CITIZENS FINANCIAL SERVICES INC

Previous wording

The following is management’s discussion and analysis of the Company’s financial condition and results of operations at the dates and for the periods presented in the accompanying consolidated financial statements for the Company. Our consolidated financial condition and results of operations consist almost entirely of the Bank’s financial condition and results of operations. Management’s discussion and analysis should be read in conjunction with the preceding financial statements presented under Part I and the Company’s audited consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2023. The results of operations for the three months ended March 31, 2024 are not necessarily indicative of the results you may expect for the full year.

Current wording

The following is management’s discussion and analysis of the Company’s consolidated financial condition and results of operations at the dates and for the periods presented in the accompanying consolidated financial statements for the Company. Our consolidated financial condition and results of operations consist almost entirely of the Bank’s financial condition and results of operations. Management’s discussion and analysis should be read in conjunction with the preceding financial statements presented under Part I and the Company’s audited consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2023. The results of operations for the three and six months ended June 30, 2024 are not necessarily indicative of the results you may expect for the full year.

Previous wording

The Company engages in the general business of banking throughout our service area of Potter, Tioga, Clinton, Bradford, Lycoming and Centre counties in north central Pennsylvania, Lebanon, Berks, Schuylkill, Lancaster and Chester counties in south central Pennsylvania and Allegany County in southern New York and with the MidCoast acquisition, the Cities of Wilmington and Dover, Delaware. We also have a limited branch office in Union county, Pennsylvania, which primarily serves agricultural and commercial customers in the central Pennsylvania market. With the HVBC acquisition, we have expanded further into southeast Pennsylvania, including Montgomery, Bucks and Philadelphia Counties as well as Burlington County, New Jersey through the acquisition of five full service branaches, four mortgage centers and one business banking facility. We maintain our central office in Mansfield, Pennsylvania. Presently we operate 48 banking facilities, 39 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, Williamsport, Schuylkill Haven, Friedensburg, Mt. Aetna, Fredericksburg, Mount Joy, Ephrata, Fivepointville, State College, Kennett Square, Warrington, Plumsteadville, Philadelphia, two branches near the city of Lebanon and two branches in Huntington Valley. The limited branch office is located in Winfield, Pennsylvania. In New York, our office is in Wellsville. In Delaware, we have three branches in Wilmington and one in Dover. The mortgage centers acquired as part of the acquisition are located in Montgomeryville, PA, Huntington Valley, PA, Philadelphia, PA and Mount Laurel, NJ. The business banking facility is located in Philadelphia, PA.

Current wording

The Company engages in the general business of banking throughout our service area of Potter, Tioga, Clinton, Bradford, Lycoming and Centre counties in north central Pennsylvania, Lebanon, Berks, Schuylkill, Lancaster and Chester counties in south central Pennsylvania and Allegany County in southern New York and with the MidCoast acquisition, the Cities of Wilmington and Dover, Delaware. We also have a limited branch office in Union county, Pennsylvania, which primarily serves agricultural and commercial customers in the central Pennsylvania market. With the HVBC acquisition, we have expanded further into southeast Pennsylvania, including Montgomery, Bucks and Philadelphia Counties as well as Burlington County, New Jersey through the acquisition of five full service branaches, four mortgage centers and one business banking facility. We maintain our central office in Mansfield, Pennsylvania. Presently we operate 48 banking facilities, 39 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, Williamsport, Schuylkill Haven, Friedensburg, Mt. Aetna, Fredericksburg, Mount Joy, Ephrata, Fivepointville, State College, Kennett Square, Warrington, Plumsteadville, Philadelphia, two branches near the city of Lebanon and two branches in Huntington Valley. The limited branch office is located in Winfield, Pennsylvania. In New York, our office is in Wellsville. In Delaware, we have three branches in Wilmington and one in Dover. The mortgage centers acquired as part of the acquisition are located in Montgomeryville, PA, Huntington Valley, PA, Philadelphia, PA and Mount Laurel, NJ. The business banking facility is located in Philadelphia, PA. The Company has submitted to open a limited purpose banking office in Georgetown, Delaware and is awaiting regulatory authorization.

Previous wording

The banking industry in the Bank’s service areas continue to be extremely competitive for loans and deposits, 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. 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, south central and south east Pennsylvania markets, as well as in our Delaware market, we experience more competition to gather deposits and to make loans. Mortgage banking firms, financial companies, financial affiliates of industrial companies, brokerage firms, retirement fund management firms and even government agencies provide additional competition for loans, deposits and other financial services. Fintech and blockchain entities offering crypto services are also increasing competition for the Company’s financial services. The Bank is generally competitive with all competing financial institutions in its service areas with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans.

