1,441,533

Nonaccrual Loans

Loans are considered for non-accrual status upon reaching 90 days delinquency, although the Company may be receiving partial payments of interest and partial repayments of principal on such loans, or if full payment of principal and interest is not expected. Additionally, if management is made aware of other information including bankruptcy, repossession, death, or legal proceedings, the loan may be placed on non-accrual status. If a loan is 90 days or more past due and is well secured and in the process of collection, it may still be considered accruing.

The following table reflects the loan receivables, excluding PCI loans, on non-accrual status as of September 30, 2022 and December 31, 2021, respectively. The balances are presented by class of loan receivable (in thousands):

	September 30, 2022		December 31, 2021
Real estate loans:
Mortgages	$	549	$	595
Home Equity		29		-
Commercial		2,833		2,945
Agricultural		3,295		3,133
Other commercial loans		94		140
Other agricultural loans		318		803
	$	7,118	$	7,616

Index

Troubled Debt Restructurings

In situations where, for economic or legal reasons related to a borrower's financial difficulties, management may grant a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the related loan is classified as a Troubled Debt Restructuring (TDR). Management strives to identify borrowers in financial difficulty early and work with them to structure more affordable terms before their loan reaches nonaccrual status. These restructured terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where borrowers are granted new terms that provide for a reduction of interest or principal, or both, management measures any impairment on the restructuring by calculating the present value of the revised loan terms and comparing this balance to the Company’s investment in the loan prior to the restructuring. As these loans are individually evaluated, they are excluded from pooled portfolios when calculating the allowance for loan and lease losses and a separate allocation within the allowance for loan and lease losses is provided. Management continually evaluates loans that are considered TDRs, including payment history under the modified loan terms, the borrower’s ability to continue to repay the loan based on continued evaluation of their operating results and cash flows from operations. As of September 30, 2022 and December 31, 2021, included within the allowance for loan losses are reserves of $16,000 and $26,000 respectively, that are associated with loans modified as TDRs.

Loan modifications that are considered TDRs completed during the three and nine months ended September 30, 2022 and the nine months ended September 30, 2021 were as follows (dollars in thousands). There were no loan modifications that were considered TDRs during the three months ended September 30, 2021.

	For the Three Months Ended September 30, 2022
	Number of contracts				Pre-modification Outstanding Recorded Investment						Post-Modification Outstanding Recorded Investment
	Interest Modification		Term Modification		Interest Modification			Term Modification			Interest Modification			Term Modification
Real estate loans:
Home Equity		-		1		$	-		$	8		$	-		$	8
Agricultural		-		2			-			1,137			-			1,137
Total		-		3		$	-		$	1,145		$	-		$	1,145

	For the Nine Months Ended September 30, 2022
	Number of contracts				Pre-modification Outstanding Recorded Investment						Post-Modification Outstanding Recorded Investment
	Interest Modification		Term Modification		Interest Modification			Term Modification			Interest Modification			Term Modification
Real estate loans:
Home Equity		-		1		$	-		$	8		$	-		$	8
Commercial		-		3			-			1,430			-			1,430
Agricultural		-		2			-			1,137			-			1,137
Total		-		6		$	-		$	2,575		$	-		$	2,575

	For the Nine Months Ended September 30, 2021
	Number of contracts				Pre-modification Outstanding Recorded Investment				Post-Modification Outstanding Recorded Investment
	Interest Modification		Term Modification		Interest Modification		Term Modification		Interest Modification		Term Modification
Real estate loans:
Commercial		-		3		-		1,407		-		1,407
Total		-		3	$	-	$	1,407	$	-	$	1,407

Recidivism, or the borrower defaulting on its obligation pursuant to a modified loan, results in the loan once again becoming a non-accrual loan. Recidivism on modified loans occurs at a notably higher rate than do defaults on new origination loans, so modified loans present a higher risk of loss than do new origination loans.

Index

Allowance for Loan Losses

The following table segregates the allowance for loan losses (ALLL) into the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of September 30, 2022 and December 31, 2021, respectively (in thousands):

	September 30, 2022								December 31, 2021
	Individually evaluated for impairment		Collectively evaluated for impairment			Total			Individually evaluated for impairment		Collectively evaluated for impairment		Total
Real estate loans:
Residential	$	6	$	999		$	1,005		$	12	$	1,135	$	1,147
Commercial		60		9,877			9,937			61		8,038		8,099
Agricultural		24		4,514			4,538			14		4,715		4,729
Construction		-		678			678			-		434		434
Consumer		4		228			232			-		262		262
Other commercial loans		13		380			393			34		989		1,023
Other agricultural loans		-		1,359			1,359			-		558		558
State and political subdivision loans		-		325			325			-		281		281
Unallocated		-		(176	)		(176	)		-		771		771
Total	$	107	$	18,184		$	18,291		$	121	$	17,183	$	17,304

The following tables roll forward the balance of the ALLL by portfolio segment for the three and nine months ended September 30, 2022 and 2021, respectively (in thousands):

	For the three months ended September 30, 2022
	Balance at June 30, 2022			Charge-offs			Recoveries		Provision			Balance at September 30, 2022			Individually evaluated for impairment		Collectively evaluated for impairment
Real estate loans:
Residential	$	1,015		$	-		$	-	$	(10	)	$	1,005		$	6	$	999
Commercial		9,216			-			-		721			9,937			60		9,877
Agricultural		4,484			-			-		54			4,538			24		4,514
Construction		563			-			-		115			678			-		678
Consumer		464			(13	)		5		(224	)		232			4		228
Other commercial loans		1,173			-			4		(784	)		393			13		380
Other agricultural loans		446			-			-		913			1,359			-		1,359
State and political subdivision loans		323			-			-		2			325			-		325
Unallocated		(114	)		-			-		(62	)		(176	)		-		(176	)
Total	$	17,570		$	(13	)	$	9	$	725		$	18,291		$	107	$	18,184

	For the three months ended September 30, 2021
	Balance at June 30, 2021		Charge-offs			Recoveries		Provision			Balance at September 30, 2021		Individually evaluated for impairment		Collectively evaluated for impairment
Real estate loans:
Residential	$	1,174	$	-		$	-	$	16		$	1,190	$	16	$	1,174
Commercial		7,106		-			-		572			7,678		97		7,581
Agricultural		4,706		-			-		40			4,746		12		4,734
Construction		496		-			-		42			538		-		538
Consumer		85		(7	)		4		236			318		-		318
Other commercial loans		1,328		-			6		(203	)		1,131		35		1,096
Other agricultural loans		583		-			-		(135	)		448		109		339
State and political subdivision loans		404		-			-		(108	)		296		-		296
Unallocated		1,049		-			-		(60	)		989		-		989
Total	$	16,931	$	(7	)	$	10	$	400		$	17,334	$	269	$	17,065

Index

	For the nine months ended September 30, 2022
	Balance at December 31, 2021		Charge-offs			Recoveries		Provision			Balance at September 30, 2022			Individually evaluated for impairment		Collectively evaluated for impairment
Real estate loans:
Residential	$	1,147	$	-		$	-	$	(142	)	$	1,005		$	6	$	999
Commercial		8,099		-			-		1,838			9,937			60		9,877
Agricultural		4,729		-			-		(191	)		4,538			24		4,514
Construction		434		-			-		244			678			-		678
Consumer		262		(30	)		15		(15	)		232			4		228
Other commercial loans		1,023		(434	)		11		(207	)		393			13		380
Other agricultural loans		558		-			-		801			1,359			-		1,359
State and political subdivision loans		281		-			-		44			325			-		325
Unallocated		771		-			-		(947	)		(176	)		-		(176	)
Total	$	17,304	$	(464	)	$	26	$	1,425		$	18,291		$	107	$	18,184

	For the nine months ended September 30, 2021
	Balance at December 31, 2020		Charge-offs			Recoveries		Provision			Balance at September 30, 2021		Individually evaluated for impairment		Collectively evaluated for impairment
Real estate loans:
Residential	$	1,174	$	-		$	-	$	16		$	1,190	$	16	$	1,174
Commercial		6,216		-			89		1,373			7,678		97		7,581
Agricultural		4,953		-			-		(207	)		4,746		12		4,734
Construction		122		-			-		416			538		-		538
Consumer		321		(16	)		16		(3	)		318		-		318
Other commercial loans		1,226		(133	)		13		25			1,131		35		1,096
Other agricultural loans		864		-			-		(416	)		448		109		339
State and political subdivision loans		479		-			-		(183	)		296		-		296
Unallocated		460		-			-		529			989		-		989
Total	$	15,815	$	(149	)	$	118	$	1,550		$	17,334	$	269	$	17,065

The Company allocates the ALLL based on the factors described below, which conform to the Company’s loan classification policy and credit quality measurements. In reviewing risk within the Company’s loan portfolio, management has determined there to be several different risk categories within the loan portfolio. The ALLL consists of amounts applicable to: (i) residential real estate loans; (ii) residential real estate home equity loans; (iii) commercial real estate loans; (iv) agricultural real estate loans; (v) real estate construction loans; (vi) other commercial and agricultural loans; (vii) consumer loans; (viii) other agricultural loans and (ix) state and political subdivision loans. Factors considered in this process include general loan terms, collateral, and availability of historical data to support the analysis. Historical loss percentages are calculated and used as the basis for calculating allowance allocations. Certain qualitative factors are evaluated to determine additional inherent risks in the loan portfolio, which are not necessarily reflected in the historical loss percentages. These factors are then added to the historical allocation percentage to get the adjusted factor to be applied to non-classified loans. The following qualitative factors are analyzed:

•

Level of and trends in delinquencies and impaired/classified loans

▪

Change in volume and severity of past due loans

▪

Volume and severity of non-accrual loans

▪

Volume and severity of classified, adversely or graded loans;

•

Level of and trends in charge-offs and recoveries;

Index

•

Trends in volume, terms and nature of the loan portfolio;

•

Effects of any changes in risk selection and underwriting standards and any other changes in lending and recovery policies, procedures and practices;

•

Changes in the quality of the Company’s loan review system;

•

Experience, ability and depth of lending management and other relevant staff;

•

National, state, regional and local economic trends and business conditions

▪

General economic conditions

▪

Unemployment rates

▪

Inflation rate/ Consumer Price Index

▪

Changes in values of underlying collateral for collateral-dependent loans;

•

Industry conditions including the effects of external factors such as competition, legal, and regulatory requirements on the level of estimated credit losses;

•

Existence and effect of any credit concentrations, and changes in the level of such concentrations; and

•

Any change in the level of board oversight.

The Company analyzes its loan portfolio at least each quarter to determine the adequacy of its ALLL.

Loans determined to be TDRs are impaired and for purposes of estimating the ALLL must be individually evaluated for impairment. In calculating the impairment, the Company calculates the present value utilizing an analysis of discounted cash flows. If the present value calculated is below the recorded investment of the loan, impairment is recognized by a charge to the provision for loan and lease losses and a credit to the ALLL.

For the three months ended September 30, 2022, the qualitative factors for levels and trends in delinquency, levels and trends in charge-offs and recoveries and general economic conditions and unemployment were reduced for consumer loans due to the significant change in the composition of the consumer loan portfolio. Due to this composition change, the qualitative factor the nature of the portfolio was increased. The provision for commercial real estate and construction loans was driven by loan growth in these pools. The provision for other commercial loans was driven by an increase in the historical loss factor due to losses in 2022. The negative provision for other agricultural loans was due to a decrease in the loan balances during 2022.

For the nine months ended September 30, 2022, the qualitative factors for general economic conditions and unemployment were reduced for all loan categories due to a return to a more normalized activity level since the Covid-19 pandemic began during which the factors were increased. The change in these factors explains the negative provision for residential and agricultural real estate loans. The qualitative factors for levels and trends in delinquency, levels and trends in charge-offs and recoveries and general economic conditions and unemployment were reduced for consumer loans due to the significant change in the composition of the consumer loan portfolio. Due to this composition change, the qualitative factor the nature of the portfolio was increased. The provision for commercial real estate, construction, and state and political loans was driven by loan growth in these pools. The provision for other commercial loans was driven by an increase in the historical loss factor due to losses in 2022. The negative provision for other agricultural loans was due to a decrease in the loan balances during 2022.

For the three months ended September 30, 2021, the allowance for commercial real estate loans increased due to loans acquired as part of the MidCoast acquisition maturing and then renewed and becoming subject to the Company’s allowance calculation. The factor related to volume and severity of past due loans was decreased for other commercial loans due to a decrease in past due loans. The factor related to the volume and severity of classified, adversely or graded loans was decreased for state and political loans due to a decrease in classified loans.

For the nine months ended September 30, 2021, the allowance for commercial real estate loans and other commercial loans increased due to loans acquired as part of the MidCoast acquisition maturing and then renewed and becoming subject to the Company’s allowance calculation. The factor related to level of past due loans for residential real estate loans and other commercial loans was decreased due to a decrease in past due loans. The factor related to volume of non-accrual loans was decreased for commercial real estate loans due to a decrease in the volume of non-accrual loans. The factor related to the volume and severity of classified, adversely or graded loans was decreased for agricultural real estate, other agricultural and state and political loans due to a decrease in classified loans. The factors for trends in volume, terms and nature of the portfolio, experience and depth of lending management and relevant staff, and changes in value of underlying value of collateral were increased for the construction loan portfolio due to the increase in the overall size of the portfolio, the increase in the size of individual construction loans and the complexity of the construction projects funded.

Index

Foreclosed Assets Held For Sale

Foreclosed assets acquired in settlement of loans are carried at fair value, less estimated costs to sell, and are included in other assets on the Consolidated Balance Sheet. As of September 30, 2022 and December 31, 2021, included within other assets are $877,000 and $1,180,000, respectively, of foreclosed assets. As of September 30, 2022, included within the foreclosed assets are $316,000 of consumer residential mortgages that were foreclosed on or received via a deed in lieu transaction prior to the period end. As of September 30, 2022, the Company had initiated formal foreclosure proceedings on $185,000 of consumer residential mortgages, which had not yet been transferred into foreclosed assets. In accordance with various state regulations, foreclosure actions have been suspended into the fourth quarter.

