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, 2020March 31, 2021
Or

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

For the transition period from_____________________ to ___________________

Commission file number 0-13222

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

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

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

Registrant’s telephone number, including area code: (570) 662‑2121

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

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

     
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 OctoberMarch 31, 2020,2021, was 3,921,8803,912,679.




Citizens Financial Services, Inc.
Form 10-Q

INDEX

  PAGE
Part IFINANCIAL INFORMATION 
Item 1.Financial Statements (unaudited): 
 
Consolidated Balance Sheet as of September 30,March 31, 2020 and December 31, 20192020
1
 
Consolidated Statement of Income for the Three  and Nine months Ended September 30,March 31, 2021 and 2020 and 2019
2
 
Consolidated Statement of Comprehensive Income for the Three and Nine months ended September 30,March 31, 2021 and 2020 and 2019
3
 
Consolidated Statement of Changes in Stockholders’ Equity for the Three and Nine months ended September 30,March 31, 2021 and 2020 and 2019
4
 
Consolidated Statement of Cash Flows for the NineThree months ended September 30,March 31, 2021 and 2020 and 2019
5
 
Notes to Consolidated Financial Statements
6-376-30
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
38-6131-50
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
6251
Item 4.
Controls and Procedures
6251
   
Part IIOTHER INFORMATION 
Item 1.
Legal Proceedings
6252
Item 1A.
Risk Factors
62-6452
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
6552
Item 3.
Defaults Upon Senior Securities
6553
Item 4.
Mine Safety Disclosures
6553
Item 5.
Other Information
6553
Item 6.
Exhibits
6653
 
Signatures
6753



IndexTable of Contents

CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED BALANCE SHEET
(UNAUDITED)

(in thousands except share data) 
September 30,
2020
  
December 31,
2019
  
March 31,
2021
  
December 31,
2020
 
ASSETS:            
Cash and due from banks:            
Noninterest-bearing $15,922  $17,727  $18,164  $16,374 
Interest-bearing  59,387   793   132,664   52,333 
Total cash and cash equivalents  75,309   18,520   150,828   68,707 
Interest bearing time deposits with other banks  13,758   14,256   13,509   13,758 
Equity securities  1,696   701   2,118   1,931 
Available-for-sale securities  287,838   240,706   321,967   295,189 
Loans held for sale  19,320   815   9,946   14,640 
                
Loans (net of allowance for loan losses:                
2020, $15,169 and 2019, $13,845)  1,350,710   1,101,724 
2021, $16,560 and 2020, $15,815)  1,387,841   1,389,466 
                
Premises and equipment  17,720   15,933   17,450   16,948 
Accrued interest receivable  6,164   4,555   5,572   5,998 
Goodwill  31,376   23,296   31,376   31,376 
Bank owned life insurance  32,408   28,128   30,190   32,589 
Other intangibles  1,538   1,346   1,696   1,668 
Other assets  20,507   16,359   23,117   19,404 
                
TOTAL ASSETS $1,858,344  $1,466,339  $1,995,610  $1,891,674 
                
LIABILITIES:                
Deposits:                
Noninterest-bearing $276,286  $203,793  $336,438  $303,762 
Interest-bearing  1,276,467   1,007,325   1,351,032   1,285,096 
Total deposits  1,552,753   1,211,118   1,687,470   1,588,858 
Borrowed funds  99,602   85,117   86,171   88,838 
Accrued interest payable  1,006   1,088   913   1,017 
Other liabilities  15,932   14,242   22,249   18,702 
TOTAL LIABILITIES  1,669,293   1,311,565   1,796,803   1,697,415 
STOCKHOLDERS’ EQUITY:                
Preferred Stock $1.00 par value; authorized 3,000,000 shares at September 30, 2020 and December 31, 2019; NaN issued in 2020 or 2019  0   0 
Common stock $1.00 par value; authorized 25,000,000 shares at September 30, 2020 and December 31, 2019; issued 4,350,342 at September 30, 2020 and 3,938,668 at December 31, 2019  4,350   3,939 
Preferred Stock $1.00 par value; authorized 3,000,000 shares at March 31, 2021 and December 31, 2020; NaN issued in 2021 or 2020
  0   0 
Common stock $1.00 par value; authorized 25,000,000 shares at March 31, 2021 and December 31, 2020; issued 4,350,342 at March 31, 2021 and 4,350,342 at December 31, 2020
  4,350   4,350 
Additional paid-in capital  75,867   55,089   75,908   75,908 
Retained earnings  121,203   110,800   133,270   126,627 
Accumulated other comprehensive income (loss)  2,865   (629)
Treasury stock, at cost: 428,934 shares at September 30, 2020 and 413,607 shares at December 31, 2019  (15,234)  (14,425)
Accumulated other comprehensive income  1,002   2,587 
Treasury stock, at cost: 437,663 shares at March 31, 2021 and 428,492 shares at December 31, 2020
  (15,723)  (15,213)
TOTAL STOCKHOLDERS’ EQUITY  189,051   154,774   198,807   194,259 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $1,858,344  $1,466,339  $1,995,610  $1,891,674 

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

1
IndexTable of Contents

CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)

 
Three Months Ended
September 30,
  
Nine Months Ended
September 30,
  
Three Months Ended
March 31,
 
(in thousands, except share and per share data) 2020  2019  2020  2019  2021  2020 
INTEREST INCOME:                  
Interest and fees on loans $16,718  $13,915  $46,763  $41,005  $16,694  $13,638 
Interest-bearing deposits with banks  106   103   298   311   106   95 
Investment securities:                        
Taxable  979   1,361   3,212   3,597   850   1,107 
Nontaxable  485   378   1,337   1,109   544   389 
Dividends  98   117   275   371   101   110 
TOTAL INTEREST INCOME  18,386   15,874   51,885   46,393   18,295   15,339 
INTEREST EXPENSE:                        
Deposits  1,635   2,315   5,279   7,027   1,598   1,987 
Borrowed funds  281   660   960   2,216   256   462 
TOTAL INTEREST EXPENSE  1,916   2,975   6,239   9,243   1,854   2,449 
NET INTEREST INCOME  16,470   12,899   45,646   37,150   16,441   12,890 
Provision for loan losses  550   400   1,500   1,150   650   400 
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES
  15,920   12,499   44,146   36,000   15,791   12,490 
NON-INTEREST INCOME:                        
Service charges  1,112   1,225   3,107   3,498   1,106   1,081 
Trust  199   148   542   589   307   198 
Brokerage and insurance  352   289   941   843   376   340 
Gains on loans sold  855   176   1,282   339   503   167 
Equity security (losses) gains, net  (33)  29   (276)  70 
Equity security gains (losses), net  187   (254)
Available for sale security gains, net  185   8   302   8   50   0 
Earnings on bank owned life insurance  180   158   514   463   1,315   156 
Other  688   144   1,046   427   391   163 
TOTAL NON-INTEREST INCOME  3,538   2,177   7,458   6,237   4,235   1,851 
NON-INTEREST EXPENSES:                        
Salaries and employee benefits  6,102   5,096   17,411   15,129   6,263   5,414 
Occupancy  714   530   1,891   1,639   783   526 
Furniture and equipment  267   165   587   501   143   131 
Professional fees  417   343   1,180   1,101   448   325 
FDIC insurance  135   (20)  341   196   129   71 
Pennsylvania shares tax  275   275   809   825   339   275 
Amortization of intangibles  57   66   162   198   49   50 
Merger and acquisition  0   275   2,179   275   0   376 
Software expenses  324   244   817   699   313   247 
ORE expenses  30   92   221   308   86   32 
Other  1,371   1,348   4,428   4,102   1,394   1,474 
TOTAL NON-INTEREST EXPENSES  9,692   8,414   30,026   24,973   9,947   8,921 
Income before provision for income taxes  9,766   6,262   21,578   17,264   10,079   5,420 
Provision for income taxes  1,759   1,066   3,702   2,817   1,616   889 
NET INCOME $8,007  $5,196  $17,876  $14,447  $8,463  $4,531 
                        
PER COMMON SHARE DATA:                        
Net Income - Basic $2.04  $1.46  $4.74  $4.06  $2.16  $1.27 
Net Income - Diluted $2.04  $1.46  $4.74  $4.05  $2.16  $1.27 
Cash Dividends Paid $0.460  $0.445  $1.460  $1.317  $0.465  $0.549 
                        
Number of shares used in computation - basic  3,918,438   3,553,996   3,769,705   3,560,695   3,909,887   3,553,818 
Number of shares used in computation - diluted  3,918,438   3,553,996   3,771,730   3,562,975   3,909,887   3,553,818 

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

2
IndexTable of Contents

CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(UNAUDITED)

     
 
Three Months Ended
September 30,
  
Nine Months Ended,
September 30,
  
Three Months Ended
March 31,
 
(in thousands) 2020  2019  2020  2019  2021  2020 
Net income $8,007  $5,196  $17,876  $14,447  $8,463  $4,531 
Other comprehensive income (loss):                        
Change in unrealized gains (losses) on available for sale securities  (44)  9   4,690   4,425   (4,094)  4,334 
Income tax effect  9   (2)  (985)  (930)  859   (910)
Change in unrecognized pension cost  59   60   482   181   91   156 
Income tax effect  (12)  (13)  (101)  (38)  (19)  (33)
Change in unrealized loss on interest rate swaps  118   0   (448)  0   2,047   0 
Income tax effect  (25)  0   95   0   (430)  0 
Less: Reclassification adjustment for investment security gains included in net income  (185)  (8)  (302)  (8)  (50)  0 
Income tax effect  38   2   63   2   11   0 
Other comprehensive income (loss), net of tax  (42)  48   3,494   3,632   (1,585)  3,547 
Comprehensive income $7,965  $5,244  $21,370  $18,079  $6,878  $8,078 

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

3
IndexTable of Contents

CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’STOCKHOLDERS' EQUITY
(UNAUDITED)

  Common Stock  Additional     
Accumulated
Other
       
(in thousands, except share data) Shares  Amount  
Paid-in
Capital
  
Retained
Earnings
  
Comprehensive
Income (Loss)
  
Treasury
Stock
  Total 
                      
Balance, June 30, 2020  4,350,342  $4,350  $75,863  $115,000  $2,907  $(15,025) $183,095 
                             
Comprehensive income:                            
Net income              8,007           8,007 
Net other comprehensive income (loss)                  (42)      (42)
Purchase of treasury stock (12,483 shares)                      (618)  (618)
Restricted stock, executive, Board of Director awards and ESOP (3,018 shares)          (3)          153   150 
Cash dividend reinvestment paid from treasury stock (5,128 shares)          7           256   263 
Cash dividends, $0.460 per share              (1,804)          (1,804)
Balance, September 30, 2020  4,350,342  $4,350  $75,867  $121,203  $2,865  $(15,234) $189,051 
                             
Balance, December 31, 2019  3,938,668  $3,939  $55,089  $110,800  $(629) $(14,425) $154,774 
                             
Comprehensive income:                            
Net income              17,876           17,876 
Net other comprehensive income (loss)                  3,494       3,494 
Stock dividend  38,318   38   1,878   (1,916)          0 
Issuance of Common stock  373,356   373   18,854               19,227 
Purchase of treasury stock (40,400 shares)                      (2,120)  (2,120)
Restricted stock, executive, Board of Director awards and ESOP (9,669 shares)          (236)          491   255 
Restricted stock vesting          281               281 
Cash dividend reinvestment paid from treasury stock (15,404 shares)          1   0       820   821 
Cash dividends, $1.460 per share              (5,557)          (5,557)
Balance, September 30, 2020  4,350,342  $4,350  $75,867  $121,203  $2,865  $(15,234) $189,051 
                             
Balance, June 30, 2019  3,938,668   3,939   55,096   103,733   (337)  (14,410)  148,021 
                             
Comprehensive income:                            
Net income              5,196           5,196 
Net other comprehensive income (loss)                  48       48 
Cash dividends, $0.445 per share              (1,587)          (1,587)
Balance, September 30, 2019  3,938,668  $3,939  $55,096  $107,342  $(289) $(14,410) $151,678 
                             
Balance, December 31, 2018  3,904,212   3,904   53,099   99,727   (3,921)  (13,580)  139,229 
                             
Comprehensive income:                            
Net income              14,447           14,447 
Net other comprehensive income (loss)                  3,632       3,632 
Stock dividend  34,456   35   2,067   (2,102)          0 
Purchase of treasury stock (20,620 shares)                      (1,236)  (1,236)
Restricted stock, executive and Board of Director awards          (300)          415   115 
Restricted stock vesting          221               221 
Forfeited restricted stock          9           (9)  0 
Cash dividends, $1.317 per share              (4,730)          (4,730)
Balance, September 30, 2019  3,938,668  $3,939  $55,096  $107,342  $(289) $(14,410) $151,678 
  Common Stock  Additional     
Accumulated
Other
       
(in thousands, except share data) Shares  Amount  
Paid-in
Capital
  
Retained
Earnings
  
Comprehensive
Income (Loss)
  
Treasury
Stock
  Total 
Balance, December 31, 2020
  4,350,342  $4,350  $75,908  $126,627  $2,587  $(15,213) $194,259 
                             
Net income              8,463           8,463 
Net other comprehensive (loss)                  (1,585)      (1,585)
Purchase of treasury stock (9,202 shares)
                      (513)  (513)
Restricted stock, executive  and Board of Director awards (6,651 shares)
          (2)              (2)
Restricted stock vesting          5               5 
Forfeited restricted stock          (3)          3   0 
Cash dividends, $0.465 per share
              (1,820)          (1,820)
Balance, March 31, 2021
  4,350,342  $4,350  $75,908  $133,270  $1,002  $(15,723) $198,807 
                             
Balance, December 31, 2019
  3,938,668  $3,939  $55,089  $110,800  $(629) $(14,425) $154,774 
                             
Net income              4,531           4,531 
Net other comprehensive income                  3,547       3,547 
Purchase of treasury stock (23,412 shares)
                      (1,279)  (1,279)
Restricted stock, executive, and Board of Director awards          1           12   13 
Restricted stock vesting          40               40 
Cash dividend reinvestment paid from treasury stock          (1)  0       255   254 
Cash dividends, $0.549 per share
              (1,957)          (1,957)
Balance, March 31, 2020
  3,938,668  $3,939  $55,129  $113,374  $2,918  $(15,437) $159,923 

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

statements
4
IndexTable of Contents

CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)

 
Nine Months Ended
September 30,
  
Three Months Ended
March 31,
 
(in thousands) 2020  2019  2021  2020 
CASH FLOWS FROM OPERATING ACTIVITIES:            
Net income $17,876  $14,447  $8,463  $4,531 
Adjustments to reconcile net income to net cash (used in) provided by operating activities:        
Adjustments to reconcile net income to net cash provided by operating activities:        
Provision for loan losses  1,500   1,150   650   400 
Depreciation and amortization  (1,648)  357   286   247 
Amortization and accretion of loans and other assets  (1,344)  (97)
Amortization and accretion of investment securities  648   129   503   120 
Deferred income taxes  359   420   74   (284)
Investment securities losses (gains), net  (26)  (78)  (237)  254 
Earnings on bank owned life insurance  (514)  (463)  (1,315)  (156)
Vesting of restricted stock  281   221 
Originations of loans held for sale  (62,677)  (15,261)  (14,206)  (7,043)
Proceeds from sales of loans held for sale  45,113   15,183   19,253   5,973 
Realized gains on loans sold  (1,282)  (339)  (503)  (167)
Increase in accrued interest receivable  (1,023)  (24)
Increase (decrease) in accrued interest payable  (246)  (24)
Decrease (increase) in accrued interest receivable  426   (32)
Decrease in accrued interest payable  (104)  (182)
Other, net  (729)  103   2,019   1,169 
Net cash (used in) provided by operating activities  (2,368)  15,821 
Net cash provided by operating activities  13,965   4,733 
CASH FLOWS FROM INVESTING ACTIVITIES:                
Available-for-sale securities:                
Proceeds from sales  18,621   5,508   5,045   0 
Proceeds from maturity and principal repayments  55,455   51,028   17,826   29,045 
Purchase of securities  (117,166)  (59,788)  (54,248)  (41,915)
Purchase of equity securities  (1,439)  (64)  0   (202)
Proceeds from sale of equity securities  168   0 
Purchase of interest bearing time deposits with other banks  (350)  (248)  0   (250)
Proceeds from life insurance death benefit  3,714   0 
Proceeds from matured interest bearing time deposits with other banks  848   1,490   249   0 
Proceeds from redemption of regulatory stock  7,923   7,784   1,179   3,300 
Purchase of regulatory stock  (6,424)  (9,127)  (1,013)  (2,798)
Net increase in loans  (24,741)  (36,653)
Net decrease in loans  2,461   22,003 
Purchase of premises and equipment  (760)  (225)  (785)  (507)
Proceeds from sale of premises and equipment  0   7 
Proceeds from sale of foreclosed assets held for sale  669   813   116   350 
Acquisition, net of cash paid  1,023   0 
Net cash used in investing activities  (66,173)  (39,475)
Net cash (used in) provided by investing activities  (25,456)  9,026 
CASH FLOWS FROM FINANCING ACTIVITIES:                
Net increase in deposits  132,807   14,148   98,612   (5,968)
Proceeds from long-term borrowings  20,000   10,000   0   5,000 
Repayments of long-term borrowings  (3,000)  (3,123)  (2,000)  0 
Net (decrease) increase in short-term borrowed funds  (17,876)  11,769 
Purchase of treasury stock  (2,120)  (1,236)
Reissuance of treasury stock  255   115 
Net decrease in short-term borrowed funds  (667)  (6,554)
Purchase of treasury and restricted stock  (513)  (1,279)
Dividends paid  (4,736)  (4,730)  (1,820)  (1,957)
Net cash provided by financing activities  125,330   26,943 
Net cash provided by (used in) financing activities  93,612   (10,758)
Net increase in cash and cash equivalents  56,789   3,289   82,121   3,001 
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD  18,520   16,797   68,707   18,520 
CASH AND CASH EQUIVALENTS AT END OF PERIOD $75,309  $20,086  $150,828  $21,521 
                
Supplemental Disclosures of Cash Flow Information:                
Interest paid $6,321  $9,267  $1,958  $2,631 
Income taxes paid $3,500  $2,450  $0  $0 
Loans transferred to foreclosed property $32  $3,728 
Right of use asset and liability $636  $1,454  $211  $0 
        
Acquisition of     
Midcoast
Community
Bancorp Inc
 
Non-cash assets acquired        
Available-for-sale securities     $0 
Loans      223,235 
Premises and equipment      1,787 
Accrued interest receivable      586 
Bank owned life insurance      3,766 
Intangibles      157 
Deferred tax asset      3,402 
Other assets      2,878 
Goodwill      8,080 
      243,891 
        
Liabilities assumed        
Noninterest-bearing deposits      38,694 
Interest-bearing deposits      170,132 
Accrued interest payable      164 
Borrowed funds      15,497 
Other liabilities      1,198 
      225,685 
Net non-cash assets acquired      18,206 
Cash and cash equivalents acquired     $8,637 

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

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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 andits 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 1st Realty of PA LLC (“Realty”). The Bank is the wholly owned subsidiary of CZFS Acquisition Company, LLC, which is a wholly owned subsidiary of the Company. Realty was formed in March of 2019 to manage and sell properties acquired by the Bank in the settlement of a bankruptcy filing with a commercial customer.


The accompanying consolidated financial statements have been prepared pursuant to rules and regulations of the Securities and Exchange Commission (“SEC”) and in conformity with U.S. generally accepted accounting principles.  Because this report is based on an interim period, certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted.  Certain of the prior year amounts have been reclassified to conform with the current year presentation.  Such reclassifications had no effect on net income or stockholders’ equity.  All material inter‑company balances and transactions have been eliminated in consolidation.


In the opinion of management of the Company, the accompanying interim financial statements at September 30, 2020March 31, 2021 and for the periods ended September 30,March 31, 2021 and 2020 and 2019 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 periodsperiod ended September 30, 2020March 31, 2021 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, 2019.2020.

Note 2 – Revenue Recognition


In accordance withUnder ASC Topic 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.

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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.

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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,March 31, 2021 and 2020 and 2019 (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  Three Months Ended 
 September 30,  September 30,  March 31, 
Revenue stream 2020  2019  2020  2019  2021  2020 
Service charges on deposit accounts                  
Overdraft fees $282   405  $847  $1,132  $258  $359 
Statement fees  50   52   156   153   56   56 
Interchange revenue  616   589   1,693   1,724   639   522 
ATM income  99   108   241   300   98   83 
Other service charges  65   71   170   189   55   61 
Total Service Charges  1,112   1,225   3,107   3,498   1,106   1,081 
Trust  199   148   542   589   307   198 
Brokerage and insurance  352   289   941   843   376   340 
Other  95   80   261   267   109   107 
Total $1,758  $1,742  $4,851  $5,197  $1,898  $1,726 


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Note 3 - Earnings per Share


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

 Three months ended  Nine months ended  Three months ended 
 September 30,  September 30,  March 31, 
 2020  2019  2020  2019  2021  2020 
Net income applicable to common stock $8,007  $5,196  $17,876  $14,447  $8,463  $4,531 
                        
Basic earnings per share computation                        
Weighted average common shares outstanding  3,918,438   3,553,996   3,769,705   3,560,695   3,909,887   3,553,818 
Earnings per share - basic $2.04  $1.46  $4.74  $4.06  $2.16  $1.27 
                        
Diluted earnings per share computation                        
Weighted average common shares outstanding for basic earnings per share  3,918,438   3,553,996   3,769,705   3,560,695   3,909,887   3,553,818 
Add: Dilutive effects of restricted stock  0   0   2,025   2,280   0   0 
Weighted average common shares outstanding for dilutive earnings per share  3,918,438   3,553,996   3,771,730   3,562,975   3,909,887   3,553,818 
Earnings per share - diluted $2.04  $1.46  $4.74  $4.05  $2.16  $1.27 


For the three months ended September 30,March 31, 2021 and 2020, and 2019, there were 9,4803,289 and 9,0137,564 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 $51.14-$57.36-$62.93 for the three month period ended September 30, 2020March 31, 2021 and per share prices ranging from $50.65-$52.44-$62.93 for the three month period ended September 30, 2019. For the nine months ended September 30, 2020 and 2019, 5,347 and 4,453 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 $58.37-$62.93 for the nine month period ended September 30, 2020 and prices ranging from $50.65-$62.93 for the nine month period ended September 30, 2019.March 31, 2020.