Current wording

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

Previous wording

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 March 31, 2024 and December 31, 2023, the Trust Department had $173.7 million and $167.9 million of assets under management, respectively.

Current wording

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 June 30, 2024 and December 31, 2023, the Trust Department had $174.7 million and $167.9 million of assets under management, respectively.

Previous wording

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 assets are not assets of the Company. Assets owned and invested by customers of the Bank through the Bank’s Investment Representatives increased from $329.4 million at December 31, 2023 to $362.4 million at March 31, 2024. 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 south central and south eastern Pennsylvania markets.

Current wording

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 assets are not assets of the Company. Assets owned and invested by customers of the Bank through the Bank’s Investment Representatives increased from $329.4 million at December 31, 2023 to $368.4 million at June 30, 2024. 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, south central and south eastern Pennsylvania markets.

Previous wording

The Company had net income of $7,024,000 for the first three months of 2024 compared to $6,867,000 for last year’s comparable period, an increase of $157,000, or 2.3%. Basic earnings per share for the first three months of 2024 were $1.49, compared to $1.71 for last year’s comparable period, representing a 12.9% decrease. Annualized return on assets and return on equity for the three months of 2024 were 0.93% and 9.10%, respectively, compared with 1.16% and 11.49% for last year’s comparable period.

Current wording

The Company had net income of $12,299,000 for the first six months of 2024 compared to $2,723,000 for last year’s comparable period, an increase of $9,576,000, or 351.7%, primarily due to the absence in the current period of one-time costs associated with the HVBC acquisition and the provision for credit losses. Basic earnings per share for the first six months of 2024 were $2.59, compared to $0.66 for last year’s comparable period, representing a 292.4% increase. Annualized return on assets and return on equity for the six months of 2024 were 0.82% and 7.91%, respectively, compared with 0.23% and 2.22% for last year’s comparable period.

Previous wording

Net interest income for the first three months of 2024 was $20,958,000, an increase of $2,878,000, or 15.9%, compared to the same period in 2023. For the first three months of 2024 the provision for credit losses was $785,000. For the first three months of 2023, we did not record a provision for credit losses. Consequently, net interest income after the provision for credit losses was $20,173,000 in the first three months of 2024 compared to $18,080,000 during the first three months of 2023.

Current wording

Net interest income for the first six months of 2024 was $42,258,000, an increase of $6,257,000, or 17.4%, compared to the same period in 2023. For the first six months of 2024 the provision for credit losses was $2,787,000. The provision for the first six months of 2023 was $4,853,000, which included $4,591,000 for non-PCD loans acquired as part of the acquisition. Excluding the $4,591,000 related to the acquisition, the provision for credit losses increased $2,525,000. Consequently, net interest income after the provision for credit losses was $39,471,000 in the first six months of 2024 compared to $31,148,000 during the first six months of 2023.

Previous wording

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 months ended March 31, 2024 and 2023 on a tax equivalent basis (dollars in thousands):

Current wording

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 six months ended June 30, 2024 and 2023 on a tax equivalent basis (dollars in thousands):

Previous wording

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 months ended March 31, 2024 and 2023. 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 March 31, 2024 and 2023 (in thousands):

Current wording

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 six months ended June 30, 2024 and 2023. 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 June 30, 2024 and 2023 (in thousands):

Previous wording

Tax equivalent net interest income increased from $18,351,000 for the three month period ended March 31, 2024 to $21,208,000 for the three month period ended March 31, 2023, an increase of $2,857,000. The acquisition of HVBC had a substantial impact on the increase. The tax equivalent net interest margin decreased from 3.30% for the first three months of 2023 to 3.05% for the comparable period in 2024. The decrease is primarily caused by the increase in the cost of interest-bearing liabilities due to higher market interest rates in 2024 compared to 2023.

Current wording

Tax equivalent net interest income increased from $36,539,000 for the six month period ended June 30, 2023 to $42,753,000 for the six month period ended June 30, 2024, an increase of $6,214,000. The acquisition of HVBC had a substantial impact on the increase. The tax equivalent net interest margin decreased from 3.23% for the first six months of 2023 to 3.09% for the comparable period in 2024. The decrease is primarily caused by the increase in the cost of interest-bearing liabilities due to higher market interest rates in 2024 compared to 2023.

Previous wording

Total tax equivalent interest income for the 2024 three month period increased $12,805,000 as compared to the 2023 three month period. This increase was a result of an increase of $8,615,000 due to a change in volume as average interest-bearing assets increased $545.6 million. As a result of the higher market interest rate environment, the yield on average interest earning assets increased 0.92% from 4.56% to 5.48% resulting in an increase interest income of $4,190,000.