Note 6 – Goodwill and Other Intangible Assets

The following table provides the gross carrying value and accumulated amortization of intangible assets as of September 30, 2022 and December 31, 2021 (in thousands):

	September 30, 2022							December 31, 2021
	Gross carrying value		Accumulated amortization			Net carrying value		Gross carrying value		Accumulated amortization			Net carrying value
Amortized intangible assets (1):
MSRs	$	2,597	$	(1,560	)	$	1,037	$	2,499	$	(1,326	)	$	1,173
Core deposit intangibles		1,943		(1,609	)		334		1,943		(1,489	)		454
Total amortized intangible assets	$	4,540	$	(3,169	)	$	1,371	$	4,442	$	(2,815	)	$	1,627
Unamortized intangible assets:
Goodwill	$	31,376						$	31,376

(1) Excludes fully amortized intangible assets

The following table provides the current year and estimated future amortization expense for amortized intangible assets for the next five years (in thousands). We based our projections of amortization expense shown below on existing asset balances at September 30, 2022. Future amortization expense may vary from these projections:

	MSRs		Core deposit intangibles		Total
Three months ended September 30, 2022 (actual)	$	74	$	40	$	114
Nine months ended September 30, 2022 (actual)		234		120		354
Three months ended September 30, 2021 (actual)		65		49		114
Nine months ended September 30, 2021 (actual)		204		147		351
Estimate for year ending December 31,
Remaining 2022		76		36		112
2023		265		121		386
2024		209		86		295
2025		161		50		211
2026		119		17		136
Thereafter		207		24		231
Total	$	1,037	$	334	$	1,371

Note 7 – Employee Benefit Plans

For additional detailed disclosure on the Company's pension and employee benefits plans, please refer to Note 11 of the Company's Consolidated Financial Statements included in the 2021 Annual Report on Form 10-K.

Index

Noncontributory Defined Benefit Pension Plan

The Bank sponsors a trusteed noncontributory defined benefit pension plan (“Pension Plan”) covering substantially all employees and officers hired prior to January 1, 2007. The Bank’s funding policy is to make annual contributions, if needed, based upon the funding formula developed by the plan’s actuary. Any employee with a hire date of January 1, 2007 or later is not eligible to participate in the Pension Plan.

In lieu of the Pension Plan, employees with a hire date of January 1, 2007 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.

For employees who are eligible to participate in the Pension Plan, the 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 and the line item on the Consolidated Statement of Income where such amounts are included, for the three and nine months ended September 30, 2022 and 2021, respectively (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2022			2021			2022			2021			Affected line item on the Consolidated Statement of Income
Service cost	$	89		$	78		$	267		$	303		Salary and Employee Benefits
Interest cost		69			55			207			215		Other Expenses
Expected return on plan assets		(234	)		(208	)		(701	)		(712	)	Other Expenses
Partial Settlement		144			-			144			-		Other Expenses
Net amortization and deferral		24			94			72			267		Other Expenses
Net periodic benefit cost	$	92		$	19		$	(11	)	$	73

The Bank does not expect to contribute to the Pension Plan during 2022.

Restricted Stock Plan

The Company maintains a Restricted Stock Plan (the “Plan”) whereby 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. In April of 2016, the Company’s stockholders authorized a total of 150,000 shares of the Company’s common stock to be made available under the Plan. As of September 30, 2022, 116,129 shares remain available to be issued under the Plan. 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.

The following table details the vesting, awarding and forfeiting of restricted stock during the three and nine months ended September 30, 2022:

	Three months						Nine months
	Unvested Shares			Weighted Average Market Price			Unvested Shares			Weighted Average Market Price
Outstanding, beginning of period		6,968		$	61.99			6,954		$	58.51
Granted		769			71.89			3,262			68.68
Forfeited		(120	)		(63.86	)		(160	)		(62.40	)
Vested		(265	)		(63.12	)		(2,704	)		(58.46	)
Outstanding, end of period		7,352		$	62.95			7,352		$	62.95

Compensation expense 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 $210,000 and $239,000 for the nine months ended September 30, 2022 and 2021, respectively. For the three months ended September 30, 2022 and 2021, compensation expense totaled $68,000 and $79,000, respectively. At September 30, 2022, the total compensation cost related to nonvested awards that had not yet been recognized was $463,000, which is expected to be recognized over the next three years.

Index

Note 8 – Accumulated Comprehensive (Loss) Income

The following tables present the changes in accumulated other comprehensive income by component, net of tax, for the three and nine months ended September 30, 2022 and 2021 (in thousands):

	Nine months ended September 30, 2022
	Unrealized gain (loss) on available for sale securities (a)			Defined Benefit Pension Items (a)			Unrealized loss on interest rate swap (a)		Total
Balance as of December 31, 2021	$	304		$	(1,968	)	$	1,509	$	(155	)
Other comprehensive (loss) income before reclassifications (net of tax)		(39,959	)		-			4,185		(35,774	)
Amounts reclassified from accumulated other comprehensive loss (net of tax)		5			57			12		74
Net current period other comprehensive (loss) income		(39,954	)		57			4,197		(35,700	)
Balance as of September 30, 2022	$	(39,650	)	$	(1,911	)	$	5,706	$	(35,855	)

	Nine months ended September 30, 2021
	Unrealized gain (loss) on available for sale securities (a)			Defined Benefit Pension Items (a)			Unrealized loss on interest rate swap (a)			Total
Balance as of December 31, 2020	$	6,058		$	(3,462	)	$	(9	)	$	2,587
Other comprehensive (loss) income before reclassifications (net of tax)		(2,827	)		-			1,091			(1,736	)
Amounts reclassified from accumulated other comprehensive income (net of tax)		(167	)		201			84			118
Net current period other comprehensive (loss) income		(2,994	)		201			1,175			(1,618	)
Balance as of September 30, 2021	$	3,064		$	(3,261	)	$	1,166		$	969

	Three months ended September 30, 2022
	Unrealized gain (loss) on available for sale securities (a)			Defined Benefit Pension Items (a)			Unrealized loss on interest rate swap (a)			Total
Balance as of June 30, 2022	$	(28,928	)	$	(1,930	)	$	4,299		$	(26,559	)
Other comprehensive (loss) income before reclassifications (net of tax)		(10,727	)		-			1,444			(9,283	)
Amounts reclassified from accumulated other comprehensive loss (net of tax)		5			19			(37	)		(13	)
Net current period other comprehensive (loss) income		(10,722	)		19			1,407			(9,296	)
Balance as of September 30, 2022	$	(39,650	)	$	(1,911	)	$	5,706		$	(35,855	)

	Three months ended September 30, 2021
	Unrealized gain (loss) on available for sale securities (a)			Defined Benefit Pension Items (a)			Unrealized loss on interest rate swap (a)		Total
Balance as of June 30, 2021	$	3,923		$	(3,326	)	$	1,013	$	1,610
Other comprehensive (loss) income before reclassifications (net of tax)		(731	)		-			123		(608	)
Amounts reclassified from accumulated other comprehensive income (net of tax)		(128	)		65			30		(33	)
Net current period other comprehensive (loss) income		(859	)		65			153		(641	)
Balance as of September 30, 2021	$	3,064		$	(3,261	)	$	1,166	$	969

(a) Amounts in parentheses indicate debits on the Consolidated Balance Sheet.

Index

The following table presents the significant amounts reclassified out of each component of accumulated other comprehensive income (loss) for the three and nine months ended September 30, 2022 and 2021 (in thousands):

Details about accumulated other comprehensive income (loss)	Amount reclassified from accumulated comprehensive income (loss) (a)						Affected line item in the Consolidated Statement of Income
	Three Months Ended September 30,
	2022			2021
Unrealized gains and losses on available for sale securities
	$	(6	)	$	162		Available for sale securities gains, net
		1			(34	)	Provision for income taxes
	$	(5	)	$	128
Defined benefit pension items
	$	(24	)	$	(81	)	Other expenses
		5			16		Provision for income taxes
	$	(19	)	$	(65	)

Unrealized gain (loss) on interest rate swap	$	47		$	(38	)	Interest expense
		(10	)		8		Provision for income taxes
	$	37		$	(30	)

Total reclassifications	$	13		$	33

Nine Months Ended September 30,
	2022			2021
Unrealized gains and losses on available for sale securities
	$	(6	)	$	212		Available for sale securities gains, net
		1			(45	)	Provision for income taxes
	$	(5	)	$	167
Defined benefit pension items
	$	(72	)	$	(254	)	Other expenses
		15			53		Provision for income taxes
	$	(57	)	$	(201	)

Unrealized loss on interest rate swap	$	(15	)	$	(106	)	Interest expense
		3			22		Provision for income taxes
	$	(12	)	$	(84	)

Total reclassifications	$	(74	)	$	(118	)

(a) Amounts in parentheses indicate expenses and other amounts indicate income on the Consolidated Statement of Income

Index

Note 9 – Fair Value Measurements

The Company has established 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 this 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.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality, the Company's creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. Our valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company’s monthly and/or quarterly valuation process.

Assets and Liabilities Required to be Measured at Fair Value on a Recurring Basis

The fair values of equity securities and securities available for sale are determined by quoted prices in active markets, when available, and classified as Level I. If quoted market prices are not available, the fair value is determined by a matrix pricing, which is a mathematical technique, widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities and classified as Level II. The fair values consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

The following tables present the assets and liabilities reported on the Consolidated Balance Sheet at their fair value on a recurring basis as of September 30, 2022 and December 31, 2021 by level within the fair value hierarchy (in thousands). Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

September 30, 2022	Level I		Level II			Level III		Total
Fair value measurements on a recurring basis:
Assets
Equity securities	$	2,257	$	-		$	-	$	2,257
Available for sale securities:
U.S. Agency securities		-		73,982			-		73,982
U.S. Treasury securities		147,844		-			-		147,844
Obligations of state and political subdivisions		-		110,450			-		110,450
Corporate obligations		-		9,438			-		9,438
Mortgage-backed securities in government sponsored entities		-		103,508			-		103,508
Other Assets
Derivative instruments		-		17,674			-		17,674
Liabilities
Derivative instruments		-		(10,450	)		-		(10,450	)

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December 31, 2021	Level I		Level II			Level III		Total
Fair value measurements on a recurring basis:
Assets
Equity securities	$	2,270	$	-		$	-	$	2,270
Available for sale securities:
U.S. Agency securities		-		73,945			-		73,945
U.S. Treasuries securities		115,347		-			-		115,347
Obligations of state and political subdivisions		-		112,021			-		112,021
Corporate obligations		-		10,333			-		10,333
Mortgage-backed securities in government sponsored entities		-		100,756			-		100,756
Other Assets
Derivative instruments		-		4,011			-		4,011
Liabilities
Derivative instruments		-		(2,101	)		-		(2,101	)

Assets and Liabilities Required to be Measured and Reported at Fair Value on a Nonrecurring Basis

Assets measured at fair value on a nonrecurring basis as of September 30, 2022 and December 31, 2021 are included in the table below (in thousands):

September 30, 2022	Level I		Level II		Level III		Total
Impaired Loans	$	-	$	-	$	497	$	497
Other real estate owned		-		-		556		556

December 31, 2021	Level I		Level II		Level III		Total
Impaired Loans	$	-	$	-	$	459	$	459
Other real estate owned		-		-		552		552

•

Impaired Loans - The Company has measured impairment on impaired loans generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties. In some cases, management may adjust the appraised value due to the age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed. Additionally, management makes estimates about expected costs to sell the property which are also included in the net realizable value. If the fair value of the collateral dependent loan is less than the carrying amount of the loan a specific reserve for the loan is made in the allowance for loan losses or a charge-off is taken to reduce the loan to the fair value of the collateral (less estimated selling costs) and the loan is included in the table above as a Level III measurement. If the fair value of the collateral exceeds the carrying amount of the loan, then the loan is not included in the table above as it is not currently being carried at its fair value. The fair values above excluded estimated selling costs of $51,000 and $47,000 at September 30, 2022 and December 31, 2021, respectively.

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•

Other Real Estate Owned (OREO) – OREO is carried at the lower of cost or fair value, less estimated costs to sell, which is measured at the date of foreclosure. If the fair value of the collateral exceeds the carrying amount of the loan, no charge-off or adjustment is necessary, the loan is not considered to be carried at fair value, and is therefore not included in the table above. If the fair value of the collateral is less than the carrying amount of the loan, management will charge the loan down to its estimated realizable value. The fair value of OREO is based on the appraised value of the property, which is generally unadjusted by management and is based on comparable sales for similar properties in the same geographic region as the subject property, and is included in the above table as a Level II measurement. In some cases, management may adjust the appraised value due to the age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed. In these cases, the loans are categorized in the above table as a Level III measurement since these adjustments are considered to be unobservable inputs. Income and expenses from operations and further declines in the fair value of the collateral subsequent to foreclosure are included in net expenses from OREO.

The following table provides a listing of the significant unobservable inputs used in the fair value measurement process for items valued utilizing Level III techniques (dollars in thousands).

Quantitative Information about Level III Fair Value Measurements
September 30, 2022	Fair Value		Valuation Technique(s)	Unobservable input	Range			Weighted average
Impaired Loans	$	497	Appraised Collateral Values	Discount for time since appraisal		0-100	%		25.14	%
				Selling costs		8%-10	%		8.57	%
				Holding period	0 - 12 months			11.51 months

Other real estate owned		556	Appraised Collateral Values	Discount for time since appraisal		20-52	%		37.41	%

December 31, 2021	Fair Value		Valuation Technique(s)	Unobservable input	Range			Weighted average
Impaired Loans		459	Appraised Collateral Values	Discount for time since appraisal		0-100	%		23.38	%
				Selling costs		8%-10	%		8.27	%
				Holding period	6 - 12 months			11.52 months

Other real estate owned		552	Appraised Collateral Values	Discount for time since appraisal		20-44	%		41.76	%

Financial Instruments Not Required to be Measured or Reported at Fair Value

The carrying amount and fair value of the Company’s financial instruments that are not required to be measured or reported at fair value on a recurring basis are as follows (in thousands):

September 30, 2022	Carrying Amount		Fair Value		Level I		Level II		Level III
Financial assets:
Interest bearing time deposits with other banks	$	6,055	$	6,055	$	-	$	-	$	6,055
Loans held for sale		1,280		1,280		-		-		1,280
Net loans		1,719,662		1,703,601		-		-		1,703,601

Financial liabilities:
Deposits		1,868,711		1,855,914		1,589,284		-		266,630
Borrowed funds		258,922		252,884		-		-		252,884

December 31, 2021		Carrying Amount		Fair Value		Level I		Level II		Level III
Financial assets:
Interest bearing time deposits with other banks	$	11,026	$	11,026	$	-	$	-	$	11,026
Loans held for sale		4,554		4,554		-		-		4,554
Net loans		1,424,229		1,426,698		-		-		1,426,698

Financial liabilities:
Deposits		1,836,151		1,836,179		1,506,535		-		329,644
Borrowed funds		73,977		72,346		-		-		72,346

The carrying amounts for cash and due from banks, bank owned life insurance, regulatory stock, accrued interest receivable and payable approximate fair value and are considered Level I measurements.

