Edgar Filing: CITIZENS & NORTHERN CORP

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2009

	¨ 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: 000-16084

CITIZENS & NORTHERN CORPORATION

(Exact name of Registrant as specified in its charter)


	PENNSYLVANIA		23-2451943
	(State or other jurisdiction of		(I.R.S. Employer
	incorporation or organization)		Identification No.)

90-92 MAIN STREET, WELLSBORO, PA 16901

(Address of principal executive offices) (Zip code)

570-724-3411

(Registrant's telephone number including area code)

Indicate by check mark whether the registrant (1) has filed all reports required 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 x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes ¨ No ¨

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

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.

Common Stock ($1.00 par value)

9,235,611 Shares Outstanding on November 2, 2009

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

CITIZENS & NORTHERN CORPORATION

Index

Part I. Financial Information

Item 1. Financial Statements

Consolidated Balance Sheet – September 30, 2009 and December 31, 2008		Page 3
Consolidated Statement of Earnings - Three Months and Nine Months Ended September 30, 2009 and 2008		Page 4
Consolidated Statement of Cash Flows - Nine Months Ended September 30, 2009 and 2008		Page 5
Consolidated Statement of Changes in Stockholders’ Equity- Nine Months Ended September 30, 2009		Page 6
Notes to Consolidated Financial Statements		Pages 7 through 24

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations		Pages 25 through 44

Item 3. Quantitative and Qualitative Disclosures About Market Risk		Pages 44 through 47

Item 4. Controls and Procedures		Page 47

Part II. Other Information

Item 1. Legal Proceedings		Page 48

Item 1A.Risk Factors		Page 48

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		Page 48

Item 3. Defaults Upon Senior Securities		Page 48

Item 4. Submission of Matters to a Vote of Security Holders		Page 48

Item 5. Other Information		Page 48

Item 6. Exhibits		Page 49

Signatures		Page 49

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

PART I – FINANCIAL INFORMATION

Item 1.

Financial Statements

CONSOLIDATED BALANCE SHEET	September 30,			December 31,
(In Thousands Except Share Data)	2009			2008
	(Unaudited)			(Note)
ASSETS
Cash and due from banks:
Noninterest-bearing	$	16,184		$	18,105
Interest-bearing		31,783			5,923
Total cash and cash equivalents		47,967			24,028
Trading securities		0			2,306
Available-for-sale securities		399,112			419,688
Held-to-maturity securities		301			406
Loans, net		720,291			735,687
Bank-owned life insurance		22,681			22,297
Accrued interest receivable		5,727			5,846
Bank premises and equipment, net		24,784			25,909
Foreclosed assets held for sale		1,408			298
Deferred tax asset, net		31,107			16,389
Intangible asset - Core deposit intangibles		583			826
Intangible asset - Goodwill		11,942			12,014
Other assets		17,475			15,943
TOTAL ASSETS	$	1,283,378		$	1,281,637

LIABILITIES
Deposits:
Noninterest-bearing	$	129,476		$	124,922
Interest-bearing		767,390			739,135
Total deposits		896,866			864,057
Dividends payable		2,355			2,147
Short-term borrowings		33,053			48,547
Long-term borrowings		216,451			236,926
Accrued interest and other liabilities		8,600			7,934
TOTAL LIABILITIES		1,157,325			1,159,611

STOCKHOLDERS' EQUITY
Preferred stock, $1,000 par value; authorized 30,000 shares; $1,000 liquidation preference per share; 26,440 shares issued at September 30, 2009 and no shares issued at December 31, 2008		25,706			0
Common stock, par value $1.00 per share; authorized 20,000,000 shares in 2009 and 2008; issued 9,399,101 at September 30, 2009 and 9,284,148 at December 31, 2008		9,399			9,284
Paid-in capital		47,227			44,308
Retained earnings		48,781			97,757
Unamortized stock compensation		(61	)		(48	)
Treasury stock, at cost; 290,406 shares at September 30, 2009 and 348,041 shares at December 31, 2008		(5,056	)		(6,061	)
Sub-total		125,996			145,240
Accumulated other comprehensive income (loss):
Unrealized gains (losses) on available-for-sale securities (including an unrealized loss of $548 at September 30, 2009 for which a portion of an other-than-temporary impairment loss has been recognized in earnings)		403			(23,120	)
Defined benefit plans		(346	)		(94	)
Total accumulated other comprehensive income (loss)		57			(23,214	)
TOTAL STOCKHOLDERS' EQUITY		126,053			122,026
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY	$	1,283,378		$	1,281,637

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

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Note: The balance sheet at December 31, 2008 has been derived from the audited financial statements at that date but does not include all the information and notes required by U.S. generally accepted accounting principles for complete financial statements.