Current wording

Total tax equivalent interest income for the 2024 six month period increased $23,875,000 as compared to the 2023 six month period. This increase was a result of an increase of $16,080,000 due to a change in volume as average interest-bearing assets increased $500.7 million. As a result of the higher market interest rate environment, the yield on average interest earning assets increased 0.88% from 4.64% to 5.52% resulting in an increase in interest income of $7,795,000.

Previous wording

Tax equivalent investment income for the three months ended March 31, 2024 increased $48,000 over the same period last year. The primary cause of the increase was due to the increase in yield on investment securities of 17 basis points to 2.29%.

Current wording

Tax equivalent investment income for the six months ended June 30, 2024 increased $41,000 over the same period last year. The primary cause of the increase was due to the increase in yield on investment securities of 18 basis points to 2.32%.

Previous wording

Total loan interest income increased $12,585,000 for the three months ended March 31, 2024 compared to the same period last year, as a result of higher volume and yields.

Current wording

Total loan interest income increased $23,527,000 for the six months ended June 30, 2024 compared to the same period last year, as a result of higher volume and yields.

Previous wording

Total interest expense increased $9,948,000 for the three months ended March 31, 2024 compared with the comparative period last year as a result of an increase in the volume of other borrowed funds and an increase in rate on interest-bearing liabilities. Interest expense increased $3,091,000 due to volume as a result of an increase in the average balance of other borrowed funds of $76.9 million. The average rate paid on interest-bearing liabilities increased from 1.65% to 2.99%. The increase was driven by the Federal Reserve interest rate increases in 2022 and 2023, which caused interest expenses to increase $6,857,000.

Current wording

Total interest expense increased $7,713,000 for the three months ended June 30, 2024 compared with the comparative period last year as a result of an increase in the volume of interest-bearing liabilities and an increase in rate on interest-bearing liabilities. Interest expense increased $2,631,000 due to volume as a result of an increase in interest bearing liabilities of $447.2 million. The average rate paid on interest-bearing liabilities increased from 2.00% to 3.00%. The increase was driven by the Federal Reserve interest rate increases in 2022 and 2023, which caused interest expenses to increase $5,082,000.

Previous wording

The following table shows the breakdown of non-interest income for the three months ended March 31, 2024 and 2023 (dollars in thousands):

Current wording

The following table shows the breakdown of non-interest income for the three and six months ended June 30, 2024 and 2023 (dollars in thousands):

Previous wording

Non-interest income for the three months ended March 31, 2024 totaled $4,971,000, an increase of $2,797,000 when compared to the same period in 2023. During the first three months of 2024, net equity security gains amounted to $55,000 as a result of market gains associated with general bank stock market gains compared with a $218,000 loss in the comparable 2023 period associated with market conditions for that period.

Current wording

Non-interest income for the six months ended June 30, 2024 totaled $8,307,000, an increase of $3,853,000 when compared to the same period in 2023. For the three months ended June 30, 2024, non-interest income increased $1,056,000 to $3,336,000. During the first six months of 2024, net equity security losses amounted to $32,000 as a result of market losses associated with general banking stock losses compared with a $292,000 loss in the comparable 2023 period associated with market conditions for that period. There were no sales of available for sale securities during the first six months of 2024. During the six months ended June 30, 2023, there were $51,000 of losses from the sale of $10.0 million available for sale municipal securities. Additionally, $76.5 million of securities obtained as part of the acquisition were sold for no gain or loss during the second quarter of 2023.

Previous wording

The increase in gains on loans sold for the three months ended March 31, 2024 compared to the comparable period in 2023 is attributable to the HVBC acquisition and their residential lending model, which focused on originating and selling residential mortgage loans, which includes the use of interest rate locks and other derivative activities, which is included in other income. The increase in earnings on bank owned life insurance is due to the HVBC acquisition, as well as the death benefits received upon the passing of a former employee. During the first quarter of 2024, the Company completed the sale of certain assets acquired as part of the HVB acquisition, which included loans and accrued interest, and software, as well as transferring certain contracts, processes and employees of a division internally known as Braavo. The proceeds from the sale totaled approximately $7.2 million and generated a pre-tax gain of approximately $1.1 million.

Current wording

The increase in gains on loans sold for the three and six month periods ended June 30, 2024 compared to 2023 is attributable the HVBC acquisition and their residential lending model, which focused on originating and selling residential mortgage loans, which includes the use of interest rate locks and other derivative activities, which is included in other income. The increase in earnings on bank owned life insurance is due to the HVBC acquisition, as well as the death benefits received upon the passing of a former employee. During the first quarter of 2024, the Company completed the sale of certain assets acquired as part of the HVB acquisition, which included loans and accrued interest, and software, as well as transferring certain contracts, processes and employees of a division internally known as Braavo. The proceeds from the sale totaled approximately $7.2 million and generated a pre-tax gain of approximately $1.1 million.