Note 10 –Proposed Acquisition of HV Bancorp, Inc.

On October 18, 2022, the Company and HV Bancorp, Inc. (“HVBC”), the holding company for Huntingdon Valley Bank (“HVB”),) entered into an Agreement and Plan of Merger (the “Merger Agreement”) pursuant to which HVBC will merge with and into the Company Concurrent with the merger, it is expected that HVB will merge with and into the Bank, with the Bank as the surviving institution.

Under the terms of the Merger Agreement, each outstanding share of HVBC common stock will be converted into either the right to receive $30.50 in cash or 0.40 shares of the Company’s common stock. Not more than 20% of the outstanding shares of HVBC common stock (including for this purpose, dissenters’ shares) may be paid in cash and the remainder will be paid in the Company’s common stock. In the event of a greater than 20% decline in market value of the Company’s common stock, HVBC may, in certain circumstances, be able to terminate the Merger Agreement unless the Company increases the number of shares into which MidCoast Bancshares common stock may be converted or increases in the cash component of the merger consideration.

The senior management of the Company and the Bank will be augmented by management team members from HVBC and HVB.

The transaction is subject to customary closing conditions, including the receipt of regulatory approvals and approval by the shareholders of HVBC. The merger is currently expected to be completed in the first half of 2023.

Each of the directors of HVBC have agreed to vote their shares in favor of the approval of the Merger Agreement at the shareholders’ meeting to be held to vote on the proposed transaction. If the merger is not consummated under certain circumstances, HVBC has agreed to pay the Company a termination fee of $2,800,000.

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Note 11 – Recent Accounting Pronouncements

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” as part of its project on financial instruments. Subsequently, this ASU was amended when the FASB issued ASU 2018-19, “Codification Improvements to Topic 326, Financial Instruments – Credit Losses,” ASU 2019-04, “Codification Improvements to Topic 326, Financial Instruments – Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments,” ASU 2019-05, “Financial Instruments – Credit Losses (Topic 326): Targeted Transition Relief,” ASU 2019-10, “Financial instruments—Credit losses (Topic 326), Derivatives and hedging (Topic 815), and Leases (Topic 842)—Effective dates,” ASU 2019-11, “Codification Improvements to Topic 326, Financial Instruments—Credit Losses,” ASU 2020-02, “Financial Instruments-Credit Losses (Topic 326) and Leases (Topic 842),” ASU 2020-03, “Codification Improvements to Financial Instruments” and ASU 2022-02, “Financial Instruments – Credit Losses (Topic 326) - Troubled Debt Restructurings and Vintage Disclosures” (collectively, ASC 326). ASC 326 introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. It modifies the impairment model for available-for-sale debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. It also modifies the measurement principles for modifications of loans to borrowers experiencing financial difficulty, including how the allowance for credit losses is measured for such loans. The Company expects to adopt the new standard effective January 1, 2023.

The amendments of ASC 326, upon adoption, will be applied on a modified retrospective basis, with the cumulative effect of adopting the new standard being recorded as an adjustment to opening retained earnings in the period of adoption. The Company has established a working group to prepare for and implement changes related to ASC 326 and has gathered historical loan loss data for purposes of evaluating appropriate portfolio segmentation and modeling methods under the standard. The Company has performed procedures to validate the historical loan loss data to ensure its suitability and reliability for purposes of developing an estimate of expected credit losses under ASC 326. The Company has engaged a vendor to assist in modeling expected lifetime losses under ASC 326. The Company expects to utilize primarily discounted cash flow methods for estimating the allowance for credit losses on loans, and is reviewing the policies and procedures to be utilized for developing that estimate. The Company is still evaluating the impact of the standard on its process for measuring impairment of available for sale securities. The adoption of ASC 326 will result in significant changes to the Company’s consolidated financial statements, which may include changes in the level of the allowance for credit losses that will be considered adequate, a reduction in total equity and regulatory capital of the Bank, differences in the timing of recognizing changes to the allowance for credit losses and expanded disclosures about the allowance for credit losses, charge-offs and recoveries of loans, and certain loan modifications. The Company has not yet determined an estimate of the effect of these changes, which will be determined based on the facts and circumstances at the time of adoption. The adoption of the standard will also result in significant changes in the Company’s internal control over financial reporting related to the allowance for credit losses.

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In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, March 2020, to provide temporary optional expedients and exceptions to the U.S. GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from LIBOR and other interbank offered rates to alternative reference rates, such as the Secured Overnight Financing Rate. Entities can elect not to apply certain modification accounting requirements to contracts affected by what the guidance calls “reference rate reform” if certain criteria are met. An entity that makes this election would not have to remeasure the contracts at the modification date or reassess a previous accounting determination. Also, entities can elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform if certain criteria are met, and can make a one-time election to sell and/or reclassify held-to-maturity debt securities that reference an interest rate affected by reference rate reform. The amendments in this ASU are effective for all entities upon issuance through December 31, 2022. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s consolidated financial position or results of operations.

In January 2021, the FASB issued ASU 2021-01, Reference Rate Reform (Topic 848), which provides optional temporary guidance for entities transitioning away from the London Interbank Offered Rate (LIBOR) and other interbank offered rates (IBORs) to new references rates so that derivatives affected by the discounting transition are explicitly eligible for certain optional expedients and exceptions within Topic 848. ASU 2021-01 clarifies that the derivatives affected by the discounting transition are explicitly eligible for certain optional expedients and exceptions in Topic 848. ASU 2021-01 is effective immediately for all entities. Entities may elect to apply the amendments on a full retrospective basis as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or on a prospective basis to new modifications from any date within an interim period that includes or is subsequent to the date of the issuance of a final update, up to the date that financial statements are available to be issued. The amendments in this update do not apply to contract modifications made, as well as new hedging relationships entered into, after December 31, 2022, and to existing hedging relationships evaluated for effectiveness for periods after December 31, 2022, except for certain hedging relationships existing as of December 31, 2022, that apply certain optional expedients in which the accounting effects are recorded through the end of the hedging relationship. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s consolidated financial position or results of operations.

In March 2022, the FASB issued ASU 2022-01, Derivatives and Hedging (ASC 815): Fair Value Hedging - Portfolio Layer Method. ASC 815 currently permits only prepayable financial assets and one or more beneficial interests secured by a portfolio of prepayable financial instruments to be included in a last-of-layer closed portfolio. The amendments in this Update allow non-prepayable financial assets to also be included in a closed portfolio hedged using the portfolio layer method. That expanded scope permits an entity to apply the same portfolio hedging method to both prepayable and non-prepayable financial assets, thereby allowing consistent accounting for similar hedges. The guidance is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s consolidated financial position or results of operations.

In March 2022, the FASB issued ASU 2022-02, Financial Instruments - Credit Losses (ASC 326): Troubled Debt Restructurings (TDRs) and Vintage Disclosures. The guidance amends ASC 326 to eliminate the accounting guidance for TDRs by creditors, while enhancing disclosure requirements for certain loan refinancing and restructuring activities by creditors when a borrower is experiencing financial difficulty. Specifically, rather than applying TDR recognition and measurement guidance, creditors will determine whether a modification results in a new loan or continuation of existing loan. These amendments are intended to enhance existing disclosure requirements and introduce new requirements related to certain modifications of receivables made to borrowers experiencing financial difficulty. Additionally, the amendments to ASC 326 require that an entity disclose current-period gross writeoffs by year of origination within the vintage disclosures, which requires that an entity disclose the amortized cost basis of financing receivables by credit quality indicator and class of financing receivable by year of origination. The guidance is only for entities that have adopted the amendments in Update 2016-13 for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. Early adoption using prospective application, including adoption in an interim period where the guidance should be applied as of the beginning of the fiscal year. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s consolidated financial position or results of operations.

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In June 2022, the FASB issued ASU 2022-03, “Fair Value Measurement (Topic 820) – Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions.” This amendment clarifies the guidance in Topic 820, Fair Value Measurement, when measuring the fair value of an equity security subject to contractual restrictions that prohibit the sale of an equity security. It also introduces new disclosure requirements for equity securities subject to contractual sale restrictions that are measured at fair value in accordance with Topic 820. The amendments are effective for fiscal years beginning after December 15, 2023 and interim periods within those fiscal years. Early adoption is permitted. The amendments will be applied prospectively with any adjustments from the adoption of the amendments recognized in earnings and disclosed on the date of adoption. The Company is currently evaluating the effect that ASU 2022-03 may have on its consolidated financial statements. This Update is not expected to have a significant impact on the Company’s consolidated financial statements.

Other accounting standards that have been issued by the FASB or other standards-setting bodies are not currently expected to have a material effect on the Company’s consolidated financial position, results of operations or cash flows.

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ITEM 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

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 expected future results of operations of Citizens Financial Services, Inc., CZFS Acquisition Company, LLC, First Citizens Community Bank, First Citizens Insurance Agency, Inc., 1^st Realty of PA LLC 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 cautions readers that the following important factors, among others, 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:

•

The COVID-19 pandemic may have an adverse effect on our business and operations, our customers, including their ability to make timely loan payments, our service providers, and on the economy and financial markets more significant that we expect.

•

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 financial markets could suffer a significant disruption, which may have a negative effect on our financial condition and that of our borrowers, and on our ability to raise money by issuing new securities.

•

It could take us longer than we anticipate implementing strategic initiatives, including expansions, designed to increase revenues or manage expenses, or we may be unable to implement those initiatives at all.

•

Acquisitions and dispositions of assets could affect us in ways that management has not anticipated.

•

We may become subject to new legal obligations or the resolution of litigation may have a negative effect on our financial condition or operating results.

•

We may become subject to new and unanticipated accounting, tax, regulatory or compliance practices or requirements. Failure to comply with any one or more of these requirements could have an adverse effect on our operations.

•

We could experience greater loan delinquencies than anticipated, adversely affecting our earnings and financial condition.

•

We could 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.

•

The agricultural economy is subject to extreme swings in both the costs of resources and the prices received from the sale of products as a result of forces of nature like weather and various viruses, government regulations, international trade agreements and consumer tastes, which could negatively impact certain of our customers.

•

Poultry producers and suppliers may experience significant disruption due to the highly pathogenic avian influenza that is spreading in the United States.

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•

Loan concentrations in certain industries could negatively impact our results, if financial results or economic conditions deteriorate.

•

A budget impasse in the Commonwealth of Pennsylvania could impact our asset values, liquidity and profitability as a result of either delayed or reduced funding to school districts and municipalities who are customers of the bank.

•

Companies providing support services related to the exploration and drilling of the natural gas reserves in our market area may be affected by federal, state and local laws and regulations such as restrictions on production, permitting, changes in taxes and environmental protection, which could negatively impact our customers and, as a result, negatively impact our loan and deposit volume and loan quality. Additionally, the activities the companies providing support services related to the exploration and drilling of the natural gas reserves may be dependent on the market price of natural gas. As a result, decreases in the market price of natural gas could also negatively impact these companies, our customers.

Additional factors that may affect our results are discussed under “Part II – Item 1A – Risk Factors” in this report and in the Company’s 2021 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 financial condition and results of operations at the dates and for the periods presented in the accompanying consolidated financial statements for the Company. Our 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 and nine months ended September 30, 2022 are not necessarily indicative of the results you may expect for the full year.

The Company currently engages in the general business of banking throughout our service area of Potter, Tioga, Clinton, Bradford and Centre counties in north central Pennsylvania, Lebanon, Berks, Schuylkill, Lancaster and Chester counties in south central Pennsylvania and Allegany County in southern New York and with the MidCoast acquisition, the Cities of Wilmington and Dover, Delaware. We also have a limited branch office in Union county, Pennsylvania, which primarily serves agricultural and commercial customers in the central Pennsylvania market. We maintain our central office in Mansfield, Pennsylvania. Presently we operate 33 banking facilities, 31 of which operate as bank branches. In Pennsylvania, the Company has full service offices located in Mansfield, Blossburg, Ulysses, Genesee, Wellsboro, Troy, Sayre, Canton, Gillett, Millerton, LeRaysville, Towanda, Rome, the Mansfield Wal-Mart Super Center, Mill Hall, Schuylkill Haven, Friedensburg, Mt. Aetna, Fredericksburg, Mount Joy, Fivepointville, State College, Kennett Square and two branches near the city of Lebanon, Pennsylvania. The limited branch office is located in Winfield, Pennsylvania. In New York, our office is in Wellsville. In Delaware, we have two branches in Wilmington and one in Dover. We have received approval to open branches in Ephrata, Pennsylvania and Greenville, Delaware, both of which we expect to open in the fourth quarter of 2022.

Covid-19 Pandemic Response and Loan Profile

In response to the Covid-19 pandemic, the Company maintained a payment relief program that included the following:

•

Interest only payment options for consumers and businesses for 60-90 days.

•

Deferral of principal payments for consumers and businesses in certain industries for 60-120 days

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During 2022, we have not modified any loans under this program. Additionally, in accordance with government regulations, we have paused certain foreclosure actions in accordance with state mandates. We also continued to participate in the in the Paycheck Protection Program for loans provided under the auspices of the Small Business Administration (SBA). As of September 30, 2022, all loans issued through this program had either been forgiven or repaid.