CONSOLIDATED STATEMENT OF EARNINGS	3 Months Ended						Fiscal Year To Date
(In Thousands, Except Per Share Data)	Sept. 30			Sept. 30,			9 Months Ended Sept. 30,
	2009			2008			2009			2008
	(Current)			(Prior Year)			(Current)			(Prior Year)
INTEREST INCOME
Interest and fees on loans	$	11,314		$	12,255		$	34,027		$	36,836
Interest on balances with depository institutions		24			9			28			27
Interest on loans to political subdivisions		436			406			1,244			1,116
Interest on federal funds sold		0			42			15			116
Interest on trading securities		2			19			33			62
Income from available-for-sale and held-to-maturity securities:
Taxable		3,726			4,815			12,648			14,574
Tax-exempt		1,186			828			3,246			2,267
Dividends		120			201			479			650
Total interest and dividend income		16,808			18,575			51,720			55,648
INTEREST EXPENSE
Interest on deposits		3,578			4,557			11,258			14,941
Interest on short-term borrowings		121			218			431			761
Interest on long-term borrowings		2,317			2,699			7,097			8,152
Total interest expense		6,016			7,474			18,786			23,854
Interest margin		10,792			11,101			32,934			31,794
Provision for loan losses		634			141			554			669
Interest margin after provision for loan losses		10,158			10,960			32,380			31,125

OTHER INCOME
Trust and financial management revenue		757			845			2,396			2,697
Service charges on deposit accounts		1,317			1,191			3,514			3,240
Service charges and fees		198			208			615			569
Insurance commissions, fees and premiums		69			77			226			246
Increase in cash surrender value of life insurance		107			190			384			580
Other operating income		834			551			1,967			2,372
Sub-total		3,282			3,062			9,102			9,704
Total other-than-temporary impairment losses on available-for-sale securities		(38,679	)		(4,747	)		(81,634	)		(6,167	)
Portion of (gain) recognized in other comprehensive loss (before taxes)		(9,268	)		0			(2,773	)		0
Net impairment losses recognized in earnings		(47,947	)		(4,747	)		(84,407	)		(6,167	)
Realized gains on available-for-sale securities, net		99			264			885			707
Net impairment losses recognized in earnings and realized gains on available-for-sale securities		(47,848	)		(4,483	)		(83,522	)		(5,460	)
Total other income		(44,566	)		(1,421	)		(74,420	)		4,244
OTHER EXPENSES
Salaries and wages		3,334			3,892			9,993			11,319
Pensions and other employee benefits		918			1,082			3,237			3,312
Occupancy expense, net		652			689			2,073			2,160
Furniture and equipment expense		690			692			2,066			1,982
FDIC assessments		393			114			1,651			161
Pennsylvania shares tax		318			292			954			876
Other operating expense		1,972			1,975			6,099			5,647
Total other expenses		8,277			8,736			26,073			25,457
(Loss) income before income tax (credit) provision		(42,685	)		803			(68,113	)		9,912
Income tax (credit) provision		(14,491	)		(209	)		(24,163	)		2,031
Net (loss) income		(28,194	)		1,012			(43,950	)		7,881
U.S Treasury preferred dividends		373			0			1,055			0
NET (LOSS) INCOME AVAILABLE TO COMMON SHAREHOLDERS	$	(28,567	)	$	1,012		$	(45,005	)	$	7,881

PER SHARE DATA:
Net (loss) income per average common share - basic	$	(3.17	)	$	0.11		$	(5.01	)	$	0.88
Net (loss) income per average common share - diluted	$	(3.17	)	$	0.11		$	(5.01	)	$	0.88