Note 4 – Investments


The amortized cost, gross unrealized gains and losses, and fair value of investment securities at September 30, 2020March 31, 2021 and December 31, 20192020 were as follows (in thousands):

September 30, 2020 
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
  
Fair
Value
 
March 31, 2021
 
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
  
Fair
Value
 
Available-for-sale securities:                        
U.S. agency securities $78,095  $2,647  $(44) $80,698  $78,375  $2,020  $(686) $79,709 
U.S. treasury securities  27,430   737   0   28,167   39,995   458   (91)  40,362 
Obligations of state and political subdivisions  89,678   2,297   (127)  91,848   101,007   1,771   (433)  102,345 
Corporate obligations  6,423   84   0   6,507   6,902   86   (5)  6,983 
Mortgage-backed securities in government sponsored entities  78,925   1,829   (136)  80,618   92,165   1,162   (759)  92,568 
Total available-for-sale securities $280,551  $7,594  $(307) $287,838  $318,444  $5,497  $(1,974) $321,967 
                                
December 31, 2019                
December 31, 2020
 
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
  
Fair
Value
 
Available-for-sale securities:                                
U.S. agency securities $83,410  $1,523  $(70) $84,863  $79,065  $2,403  $(52) $81,416 
U.S. treasury securities  27,394   267   0   27,661   27,442   601   0   28,043 
Obligations of state and political subdivisions  60,667   865   (77)  61,455   100,089   2,938   (55)  102,972 
Corporate obligations  3,250   78   0   3,328   6,413   96   0   6,509 
Mortgage-backed securities in government sponsored entities  63,086   468   (155)  63,399   74,512   1,874   (137)  76,249 
Total available-for-sale securities $237,807  $3,201  $(302) $240,706  $287,521  $7,912  $(244) $295,189 

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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, 2020March 31, 2021 and December 31, 20192020 (in thousands). As of September 30, 2020,March 31, 2021, the Company owned 3088 securities whose fair value was less than their cost basis.

September 30, 2020 Less than Twelve Months  Twelve Months or Greater  Total 
 
Fair
Value
  
Gross
Unrealized
Losses
  
Fair
Value
  
Gross
Unrealized
Losses
  
Fair
Value
  
Gross
Unrealized
Losses
  Less than Twelve Months  Twelve Months or Greater  Total 
March 31, 2021
 
Fair
Value
  
Gross
Unrealized
Losses
  
Fair
Value
  
Gross
Unrealized
Losses
  
Fair
Value
  
Gross
Unrealized
Losses
 
U.S. agency securities $6,979  $(44) $0  $0  $6,979  $(44) $27,104  $(686) $0  $0  $27,104  $(686)
U.S. treasury securities  12,444   (91)  0   0   12,444   (91)
Obligations of state and political subdivisions  11,257   (127)  0   0   11,257   (127)  29,716   (346)  3,361   (87)  33,077   (433)
Corporate obligations  495   (5)  0   0   495   (5)
Mortgage-backed securities in government sponsored entities  8,884   (98)  5,779   (38)  14,663   (136)  34,119   (720)  5,550   (39)  39,669   (759)
Total securities $27,120  $(269) $5,779  $(38) $32,899  $(307) $103,878  $(1,848) $8,911  $(126) $112,789  $(1,974)
                                                
December 31, 2019                        
December 31, 2020
                        
U.S. agency securities $14,587  $(63) $13,094  $(7) $27,681  $(70) $13,720  $(52) $0  $0  $13,720  $(52)
U.S. treasury securities  0   0   0   0   0   0 
Obligations of states and
political subdivisions
  7,508   (75)  1,507   (2)  9,015   (77)  5,407   (55)  0   0   5,407   (55)
Corporate obligations  0   0   0   0   0   0 
Mortgage-backed securities in government sponsored entities  27,737   (97)  9,559   (58)  37,296   (155)  14,600   (99)  5,633   (38)  20,233   (137)
Total securities $49,832  $(235) $24,160  $(67) $73,992  $(302) $33,727  $(206) $5,633  $(38) $39,360  $(244)


As of September 30, 2020March 31, 2021 and December 31, 2019,2020, the Company’s investment securities portfolio contained unrealized losses on agency securities issued or backed by the full faith and credit of the United States government or are generally viewed as having the implied guarantee of the U.S. government, U.S. Treasury securities, obligations of states and political subdivisions, corporate obligations and mortgage backed securities issued by 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 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.

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Proceeds from sales of securities available-for-sale for the nine months ended September 30, 2020 and 2019 were $18,621,000 and $5,508,000, respectively. Proceeds from sales of securities available-for-sale for the three months ended September 30, 2020 and 2019March 31, 2021 were $13,145,000 and $5,508,000, respectively.$5,045,000. There were 0 sales of available for sale securities during the three months ended March 31, 2020. The gross gains and losses were as follows (in thousands) thousands):

 Three Months Ended  Nine Months Ended 
  September 30  September 30 
  2020  2019  2020  2019 
Gross gains on available for sale securities $192  $9  $309  $9 
Gross losses on available for sale securities  (7)  (1)  (7)  (1)
Net gains $185  $8  $302  $8 

 Three Months Ended 
  March 31 
  2021  2020 
Gross gains on available for sale securities $50  $0 
Gross losses on available for sale securities  0   0 
Net gains $50  $0 


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,March 31, 2021 and 2020, and 2019, and the portion of unrealized gains for the period that relates to equity investments held at September 30,March 31, 2021 and 2020 and 2019 (in thousands):

 
Three Months Ended
September 30,
  
Nine Months Ended
September 30,
  
Three Months Ended
March 31,
 
Equity securities 2020  2019  2020  2019  2021  2020 
Net gains (losses) recognized in equity securities during the period $(33) $29  $(276) $70  $187  $(254)
Less: Net gains realized on the sale of equity securities during the period  68   0   68   0   0   0 
Net unrealized gains (losses) $(101) $29  $(344) $70  $187  $(254)


Investment securities with an approximate carrying value of $250.2$244.1 million and $209.1$245.4 million at September 30, 2020March 31, 2021 and December 31, 2019,2020, 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, 2020,March 31, 2021, by contractual maturity, are shown below (in thousands):

 
Amortized
Cost
  Fair Value 
Available-for-sale debt securities:      
Due in one year or less $19,293  $19,530 
Due after one year through five years  65,451   68,561 
Due after five years through ten years  58,962   60,506 
Due after ten years  136,845   139,241 
Total $280,551  $287,838 

 
Amortized
Cost
  Fair Value 
Available-for-sale debt securities:      
Due in one year or less $19,997  $20,279 
Due after one year through five years  68,523   70,801 
Due after five years through ten years  82,046   82,528 
Due after ten years  147,878   148,359 
Total $318,444  $321,967 

Note 5 – Loans


The Company grants loans primarily to customers throughout north central, central and south central Pennsylvania and the southern tier of New York. The recently completed MidCoast acquisition has expanded our lending market into Wilmington and Dover, Delaware.   Although the Company had a diversified loan portfolio at September 30, 2020March 31, 2021 and December 31, 2019,2020, 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, 2020March 31, 2021 and December 31, 20192020 (in thousands):

September 30, 2020 Total Loans  
Individually
evaluated for
impairment
  
Loans acquired
with deteriorated
credit quality
  
Collectively
evaluated for
impairment
 
Real estate loans:            
Residential $208,084  $1,041  $20  $207,023 
Commercial  535,456   9,465   3,306   522,685 
Agricultural  310,702   4,398   1,722   304,582 
Construction  28,656   0   0   28,656 
Consumer  30,625   15   0   30,610 
Other commercial loans  129,731   1,603   0   128,128 
Other agricultural loans  40,790   1,246   306   39,238 
State and political subdivision loans  81,835   0   0   81,835 
Total  1,365,879   17,768   5,354   1,342,757 
Allowance for loan losses  15,169   791   0   14,378 
Net loans $1,350,710  $16,977  $5,354  $1,328,379 

March 31, 2021
 Total Loans  
Individually evaluated
for impairment
  
Loans acquired with
deteriorated credit quality
  
Collectively evaluated
for impairment
 
Real estate loans:            
Residential $203,273  $969  $20  $202,284 
Commercial  605,547   9,321   2,911   593,315 
Agricultural  315,313   4,561   1,664   309,088 
Construction  42,651   0   0   42,651 
Consumer  26,181   1   0   26,180 
Other commercial loans  109,168   1,127   132   107,909 
Other agricultural loans  41,378   1,118   0   40,260 
State and political subdivision loans  60,890   0   0   60,890 
Total  1,404,401   17,097   4,727   1,382,577 
Allowance for loan losses  16,560   485   0   16,075 
Net loans $1,387,841  $16,612  $4,727  $1,366,502 
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December 31, 2019 Total Loans  
Individually evaluated
for impairment
  
Loans acquired
with deteriorated
credit quality
  
Collectively
evaluated for
impairment
 
December 31, 2020
 Total Loans  
Individually evaluated
for impairment
  
Loans acquired with
deteriorated credit quality
  
Collectively evaluated
for impairment
 
Real estate loans:                        
Residential $217,088  $1,166  $23  $215,899  $201,911  $990  $20  $200,901 
Commercial  342,023   11,537   1,210   329,276   596,255   9,183   2,937   584,135 
Agricultural  311,464   3,782   0   307,682   315,158   4,645   1,686   308,827 
Construction  15,519   0   0   15,519   35,404   0   0   35,404 
Consumer  9,947   4   0   9,943   30,277   2   0   30,275 
Other commercial loans  69,970   1,902   49   68,019   114,169   1,335   232   112,602 
Other agricultural loans  55,112   1,281   0   53,831   48,779   1,122   0   47,657 
State and political subdivision loans  94,446   0   0   94,446   63,328   0   0   63,328 
Total  1,115,569   19,672   1,282   1,094,615   1,405,281   17,277   4,875   1,383,129 
Allowance for loan losses  13,845   735   0   13,110   15,815   510   0   15,305 
Net loans $1,101,724  $18,937  $1,282  $1,081,505  $1,389,466  $16,767  $4,875  $1,367,824 


During 20202021 the Company participatedcontinued its participation in the Paycheck Protection Program (“PPP”), administered directly by the U.S. SBA. The PPP provides loans to small businesses who were affected by economic conditions as a result of COVID-19 to provide cash-flow assistance to employers who maintain their payroll (including healthcare and certain related expenses), mortgage interest, rent, leases, utilities and interest on existing debt during the COVID-19 emergency. As of September 30,March 31, 2021 and December 31, 2020, the Company had outstanding principal balances of $53.9 million.$28.3 million and $37.2 million, respectively, of PPP loans that are included in other commercial loans. During 2021, the Company originated $18.5 million of loans that remain outstanding as of March 31, 2021. The PPP loans are fully guaranteed by the SBA and may be 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 is made as long as certain conditions are met regarding employee retention and compensation levels. PPP loans deemed eligible for forgiveness by the SBA will be repaid by the SBA to the Company. PPPThe SBA has issued guidance for forgiveness with a streamlined approach for loans are included in the other commercial loan category.of $150,000 or less.



In accordance with the SBA terms and conditions on these PPP loans, the Company received approximately $2.1$1.4 million in fees associated with the processing of these loans. the loans outstanding as of March 31, 2021. Upon funding of the loan, these fees were deferred and will be amortized over the life of the loan as an adjustment to yield in accordance with FASB ASC 310-20-25-2. As of March 31, 2021, $1.2 million of deferred fees related to the PPP loans remain to be amortized.



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 loans (“PCI”) are loans that have evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. There were no material increases or decreases in the expected cash flows of these loans between April 17, 2020 (the “acquisition date”) and September 30, 2020.March 31, 2021. The fair value of purchased credit-impaired loans, on the acquisition date, was determined, primarily based on the fair value of loan collateral. The carrying value of purchased loans acquired with deteriorated credit quality as a result of the MidCoast acquisition was $4,654,000$4,034,000 at September 30, 2020.March 31, 2021.


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On the acquisition date, the preliminary estimate of the unpaid principal balance for all loans evidencing credit impairment acquired in the MidCoast acquisition was $8,005,000$8,005,000 and the estimated fair value of the loans was $4,869,000.$4,869,000. Total contractually required payments on these loans, including interest, at the acquisition date was $8,801,000.$8,801,000. However, the Company’s preliminary estimate of expected cash flows was $5,835,000$5,835,000 at the acquisition date. At the acquisition date, the Company established a credit risk related non-accretable discount (a discount representing amounts which are not expected to be collected from the customer nor liquidation of collateral) of $2,966,000$2,966,000 relating to these impaired loans, reflected in the recorded net fair value. Such amount is reflected as a non-accretable fair value adjustment to loans. The Company further estimated the timing and amount of expected cash flows in excess of the estimated fair value and established an accretable discount of $966,000$966,000 on the acquisition date relating to these impaired loans.

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The table below presents the components of the purchase accounting adjustments related to the purchased impaired loans acquired in the MidCoast Acquisitionacquisition as of the April 17, 2020 Acquisition date (in thousands):

 April 17, 2020 
Contractually required principal and interest at acquisition $8,801 
Non-accretable  discount  (2,966)
Expected cash flows  5,835 
Accretable discount $(966)
Estimated fair value $4,869 


Changes in the accretable yield for PCI loans were as follows for the three and nine months ended September 30,March 31, 2021 and 2020, and 2019, respectively (in thousands):

 
Three months ended
September 30,
  
Nine months ended
September 30,
  
Three months ended
March 31
 
 2020  2019  2020  2019  2021  2020 
Balance at beginning of period $987  $100  $89  $104  $788  $89 
Acquisition of Midcoast  0   0   966   0 
Accretion  (100)  (10)  (168)  (14)  (100)  (1)
Balance at end of period $887  $90  $887  $90  $688  $88 


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, 2020  December 31, 2019  March 31, 2021  December 31, 2020 
Outstanding balance $9,479  $4,072  $8,747  $8,958 
Carrying amount  5,354   1,282   4,727   4,875 


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.

12
Table of Contents

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.

12
Index

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, 2020 
Unpaid
Principal
Balance
  
Recorded
Investment
With No
Allowance
  
Recorded
Investment
With
Allowance
  
Total
Recorded
Investment
  
Related
Allowance
 
March 31, 2021
 
Unpaid
Principal
Balance
  
Recorded
Investment
With No
Allowance
  
Recorded
Investment
With
Allowance
  
Total
Recorded
Investment
  
Related
Allowance
 
Real estate loans:                              
Mortgages $1,125  $609  $296  $905  $20  $1,059  $724  $122  $846  $9 
Home Equity  159   77   59   136   9   147   69   54   123   8 
Commercial  10,053   8,325   1,140   9,465   341   10,100   8,408   913   9,321   101 
Agricultural  4,614   2,526   1,872   4,398   79   4,791   2,777   1,784   4,561   12 
Consumer  15   3   12   15   12   1   1   0   1   0 
Other commercial loans  2,225   1,243   360   1,603   181   1,793   889   238   1,127   170 
Other agricultural loans  1,368   123   1,123   1,246   149   1,301   17   1,101   1,118   185 
Total $19,559  $12,906  $4,862  $17,768  $791  $19,192  $12,885  $4,212  $17,097  $485 

December 31, 2019               
December 31, 2020
 
Unpaid
Principal
Balance
  
Recorded
Investment
With No
Allowance
  
Recorded
Investment
With
Allowance
  
Total
Recorded
Investment
  
Related
Allowance
 
Real estate loans:                              
Mortgages $1,212  $794  $223  $1,017  $20  $1,070  $740  $123  $863  $9 
Home Equity  170   83   66   149   12   150   70   57   127   9 
Commercial  12,070   10,723   814   11,537   251   9,847   8,323   860   9,183   95 
Agricultural  3,900   1,580   2,202   3,782   151   4,811   2,799   1,846   4,645   83 
Consumer  4   4   0   4   0   2   2   0   2   0 
Other commercial loans  2,517   1,555   347   1,902   147   1,908   1,094   241   1,335   170 
Other agricultural loans  1,347   126   1,155   1,281   154   1,262   19   1,103   1,122   144 
Total $21,220  $14,865  $4,807  $19,672  $735  $19,050  $13,047  $4,230  $17,277  $510 


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,March 31, 2021 and 2020 and 2019 (in thousands):

 For the Nine Months Ended  For the Three Months Ended 
 September 30, 2020  September 30, 2019  March 31, 2021  March 31, 2020 
 
Average
Recorded
Investment
  
Interest
Income
Recognized
  
Interest
Income
Recognized
Cash Basis
  
Average
Recorded
Investment
  
Interest
Income
Recognized
  
Interest
Income
Recognized
Cash Basis
  
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 $998  $15  $0  $1,075  $12  $0  $851  $5  $0  $1,031  $5  $0 
Home Equity  142   5   0   108   4   0   124   1   0   146   2   0 
Commercial  10,836   294   20   11,768   342   11   9,238   67   7   11,486   104   2 
Agricultural  3,718   58   0   5,068   61   0   4,590   22   0   3,777   21   0 
Consumer  3   0   0   2   0   0   1   0   0   3   0   0 
Other commercial loans  1,757   2   0   2,088   1   0   1,121   1   0   1,839   1   0 
Other agricultural loans  1,275   6   0   1,419   4   0   1,103   2   0   1,276   2   0 
Total $18,729  $380  $20  $21,528  $424  $11  $17,028  $98  $7  $19,558  $135  $2 

13
IndexTable of Contents

 For the Three Months Ended 
  September 30, 2020  September 30, 2019 
  
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 $900  $5  $0  $1,048  $3  $0 
Home Equity  138   2   0   143   2   0 
Commercial  9,436   75   18   11,906   112   0 
Agricultural  3,633   18   0   4,795   5   0 
Consumer  5   0   0   4   0   0 
Other commercial loans  1,626   0   0   2,073   0   0 
Other agricultural loans  1,259   2   0   1,408   0   0 
Total $16,997  $102  $18  $21,377  $122  $0 

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.

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.

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IndexTable of Contents

The following tables represent credit exposures by internally assigned grades as of September 30, 2020March 31, 2021 and December 31, 20192020 (in thousands):

September 30, 2020 Pass  
Special
Mention
  Substandard  Doubtful  Loss  Ending Balance 
March 31, 2021
 Pass  
Special
Mention
  Substandard  Doubtful  Loss  
Ending
Balance
 
Real estate loans:                                    
Commercial $514,291  $10,727  $10,400  $38  $0  $535,456  $567,989  $28,936  $8,622  $0  $0  $605,547 
Agricultural  287,998   11,882   10,822   0   0   310,702   288,128   15,603   11,582   0   0   315,313 
Construction  28,656   0   0   0   0   28,656   42,651   0   0   0   0   42,651 
Other commercial loans  124,563   1,239   3,843   86   0   129,731   102,276   3,134   3,675   83   0   109,168 
Other agricultural loans  37,529   1,593   1,668   0   0   40,790   38,114   1,849   1,415   0   0   41,378 
State and political subdivision loans  81,493   0   342   0   0   81,835   56,245   4,372   273   0   0   60,890 
Total $1,074,530  $25,441  $27,075  $124  $0  $1,127,170  $1,095,403  $53,894  $25,567  $83  $0  $1,174,947 

December 31, 2019 Pass  
Special
Mention
  Substandard  Doubtful  Loss  Ending Balance 
December 31, 2020
                  
Real estate loans:                                    
Commercial $329,831  $4,305  $7,848  $39  $0  $342,023  $563,121  $24,329  $8,805  $0  $0  $596,255 
Agricultural  287,044   14,261   10,159   0   0   311,464   289,216   14,307   11,635  ��0   0   315,158 
Construction  15,519   0   0   0   0   15,519   35,404   0   0   0   0   35,404 
Other commercial loans  66,880   984   2,042   64   0   69,970   106,604   3,808   3,672   85   0   114,169 
Other agricultural loans  51,711   1,077   2,324   0   0   55,112   45,758   1,431   1,590   0   0   48,779 
State and political subdivision loans  93,993   0   453   0   0   94,446   58,649   4,372   307   0   0   63,328 
Total $844,978  $20,627  $22,826  $103  $0  $888,534  $1,098,752  $48,247  $26,009  $85  $0  $1,173,093 


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, 2020March 31, 2021 and December 31, 20192020 (in thousands):

September 30, 2020 Performing  Non-performing  PCI  Total 
March 31, 2021 Performing  Non-performing  PCI  Total 
Real estate loans:                        
Mortgages $149,171  $1,466  $20  $150,657  $148,560  $1,023  $20  $149,603 
Home Equity  57,407   20   0   57,427   53,648   22   0   53,670 
Consumer  30,613   12   0   30,625   26,181   0   0   26,181 
Total $237,191  $1,498  $20  $238,709  $228,389  $1,045  $20  $229,454 
                                
December 31, 2019 Performing  Non-performing  PCI  Total 
December 31, 2020 Performing  Non-performing  PCI  Total 
Real estate loans:                                
Mortgages $156,151  $904  $23  $157,078  $145,843  $1,039  $20  $146,902 
Home Equity  59,950   60   0   60,010   54,961   48   0   55,009 
Consumer  9,939   8   0   9,947   30,247   30   0   30,277 
Total $226,040  $972  $23  $227,035  $231,051  $1,117  $20  $232,188 

15
Index
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, 2020March 31, 2021 and December 31, 20192020 (in thousands):

