Edgar Filing: CITIZENS & NORTHERN CORP

Unassociated Document

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 June 30, 2010

¨ 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, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨

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)

12,129,707 Shares Outstanding on August 4, 2010

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

CITIZENS & NORTHERN CORPORATION
Index

Part I. Financial Information

Item 1. Financial Statements

Consolidated Balance Sheet – June 30, 2010 and December 31, 2009		Page 3

Consolidated Statement of Operations - Three Months and Six Months Ended June 30, 2010 and 2009		Page 4

Consolidated Statement of Cash Flows - Six Months Ended June 30, 2010 and 2009		Page 5

Consolidated Statement of Changes in Stockholders’ Equity- Six Months Ended June 30, 2010 and 2009		Page 6

Notes to Consolidated Financial Statements		Pages 7 - 22

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations		Pages 23 - 41

Item 3. Quantitative and Qualitative Disclosures About Market Risk		Pages 41 - 44

Item 4. Controls and Procedures		Page 44

Part II. Other Information		Pages 45 - 47

Signatures		Page 48

Exhibit 10.1 Restricted Stock Agreement dated March 5, 2010 between the Corporation and Charles H. Updegraff, Jr.		Pages 49 - 51

Exhibit 31.1. Rule 13a-14(a)/15d-14(a) Certification - Chief Executive Officer		Page 52

Exhibit 31.2. Rule 13a-14(a)/15d-14(a) Certification - Chief Financial Officer		Page 53

Exhibit 32. Section 1350 Certifications		Page 54

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheet	June 30,	December 31,
(In Thousands Except Share Data)	2010	2009
	(Unaudited)	(Note)
ASSETS
Cash and due from banks:
Noninterest-bearing	$15,807	$18,247
Interest-bearing	67,845	73,818
Total cash and cash equivalents	83,652	92,065
Trading securities	0	1,045
Available-for-sale securities	426,246	396,288
Held-to-maturity securities	0	300
Loans, net of allowance for loan losses of $8,461,000 at June 30, 2010
and $8,265,000 at December 31, 2009	715,363	713,338
Bank-owned life insurance	23,029	22,798
Accrued interest receivable	5,229	5,613
Bank premises and equipment, net	23,401	24,316
Foreclosed assets held for sale	863	873
Deferred tax asset, net	20,390	22,037
Intangible asset - Core deposit intangibles	414	502
Intangible asset – Goodwill	11,942	11,942
Other assets	28,128	30,678
TOTAL ASSETS	$1,338,657	$1,321,795

LIABILITIES
Deposits:
Noninterest-bearing	$151,748	$137,470
Interest-bearing	816,792	789,319
Total deposits	968,540	926,789
Dividends payable	169	169
Short-term borrowings	28,132	39,229
Long-term borrowings	173,831	196,242
Accrued interest and other liabilities	6,490	6,956
TOTAL LIABILITIES	1,177,162	1,169,385

STOCKHOLDERS' EQUITY
Preferred stock, $1,000 par value; authorized 30,000 shares; $1,000 liquidation
preference per share; 26,440 shares issued at June 30, 2010 and
December 31, 2009	25,833	25,749
Common stock, par value $1.00 per share; authorized 20,000,000 shares in 2010 and
2009; issued 12,384,285 at June 30, 2010 and 12,374,481 at December 31, 2009	12,384	12,374
Paid-in capital	66,888	66,833
Retained earnings	59,546	53,027
Unamortized stock compensation	(158)	(107)
Treasury stock, at cost; 254,578 shares at June 30, 2010
and 262,780 shares at December 31, 2009	(4,431)	(4,575)
Sub-total	160,062	153,301
Accumulated other comprehensive income (loss):
Unrealized gains (losses) on available-for-sale securities	1,684	(522)
Defined benefit plans	(251)	(369)
Total accumulated other comprehensive income (loss)	1,433	(891)
TOTAL STOCKHOLDERS' EQUITY	161,495	152,410
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY	$1,338,657	$1,321,795

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

Note: The balance sheet at December 31, 2009 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.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