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

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Consolidated Statements of Cash Flows	9 Months Ended
(In Thousands)	Sept. 30,			Sept. 30,
	2009			2008
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income	$	(43,950	)		7,881
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Provision for loan losses		554			669
Realized losses on available-for-sale securities, net		83,522			5,460
Loss (gain) on sale of foreclosed assets, net		11			(46	)
Depreciation expense		2,159			2,174
Loss on disposition of premises and equipment		8			0
Accretion and amortization on securities, net		220			136
Accretion and amortization on loans, deposits and borrowings, net		(266	)		(314	)
Increase in cash surrender value of life insurance		(384	)		(580	)
Stock-based compensation		336			274
Amortization of core deposit intangibles		243			414
Deferred income taxes		(27,928	)		(1,159	)
Net decrease (increase) in trading securities		663			(1,722	)
Increase in accrued interest receivable and other assets		(1,521	)		(549	)
Increase in accrued interest payable and other liabilities		557			1,067
Net Cash Provided by Operating Activities		14,224			13,705
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturity of held-to-maturity securities		105			2
Proceeds from sales of available-for-sale securities		16,936			22,682
Proceeds from calls and maturities of available-for-sale securities		50,301			44,525
Purchase of available-for-sale securities		(89,633	)		(79,737	)
Purchase of Federal Home Loan Bank of Pittsburgh stock		(4	)		(2,629	)
Redemption of Federal Home Loan Bank of Pittsburgh stock		0			3,299
Net decrease (increase) in loans		13,493			(22,706	)
Purchase of premises and equipment		(1,042	)		(878	)
Return of principal on limited partnership investment		25			34
Proceeds from sale of foreclosed assets		336			374
Net Cash Used in Investing Activities		(9,483	)		(35,034	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits		32,789			18,045
Net (decrease) increase in short-term borrowings		(15,494	)		11,972
Proceeds from long-term borrowings		0			29,703
Repayments of long-term borrowings		(20,297	)		(39,592	)
Issuance of US Treasury preferred stock and warrant		26,409			0
Issuance of common stock		1,840			0
Purchase of treasury stock		0			(1,567	)
Sale of treasury stock		30			154
Tax benefit from compensation plans		143			0
US Treasury preferred dividends paid		(768	)		0
Common dividends paid		(5,454	)		(5,887	)
Net Cash Provided by Financing Activities		19,198			12,828
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		23,939			(8,501	)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR		24,028			31,661
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	47,967		$	23,160
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Assets acquired through foreclosure of real estate loans	$	1,457		$	382
Securities transferred from trading to available-for-sale	$	1,643		$	3,072
Interest paid	$	19,117		$	24,097
Income taxes paid	$	3,475		$	3,492

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

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Consolidated Statement of Changes
in Stockholders' Equity
(In Thousands Except Per Share Data)											Accumulated
											Other			Unamortized
	Preferred		Common		Paid-in			Retained			Comprehensive			Stock			Treasury
	Stock		Stock		Capital			Earnings			Income (Loss)			Compensation			Stock			Total
Balance, December 31, 2008	$	0	$	9,284	$	44,308		$	97,757		$	(23,214	)	$	(48	)	$	(6,061	)	$	122,026
Comprehensive (loss) income:
Net loss									(43,950	)											(43,950	)
Unrealized gain on securities, net of reclassification and tax												25,901									25,901
Change in value of FASB 158 adjustment to equity												(252	)								(252	)
Total comprehensive loss																					(18,301	)
Reclassify non-credit portion of other- than-temporary impairment losses recognized in prior period									2,378			(2,378	)								0
Issuance of U.S. Treasury preferred stock		25,588				821															26,409
Accretion of discount associated with U.S. Treasury preferred stock		118							(118	)											0
Cash dividends on U.S. Treasury preferred stock									(937	)											(937	)
Cash dividends declared on common stock, $.72 per share									(6,490	)											(6,490	)
Common shares issued				115		1,725															1,840
Common shares issued for dividend reinvestment plan						93												904			997
Common shares issued from treasury related to exercise of stock options						(4	)											34			30
Restricted stock granted						10									(79	)		69			0
Forfeiture of restricted stock						(1	)								3			(2	)		0
Stock-based compensation expense						273									63						336
Tax benefit from stock-based compensation						2															2
Tax benefit from employee benefit plan									141												141
Balance, September 30, 2009	$	25,706	$	9,399	$	47,227		$	48,781		$	57		$	(61	)	$	(5,056	)	$	126,053

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

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Notes to Consolidated Financial Statements

1. BASIS OF INTERIM PRESENTATION

The financial information included herein, with the exception of the consolidated balance sheet dated December 31, 2008, is unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations, cash flows and changes in stockholders’ equity for the interim periods. Certain 2008 information has been reclassified for consistency with the 2009 presentation.

