In connection with the transaction, the Corporation recorded goodwill of $16.4 million and a core deposit intangible asset of $1.5 million. Total loans acquired on April 1, 2019 were valued at $259.3 million, while total deposits assumed were valued at $223.3 million, borrowings were valued at $111.6 million and subordinated debt was valued at $12.4 million. The subordinated debt included an instrument with a fair value of $5.4 million that was redeemed on April 1, 2019 with 0 realized gain or loss. The Corporation acquired available-for-sale debt securities valued at $94.6 million and sold the securities in early April for approximately 0 realized gain or loss. The assets purchased and liabilities assumed in the cash portion of merger consideration transferred in the table below).
The merger was accounted for using the acquisition method of accounting and, accordingly, purchased assets, including identifiable intangible assets, and assumed liabilities were recorded at their respective acquisition dateestimated fair values. The fair value measurementsvalues at the time of assets acquired and liabilities assumed areclosing, subject to refinement for up to one year after the closing date of the acquisition as additional information relative to closing date fair values become available.date. There were no changes in the third quarter 2019adjustments to the preliminary fair value measurements made as of April 1, 2019.
The preliminary fair value of assets acquired, excluding goodwill, totaled $374,922,000, while the preliminary fair value ofor liabilities assumed totaled $348,947,000. Goodwill represents consideration transferred in excess of the fair value of the net assets acquired. At April 1, 2019, the Corporation recognized preliminary goodwill of $16,676,000 associated with the acquisition. The goodwill resulting from the acquisition represents the value expected from the expansion of the Corporation’s market into Southeastern Pennsylvania. Goodwill acquired in the Monument merger is not deductible for tax purposes as the acquisition is accounted for as a tax-free exchange for tax purposes.2020.
CITIZENS & NORTHERN CORPORATION – FORM 10-Q
The following table summarizes the consideration paid for Monument and the preliminary estimated fair values of the assets acquired and liabilities assumed at the acquisition date:
| (In Thousands) | | | |
| | | | |
| Fair value of consideration transferred: | | | |
| Cash | | $ | 9,698 | |
| Common stock issued | | | 32,953 | |
| Total consideration transferred | | $ | 42,651 | |
| | | | | |
| Preliminary estimated fair values of assets acquired and (liabilities) assumed: | | | | |
| Cash and cash equivalents | | $ | 7,920 | |
| Available-for-sale debt securities | | | 94,568 | |
| Loans receivable | | | 259,295 | |
| Accrued interest receivable | | | 1,593 | |
| Bank premises and equipment | | | 1,465 | |
| Foreclosed assets held for sale | | | 1,064 | |
| Deferred tax asset, net | | | 664 | |
| Core deposit intangible | | | 1,461 | |
| Goodwill | | | 16,676 | |
| Other assets | | | 6,892 | |
| Deposits | | | (223,303 | ) |
| Short-term borrowings | | | (111,568 | ) |
| Subordinated debt | | | (12,375 | ) |
| Accrued interest and other liabilities | | | (1,701 | ) |
| Estimated excess fair value of assets acquired over liabilities assumed | | $ | 42,651 | |
In the consolidated statements of cash flows, noncash investing and financing activities include the issuance of common stock as part of the merger consideration as well as the following categories of assets acquired and liabilities assumed from Monument as reflected in the table above: available-for-sale debt securities, loans receivable, bank premises and equipment, foreclosed assets held for sale, core deposit intangible, goodwill, Federal Home Loan Bank of Pittsburgh stock of $5,478,000 (included in other assets above), deposits, short-term borrowings and subordinated debt.
Acquisition date fair values for available-for-sale securities were determined using Level 1 inputs consistent with the methods discussed further in Note 13. The Corporation sold the acquired securities in April 2019 for approximately no realized gain or loss.
The determination of estimated fair values of the acquired loans required the Corporation to make certain estimates about discount rates, future expected cash flows, market conditions and other future events that are highly subjective in nature. Based on such factors as past due status, nonaccrual status, bankruptcy status, and credit risk ratings, the acquired loans were evaluated, and four loans (from three relationships) displayed evidence of credit quality deterioration. These loans are accounted for under ASC 310-30 (purchased credit impaired, or “PCI”). The majority of the purchased loans did not display evidence of impairment, and thus are accounted for under ASC 310-20. Expected cash flows, both principal and interest, were estimated based on key assumptions covering such factors as prepayments, default rates and severity of loss given default. These assumptions were developed using both Monument’s historical experience and the portfolio characteristics as of the acquisition date as well as available market research. The fair value estimates for acquired loans were based on the amount and timing of expected principal, interest and other cash flows, including expected prepayments, discounted at prevailing market interest rates applicable to the types of acquired loans, which the Corporation considers Level 3 fair value measurements.