September 30, 2020 
30-59 Days
Past Due
  
60-89 Days
Past Due
  
90 Days
Or Greater
  
Total Past
Due
  Current  PCI  
Total
Loan
Receivables
  
90 Days or
Greater and
Accruing
 
March 31, 2021
 
30-59
Days
Past Due
  
60-89
Days
Past Due
  
90 Days
Or Greater
  
Total
Past
Due
  Current  PCI  
Total
Loan
Receivables
  
90 Days or
Greater
and
Accruing
 
Real estate loans:                                                
Mortgages $736  $208  $811  $1,755  $148,882  $20  $150,657  $622  $288  $29  $517  $834  $148,749  $20  $149,603  $251 
Home Equity  100   43   18   161   57,266   0   57,427   0   49   11   8   68   53,602   0   53,670   0 
Commercial  1,651   78   4,805   6,534   525,616   3,306   535,456   413   848   190   1,440   2,478   600,158   2,911   605,547   0 
Agricultural  116   215   1,327   1,658   307,322   1,722   310,702   147   356   25   1,330   1,711   311,938   1,664   315,313   150 
Construction  0   0   0   0   28,656   0   28,656   0   0   0   0   0   42,651   0   42,651   0 
Consumer  142   33   12   187   30,438   0   30,625   12   149   4   0   153   26,028   0   26,181   0 
Other commercial loans  169   0   1,491   1,660   128,071   0   129,731   0   919   0   160   1,079   107,957   132   109,168   27 
Other agricultural loans  9   0   136   145   40,339   306   40,790   0   224   0   50   274   41,104   0   41,378   50 
State and political subdivision loans  0   0   0   0   81,835   0   81,835   0   0   0   0   0   60,890   0   60,890   0 
Total $2,923  $577  $8,600  $12,100  $1,348,425  $5,354  $1,365,879  $1,194  $2,833  $259  $3,505  $6,597   1,393,077  $4,727  $1,404,401  $478 
                                
Loans considered non-accrual $539   171  $3,027  $3,737  $6,943  $0  $10,680     
Loans still accruing  2,294   88   478   2,860   1,386,134   4,727   1,393,721     
Total $2,833  $259  $3,505  $6,597  $1,393,077  $4,727  $1,404,401     

Loans considered non-accrual $53  $0  $7,406  $7,459  $4,252  $0  $11,711 
Loans still accruing  2,870   577   1,194   4,641   1,344,173   5,354   1,354,168 
Total $2,923  $577  $8,600  $12,100  $1,348,425  $5,354  $1,365,879 

December 31, 2019 
30-59 Days
Past Due
  
60-89 Days
Past Due
  
90 Days
Or Greater
  
Total Past
Due
  Current  PCI  
Total
Loan
Receivables
  
90 Days or
Greater and
Accruing
 
Real estate loans:                        
Mortgages $581  $57  $319  $957  $156,098  $23  $157,078  $1 
Home Equity  334   11   56   401   59,609   0   60,010   1 
Commercial  750   573   3,720   5,043   335,770   1,210   342,023   0 
Agricultural  118   0   785   903   310,561   0   311,464   299 
Construction  0   0   0   0   15,519   0   15,519   0 
Consumer  113   10   8   131   9,816   0   9,947   2 
Other commercial loans  217   71   1,946   2,234   67,687   49   69,970   184 
Other agricultural loans  29   32   0   61   55,051   0   55,112   0 
State and political subdivision loans  0   0   0   0   94,446   0   94,446   0 
Total $2,142  $754  $6,834  $9,730  $1,104,557  $1,282  $1,115,569  $487 

December 31, 2020
                        
Real estate loans:                        
Mortgages $864  $414  $518  $1,796  $145,086  $20  $146,902  $252 
Home Equity  152   62   34   248   54,761   0   55,009   23 
Commercial  836   439   1,822   3,097   590,221   2,937   596,255   70 
Agricultural  2,283   0   1,329   3,612   309,860   1,686   315,158   150 
Construction  0   0   0   0   35,404   0   35,404   0 
Consumer  147   9   30   186   30,091   0   30,277   30 
Other commercial loans  930   0   133   1,063   112,874   232   114,169   0 
Other agricultural loans  1,044   0   0   1,044   47,735   0   48,779   0 
State and political subdivision loans  0   0   0   0   63,328   0   63,328   0 
Total $6,256  $924  $3,866  $11,046  $1,389,360  $4,875  $1,405,281  $525 
Loans considered non-accrual $90  $95  $6,347  $6,532  $5,004  $-  $11,536  $3,032  $28  $3,341  $6,401  $4,331  $0  $10,732     
Loans still accruing  2,052   659   487   3,198   1,099,553   1,282   1,104,033   3,224   896   525   4,645   1,385,029   4,875   1,394,549     
Total $2,142  $754  $6,834  $9,730  $1,104,557  $1,282  $1,115,569  $6,256  $924  $3,866  $11,046  $1,389,360  $4,875  $1,405,281     

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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, 2020March 31, 2021 and December 31, 2019,2020, respectively. The balances are presented by class of loan receivable (in thousands):

 September 30, 2020  December 31, 2019  March 31, 2021  December 31, 2020 
Real estate loans:            
Mortgages $844  $903  $772  $787 
Home Equity  20   59   22   25 
Commercial  5,141   5,080   4,853   4,529 
Agricultural  3,161   2,578   3,064   3,133 
Consumer  0   6 
Other commercial loans  1,551   1,837   1,050   1,284 
Other agricultural loans  994   1,073   919   974 
 $11,711  $11,536  $10,680  $10,732 

Loan Modifications Related to COVID-19


The Company has electedcontinues to follow the loan modification guidance under Section 4013 of the CARES Act with regard to COVID-19 modifications made between March 1, 2020 and the earlier of either December 31, 2020January 1 , 2022 or the 60th day after the end of the COVID-19 national emergency. Under section 4013 of the CARES Act, loans less than 30 days past due as of December 31, 2019 will be considered current for COVID-19 modifications. A financial institution can then suspend the requirements under GAAP for loan modifications related to COVID-19 that would otherwise be categorized as a TDR, and suspend any determination of a loan modified as a result of COVID-19 as being a TDR, including the requirement to determine impairment for accounting purposes. Similarly, the Financial Accounting Standards Board has confirmed that short-term modifications made on a good-faith basis in response to COVID-19 to loan customers who were current prior to any relief are not TDRs. A modification of six months or less is considered to be a short-term loan modification. In response to the COVID-19 pandemic, the Company has prudently executed loan modifications for existing loan customers, which includes deferrals of interest and in certain cases deferrals of principal and interest. The following table presents information regarding loans which were subject to a loan modification related to COVID-19 during 2021, with balances as of the date of modificationDecember 31, 2021 and September 30, 2020,March 31, 2021, as well as the balance by modification type as of September 30, 2020.March 31, 2021.

 
Number of
loans
  
Balance as of
Modification date
  
Number of loans
as of
September 30, 2020
  
Balance as of
September 30, 2020
  Principal and Interest Deferral  Principal Deferral  
% of loans as of
September 30, 2020
  
Number of
loans
  Balance as of December 31, 2020  Number of loans  Balance as of March 31, 2021  Principal and Interest Deferral  Principal Deferral  
% of loans as of March 31, 2021
 
Real estate loans:                                          
Mortgages  49  $9,996   1  $75  $75  $0   0.05%  1  $209   0  $0  $0  $0   0.00%
Home Equity  29   1,389   0   0   0   0   0.00%  1   49   0   0   0   0   0.00%
Commercial  259   144,647   9   17,712   13,039   4,673   3.31%  12   26,039   4   13,864   6,205   7,659   2.29%
Agricultural  50   20,421   2   2,368   0   2,368   0.76%  3   181   0   0   0   0   0.00%
Construction  3   1,178   0   0   0   0   0.00%  0   0   0   0   0   0   0.00%
Consumer  10   68   0   0   0   0   0.00%  0   0   0   0   0   0   0.00%
Other commercial loans  88   24,077   0   0   0   0   0.00%  2   249   0   0   0   0   0.00%
Other agricultural loans  46   3,347   0   0   0   0   0.00%  0   0   0   0   0   0   0.00%
Total  534  $205,123   12  $20,155  $13,114  $7,041   1.48%  19  $26,727   4  $13,864  $6,205  $7,659   0.99%

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Troubled Debt Restructurings


In situations where, for economic or legal reasons related to a borrower’sborrower'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, 2020March 31, 2021 and December 31, 2019,2020, included within the allowance for loan losses are reserves of $293,000$160,000 and $345,000$257,000 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,March 31, 2021 and 2020 and 2019 were as follows (dollars in thousands):

 For the Three Months Ended September 30, 2020  For the Three Months Ended March 31, 2021 
 Number of contracts  Pre-modification Outstanding Recorded Investment  Post-Modification Outstanding Recorded Investment  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  
Interest
Modification
  
Term
Modification
  
Interest
Modification
  
Term
Modification
  
Interest
Modification
  
Term
Modification
 
                                    
Real estate loans:                                    
Commercial  0   1  $0  $276  $0  $276   0   2  $0  $290  $0  $290 
Consumer  0   1   0   3   0   3 
Total  0   2  $0  $279  $0  $279   0   2  $0  $290  $0  $290 

 For the Nine Months Ended September 30, 2020 
  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  0   3   0   682   0   682 
Agricultural  0   1   0   150   0   150 
Consumer  0   1   0   3   0   3 
Total  0   5  $0  $835  $0  $835 

 For the Three Months Ended September 30, 2019  For the Three Months Ended March 31, 2020 
 Number of contracts  Pre-modification Outstanding Recorded Investment  Post-Modification Outstanding Recorded Investment  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  
Interest
Modification
  
Term
Modification
  
Interest
Modification
  
Term
Modification
  
Interest
Modification
  
Term
Modification
 
Real estate loans:                                    
Commercial  0   1  $0  $118  $0  $118 
Consumer  0   1   0   3   0   3 
Agricultural  0   1  $0  $150  $0  $150 
Total  0   2  $0  $121  $0  $121   0   1  $0  $150  $0  $150 

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 For the Nine Months Ended September 30, 2019 
  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:                  
Mortgages  0   1  $0  $4  $0  $4 
Home Equity  0   1   0   40   0   40 
Commercial  0   5   0   918   0   918 
Consumer  0   1   0   3   0   3 
Total  0   8  $0  $965  $0  $965 


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. The following table presents the recorded investment in loans that were modified as TDRs during each 12-month period prior to the current reporting periods, which began January 1, 2020 and 2019 (9 month periods) and July 1, 2020 and 2019(3 month periods), respectively, and that subsequently defaulted during these reporting periods (dollars in thousands):

 For the Three Months Ended  For the Nine Months Ended 
  September 30, 2020  September 30, 2019  September 30, 2020  September 30, 2019 
  Number of contracts  
Recorded
investment
  Number of contracts  
Recorded
investment
  Number of contracts  
Recorded
investment
  Number of contracts  
Recorded
investment
 
Real estate loans:                        
Commercial  1  $110   0  $0   1  $110   1  $542 
Agricultural  0   0   0   0   0   0   1   1,439 
Other agricultural loans  0   0   0   0   0   0   4   261 
Total recidivism  1  $110   0  $0   1  $110   6  $2,242 

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, 2020March 31, 2021 and December 31, 2019,2020, respectively (in thousands):

 September 30, 2020  December 31, 2019  March 31, 2021  December 31, 2020 
 
Individually evaluated for
impairment
  
Collectively evaluated for
impairment
  Total  
Individually evaluated for
impairment
  
Collectively evaluated for
impairment
  Total  
Individually evaluated for
impairment
  
Collectively evaluated for
impairment
  Total  
Individually evaluated for
impairment
  
Collectively evaluated for
impairment
  Total 
Real estate loans:                                    
Residential $29  $1,190  $1,219  $32  $1,082  $1,114  $17  $1,150  $1,167  $18  $1,156  $1,174 
Commercial  341   4,965   5,306   251   4,298   4,549   101   6,582   6,683   95   6,121   6,216 
Agricultural  79   4,727   4,806   151   4,871   5,022   12   4,905   4,917   83   4,870   4,953 
Construction  0   85   85   0   43   43   0   151   151   0   122   122 
Consumer  12   340   352   0   112   112   0   237   237   0   321   321 
Other commercial loans  181   1,049   1,230   147   1,108   1,255   170   1,334   1,504   170   1,056   1,226 
Other agricultural loans  149   586   735   154   807   961   185   604   789   144   720   864 
State and political subdivision loans  0   514   514   0   536   536   0   470   470   0   479   479 
Unallocated  0   922   922   0   253   253   0   642   642   0   460   460 
Total $791  $14,378  $15,169  $735  $13,110  $13,845  $485  $16,075  $16,560  $510  $15,305  $15,815 


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The following tables roll forward the balance of the ALLL by portfolio segment for the three and nine months ended September 30,March 31, 2021 and 2020, and 2019, respectively (in thousands):

 For the three months ended September 30, 2020  For the three months ended March 31, 2021 
 
Balance at
June 30, 2020
  Charge-offs  Recoveries  Provision  
Balance at
September 30, 2020
  
Balance at
December 31, 2020
  Charge-offs  Recoveries  Provision  
Balance at
March 31, 2021
 
Real estate loans:                              
Residential $1,206  $-  $0  $13  $1,219  $1,174  $0  $0  $(7) $1,167 
Commercial  4,944   (220)  3   579   5,306   6,216   0   89   378   6,683 
Agricultural  5,061   (4)  19   (270)  4,806   4,953   0   0   (36)  4,917 
Construction  81   0   0   4   85   122   0   0   29   151 
Consumer  362   (12)  3   (1)  352   321   (4)  6   (86)  237 
Other commercial loans  1,201   (1)  4   26   1,230   1,226   0   4   274   1,504 
Other agricultural loans  821   0   0   (86)  735   864   0   0   (75)  789 
State and political subdivision loans  547   0   0   (33)  514   479   0   0   (9)  470 
Unallocated  604   0   0   318   922   460   0   0   182   642 
Total $14,827  $(237) $29  $550  $15,169  $15,815  $(4) $99  $650  $16,560 

 For the three months ended September 30, 2019 
  
Balance at
June 30, 2019
  Charge-offs  Recoveries  Provision  
Balance at
September 30, 2019
 
Real estate loans:               
Residential $1,066  $(24) $0  $49  $1,091 
Commercial  4,400   -   0   241   4,641 
Agricultural  4,532   0   0   180   4,712 
Construction  36   0   0   (17)  19 
Consumer  118   (10)  6   5   119 
Other commercial loans  1,328   0   3   18   1,349 
Other agricultural loans  741   0   0   128   869 
State and political subdivision loans  539   0   0   (3)  536 
Unallocated  544   0   0   (201)  343 
Total $13,304  $(34) $9  $400  $13,679 

 For the nine months ended September 30, 2020  For the three months ended March 31, 2020 
 
Balance at
December 31, 2019
  Charge-offs  Recoveries  Provision  
Balance at
September 30, 2020
  
Balance at
December 31, 2019
  Charge-offs  Recoveries  Provision  
Balance at
March 31, 2020
 
Real estate loans:                              
Residential $1,114  $0  $0  $105  $1,219  $1,114  $0  $0  $40  $1,154 
Commercial  4,549   (221)  37   941   5,306   4,549   (1)  1   180   4,729 
Agricultural  5,022   (4)  19   (231)  4,806   5,022   0   0   (144)  4,878 
Construction  43   0   0   42   85   43   0   0   13   56 
Consumer  112   (30)  15   255   352   112   (8)  8   5   117 
Other commercial loans  1,255   (1)  9   (33)  1,230   1,255   0   2   40   1,297 
Other agricultural loans  961   0   0   (226)  735   961   0   0   (126)  835 
State and political subdivision loans  536   0   0   (22)  514   536   0   0   22   558 
Unallocated  253   0   0   669   922   253   0   0   370   623 
Total $13,845  $(256) $80  $1,500  $15,169  $13,845  $(9) $11  $400  $14,247 

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 For the nine months ended September 30, 2019 
  
Balance at
December 31, 2018
  Charge-offs  Recoveries  Provision  
Balance at
September 30, 2019
 
Real estate loans:               
Residential $1,105  $(24) $0  $10  $1,091 
Commercial  4,115   (293)  0   819   4,641 
Agricultural  4,264   0   0   448   4,712 
Construction  58   0   0   (39)  19 
Consumer  120   (32)  24   7   119 
Other commercial loans  1,354   (38)  8   25   1,349 
Other agricultural loans  752   0   0   117   869 
State and political subdivision loans  762   0   0   (226)  536 
Unallocated  354   0   0   (11)  343 
Total $12,884  $(387) $32  $1,150  $13,679 


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 of non-accrual loans
▪◾Volume and severity of classified, adversely or graded loans;
Level of and trends in charge-offs and recoveries;
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.

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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.

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Index

For the three months ended September 30, 2020,March 31, 2021, the allowance for commercial real estate agricultural real estate and other agriculturalcommercial loans was increased due to a general deterioration in economic activityloans acquired as a resultpart of the Covid-19 pandemic. In addition,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 was increaseddecreased due to an increasea decrease in past due loans. The factor related to the volume and severity of classified, adversely or graded loans was decreased for municipal loans, agriculture real estate loans and other agricultural loans due to a decrease in classified loans


For the three months ended March 31, 2020, the allowance for all categories was increased due to a general deterioration in economic activity and unemployment as a result of the Covid-19 pandemic. In addition, commercial real estate was increased due to an increase in past due loans. The decrease in the provision for agricultural real estate loans and other agricultural loans is due to the decrease in outstanding loans in these loan portfolios as of September 30, 2020 compared to June 30, 2020.


For the nine months ended September 30, 2020, the allowance for all categories was increased due to a general deterioration in economic activity and increase in unemployment as a result of the Covid-19 pandemic. In addition, commercial real estate was increased due to an increase in past due and nonaccrual loans. Factors related to residential real estate were increased due to an increase in past due loans. The factor related to the volume and severity of classified, adversely or graded loans was decreased for municipal loans, agriculture real estate loans and other agricultural loans due to a decrease in classified loans. The decrease in the provision for other agricultural loans is due to the decrease in outstanding loans in these loan portfolios as of September 30,March 31, 2020 compared to December 31, 2019.


For the three months ended September 30, 2019, the allowance for commercial real estate was increased in general reserves due to an increase in the size of the portfolio and an increase in the historical loss percentage of the portfolio. This was represented as an increase in the provision. The allowance for agricultural real estate loans was increased in general reserves as a result of overall growth in the portfolio. The result of this was represented as an increase in the provision. The allowance for other agricultural loans was increased as a result of a general increase in the size of the portfolio. The result of these changes was represented as an increase in the provision.


For the nine months ended September 30, 2019, the allowance for commercial real estate was increased in general reserves due to general increase in the size of the portfolio and an increase in the historical loss percentage of the portfolio. There also was an increase in specific reserves for commercial real estate, which was partially offset by the decrease in substandard loans. The total change was represented as an increase in the provision. The allowance for agricultural real estate loans was increased in general reserves as a result of higher loan balances. Additionally, there was an increase in specific reserves. The allowance for other agricultural loans was increased as a result of a general increase in the size of the portfolio. The result of these changes was represented as an increase in the provision. These resulted in an increase in the provision. The allowance for state and political subdivision was decreased as a result a decrease in the volume of classified loans. The result of this change was represented as a decrease in the provision.

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, 2020March 31, 2021 and December 31, 2019,2020, included within other assets are $2,726,000$1,720,000 and $3,404,000,$1,836,000, respectively, of foreclosed assets. As of September 30, 2020,March 31, 2021, included within the foreclosed assets are $199,000$359,000 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, 2020,March 31, 2021, the Company had initiated formal foreclosure proceedings on $723,000$545,000 of consumer residential mortgages, which had not yet been transferred into foreclosed assetsassets. In accordance with various state regulations, foreclosure actions have been suspended into the fourth quarter.


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Index
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, 2020March 31, 2021 and December 31, 20192020 (in thousands):

 September 30, 2020  December 31, 2019  March 31, 2021  December 31, 2020 
 Gross carrying value  
Accumulated
amortization
  Net carrying value  Gross carrying value  
Accumulated
amortization
  Net carrying value  Gross carrying value  
Accumulated
amortization
  Net carrying value  Gross carrying value  
Accumulated
amortization
  Net carrying value 
Amortized intangible assets (1):                                    
MSRs $2,058  $(1,220) $838  $1,718  $(1,077) $641  $2,302  $(1,203) $1,099  $2,153  $(1,131) $1,022 
Core deposit intangibles  1,943   (1,243)  700   1,786   (1,081)  705   1,943   (1,346)  597   1,943   (1,297)  646 
Covenant not to compete  125   (125)  0   125   (125)  0 
Total amortized intangible assets $4,126  $(2,588) $1,538  $3,629  $(2,283) $1,346  $4,245  $(2,549) $1,696  $4,096  $(2,428) $1,668 
Unamortized intangible assets:                                                
Goodwill $31,376          $23,296          $31,376          $31,376         

(1) Excludes fully amortized intangible assets

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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, 2020.March 31, 2021. Future amortization expense may vary from these projections:

 MSRs  Core deposit intangibles  Covenant not to compete  Total  MSRs  Core deposit intangibles  Total 
Three months ended September 30, 2020 (actual) $46  $57  $0  $103 
Nine months ended September 30, 2020 (actual)  144   162   0   306 
Three months ended September 30, 2019 (actual)  44   58   8   110 
Nine months ended September 30, 2019 (actual)  138   174   24   336 
Three months ended March 31, 2021 (actual)
 $72  $49  $121 
Three months ended March 31, 2020 (actual)
  48   50   98 
Estimate for year ending December 31,                            
Remaining 2020  60   55   0   115 
2021  213   192   0   405 
Remaining 2021  219   143   362 
2022  168   156   0   324   241   156   397 
2023  130   121   0   251   190   121   311 
2024  98   85   0   183   147   85   232 
2025  110   50   160 
Thereafter  169   91   0   260   192   42   234 
Total $838  $700  $0  $1,538  $1,099  $597  $1,696 


Note 7 - Employee Benefit Plans


For additional detailed disclosure on the Company’sCompany's pension and employee benefits plans, please refer to Note 11 of the Company’sCompany's Consolidated Financial Statements included in the 20192020 Annual Report on Form 10-K.