Results reported for the three-month and nine-month periods ended September 30, 2009 might not be indicative of the results for the year ending December 31, 2009.

This document has not been reviewed or confirmed for accuracy or relevance by the Federal Deposit Insurance Corporation or any other regulatory agency.

2. CHANGES IN ACCOUNTING PRINCIPLES

The Financial Accounting Standards Board (“FASB”) issued an accounting pronouncement establishing the “FASB Accounting Standards Codification” (the “ASC”) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities. The pronouncement was effective for financial statements issued for interim and annual periods ending after September 15, 2009, for most entities. The Corporation adopted this new accounting pronouncement for the quarterly period ended September 30, 2009, as required, and adoption did not have any material impact on the Corporation’s consolidated financial statements.

As of January 1, 2009, the Corporation adopted the following new accounting pronouncements:

FASB Staff Position (FSP) FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” was subsequently incorporated into ASC topic 320, “Investments – Debt and Equity Securities.” The ASC amends other-than-temporary impairment (OTTI) accounting guidance for debt securities, requires new disclosures and changes the presentation and amount of OTTI recognized in the income statement. The ASC requires impairment of debt securities be separated into (a) the amount of the total impairment related to credit loss, which is recognized in the income statement, and (b) the amount of the total impairment related to all other factors, which is recognized in other comprehensive income. The total OTTI is presented in the income statement with an offset for the amount of total OTTI recognized in other comprehensive income. As required, the Corporation recognized the cumulative effect of adopting this ASC as an increase in retained earnings of $2,378,000, and a decrease in accumulated other comprehensive loss of the same amount, as of January 1, 2009. For the nine-month period ended September 30, 2009, the effect of adopting this ASC was to increase the amount of impairment losses recognized in earnings by $2,773,000, and decrease the income tax provision by $943,000, resulting in a reduction in net income (larger net loss) of $1,830,000, or $0.20 per average common share. For the three-month period ended September 30, 2009, the effect of adopting this ASC was to increase impairment losses recognized in earnings by $9,268,000, and reduce the income tax provision by $3,151,000, resulting in a reduction in net income (larger net loss) of $6,117,000, or $0.68 per average common share. Additional disclosures required by this ASC are provided in Note 6 to the Consolidated Financial Statements.

New guidance impacting FASB ASC topic 820, “Fair Value Measurements and Disclosures” was initially provided by FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” The ASC provides additional guidance for estimating fair value in accordance with FASB Statement No. 157, “Fair Value Measurements,” when the volume and level of activity for the asset or liability have significantly decreased. The ASC also includes guidance on identifying circumstances that indicate a transaction is not orderly. There were no changes in the Corporation’s valuation techniques or their application that resulted from adoption of this ASC. The ASC amends the disclosure requirements of FASB Statement No. 157 to require the Corporation to disclose in interim and annual periods the inputs and valuation techniques used to measure fair value and to discuss changes in valuation techniques and related inputs during the period. Further, the ASC requires presentation of information concerning securities in more detailed “major security types” than had been required in the past. Disclosures required by this ASC are provided in Notes 5 and 6 to the Consolidated Financial Statements.

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

FASB ASC 825-1050 guidance on “Financial Instruments” was adopted with FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Values of Financial Instruments,” and requires the Corporation to provide disclosures each quarter that had previously been required only on an annual basis, about the fair value of financial instruments. The required disclosures are provided in Note 8 to the Consolidated Financial Statements.

3. PER COMMON SHARE DATA

Basic net (loss) income per average common share represents income available to common shareholders divided by the weighted-average number of shares of common stock outstanding. As shown in the table that follows, diluted net income per common share for the three-month and nine-month periods ended September 30, 2008 was computed using weighted average common shares outstanding, plus weighted-average common shares available from the exercise of all dilutive stock options, less the number of common shares that could be repurchased with the proceeds of stock option exercises based on the average share price of the Corporation's common stock during the period. For the three-month and nine-month periods ended September 30, 2009, outstanding stock options and the warrant (issued in January 2009) are anti-dilutive, and are therefore excluded in determining diluted loss per common share.