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, reputational 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 market 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.

Reputational risk, or the risk to our business, earnings, liquidity, and capital from negative public opinion, could result from our actual or alleged conduct in a variety of areas, including legal and regulatory compliance, lending practices, corporate governance, litigation, ethical issues, or inadequate protection of customer information, including fraudulent activity outside the Company’s control. We expend significant resources to comply with regulatory requirements. Failure to comply could result in reputational harm or significant legal or remedial costs. Damage to our reputation could adversely affect our ability to retain and attract new customers, and adversely impact our earnings and liquidity.

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

Competition

The banking industry in the Bank’s service areas continue to be extremely competitive, both among commercial banks and with other financial service providers such as consumer finance companies, thrifts, investment firms, mutual funds, insurance companies, credit unions, agricultural cooperatives and intenet entities for loans and deposits. Competition in our north central Pennsylvania market has increased as a result of other financial institutions looking to expand into new markets. With larger population centers in our central and south central markets, as well as in our Delaware market, we experience more competition to gather deposits and to make loans. Mortgage banking firms, financial companies, financial affiliates of industrial companies, brokerage firms, retirement fund management firms and even government agencies provide additional competition for loans, deposits and other financial services. Fintech and blockchain entities offering crypto services are also increasing competition for the Company’s financial services. The Bank is generally competitive with all competing financial institutions in its service areas with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans.

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Trust and Investment Services; Oil and Gas Lease Services

Our Investment and Trust Services Division offers professional trust administration, investment management services, estate planning and administration, and custody of securities. In addition to traditional trust and investment services offered, we assist our customers through various oil and gas specific leasing matters from lease negotiations to establishing a successful approach to personal wealth management. Assets held by the Company in a fiduciary or agency capacity for its customers are not included in the Consolidated Balance Sheets since such items are not assets of the Company. Revenues and fees of the Trust Department are reflected in trust income in the Consolidated Statement of Income. As of September 30, 2022 and December 31, 2021, the Trust Department had $143.3 million and $154.8 million of assets under management, respectively.

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 Agency, Inc. The assets associated with these products are not included in the Consolidated Balance Sheets since such items are not assets of the Company. Assets owned and invested by customers of the Bank through the Bank’s Investment Representatives decreased from $282.1 million at December 31, 2021 to $268.9 million at September 30, 2022. Fee income from the sale of these products is reflected in brokerage and insurance income in the Consolidated Statement of Income. Management believes that there are opportunities to increase non-interest income through these products and services, especially in our central and south central Pennsylvania markets.

Results of Operations

Overview of the Income Statement

The Company had net income of $21,185,000 for the first nine months of 2022 compared to $22,174,000 for last year’s comparable period, a decrease of $989,000, or 4.5%. Basic earnings per share for the first nine months of 2022 were $5.34, compared to $5.56 for last year’s comparable period, representing a 4.0% decrease. Annualized return on assets and return on equity for the nine months of 2022 were 1.27% and 12.77%, respectively, compared with 1.49% and 14.66% for last year’s comparable period.

Net income for the three months ended September 30, 2022 was $7,544,000 compared to $7,064,000 in the comparable 2021 period, an increase of $480,000 or 6.8%. Basic earnings per share for the three months ended September 30, 2022 were $1.90, compared to $1.77 for last year’s comparable period, representing a 7.3% increase. Annualized return on assets and return on equity for the quarter ended September 30, 2022 was 1.31% and 13.34%, respectively, compared with 1.40% and 13.65% for the same 2021 period.

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 paid on interest-bearing liabilities.

Net interest income for the first nine months of 2022 was $52,837,000, an increase of $3,594,000, or 7.3%, compared to the same period in 2021. For the first nine months of 2022 the provision for loan losses was $1,425,000, a decrease of $125,000 over the comparable period in 2021. Consequently, net interest income after the provision for loan losses was $51,412,000 in the first nine months of 2022 compared to $47,693,000 during the first nine months of 2021.

For the three months ended September 30, 2022, net interest income was $18,846,000 compared to $16,590,000, an increase of $2,256,000, or 13.6% over the comparable period in 2021. The provision for loan losses in the third quarter was $725,000 compared to $400,000 for last year’s third quarter. Consequently, net interest income after the provision for loan losses was $18,121,000 for the quarter ended September 30, 2022 compared to $16,190,000 in 2021.

Index

The following table sets forth the average balances of, and the interest earned or incurred on, for each principal category of assets, liabilities and stockholders’ equity, the related rates, net interest income and interest rate spread created for the three and nine months ended September 30, 2022 and 2021 on a tax equivalent basis (dollars in thousands):

	Analysis of Average Balances and Interest Rates Nine Months Ended
	September 30, 2022							September 30, 2021
	Average Balance (1)		Interest		Average Rate			Average Balance (1)		Interest		Average Rate
(dollars in thousands)		$	$			%			$	$			%
ASSETS
Short-term investments:
Interest-bearing deposits at banks		65,727		150		0.31			109,272		86		0.11
Total short-term investments		65,727		150		0.31			109,272		86		0.11
Interest bearing time deposits at banks		9,126		183		2.70			12,952		249		2.57
Investment securities:
Taxable		368,702		4,406		1.59			238,438		3,156		1.76
Tax-exempt (3)		120,107		2,316		2.57			103,559		2,091		2.69
Total investment securities		488,809		6,722		1.83			341,997		5,247		2.05
Loans (2)(3)(4):
Residential mortgage loans		202,856		7,128		4.70			203,300		7,464		4.91
Construction		69,437		2,213		4.26			52,409		1,602		4.09
Commercial Loans		829,366		28,808		4.64			732,554		26,914		4.91
Agricultural Loans		347,771		11,342		4.36			351,478		11,322		4.31
Loans to state & political subdivisions		54,836		1,327		3.24			54,994		1,505		3.66
Other loans		47,732		1,868		5.23			22,912		1,028		6.00
Loans, net of discount		1,551,998		52,686		4.54			1,417,647		49,835		4.70
Total interest-earning assets		2,115,660		59,741		3.78			1,881,868		55,417		3.94
Cash and due from banks		6,652							6,560
Bank premises and equipment		17,199							17,212
Other assets		82,726							75,818
Total non-interest earning assets		106,577							99,590
Total assets		2,222,237							1,981,458
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
NOW accounts		520,882		1,392		0.36			450,636		1,086		0.32
Savings accounts		323,667		260		0.11			285,124		249		0.12
Money market accounts		347,422		1,037		0.40			248,495		502		0.27
Certificates of deposit		305,878		1,780		0.78			357,460		2,708		1.01
Total interest-bearing deposits		1,497,849		4,469		0.40			1,341,715		4,545		0.45
Other borrowed funds		112,582		1,699		2.02			87,200		924		1.42
Total interest-bearing liabilities		1,610,431		6,168		0.51			1,428,915		5,469		0.51
Demand deposits		370,785							335,188
Other liabilities		19,785							15,724
Total non-interest-bearing liabilities		390,570							350,912
Stockholders' equity		221,236							201,631
Total liabilities & stockholders' equity		2,222,237							1,981,458
Net interest income				53,573							49,948
Net interest spread (5)						3.27	%						3.43	%
Net interest income as a percentage of average interest-earning assets						3.39	%						3.55	%
Ratio of interest-earning assets to interest-bearing liabilities						131	%						132	%

(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 21%.

(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.

Index

	Analysis of Average Balances and Interest Rates Three Months Ended

	September 30, 2022							September 30, 2021
	Average Balance (1)		Interest		Average Rate			Average Balance (1)		Interest		Average Rate
(dollars in thousands)		$	$			%			$	$			%
ASSETS
Short-term investments:
Interest-bearing deposits at banks		14,255		12		0.33			111,392		40		0.14
Total short-term investments		14,255		12		0.33			111,392		40		0.14
Interest bearing time deposits at banks		6,640		49		2.93			12,129		78		2.55
Investment securities:
Taxable		391,774		1,696		1.73			264,740		1,158		1.75
Tax-exempt (3)		123,046		797		2.59			107,125		709		2.65
Total investment securities		514,820		2,493		1.94			371,865		1,867		2.01
Loans (2)(3)(4):
Residential mortgage loans		204,352		2,416		4.69			203,426		2,417		4.71
Construction		76,934		885		4.56			67,780		671		3.93
Commercial Loans		900,297		10,732		4.73			745,313		8,976		4.78
Agricultural Loans		346,380		3,887		4.45			344,365		3,728		4.29
Loans to state & political subdivisions		59,454		502		3.35			49,673		437		3.49
Other loans		81,499		1,074		5.23			16,678		347		8.25
Loans, net of discount		1,668,916		19,496		4.63			1,427,235		16,576		4.61
Total interest-earning assets		2,204,631		22,050		3.96			1,922,621		18,561		3.83
Cash and due from banks		6,755							6,542
Bank premises and equipment		17,437							17,259
Other assets		82,012							71,329
Total non-interest earning assets		106,204							95,130
Total assets		2,310,835							2,017,751
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
NOW accounts		530,234		675		0.51			466,981		383		0.33
Savings accounts		328,056		106		0.13			297,470		74		0.10
Money market accounts		347,460		515		0.59			258,872		163		0.25
Certificates of deposit		288,926		542		0.74			336,782		802		0.94
Total interest-bearing deposits		1,494,676		1,838		0.49			1,360,105		1,422		0.41
Other borrowed funds		189,174		1,099		2.30			80,275		330		1.63
Total interest-bearing liabilities		1,683,850		2,937		0.69			1,440,380		1,752		0.48
Demand deposits		380,110							358,716
Other liabilities		20,618							11,683
Total non-interest-bearing liabilities		400,728							370,399
Stockholders' equity		226,257							206,972
Total liabilities & stockholders' equity		2,310,835							2,017,751
Net interest income				19,113							16,809
Net interest spread (5)						3.27	%						3.35	%
Net interest income as a percentage of average interest-earning assets						3.44	%						3.47	%
Ratio of interest-earning assets to interest-bearing liabilities						131	%						133	%

(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 21%.

(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.

Index

Tax exempt revenue is shown on a tax-equivalent basis (non-Gaap) for proper comparison using a federal statutory income tax rate of 21% for the three and nine months ended September 30, 2022 and 2021. 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 Federal statutory rate during the corresponding period. The following table represents the adjustment to convert net interest income to net interest income on a fully taxable equivalent basis for the periods ended September 30, 2022 and 2021 (in thousands):

	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2022		2021		2022		2021
Interest and dividend income from investment securities and interest bearing deposits at banks (non-tax adjusted)	$	2,387	$	1,837	$	6,569	$	5,143
Tax equivalent adjustment		167		148		486		439
Interest and dividend income from investment securities and interest bearing deposits at banks (tax equivalent basis)	$	2,554	$	1,985	$	7,055	$	5,582

Interest and fees on loans (non-tax adjusted)	$	19,396	$	16,505	$	52,436	$	49,569
Tax equivalent adjustment		100		71		250		266
Interest and fees on loans (tax equivalent basis)	$	19,496	$	16,576	$	52,686	$	49,835

Total interest income	$	21,783	$	18,342	$	59,005	$	54,712
Total interest expense		2,937		1,752		6,168		5,469
Net interest income		18,846		16,590		52,837		49,243
Total tax equivalent adjustment		267		219		736		705
Net interest income (tax equivalent basis)	$	19,113	$	16,809	$	53,573	$	49,948

The following table shows the tax-equivalent effect of changes in volume and rate on interest income and expense (in thousands):

	Three months ended September 30, 2022 vs 2021 (1)									Nine months ended September 30, 2022 vs 2021 (1)
	Change in Volume			Change in Rate			Total Change			Change in Volume			Change in Rate			Total Change
	Change in Volume			Change in Rate			Total Change			Change in Volume			Change in Rate			Total Change
Interest Income:
Short-term investments:
Interest-bearing deposits at banks	$	(53	)	$	25		$	(28	)	$	(17	)	$	81		$	64
Interest bearing time deposits at banks		(43	)		14			(29	)		(78	)		12			(66	)
Investment securities:
Taxable		550			(12	)		538			1,521			(271	)		1,250
Tax-exempt		103			(15	)		88			313			(88	)		225
Total investments		653			(27	)		626			1,834			(359	)		1,475
Loans:
Residential mortgage loans		11			(12	)		(1	)		(17	)		(319	)		(336	)
Construction		97			117			214			540			71			611
Commercial Loans		1,847			(91	)		1,756			3,226			(1,332	)		1,894
Agricultural Loans		22			137			159			(111	)		131			20
Loans to state & political subdivisions		82			(17	)		65			(4	)		(174	)		(178	)
Other loans		803			(76	)		727			953			(113	)		840
Total loans, net of discount		2,862			58			2,920			4,587			(1,736	)		2,851
Total Interest Income		3,419			70			3,489			6,326			(2,002	)		4,324
Interest Expense:
Interest-bearing deposits:
NOW accounts		57			235			292			180			126			306
Savings accounts		8			24			32			27			(16	)		11
Money Market accounts		71			281			352			243			292			535
Certificates of deposit		(104	)		(156	)		(260	)		(356	)		(572	)		(928	)
Total interest-bearing deposits		32			384			416			94			(170	)		(76	)
Other borrowed funds		589			180			769			315			460			775
Total interest expense		621			564			1,185			409			290			699
Net interest income	$	2,798		$	(494	)	$	2,304		$	5,917		$	(2,292	)	$	3,625

(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.

Index

Tax equivalent net interest income increased from $49,948,000 for the nine month period ended September 30, 2021 to $53,573,000 for the nine month period ended September 30, 2022, an increase of $3,625,000. The increase would have been greater if not for PPP loan amortization in 2021, which was $1,323,000 greater in 2021 than 2022. The tax equivalent net interest margin decreased from 3.55% for the first nine months of 2021 to 3.39% for the comparable period in 2022. The decrease is primarily caused by the decrease in the yield of interest-earning assets due to the low market interest rate environment in the first part of 2022 and all of 2021 in response to the pandemic as well as the decrease in the amortization of PPP loan fees.