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. Additionally, the Bank assumed the noncontributory defined benefit pension plan of the First National Bank of Fredericksburg (FNB) when FNB was acquired in December 2015. The FNB plan was closed and all assets were distributed in the fourth quarter of 2019. The Bank’s funding policy is to make annual contributions, if needed, based upon the funding formula developed by the plans’ 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.

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Index

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,March 31, 2021 and 2020, and 2019, respectively (in thousands):

 
Three Months Ended
September 30,
  
Nine Months Ended
September 30,
   
Three Months Ended
March 31,
  
 2020  2019  2020  2019 
Affected line item on the Consolidated
Statement of Income
 2021  2020 Affected line item on the Consolidated Statement of Income
Service cost $82  $78  $247  $256 Salary and Employee Benefits $110  $83 Salary and Employee Benefits
Interest cost  83   123   249   401 Other Expenses  82   87 Other Expenses
Expected return on plan assets  (215)  (187)  (646)  (595)Other Expenses  (252)  (225)Other  Expenses
Partial Settlement  0   0   307   0 Other Expenses
Net amortization and deferral  59   60   175   181 Other Expenses  91   62 Other Expenses
Net periodic benefit cost $9  $74  $332  $243   $31  $7  


The Bank expectsdoes 0t expect to contribute $250,000 to the Pension Plan during the fourth quarter of 2020.2021.

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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, 2020, 124,479March 31, 2021, 123,966 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, 2020:March 31, 2021:

 Three months  Nine months  Three months 
 
Unvested
Shares
  
Weighted
Average
Market Price
  
Unvested
Shares
  
Weighted
Average
Market Price
  
Unvested
Shares
  
Weighted
Average
Market Price
 
Outstanding, beginning of period  10,786  $56.60   10,877  $60.11   10,202  $55.93 
Granted  85   58.37   4,732   51.29   88   56.81 
Forfeited  0   0   0   0   (60)  (54.07)
Vested  0   0   (4,738)  (59.32)  (32)  (58.24)
Outstanding, end of period  10,871  $56.61   10,871  $56.61   10,198  $55.94 


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 $248,000$84,000 and $219,000$82,000 for the nine months ended September 30, 2020 and 2019, respectively. For the three months ended September 30,March 31, 2021 and 2020, and 2019, compensation expense totaled $83,000 and $78,000, respectively. At September 30, 2020,March 31, 2021, the total compensation cost related to nonvested awards that had not yet been recognized was $615,000,$570,000, which is expected to be recognized over the next three years.years.

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Note 8 – Accumulated Comprehensive Income (Loss)


The following tables present the changes in accumulated other comprehensive income (loss) by component, net of tax, for the three and nine months ended September 30,March 31, 2021 and 2020 and 2019 (in thousands):

 Nine months ended September 30, 2020 
  
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, 2019 $2,290  $(2,919) $0  $(629)
Other comprehensive income (loss) before reclassifications (net of tax)  3,705   0   (353)  3,352 
Amounts reclassified from accumulated other comprehensive income (loss) (net of tax)  (239)  381   0   142 
Net current period other comprehensive income (loss)  3,466   381   (353)  3,494 
Balance as of September 30, 2020 $5,756  $(2,538) $(353) $2,865 
 Three months ended March 31, 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)  (3,235)  0   1,617   (1,618)
Amounts reclassified from accumulated other comprehensive (loss) income (net of tax)  (39)  72   0   33 
Net current period other comprehensive (loss) income  (3,274)  72   1,617   (1,585)
Balance as of March 31, 2021
 $2,784  $(3,390) $1,608   1,002 

 Nine months ended September 30, 2019 
  
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, 2018 $(973) $(2,948) $0  $(3,921)
Other comprehensive income (loss) before reclassifications (net of tax)  3,495   0   0   3,495 
Amounts reclassified from accumulated other comprehensive income (loss) (net of tax)  (6)  143   0   137 
Net current period other comprehensive income (loss)  3,489   143   0   3,632 
Balance as of September 30, 2019 $2,516  $(2,805) $0  $(289)

 Three months ended September 30, 2020 
  
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, 2020 $5,938  $(2,585) $(446) $2,907 
Other comprehensive income (loss) before reclassifications (net of tax)  (35)  0   93   58 
Amounts reclassified from accumulated other comprehensive income (loss) (net of tax)  (147)  47   0   (100)
Net current period other comprehensive income (loss)  (182)  47   93   (42)
Balance as of September 30, 2020 $5,756  $(2,538) $(353) $2,865 

 Three months ended September 30, 2019  Three months ended March 31, 2020 
 
Unrealized gain
(loss) on available
for sale securities (a)
  
Defined Benefit
Pension Items (a)
  
Unrealized loss on
interest rate swap (a)
  Total  
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, 2019 $2,515  $(2,852) $0  $(337)
Balance as of December 31, 2019
 $2,290  $(2,919) $0  $(629)
Other comprehensive income (loss) before reclassifications (net of tax)  7   0   0   7   3,424   0   -   3,424 
Amounts reclassified from accumulated other comprehensive income (loss) (net of tax)  (6)  47   0   41   0   123   -   123 
Net current period other comprehensive income (loss)  1   47   0   48   3,424   123   -   3,547 
Balance as of September 30, 2019 $2,516  $(2,805) $0  $(289)
Balance as of March 31, 2020
 $5,714  $(2,796) $-  $2,918 

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

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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,March 31, 2021 and 2020 and 2019 (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, 2020  
  2020  2019  
Unrealized gains and losses on available for sale securities           
  $185  $8 Available for sale securities gains, net
   (38)  (2)Provision for income taxes
  $147  $6  
             
Defined benefit pension items           
  $(59) $(60)Other expenses
   12   13 Provision for income taxes
  $(47) $(47) 
             
Total reclassifications $100  $(41) 

Details about accumulated other comprehensive income (loss) 
Amount reclassified from
accumulated comprehensive
income (loss) (a)
 Affected line item in the Consolidated Statement of Income
 Nine Months Ended September 30,   Three Months Ended March 31,  
 2020  2019   2021  2020  
Unrealized gains and losses on available for sale securities                      
 $302  $8 Available for sale securities gains, net $50  $0 Available for sale securities gains, net
  (63)  (2)Provision for income taxes  (11)  0 Provision for income taxes
 $239  $6   $39  $0 Net of tax
                        
Defined benefit pension items                      
 $(482) $(181)Other expenses $(91) $(156)Other expenses
  101   38 Provision for income taxes  19   33 Provision for income taxes
 $(381) $(143)  $(72) $(123)Net of tax
            
Total reclassifications $(142) $(137)  $(33) $(123) 

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

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.

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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, 2020March 31, 2021 and December 31, 20192020 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, 2020 Level I  Level II  Level III  Total 
March 31, 2021
 Level I  Level II  Level III  Total 
Fair value measurements on a recurring basis:                        
Assets                        
Equity securities $1,696  $0  $0  $1,696  $2,118  $0  $0  $2,118 
Available for sale securities:                                
U.S. Agency securities  0   80,698   0   80,698   0   79,709   0   79,709 
U.S. Treasury securities  28,167   0   0   28,167   40,362   0   0   40,362 
Obligations of state and
political subdivisions
  0   91,848   0   91,848   0   102,345   0   102,345 
Corporate obligations  0   6,507   0   6,507   0   6,983   0   6,983 
Mortgage-backed securities in
government sponsored entities
  0   80,618   0   80,618   0   92,568   0   92,568 
Other Assets                
Derivative instruments  0   4,651   0   4,651 
Liabilities                                
Interest rate swaps  0   448   0   448 
                
December 31, 2019 Level I  Level II  Level III  Total 
Fair value measurements on a recurring basis:                
Assets                
Equity securities $701  $0  $0  $701 
Available for sale securities:                
U.S. Agency securities  0   84,863   0   84,863 
U.S. Treasuries securities  27,661   0   0   27,661 
Obligations of state and
political subdivisions
  0   61,455   0   61,455 
Corporate obligations  0   3,328   0   3,328 
Mortgage-backed securities in
government sponsored entities
  0   63,399   0   63,399 
Derivative instruments  0   (2,615)  0   (2,615)

December 31, 2020
 Level I  Level II  Level III  Total 
Fair value measurements on a recurring basis:            
Assets            
Equity securities $1,931  $0  $0  $1,931 
Available for sale securities:                
U.S. Agency securities  0   81,416   0   81,416 
U.S. Treasuries securities  28,043   0   0   28,043 
Obligations of state and political subdivisions  0   102,972   0   102,972 
Corporate obligations  0   6,509   0   6,509 
Mortgage-backed securities in government sponsored entities  0   76,249   0   76,249 
Other Assets                
Derivative instruments  0   1,111   0   1,111 
Liabilities                
Derivative instruments  0   (1,122)  0   (1,122)

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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, 2020March 31, 2021 and December 31, 20192020 are included in the table below (in thousands):

September 30, 2020 Level I  Level II  Level III  Total 
March 31, 2021
 Level I  Level II  Level III  Total 
Impaired Loans $0  $0  $4,072  $4,072  $0  $0  $3,264  $3,264 
Other real estate owned  0   0   2,692   2,692   0   0   1,527   1,527 
                                
December 31, 2019 Level I  Level II  Level III  Total 
December 31, 2020
 Level I  Level II  Level III  Total 
Impaired Loans $0  $0  $3,860  $3,860  $0  $0  $3,243  $3,243 
Other real estate owned  0   0   3,299   3,299   0   0   1,700   1,700 

•
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 $449,000$351,000 and $424,000$356,000 at September 30, 2020March 31, 2021 and December 31, 2019, respectively.2020, respectively.

•
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).

September 30, 2020 Fair Value Valuation Technique(s)Unobservable input Range  
Weighted
average
 
March 31, 2021
 Fair Value Valuation Technique(s)Unobservable input Range  
Weighted
average
 
Impaired Loans $4,072 Appraised Collateral ValuesDiscount for time since appraisal  0-100%  17.70% $3,264 Appraised Collateral ValuesDiscount for time since appraisal  0-100%  21.83%
         Selling costs  5%-10%  9.25%         Selling costs  5%-11%  9.40%
         Holding period 0 - 12 months  11.86 months          Holding period 0 - 12 months  11.49 months 
                          
Other real estate owned  2,692 Appraised Collateral ValuesDiscount for time since appraisal  10-30%  18.79%  1,527 Appraised Collateral ValuesDiscount for time since appraisal  20-33%  30.58%

December 31, 2019 Fair Value Valuation Technique(s)Unobservable input Range  
Weighted
average
 
December 31, 2020
 Fair Value Valuation Technique(s)Unobservable input Range  
Weighted
average
 
Impaired Loans  3,860 Appraised Collateral ValuesDiscount for time since appraisal  0-100%  19.22%  3,243 Appraised Collateral ValuesDiscount for time since appraisal  0-100%  20.61%
         Selling costs  5%-10%  9.26%         Selling costs  5%-10%  9.51%
         Holding period 6 - 12 months  11.76 months          Holding period 6 - 12 months  11.65 months 
                          
Other real estate owned  3,299 Appraised Collateral ValuesDiscount for time since appraisal  5-43%  16.37%  1,700 Appraised Collateral ValuesDiscount for time since appraisal  20-31%  28.67%

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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, 2020 
Carrying
Amount
  Fair Value  Level I  Level II  Level III 
Financial assets:               
Interest bearing time deposits with other banks $13,758  $14,406  $0  $0  $14,406 
Loans held for sale  19,320   19,320   0   0   19,320 
Net loans  1,350,710   1,369,709   0   0   1,369,709 
                     
Financial liabilities:                    
Deposits  1,552,753   1,558,516   1,168,405   0   390,111 
Borrowed funds  99,602   99,616   0   0   99,616 

December 31, 2019 
Carrying
Amount
  Fair Value  Level I  Level II  Level III 
March 31, 2021 
Carrying
Amount
  Fair Value  Level I  Level II  Level III 
Financial assets:                              
Interest bearing time deposits with other banks $14,256  $14,635  $0  $0  $14,635  $13,509  $13,509  $0  $0  $13,509 
Loans held for sale  815   815   0   0   815   9,946   9,946   0   0   9,946 
Net loans  1,101,724   1,091,006   0   0   1,091,006   1,387,841   1,399,392   0   0   1,399,392 
                                        
Financial liabilities:                                        
Deposits  1,211,118   1,211,200   938,387   0   272,813   1,687,470   1,690,832   1,314,705   0   376,127 
Borrowed funds  85,117   84,581   0   0   84,581   86,171   83,141   0   0   83,141 
                    
December 31, 2020                    
Financial assets:                    
Interest bearing time deposits with other banks $13,758  $13,758  $0  $0  $13,758 
Loans held for sale  14,640   14,640   0   0   14,640 
Net loans  1,389,466   1,404,166   0   0   1,404,166 
                    
Financial liabilities:                    
Deposits  1,588,858   1,593,738   1,207,666   0   386,075 
Borrowed funds  88,838   88,263   0   0   88,263 


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 – Acquisition of MidCoast Community Bancorp, Inc.Subsequent Event – subordinated debt issuance


InThe Company completed on April 16, 2021, a private placement of $10 million aggregate principal amount of 4.00% fixed-to-floating rate subordinated notes due 2031 (the "Notes") to certain qualified investors. Unless earlier redeemed, the third quarterNotes mature on April 16, 2031. The Notes will initially bear interest from the initial issue date to but excluding April 16, 2026 or the earlier redemption, at a fixed rate of 2019,4.00% per annum,  payable semiannually.  Subsequently and through maturity, the Company announcedNotes will be bear interest equal to the signing90-day average secured overnight financing rate, determined on the determination date of a definitive merger agreement to acquirethe applicable interest period, plus 100%323 basis points, payable quarterly in arrears on March 30, June 30, September 30 and December 30 of each year. The Company may also redeem the outstanding equity interestNotes, in whole or in part, on or after April 16, 2026, and at any time upon the occurrence of MidCoast Community Bancorp, Inc. (“MidCoast”) for $6.50 per sharecertain events, subject in cash and stock. MidCoast was a Pennsylvania Corporation that conducted its business primarily through, its wholly owned subsidiary MidCoast Community Bank, which operated from a main office in Wilmington, Delaware, andeach case to the approval of the Board of Governors of the Federal Reserve System (the "Federal Reserve"). The Notes were designed to qualify as Tier 2 branches in Wilmington, Delaware,capital under the Federal Reserve's capital adequacy regulations. The Company expects to use the net proceeds of the offering for general corporate purposes, which may include working capital, the funding of organic growth or potential acquisitions, and the repurchase of the Company's common stock.1 branch in Dover, Delaware.


The transaction closed on April 17, 2020, with MidCoast Community Bank having been merged into First Citizens Community Bank, with First Citizens Community Bank as the surviving entity. The acquisition established the Company’s presence in the Wilmington and Dover, Delaware markets.


Under the terms of the merger agreement, the Company acquired all of the outstanding shares of MidCoast for a total purchase price of approximately $26,843,000.  As a result of the acquisition, the Company issued 373,356 common shares and $7.6 million in cash to the former shareholders of MidCoast. The shares were issued with a value of $51.50 per share, which was based on the close price of the Company’s stock on April 17, 2020.

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The acquired assets and assumed liabilities were measured at estimated fair values. Management made significant estimates and exercised significant judgment in accounting for the acquisition.  Management measured loan fair values based on loan file reviews, appraised collateral values, expected cash flows, and historical loss factors of MidCoast.  Real estate acquired through foreclosure was primarily valued based on appraised collateral values.  The Company also recorded an identifiable intangible asset representing the core deposit base of MidCoast based on management’s evaluation of the cost of such deposits relative to alternative funding sources.  Management used significant estimates including the average lives of depository accounts, future interest rate levels, and the cost of servicing various depository products.


The business combination resulted in the acquisition of loans with and without evidence of credit quality deterioration. MidCoast’s loans were deemed to have credit impairment at the acquisition date if the Company did not expect to receive all contractually required cash flows due to concerns about credit quality.  Such loans were fair valued and the difference between contractually required payments at the acquisition date and cash flows expected to be collected was recorded as a non-accretable difference. At the acquisition date, the Company recorded $4,869,000 of purchased credit-impaired loans. The method of measuring carrying value of purchased loans differs from loans originated by the Company (originated loans), and as such, the Company identifies purchased loans and purchased loans with a credit quality discount and originated loans at amortized cost.


MidCoast’s loans without evidence of credit deterioration were fair valued by discounting both expected principal and interest cash flows using an observable discount rate for similar instruments that a market participant would consider in determining fair value.  Additionally, consideration was given to management’s best estimates of default rates and pre-payment speeds.


The following table summarizes the purchase of MidCoast as of April 17, 2020:

(In Thousands, Except Per Share Data)      
Purchase Price Consideration in Common Stock      
Citizens Financial Services, Inc. shares issued  373,356    
Value assigned to Citizens Financial Services, Inc. common share $51.50    
Purchase price assigned to MidCoast common shares exchanged for Citizens Financial Services, Inc.     $19,227 
Purchase Price Consideration - Cash for Common Stock        
Purchase price assigned to The First National Bank of Fredericksburg common shares exchanged for cash      7,616 
Total Purchase Price      26,843 
Net Assets Acquired:        
MidCoast Community Bancorp, Inc shareholders’ equity $24,330     
Adjustments to reflect assets acquired at fair value:        
Investments       
Loans        
Interest rate  1,424     
General credit  (4,375)    
Specific credit - non-amortizing  (2,135)    
Specific credit - amortizing  (966)    
Core deposit intangible  157     
Owned premises  (426)    
Other assets  65     
Deferred tax assets  2,217     
Adjustments to reflect liabilities acquired at fair value:        
Time deposits  (1,018)    
Borrowings  (497)    
Other liabilities  (13)    
       18,763 
Goodwill resulting from merger     $8,080 

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Index
The following condensed statement reflects the amounts recognized as of the acquisition date for each major class of asset acquired and liability assumed:

(In Thousands)      
Total purchase price    $26,843 
Net assets acquired:       
Cash and cash equivalents $8,637     
Loans  223,235     
Premises and equipment, net  1,787     
Accrued interest receivable  586     
Bank-owned life insurance  3,766     
Intangibles  157     
Deferred tax asset  3,402     
Other assets  2,878     
Time deposits  (123,841)    
Deposits other than time deposits  (84,985)    
Accrued interest payable  (164)    
Borrowings  (15,497)    
Other liabilities  (1,198)    
       18,763 
Goodwill resulting from the MidCoast merger     $8,080 


The Company recorded goodwill and other intangibles associated with the acquisition of MidCoast totaling $8,237,000.  Goodwill is not amortized, but is periodically evaluated for impairment.  The Company did not recognize any impairment from April 17, 2020 to September 30, 2020. None of the goodwill acquired is expected to be deductible for tax purposes.


Identifiable intangibles are amortized to their estimated residual values over the expected useful lives. Such lives are also periodically reassessed to determine if any amortization period adjustments are required. For the period from April 17, 2020 to September 30, 2020, no such adjustments were recorded.  The identifiable intangible asset consists of core deposit intangibles which are being amortized on an accelerated basis over the useful life of such assets.  The gross carrying amount of the core deposit intangible at September 30, 2020 was $157,000, with $12,000 accumulated amortization, respectively, as of that date.


As of September 30, 2020, the current year and estimated future amortization expense for the core deposit intangibles was (in thousands):

 Core deposit intangibles 
Three months ended September 30, 2020 (actual) $7 
Nine months ended September 30, 2020 (actual)  12 
Estimate for year ending December 31,    
Remaining 2020  7 
2021  27 
2022  24 
2023  21 
2024  18 
Thereafter  48 
Total $145 


Amounts recognized separately from the acquisition include primarily legal fees, investment banking fees, system conversion costs, severance costs and contract termination costs. These costs were included in merger and acquisition expenses within non-interest expenses on the Consolidated Statement of Income and amounted to approximately $2,179,000 for the nine months ended September 30, 2020.

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Results of operations for MidCoast prior to the acquisition date are not included in the Consolidated Statement of Income for the nine months ended September 30, 2020. 


The following table presents financial information regarding the former MidCoast operations included in our Consolidated Statement of Income from the date of acquisition through September 30, 2020 under the column “Actual from Acquisition Date through September 30, 2020”.  In addition, the following table presents unaudited pro forma information as if the acquisition of MidCoast had occurred on January 1, 2019 under the “Pro Forma” columns.  The table below has been prepared for comparative purposes only and is not necessarily indicative of the actual results that would have been attained had the acquisition occurred as of the beginning of the periods presented, nor is it indicative of future results. Furthermore, the unaudited proforma information does not reflect management’s estimate of any revenue-enhancing opportunities nor anticipated cost savings as a result of the integration and consolidation of the acquisition.  Merger and acquisition integration costs and amortization of fair value adjustments are included in the numbers below.