Previous wording

The following tables reflect the breakdown of non-interest expense for the three months ended March 31, 2024 and 2023 (dollars in thousands):

Current wording

The following tables reflect the breakdown of non-interest expense for the three and six months ended June 30, 2024 and 2023 (dollars in thousands):

Previous wording

Non-interest expenses increased $4,865,000 for the three months ended March 31, 2024 compared to the same period in 2023. Salaries and employee benefits increased $2,613,000 or 34.0%. The increase was due to merit increases effective at the beginning of 2024, additional full time equivalent employees (FTE) of 80.9, which is an increase of 25.8%, and an increase in health care expenses due to higher claims on the Company’s partially self-funded plan and the additional headcount.

Current wording

Non-interest expenses increased $431,000 for the six months ended June 30, 2024 compared to the same period in 2023. Salaries and employee benefits increased $4,314,000 or 27.7%. The increase was due to merit increases effective at the beginning of 2024, additional full time equivalent employees (FTE) of 78.6, which is an increase of 25.1%, and an increase in health care expenses due to higher claims on the Company’s partially self-funded plan and the additional headcount.

Previous wording

The decrease in merger and acquisition expenses was due to fees associated with the acquisition of HVBC that closed in June 2023 with no corresponding activity in 2024. The increase in occupancy, furniture and fixtures, software expenses and amortization of intangibles was due to the HVBC acquisition. FDIC insurance expense increased $225,000 due to the Company’s increased size and the Bank’s lower leverage capital ratio. Professional fees increased due to various legal matters, of which $201,000 was related to the sale of certain assets. Other expenses increased primarily due to the acquisition, with increases experienced in subscriptions, marketing and advertising, postage, printing, data communication expenses and FHLB letter of credit fees. Independent of the acquisition, other expenses increased due to insurance reimbursement received in 2023 to cover amounts previously expensed.

Current wording

The decrease in merger and acquisition expenses was due to the absence in the current period of fees associated with the acquisition of HVB that closed in June 2023 and includes severance costs, change in control payments, contract termination payments and various professional and consulting fees. The increase in occupancy, furniture and fixtures, amortization of intangibles, and software expenses was due to the HVBC acquisition. The increase in FDIC insurance is due to the acquisition and organic growth. Other expenses increased primarily due to the acquisition, with increases experienced in subscriptions, marketing and advertising, postage, printing, data communication expenses and FHLB letter of credit fees. Independent of the acquisition, other expenses increased due to insurance reimbursement received in 2023 to cover amounts previously charged-off.

Previous wording

The provision for income taxes was $1,477,000 for the three month period ended March 31, 2024 compared to $1,609,000 for the same period in 2023. This decrease was attributable to death benefits received upon the passing of a former employees and certain expenses in 2023 not being tax deductible. Through management of our municipal loan and bond portfolios, management is focused on minimizing our effective tax rate. The effective tax rate was 17.4% and 19.0% for the three months ended March 31, 2024 and 2023, respectively, compared to the statutory rate of 21%.

Current wording

The provision for income taxes was $2,590,000 for the six month period ended June 30, 2024 compared to $421,000 for the same period in 2023. The increase is primarily attributable to the increase in income before the provision for income taxes of $11,745,000 for the comparable periods due to the one-time costs associated with the HVBC acquisition. Through management of our municipal loan and bond portfolios, management is focused on minimizing our effective tax rate. Our effective tax rate was 17.4% and 13.4% for the first six months of 2024 and 2023, respectively, compared to the statutory rate of 21%.

Previous wording

We are invested in seven limited partnerships that have established low-income housing projects in our market areas, with our most recent investments made in the second half of 2022. Three projects are currently in construction phase with credits being recognized on two of the projects for the first time in 2023 with the expectation that the remaining one will generate credits in the second half of 2024. The remaining four partnership credits are fully utilized as of December 31, 2023. We anticipate recognizing an aggregate of $8.4 million of tax credits over the next 12 years.

Current wording

We are invested in seven limited partnerships that have established low-income housing projects in our market areas, with our most recent investments made in the second half of 2022. Three projects are currently in construction phase with credits being recognized on two of the projects for the first time in 2023 with the expectation that the remaining one will generate credits in the second half of 2024. The remaining four partnership credits are fully utilized as of December 31, 2023. We anticipate recognizing an aggregate of $8.2 million of tax credits over the next 12 years.