Total tax equivalent interest income for the 2022 nine month period increased $4,324,000 as compared to the 2021 nine month period. This increase was a result of an increase of $6,326,000 due to a change in volume as average interest-bearing assets increased $233.8 million. As a result of the low rate interest environment and lower PPP amortization, the yield on average interest earning assets decreased 16 basis point from 3.94% to 3.78% resulting in a decrease interest income of $2,002,000.

Tax equivalent investment income for the nine months ended September 30, 2022 increased $1,475,000 over the same period last year. The primary cause of the increase in the average balance of investment securities of $146.8 million.

•

The average balance of taxable securities increased $130.3 million due to purchases made as a result of substantial deposit growth, which resulted in an increase in investment income of $1,521,000. The yield on taxable securities decreased 17 basis points from 1.76% to 1.59% as a result of purchases made in a lower rate environment in 2021. This resulted in a decrease in investment income of $271,000.

•

The average balance of tax-exempt securities increased by $16.5 million, which resulted in an increase in investment income of $313,000. The yield on tax-exempt securities decreased 12 basis points from 2.69% to 2.57%, which corresponds to a decrease in interest income of $88,000. The yield decrease was attributable to higher yielding securities being called and maturing and being replaced by securities that were purchased in a lower rate environment. For a discussion of the Company’s current investment strategy, see the “Financial Condition – Investments”.

Total loan interest income increased $2,851,000 for the nine months ended September 30, 2022 compared to the same period last year, as a result of a loan growth experienced in 2022.

•

Interest income on residential mortgage loans decreased $336,000. The change due to rate was a decrease of $319,000 as the average yield on residential mortgages decreased from 4.91% to 4.70% as a result of the lower rate environment due to the COVID-19 pandemic that occurred during 2021.

Index

•

The average balance of construction loans increased $17.0 million as a result of projects in our Delaware market. This resulted in an increase of $540,000 on total interest income due to volume.

•

The average balance of commercial loans increased $96.8 million from a year ago. The growth was primarily attributable to growth in the Delaware market. This had a positive impact of $3,226,000 on total interest income due to volume. The yield decreased 27 basis points to 4.64% due to the lower rate environment caused by the pandemic, as well as, the reduced amortization income on PPP loans and competition for loan growth, which decreased loan interest income $1,332,000.

•

The average yield of state and political subdivision loans decreased 42 basis points to 3.24% due to the lower rate environment caused by the pandemic for 2021 and the first part of 2022 resulting in a decrease in income of $174,000.

•

The average balance of other loans increased $24.8 million as a result of outstanding student loans. This resulted in an increase of $953,000 on total interest income due to volume. The average yield on other loans decreased 77 basis points to 5.23% due to the rate earned on the student loans, resulting in a decrease in interest income of $113,000.

Total interest expense increased $699,000 for the nine months ended September 30, 2022 compared with the comparative period last year as a result of an increase in the volume of interest-bearing liabilities and an increase in rate on other borrowed funds. Interest expense increased $409,000 due to volume as a result of an increase in the average balance of interest earning liabilities of $181.5 million. The average rate paid on other borrowed funds increased from 1.42% to 2.02%. The increase was driven by the Federal Reserve interest rate increases in 2022, which caused borrowing costs to increase $460,000.

•

The average balance of interest bearing deposits increased $156.1 million from September 30, 2021 to September 30, 2022. The primary cause of the increase was general deposit growth across all markets, a portion of which was funded through government stimulus in response to the pandemic and growth in municipal deposits through new customers and expansion of existing relationships. We experienced increases of $70.2 million in NOW accounts, $38.5 million in savings accounts and $98.9 million in money market accounts. The cumulative effect of these volume changes was an increase in interest expense of $450,000. Certificates of deposits decreased $51.6 million due to the low rate environment, which resulted in a decrease in interest expense due to volume of $356,000 related to certificates of deposits. (see also “Financial Condition – Deposits”). The average rate paid on interest bearing deposits was 0.40% for the first nine months of 2022 and 0.45% for the comparable period in 2021. This resulted in a decrease in interest expense of $170,000. The decrease was due to the Federal Reserve cutting interest rates during the first quarter of 2020, which remained there throughout 2021 the first part of 2022.

•

The average balance of other borrowed funds increased $25.4 million to fund loan growth experienced in 2022. This resulted in an increase in interest expense of $315,000. There was an increase in the average rate paid on other borrowed funds from 1.42% to 2.02% due to the interest rate increases by the Federal Reserve that increased borrowings costs resulting in an increase in interest expense of $460,000.

Tax equivalent net interest income for the three months ended September 30, 2022 was $19,113,000 which compares to $16,809,000 for the same period last year. This represents an increase of $2,304,000 and was primarily caused by an increase in the volume of interest earning assets.

Total tax equivalent interest income was $22,050,000 for the three month period ended September 30, 2022, compared to $18,561,000 for the comparable period last year, an increase of $3,489,000. The increase was driven by the increase in average interest-earning assets of $282.0 million. This corresponds to an increase in interest income of $3,419,000. We also experienced a $70,0000 increase in interest income due to rate as the yield on average interest earning assets increased 13 basis point from 3.83% to 3.96%.

Index

•

Total investment income increased by $626,000 compared to same period last year. The primary cause of the increase was the increase in the average balance of investments of $143.0 million due to purchases made as a result of deposit growth, which corresponds to an increase in investment income of $653,000. Yields on investments decreased 7 basis points to 1.94%, which corresponds to a decrease of $27,000 in interest income. The decrease in yield is due to investments purchased in a lower rate environment during 2020 2021 and the first three months of 2022.

•

Total loan interest income increased $2,920,000 compared to the same period last year, with the change due to an increase in the average balance of outstanding loans of $241.7 million, primarily in Delaware, which corresponds to an increase of $2,862,000. The yield on loans increased 2 basis points to 4.63% due to a higher rate environment caused by recent Federal Reserve interest rate increases, which increased loan interest income $58,000.

Total interest expense increased $1,185,000 for the three months September 30, 2022 compared with last year as a result of the average rate on interest-bearing liabilities increasing 21 basis points from 0.48% to 0.69%, which increased interest expense $564,000 and an increase due to volume of $621,000 due to additional borrowings in 2022 than 2021.

•

The average balance of interest bearing deposits increased $134.6 million for the three month period ended September 30, 2022, as a result organic growth across all market areas. Due to a decrease in the average balance of certificates of deposit of $47.9 million, the changes due to volume for deposits was an increase of only $32,000. The rate paid on interest bearing deposits was 0.49% for the three months ended September 30, 2022 and 0.41% for the comparable period in 2021. This results in an increase in interest expense of $384,000.

•

The average balance of other borrowed funds increased $108.9 million from a year ago due to borrowings to fund loan growth in 2022. This resulted in an increase in interest expense of $589,000. There was an increase in the average rate on other borrowed funds from 1.63% to 2.30% as a result of market interest rate move resulting in an increase in interest expense of $180,000.

Provision for Loan Losses

For the nine month period ended September 30, 2022, we recorded a provision for loan losses of $1,425,000, which represents a decrease of $125,000 from the $1,550,000 provision recorded in the corresponding nine months of last year. The provision was lower in 2022 due the improved economic outlook compared to 2021 that was impacted more by the Covid-19 pandemic, which offset the impact of the loan growth that occurred in 2022. (see “Financial Condition – Allowance for Loan Losses and Credit Quality Risk”).

For the three months ended September 30, 2022, we recorded a provision of $725,000 compared to $400,000 in 2021 with the increase being due to the organic loan growth experienced in the third quarter of 2022 compared to the same period in in 2021.

Index

Non-interest Income

The following table shows the breakdown of non-interest income for the three and nine months ended September 30, 2022 and 2021 (dollars in thousands):

	Nine months ended September 30,					Change
	2022			2021		Amount			%
Service charges	$	4,081		$	3,479	$	602			17.3
Trust		620			674		(54	)		(8.0	)
Brokerage and insurance		1,428			1,190		238			20.0
Gains on loans sold		241			1,109		(868	)		(78.3	)
Equity security (losses) gains, net		(198	)		288		(486	)		(168.8	)
Available for sale security (losses) gains, net		(6	)		212		(218	)		(102.8	)
Earnings on bank owned life insurance		635			1,643		(1,008	)		(61.4	)
Other		626			1,198		(572	)		(47.7	)
Total	$	7,427		$	9,793	$	(2,366	)		(24.2	)

	Three months ended September 30,					Change
		2022			2021	Amount			%
Service charges	$	1,509		$	1,210	$	299			24.7
Trust		187			182		5			2.7
Brokerage and insurance		446			408		38			9.3
Gains on loans sold		95			295		(200	)		(67.8	)
Equity security (losses) gains, net		(19	)		72		(91	)		(126.4	)
Available for sale security gains (losses), net		(6	)		162		(168	)		(103.7	)
Earnings on bank owned life insurance		216			165		51			30.9
Other		264			358		(94	)		(26.3	)
Total	$	2,692		$	2,852	$	(160	)		(5.6	)

Non-interest income for the nine months ended September 30, 2022 totaled $7,427,000, a decrease of $2,366,000 when compared to the same period in 2021. During the first nine months of 2022, net equity security losses amounted to $198,000 as a result of market losses associated with general stock market losses compared with a $288,000 gain in the comparable 2021 period associated with market conditions for that period. During the first nine months of 2022, $4.5 million of US Agency securities were sold for a pre-tax loss of $6,000. During the first nine months of 2021, we sold $17.2 million of US treasury securities for a pre-tax gain of $177,000 and $12.0 million of US Agency securities for a pre-tax gain of $35,000.

The decrease in Trust revenues is due to lower estate settlement fees in 2022 compared to 2021. The decrease in earnings on bank owned life insurance is due to two former employees of the Company passing during the first quarter of 2021, which generated a death benefit payable to the Company of $1,155,000. The increase in service charges is due to increased customer account usage of their debit cards and NSF fees. The decrease in other income is due to fees on derivative transactions to certain customers, which generated fee income of $494,000 in 2021. The decrease in gains on loans sold is attributable to a reduced level of loan sales as rates on the secondary market have increased, which has resulted in a significant decrease in refinancings of mortgages.

For the three month period ended September 30, 2022, the changes experienced from the prior year related gains on loans sold and service charges correspond to the changes experienced for the nine month period.

Non-interest Expense

The following tables reflect the breakdown of non-interest expense for the three and nine months ended September 30, 2022 and 2021 (dollars in thousands):

	Nine months ended September 30,					Change Amount			%
	2022			2021		Change Amount			%
Salaries and employee benefits	$	20,964		$	19,312	$	1,652			8.6
Occupancy		2,327			2,222		105			4.7
Furniture and equipment		416			407		9			2.2
Professional fees		1,321			1,153		168			14.6
FDIC insurance		440			387		53			13.7
Pennsylvania shares tax		1,017			856		161			18.8
Amortization of intangibles		120			146		(26	)		(17.8	)
Software expenses		1,069			1,003		66			6.6
ORE (income) expenses		(125	)		383		(508	)		(132.6	)
Other		5,496			4,798		698			14.5
Total	$	33,045		$	30,667	$	2,378			7.8

	Three months ended September 30,				Change Amount			%
		2022		2021	Change Amount			%
Salaries and employee benefits	$	6,933	$	6,568	$	365			5.6
Occupancy		779		728		51			7.0
Furniture and equipment		122		123		(1	)		(0.8	)
Professional fees		588		310		278			89.7
FDIC insurance		160		129		31			24.0
Pennsylvania shares tax		339		339		-			-
Amortization of intangibles		40		48		(8	)		(16.7	)
Software expenses		370		336		34			10.1
ORE expenses		122		130		(8	)		(6.2	)
Other		2,161		1,689		472			27.9
Total	$	11,614	$	10,400	$	1,214			11.7

Index

Non-interest expenses increased $2,378,000 for the nine months ended September 30, 2022 compared to the same period in 2021. Salaries and employee benefits increased $1,652,000 or 8.6%. The increase was due to merit increases effective at the beginning of 2022, additional full time equivalent employees (FTE) of 13.2, which is an increase of 4.5%, primarily in the Delaware market and an increase in deferred compensation costs due to a reversal of deferred compensation that occurred in 2021 as a result of a former executive passing.

The increase in professional fees was due to fees associated with the acquisition of HVB announced in the fourth quarter of 2022 that is expected to close in the first half of 2023. The decrease in ORE expenses was due to the sales of OREO properties in 2022 for a gain of $481,000. The increase in other expenses is additional marketing expenses, primarily in the Delaware market, charge-offs associated with fraudulent customer account activity, data processing costs and the Delaware franchise tax due to growth in that market.

For the three months ended, September 30, 2022, non-interest expenses increased $1,214,000 when compared to the same period in 2021. The changes in salaries and employee benefits, professional fees and other expenses correspond to the changes for the nine month period.

Provision for Income Taxes

The provision for income taxes was $4,609,000 for the nine month period ended September 30, 2022 compared to $4,645,000 for the same period in 2021. The decrease is primarily attributable to the death benefits received in 2021 being excluded from taxable income. The income before the provision for income taxes decreased $1.0 million for the comparable periods. Through management of our municipal loan and bond portfolios, management is focused on minimizing our effective tax rate. Our effective tax rate was 17.9% and 16.3% for the first nine months of 2022 and 2021, respectively, compared to the statutory rate of 21%. The increase in the effective tax rate is due to life insurance earnings being exempt from federal income taxes.

For the three months ended September 30, 2022, the provision for income taxes was $1,655,000 compared to $1,578,000 for the same period in 2021. The increase is attributable to the increase in income before the provision for income taxes of $557,000 for the comparable periods. Our effective tax rate was 18.0% and 18.3% for the three months ended September 30, 2022 and 2021, respectively.

We are invested in six limited partnerships that have established low-income housing projects in our market areas with our most recent investment in the second quarter of 2022. We anticipate recognizing an aggregate of $4.7 million of tax credits over the next 10 years, with an additional $35,000 anticipated to be recognized during 2022.