    Pro Forma for 
  Actual from Acquisition  Three Months Ended  Nine Months Ended 
  Date Through  September 30,  September 30, 
(In Thousands, Except Per Share Data) September 30, 2020  2020  2019  2020  2019 
Net interest income $5,387  $16,052  $15,404  $47,642  $44,918 
Non-interest income  107   3,538   2,239   7,779   6,416 
Net income  3,035   7,678   5,849   16,306   16,649 
Pro forma earnings per share:                    
Basic     $1.96  $1.49  $4.16  $4.23 
Diluted     $1.96  $1.49  $4.16  $4.23 


Note 11 – Recent Accounting Pronouncements


In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments, which changes the impairment model for most financial assets. This Update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations.  The underlying premise of the Update is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset.  The income statement will be effected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted for annual and interim periods beginning after December 15, 2018. With certain exceptions, transition to the new requirements will be through a cumulative effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is adopted.  In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). This Update defers the effective date of ASU 2016-13 for SEC filers that are eligible to be smaller reporting companies, non-SEC filers, and all other companies to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. We expect to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements. In that regard, we have formed a cross-functional working group. The working group is comprised of individuals from various functional areas including credit, loan origination and finance. We are currently working through our implementation plan which includes assessment and documentation of processes, internal controls and data sources; model development and documentation; and system configuration, among other things. We are also in the process of implementing a third-party vendor solution to assist us in the application of the ASU 2016-13. The adoption of the ASU 2016-13 could result in an increase in the allowance for loan losses as a result of changing from an “incurred loss” model, which encompasses allowances for current known and inherent losses within the portfolio, to an “expected loss” model, which encompasses allowances for losses expected to be incurred over the life of the portfolio. While we are currently unable to reasonably estimate the impact of adopting ASU 2016-13, we expect that the impact of adoption will be significantly influenced by the composition, characteristics and quality of our loan portfolio as well as the prevailing economic conditions and forecasts as of the adoption date.

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In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. To simplify the subsequent measurement of goodwill, the FASB eliminated Step 2 from the goodwill impairment test.  In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination.  Instead, under the amendments in this Update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting units fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.  A public business entity that is a U.S. Securities and Exchange Commission (SEC) filer should adopt the amendments in this Update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842), which deferred the effective date for ASC 350, Intangibles – Goodwill and Other, for smaller reporting companies to fiscal years beginning after December 15, 2022, and interim periods within those fiscal years. This Update is not expected to have a significant impact on the Company’s consolidated financial statements.


In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes the Disclosure Requirements for Fair Value Measurements.  The Update removes the requirement to disclose the amount of and reasons for transfers between Level I and Level II of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level III fair value measurements. The Update requires disclosure of changes in unrealized gains and losses for the period included in other comprehensive income (loss) for recurring Level III fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level III fair value measurements. This Update is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019.  This Update is not expected to have a significant impact on the Company’s consolidated financial statements.


In August 2018, the FASB issued ASU 2018-14, Compensation – Retirement Benefits (Topic 715-20). This Update amends ASC 715 to add, remove and clarify disclosure requirements related to defined benefit pension and other postretirement plans. The Update eliminates the requirement to disclose the amounts in accumulated other comprehensive income expected to be recognized as part of net periodic benefit cost over the next year. The Update also removes the disclosure requirements for the effects of a one-percentage-point change on the assumed health care costs and the effect of this change in rates on service cost, interest cost and the benefit obligation for postretirement health care benefits. This Update is effective for public business entities for fiscal years ending after December 15, 2020, and must be applied on a retrospective basis.  For all other entities, this Update is effective for fiscal years ending after December 15, 2021.  This Update is not expected to have a significant impact on the Company’s consolidated financial statements.

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In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, which affects a variety of topics in the Codification and applies to all reporting entities within the scope of the affected accounting guidance. Topic 326, Financial Instruments – Credit Losses amendments are effective for SEC registrants for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. For all other public business entities, the effective date is for fiscal years beginning after December 15, 2020, and for all other entities, the effective date is for fiscal years beginning after December 15, 2021.  Topic 815, Derivatives and Hedging amendments are effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods beginning after December 15, 2020. For entities that have adopted the amendments in Update 2017-12, the effective date is as of the beginning of the first annual period beginning after the issuance of this Update. Topic 825, Financial Instruments amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years. In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). This Update defers the effective date of ASU 2016-13 for SEC filers that are eligible to be smaller reporting companies, non-SEC filers and all other companies to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Furthermore, the ASU provides a one-year deferral of the effective dates of the ASUs on derivatives and hedging for companies that are not public business entities. The Company qualifies as a smaller reporting company and does not expect to early adopt these ASUs.


In May 2019, the FASB issued ASU 2019-05, Financial Instruments – Credit Losses, Topic 326, which allows entities to irrevocably elect the fair value option for certain financial assets previously measured at amortized cost upon adoption of the new credit losses standard. To be eligible for the transition election, the existing financial asset must otherwise be both within the scope of the new credit losses standard and eligible for the applying the fair value option in ASC 825-10.3. The election must be applied on an instrument-by-instrument basis and is not available for either available-for-sale or held-to-maturity debt securities. For entities that elect the fair value option, the difference between the carrying amount and the fair value of the financial asset would be recognized through a cumulative-effect adjustment to opening retained earnings as of the date an entity adopted ASU 2016-13. Changes in fair value of that financial asset would subsequently be reported in current earnings. For entities that have not yet adopted ASU 2016-13, the effective dates and transition requirements are the same as those in ASU 2016-13. For entities that have adopted ASU 2016-13, ASU 2019-05 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted once ASU 2016-13 has been adopted.  In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). The Update defers the effective date of ASU 2016-13 for SEC filers that are eligible to be smaller reporting companies, non-SEC filers and all other companies to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company qualifies as a smaller reporting company and does not expect to early adopt ASU 2016-13.


In July 2019, the FASB issued ASU 2019-07, Codification Updates to SEC Sections, Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No. 33-10532, Disclosure Update and Simplification, and Nos. 33-10231 and 33-10442, Investment Company Reporting Modernization, and Miscellaneous Updates. This ASU amends various SEC paragraphs pursuant to the issuance of SEC Final Rule Releases No. 33-10532, Disclosure Update and Simplification, and Nos. 33-10231 and 33-10442, Investment Company Reporting Modernization. Other miscellaneous updates to agree to the electronic Code of Federal Regulations also have been incorporated.


In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). The Update defers the effective dates of ASU 2016-13 for SEC filers that are eligible to be smaller reporting companies, non-SEC filers, and all other companies to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. This Update also amends the mandatory effective date for the elimination of Step 2 from the goodwill impairment test under ASU No. 2017-04, Intangibles ‒ Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (Goodwill),to align with those used for credit losses. Furthermore, the ASU provides a one-year deferral of the effective dates of the ASUs on derivatives and hedging and leases for companies that are not public business entities. The Company qualifies as a smaller reporting company and does not expect to early adopt these ASUs.

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In November 2019, the FASB issued ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, to clarify its new credit impairment guidance in ASC 326, based on implementation issues raised by stakeholders. This Update clarified, among other things, that expected recoveries are to be included in the allowance for credit losses for these financial assets; an accounting policy election can be made to adjust the effective interest rate for existing troubled debt restructurings based on the prepayment assumptions instead of the prepayment assumptions applicable immediately prior to the restructuring event; and extends the practical expedient to exclude accrued interest receivable from all additional relevant disclosures involving amortized cost basis. The effective dates in this Update are the same as those applicable for ASU 2019-10. 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 December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740), to simplify the accounting for income taxes, change the accounting for certain tax transactions, and make minor improvements to the codification. This Update provides a policy election to not allocate consolidated income taxes when a member
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Table of a consolidated tax return is not subject to income tax and provides guidance to evaluate whether a step-up in tax basis of goodwill relates to a business combination in which book goodwill was recognized or a separate transaction. The Update also changes current guidance for making an intraperiod allocation, if there is a loss in continuing operations and gains outside of continuing operations; determining when a deferred tax liability is recognized after an investor in a foreign entity transitions to or from the equity method of accounting; accounting for tax law changes and year-to-date losses in interim periods; and determining how to apply the income tax guidance to franchise taxes that are partially based on income. For public business entities, the amendments in this Update are effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2020. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2021, and interim periods within 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.Contents


In January 2020, the FASB issued ASU 2020-1, Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815), to clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting for the purposes of applying the measurement alternative in accordance with Topic 321 immediately before applying or upon discontinuing the equity method. The amendments also clarify that, for the purpose of applying paragraph 815-10-15-141(a) an entity should not consider whether, upon the settlement of the forward contract or exercise of the purchased option, individually or with existing investments, the underlying securities would be accounted for under the equity method in Topic 323 or the fair value option, in accordance with the financial instruments guidance in Topic 825. An entity also would evaluate the remaining characteristics in paragraph 815-10-15-141 to determine the accounting for those forward contracts and purchased options. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. 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 2020, the FASB issued ASU 2020-2, Financial Instruments – Credit Losses (Topic 326) and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842), February 2020, to add and amend SEC paragraphs in the Accounting Standards Codification to reflect the issuance of SEC Staff Accounting Bulletin No. 119, related to the new credit losses standard, and comments by the SEC staff related to the revised effective date of the new leases standard. This ASU is effective upon issuance. This did not have a significant impact on the Company’s consolidated financial statements.

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In March 2020, the FASB issued ASU 2020-3, Codification Improvements to Financial Instruments. This ASU was issued to improve and clarify various financial instruments topics, including the current expected credit losses (CECL) standard issued in 2016. The ASU includes seven issues that describe the areas of improvement and the related amendments to GAAP; they are intended to make the standards easier to understand and apply and to eliminate inconsistencies, and they are narrow in scope and are not expected to significantly change practice for most entities. Among its provisions, the ASU clarifies that all entities, other than public business entities that elected the fair value option, are required to provide certain fair value disclosures under ASC 825, Financial Instruments, in both interim and annual financial statements. It also clarifies that the contractual term of a net investment in a lease under Topic 842 should be the contractual term used to measure expected credit losses under Topic 326. Amendments related to ASU 2019-04 are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is not permitted before an entity’s adoption of ASU 2016-01. Amendments related to ASU 2016-13 for entities that have not yet adopted that guidance are effective upon adoption of the amendments in ASU 2016-13. Early adoption is not permitted before an entity’s adoption of ASU 2016-13. Amendments related to ASU 2016-13 for entities that have adopted that guidance are effective for fiscal years beginning after December 15, 2019, including interim periods within those years. Other amendments are effective upon issuance of this ASU. 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 2020, the FASB issued ASU 2020-4, 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 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.

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In August 2020, the FASB issued ASU 2020-6, Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40), which simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts on an entity’s own equity.  This ASU removes from U.S. GAAP the separation models for (1) convertible debt with a cash conversion feature and (2) convertible instruments with a beneficial conversion feature. As a result, entities will not separately present in equity an embedded conversion feature in such debt. Instead, they will account for a convertible debt instrument wholly as debt, and for convertible preferred stock wholly as preferred stock (i.e., as a single unit of account), unless (1) a convertible instrument contains features that require bifurcation as a derivative under ASC 815 or (2) a convertible debt instrument was issued at a substantial premium.  This ASU requires entities to provide expanded disclosures about the terms and features of convertible instruments, how the instruments have been reported in the entity’s financial statements, and information about events, conditions, and circumstances that can affect how to assess the amount or timing of an entity’s future cash flows related to those instruments. The amendments in this ASU are effective for public business entities that are not smaller reporting companies, for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years.  For all other entities, this ASU is effective for fiscal years beginning after December 15, 2023, and interim periods within those fiscal years. The guidance may be early adopted for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. This Update is not expected to have a significant impact on the Company’s financial statements.


In October 2020, the FASB issued ASU 2020-10, Codification Improvements, which makes minor technical corrections and clarifications to the ASC. The amendments in Sections B and C of the ASU are effective for annual periods beginning after December 15, 2020, for public business entities. For all other entities, the amendments are effective for annual periods beginning after December 15, 2021, and interim periods within annual periods beginning after December 15, 2022. This Update is not expected to have a significant impact on the Company’s financial statements.


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 financial position or results of operations.

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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., First Citizens Community Bank, First Citizens Insurance Agency, Inc., 1st 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 scope, duration and severity of the COVID-19 pandemic and its effects on our business and operations, our customers, including their ability to make timely payments on loans, our service providers, and on the economy and financial markets in general.
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 to implement strategic initiatives designed to increase revenues or manage expenses, or we may be unable to implement those initiatives at all.
We may not be able to successfully integrate businesses we acquire or be able to fully realize the expected financial and other benefits from acquisitions.
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, or regulatory practices or requirements.
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, which could negatively impact some of our customers.
Agricultural customers could be affected by factors outside of their control including adverse weather conditions, loss of crops or livestock due to diseases or other factors, and government policies, regulations and tariffs.
Loan concentrations in certain industries could negatively impact financial 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.

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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.

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Additional factors that may affect our results are discussed under “Part II – Item 1A – Risk Factors” in this report and in the Company’s 20192020 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'smanagement’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 consolidated 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, 2020March 31, 2021 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 LancasterChester counties in south central Pennsylvania and Allegany County in southern New York and with the recently closed 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 3133 banking facilities, 3031 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 FivepointvilleKennett Square branch was opened in the firstfourth  quarter of 2019.2020. The limited branch office is located in Winfield, Pennsylvania. In New York, our office is in Wellsville. With the MidCoast merger MidCoast completed in the second quarter of 2020, we added three branches in Delaware with two being in the Wilmington market and one in Dover. In the fourth quarter of 2020, we will be opening a full service branch in Kennett Square, Pennsylvania, which is located Chester County and will further serve customers acquired as part of the MidCoast acquisition.

Covid-19 Pandemic Response and Loan Profile

In response to the Covid-19 pandemic, the Company createdmaintains a payment relief program that includedincludes the following:
Waiver of late fees for March, April and May
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
Waiver of Company ATM fees for customers utilizing foreign ATMS through May
Waiver of early withdrawal penalties through May 1, 2020 on CDs

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Through September 30, 2020,During 2021, we have modified 53419 loans totaling $205.1$26.7 million, primarily business related loans. As of September 30, 2020,March 31, 2021, loans with aggregate balances of $20.2$13.9 million were still under a modifiedmodification agreement. Of the $20.2$13.9 million modifications outstanding as of September 30, 2020, $6.7March 31, 2021, $7.7 million mature by the end of October 2020,May 2021, with the remainder maturing by DecemberAugust 31, 2020.2021. Additionally, in accordance with government regulations, we have paused allcertain foreclosure actions in accordance with state mandates.

We also are participating in the Paycheck Protection Program for loans provided under the auspices of the Small Business Administration (SBA). As of September 30, 2020,March 31, 2021, we had outstanding 591326 loans with balances totaling $53.9$28.3 million that earn interest at 1% per annum and are expected to generate fee revenue of approximately $2.1$1.2 million over the next 24 months. A portion of these loans may be forgiven by the SBA depending on the customers usage of the proceeds beginning in the fourth quarterproceeds.

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The Company tracks industry concentrations to identify risks that could lead to additional credit exposure. As a result of the Covid 19 pandemic, the Company has determined that hotels/motels and restaurants represent a higher level of credit risk. At September 30, 2020,March 31, 2021, the Company has limited loan concentrations to these industries as follows:
Hotels/Motels - $41.4$59.3 million or 3.0%4.2% of outstanding loans
Restaurants - $27.7$26.8 million or 2.0%1.9% of outstanding loans
Amusement/Theme parks - $13.8$13.9 million, or 1.0% of outstanding loans

Our agricultural relationships are also being strained by the pandemic as demand for certain products has declined and processing plant issues have resulted in strains on our customers as a result of the pandemic. Agricultural lending comprises $351.5$356.7 million, or 25.7%25.4% of outstanding balances as of September 30, 2020.March 31, 2021. The federal government has provided financial assistance to some of our customers through various programs to combat some of the impact of the COVID-19 pandemic.

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.

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Index
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.operations

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Table of Contents
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 internet 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 the newin our Delaware operations,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.  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.

Trust and Investment Services; Oil and Gas 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, 2020March 31, 2021 and December 31, 2019,2020, the Trust Department had $137.1$150.9 million and $134.3$150.3 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 increased from $215.4$241.0 million at December 31, 20192020 to $227.1$252.9 million at September 30, 2020.March 31, 2021. 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 $17,876,000$8,463,000 for the first ninethree months of 20202021 compared to $14,447,000$4,531,000 for last year’s comparable period, an increase of $3,429,000,$3,932,000, or 23.7%86.8%. Basic earnings per share for the first ninethree months of 20202021 were $4.74,$2.16 compared to $4.06$1.27 last year, representing a 16.8%70.1% increase.  Annualized return on assets and return on equity for the ninefirst three months of 20202021 were 1.43%1.77% and 13.85%17.25%, respectively, compared with 1.33%1.24% and 12.99%11.48% for last year’s comparable period.

Net income for the three months ended September 30, 2020 was $8,007,000 compared to $5,196,000 in the comparable 2019 period, an increase of $2,811,000 or 54.1%. Basic earnings per share for the three months ended September 30, 2020 were $2.04, compared to $1.46 last year, representing a 39.7% increase. Annualized return on assets and return on equity for the quarter ended September 30, 2020 was 1.75% and 17.36%, respectively, compared with 1.43% and 13.74% for the same 2019 period.

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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 ninethree months of 20202021 was $45,646,000,$16,441,000, an increase of $8,496,000,$3,551,000, or 22.9%27.6%, compared to the same period in 2019.2020.  For the first ninethree months of 20202021 the provision for loan losses was $1,500,000,$650,000, an increase of $350,000$250,000 over the comparable period in 2019.2020. Consequently, net interest income after the provision for loan losses was $44,146,000$15,791,000 in the first ninethree months of 20202021 compared to $36,000,000$12,490,000 during the first ninethree months of 2019.2020.

For the three months ended September 30, 2020, net interest income was $16,470,000 compared to $12,899,000, an increase
34
Table of $3,571,000, or 27.7% over the comparable period in 2019. The provision for loan losses this quarter was $550,000 compared to $400,000 for last year’s third quarter.  Consequently, net interest income after the provision for loan losses was $15,920,000 for the quarter ended September 30, 2020 compared to $12,499,000 in 2019.Contents

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,March 31, 2021 and 2020 and 2019 on a tax equivalent basis (dollars in thousands):

 Analysis of Average Balances and Interest Rates 
 
Analysis of Average Balances and Interest Rates
Nine Months Ended
  Three Months Ended 
 September 30, 2020  September 30, 2019  March 31, 2021  March 31, 2020 
(dollars in thousands) 
Average
Balance (1)
$
  
Interest
$
  
Average
Rate
%
  
Average
Balance (1)
$
  
Interest
$
  
Average
Rate
%
  
Average
Balance (1)
$
  
Interest
$
  
Average
Rate
%
  
Average
Balance (1)
$
  
Interest
$
  
Average
Rate
%
 
ASSETS                                    
Short-term investments:                                    
Interest-bearing deposits at banks  35,580   23   0.09   9,546   19   0.27   94,523   19   0.08   9,538   3   0.17 
Total short-term investments  35,580   23   0.09   9,546   19   0.27   94,523   19   0.08   9,538   3   0.17 
Interest bearing time deposits at banks  14,266   275   2.57   15,364   292   2.54   13,730   87   2.57   14,272   92   2.59 
Investment securities:                                                
Taxable  185,220   3,487   2.51   189,157   3,968   2.80   200,492   951   1.90   179,893   1,217   2.71 
Tax-exempt (3)  74,664   1,693   3.02   58,150   1,404   3.22   100,422   689   2.74   62,555   493   3.15 
Total investment securities  259,884   5,180   2.66   247,307   5,372   2.90   300,914   1,640   2.18   242,448   1,710   2.82 
Loans (2)(3)(4):                                                
Residential mortgage loans  212,912   8,450   5.30   215,325   8,584   5.33   203,941   2,553   5.08   215,838   2,843   5.30 
Construction  25,715   952   4.95   20,576   796   5.17   38,314   410   4.34   17,726   223   5.06 
Commercial Loans  556,133   22,282   5.35   415,287   17,064   5.49   713,900   9,063   5.15   415,199   5,534   5.36 
Agricultural Loans  357,498   12,096   4.52   338,266   11,657   4.61   358,565   3,830   4.33   360,179   4,112   4.59 
Loans to state & political subdivisions  89,407   2,709   4.05   98,680   2,910   3.94   62,516   598   3.87   94,122   939   4.01 
Other loans  17,878   794   5.93   9,680   562   7.76   26,605   348   5.30   9,461   171   7.27 
Loans, net of discount  1,259,543   47,283   5.01   1,097,814   41,573   5.06   1,403,841   16,802   4.85   1,112,525   13,822   5.00 
Total interest-earning assets  1,569,273   52,761   4.49   1,370,031   47,256   4.61   1,813,008   18,548   4.15   1,378,783   15,627   4.56 
Cash and due from banks  7,643           6,243           6,377           6,263         
Bank premises and equipment  17,152           16,120           17,003           16,062         
Other assets  75,238           56,978           80,953           56,983         
Total non-interest earning assets  100,033           79,341           104,333           79,308         
Total assets  1,669,306           1,449,372           1,917,341           1,458,091         
LIABILITIES AND STOCKHOLDERS' EQUITY                     
LIABILITIES AND STOCKHOLDERS’ EQUITYLIABILITIES AND STOCKHOLDERS’ EQUITY                     
Interest-bearing liabilities:                                                
NOW accounts  374,347   904   0.32   331,084   1,756   0.71   422,135   320   0.31   332,068   437   0.53 
Savings accounts  237,873   387   0.22   216,858   608   0.37   268,252   89   0.13   225,985   184   0.33 
Money market accounts  196,985   810   0.55   163,443   1,520   1.24   238,788   176   0.30   174,294   393   0.91 
Certificates of deposit  333,044   3,178   1.27   282,754   3,143   1.49   380,791   1,013   1.08   261,278   973   1.50 
Total interest-bearing deposits  1,142,249   5,279   0.62   994,139   7,027   0.95   1,309,966   1,598   0.49   993,625   1,987   0.93 
Other borrowed funds  92,120   960   1.39   108,975   2,216   2.72   86,226   256   1.20   93,849   462   1.98 
Total interest-bearing liabilities  1,234,369   6,239   0.68   1,103,114   9,243   1.12   1,396,192   1,854   0.54   1,087,474   2,449   0.91 
Demand deposits  246,424           184,159           306,377      ��    196,604         
Other liabilities  16,390           13,817           18,582           16,082         
Total non-interest-bearing liabilities  262,814           197,976           324,959           212,686         
Stockholders' equity  172,123           148,282         
Total liabilities & stockholders' equity  1,669,306           1,449,372         
Stockholders’ equity  196,190           157,931         
Total liabilities & stockholders’ equity  1,917,341           1,458,091         
Net interest income      46,522           38,013           16,694           13,178     
Net interest spread (5)          3.81%          3.49%          3.61%          3.65%
Net interest income as a percentage of average interest-earning assets          3.96%          3.71%          3.73%          3.84%
Ratio of interest-earning assets to interest bearing liabilities          127%          124%
Ratio of interest-earning assets to interest-bearing liabilities          130%          127%

(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 ausinga 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 andassetsand the average rate paid on interest-bearing liabilities.