CITIZENS & NORTHERN CORPORATION – FORM 10-Q
Loans acquired from Monument were measured at fair value at the acquisition date with no carryover of an allowance for loan losses. The following table presents performing and PCI loans acquired, by loan segment and class, at April 1, 2019:
(In Thousands)
| | | Performing | | | PCI | | | Total | |
| Residential mortgage: | | | | | | | | | | | | |
| Residential mortgage loans - first liens | | $ | 107,645 | | | $ | 77 | | | $ | 107,722 | |
| Residential mortgage loans - junior liens | | | 2,433 | | | | 0 | | | | 2,433 | |
| Home equity lines of credit | | | 2,674 | | | | 0 | | | | 2,674 | |
| 1-4 Family residential construction | | | 510 | | | | 0 | | | | 510 | |
| Total residential mortgage | | | 113,262 | | | | 77 | | | | 113,339 | |
| Commercial: | | | | | | | | | | | | |
| Commercial loans secured by real estate | | | 113,821 | | | | 364 | | | | 114,185 | |
| Commercial and industrial | | | 7,571 | | | | 0 | | | | 7,571 | |
| Commercial construction and land | | | 4,617 | | | | 0 | | | | 4,617 | |
| Loans secured by farmland | | | 267 | | | | 0 | | | | 267 | |
| Multi-family (5 or more) residential | | | 17,493 | | | | 0 | | | | 17,493 | |
| Other commercial loans | | | 835 | | | | 0 | | | | 835 | |
| Total commercial | | | 144,604 | | | | 364 | | | | 144,968 | |
| Consumer | | | 988 | | | | 0 | | | | 988 | |
| Total | | $ | 258,854 | | | $ | 441 | | | $ | 259,295 | |
The following table presents the preliminary fair value adjustments made to the amortized cost basis of loans acquired at April 1, 2019:
| (In Thousands) | | | |
| | | | |
| Gross amortized cost at acquisition | | $ | 263,334 | |
| Market rate adjustment | | | (1,807 | ) |
| Credit fair value adjustment on non-credit impaired loans | | | (1,914 | ) |
| Credit fair value adjustment on impaired loans | | | (318 | ) |
| Estimated fair value of acquired loans | | $ | 259,295 | |
The market rate adjustment represents the movement in interest rates, irrespective of credit adjustments, compared to the contractual rates of the acquired loans. The credit adjustment made on non-PCI loans represents changes in credit quality of the underlying borrowers from loan inception to the acquisition date.
The credit adjustment on PCI loans is derived in accordance with ASC 310-30 and represents the portion of the loan balances that have been deemed uncollectible for each loan. The PCI loans are secured by real estate and the fair value of each loan was determined based on the estimated proceeds to be derived from selling the collateral, net of selling costs. The PCI loans were placed into nonaccrual status upon acquisition (and remained in nonaccrual status at September 30, 2019) as the Corporation cannot reasonably estimate cash flows expected to be collected in order to compute yield on the loans.
The Corporation recognized a core deposit intangible of $1,461,000. The core deposit intangible represents the estimated value of lower-cost funding provided by the nonmaturity deposits assumed in comparison with the Corporation’s estimated cost of borrowing funds in the market. The core deposit intangible will be amortized over a weighted-average life of 4.4 years.
Deposit liabilities assumed were segregated into two categories: (1) nonmaturity deposits (checking, savings and money market), and (2) time deposits (deposit accounts with a stated maturity). The fair values of both categories of deposits were determined using level 2 fair value measurements. For nonmaturity deposits, the acquisition date outstanding balance of the assumed demand deposit accounts approximates fair value. In determining the fair value of time deposits, the Corporation discounted the contractual cash flows of the deposit accounts using prevailing market interest rates for time deposit accounts of similar type and duration.
CITIZENS & NORTHERN CORPORATION – FORM 10-Q
Short-term borrowings assumed consisted of advances from the Federal Home Loan Bank of Pittsburgh. The fair value of short-term borrowings was determined using Level 2 measurements by discounting the contractual cash flows of the borrowings using Federal Home Loan Bank interest rates available April 1, 2019 for advances to the same maturities as those of the deposits assumed.
Subordinated debt assumed included two issues: (1) agreements with par values totaling $5,375,000 which were redeemed on April 1, 2019; and (2) agreements with par values totaling $7,000,000, maturing April 1, 2027 and which may be redeemed at par beginning April 1, 2022. The fair value of subordinated debt was determined using Level 2 measurements by comparing the interest rates on the debt to the rates on similar recent issues of comparable size by other similar-sized banking companies.
The Corporation incurred merger-related expenses of $3,818,000 in the nine-month period ended September 30, 2019, including $206,000 in the third quarter 2019. For the three-month and nine-month periods ended September 30, 2018, merger-related expenses totaled $200,000. Merger-related expenses, include costs associated with termination of data processing contracts,including legal and professional expenses and conversion of Monument’s customer accounting data into the Corporation’s core system, were $3,301,000 in the second quarter 2019 and $3,612,000 in the six-month period ended June 30, 2019.
Acquisition of Covenant Financial, Inc.