CONSOLIDATED STATEMENT OF OPERATIONS	Three Months Ended		Fiscal Year To Date
(In Thousands, Except Per Share Data)	June 30,	June 30,	Six Months Ended June 30,
	2010	2009	2010	2009
INTEREST INCOME	(Current)	(Prior Year)	(Current)	(Prior Year)
Interest and fees on loans	$11,009	$11,356	$21,959	$22,713
Interest on balances with depository institutions	38	3	76	4
Interest on loans to political subdivisions	399	415	797	808
Interest on federal funds sold	0	7	0	15
Interest on trading securities	0	8	1	31
Income from available-for-sale and held-to-maturity securities:
Taxable	2,699	4,268	5,784	8,922
Tax-exempt	1,184	1,124	2,365	2,060
Dividends	57	160	137	359
Total interest and dividend income	15,386	17,341	31,119	34,912
INTEREST EXPENSE
Interest on deposits	3,058	3,699	6,215	7,680
Interest on short-term borrowings	51	140	151	310
Interest on long-term borrowings	1,927	2,325	3,930	4,780
Total interest expense	5,036	6,164	10,296	12,770
Net interest income	10,350	11,177	20,823	22,142
Provision (credit) for loan losses	76	93	283	(80)
Net interest income after provision (credit) for loan losses	10,274	11,084	20,540	22,222

OTHER INCOME
Trust and financial management revenue	830	870	1,729	1,639
Service charges on deposit accounts	1,190	1,150	2,283	2,197
Service charges and fees	210	227	403	417
Insurance commissions, fees and premiums	61	76	121	157
Increase in cash surrender value of life insurance	119	126	231	277
Other operating income	776	605	1,864	1,133
Sub-total	3,186	3,054	6,631	5,820
Total other-than-temporary impairment losses on available-for-sale securities	0	(17,974)	(381)	(42,955)
Portion of (gain) loss recognized in other comprehensive loss (before taxes)	(2)	(1,806)	(52)	6,495
Net impairment losses recognized in earnings	(2)	(19,780)	(433)	(36,460)
Realized gains on available-for-sale securities, net	321	785	810	786
Net impairment losses recognized in earnings and realized
gains on available-for-sale securities	319	(18,995)	377	(35,674)
Total other income	3,505	(15,941)	7,008	(29,854)
OTHER EXPENSES
Salaries and wages	3,199	3,318	6,277	6,659
Pensions and other employee benefits	983	1,075	1,922	2,319
Occupancy expense, net	651	679	1,350	1,421
FDIC assessments	415	956	819	1,258
Furniture and equipment expense	542	702	1,110	1,376
Pennsylvania shares tax	306	318	611	636
Other operating expense	1,533	2,110	3,434	4,127
Total other expenses	7,629	9,158	15,523	17,796
Income (loss) before income tax provision	6,150	(14,015)	12,025	(25,428)
Income tax provision	1,281	(5,284)	2,718	(9,672)
Net income (loss)	4,869	(8,731)	9,307	(15,756)
U.S Treasury preferred dividends	372	373	745	682
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS	$4,497	($9,104)	$8,562	($16,438)

PER SHARE DATA:
Net income (loss) per average common share - basic	$0.37	($1.01)	$0.71	($1.83)
Net income (loss) per average common share - diluted	$0.37	($1.01)	$0.71	($1.83)