Previous wording

Total assets were $2.92 billion at March 31, 2024, a decrease of $54.2 million from $2.98 billion at December 31, 2023, due primarily to a decrease in cash, investments and loans outstanding. Cash and cash equivalents decreased $23.2 million to $29.6 million. Available for sale securities decreased $12.7 million and net loans decreased $9.6 million to $2.22 billion at March 31, 2024 due to decreases in the student loan portfolio. Total deposits decreased $18.6 million to $2.30 billion since year-end 2023, while borrowed funds decreased $38.5 million to $283.6 million.

Current wording

Total assets were $2.95 billion at June 30, 2024, a decrease of $27.8 million from $2.98 billion at December 31, 2023, due primarily to decreases in cash and investments securities. Cash and cash equivalents decreased $14.4 million to $38.4 million. Available for sale securities decreased $14.9 million. Total deposits decreased $48.4 million to $2.27 billion since year-end 2023, while borrowed funds increased $12.8 million to $283.6 million.

Previous wording

Cash and cash equivalents totaled $29.6 million at March 31, 2024 compared to $52.8 million at December 31, 2023. The decrease is due to a decrease in the cash letter as part of our balance at the Federal Reserve. Management actively measures and evaluates the Company’s liquidity position through our Asset–Liability Committee and believes the Company’s liquidity needs are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources including the Bank’s core deposits, Federal Home Loan Bank financing, federal funds lines with correspondent banks, brokered certificates of deposit and the portion of the investment and loan portfolios that mature within one year. Management expects that these sources of funds will permit us to meet cash obligations and off-balance sheet commitments as they come due.

Current wording

Cash and cash equivalents totaled $38.4 million at June 30, 2024 compared to $52.8 million at December 31, 2023. The decrease is due to a decrease in the cash held at the Federal Reserve. Management actively measures and evaluates the Company’s liquidity position through our Asset–Liability Committee and believes the Company’s liquidity needs are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources including the Bank’s core deposits, Federal Home Loan Bank financing, federal funds lines with correspondent banks, brokered certificates of deposit and the portion of the investment and loan portfolios that mature within one year. Management expects that these sources of funds will permit us to meet cash obligations and off-balance sheet commitments as they come due.

Previous wording

Our investment portfolio decreased by $13.0 million, or 3.1%, from December 31, 2023 to March 31, 2024. During 2024, we purchased $6.6 million of mortgage-backed securities in government sponsored entities. We experienced $3.1 million of principal repayments and $13.5 million of calls and maturities. As a result of increases in market interest rates, the unrealized loss on available for sale investment portfolio increased $2.3 million. Excluding our short-term investments consisting of monies held primarily at the Federal Reserve for liquidity purposes, our investment portfolio for the three month period ended March 31, 2024 yielded 2.29%, compared to 2.12% in the comparable period in 2023, on a tax equivalent basis.

Current wording

Our investment portfolio decreased by $15.3 million, or 3.6%, from December 31, 2023 to June 30, 2024. During 2024, we purchased $14.0 million of mortgage-backed securities in U.S government sponsored entities. We experienced $5.6 million of principal repayments and $21.5 million of calls and maturities. As a result of increases in market interest rates, the unrealized loss on available for sale investment portfolio increased $1.2 million. Excluding our short-term investments consisting of monies held primarily at the Federal Reserve for liquidity purposes, our investment portfolio for the six month period ended June 30, 2024 yielded 2.32%, compared to 2.14% in the comparable period in 2023, on a tax equivalent basis.

Previous wording

Loans held for sale decreased $1.0 million to $8.3 million as of March 31, 2024 from December 31, 2023 due to the first quarter typically being the slowest quarter for residential home sales.

Current wording

Loans held for sale increased $4.8 million to $14.2 million as of June 30, 2024 from December 31, 2023 due to the second quarter typically being more active for residential home sales than the fourth quarter.

Previous wording

The Bank’s lending efforts have historically been focused in north central Pennsylvania, the south central Pennsylvania counties of Lebanon, Schuylkill, Berks and Lancaster, the central Pennsylvania counties of Clinton and Centre, and southern New York. We have a limited branch office in Union County that is staffed by a lending team to primarily support agricultural opportunities in central Pennsylvania. In April 2020, we completed the MidCoast acquisition, which expanded our markets into the State of Delaware with activity centered around the cities of Wilmington and Dover, Delaware. Since the MidCoast acquisition, we have opened two additional branches in the Delaware market to better serve customers in the Wilmington market, as well as the surrounding area of Chester County, Pennsylvania. In June 2023, we completed the HVBC acquisition, which expanded our markets into south east Pennsylvania, including the counties of Montgomery, Bucks and Philadelphia. It also includes a Mortgage production in Mount Laurel, New Jersey. In the fourth quarter of 2023, we opened an office in Williamsport, Pennsylvania, to further our efforts in central 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.