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 Analysis of Average Balances and Interest Rates 
  Three Months Ended 
  September 30, 2020  September 30, 2019 
(dollars in thousands) 
Average
Balance (1)
$
  
Interest
$
  
Average
Rate
%
  
Average
Balance (1)
$
  
Interest
$
  
Average
Rate
%
 
ASSETS                  
Short-term investments:                  
Interest-bearing deposits at banks  67,954   14   0.08   10,047   6   0.24 
Total short-term investments  67,954   14   0.08   10,047   6   0.24 
Interest bearing time deposits at banks  14,143   92   2.59   15,100   97   2.55 
Investment securities:                        
Taxable  192,641   1,077   2.24   182,113   1,478   3.25 
Tax-exempt (3)  84,097   614   2.92   59,464   477   3.22 
Total investment securities  276,738   1,691   2.45   241,577   1,955   3.24 
Loans (2)(3)(4):                        
Residential mortgage loans  209,161   2,807   5.34   215,748   2,892   5.32 
Construction  29,087   356   4.87   13,149   176   5.31 
Commercial Loans  652,380   8,472   5.17   424,662   5,863   5.48 
Agricultural Loans  356,164   3,971   4.44   344,897   4,018   4.62 
Loans to state & political subdivisions  83,671   872   4.15   96,192   958   3.95 
Other loans  30,460   401   5.24   9,566   196   8.13 
Loans, net of discount  1,360,923   16,879   4.93   1,104,214   14,103   5.07 
Total interest-earning assets  1,719,758   18,676   4.32   1,370,938   16,161   4.68 
Cash and due from banks  7,350           5,944         
Bank premises and equipment  17,802           15,967         
Other assets  90,238           58,869         
Total non-interest earning assets  115,390           80,780         
Total assets  1,835,148           1,451,718         
LIABILITIES AND STOCKHOLDERS' EQUITY                     
Interest-bearing liabilities:                        
NOW accounts  406,635   211   0.21   335,279   590   0.70 
Savings accounts  247,414   96   0.15   221,771   218   0.39 
Money market accounts  218,682   215   0.39   167,229   505   1.20 
Certificates of deposit  382,551   1,113   1.16   266,385   1,002   1.49 
Total interest-bearing deposits  1,255,282   1,635   0.52   990,664   2,315   0.93 
Other borrowed funds  98,350   281   1.14   102,622   660   2.56 
Total interest-bearing liabilities  1,353,632   1,916   0.56   1,093,286   2,975   1.08 
Demand deposits  280,457           194,024         
Other liabilities  16,611           13,139         
Total non-interest-bearing liabilities  297,068           207,163         
Stockholders' equity  184,448           151,269         
Total liabilities & stockholders' equity  1,835,148           1,451,718         
Net interest income      16,760           13,186     
Net interest spread (5)          3.76%          3.60%
Net interest income as a percentage of average interest-earning assets          3.88%          3.82%
Ratio of interest-earning assets to interest-bearing liabilities          127%          125%

(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 rateTable 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.

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IndexContents
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, 2020March 31, 2021 and 2019.2020.  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,March 31, 2021 and 2020 and 2019 (in thousands):

 For the Three Months  For the Nine Months  
For the Three Months
Ended March 31,
 
 Ended September 30,  Ended September 30,  2021  2020 
 2020  2019  2020  2019       
Interest and dividend income from investment securities and interest bearing deposits at banks (non-tax adjusted) $1,668  $1,959  $5,122  $5,388  $1,601  $1,701 
Tax equivalent adjustment  129   99   356   295   145   104 
                        
Interest and dividend income from investment securities and interest bearing deposits at banks (tax equivalent basis) $1,797  $2,058  $5,478  $5,683  $1,746  $1,805 
                        
Interest and fees on loans (non-tax adjusted) $16,718  $13,915  $46,763  $41,005  $16,694  $13,638 
Tax equivalent adjustment  161   188   520   568   108   184 
Interest and fees on loans (tax equivalent basis) $16,879  $14,103  $47,283  $41,573  $16,802  $13,822 
                        
Total interest income $18,386  $15,874  $51,885  $46,393  $18,295  $15,339 
Total interest expense  1,916   2,975   6,239   9,243   1,854   2,449 
Net interest income  16,470   12,899   45,646   37,150   16,441   12,890 
Total tax equivalent adjustment  290   287   876   863   253   288 
Net interest income (tax equivalent basis) $16,760  $13,186  $46,522  $38,013  $16,694  $13,178 

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, 2020 vs 2019 (1)  Nine months ended September 30, 2020 vs 2019 (1) 
    Change  Total  Change in  Change  Total  Three months ended March 31, 2021 vs 2020 (1) 
 Change in Volume  in Rate  Change  Volume  in Rate  Change  
Change in
Volume
  
Change
in Rate
  
Total
Change
 
Interest Income:                           
Short-term investments:                           
Interest-bearing deposits at banks $9  $(1) $8  $5  $(1) $4  $17  $(1) $16 
Interest bearing time deposits at banks  (7)  2   (5)  (21)  4   (17)  (4)  (1)  (5)
Investment securities:                                    
Taxable  92   (493)  (401)  (81)  (400)  (481)  167   (433)  (266)
Tax-exempt  175   (38)  137   368   (79)  289   248   (52)  196 
Total investments  267   (531)  (264)  287   (479)  (192)  415   (485)  (70)
Loans:                                    
Residential mortgage loans  (96)  11   (85)  (88)  (46)  (134)  (174)  (116)  (290)
Construction  193   (13)  180   189   (33)  156   213   (26)  187 
Commercial Loans  2,920   (311)  2,609   5,647   (429)  5,218   3,736   (207)  3,529 
Agricultural Loans  142   (189)  (47)  655   (216)  439   (54)  (228)  (282)
Loans to state & political subdivisions  (137)  51   (86)  (281)  80   (201)  (311)  (30)  (341)
Other loans  245   (40)  205   321   (89)  232   208   (31)  177 
Total loans, net of discount  3,267   (491)  2,776   6,443   (733)  5,710   3,618   (638)  2,980 
Total Interest Income  3,536   (1,021)  2,515   6,714   (1,209)  5,505   4,046   (1,125)  2,921 
Interest Expense:                                    
Interest-bearing deposits:                                    
NOW accounts  162   (541)  (379)  271   (1,123)  (852)  204   (321)  (117)
Savings accounts  28   (150)  (122)  67   (288)  (221)  44   (139)  (95)
Money Market accounts  241   (531)  (290)  415   (1,125)  (710)  262   (479)  (217)
Certificates of deposit  232   (121)  111   164   (129)  35   112   (72)  40 
Total interest-bearing deposits  663   (1,343)  (680)  917   (2,665)  (1,748)  622   (1,011)  (389)
Other borrowed funds  (28)  (351)  (379)  (301)  (955)  (1,256)  (39)  (167)  (206)
Total interest expense  635   (1,694)  (1,059)  616   (3,620)  (3,004)  583   (1,178)  (595)
Net interest income $2,901  $673  $3,574  $6,098  $2,411  $8,509  $3,463  $53  $3,516 

(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.

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Tax equivalent net interest income increased from $38,013,000$13,178,000 for the ninethree month period ended September 30, 2019March 31, 2020 to $46,522,000$16,694,000 for the ninethree month period ended September 30, 2020,March 31, 2021, an increase of $8,509,000.$3,516,000. The tax equivalent net interest margin increaseddecreased from 3.71%3.84% for the first ninethree months of 20192020 to 3.96%3.73% for the comparable period in 2020.2021. The increasedecrease is primarily caused by the decrease in the costyield of interest-bearing liabilities and the increase in average outstanding loans.interest-earning assets.

Total tax equivalent interest income for the 2020 nine2021 three month period increased $5,505,000$2,921,000 as compared to the 2019 nine2020 three month period. This increase was a result of an increase of $6,714,000$4,046,000 due to a change in volume as average interest-bearing assets increased $199.2$434.2 million. As a result of the low rate interest environment, the yield on average interest earning assets decreased 1241 basis point from 4.61%4.56% to 4.49%.4.15% resulting in a decrease interest income of $1,125,000.

Tax equivalent investment income for the ninethree months ended September 30, 2020March 31, 2021 decreased $192,000$70,000 over the same period last year. The primary cause of the decrease was a decrease in the yield on taxable investments of 2981 basis points.

The yield on taxable securities decreased 2981 basis points from 2.80%2.71% to 2.51%1.90% as a result of calls of investments that were purchased at a discount in the thirdfirst quarter of 2019.2020 and purchases made in a lower rate environment in 2020. This resulted in a decrease in investment income of $400,000.$433,000. The average balance of taxable securities decreased $3.9 million, which resulted in a decrease in investment income of $81,000.
The average balance of tax-exempt securities increased by $16.5$20.6 million, which resulted in an increase in investment income of $368,000.$167,000.

The average balance of tax-exempt securities increased by $37.9 million, which resulted in an increase in investment income of $248,000. The yield on tax-exempt securities decreased 2041 basis points from 3.22%3.15% to 3.02%2.74%, which corresponds to a decrease in interest income of $79,000.$52,000. 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 $5,710,000$2,980,000 for the ninethree months ended September 30, 2020March 31, 2021 compared to the same period last year, as a result of the MidCoast acquisition that closed in the second quarter of 2020 and loan growth achieved in 20192020 that occurred primarily in our Delaware market.

Interest income on residential mortgage loans decreased $290,000. The average balance of residential mortgage loans decreased $11.9 million due to refinancings in the secondary market resulting in a decrease of $174,000 due to volume. The change due to rate was a decrease of $116,000 as the average yield on residential mortgages decreased from 5.30% to 5.08% as a result of the lower rate environment due to the COVID-19 pandemic.

The average balance of construction loans increased $20.6 million as a result of projects in our central and south central Pennsylvania markets.markets, as well as the Delaware market. This resulted in an increase of $213,000 on total interest income due to volume.

The average balance of commercial loans increased $140.8$298.7 million from a year ago. The growth was primarily attributable to the MidCoast acquisition.acquisition and growth in Delaware. This had a positive impact of $5,647,000$3,736,000 on total interest income due to volume. The yield decreased 1421 basis points to 5.35%5.15%, which decreased loan interest income $429,000.$207,000.

Interest income on agricultural loans increased $439,000decreased $282,000 from 20192020 to 2020.2021. The increasedecrease in the average balance of agricultural loans of $19.2$1.6 million is primarily attributable to loan growth in our central and south central Pennsylvania markets and the MidCoast acquisition. The increase in the average balance of these loans resulted in an increasea decrease in interest income due to volume of $655,000.$54,000. The yield on agricultural loans decreased 926 basis points to 4.52%4.33%, which decreased loan interest income $216,000.$228,000.

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The average balance of state and political subdivision loans decreased $9.3$31.6 million from a year ago as a result of several pay-offs during 2020.2020 and 2021. This resulted in a decrease of $281,000$311,000 on total interest income due to volume.

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The average balance of other loans increased $8.2$17.1 million as a result of an increase in outstanding student loans. This resulted in an increase of $321,000$208,000 on total interest income due to volume.

Total interest expense decreased $3,004,000$595,000 for the ninethree months ended September 30, 2020March 31, 2021 compared with the comparative period last year primarily as a result of a decrease in the cost of interest-bearing liabilities. Interest expense decreased $3,620,000$1,178,000 due to rate as a result of a decrease in the average rate paid on interest-bearing liabilities from 1.12%0.91% to 0.68%0.54%. The decrease was driven by the Federal Reserve interest rate cuts in the second half of 2019 and the first quarter of 2020.

The average balance of interest bearing deposits increased $148.1$316.3 million from September 30, 2019March 31, 2020 to September 30, 2020.March 31, 2021. The primary cause of the increase was the MidCoast acquisition completed in the second quarter of 2020.2020 and government stimulus funds in response to the pandemic. We experienced increases of $43.3$90.1 million in NOW accounts, $21.0$42.3 million in savings accounts, $33.5$64.5 million in money market accounts and $50.3$119.5 million in certificates of deposit. The cumulative effect of these volume changes was an increase in interest expense of $917,000.$622,000.  (see also “Financial Condition – Deposits”). The average rate paid on interest bearing deposits was 0.62%0.49% for the first ninethree months of 20202021 and 0.95%0.93% for the comparable period in 2019.2020. This resulted in a decrease in interest expense of $2,665,000.$1,011,000. The decrease was due to the Federal Reserve cutting interest rates during 2019 andthe first quarter of 2020.

The average balance of other borrowed funds decreased $16.9$7.6 million from a year ago. This resulted in a decrease in interest expense of $301,000.$39,000. There was a decrease in the average rate paid on other borrowed funds from 2.72%1.98% to 1.39%1.20% due to a decrease in rates as a result of Federal Reserve interest rate decreases in 2019 and 2020 resulting in a decrease in interest expense of $955,000.

Tax equivalent net interest income for the three months ended September 30, 2020 was $16,760,000 which compares to $13,186,000 for the same period last year.  This represents an increase of $3,574,000 or 27.1% and was primarily caused by the MidCoast acquisition completed in the second quarter of 2020.

Total tax equivalent interest income was $18,676,000 for the three month period ended September 30, 2020, compared to $16,161,000 for the comparable period last year, an increase of $2,515,000. As with the nine month period, the increase was driven by the MidCoast acquisition and the associated increase in volume of $3,536,000 due to average interest earning assets increasing $348.8 million offset by a decrease of $1,021,000 as a result of the average yield on interest-earning assets decreasing 36 basis points from 4.68% to 4.32% for the comparable periods.

Total investment income decreased by $264,000 compared to same period last year.  The primary cause of the decrease was the decrease in the yield on taxable securities, which decreased 1.01% to 2.24%, which corresponds to a decrease of $493,000 in interest income. The decrease in yield is due to security calls made in the third quarter of 2019 that were purchased at a discount. The average balance of investments increased $35.2 million, which corresponds to an increase in investment income of $267,000.
Total loan interest income increased $2,776,000 compared to the same period last year, with the change corresponding to the year to date change. As a result of the MidCoast acquisition and the PPP loan program, the average loan balance increased by $256.7 million, which corresponds to an increase in loan interest income of $3,267,000.

Total interest expense decreased $1,059,000 for the three months ended September 30, 2020 compared with last year as a result of the average rate on interest-bearing liabilities decreasing 52 basis points from 1.08% to 0.56%, which decreased interest expense $1,694,000.

The average balance of interest bearing deposits increased $264.6 million for the three month period ended September 30, 2020, as a result of the MidCoast acquisition, which corresponds to a change due to volume of $663,000.  The rate paid on interest bearing deposits was 0.52% for the three months ended September 30, 2020 and 0.93% for the comparable period in 2019. This results in a decrease in interest expense of $1,343,000.

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The average balance of other borrowed funds decreased $4.3 million from a year ago. This resulted in a decrease in interest expense of $28,000. There was a decrease in the average rate on other borrowed funds from 2.56% to 1.14% as a result of the Federal Reserve interest rate decreases in 2019 and 2020 resulting in a decrease in interest expense of $351,000.$167,000.

Provision for Loan Losses

For the ninethree month period ended September 30, 2020,March 31, 2021, we recorded a provision for loan losses of $1,500,000,$650,000, which represents an increase of $350,000$250,000 from the $1,150,000$400,000 provision recorded in the corresponding ninethree months of last year. The provision was higher in 2020 than 2019 primarily2021 due to the economic environmentloans acquired as a resultpart of the COVID-19 pandemicMidCoast acquisition maturing and the higher levels of unemployment, which offset the decrease in loans when the MidCoast acquired loans and PPP loans guaranteed by the SBA are excluded from 2020 activity. (see “Financial Condition – Allowance for Loan Losses and Credit Quality Risk”).

For the three months ended September 30, 2020, we recorded a provision of $550,000 compared to $400,000 in 2019being refinanced with the increase being a result of the economic environment dueCompany and now subject to the Covid 19 pandemic.Company’s allowance calculation. (see “Financial Condition – Allowance for Loan Losses and Credit Quality Risk”).

Non-interest Income

The following table shows the breakdown of non-interest income for the three and nine months ended September 30,March 31, 2021 and 2020 and 2019 (dollars in thousands):

 Nine months ended September 30,  Change  Three months ended March 31,  Change 
 2020  2019  Amount  %  2021  2020  Amount  % 
Service charges $3,107  $3,498  $(391)  (11.2) $1,106  $1,081  $25   2.3 
Trust  542   589   (47)  (8.0)  307   198   109   55.1 
Brokerage and insurance  941   843   98   11.6   376   340   36   10.6 
Gains on loans sold  1,282   339   943   278.2   503   167   336   201.2 
Equity security (losses) gains, net  (276)  70   (346)  (494.3)
Equity security gains (losses), net  187   (254)  441   (173.6)
Available for sale security gains, net  302   8   294   3,675.0   50   -   50  NA 
Earnings on bank owned life insurance  514   463   51   11.0   1,315   156   1,159   742.9 
Other  1,046   427   619   145.0   391   163   228   139.9 
Total $7,458  $6,237  $1,221   19.6  $4,235  $1,851  $2,384   128.8 

 Three months ended September 30,  Change 
  2020  2019  Amount  % 
Service charges $1,112  $1,225  $(113)  (9.2)
Trust  199   148   51   34.5 
Brokerage and insurance  352   289   63   21.8 
Gains on loans sold  855   176   679   385.8 
Equity security gains, net  (33)  29   (62)  (213.8)
Available for sale security gains, net  185   8   177   2,212.5 
Earnings on bank owned life insurance  180   158   22   13.9 
Other  688   144   544   377.8 
Total $3,538  $2,177  $1,361   62.5 

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Non-interest income for the ninethree months ended September 30, 2020March 31, 2021 totaled $7,458,000,$4,235,000, an increase of $1,221,000$2,384,000 when compared to the same period in 2019.2020.  During the first ninethree  months of 2020,2021, net equity security lossesgains amounted to $276,000$187,000 as a result of market lossesgains associated with general stock market increases compared with a $254,000 loss in the comparable 2020 period associated with the Covid-19 pandemic compared to gains of $70,000 last year.pandemic. During the first ninethree months of 2020,2021, there were $302,000$50,000 of gains from the sale of available for sale securities compared to $8,000 forsecurities. There were no sales in the comparable period in 2019.of 2020. We sold $18.6$5.0 million of US agency mortgage backedtreasury securities for a pre-tax gain of $302,000.$50,000 in 2021.

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The increase in gains on loans sold is attributable to a $29.9$13.3 million increase in loans sold for the ninethree months ended September 30, 2020March 31, 2021 as a result of the low rate environment, which has significantly increased residential refinancings. The decrease in service charges of $391,000 for the nine months ended September 30, 2020 is attributable to the Bank’s response to the COVID-19  pandemic and a decrease in customer spending as a result of mandatory stay at home orders. The decreaseincrease in Trust revenues is due to lowerhigher estate settlement fees and asset levels in 20202021 compared to 2019.2020. The increase in other income is due to fees on offering back to back swaps to certain customers, which generated fee income of $610,000$226,000 in 2020.

For the three month period ended September 30, 2020, the changes experienced from the prior year related available for sale security gains, gains on loans sold, service charges and  other income correspond to the changes experienced for the nine month period.2021. The increase in trust fees wasearnings on bank owned life insurance is due to estate settlement fees intwo former employees of the thirdCompany passing during the first quarter of 2020.2021, which generated a death benefit payable to the Company of $1,155,000

Non-interest Expense

The following tables reflect the breakdown of non-interest expense for the three and nine months ended September 30,March 31, 2021 and 2020 and 2019 (dollars in thousands):

 Nine months ended September 30,  Change     Three months ended March 31,  Change    
 2020  2019  Amount  %  2021  2020  Amount  % 
Salaries and employee benefits $17,411  $15,129  $2,282   15.1  $6,263  $5,414  $849   15.7 
Occupancy  1,891   1,639   252   15.4   783   526   257   48.9 
Furniture and equipment  587   501   86   17.2   143   131   12   9.2 
Professional fees  1,180   1,101   79   7.2   448   325   123   37.8 
FDIC insurance  341   196   145   74.0   129   71   58   81.7 
Pennsylvania shares tax  809   825   (16)  (1.9)  339   275   64   23.3 
Amortization of intangibles  162   198   (36)  (18.2)  49   50   (1)  (2.0)
Merger and acquisition  2,179   275   1,904   692.4   -   376   (376) NA 
Software expenses  817   699   118   16.9   313   247   66   26.7 
ORE expenses  221   308   (87)  (28.2)
ORE expenses (recovery)  86   32   54   168.8 
Other  4,428   4,102   326   7.9   1,394   1,474   (80)  (5.4)
Total $30,026  $24,973  $5,053   20.2  $9,947  $8,921  $1,026   11.5 

 Three months ended September 30,  Change    
  2020  2019  Amount  % 
Salaries and employee benefits $6,102  $5,096  $1,006   19.7 
Occupancy  714   530   184   34.7 
Furniture and equipment  267   165   102   61.8 
Professional fees  417   343   74   21.6 
FDIC insurance  135   (20)  155   (775.0)
Pennsylvania shares tax  275   275   -   - 
Amortization of intangibles  57   66   (9)  (13.6)
Merger and acquisition  -   275   (275) NA 
Software expenses  324   244   80   32.8 
ORE expenses (recovery)  30   92   (62)  (67.4)
Other  1,371   1,348   23   1.7 
Total $9,692  $8,414  $1,278   15.2 

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Non-interest expenses increased $5,053,000$1,026,000 for the ninethree months ended September 30, 2020March 31, 2021 compared to the same period in 2019.2020. Salaries and employee benefits increased $2,282,000$849,000 or 15.1%15.7%. The increase was due to merit increases effective at the beginning of 2020,2021, additional headcount as part of the MidCoast acquisition and increased health care expenses.profit sharing expenses due to increased profitability of the Company.