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

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

CONSOLIDATED STATEMENT OF CASH FLOWS
(In Thousands) (Unaudited)	Six Months Ended June 30,
	2010	2009
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$9,307	($15,756)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Provision (credit) for loan losses	283	(80)
Realized (gains) losses on available-for-sale securities, net	(377)	35,674
Loss on sale of foreclosed assets, net	36	10
Depreciation expense	1,209	1,433
(Gain) loss on disposition of premises and equipment	(449)	8
Accretion and amortization on securities, net	1,273	20
Accretion and amortization on loans, deposits and borrowings, net	(126)	(176)
Increase in cash surrender value of life insurance	(231)	(277)
Stock-based compensation	32	314
Amortization of core deposit intangibles	88	161
Deferred income taxes	440	(7,856)
Origination of mortgage loans for sale	(12,830)	(6,669)
Proceeds from sales of mortgage loans	13,310	5,688
Net decrease in trading securities	1,045	116
Decrease (increase) in accrued interest receivable and other assets	3,371	(6,422)
Decrease in accrued interest payable and other liabilities	(253)	(245)
Net Cash Provided by Operating Activities	16,128	5,943
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturity of held-to-maturity securities	300	4
Proceeds from sales of available-for-sale securities	45,522	14,452
Proceeds from calls and maturities of available-for-sale securities	85,954	31,779
Purchase of available-for-sale securities	(159,082)	(61,178)
Purchase of Federal Home Loan Bank of Pittsburgh stock	0	(4)
Net (increase) decrease in loans	(3,202)	16,519
Purchase of premises and equipment	(335)	(650)
Return of principal on limited liability entity investments	23	26
Proceeds from disposition of premises and equipment	100	0
Proceeds from sale of foreclosed assets	408	320
Net Cash (Used in) Provided by Investing Activities	(30,312)	1,268
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits	41,746	21,874
Net (decrease) in short-term borrowings	(11,097)	(9,157)
Repayments of long-term borrowings	(22,300)	(15,151)
Issuance of US Treasury preferred stock and warrant	0	26,409
Sale of treasury stock	0	30
Tax benefit from compensation plans	18	92
US Treasury preferred dividends paid	(662)	(427)
Common dividends paid	(1,934)	(3,630)
Net Cash Provided by Financing Activities	5,771	20,040
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS	(8,413)	27,251
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR	92,065	24,028
CASH AND CASH EQUIVALENTS, END OF PERIOD	$83,652	$51,279

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Assets acquired through foreclosure of real estate loans	$434	$954
Interest paid	$10,566	$13,049
Income taxes paid	$176	$1,275

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

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Consolidated Statement of Changes in Stockholders' Equity
Six Months Ended June 30, 2010 and 2009
(In Thousands Except Per Share Data)					Accum. Other	Unamortized
(Unaudited)	Preferred	Common	Paid-in	Retained	Comprehensive	Stock	Treasury
	Stock	Stock	Capital	Earnings	Income (Loss)	Compensation	Stock	Total
Six Months Ended June 30, 2010:
Balance, January 1, 2010	$25,749	$12,374	$66,833	$53,027	($891)	($107)	($4,575)	$152,410
Comprehensive income:
Net income				9,307				9,307
Unrealized gain on securities, net
of reclassification and tax					2,206			2,206
Other comprehensive income related
to defined benefit plans					118			118
Total comprehensive income								11,631
Accretion of discount associated with
U.S. Treasury preferred stock	84			(84)				0
Cash dividends - U.S. Treasury preferred				(661)				(661)
Cash dividends declared on common
stock, $.17 per share				(2,061)				(2,061)
Common shares issued for dividend
reinvestment plan		10	116					126
Restricted stock granted			(59)			(100)	159	0
Forfeiture of restricted stock			(2)			17	(15)	0
Stock-based compensation expense						32		32
Tax benefit from employee benefit plan				18				18
Balance, June 30, 2010	$25,833	$12,384	$66,888	$59,546	$1,433	($158)	($4,431)	$161,495
Six Months Ended June 30, 2009:
Balance, January 1, 2009	$0	$9,284	$44,308	$97,757	($23,214)	($48)	($6,061)	$122,026
Comprehensive (loss) income:
Net loss				(15,756)				(15,756)
Unrealized gain on securities, net
of reclassification and tax					7,938			7,938
Other comprehensive loss related
to defined benefit plans					(261)			(261)
Total comprehensive loss								(8,079)
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	25,588		821					26,409
Accretion of discount associated with
U.S. Treasury preferred stock	76			(76)				0
Cash dividends - U.S. Treasury preferred				(606)				(606)
Cash dividends declared on common
stock, $.48 per share				(4,303)				(4,303)
Shares issued for dividend
reinvestment plan			46				629	675
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			41		314
Tax benefit from employee benefit plan				92				92
Balance, June 30, 2009	$25,664	$9,284	$45,453	$79,486	($17,915)	($83)	($5,331)	$136,558

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

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Notes to Consolidated Financial Statements

1. BASIS OF INTERIM PRESENTATION

The consolidated financial information included herein, with the exception of the consolidated balance sheet dated December 31, 2009, is unaudited. 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; however, the information does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for complete financial statements. Certain 2009 information has been reclassified for consistency with the 2010 presentation.

Operating results reported for the three- and six-months ended June 30, 2010 might not be indicative of the results for the year ending December 31, 2010. The Corporation evaluates subsequent events through the date of filing with the Securities and Exchange Commission.