Current wording

Lending efforts have historically been focused in north central Pennsylvania, the south central Pennsylvania counties of Lebanon, Schuylkill, Berks and Lancaster, the central Pennsylvania counties of Clinton and Centre, and southern New York. We have a limited branch office in Union County that is staffed by a lending team to primarily support agricultural opportunities in central Pennsylvania. In April 2020, we completed the MidCoast acquisition, which expanded our markets into the State of Delaware with activity centered around the cities of Wilmington and Dover, Delaware. Since the MidCoast acquisition, we have opened two additional branches in the Delaware market to better serve customers in the Wilmington market, as well as the surrounding area of Chester County, Pennsylvania. In June 2023, we completed the HVBC acquisition, which expanded our markets into south east Pennsylvania, including the counties of Montgomery, Bucks and Philadelphia. It also includes a Mortgage production office in Mount Laurel, New Jersey. In the fourth quarter of 2023, we opened an office in Williamsport, Pennsylvania, to further our efforts in central 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.

Previous wording

Loan activity in the first quarter of 2024 has been limited. Several construction loans were completed and transferred to the commercial and agricultural real estate portfolios. As part of the Braavo sale, we sold $6.1 million of other commercial loans. Due to timing, student loans decreased in the first quarter resulting in the decrease in consumer loans.

Current wording

Loan activity in the first half of 2024 has been limited. The decrease in construction loans was due to the underlying projects being completed and transferred to the commercial and agricultural real estate portfolios. As part of the Braavo sale, we sold $6.1 million of other commercial loans. Due to timing, student loans increased in the first half of 2024 resulting in an increase in consumer loans.

Previous wording

The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending. Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions which have (1) total reported loans for construction, land development and other land acquisitions which represent 100% or more of an institution’s total risk-based capital; or (2) total commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the institution’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios and may be required to hold higher levels of capital. The Company, like many community banks, has a concentration in commercial real estate loans, and the Company has experienced growth in its commercial real estate portfolio in recent years. As of March 31, 2024, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represented 298.4% of consolidated risk based capital. Construction, land and land development loans represented 54.5% of consolidated risk based capital. Management has extensive experience in commercial real estate lending and has implemented and continues to maintain heightened risk management procedures and strong underwriting criteria with respect to its commercial real estate portfolio. We may be required to maintain higher levels of capital as a result of our commercial real estate concentrations, which could require us to obtain additional capital and may adversely affect shareholder returns. The Company has an extensive Capital Policy and Capital Plan, which includes pro-forma projections including stress testing within which the Board of Directors has established internal minimum targets for regulatory capital ratios that are in excess of well capitalized ratios. The Company continues to refine information reviewed related to commercial real estate and to implement additional monitoring and testing of commercial real estate loans.

Current wording

The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending. Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions which have (1) total reported loans for construction, land development and other land acquisitions which represent 100% or more of an institution’s total risk-based capital; or (2) total commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the institution’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios and may be required to hold higher levels of capital. The Company, like many community banks, has a concentration in commercial real estate loans, and the Company has experienced growth in its commercial real estate portfolio in recent years. As of June 30, 2024, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represented 305.2% of consolidated risk based capital. Construction, land and land development loans represented 64.4% of consolidated risk based capital. Management has extensive experience in commercial real estate lending and has implemented and continues to maintain heightened risk management procedures and strong underwriting criteria with respect to its commercial real estate portfolio. We may be required to maintain higher levels of capital as a result of our commercial real estate concentrations, which could require us to obtain additional capital and may adversely affect shareholder returns. The Company has an extensive Capital Policy and Capital Plan, which includes pro-forma projections including stress testing within which the Board of Directors has established internal minimum targets for regulatory capital ratios that are in excess of well capitalized ratios. The Company continues to refine information reviewed related to commercial real estate and to implement additional monitoring and testing of commercial real estate loans.