The increase in occupancy expenses is due to the additional branches acquired as part of the MidCoast acquisition. The increasedecrease in merger and acquisition costs was due to costs associated with the MidCoast acquisition that closed in April 2020. The increase in other expenses is attributable to the partial settlement of the Company’s pension plan due to lump sum distributions taken during the second quarter of 2020. The increase in FDIC insurance was due to final credit received from the FDIC in 2019the first quarter of 2020 as the Deposit Insurance Fund reserve ratio exceeded 1.38%.

For the three months ended, September 30, 2020, non-interest expenses increased $1,278,000 when compared to the same period in 2019. The changes are driven by the MidCoast acquisition that closed in the April 2020 resulting in additional headcount and branches. The increase in FDIC insurance was due to credit received from the FDIC in 2019 as the Deposit Insurance Fund exceeded 1.38%.

Provision for Income Taxes

The provision for income taxes was $3,702,000$1,616,000 for the ninethree month period ended September 30, 2020March 31, 2021 compared to $2,817,000$889,000 for the same period in 2019.2020. The increase is primarily attributable to the increase in income before the provision for income taxes of $4,314,000$4,659,000 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 17.2%16.0% and 16.3%16.4% for the first ninethree months of 20202021 and 2019,2020, respectively, compared to the statutory rate of 21%.

For The decrease in the three months ended September 30, 2020, the provision for income taxes was $1,759,000 compared to $1,066,000 for the same period in 2019. The increase is attributable to the increase in income before the provision for income taxes of $3,504,000 for the comparable periods. Our effective tax rate was 18.0% and 17.0% for the three months ended September 30, 2020 and 2019, respectively.is due to life insurance earnings being exempt from federal income taxes.

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We are invested in four limited partnerships that have established low-income housing projects in our market areas. We anticipate recognizing an aggregate of $317,000$247,000 of tax credits over the next 2.251.75 years, with an additional $35,000$106,000 anticipated to be recognized during 2020.2021.

Financial Condition

Total assets were $1.86$2.00 billion at September 30, 2020,March 31, 2021, an increase of $392.0$103.9 million from $1.47$1.89 billion at December 31, 2019,2020, due primarily to the MidCoast acquisition and PPP loans, as well as deposit growth which is duefueled by government stimulus payments in response to individuals holding more cash due to the COVID-19 pandemic. Cash and cash equivalents increased $56.8$82.1 million to $75.3$150.8 million. Available for sale securities increased $47.1$26.8 million and net loans increased $249.0decreased $1.6 million to $1.35$1.39 billion at September 30, 2020.March 31 2021. Total deposits increased $341.6$98.6 million to $1.55$1.69 billion since year-end 2019,2020, while borrowed funds increased $14.5decreased $2.7 million to $99.6$86.2 million.

Cash and Cash Equivalents

Cash and cash equivalents totaled $75.3$150.8 million at September 30, 2020March 31, 2021 compared to $18.5$68.7 million at December 31, 2019,2020, an increase of $56.8$82.1 million. The increase was attributable to deposit growth as customers continue to hold more cash during the pandemic.receive government stimulus funds payments. Management actively measures and evaluates its liquidity position through our Asset–Liability Committee and believes its 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.

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Investments

The following table shows the composition of the investment portfolio (including debt and equity securities) as of September 30, 2020March 31, 2021 and December 31, 20192020 (dollars in thousands):
 September 30, 2020  December 31, 2019 
  Amount  %  Amount  % 
Debt securities:            
U. S. Agency securities $80,698   27.9  $84,863   35.1 
U. S. Treasury notes  28,167   9.7   27,661   11.5 
Obligations of state & political subdivisions  91,848   31.7   61,455   25.5 
Corporate obligations  6,507   2.3   3,328   1.4 
Mortgage-backed securities in  government sponsored entities  80,618   27.8   63,399   26.2 
Equity securities  1,696   0.6   701   0.3 
Total $289,534   100.0  $241,407   100.0 

 September 30, 2020/ 
 December 31, 2019 
 Change  March 31, 2021  December 31, 2020 
 Amount  %  Amount  %  Amount  % 
Debt securities:                  
U. S. Agency securities $(4,165)  (4.9) $79,709   24.6  $81,416   27.4 
U. S. Treasury notes  506   1.8   40,362   12.5   28,043   9.4 
Obligations of state & political subdivisions  30,393   49.5   102,345   31.6   102,972   34.7 
Corporate obligations  3,179   95.5   6,983   2.1   6,509   2.2 
Mortgage-backed securities in government sponsored entities  17,219   27.2   92,568   28.5   76,249   25.7 
Equity securities  995   141.9   2,118   0.7   1,931   0.6 
Total $48,127   19.9  $324,085   100.0  $297,120   100.0 

 
March 31, 2021/
December 31, 2020
Change
 
  Amount  % 
Debt securities:      
U. S. Agency securities $(1,707)  (2.1)
U. S. Treasury notes  12,319   43.9 
Obligations of state & political subdivisions  (627)  (0.6)
Corporate obligations  474   7.3 
Mortgage-backed securities in government sponsored entities  16,319   21.4 
Equity securities  187   9.7 
Total $26,965   9.1 

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Our investment portfolio increased by $48.1$27.0 million, or 19.9%9.1%, from December 31, 20192020 to September 30, 2020.March 31, 2021. During 2020,2021, we purchased $21.2$6.1 million of U.S. agency obligations, $44.1$17.5 million of U.S. treasury securities, $4.0 million state and political securities, $43.9$26.1 million of mortgage backed securities $3.2 millionand $500,000 corporate securities and $1.4 million of equity securities, which was offset by $14.4$8.3 million of principal repayments and $41.1$9.5 million of calls and maturities that occurred during the first ninethree months of 2020. Additionally, with the Federal Reserve purchasing2021. We sold $5.0 million of treasury securities in the “To be Announced” mortgage market, we sold $18.6 million withto recognize a gain of $302,000.and to redeploy into higher yielding investments. As a result of changes in market interest rates, the unrealized gain on available for sale investment portfolio increased $4.4decreased $4.1 million. Excluding our short-term investments consisting of monies held primarily at the Federal Reserve for liquidity purposes, our investment portfolio for the ninethree month period ended September 30, 2020March 31, 2021 yielded 2.66%2.18%, compared to 2.90%2.82% in the comparable period in 2019,2020, on a tax equivalent basis.

The investment strategy for 20202021 has been to utilize cashflows from the investment portfolio and deposit inflows to purchase U.S. treasury securities, mortgage backed securities in government sponsored entities and obligations of state and political securities. The increase in the investment portfolio was in response to opportunities provided by the Covid-19 pandemicdeposit inflows that allowedoccurred in the Company to purchase high quality municipal securities and mortgage backed securities with relatively high spreads compared to recent periods.first quarter of 2021. We continually monitor interest rate trading ranges and tryseek to focustime investment security purchases to times 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, while providing sufficient cashflows to meet liquidity needs.

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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 Held for Sale

Loans held for sale increased $18.5decreased $4.7 million to $19.3$9.9 million as of September 30, 2020March 31, 2021 from December 31, 2019.2020. The increasedecrease in loans held for sale was due to a decrease in the amount of refinancings occurring due oto the low rate environment as well as system and personnel constraints due to the COVID-19 pandemic.environment.

Loans

The following table shows the composition of the loan portfolio as of September 30, 2020March 31, 2021 and December 31, 20192020 (dollars in thousands):

 September 30,  December 31, 
 2020  2019  
March 31,
2021
  
December 31,
2020
 
 Amount  %  Amount  %  Amount  %  Amount  % 
Real estate:                        
Residential $208,084   15.2  $217,088   19.5  $203,273   14.5  $201,911   14.4 
Commercial  535,456   39.2   342,023   30.7   605,547   43.1   596,255   42.4 
Agricultural  310,702   22.7   311,464   27.9   315,313   22.5   315,158   22.4 
Construction  28,656   2.1   15,519   1.4   42,651   3.0   35,404   2.5 
Consumer  30,625   2.2   9,947   0.8   26,181   1.9   30,277   2.2 
Other commercial loans  129,731   9.5   69,970   6.3   109,168   7.8   114,169   8.1 
Other agricultural loans  40,790   3.0   55,112   4.9   41,378   2.9   48,779   3.5 
State & political subdivision loans  81,835   6.1   94,446   8.5   60,890   4.3   63,328   4.5 
Total loans  1,365,879   100.0   1,115,569   100.0   1,404,401   100.0   1,405,281   100.0 
Less allowance for loan losses  15,169       13,845       16,560       15,815     
Net loans $1,350,710      $1,101,724      $1,387,841      $1,389,466     

 September 30, 2020/ 
 December 31, 2019 
 Change  
March 31, 2021/
December 31, 2020
Change
 
 Amount  %  Amount  % 
Real estate:            
Residential $(9,004)  (4.1) $1,362   0.7 
Commercial  193,433   56.6   9,292   1.6 
Agricultural  (762)  (0.2)  155   0.0 
Construction  13,137   84.7   7,247   20.5 
Consumer  20,678   207.9   (4,096)  (13.5)
Other commercial loans  59,761   85.4   (5,001)  (4.4)
Other agricultural loans  (14,322)  (26.0)  (7,401)  (15.2)
State & political subdivision loans  (12,611)  (13.4)  (2,438)  (3.8)
Total loans $250,310   22.4  $(880)  (0.1)

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The Bank’s lending efforts have historically been focused in north central Pennsylvania and southern New York. TheWith the acquisition of FNB and the opening of offices in 2015 expanded theLancaster County, this focus intohas grown to include Lebanon, LancasterSchuylkill, Berks and SchuylkillLancaster County markets inof south central, Pennsylvania. The opening of the WinfieldWe have a limited branch office in 2016Union 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, ofwhich expanded our markets into the State College branch in 2017 has increased our presence inof Delaware with activity centered around the central Pennsylvania market. The recently closed MidCoast acquisition has expanded our lending market intocities 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 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, 2020,March 31, 2021, the Company had one industry specific loan concentration to the dairy industry, totaling $143.0$135.5 million or 10.5%9.7% of total loans.loans compared to $153.6$139.1 million or 13.8%9.9% of total loans at December 31, 2019.
2020.

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During the first ninethree months of 2020,2021, the primary driver of growth was the MidCoast acquisition,Delaware markets, which increasedsaw significant activity in commercial real estate loan and construction loan activity. The decrease in consumer loans $223.2is due to a decrease in student loans, which is expected to pick up over the remainder of 2021. Other agricultural loans decreased $7.4 million primarily due to paydowns on lines of credit. The decrease in state and political loans of $2.4 million is due to pricing in the municipal bond market, which was attractive to the borrowers during the first quarter of 2021 and is expected to pose significant challenges in the second quarter as well. The decrease in other commercial loans is due to the PPP program. Loans issued as part of the PPP program administered by the SBA, which generated loan growth of $53.9total $28.3 million as of September 30, 2020. Excluding the acquisition and PPP program, loans would have decreased $29.2March 31, 2021 compared to $37.2 million since year-end as of December 31, 2020 for a resultchange of three large relationships paying off in the first part of 2020.$8.9 million. 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 the exploration 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 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.

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Residential real estate loans decreasedincreased slightly during the first ninethree months of 2020.2021. Loan demand for conforming mortgages, which the Company typically sells on the secondary market, increased significantly in 2020 when compared to 2019remained high during the first quarter of 2021 as a result of the low rate environment. For loans sold on the secondary market, the Company recognizes fee income for servicing these sold loans, which is included in non-interest income.

In response to the Covid-19 pandemic, the Company has implemented programs to assist our customers. These include allowing customers to make interest only payments for up to 60 days and allowing certain customers in specific industries like hospitality to defer both principal and interest payments for up to 120 days. Customers are eligible to request additional modifications. The Company also agreed to waive late fees for March, April and May of 2020.

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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 at the balance sheet date.  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 following table presents an analysis of the allowance for loan losses and non-performing loans and assets as of and for the ninethree months ended September 30, 2020March 31, 2021 and for the years ended December 31, 2020, 2019, 2018 and 2017 and 2016 (dollarsdollars in thousands):

 March 31,  December 31, 
  2021  2020  2019  2018  2017 
Balance at beginning of period $15,815  $13,845  $12,884  $11,190  $8,886 
Charge-offs:                    
Real estate:                    
Residential  -   -   32   118   107 
Commercial  -   435   578   66   41 
Agricultural  -   4   -   -   30 
Consumer  4   50   49   40   130 
Other commercial loans  -   44   38   91   - 
Other agricultural loans  -   -   60   50   5 
Total loans charged-off  4   533   757   365   313 
Recoveries:                    
Real estate:                    
Residential  -   14   -   69   - 
Commercial  89   37   -   3   11 
Agricultural  -   19   -   -   - 
Consumer  6   21   33   31   49 
Other commercial loans  4   12   10   30   16 
Other agricultural loans  -   -   -   1   1 
Total loans recovered  99   103   43   134   77 
                     
Net loans (recovered) charged-off  (95)  430   714   231   236 
Provision charged to expense  650   2,400   1,675   1,925   2,540 
Balance at end of year $16,560  $15,815  $13,845  $12,884  $11,190 
                     
Loans outstanding at end of period $1,404,401  $1,405,281  $1,115,569  $1,081,883  $1,000,525 
Average loans outstanding, net $1,403,841  $1,291,838  $1,102,565  $1,044,250  $883,355 
Non-performing assets:                    
Non-accruing loans $10,680  $10,732  $11,536  $13,724  $10,171 
Accrual loans - 90 days or more past due  478   525   487   68   555 
Total non-performing loans $11,158  $11,257  $12,023  $13,792  $10,726 
Foreclosed assets held for sale  1,720   1,836   3,404   601   1,119 
Total non-performing assets $12,878  $13,093  $15,427  $14,393  $11,845 
                     
Annualized net (recoveries) charge-offs to average loans  (0.03)%  0.03%  0.06%  0.02%  0.03%
Allowance to total loans  1.18%  1.13%  1.24%  1.19%  1.12%
Allowance to total non-performing loans  148.41%  140.49%  115.15%  93.42%  104.33%
Non-performing loans as a percent of loans net of unearned income  0.79%  0.80%  1.08%  1.27%  1.07%
Non-performing assets as a percent of loans net of unearned income  0.92%  0.93%  1.38%  1.33%  1.18%

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 September 30,  December 31, 
  2020  2019  2018  2017  2016 
Balance               
at beginning of period $13,845  $12,884  $11,190  $8,886  $7,106 
Charge-offs:                    
Real estate:                    
Residential  -   32   118   107   85 
Commercial  221   578   66   41   100 
Agricultural  4   -   -   30   - 
Consumer  30   49   40   130   100 
Other commercial loans  1   38   91   -   55 
Other agricultural loans  -   60   50   5   - 
Total loans charged-off  256   757   365   313   340 
Recoveries:                    
Real estate:                    
Residential  -   -   69   -   - 
Commercial  37   -   3   11   479 
Agricultural  19   -   -   -   - 
Consumer  15   33   31   49   88 
Other commercial loans  9   10   30   16   33 
Other agricultural loans  -   -   1   1   - 
Total loans recovered  80   43   134   77   600 
                     
Net loans (recovered) charged-off  176   714   231   236   (260)
Provision charged to expense  1,500   1,675   1,925   2,540   1,520 
Balance at end of year $15,169  $13,845  $12,884  $11,190  $8,886 
                     
Loans outstanding at end of period $1,365,879  $1,115,569  $1,081,883  $1,000,525  $799,611 
Average loans outstanding, net $1,259,543  $1,102,565  $1,044,250  $883,355  $725,881 
Non-performing assets:                    
Non-accruing loans $11,711  $11,536  $13,724  $10,171  $11,454 
Accrual loans - 90 days or more past due  1,194   487   68   555   405 
Total non-performing loans $12,905  $12,023  $13,792  $10,726  $11,859 
Foreclosed assets held for sale  2,726   3,404   601   1,119   1,036 
Total non-performing assets $15,631  $15,427  $14,393  $11,845  $12,895 
                     
Annualized net charge-offs to average loans  0.02%  0.06%  0.02%  0.03%  -0.04%
Allowance to total loans  1.11%  1.24%  1.19%  1.12%  1.11%
Allowance to total non-performing loans  117.54%  115.15%  93.42%  104.33%  74.93%
Non-performing loans as a percent of loans net of unearned income  0.94%  1.08%  1.27%  1.07%  1.48%
Non-performing assets as a percent of loans net of unearned income  1.14%  1.38%  1.33%  1.18%  1.61%

Management believes that it uses the best information available when establishing the allowance for loan losses and that the allowance for loan losses is adequate as of September 30, 2020.March 31, 2021.  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, 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.  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 and other commercial and agricultural loans, on non-accrual are evaluated quarterly for impairment.

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Index
The allowance for loan losses was $15,169,000$16,560,000 or 1.11%1.18% of total loans as of September 30, 2020,March 31, 2021, as compared to $13,845,000$15,815,000 or 1.24%1.13% of loans as of December 31, 2019.2020. The $1,324,000$745,000 increase in the allowance during the first ninethree months of 20202021 is the result of a $1,500,000$650,000 provision and net charge-offsrecoveries of $176,000. The decrease as a percent of loans is attributable to the increase in loans as part of the acquisition of MidCoast and the associated purchase accounting adjustments that were applied to the MidCoast loan portfolio.$95,000. 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, 2020March 31, 2021 and December 31, 2020, 2019, 2018 2017 and 20162017 (dollars in thousands):
 September 30,  December 31  March 31,  December 31 
 2020  2019     2018     2017     2016     2021  2020     2019     2018     2017    
 Amount  %  Amount  %  Amount  %  Amount  %  Amount  %  Amount  %  Amount  %  Amount  %  Amount  %  Amount  % 
Real estate loans:                                                            
Residential $1,219   15.2  $1,114   19.4  $1,105   19.9  $1,049   21.4  $1,064   25.9  $1,167   14.5  $1,174   14.4  $1,114   19.4  $1,105   19.9  $1,049   21.4 
Commercial  5,306   39.2   4,549   30.7   4,115   29.5   3,867   30.8   3,589   31.6   6,683   43.1   6,216   42.4   4,549   30.7   4,115   29.5   3,867   30.8 
Agricultural  4,806   22.7   5,022   27.9   4,264   26.3   3,143   24.0   1,494   15.5   4,917   22.5   4,953   22.4   5,022   27.9   4,264   26.3   3,143   24.0 
Construction  85   2.1   43   1.4   58   3.1   23   1.3   47   3.2   151   3.0   122   2.5   43   1.4   58   3.1   23   1.3 
Consumer  352   2.2   112   0.9   120   0.9   124   1.0   122   1.4   237   1.9   321   2.2   112   0.9   120   0.9   124   1.0 
Other commercial loans  1,230   9.5   1,255   6.3   1,354   6.9   1,272   7.2   1,327   7.3   1,504   7.8   1,226   8.1   1,255   6.3   1,354   6.9   1,272   7.2 
Other agricultural loans  735   3.0   961   4.9   752   3.9   492   3.8   312   2.9   789   2.9   864   3.5   961   4.9   752   3.9   492   3.8 
State & political subdivision loans  514   6.1   536   8.5   762   9.5   816   10.5   833   12.2   470   4.3   479   4.5   536   8.5   762   9.5   816   10.5 
Unallocated  922   N/A   253   N/A   354   N/A   404   N/A   98   N/A   642   N/A   460   N/A   253   N/A   354   N/A   404   N/A 
Total allowance for loan losses $15,169   100.0  $13,845   100.0  $12,884   100.0  $11,190   100.0  $8,886   100.0  $16,560   100.0  $15,815   100.0  $13,845   100.0  $12,884   100.0  $11,190   100.0 

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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 totaled 61.9%65.6% of the loan portfolio 66.7%as of March 31, 2021, 70.05% of the allowance at that date was assigned to this segment of the loan portfolio as these loans have more inherent credit risk than residential real estate or loans to state and political subdivisions.

The following table identifies amounts of loans contractually past due 30 to 89 days and non-performing loans by loan category, as well as the change from December 31, 20192020 to September 30, 2020March 31, 2021 in non-performing loans (dollars in thousands). Non-performing loans include 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'smanagement’s assessment of its ultimate ability to collect principal and interest.