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

2. PER COMMON SHARE DATA

Basic net income (loss) per average common share represents income (loss) available to common shareholders divided by the weighted-average number of shares of common stock outstanding. For all periods presented, all outstanding stock options and the warrant (issued in January 2009) are anti-dilutive, and are therefore excluded in determining diluted income (loss) per common share.

	Net Income
	(Loss)	Weighted-	Earnings
	Available	Average	(Loss)
	to Common	Common	Per
	Shareholders	Shares	Share
Six Months Ended June 30, 2010
Earnings per common share – basic and diluted	$ 8,562,000	12,119,358	$0.71

Six Months Ended June 30, 2009
Earnings per common share – basic and diluted	$ (16,438,000)	8,964,850	($1.83)

Quarter Ended June 30, 2010
Earnings per common share – basic and diluted	$ 4,497,000	12,125,072	$0.37

Quarter Ended June 30, 2009
Earnings per common share – basic and diluted	$ (9,104,000)	8,973,531	($1.01)

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

3. COMPREHENSIVE INCOME (LOSS)

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

(In Thousands)	3 Months Ended		6 Months Ended
	June 30,		June 30,
	2010	2009	2010	2009
Net income (loss)	$4,869	($8,731)	$9,307	($15,756)

Unrealized gains (losses) on available-for-sale securities:
Unrealized holding gains (losses) on available-for-sale securities	3,966	(9,517)	3,724	(23,647)
Reclassification adjustment for (gains) losses realized in income	(319)	18,995	(377)	35,674
Other comprehensive gain before income tax	3,647	9,478	3,347	12,027
Income tax related to other comprehensive gain	1,245	3,222	1,141	4,089
Other comprehensive gain on available-for-sale securities	2,402	6,256	2,206	7,938

Unfunded pension and postretirement obligations:
Change in items from defined benefit plans included in
accumulated other comprehensive income (loss)	(14)	(209)	152	(462)
Amortization of net transition obligation, prior service cost and net
actuarial loss included in net periodic benefit cost	13	54	27	66
Other comprehensive (loss) gain before income tax	(1)	(155)	179	(396)
Income tax related to other comprehensive (loss) gain	0	(53)	61	(135)
Other comprehensive (loss) gain on unfunded retirement obligations	(1)	(102)	118	(261)

Net other comprehensive gain	2,401	6,154	2,324	7,677

Total comprehensive income (loss)	$7,270	($2,577)	$11,631	($8,079)

The Corporation recognized other comprehensive income of $52,000 before income tax ($34,000 after income tax) related to available-for-sale debt securities for which a portion of an other-than-temporary impairment (OTTI) loss has been recognized in earnings in the six months ended June 30, 2010, including other comprehensive income of $2,000 before income tax ($1,000 after income tax) in the second quarter 2010. In the six-month period ended June 30, 2009, the Corporation recognized other comprehensive loss of $6,495,000 before income tax ($4,287,000 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 second quarter 2009, the Corporation recognized other comprehensive income of $1,806,000 before income tax, or $1,192,000 after income tax, related to available-for-sale securities for which a portion of an OTTI loss has been recognized in earnings.

The components of accumulated other comprehensive income (loss), included in stockholders’ equity, are as follows:

	June 30,	Dec. 31,
	2010	2009
Net unrealized gain (loss) on available-for-sale securities	$2,580	($767)
Tax effect	(896)	245
Net-of-tax amount	1,684	(522)

Unrealized loss on defined benefit plans	(380)	(559)
Tax effect	129	190
Net-of-tax amount	(251)	(369)

Total accumulated other comprehensive income (loss)	$1,433	($891)

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

4. FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS

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.

