CITIZENS & NORTHERN CORP

Net income for the year ended December 31, 2019 was $19,504,000, or $1.46 per diluted share as compared to 2018 net income of $22,013,000 or $1.79 per share. Earnings for the year ended December 31, 2019 were significantly impacted by the Monument acquisition, including the effects of merger-related expenses described earlier. Earnings for the year ended December 31, 2018 included the benefit of a realized gain on a restricted equity security (Visa Inc. Class B stock) partially offset by the impact of a loss on available-for-sale debt securities. In 2018, pre-tax realized gains on Visa Class B stock totaled $2.3 million while pre-tax realized losses on available-for-sale securities totaled $288,000. Excluding the impact of merger-related expenses and net securities gains, adjusted (non-U.S. GAAP) earnings for 2019 would be $22,756,000 or $1.70 per share as compared to similarly adjusted (non-GAAP) earnings of $20,712,000 or $1.68 per share for 2018.

PURCHASED LOANS – The Corporation purchased loans in connection with its acquisition of Monument, some of which had, at the acquisition date of April 1, 2019, shown evidence of credit deterioration since origination. The Corporation considers several factors as indicators that an acquired loan has evidence of deterioration in credit quality. These factors include loans 90 days or more past due, loans with an internal risk rating of substandard or below, loans classified as nonaccrual by the acquired institution and loans that have been previously modified in a troubled debt restructuring. The purchased loans that showed evidence of credit impairment were designated as the purchased credit impaired (“PCI”) loans and were recorded at fair value, with no carryover of the allowance for loan losses. The PCI loans acquired are secured by real estate and the fair value of each loan at the acquisition date was determined based on the estimated proceeds to be derived from selling the collateral, net of selling costs. The PCI loans were placed into nonaccrual status upon acquisition (and remained in nonaccrual status at December 31, 2019) as the Corporation cannot reasonably estimate cash flows expected to be collected in order to compute yield on the loans.

In December 2019, the Corporation announced a plan of merger to acquire Covenant Financial, Inc. (“Covenant”) in a transaction valued on December 18, 2019 at approximately $77 million. Under the terms of the definitive agreement, the Corporation will pay cash for 25% of the Covenant shares and will convert 75% of Covenant shares to the Corporation’s common stock. Covenant is the holding company for Covenant Bank, which operates banking offices in Bucks and Chester Counties of PA. Covenant had total assets of $516 million, liabilities of $474 million and stockholders’ equity of $42 million at December 31, 2019. The merger is subject to satisfaction of customary closing conditions, including receipt of regulatory approvals and approval of Covenant’s shareholders. The merger is expected to close in the third quarter 2020. In 2019, the Corporation incurred merger-related expenses totaling $287,000 related to the planned acquisition of Covenant. Management estimates pre-tax merger-related expenses associated with the Covenant acquisition will total approximately $8 million ($6.6 million, net of tax), with most of the expenses expected to be incurred in the third quarter 2020.

As shown in the tables immediately above, total loans classified as special mention increased to $19,658,000 at December 31, 2019 from $7,394,000 at December 31, 2018. At December 31, 2019, there were 60 loans classified as special mention, with an average balance of $328,000. In comparison, at December 31, 2018, there were 53 loans classified as special mention, with an average balance of $140,000. Of the total balance of special mention loans at December 31, 2019, loans of $500,000 or more totaled $15,357,000, or 78% of the total. Special mention loans with balances of $500,000 or more at December 31, 2019 included 9 commercial loans to 7 different borrowers, summarized with comparative December 31, 2018 (if applicable) as follows:

There was no specific allowance for loan losses recorded on any loans classified as special mention at December 31, 2019. At December 31, 2018, there were specific allowances totaling $1,365,000 on the 2 loans in the table above that were upgraded from substandard at December 31, 2018 to special mention at December 31, 2019. These loans were no longer considered impaired in 2019 and the specific allowances were eliminated in 2019. One of the loans originated in 2019 and classified as special mention at December 31, 2019, with an outstanding balance of $3,500,000 at December 31, 2019, was made on a partially unsecured basis. The Corporation estimates the liquidation value of the related collateral, net of selling costs, would be approximately $1,500,000, with a shortfall of $2,000,000. Despite the shortfall from the estimated value of the collateral, based on available information, the Corporation believes the loan should be repaid in full due to the high reported value of the borrower’s net worth.