In December 2019, the Corporation announced a plan of merger to acquire Covenant Financial, Inc. (“Covenant”). In July 2020, the Corporation and Covenant announced the completion of the merger as of July 1, 2020. Covenant was the holding company for Covenant Bank, which operated banking offices in Bucks and Chester Counties of PA. Under the terms of the Agreement and Plan of Merger, Covenant merged into the Corporation, and Covenant Bank merged into C&N Bank. In the transaction, Covenant shareholders elected to receive either 0.6212 shares of Corporation common stock or $16.50 in cash for each share of Covenant common stock owned, subject to proration to ensure that, overall, 25% of the Covenant shares were converted into cash and 75% of the Covenant shares were converted into Corporation stock. The election and proration process commenced in June 2020 and was completed in early July 2020. Holders of Covenant common stock prior to the consummation of the merger own approximately 12.9% of the Corporation’s common stock outstanding following the merger.
Based on the average of the high and low trading price of the Corporation’s common stock of $20.32 per share on July 1, 2020, the total purchase consideration is valued at approximately $63.3 million. As of June 30, 2020, Covenant reported total assets of $608 million, including gross loans of $472 million, total deposits of $480 million and total stockholders’ equity of $44 million. As of the date the Corporation’s June 30, 2020 financial statements are issued, some of the information required to be disclosed under U.S. GAAP was not available since, given the short period between the July 1, 2020 merger date and the financial statement issuance, the calculation of the fair value of all material Covenant assets acquired and liabilities assumed had not yet been completed.
Merger-related expenses related to the planned acquisition of Covenant totaled $983,000 in the second quarter 2020 and $1,124,000 in the six-month period ended June 30, 2020. Merger-related expenses include severance and similar expenses as well as initial expenses related to conversion of Covenant’s core customer data into the Corporation’s core system and legal and other professional fees and various other costs.
The following table presents pro forma information as if the merger between the Corporation and Monument had been completed on January 1, 2018. The pro forma information does not necessarily reflect the results of operations that would have occurred had the merger taken place at the beginning of 2018. The supplemental pro forma information excludes the after-tax cost ofexpenses. Management estimates total pre-tax merger-related expenses totaling $147,000associated with the Covenant transaction will be approximately $8.0 million, including remaining expenses of approximately $6.6 million. Most of the expenses are expected to be incurred in the three-month period ended September 30, 2019, $3,020,000 in the nine-month period ended September 30, 2019 and $194,000 in the three-month and nine-month periods ended September 30, 2018. The pro forma information does not include the impact of possible business model changes nor does it consider any potential impacts of current market conditions or revenues, expense efficiencies or other factors.third quarter 2020.
(In Thousands Except Per Share Data)
| | | 3 Months Ended | | | 9 Months Ended | |
| | | Sept. 30, | | | Sept. 30, | | | Sept. 30, | | | Sept. 30, | |
| | | 2019 | | | 2018 | | | 2019 | | | 2018 | |
| Interest income | | $ | 17,125 | | | $ | 16,852 | | | $ | 51,591 | | | $ | 48,905 | |
| Interest expense | | | 2,814 | | | | 2,745 | | | | 8,675 | | | | 7,509 | |
| Net interest income | | | 14,311 | | | | 14,107 | | | | 42,916 | | | | 41,396 | |
| Provision for loan losses | | | 1,158 | | | | 450 | | | | 242 | | | | 727 | |
| Net interest income after provision for loan losses | | | 13,153 | | | | 13,657 | | | | 42,674 | | | | 40,669 | |
| Noninterest income | | | 4,963 | | | | 4,484 | | | | 14,234 | | | | 13,656 | |
| Net gains on securities | | | 13 | | | | 569 | | | | 20 | | | | 2,767 | |
| Other noninterest expenses | | | 11,474 | | | | 11,690 | | | | 35,357 | | | | 34,782 | |
| Income before income tax provision | | | 6,655 | | | | 7,020 | | | | 21,571 | | | | 22,310 | |
| Income tax provision | | | 1,165 | | | | 1,066 | | | | 3,765 | | | | 3,679 | |
| Net income | | $ | 5,490 | | | $ | 5,954 | | | $ | 17,806 | | | $ | 18,631 | |
| | | | | | | | | | | | | | | | | |
| Earnings per common share - basic | | $ | 0.40 | | | $ | 0.44 | | | $ | 1.26 | | | $ | 1.37 | |
| Earnings per common share - diluted | | $ | 0.40 | | | $ | 0.44 | | | $ | 1.26 | | | $ | 1.37 | |
CITIZENS & NORTHERN CORPORATION – FORM 10-Q
3. PER SHARE DATA
Basic earnings per common share are calculated using the two-class method to determine income attributable to common shareholders. Unvested restricted stock awards that contain nonforfeitable rights to dividends are considered participating securities under the two-class method. Distributed dividends and an allocation of undistributed net income to participating securities reduce the amount of income attributable to common shareholders. Income attributable to common shareholders is then divided by weighted-average common shares outstanding for the period to determine basic earnings per common share.