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 June 30, 2010 and December 31, 2009, assets measured at fair value on a recurring basis and the valuation methods used are as follows:

		June 30, 2010
		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	$5,031	$51,495	$0	$56,526
Obligations of states and political subdivisions	1,193	108,619	0	109,812
Mortgage-backed securities	0	145,782	0	145,782
Collateralized mortgage obligations,
Issued by U.S. Government agencies	19,681	73,646	0	93,327
Corporate bonds	0	1,036	0	1,036
Trust preferred securities issued by individual institutions	0	5,543	240	5,783
Collateralized debt obligations:
Pooled trust preferred securities - senior tranches	0	0	8,000	8,000
Other collateralized debt obligations	0	690	0	690
Total debt securities	25,905	386,811	8,240	420,956
Marketable equity securities	5,290	0	0	5,290
Total available-for-sale securities	$31,195	$386,811	$8,240	$426,246

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

		December 31, 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	$13,512	$35,481	$0	$48,993
Obligations of states and political subdivisions	0	104,990	0	104,990
Mortgage-backed securities	5,212	151,166	0	156,378
Collateralized mortgage obligations:
Issued by U.S. Government agencies	5,095	42,613	0	47,708
Private label	0	15,494	0	15,494
Corporate bonds	0	1,041	0	1,041
Trust preferred securities issued by individual institutions	0	5,218	800	6,018
Collateralized debt obligations:
Pooled trust preferred securities - senior tranches	0	0	8,199	8,199
Pooled trust preferred securities - mezzanine tranches	0	0	115	115
Other collateralized debt obligations	0	690	0	690
Total debt securities	23,819	356,693	9,114	389,626
Marketable equity securities	6,662	0	0	6,662
Total available-for-sale securities	30,481	356,693	9,114	396,288

TRADING SECURITIES,
Obligations of states and political subdivisions	0	1,045	0	1,045

Total	$30,481	$357,738	$9,114	$397,333

Management determined there have been few trades of pooled trust-preferred securities since the first half of 2008, except for a limited number of transactions that have taken 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 June 30, 2010, management calculated the fair value of the Corporation’s senior tranche pooled trust-preferred security by applying a discount rate to the estimated cash flows. Management used the cash flow estimates determined using the process described in Note 5 for evaluating pooled trust-preferred securities for other-than-temporary impairment (OTTI). Management used a discount rate considered reflective of a market participant’s expectations regarding the extent of credit and liquidity risk inherent in the security. In establishing the discount rate, management considered: (1) the implied discount rate as of the end of 2007, prior to the market for trust-preferred securities becoming inactive; (2) adjustment to the year-end 2007 discount rate for the change in the spread between indicative market rates over corresponding risk-free rates in 2010; 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 estimate of cash flows and the discount rate used to calculate the fair value of the pooled trust-preferred security were based on sensitive assumptions, and market participants might use substantially different assumptions, which could result in calculations of a fair value that would be substantially different than the amount calculated by management.

In the fourth quarter 2009, the Corporation transferred a trust preferred security issued by a financial institution (The South Financial Group, Inc.) to Level 3 from Level 2. This security was transferred to Level 3 because management had been trying to sell the security since October 2009, but had not been able to obtain a bid from a potential buyer nor otherwise been able to find a price quote. In April 2010, management received an offer to purchase a portion of the Corporation’s holding and sold a portion of the security held. The Corporation received total proceeds of $240,000. Management has valued the remaining portion of the security at June 30, 2010 based on the price from the April 2010 sale.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Following is a reconciliation of activity for available-for-sale securities measured at fair value based on significant unobservable information:

	3 Months Ended		Fiscal Year To Date
	June 30,	June 30,	6 Months Ended June 30,
	2010	2009	2010	2009
	(Current)	(Prior Year)	(Current)	(Prior Year)
Balance, beginning of period	$8,552	$49,833	$9,114	$58,914
Transfers	0	0	0	0
Purchases, issuances and settlements	(321)	(72)	(499)	41
Proceeds from sales	(240)	0	(240)	0
Realized losses, net	0	0	0	(335)
Unrealized losses included in earnings	(2)	(19,176)	(423)	(30,281)
Unrealized gains (losses) included in other
comprehensive income	251	6,885	288	9,131
Balance, end of period	$8,240	$37,470	$8,240	$37,470

Unrealized losses included in earnings are from the Corporation’s other-than-temporary impairment analysis of securities, as described in Note 5, and are included in net impairment losses recognized in earnings in the consolidated statement of operations.