 September 30, 2020  December 31, 2019 
    Non-Performing Loans     Non-Performing Loans 
 30 - 89 Days  90 Days        30 - 89 Days  90 Days        March 31, 2021  December 31, 2020 
 Past Due  Past Due  Non-  Total Non-  Past Due  Past Due  Non-  Total Non-     Non-Performing Loans     Non-Performing Loans 
(in thousands) Accruing  Accruing  accrual  Performing  Accruing  Accruing  accrual  Performing  
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 $1,064  $622  $864  $1,486  $933  $2  $962  $964  $377  $251  $794  $1,045  $1,351  $275  $812  $1,087 
Commercial  1,701   413   5,141   5,554   1,225   -   5,080   5,080   665   -   4,853   4,853   1,247   70   4,529   4,599 
Agricultural  331   147   3,161   3,308   118   299   2,578   2,877   44   150   3,064   3,214   366   150   3,133   3,283 
Construction  -   -   -   -   -   -   -   -   -   -   -   -   -   -   -   - 
Consumer  142   12   -   12   123   2   6   8   153   27   -   27   155   30   -   30 
Other commercial loans  200   -   1,551   1,551   283   184   1,837   2,021   919   50   1,050   1,100   930   -   1,284   1,284 
Other agricultural loans  9   -   994   994   29   -   1,073   1,073   224   -   919   919   71   -   974   974 
Total nonperforming loans $3,447  $1,194  $11,711  $12,905  $2,711  $487  $11,536  $12,023  $2,382  $478  $10,680  $11,158  $4,120  $525  $10,732  $11,257 

 Change in Non-Performing Loans 
  March 31, 2021 /December 31, 2020 
(in thousands) Amount  % 
Real estate:      
Residential $(42)  (3.9)
Commercial  254   5.5 
Agricultural  (69)  (2.1)
Construction  -  NA 
Consumer  (3)  (10.0)
Other commercial loans  (184)  (14.3)
Other agricultural loans  (55)  (5.6)
Total nonperforming loans $(99)  (0.9)

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 Change in Non-Performing Loans 
  September 30, 2020 /December 31, 2019 
(in thousands) Amount  % 
Real estate:      
Residential $522   54.1 
Commercial  474   9.3 
Agricultural  431   15.0 
Construction  -  NA 
Consumer  4   50.0 
Other commercial loans  (470)  (23.3)
Other agricultural loans  (79)  (7.4)
Total nonperforming loans $882   7.3 

For the ninethree months ended September 30, 2020,March 31, 2021, we recorded a provision for loan losses of $1,500,000.$650,000. Non-performing loans increased $882,000decreased $99,000 or 7.3%0.9%, from December 31, 20192020 to September 30, 2020,March 31, 2021, primarily due to two residential mortgage customers going past due  by greater than 90 daysa commercial customer and an agricultural relationship being placedreal estate customer making payments on non-accrual status.their loans. Approximately 57.7%50.5% of the Bank’s non-performing loans at September 30, 2020March 31, 2021 are associated with the following fourthree customer relationships:

A commercial loan relationship with $2.2$2.0 million outstanding, and additional letters of credit of $2.1 million available, secured by undeveloped land, stone quarries and equipment, was on non-accrual status as of September 30, 2020.March 31, 2021. The customer is an excavation company and expanded to meetslowdown in the needs of theexploration for natural gas industry for stone for pad and road development. The decreased exploration activities havehas significantly impacted the cash flows of the customer.customer, who provides excavation services and stone for pad construction related to these activities. During 2019, the Company had the underlying equipment collateral appraised. The 2019 appraisal indicated a decrease in collateral values compared to the appraisal ordered for the loan origination and an appraisal performed in 2017, however, the loan iswas still considered well secured on a loan to value basis.basis at March 31, 2021. In the fourth quarter of 2020, a forbearance agreement was signed with this customer, which the customer remains in compliance with as of March 31, 2021. Management determined that no specific reserve was required as of September 30, 2020.March 31, 2021.

An agricultural loan customer with a total loan relationship of $2.6$2.4 million, secured by real estate, equipment and cattle, was on non-accrual status as of September 30, 2020.March 31, 2021. The customer declared bankruptcy during the fourth quarter of 2018 and developed a workout plan that was approved in the fourth quarter of 2019 and resulted in monthly payments resuming in late 2019.2019 that continued in 2020 and 2021. Included within these loans to this customer are $1,022,000$911,000 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. As of September 30, 2020,March 31, 2021, there was a specific reserve of $214,000$131,000 for this relationship.
A commercial customer with a loan relationship of $1.6 million, secured by commercial real estate, business assets and vehicles, was on non-accrual status as of September 30, 2020. The business expanded into a new market, which has not grown as originally expected and has created cashflow issues. The customer has signed contracts to sell a portion of the collateral, which will be used to pay down a portion of these balances in the fourth quarter of 2020. Management reviewed the collateral and determined that no specific reserve was required as of September 30, 2020.
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, 2020.March 31, 2021. The COVID-19 pandemic has createdescalated the cash flow difficulties for this customer.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, 2020.March 31, 2021.

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Index
Management of the Company believes that the allowance for loan losses as of September 30, 2020March 31, 2021 is adequate, which is based on the following factors:
•
Four loan relationships comprised 57.7% of the non-performing loan balance, which had approximately $214,000 of specific reserves, as of September 30, 2020.

The three loan relationships described above comprised 50.5% of the non-performing loan balance, which had approximately $131,000 of specific reserves, as of March 31, 2021.

The Company has a history of low charge-offs, and has a net recovery for the first three months of 2021. Net (recoveries) charge-offs for the first three months of 2021 were (0.03) % and were 0.03% for all of 2020.
•
The Company has a history of low charge-offs, which have returned to lower levels in the first half of 2020 after being slightly elevated in 2019. Net charge-offs for the first nine months of 2020 were 0.02% and were 0.06% for all of 2019.

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, 2020March 31, 2021, and December 31, 2019,2020, the cash surrender value of the life insurance was $32.4$30.2 million and $28.1$32.6 million, respectively. The change in cash surrender value, net of purchases and amounts acquired through acquisitions, is recognized in the results of operations. As part of the acquisition, the Bank acquired $3.8 million of bank owned life insurance. The amounts recorded as non-interest income totaled $180,000$1,315,000 and $158,000$156,000 for the three month periods ended September 30,March 31, 2021 and 2020, and 2019, respectively. ForDuring the nine months ended September 30, 2020 and 2019, $514,000 and $463,000, respectively, was recorded in non-interest income.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.

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Table of Contents
The Company agreements 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 beneficiariesbeneficiary’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, 2020March 31, 2021, and December 31, 2019,2020, included in other liabilities on the Consolidated Balance Sheet was a liability of $678,000$689,000 and $684,000,$687,000, respectively, for the obligation under the split-dollar benefit agreements.

Premises and Equipment

Premises and equipment increased $1.8 million$502,000 to $17.7$17.5 million as of September 30, 2020March 31, 2021 from December 31, 2019. As2020 as a result of the acquisition, $1.8 million was acquired, which is the primary driver of the increase.a building purchase.

Deposits

The following table shows the composition of deposits as of September 30, 2020March 31, 2021 and December 31, 20192020 (dollars in thousands):

 September 30,  December 31, 
 2020  2019  
March 31,
2021
  
December 31,
2020
 
 Amount  %  Amount  %  Amount  %  Amount  % 
Non-interest-bearing deposits $276,286   17.8  $203,793   16.9  $336,438   19.9  $303,762   19.1 
NOW accounts  407,837   26.3   340,273   28.1   442,338   26.2   422,083   26.6 
Savings deposits  248,716   16.0   224,456   18.5   283,594   16.8   255,853   16.1 
Money market deposit accounts  235,566   15.2   169,865   14.0   252,335   15.0   225,968   14.2 
Certificates of deposit  384,348   24.7   272,731   22.5   372,765   22.1   381,192   24.0 
Total $1,552,753   100.0  $1,211,118   100.0  $1,687,470   100.0  $1,588,858   100.0 

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Index

      
 September 30, 2020/ 
 December 31, 2019 
 Change  
March 31, 2021/
December 31, 2020
Change
 
 Amount  %  Amount  % 
Non-interest-bearing deposits $72,493   35.6  $32,676   10.8 
NOW accounts  67,564   19.9   20,255   4.8 
Savings deposits  24,260   10.8   27,741   10.8 
Money market deposit accounts  65,701   38.7   26,367   11.7 
Certificates of deposit  111,617   40.9   (8,427)  (2.2)
Total $341,635   28.2  $98,612   6.2 

Deposits increased $341.6$98.6 million since December 31, 2019. As part2020. The driver of the MidCoast acquisition,increase was government stimulus funds in response to the Bank acquired $208.8 million in deposits. A portion of the remaining increase is related to customers who depositedCOVID 19 pandemic, which includes PPP loan proceeds deposited into a non-interest bearing deposit account at the Bank. We continue to enhance our cash management services to improve our customer services and to grow deposits through our current customers.

Borrowed Funds

Borrowed funds were $99.6$86.2 million and $85.1$88.8 million as of September 30, 2020December 31, 2021 and December 31, 2019,2020, respectively. As part of the MidCoast acquisition, $15.5 million of borrowings were acquired. Excluding the acquisition, Overnight advances decreased $24.8 million, while short term advances increased $5.0 million. WeThe decrease in borrowed $20.0 million on a long-term basis and subsequentfunds was due to the acquisition, we repaid $3.0 millionmaturity of a long term$2.0 million long-term advance acquired as part of the acquisition. There was $1.9 million increaseand $667,000 decrease in repurchase agreements. As of September 30, 2020,March 31, 2021, long-term advances total $53.5$47.0 million, while short-term advances total $25.0 million and repurchase agreements total $14.2 million.

During the second quarter, we implemented several interest rate hedging strategies.
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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 involvesinvolve 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, 2020March 31, 2021 was $448,000$2,036,000 and is included within other liabilitiesassets 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 flat to inverted interestrising rate environment. The Company'sCompany’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.

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Index
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 $189.1$198.8 million at September 30, 2020March 31, 2021 compared to $154.8$194.3 million at December 31, 2019,2020, an increase of $34,277,000,$4,548,000, or 22.2%2.3%.  Excluding accumulated other comprehensive income (loss), stockholders’ equity increased $30.8$6.1 million, or 19.8%3.2%. As part of the MidCoast acquisition, we issued 373,356 shares with a value of $19.2 million based on the Company’s closing stock price of $51.50 per share on April 17, 2020. The Company purchased 40,4009,202 shares of treasury stock at a weighted average cost of $52.48 per share. The Company reissued 6,911 shares to employees and Directors as a reward for years of services and performance at a weighted average cost of $50.78$55.65 per share. For the ninethree months of 2020,2021, the Company had net income of $17.9$8.5 million and declared cash dividends of $5.6$1.8 million, or $1.46$0.465 per share, representing a cash dividend payout ratio of 31.1%21.5%.

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 changes in the interest rate environment, the defined benefit plan obligations and the interest rate swaps entered into during 2020, accumulated other comprehensive income increaseddecreased approximately $3.5$1.6 million from December 31, 2019.2020.

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.

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). Management believes, as of September 30, 2020March 31, 2021 and December 31, 2019,2020, that the Bank meets all capital adequacy requirements to which it was subject at such dates.

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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 will terminate upon the earlier of the termination of the national emergency related to COVID-19 orterminated on December 31, 2020.  Following such termination there is a grace period for returning to the 9% CBLR threshold.  The CBLR will be set at 8% for the remainder of 2020, 8.5% for 2021, and 9% thereafter.  The grace period is also adjusted to account for the graduating increase. As a result, in 2020 and 2021, a qualifying community bank utilizing the grace period must maintain a CBLR of at least 7% and 7.5%, respectively.. 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, 2020,March 31, 2021, the Bank was considered “well-capitalized” under the CBLR framework, with a leverage ratio of 8.66%8.84%.

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Off-Balance Sheet Activities

Some financial instruments, such as loan commitments, credit lines, and letters of credit, are issued to meet customer financing needs.  The contractual amount of financial instruments with off-balance sheet risk was as follows at September 30, 2020March 31, 2021 and December 31, 20192020 (in thousands):
 September 30, 2020  December 31, 2019 
Commitments to extend credit $291,686  $211,530 
Standby letters of credit  19,261   17,857 
  $310,947  $229,387 

 March 31, 2021  December 31, 2020 
Commitments to extend credit $304,350  $274,327 
Standby letters of credit  18,709   21,978 
  $323,059  $296,305 

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, 2020March 31, 2021 and December 31, 20192020 was $12,176,000$12,172,000 and $11,872,000,$12,210,000, respectively. The Company reserves the right to discontinue this service without prior notice.

Liquidity

Liquidity is a measure of the Company'sCompany’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'depositors’ withdrawal demands, extend credit to meet borrowers'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'sCompany’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.

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The Company'sCompany’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 ninethree months of 20202021 were $669,000$785,000 compared to $225,000$507,000 during the same time period in 2019.2020.

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 $680.5$727.4 million, of which $103.9$109.9 million was outstanding, at September 30, 2020.March 31, 2021. The Bank also had two federal funds lines with third party providers in the total amount of $34.0 million as of September 30, 2020,March 31, 2021, which are unsecured and undrawn upon. We also have a borrower in custody line with the Federal Reserve Bank of approximately $10.7$12.8 million, which also is not drawn upon as of September 30, 2020.March 31, 2021. The Company continues to evaluate its liquidity needs and as necessary finds additional sources.

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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, 2020,March 31, 2021, Citizens Financial Services, Inc. (on an unconsolidated basis) had liquid assets of $4.4$7.7 million.

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 0.09%0.11% 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'sCompany’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.

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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, 2020March 31, 2021 (dollars in thousands):
    Change In  % Change In     Change In  % Change In 
 Prospective One-Year  Prospective  Prospective  Prospective One-Year  Prospective  Prospective 
Changes in Rates Net Interest Income  Net Interest Income  Net Interest Income  Net Interest Income  Net Interest Income  Net Interest Income 
-100 Shock  57,974   (786)  (1.34)  59,242   (1,080)  (1.79)
Base  58,760   -   -   60,322   -   - 
+100 Shock  57,749   (1,011)  (1.72)  59,803   (519)  (0.86)
+200 Shock  56,961   (1,799)  (3.06)  59,821   (501)  (0.83)
+300 Shock  56,159   (2,601)  (4.43)  59,763   (559)  (0.93)
+400 Shock  55,160   (3,600)  (6.13)  59,573   (749)  (1.24)
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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.

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, 2020March 31, 2021 that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting.

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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 risk factor discussed below and 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, 2019,2020, which could materially affect our business, financial condition or future results. At September 30, 2020,March 31, 2021, the risk factors of the Company have not changed materially from those reported in our 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.

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The COVID-19 pandemic has adversely impacted our business and financial results and that of many of our customers, and the ultimate impact will depend on future developments, which are highly uncertain, cannot be predicted and outside of our control, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.

The COVID-19 pandemic has created extensive disruptions to the global economy and to the lives of individuals throughout the world. Governments, businesses, and the public are taking unprecedented actions to contain the spread of COVID-19 and to mitigate its effects, including quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal and monetary stimulus, and legislation designed to deliver financial aid and other relief. While the scope, duration, and full effects of COVID-19 are rapidly evolving and not fully known, the pandemic and the efforts to contain it have disrupted global economic activity, adversely affected the functioning of financial markets, impacted market interest rates, increased economic and market uncertainty, and disrupted trade and supply chains.  If these effects continue for a prolonged period or result in sustained economic stress or recession, many of the risk factors identified in our Form 10-K could be exacerbated and the effects of COVID-19 could have a material adverse impact on us in a number of ways as described in more detail below.

Credit Risk – Our risks of timely loan repayment and the value of collateral supporting the loans are affected by the strength of our borrowers’ businesses. Concern about the spread of COVID-19 has caused and is likely to continue to cause business shutdowns, limitations on commercial activity and financial transactions, labor shortages, supply chain interruptions, increased unemployment and commercial property vacancy rates, reduced profitability and ability for property owners to make mortgage payments, and overall economic and financial market instability, all of which may cause our customers to be unable to make scheduled loan payments. Hotel and restaurant operators and others in the leisure, hospitality and travel industries and the agricultural industry, among other industries, have been particularly hurt by COVID-19.  If the effects of COVID-19 result in widespread and sustained repayment shortfalls on loans in our portfolio, we could incur significant delinquencies, foreclosures and credit losses, particularly if the available collateral is insufficient to cover our credit exposure. The future effects of COVID-19 on economic activity could negatively affect the collateral values associated with our existing loans, the ability to liquidate the real estate collateral securing our residential and commercial real estate loans, our ability to maintain loan origination volume and to obtain additional financing, the future demand for or profitability of our lending and services, and the financial condition and credit risk of our customers. Further, in the event of delinquencies, regulatory changes and policies designed to protect borrowers may slow or prevent us from making our business decisions or may result in a delay in our taking certain remediation actions, such as foreclosure. In addition, we have unfunded commitments to extend credit to customers. During a challenging economic environment like now, our customers depend more on our credit commitments and increased borrowings under these commitments could adversely impact our liquidity. Furthermore, in an effort to support our communities during the pandemic, we are participating in the Paycheck Protection Program under the CARES Act whereby loans to small businesses are made and those loans are subject to the regulatory requirements that would require forbearance of loan payments for a specified time or that would limit our ability to pursue all available remedies in the event of a loan default. If the borrower under the PPP loan fails to qualify for loan forgiveness, we are at the heightened risk of holding these loans at unfavorable interest rates as compared to the loans to customers that we would have otherwise extended credit.

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Strategic Risk – Our success may be affected by a variety of external factors that may affect the price or marketability of our products and services, changes in interest rates that may increase our funding costs, reduced demand for our financial products due to economic conditions and the various response of governmental and nongovernmental authorities. The COVID-19 pandemic has significantly increased economic and demand uncertainty and has led to disruption and volatility in the global capital markets. Furthermore, many of the governmental actions have been directed toward curtailing household and business activity to contain COVID-19. These actions have been rapidly expanding in scope and intensity. For example, in many of our markets, local governments have acted to temporarily close or restrict the operations of most businesses. The future effects of COVID-19 on economic activity could negatively affect the future banking products we provide, including a decline in originating loans.

Operational Risk – Current and future restrictions on our workforce’s access to our facilities could limit our ability to meet customer servicing expectations and have a material adverse effect on our operations. We rely on business processes and branch activity that largely depend on people and technology, including access to information technology systems as well as information, applications, payment systems and other services provided by third parties. In response to COVID-19, we have modified our business practices with a portion of our employees working remotely from their homes to have our operations uninterrupted as much as possible. Further, technology in employees’ homes may not be as robust as in our offices and could cause the networks, information systems, applications, and other tools available to employees to be more limited or less reliable than in our offices. The continuation of these work-from-home measures also introduces additional operational risk, including increased cybersecurity risk from phishing, malware, and other cybersecurity attacks, all of which could expose us to risks of data or financial loss and could seriously disrupt our operations and the operations of any impacted customers.

Moreover, we rely on many third parties in our business operations, including the appraiser of the real property collateral, vendors that supply essential services such as loan servicers, providers of financial information, systems and analytical tools and providers of electronic payment and settlement systems, and local and federal government agencies, offices, and courthouses. In light of the developing measures responding to the pandemic, many of these entities may limit the availability and access of their services. If the third-party service providers continue to have limited capacities for a prolonged period or if additional limitations or potential disruptions in these services materialize, it may negatively affect our operations.

Interest Rate Risk/Market Value Risk – Our net interest income, lending and investment activities, deposits and profitability could be negatively affected by volatility in interest rates caused by uncertainties stemming from COVID-19. In March 2020, the Federal Reserve lowered the target range for the federal funds rate to a range from 0% to 0.25%, citing concerns about the impact of COVID-19 on financial markets and market stress in the energy sector. A prolonged period of extremely volatile and unstable market conditions would likely increase our funding costs and negatively affect market risk mitigation strategies. Higher income volatility from changes in interest rates and spreads to benchmark indices could cause a loss of future net interest income and a decrease in prevailing fair market values of our investment securities and other assets. Fluctuations in interest rates will impact both the level of income and expense recorded on most of our assets and liabilities and the market value of all interest-earning assets and interest-bearing liabilities, which in turn could have a material adverse effect on our net income, operating results, or financial condition.

Because there have been no comparable recent global pandemics that resulted in similar global impact, we do not yet know the full extent of COVID-19’s effects on our business, operations, or the global economy as a whole. Any future development will be highly uncertain and cannot be predicted, including the scope and duration of the pandemic, the effectiveness of our work-from-home arrangements, third party providers’ ability to support our operations, and any actions taken by governmental authorities and other third parties in response to the pandemic. The uncertain future development of this crisis could materially and adversely affect our business, operations, operating results, financial condition, liquidity or capital levels.

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Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

ISSUER PURCHASES OF EQUITY SECURITIESISSUER PURCHASES OF EQUITY SECURITIES 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)
  
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)
 
            
7/1/20 to 7/31/20  9,200  $49.75   9,200   11,523 
8/1/20 to 8/31/20  3,283  $48.72   3,283   8,240 
9/1/20 to 9/30/20  -  $0.00   -   8,240 
1/1/21 to 1/31/21  -  $0.00   -   158,202 
2/1/21 to 2/28/21  8,121  $55.61   8,121   150,081 
3/1/21 to 3/31/21  1,081  $55.94   1,081   149,000 
Total  12,483  $49.48   12,483   8,240   9,202  $55.65   9,202   149,000 

(1)On October 20, 2015, the Company announced that the Board of Directors authorized the Company to repurchase up to an additional 150,000 shares.  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. This authorization was fully utilized during the first quarter of 2021.

(2)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.

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Item 3 ‑ Defaults Upon Senior Securities

Not applicable.

Item 4 – Mine Safety Disclosure

Not applicable.

Item 5 ‑ Other Information

None

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Item 6 ‑ Exhibits

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

3.1
Articles of Incorporation of Citizens Financial Services, Inc., as amended (1)
  
3.2
Bylaws of Citizens Financial Services, Inc. (2)
  
4.1
Form of Common Stock Certificate. (3)
  
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
  
101The following materials from the Company’s Quarterly Report on Form 10-Q for the period ended  September 30, 2020,March 31, 2021, 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).

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

(2)Incorporated by reference to Exhibit 9.01 to the Company’s Current Report on Form 8-K, as filed with the Commission on December 24, 2009.
(2)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.

(3)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.
(3)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.

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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 5, 2020May 6, 2021 /s//s/ Randall E. Black
 By: Randall E. Black
 President and Chief Executive Officer
 (Principal Executive Officer)
  
November 5, 2020May 6, 2021/s/ Stephen J. Guillaume
 By: Stephen J. Guillaume
 Chief Financial Officer
 (Principal Financial and Accounting Officer)



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