Index

Financial Condition

Total assets were $2.35 billion at September 30, 2022, an increase of $205.8 million from $2.14 billion at December 31, 2021, due primarily to loan growth that was funded by deposit growth and additional borrowings. Cash and cash equivalents decreased $149.7 million to $23.1 million. Available for sale securities increased $32.8 million and net loans increased $295.4 million to $1.72 billion at September 30, 2022. Total deposits increased $32.6 million to $1.87 billion since year-end 2021, while borrowed funds increased $184.9 million to $258.9 million.

Cash and Cash Equivalents

Cash and cash equivalents totaled $23.2 million at September 30, 2022 compared to $172.8 million at December 31, 2021, a decrease of $149.7 million. The decrease was attributable to investment purchases and organic loan growth. Management actively measures and evaluates the Company’s liquidity position through our Asset–Liability Committee and believes the Company’s liquidity needs are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources including the Bank’s core deposits, Federal Home Loan Bank financing, federal funds lines with correspondent banks, brokered certificates of deposit and the portion of the investment and loan portfolios that mature within one year. Management expects that these sources of funds will permit us to meet cash obligations and off-balance sheet commitments as they come due.

Investments

The following table shows the composition of the investment portfolio (including debt and equity securities) as of September 30, 2022 and December 31, 2021 (dollars in thousands):

	September 30, 2022				December 31, 2021
	Amount		%		Amount		%
Debt securities:
U. S. Agency securities	$	73,982		16.5	$	73,945		17.8
U. S. Treasury notes		147,844		33.1		115,347		27.8
Obligations of state & political subdivisions		110,450		24.7		112,021		27.0
Corporate obligations		9,438		2.1		10,333		2.5
Mortgage-backed securities in
government sponsored entities		103,508		23.1		100,756		24.3
Equity securities		2,257		0.5		2,270		0.6
Total	$	447,479		100.0	$	414,672		100.0

	September 30, 2022/ December 31, 2021 Change
	Amount			%
Debt securities:
U. S. Agency securities	$	37			0.1
U. S. Treasury notes		32,497			28.2
Obligations of state & political subdivisions		(1,571	)		(1.4	)
Corporate obligations		(895	)		(8.7	)
Mortgage-backed securities in
government sponsored entities		2,752			2.7
Equity securities		(13	)		(0.6	)
Total	$	32,807			7.9

Index

Our investment portfolio increased by $32.8 million, or 7.9%, from December 31, 2021 to September 30, 2022. During 2022, we purchased $13.0 million of U.S. agency obligations, $53.8 million of U.S. treasury securities, $18.4 million state and political securities, $33.3 million of mortgage backed securities and $218,000 of equity securities, which was offset by $16.7 million of principal repayments and $11.8 million of calls and maturities that occurred during the first nine months of 2022. As a result of increases in market interest rates, the unrealized loss on available for sale investment portfolio increased $50.6 million. Excluding our short-term investments consisting of monies held primarily at the Federal Reserve for liquidity purposes, our investment portfolio for the nine month period ended September 30, 2022 yielded 1.83%, compared to 2.05% in the comparable period in 2021, on a tax equivalent basis.

The investment strategy for 2022 has been to utilize excess cash, cashflows from the investment portfolio and deposit inflows to purchase U.S. treasury securities, due to a limited spread between US treasuries and agencies, mortgage backed securities issued by government sponsored entities and obligations of state and political securities. The increase in the investment portfolio was in response to the deposit inflows that occurred in 2021 and the first nine months of 2022. We continually monitor interest rate trading ranges and seek to time investment security purchases when rates are in the top third of the trading range. The Bank believes its investment strategy has appropriately mitigated its interest rate risk exposure for various rate environments, including a rising rate environment, while providing sufficient cashflows to meet liquidity needs.

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 investment portfolio, the Company believes it maintains sufficient liquidity to satisfy depositor withdrawal requirements and various credit needs of its customers.

Loans

The following table shows the composition of the loan portfolio as of September 30, 2022 and December 31, 2021 (dollars in thousands):

	September 30, 2022				December 31, 2021
	Amount		%		Amount		%
Real estate:
Residential	$	203,673		11.7	$	201,097		14.0
Commercial		857,314		49.3		687,338		47.7
Agricultural		317,761		18.3		312,011		21.6
Construction		79,154		4.6		55,036		3.8
Consumer		124,375		7.2		25,858		1.8
Other commercial loans		66,241		3.8		74,585		5.2
Other agricultural loans		29,509		1.7		39,852		2.8
State & political subdivision loans		59,926		3.4		45,756		3.1
Total loans		1,737,953		100.0		1,441,533		100.0
Less allowance for loan losses		18,291				17,304
Net loans	$	1,719,662			$	1,424,229

	September 30, 2022/ December 31, 2021 Change
	Amount			%
Real estate:
Residential	$	2,576			1.3
Commercial		169,976			24.7
Agricultural		5,750			1.8
Construction		24,118			43.8
Consumer		98,517			381.0
Other commercial loans		(8,344	)		(11.2	)
Other agricultural loans		(10,343	)		(26.0	)
State & political subdivision loans		14,170			31.0
Total loans	$	296,420			20.6

Index

The Bank’s lending efforts have historically been focused in north central Pennsylvania and southern New York. With the acquisition of FNB and the opening of offices in Lancaster County, this focus has grown to include Lebanon, Schuylkill, Berks and Lancaster County markets of south central, Pennsylvania. We have a limited branch office in Union County that is staffed by a lending team to primarily support agricultural opportunities in central Pennsylvania. In December 2017, we completed a branch acquisition in State College, which provides us with opportunities in Centre County, Pennsylvania and other areas of central Pennsylvania. In April 2020, we completed the MidCoast acquisition, which expanded our markets into the State of Delaware with activity centered around the cities of Wilmington and Dover, Delaware. In November of 2020, we opened a branch in Kennett Square, Pennsylvania, to further serve customers obtained as part of the MidCoast acquisition, as well as to expand operations into Chester County, Pennsylvania. We have received approval to open offices in Ephrata, Pennsylvania, which will help to better serve our customers in Lancaster County and Greenville, Delaware to provide better services to the Wilmington market. We expect both offices to open in the fourth quarter of 2022. We originate loans primarily through direct loans to our existing customer base, with new customers generated through the strong relationships our lending teams have with their customers and our lenders expertise in certain areas, as well as by referrals from real estate brokers, building contractors, attorneys, accountants, corporate and advisory board members, existing customers and the Bank’s website. The Bank offers a variety of loans although historically most of our lending has focused on real estate loans including residential, commercial, agricultural, and construction loans. All lending is governed by a lending policy that is developed and administered by management and approved by the Board of Directors. As of September 30, 2022, the Company had one industry specific loan concentration to the dairy industry, totaling $121.5 million or 7.0% of total loans compared to $127.4 million or 8.8% of total loans at December 31, 2021.

During the first nine months of 2022, the primary driver of growth was the Delaware markets, which saw significant activity in commercial real estate loan, construction loan and consumer loan activity. Agricultural loans decreased $10.3 million primarily due to paydowns on lines of credit. The decrease in other commercial loans is due to forgiveness of PPP loans. Loans issued as part of the PPP program totaled $6.8 million as of December 31, 2021, all of which were either forgiven or repaid by September 30, 2022. The increase in consumer loans is due to an increase in student loans, which is expected to have additional increases over the remainder of 2022. The increase in state and political loans was due to two loans closed in the second quarter. Commercial and agricultural loan demand is subject to significant competitive pressures, the yield curve, and overall national, regional and local economic conditions.

While the Bank lends to companies that service companies that explore for natural gas in our market area, the Bank has not originated any loans to companies performing the actual drilling and exploration activities. Loans made by the Bank are to service industry customers which include trucking companies, stone quarries and other support businesses, favoring customers that have had a relationship with the Bank prior to supporting the exploration for natural gas. We also have originated loans to businesses and individuals for restaurants, hotels and apartment rentals that have been developed and expanded to meet the housing and living needs of the gas industry workers. Due to our understanding of the industry and its cyclical nature, the loans made for natural gas-related activities have been originated in accordance with specific policies and procedures for lending to these entities, which include more stringent loan to value thresholds, shortened amortization periods, and expansion of our monitoring of loan concentrations associated with this activity.

For loans sold on the secondary market, the Company recognizes fee income for servicing these sold loans, which is included in non-interest income.

Index

Allowance for Loan Losses

The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb probable future loan losses inherent in the loan portfolio. The provision for loan losses is charged against current income. Loans deemed not collectable are charged-off against the allowance while subsequent recoveries increase the allowance. The allowance for loan losses was $18,291,000 or 1.05% of total loans as of September 30, 2022 as compared to $17,304,000 or 1.20% of loans as of December 31, 2021. The $987,000 increase is a result of a $1,425,000 provision for loan losses less net charge-offs of $438,000. During 2022, net charge-offs primarily related to one customer that filed bankruptcy. The following table shows the distribution of the allowance for loan losses and the percentage of loans compared to total loans by loan category as of September 30, 2022 and December 31, 2021 (dollars in thousands):

	September 30, 2022					December 31, 2021
	Amount			%		Amount		%
Real estate loans:
Residential	$	1,005			11.7	$	1,147		14.0
Commercial		9,937			49.3		8,099		47.7
Agricultural		4,538			18.3		4,729		21.6
Construction		678			4.6		434		3.8
Consumer		232			7.2		262		1.8
Other commercial loans		393			3.8		1,023		5.2
Other agricultural loans		1,359			1.7		558		2.8
State & political subdivision loans		325			3.4		281		3.1
Unallocated		(176	)		N/A		771		N/A
Total allowance for loan losses	$	18,291			100.0	$	17,304		100.0

The following table provides information related to credit loss experience and loan quality for the nine months ended September 30, 2022 and the year ended December 31, 2021 (dollars in thousands).

September 30, 2022	Credit Loss Expense (Benefit)			Net (charge- offs) Recoveries			Average Loans		Ratio of net (charge-offs) recoveries to Average loans			Allowance to total loans			Non- accrual loans as a percent of loans			Allowance to total non- accrual loans
Real estate:
Residential	$	(142	)	$	-		$	202,856		0.00	%		0.49	%		0.28	%		173.88	%
Commercial		1,838			-			755,444		0.00	%		1.16	%		0.33	%		350.76	%
Agricultural		(191	)		-			312,222		0.00	%		1.43	%		1.04	%		137.72	%
Construction		244			-			69,437		0.00	%		0.86	%		0.00	%	NA
Consumer		(15	)		(15	)		47,732		-0.03	%		0.19	%		0.00	%	NA
Other commercial loans		(207	)		(423	)		73,922		-0.57	%		0.59	%		0.14	%		418.09	%
Other agricultural loans		801			-			35,549		0.00	%		4.61	%		1.08	%		427.36	%
State & political subdivision loans		44			-			54,836		0.00	%		0.54	%		0.00	%	NA
Unallocated		(947	)		-			-	NA			NA			NA			NA
Total	$	1,425		$	(438	)	$	1,551,998		-0.03	%		1.05	%		0.41	%		256.97	%

December 31, 2021	Credit Loss Expense (Benefit)			Net (charge- offs) Recoveries			Average Loans		Ratio of net (charge-offs) recoveries to Average loans			Allowance to total loans			Non-accrual loans as a percent of loans			Allowance to total non- accrual loans
Real estate:
Residential	$	(27	)	$	-		$	203,062		0.00	%		0.57	%		0.30	%		192.77	%
Commercial		1,848			35			639,161		0.01	%		1.18	%		0.43	%		275.01	%
Agricultural		(224	)		-			312,770		0.00	%		1.52	%		1.00	%		150.94	%
Construction		312			-			56,315		0.00	%		0.79	%		0.00	%	NA
Consumer		(53	)		(6	)		24,125		-0.02	%		1.01	%		0.00	%	NA
Other commercial loans		(113	)		(90	)		99,839		-0.09	%		1.37	%		0.19	%		730.71	%
Other agricultural loans		(306	)		-			37,181		0.00	%		1.40	%		2.01	%		69.49	%
State & political subdivision loans		(198	)		-			52,804		0.00	%		0.61	%		0.00	%	NA
Unallocated		311			-			-	NA			NA			NA			NA
Total	$	1,550		$	(61	)	$	1,425,257		0.00	%		1.20	%		0.53	%		227.21	%

Index

The Company believes it utilizes a disciplined and thorough loan review process based upon its internal loan policy approved by the Company’s Board of Directors. The purpose of the review is to assess loan quality, analyze delinquencies, identify problem loans, evaluate potential charge-offs and recoveries, and assess general overall economic conditions in the markets served. An external independent loan review is performed on our commercial portfolio at least semi-annually for the Company. The external consultant is engaged to 1) review a minimum of 50% of the dollar volume of the commercial loan portfolio on an annual basis, 2) new loans originated for over $1.0 million in the last year, 3) review a sample of borrowers with commitments greater than or equal to $1.0 million, 4) 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. As part of this review, our underwriting process and loan grading system is evaluated.

Management believes it uses the best information available to make such determinations and that the allowance for loan losses is adequate as of September 30, 2022. However, future adjustments could be required if circumstances differ substantially from assumptions and estimates used in making the initial determination. A prolonged downturn in the economy, changes in the economies of various segments of our agricultural and commercial portfolios, high unemployment rates, significant changes in the value of collateral and delays in receiving financial information from borrowers could result in increased levels of non-performing assets, charge-offs, loan loss provisions and reduction in income. Additionally, bank regulatory agencies periodically examine the Bank’s allowance for loan losses. The banking agencies could require the recognition of additions to the allowance for loan losses based upon their judgment of information available to them at the time of their examination.

On a monthly basis, problem loans are identified and updated primarily using internally prepared past due reports. Based on data surrounding the collection process of each identified loan, the loan may be added or deleted from the monthly watch list. The watch list includes loans graded special mention, substandard, doubtful, and loss, as well as additional loans that management may choose to include. Watch list loans are continually monitored going forward until satisfactory conditions exist that allow management to upgrade and remove the loan from the watchlist. In certain cases, loans may be placed on non-accrual status or charged-off based upon management’s evaluation of the borrower’s ability to pay. All commercial loans, which include commercial real estate, agricultural real estate, state and political subdivision loans, other commercial loans and other agricultural loans, on non-accrual are evaluated quarterly for impairment.