Previous wording

The allowance for credit losses - loans is maintained at a level which, in management’s judgment, is adequate to absorb losses in the loan portfolio. The provision for credit losses - loans is charged against current income. Loans deemed not collectable are charged-off against the allowance while subsequent recoveries increase the allowance. The allowance for credit losses - loans was $21,598,000 or 0.96% of total loans as of March 31, 2024 as compared to $21,153,000 or 0.94% of loans as of December 31, 2023. The $445,000 increase is a result of a $1,112,000 provision for credit losses – loans less net charge-offs of $667,000. Net charge-offs for 2024 are driven by loans acquired as part of the HVBC acquisition due to collateral issues. The following table shows the distribution of the allowance for credit losses - loans and the percentage of loans compared to total loans by loan category as of March 31, 2024 and December 31, 2023 (dollars in thousands):

Current wording

The allowance for credit losses - loans is maintained at a level which, in management’s judgment, is adequate to absorb losses in the loan portfolio. The provision for credit losses - loans is charged against current income. Loans deemed not collectable are charged-off against the allowance while subsequent recoveries increase the allowance. The allowance for credit losses - loans was $22,797,000 or 1.01% of total loans as of June 30, 2024 as compared to $21,153,000 or 0.94% of loans as of December 31, 2023. The $1,644,000 increase is a result of a $2,986,000 provision for credit losses – loans less net charge-offs of $1,342,000. Net charge-offs for 2024 are driven by loans acquired as part of the HVBC acquisition due to collateral issues. The following table shows the distribution of the allowance for credit losses - loans and the percentage of loans compared to total loans by loan category as of June 30, 2024 and December 31, 2023 (dollars in thousands):

Previous wording

The following table provides information related to credit loss experience and loan quality for the three months ended March 31, 2024 and the year ended December 31, 2023 (dollars in thousands).

Current wording

The following table provides information related to credit loss experience and loan quality for the six months ended June 30, 2024 and the year ended December 31, 2023 (dollars in thousands).

Previous wording

Management believes it uses the best information available to make such determinations and that the allowance for credit losses - loans is adequate as of March 31, 2024. However, future adjustments could be required if circumstances differ substantially from assumptions and estimates used in making the initial determination. A prolonged downturn in the economy, changes in the economies of various segments of our agricultural and commercial portfolios, high unemployment rates, significant changes in the value of collateral and delays in receiving financial information from borrowers could result in increased levels of non-performing assets, charge-offs, loan loss provisions and reduction in income. Additionally, bank regulatory agencies periodically examine the Bank’s allowance for credit losses. The banking agencies could require the recognition of additions to the allowance for credit losses - loans based upon their judgment of information available to them at the time of their examination.

Current wording

Management believes it uses the best information available to make such determinations and that the allowance for credit losses - loans is adequate as of June 30, 2024. However, future adjustments could be required if circumstances differ substantially from assumptions and estimates used in making the initial determination. A prolonged downturn in the economy, changes in the economies of various segments of our agricultural and commercial portfolios, high unemployment rates, significant changes in the value of collateral and delays in receiving financial information from borrowers could result in increased levels of non-performing assets, charge-offs, credit loss provisions and reduction in income. Additionally, bank regulatory agencies periodically examine the Bank’s allowance for credit losses. The banking agencies could require the recognition of additions to the allowance for credit losses - loans based upon their judgment of information available to them at the time of their examination.

Previous wording

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

Current wording

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

Previous wording

Nonperforming loans increased $2.8 million during 2024. During the first quarter of 2024, the Bank placed one large commercial relationship and one large construction relationship on non-accrual status, which accounts for the majority of the change in non-performing loans since year-end. At March 31, 2024, approximately 55.8% of the Bank’s non-performing loans are associated with the following six customer relationships:

Current wording

Nonperforming loans increased $2.5 million during 2024. During the first half of 2024, the Bank placed one large commercial relationship, one large construction relationship and numerous other commercial loans on non-accrual status, while also foreclosing on one construction loan that was transferred to foreclosed assets held for sale, which accounts for the majority of the change in non-performing loans since year-end. At June 30, 2024, approximately 52.3% of the Bank’s non-performing loans are associated with the following six customer relationships:

Previous wording

The Company owns 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 March 31, 2024, and December 31, 2023, the cash surrender value of the life insurance was $49.4 million and $49.9 million, respectively. The change in cash surrender value, net of purchases and amounts acquired through acquisitions, is recognized in the results of operations. The amounts recorded as non-interest income totaled $668,000 and $218,000 for the three month periods ended March 31, 2024 and 2023, respectively. During the first quarter of 2024, the Company received proceeds of $1,147,000, which included death benefits of $326,000 on a former employee 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.

Current wording

The Company owns 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 June 30, 2024, and December 31, 2023, the cash surrender value of the life insurance was $49.8 million and $49.9 million, respectively. The change in cash surrender value, net of purchases and amounts acquired through acquisitions, is recognized in the results of operations. The amounts recorded as non-interest income totaled $996,000 and $452,000 for the six month periods ended June 30, 2024 and 2023, respectively. During the first quarter of 2024, the Company received proceeds of $1,147,000, which included death benefits of $326,000 on a former employee 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.