				Weighted-			Net
	Net			Average			(Loss)
	(Loss)			Common			Income Per
	Income			Shares			Share
Nine Months Ended September 30, 2009

Earnings per common share – basic and diluted	$	(45,005,000	)		8,978,665		$	(5.01	)

Nine Months Ended September 30, 2008

Earnings per share – basic	$	7,881,000			8,965,230		$	0.88
Dilutive effect of potential common stock arising from stock options:

Exercise of outstanding stock options					145,729
Hypothetical share repurchase at $ 19.88					(125,748	)
Earnings per share – diluted	$	7,881,000			8,985,211		$	0.88

Quarter Ended September 30, 2009

Earnings per common share – basic and diluted	$	(28,567,000	)		9,005,850		$	(3.17	)

Quarter Ended September 30, 2008

Earnings per share – basic	$	1,012,000			8,957,774		$	0.11
Dilutive effect of potential common stock arising from stock options:

Exercise of outstanding stock options					174,332
Hypothetical share repurchase at $ 21.41					(145,853	)
Earnings per share – diluted	$	1,012,000			8,986,253		$	0.11

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

4. COMPREHENSIVE (LOSS) INCOME

Comprehensive (loss) income is the total of (1) net (loss) income, and (2) all other changes in equity from non-stockholder sources, which are referred to as other comprehensive income. The components of comprehensive (loss) income, and the related tax effects, are as follows:

(In Thousands)	3 Months Ended						9 Months Ended
	Sept. 30,						Sept. 30,
	2009			2008			2009			2008
Net (loss) income	$	(28,194	)	$	1,012		$	(43,950	)	$	7,881

Unrealized gains (losses) on available-for-sale securities:
Unrealized holding losses on available-for-sale securities		(20,631	)		(15,623	)		(44,278	)		(30,452	)
Reclassification adjustment for losses realized in income		47,848			4,483			83,522			5,460
Other comprehensive gain (loss) before income tax		27,217			(11,140	)		39,244			(24,992	)
Income tax related to other comprehensive gain (loss)		9,254			(3,787	)		13,343			(8,497	)
Other comprehensive gain (loss) on available-for-sale securities		17,963			(7,353	)		25,901			(16,495	)

Unfunded pension and postretirement obligations:

Change in items from defined benefit plans included in accumulated other comprehensive loss		0			0			(462	)		0
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost		14			444			80			455
Other comprehensive gain (loss) before income tax		14			444			(382	)		455
Income tax related to other comprehensive gain (loss)		5			163			(130	)		165
Other comprehensive gain (loss) on unfunded retirement obligations		9			281			(252	)		290

Net other comprehensive income (loss)		17,972			(7,072	)		25,649			(16,205	)

Total comprehensive loss	$	(10,222	)	$	(6,060	)	$	(18,301	)	$	(8,324	)

In the nine-month period ended September 30, 2009, the Corporation recognized other comprehensive income of $2,773,000 before income tax, or $1,830,000 after income tax, related to available-for-sale debt securities for which a portion of an OTTI loss has been recognized in earnings. In the third quarter 2009, the Corporation recognized other comprehensive income of $9,268,000 before income tax, or $6,117,000 after income tax, related to available-for-sale debt securities for which a portion of an OTTI loss has been recognized in earnings.

5. ASSETS MEASURED AT FAIR VALUE ON A RECURRING BASIS

The Corporation measures certain assets at fair value on a recurring basis. Fair value is defined as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date. FASB ASC topic 820, “Fair Value Measurements and Disclosures” (formerly Statement of Financial Accounting Standards No. 157) establishes a framework for measuring fair value that includes a hierarchy used to classify the inputs used in measuring fair value. The hierarchy prioritizes the inputs used in determining valuations into three levels. The level in the fair value hierarchy within which the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement. The levels of the fair value hierarchy are as follows:

Level 1 – Fair value is based on unadjusted quoted prices in active markets that are accessible to the Corporation for identical assets. These generally provide the most reliable evidence and are used to measure fair value whenever available.

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Level 2 – Fair value is based on significant inputs, other than Level 1 inputs, that are observable either directly or indirectly for substantially the full term of the asset through corroboration with observable market data. Level 2 inputs include quoted market prices in active markets for similar assets, quoted market prices in markets that are not active for identical or similar assets and other observable inputs.

Level 3 – Fair value is based on significant unobservable inputs. Examples of valuation methodologies that would result in Level 3 classification include option pricing models, discounted cash flows and other similar techniques.