See also “Note 5 – Loans and Related Allowance for Loan Losses” to the consolidated financial statements.

As a result of previous loss experiences and other risk factors utilized in determining the allowance, the Bank’s allocation of the allowance does not directly correspond to the actual balances of the loan portfolio. While commercial and agricultural real estate loans total 67.6% of the loan portfolio at September 30, 2022, 79.1% of the allowance is assigned to these portions of the loan portfolio as these loans have more inherent risks than residential real estate or loans to state and political subdivisions. Residential real estate loans comprise 11.7% of the loan portfolio as of September 30, 2022 and 5.5% of the allowance is assigned to this segment as generally there are less inherent risks then commercial and agricultural loans.

Index

The following table is a summary of our non-performing assets as of September 30, 2022 and December 31, 2021.

	September 30,		December 31,
(dollars in thousands)	2022		2021
Non-performing loans:
Non-accruing loans	$	7,118	$	7,616
Accrual loans - 90 days or more past due		93		46
Total non-performing loans		7,211		7,662
Foreclosed assets held for sale		877		1,180
Total non-performing assets	$	8,088	$	8,842

The following table identifies amounts of loans contractually past due 30 to 90 days and non-performing loans by loan category, as well as the change from December 31, 2021 to September 30, 2022 in non-performing loans (in thousands). Non-performing loans include those accruing loans that are contractually past due 90 days or more and non-accrual loans. Interest does not accrue on non-accrual loans. Subsequent cash payments received are applied to the outstanding principal balance or recorded as interest income, depending upon management's assessment of its ultimate ability to collect principal and interest.

	September 30, 2022								December 31, 2021
			Non-Performing Loans								Non-Performing Loans
(in thousands)	30 - 89 Days Past Due Accruing		90 Days Past Due Accruing		Non- accrual		Total Non- Performing		30 - 89 Days Past Due Accruing		90 Days Past Due Accruing		Non- accrual		Total Non- Performing
Real estate:
Residential	$	1,525	$	21	$	578	$	599	$	492	$	13	$	595	$	608
Commercial		677		72		2,833		2,905		243		33		2,945		2,978
Agricultural		-		-		3,295		3,295		31		-		3,133		3,133
Construction		-		-		-		-		-		-		-		-
Consumer		108		-		-		-		163		-		-		-
Other commercial loans		107		-		94		94		28		-		140		140
Other agricultural loans		199		-		318		318		10		-		803		803
Total nonperforming loans	$	2,616	$	93	$	7,118	$	7,211	$	967	$	46	$	7,616	$	7,662

	Change in Non-Performing Loans
	September 30, 2022 /December 31, 2021
(in thousands)	Amount			%
Real estate:
Residential	$	(9	)		(1.5	)
Commercial		(73	)		(2.5	)
Agricultural		162			5.2
Construction		-		NA
Consumer		-		NA
Other commercial loans		(46	)		(32.9	)
Other agricultural loans		(485	)		(60.4	)
Total nonperforming loans	$	(451	)		(5.9	)

The Company worked with customers directly affected by the COVID-19 pandemic. The Company offered assistance in accordance with regulatory guidelines. As a result of the COVID-19 pandemic, the Company is engaging in more frequent communication with borrowers to better understand their financial situation and the challenges faced, allowing it to respond proactively as needs and issues arise. Should economic conditions worsen, the Company could experience increases in non-performing loans and further increases in its required allowance for loan losses and record additional provision expense. It is possible that the Company's asset quality measures could worsen at future measurement periods if the effects of the COVID-19 pandemic are prolonged.

For the nine months ended September 30, 2022, we recorded a provision for loan losses of $1,425,000 which compares to $1,550,000 for the same period in 2021, a decrease of $125,000. The decrease is primarily attributable to the impact that the COVID-19 pandemic had in 2021 on the national and local economies compared to 2022. Non-performing loans decreased $451,000 from December 31, 2021 to September 30, 2022. At September 30, 2022, approximately 61.2% of the Bank’s non-performing loans are associated with the following three customer relationships:

Index

•

A commercial loan relationship with $1.3 million outstanding, and additional letters of credit of $1.2 million available, secured by undeveloped land, stone quarries and equipment, was on non-accrual status as of September 30, 2022. The Company services the natural gas industry, as well as local municipalities. As a result, the reduced exploration for natural gas in north central Pennsylvania has significantly impacted the cash flows of the customer, who provides excavation services and stone for pad construction related to these activities. During 2020, the Company had the underlying equipment collateral appraised and in the first quarter of 2022, the Company had the quarry appraised. The appraisals indicated a decrease in collateral values compared to the appraisal ordered for the loan origination, however, the loan was still considered well secured on a loan to value basis at September 30, 2022. In 2021 and 2022, the customer has liquidated some excess equipment and the funds have been utilized to pay down a portion of the loans. Management determined that no specific reserve was required as of September 30, 2022.

•

An agricultural loan customer with a total loan relationship of $1.9 million, secured by real estate, equipment and cattle, was on non-accrual status as of September 30, 2022. The customer declared bankruptcy during the fourth quarter of 2018 and developed a workout plan that was approved by the bankruptcy court in the fourth quarter of 2019 and resulted in monthly payments resuming in late 2019 that continues into 2022. Included within these loans to this customer are $736,000 of loans which are subject to Farm Service Agency guarantees. Depressed milk prices and the pandemic have created cash flow difficulties for this customer. Absent a sizable and sustained increase in milk prices, which is not assured, we will need to rely upon the collateral for repayment of interest and principal. During 2020, the Company had the underlying collateral appraised. Management determined that no specific reserve was required as of September 30, 2022.

•

An agricultural loan customer with a total loan relationship of $1.2 million, secured by real estate was on non-accrual status as of September 30, 2022. The COVID-19 pandemic has escalated the cash flow difficulties this customer was experiencing. We expect that we will need to rely upon the collateral for repayment of interest and principal. Management reviewed the collateral and determined that no specific reserve was required as of September 30, 2022.

Management believes that the allowance for loan losses at September 30, 2022 was adequate at that date, which was based on the following factors:

•

Three loan relationships comprise 61.2% of the non-performing loan balance, which did not require any specific reserves as of September 30, 2022.

•

The Company has a history of low charge-offs, which were 0.03% of average loans on an annualized basis for 2022 and 0.0% for 2021.

Bank Owned Life Insurance

The Company holds bank owned life insurance policies to offset future employee benefit costs. These policies provide the Bank with an asset that generates earnings to partially offset the current costs of benefits, and eventually (at the death of the insureds) provide partial recovery of cash outflows associated with the benefits. As of September 30, 2022, and December 31, 2021, the cash surrender value of the life insurance was $39.1 million and $38.5 million, respectively. The change in cash surrender value, net of purchases and amounts acquired through acquisitions, is recognized in the results of operations. The amounts recorded as non-interest income totaled $216,000 and $165,000 for the three month periods ended September 30, 2022 and 2021, respectively. For the nine months ended September 30, 2022 and 2021, $635,000 and $1,643,000, respectively, was recorded in non-interest income. During the first quarter of 2021, the Company received proceeds of $3,714,000, which included death benefits of $1,155,000 on two former employees of the Company. The Company evaluates annually the risks associated with the life insurance policies, including limits on the amount of coverage and an evaluation of the various carriers’ credit ratings.

Index

The Company policies that were purchased directly from insurance companies are structured so that any death benefits received from a policy while the insured person is an active employee of the Bank will be split with the beneficiary of the policy. Under these agreements, the employee’s beneficiary will be entitled to receive 50% of the net amount at risk from the proceeds. The net amount at risk is the total death benefit payable less the cash surrender value of the policy as of the date of death. The policies acquired as part of the acquisition of FNB provide a fixed split-dollar benefit for the beneficiary’s estate, which is dependent on several factors including whether the covered individual was a former Director of First National Bank of Fredericksburg (“FNB”) or a former employee of FNB and their salary level. As of September 30, 2022, and December 31, 2021, included in other liabilities on the Consolidated Balance Sheet was a liability of $669,000 and $696,000, respectively, for the obligation under the split-dollar benefit agreements.

Premises and Equipment

Premises and equipment increased $351,000 to $17.4 million as of September 30, 2022 from December 31, 2021 as a result of a building purchase that will be utilized for a new branch in Ephrata, Pennsylvania.

Deposits

The following table shows the composition of deposits as of September 30, 2022 and December 31, 2021 (dollars in thousands):

	September 30, 2022				December 31, 2021
	Amount		%		Amount		%
Non-interest-bearing deposits	$	381,380		20.4	$	358,073		19.5
NOW accounts		531,882		28.5		485,292		26.4
Savings deposits		328,912		17.6		313,048		17.0
Money market deposit accounts		347,110		18.6		350,122		19.1
Certificates of deposit		279,427		14.9		329,616		18.0
Total	$	1,868,711		100.0	$	1,836,151		100.0

	September 30, 2022/ December 31, 2021 Change
	Amount			%
Non-interest-bearing deposits	$	23,307			6.5
NOW accounts		46,590			9.6
Savings deposits		15,864			5.1
Money market deposit accounts		(3,012	)		(0.9	)
Certificates of deposit		(50,189	)		(15.2	)
Total	$	32,560			1.8

Deposits increased $32.6 million since December 31, 2021. The Company experienced deposit growth across all markets and product types. Through the first nine months of 2022, customers continued to transfer certificates of deposits primarily into money market and NOW accounts. There were no brokered certificates of deposits as of September 30, 2022 or December 31, 2021.

Borrowed Funds

Borrowed funds were $258.9 million and $74.0 million as of September 30, 2022 and December 31, 2021, respectively. The increase in borrowed funds was due additional borrowings to fund loan growth that occurred in 2022. During 2022, short term advances from the Federal Home Loan Bank of Pittsburgh increased $189.0 million, which were offset by $4.7 million of long term borrowings from the Federal Home Loan Bank of Pittsburgh maturing and an increased in repurchase agreements of $614,000. As of September 30, 2022, long-term advances total $27.4 million, short-term advances total $214.0 million and repurchase agreements total $17.5 million.

Index

In April 2020, the Bank entered into two interest rate swap agreements to convert floating-rate debt to fixed rate debt on notional amounts of $15.0 million and $10.0 million. The interest rate swap instruments involve an agreement to receive a floating rate and pay a fixed rate, at specified intervals, calculated on the agreed-upon notional amounts. The differentials paid or received on interest rate swap agreements are recognized as adjustments to interest expense in the period. The interest rate swap agreements were entered into on April 1, 2020 and expire on April 1, 2025 and April 1, 2027. In April 2020, the Company entered into an interest rate swap agreement to convert floating-rate debt to fixed rate debt on a notional amounts of $7.5 million. The interest rate swap instrument involves an agreement to receive a floating rate and pay a fixed rate, at specified intervals, calculated on the agreed-upon notional amount. The differentials paid or received on interest rate swap agreements are recognized as adjustments to interest expense in the period. The interest rate swap agreements were entered into on April 13, 2020 and expire on June 17, 2027. In May of 2020, the Bank entered into three two year forward interest rate swaps that will convert floating rate debt to fixed rate debt on notional amounts of $6.0 million each. The interest rate swap instruments involves an agreement to receive a floating rate and pay a fixed rate, at specified intervals, calculated on the agreed-upon notional amount. The differentials paid or received on interest rate swap agreements are recognized as adjustments to interest expense in the period. The interest rate swap agreements were entered into on May 14, 2020 and expire on May 14, 2027, 2029 and 2032. The fair value of the interest rate swaps at September 30, 2022 was $6,169,000 and is included within fair value of derivative instruments on the consolidated balance sheets.

The Company’s current strategy for borrowings is to consider terms and structures to manage interest rate risk and liquidity in a rising rate environment. The Company's daily cash requirements or short-term investments are primarily met by using the financial instruments available through the Federal Home Loan Bank of Pittsburgh.

Stockholders’ Equity

We evaluate stockholders’ equity in relation to total assets and the risks associated with those assets. The greater the capital resource, the more likely a corporation will meet its cash obligations and absorb unforeseen losses. For these reasons, capital adequacy has been, and will continue to be, of paramount importance to the Company. As such, the Company has implemented policies and procedures to ensure that it has adequate capital levels. As part of this process, we routinely stress test our capital levels and identify potential risk and alternative sources of additional capital should the need arise.

Total stockholders’ equity was $191.4 million at September 30, 2022 compared to $212.5 million at December 31, 2021, a decrease of $21,062,000, or (9.9%). Excluding accumulated other comprehensive loss, stockholders’ equity increased $14.6 million, or 6.9%. The accumulated comprehensive loss increased $35.7 million, which was primarily the result of the decline in fair value of the Company’s available for sale investment portfolio caused by the rise in market interest rates. The Company purchased 18,697 shares of treasury stock at a weighted average cost of $68.40 per share. For the nine months of 2022, the Company had net income of $21.2 million and declared cash dividends of $5.7 million, or $1.421 per share, representing a cash dividend payout ratio of 26.8%.

All of the Company’s debt investment securities are classified as available-for-sale, making this portion of the Company’s balance sheet more sensitive to the changing market value of investments. As a result of increases in market interest rates, the defined benefit plan obligations and the interest rate swaps entered into during 2020, accumulated other comprehensive loss decreased approximately $35.7 million from December 31, 2021.