Previous wording

The Company policies that were purchased directly from insurance companies and acquired as part of the HVBC acquisition are structured so that any death benefits received from a policy while the insured person is an active employee of the Bank will be split with the beneficiary of the policy. Under these agreements, the employee’s beneficiary will be entitled to receive 50% of the net amount at risk from the proceeds. The net amount at risk is the total death benefit payable less the cash surrender value of the policy as of the date of death. The policies acquired as part of the acquisition of FNB provide a fixed split-dollar benefit for the beneficiary’s estate, which is dependent on several factors including whether the covered individual was a former Director of First National Bank of Fredericksburg (“FNB”) or a former employee of FNB and their salary level. As of March 31, 2024 and December 31, 2023, included in other liabilities on the Consolidated Balance Sheet was a liability of $598,000 and $610,000, respectively, for the obligation under the split-dollar benefit agreements.

Current wording

The Company policies that were purchased directly from insurance companies and acquired as part of the HVBC acquisition are structured so that any death benefits received from a policy while the insured person is an active employee of the Bank will be split with the beneficiary of the policy. Under these agreements, the employee’s beneficiary will be entitled to receive 50% of the net amount at risk from the proceeds. The net amount at risk is the total death benefit payable less the cash surrender value of the policy as of the date of death. The policies acquired as part of the acquisition of FNB provide a fixed split-dollar benefit for the beneficiary’s estate, which is dependent on several factors including whether the covered individual was a former Director of First National Bank of Fredericksburg (“FNB”) or a former employee of FNB and their salary level. As of June 30, 2024 and December 31, 2023, included in other liabilities on the Consolidated Balance Sheet was a liability of $582,000 and $610,000, respectively, for the obligation under the split-dollar benefit agreements.

Previous wording

Premises and equipment decreased $301,000 to $21.1 million as of March 31, 2024 from December 31, 2023 as a result of a depreciation.

Current wording

Premises and equipment decreased $485,000 to $20.9 million as of June 30, 2024 from December 31, 2023 as a result of depreciation.

Previous wording

Other assets decreased $7.2 million to $51.9 million. The primary driver of the decrease was an investment security that matured, but did not settle as of December 31, 2023. It subsequently settled in 2024

Current wording

Other assets decreased $5.9 million to $53.2 million. The primary driver of the decrease was an investment security that matured, but did not settle as of December 31, 2023. It subsequently settled in 2024.

Previous wording

Deposits decreased $18.6 million since December 31, 2023. The reduction in deposits resulted from customer funds transferred to higher-yielding investment alternatives; and seasonal reductions in municipal deposits as well as withdrawals used to fund various projects within municipalities. Brokered deposits totaled $116.8 million and $109.3 million as of March 31, 2024 and December 31, 2023, respectively. At March 31, 2024, the Bank estimates that balances held by customers in excess ofthe FDIC insurance limit ($250,000 per insured account)totaled $1.07 billion, or 46.4% of the Bank’s total deposits. Included in this balance are balances held through Intrafi, which provides customers with FDIC insurance coverage by placing customer funds with insured banks within the Intrafi network, as well as deposits collateralized by securities (almost exclusively municipal deposits). The total of these itemswas$541.3 million, or 23.5% of the Bank’s total deposits, as of March 31, 2024.

Current wording

Deposits decreased $48.4 million since December 31, 2023. The reduction in deposits resulted from customer funds transferred to higher-yielding investment alternatives; and seasonal reductions in municipal deposits as well as withdrawals used to fund various projects within municipalities. Brokered deposits totaled $116.8 million and $109.3 million as of June 30, 2024 and December 31, 2023, respectively. At June 30, 2024, the Bank estimates that balances held by customers in excess ofthe FDIC insurance limit ($250,000 per insured account)totaled $1.04 billion, or 45.7% of the Bank’s total deposits. Included in this balance are balances held through Intrafi, which provides customers with FDIC insurance coverage by placing customer funds with insured banks within the Intrafi network, as well as deposits collateralized by securities (almost exclusively municipal deposits). The total of these itemswas$498.0 million, or 21.9% of the Bank’s total deposits, as of June 30, 2024.

Previous wording

Borrowed funds were $283.6 million and $322.0 million as of March 31, 2024 and December 31, 2023, respectively. The decrease in borrowed funds was due to the decrease in loans, investments and cash, which was used to paydown outstanding borrowings.

Current wording

Borrowed funds were $334.8 million and $322.0 million as of June 30, 2024 and December 31, 2023, respectively. The increase in borrowed funds was due to the increase in loans and the seasonal decline in deposits.