At September 30, 2009, assets measured at fair value on a recurring basis and the valuation methods used are as follows:

			September 30, 2009
			Market Values Based on:
	Quoted Prices		Other
	in Active		Observable		Unobservable		Total
	Markets		Inputs		Inputs		Fair
(In Thousands)	(Level 1)		(Level 2)		(Level 3)		Value

AVAILABLE-FOR-SALE SECURITIES:
Obligations of other U.S. Government agencies	$	2,386	$	30,752	$	0	$	33,138
Obligations of states and political subdivisions		3,214		104,172		0		107,386
Mortgage-backed securities		0		162,386		0		162,386
Collateralized mortgage obligations:
Issued by U.S. Government agencies		196		33,680		0		33,876
Private label		13,629		20,385		0		34,014
Corporate bonds		0		1,044		0		1,044
Trust preferred securities issued by individual institutions		0		4,831		0		4,831
Collateralized debt obligations:
Pooled trust preferred securities - senior tranches		0		0		8,370		8,370
Pooled trust preferred securities - mezzanine tranches		0		0		759		759
Other collateralized debt obligations		0		704		0		704
Total debt securities		19,425		357,954		9,129		386,508
Marketable equity securities		12,604		0		0		12,604
Total available-for-sale securities	$	32,029	$	357,954	$	9,129	$	399,112

Management determined there were virtually no trades of pooled trust-preferred securities in the second half of 2008 or the first nine months of 2009, except for a limited number of transactions that took place as a result of bankruptcies, forced liquidations or similar circumstances. Also, in management’s judgment, there were no available quoted market prices in active markets for assets sufficiently similar to the Corporation’s pooled trust-preferred securities to be reliable as observable inputs. Accordingly, in the third quarter of 2008, the Corporation changed its method of valuing pooled trust-preferred securities from a Level 2 methodology that had been used in prior periods, based on price quotes received from pricing services, to a Level 3 methodology, using discounted cash flows.

At September 30, 2009, management calculated the fair values of pooled trust-preferred securities by applying discount rates to estimated cash flows for each security. Management used the cash flow estimates for each security determined using the process described in Note 6. At September 30, 2009, management made significant changes in assumptions regarding future deferrals and defaults in comparison to assumptions used in the previous four quarters’ analyses. These changes had the effect of increasing estimated future defaults, which resulted in lower levels of future cash flows expected to be received, as compared to estimated future cash flows to be received based on the assumptions used in previous quarters. The Corporation’s process for evaluating pooled trust-preferred securities for OTTI is described in more detail in Note 6. Management used discount rates considered reflective of a market participant’s expectations regarding the extent of credit and liquidity risk inherent in the securities. In establishing the discount rates, management considered: (1) the implied discount rates as of the end of 2007, prior to the market for trust-preferred securities becoming inactive; (2) adjustment to the year-end 2007 discount rates for the change in the spread between indicative market rates (3-month LIBOR, for most of the Corporation’s securities) over corresponding risk-free rates (3-month U.S. Treasury Bill, for most of the Corporation’s securities) in 2009; and (3) an additional adjustment – an increase of 2% in the discount rate – for liquidity risk. Management considered the additional 2% increase in the discount rate necessary in order to give some consideration to price estimates based on trades made under distressed conditions, as reported by brokers and pricing services. Management’s estimates of cash flows and discount rates used to calculate fair values of pooled trust-preferred securities were based on sensitive assumptions, and market participants might use substantially different assumptions, which could result in calculations of fair values that would be substantially different than the amounts calculated by management.

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Following is a reconciliation of activity for assets (pooled trust-preferred securities) measured at fair value based on significant unobservable information:

	3 Months Ended						Fiscal Year To Date
	Sept. 30,			Sept. 30,			9 Months Ended Sept. 30,
	2009			2008			2009			2008
	(Current)			(Prior Year)			(Current)			(Prior Year)
Balance, beginning of period	$	37,470		$	0		$	58,914		$	0
Transfers		0			73,018			0			73,018
Purchases, issuances and settlements		34			13			75			13
Realized losses		0			0			(335	)		0
Unrealized losses included in earnings		(42,495	)		(4,289	)		(72,776	)		(4,289	)
Unrealized gains (losses) included in other comprehensive income		14,120			(5,498	)		23,251			(5,498	)
Balance, end of period	$	9,129		$	63,244		$	9,129		$	63,244

Unrealized losses included in earnings are from the Corporation’s other-than-temporary impairment analysis of securities, as described in Note 6, and are included in net impairment losses recognized in earnings in the consolidated statement of earnings.