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory-and possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under U.S. GAAP, regulatory reporting requirements, and regulatory capital standards. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Index

Quantitative measures established by regulatory capital standards to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and Tier 1 capital (as defined) to risk-weighted assets (as defined), common equity Tier 1 capital (as defined) to total risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). As permitted by applicable federal regulation, the Bank has opted to use the community bank leverage ratio (the “CBLR”) framework for determining its capital adequacy. Under the CBLR framework a qualifying community bank is considered well-capitalized if its leverage ratio (Tier 1 capital divided by average total consolidated assets) exceeds 9%. Following the passage of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act in response to the COVID-19 pandemic, the federal banking regulators revised the CBLR framework as follows: (i) beginning in the second quarter of 2020, a qualifying community bank need only have a leverage ratio of at least 8%, subject to the other qualifying requirements, and (ii) if a qualifying community bank’s leverage ratio falls below 8%, then it will have two calendar quarters to maintain a leverage ratio of 7% or greater. These revisions under the CARES Act are effective April 23, 2020 and terminated on December 31, 2020. Following such termination there is a grace period for returning to the 9% CBLR threshold. The CBLR was set at 8.5% for 2021, and 9% thereafter. The grace period is also adjusted to account for the graduating increase. As a result, in 2021, a qualifying community bank utilizing the grace period must maintain a CBLR of at least 7.5%. Thereafter, a qualifying community bank utilizing the grace period must maintain a CBLR of at least 8%. If a qualifying community bank fails to maintain the applicable minimum CBLR during the grace period, or if it is unable to restore compliance with the CBLR within the grace period, then it will revert to the Basel III capital framework and the normal Prompt Corrective Action capital categories will apply. At September 30, 2022, the Bank leverage ratio under the CBLR framework was 8.67%, which is less than 9.0% requirement to be considered “well-capitalized” under the CBLR. As such as of September 30, 2022 and going forward, the Bank will revert to the prompt corrective action framework and will not be utilizing the CBLR framework. The following table provides the Bank’s computed risk‑based capital ratios as of September 30, 2022, which reflects the Bank being well capitalized on that date (dollars in thousands):

	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions
September 30, 2022	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total Capital (to Risk Weighted Assets):
Company	$	232,630		12.49	%	$	148,976		8.00	%	$	186,219		10.00	%
Bank	$	216,172		11.63	%	$	148,749		8.00	%	$	185,937		10.00	%

Tier 1 Capital (to Risk Weighted Assets):
Company	$	204,174		10.96	%	$	111,732		6.00	%	$	148,976		8.00	%
Bank	$	197,716		10.63	%	$	111,562		6.00	%	$	148,749		8.00	%

Common Equity Tier 1 Capital (to Risk Weighted Assets):
Company	$	196,674		10.56	%	$	83,799		4.50	%	$	121,043		6.50	%
Bank	$	197,716		10.63	%	$	83,671		4.50	%	$	120,859		6.50	%

Tier 1 Capital (to Average Assets):
Company	$	204,174		8.95	%	$	91,292		4.00	%	$	114,115		5.00	%
Bank	$	197,716		8.67	%	$	91,198		4.00	%	$	113,998		5.00	%

Off-Balance Sheet Activities

Some financial instruments, such as loan commitments, credit lines, and letters of credit, are issued to meet customer financing needs but are not recorded on the Company’s balance sheet. The contractual amount of financial instruments with off-balance sheet risk was as follows at September 30, 2022 and December 31, 2021 (in thousands):

	September 30, 2022		December 31, 2021
Commitments to extend credit	$	431,274	$	275,998
Standby letters of credit		16,823		17,083
	$	448,097	$	293,081

Index

We also offer limited overdraft protection as a non-contractual courtesy which is available to demand deposit accounts in good standing. Overdraft charges as a result of ATM withdrawals and one time point of sale (non-recurring) transactions require prior approval of the customer. The non-contractual amount of financial instruments with off-balance sheet risk at September 30, 2022 and December 31, 2021 was $12,225,000 and $12,230,000, respectively. The Company reserves the right to discontinue this service without prior notice.

Liquidity

Liquidity is a measure of the Company's ability to efficiently meet normal cash flow requirements of both borrowers and depositors. To maintain proper liquidity, we use funds management policies, which include liquidity target ratios, along with our investment policies to assure we can meet our financial obligations to depositors, credit customers and stockholders. Liquidity is needed to meet depositors' withdrawal demands, extend credit to meet borrowers' needs, provide funds for normal operating expenses and cash dividends, and to fund other capital expenditures.

Cash generated by operating activities, investing activities and financing activities influences liquidity management. Our Company's historical activity in this area can be seen in the Consolidated Statement of Cash Flows. The most important source of funds is core deposits. Repayment of principal on outstanding loans and cash flows created from the investment portfolio are also factors in liquidity management. Other sources of funding include brokered certificates of deposit and the sale of loans or investments, if needed.

The Company's use of funds is shown in the investing activity section of the Consolidated Statement of Cash Flows, where the net loan activity is presented. Other uses of funds include purchasing stock from the Federal Home Loan Bank (FHLB) of Pittsburgh, as well as capital expenditures. Capital expenditures (including software purchases), during the first nine months of 2022 were $1,150,000 compared to $1,043,000 during the same time period in 2021.

Short-term debt from the FHLB supplements the Bank’s availability of funds. The Bank achieves liquidity primarily from temporary or short‑term investments in the Federal Reserve and the FHLB. The Bank had a maximum borrowing capacity at the FHLB of approximately $833.8 million, of which $269.0 million was outstanding, at September 30, 2022. The Bank also had two federal funds lines with third party providers in the total amount of $34.0 million as of September 30, 2022, which are unsecured and undrawn upon. We also have a borrower in custody line with the Federal Reserve Bank of approximately $1.1 million, which also is not drawn upon as of September 30, 2022. The Company continues to evaluate its liquidity needs and as necessary finds additional sources.

Citizens Financial Services, Inc. is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, Citizens Financial Services, Inc. is responsible for paying any dividends declared to its shareholders. Citizens Financial also has repurchased shares of its common stock. Citizens Financial Services, Inc.’s primary source of income is dividends received from the Bank. Both federal and state laws impose restrictions on the ability of the Bank to pay dividends. In particular, the Bank may not, as a state-chartered bank which is a member of the Federal Reserve System, declare a dividend without approval of the Federal Reserve, unless the dividend to be declared by the Bank’s Board of Directors does not exceed the total of: (i) the Bank’s net profits for the current year to date, plus (ii) its retained net profits for the preceding two current years, less any required transfers to surplus. The Federal Reserve Board and the FDIC have formal and informal policies which provide that insured banks and bank holding companies should generally pay dividends only out of current operating earnings, with some exceptions. The Prompt Corrective Action Rules, described above, further limit the ability of banks to pay dividends, because banks which are not classified as well capitalized or adequately capitalized may not pay dividends and no dividend may be paid which would make the Bank undercapitalized after the dividend. At September 30, 2022, Citizens Financial Services, Inc. (on an unconsolidated basis) had liquid assets of approximately $15.0 million.

Index

Interest Rate and Market Risk Management

The objective of interest rate sensitivity management is to maintain an appropriate balance between the stable growth of income and the risks associated with maximizing income through interest sensitivity imbalances and the market value risk of assets and liabilities.

Because of the nature of our operations, we are not subject to foreign currency exchange or commodity price risk and, because we have no trading portfolio, we are not subject to trading risk. Currently, the Company has equity securities that represent only 0.10% of its total assets and, therefore, equity risk is not significant.

The primary components of interest-sensitive assets include adjustable-rate loans and investments, loan repayments, investment maturities and money market investments. The primary components of interest-sensitive liabilities include maturing certificates of deposit, IRA certificates of deposit and short-term borrowings. Savings deposits, NOW accounts and money market investor accounts are considered core deposits and are not short-term interest sensitive (except for the top-tier money market investor accounts, typically help by local governments, which are paid current market interest rates).

Gap analysis, one of the methods used by us to analyze interest rate risk, does not necessarily show the precise impact of specific interest rate movements on our Company's net interest income because the re-pricing of certain assets and liabilities is discretionary and is subject to competitive and other pressures. In addition, assets and liabilities within the same period may, in fact, be repaid at different times and at different rate levels. We have not experienced the kind of earnings volatility that might be indicated from gap analysis.

The Company currently uses a computer simulation model to better measure the impact of interest rate changes on net interest income. We use the model as part of our risk management and asset liability management processes that we believe will effectively identify, measure, and monitor the Company’s risk exposure. In this analysis, the Company examines the results of movements in interest rates with additional assumptions made concerning prepayment speeds on mortgage loans and mortgage securities. Shock scenarios, which assume a parallel shift in interest rates and is instantaneous, typically have the greatest impact on net interest income. The following is a rate shock analysis and the impact on net interest income as of September 30, 2022 (dollars in thousands):

Changes in Rates	Prospective One-Year Net Interest Income		Change In Prospective Net Interest Income			% Change In Prospective Net Interest Income
-300 Shock	$	76,667	$	(1,566	)		(2.00	)
-200 Shock		77,560		(673	)		(0.86	)
-100 Shock		78,588		355			0.45
Base		78,233		-			-
+100 Shock		76,655		(1,578	)		(2.02	)
+200 Shock		74,883		(3,350	)		(4.28	)
+300 Shock		73,240		(4,993	)		(6.38	)
+400 Shock		71,584		(6,649	)		(8.50	)

The model makes estimates, at each level of interest rate change, regarding cash flows from principal repayments on loans and mortgage backed securities, call activity of other investment securities, and deposit selection, re-pricing and maturity structure. Because of these assumptions, actual results could differ significantly from these estimates which would result in significant differences in the calculated projected change on net interest income. Additionally, the changes above do not necessarily represent the level of change under which management would undertake specific measures to realign its portfolio in order to reduce the projected level of change. It should be noted that the changes in net interest income noted above are in line with Company policy for interest rate risk.

Index

Item 3

Quantitative and Qualitative Disclosure about Market Risk

In the normal course of conducting business activities, the Company is exposed to market risk, principally interest rate risk, through the operations of its banking subsidiary. Interest rate risk arises from market driven fluctuations in interest rates that affect cash flows, income, expense and values of financial instruments and was discussed previously in this Form 10-Q. Management and a committee of the Board of Directors manage interest rate risk (see also “Interest Rate and Market Risk Management”).

Item 4

Control and Procedures

(a) Disclosure Controls and Procedures

The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the SEC (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

(b) Changes to Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting during the quarter ended September 30, 2022 that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting.

PART II ‑ OTHER INFORMATION

Item 1

Legal Proceedings

Management is not aware of any pending or threatened litigation that would have a material adverse effect on the consolidated financial position of the Company. Any pending proceedings are ordinary, routine litigation incidental to the business of the Company and its subsidiary. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Company and its subsidiary by government authorities.

Item 1A

Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1.A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2021, which could materially affect our business, financial condition or future results. At September 30, 2022, the risk factors of the Company have not changed materially from those reported in our 2021 Annual Report on Form 10-K. However, the risks described in our Annual Report on Form 10-K are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

Index

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

ISSUER PURCHASES OF EQUITY SECURITIES

Period	Total Number of Shares (or units Purchased)		Average Price Paid per Share (or Unit)		Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans of Programs		Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs (1)
7/1/22 to 7/31/22		-	$	0.00		-		116,392
8/1/22 to 8/31/22		-	$	0.00		-		116,392
9/1/22 to 9/30/22		-	$	0.00		-		116,392
Total		-	$	0.00		-		116,392

(1)

On April 21, 2020, the Company announced that the Board of Directors authorized the Company to repurchase up to an additional 150,000 shares at an aggregate purchase price not to exceed $12.0 million over a period of 36 months. The repurchases will be conducted through open-market purchases or privately negotiated transactions and will be made from time to time depending on market conditions and other factors. No time limit was placed on the duration of the share repurchase program. Any repurchased shares will be held as treasury stock and will be available for general corporate purposes.

Item 3

Defaults Upon Senior Securities

Not applicable.

Item 4

Mine Safety Disclosure

Not applicable.

Item 5

Other Information

None

Item 6

Exhibits

(a) The following documents are filed as a part of this report:

3.1		Restated Articles of Incorporation of Citizens Financial Services, Inc. ⁽¹⁾

3.2		Articles of Amendment of Restated Articles of Incorporation of Citizens Financial Services, Inc. ⁽²⁾

3.3		Bylaws of Citizens Financial Services, Inc.⁽³⁾

4.1		Form of Common Stock Certificate. ⁽⁴⁾

31.1		Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer

31.2		Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer

32.1		Section 1350 Certification of Chief Executive Officer and Chief Financial Officer

101		The following materials from the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2022, formatted in XBRL (Extensible Business Reporting Language): (i) The Consolidated Balance Sheet (unaudited), (ii) the Consolidated Statement of Income (unaudited), (iii) the Consolidated Statement of Comprehensive Income (unaudited), (iv) the Consolidated Statement of Changes in Stockholders’ Equity, (v) the Consolidated Statement of Cash Flows (unaudited) and (vi) related notes (unaudited).

104		Cover Page Interactive Data File (embedded within the Inline XBRL document)

⁽¹⁾	Incorporated by reference to Exhibit 3.1 to the Company’s Form 10-Q for the quarter ended June 30, 2018, as filed with the Commission on August 9, 2018.

⁽²⁾	Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, as filed with the Commission on April 26, 2021.

⁽³⁾	Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, as filed with the Commission on December 17, 2020.

⁽⁴⁾	Incorporated by reference to Exhibit 4 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005, as filed with the Commission on March 14, 2006.

Index

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	Citizens Financial Services, Inc.
	(Registrant)

November 8, 2022		/s/ Randall E. Black

	By:	Randall E. Black
	President and Chief Executive Officer
	(Principal Executive Officer)

November 8, 2022		/s/ Stephen J. Guillaume

	By:	Stephen J. Guillaume
	Chief Financial Officer
	(Principal Financial and Accounting Officer)


		PAGE
Part I	FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited):
	Consolidated Balance Sheet as of September 30, 2022 and December 31, 2021	1
	Consolidated Statement of Income for the Three and Nine months Ended September 30, 2022 and 2021	2
	Consolidated Statement of Comprehensive (Loss) Income for the Three and Nine Months ended September 30, 2022 and 2021	3
	Consolidated Statement of Changes in Stockholders’ Equity for the Three and Nine Months ended September 30, 2022 and 2021	4
	Consolidated Statement of Cash Flows for the Nine Months ended September 30, 2022 and 2021	5
	Notes to Consolidated Financial Statements	6-30
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	31-54
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	55
Item 4.	Controls and Procedures	55

Part II	OTHER INFORMATION
Item 1.	Legal Proceedings	55
Item 1A.	Risk Factors	55
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	56
Item 3.	Defaults Upon Senior Securities	56
Item 4.	Mine Safety Disclosures	56
Item 5.	Other Information	56
Item 6.	Exhibits	56
	Signatures	57