6. SECURITIES

The Corporation held no trading assets at September 30, 2009. The Corporation’s trading assets during the first nine months of 2009 and at December 31, 2008 were composed exclusively of municipal bonds. Gains and losses from trading activities are included in other operating income in the consolidated statement of earnings as follows (in thousands):

	3 Months Ended						Fiscal Year To Date
	Sept. 30,			Sept. 30,			9 Months Ended Sept. 30,
	2009			2008			2009			2008
	(Current)			(Prior Year)			(Current)			(Prior Year)
Gross realized gains	$	20		$	20		$	61		$	60
Gross realized losses		0			0			(104	)		(63	)
Net change in unrealized gains/(losses)		(2	)		(140	)		64			(141	)
Net gains (losses)	$	18		$	(120	)	$	21		$	(144	)
Income taxes related to net gains/(losses)	$	6		$	(41	)	$	7		$	(49	)

Amortized cost and fair value of available-for-sale and held-to-maturity securities at September 30, 2009 and December 31, 2008 are summarized as follows:

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

			September 30, 2009
			Gross		Gross
			Unrealized		Unrealized
	Amortized		Holding		Holding			Fair
(In Thousands)	Cost		Gains		Losses			Value

AVAILABLE-FOR-SALE SECURITIES:
Obligations of other U.S. Government agencies	$	32,777	$	362	$	(1	)	$	33,138
Obligations of states and political subdivisions		108,590		2,722		(3,926	)		107,386
Mortgage-backed securities		156,342		6,045		(1	)		162,386
Collateralized mortgage obligations:
Issued by U.S. Government agencies		33,086		842		(52	)		33,876
Private label		34,252		3		(241	)		34,014
Corporate bonds		1,000		44		0			1,044
Trust preferred securities issued by individual institutions		7,062		0		(2,231	)		4,831
Collateralized debt obligations:
Pooled trust preferred securities - senior tranches		11,742		0		(3,372	)		8,370
Pooled trust preferred securities - mezzanine tranches		1,589		0		(830	)		759
Other collateralized debt obligations		704		0		0			704
Total debt securities		387,144		10,018		(10,654	)		386,508
Marketable equity securities		11,335		1,871		(602	)		12,604
Total	$	398,479	$	11,889	$	(11,256	)	$	399,112

HELD-TO-MATURITY SECURITIES,
Obligations of the U.S. Treasury	$	301	$	6	$	0		$	307

			December 31, 2008
			Gross		Gross
			Unrealized		Unrealized
	Amortized		Holding		Holding			Fair
(In Thousands)	Cost		Gains		Losses			Value

AVAILABLE-FOR-SALE SECURITIES:
Obligations of other U.S. Government agencies	$	15,500	$	701	$	0		$	16,201
Obligations of states and political subdivisions		80,838		197		(6,812	)		74,223
Mortgage-backed securities		171,453		2,632		(229	)		173,856
Collateralized mortgage obligations:
Issued by U.S. Government agencies		24,082		181		(1	)		24,262
Private label		46,537		6		(2,571	)		43,972
Corporate bonds		1,000		117		0			1,117
Trust preferred securities issued by individual institutions		10,436		0		(2,835	)		7,601
Collateralized debt obligations:
Pooled trust preferred securities - senior tranches		11,938		0		(3,296	)		8,642
Pooled trust preferred securities - mezzanine tranches		70,826		0		(20,554	)		50,272
Other collateralized debt obligations		692		0		0			692
Total debt securities		433,302		3,834		(36,298	)		400,838
Marketable equity securities		21,405		1,918		(4,473	)		18,850
Total	$	454,707	$	5,752	$	(40,771	)	$	419,688
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury	$	304	$	16	$	0		$	320
Obligations of other U.S. Government agencies		100		4		0			104
Mortgage-backed securities		2		0		0			2
Total	$	406	$	20	$	0		$	426

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

The following table presents gross unrealized losses and fair value of available-for-sale investments aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2009 and December 31, 2008.

September 30, 2009

Less Than 12 Months

12 Months or More

Total

(In Thousands)

Fair

Unrealized

Fair

Unrealized

Fair

Unrealized