Assets measured at fair value on a nonrecurring basis include impaired commercial loans and foreclosed real estate assets held for sale. All of the Corporation’s impaired commercial loans for which a valuation allowance was necessary at June 30, 2010 and December 31, 2009 were valued based on the estimated amount of net proceeds from liquidation of real estate and other collateral, or based on the estimated present value of cash flows to be received. The Corporation considers the fair value of such impaired commercial loans to be based on unobservable inputs (Level 3), and the balance of impaired loans for which a valuation allowance was recorded, net of allowance for loan losses, was $1,488,000 at June 30, 2010 and $1,564,000 at December 31, 2009. Similarly, the carrying values of foreclosed real estate assets held for sale were based on unobservable inputs (Level 3), with a balance of $863,000 at June 30, 2010 and $873,000 at December 31, 2009.

Certain of the Corporation’s financial instruments are not measured at fair value in the consolidated financial statements. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from disclosure requirements. Therefore, the aggregate fair value amounts presented may not represent the underlying fair value of the Corporation.

The Corporation used the following methods and assumptions in estimating fair value disclosures for financial instruments:

CASH AND CASH EQUIVALENTS - The carrying amounts of cash and short-term instruments approximate fair values.

SECURITIES - Fair values for securities, excluding restricted equity securities, are based on quoted market prices or other methods as described above. The carrying value of restricted equity securities approximates fair value based on applicable redemption provisions.

LOANS - Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, commercial real estate, residential mortgage and other consumer. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories. The fair value of performing loans is calculated by discounting contractual cash flows, adjusted for estimated prepayments based on historical experience, using estimated market discount rates that reflect the credit and interest rate risk inherent in the loans. Fair value of nonperforming loans is based on recent appraisals or estimates prepared by the Corporation’s lending officers.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

DEPOSITS - The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, money market and interest checking accounts, is (by definition) equal to the amount payable on demand at June 30, 2010 and December 31, 2009. The fair value of all other deposit categories is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value estimates of deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market, commonly referred to as the core deposit intangible.

BORROWED FUNDS - The fair value of borrowings is estimated using discounted cash flow analyses based on rates currently available to the Corporation for similar types of borrowing arrangements.

ACCRUED INTEREST - The carrying amounts of accrued interest receivable and payable approximate fair values.

The estimated fair values, and related carrying amounts, of the Corporation’s financial instruments are as follows:

(In Thousands)	June 30, 2010		December 31, 2009
	Carrying	Fair	Carrying	Fair
	Amount	Value	Amount	Value
Financial assets:
Cash and cash equivalents	$83,652	$83,652	$92,065	$92,065
Trading securities	0	0	1,045	1,045
Available-for-sale securities	426,246	426,246	396,288	396,288
Held-to-maturity securities	0	0	300	302
Restricted equity securities	8,965	8,965	8,970	8,970
Loans, net	715,363	720,453	713,338	719,689
Accrued interest receivable	5,229	5,229	5,613	5,613

Financial liabilities:
Deposits	968,540	976,258	926,789	935,380
Short-term borrowings	28,132	27,702	39,229	38,970
Long-term borrowings	173,831	194,297	196,242	218,767
Accrued interest payable	521	521	681	681

5. SECURITIES

Amortized cost and fair value of available-for-sale and held-to-maturity securities at June 30, 2010 and December 31, 2009 are summarized as follows:

		June 30, 2010
		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	$56,137	$389	$0	$56,526
Obligations of states and political subdivisions	112,319	1,670	(4,177)	109,812
Mortgage-backed securities	139,306	6,476	0	145,782
Collateralized mortgage obligations,
Issued by U.S. Government agencies	92,460	900	(33)	93,327
Corporate bonds	1,000	36	0	1,036
Trust preferred securities issued by individual institutions	6,468	0	(685)	5,783
Collateralized debt obligations:
Pooled trust preferred securities - senior tranches	11,047	0	(3,047)	8,000
Other collateralized debt obligations	690	0	0	690
Total debt securities	419,427	9,471	(7,942)	420,956
Marketable equity securities	4,239	1,149	(98)	5,290
Total	$423,666	$10,620	($8,040)	$426,246

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

		December 31, 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	$48,949	$131	($87)	$48,993
Obligations of states and political subdivisions	109,109	1,487	(5,606)	104,990
Mortgage-backed securities	150,700	5,700	(22)	156,378
Collateralized mortgage obligations:
Issued by U.S. Government agencies	47,083	898	(273)	47,708
Private label	15,465	50	(21)	15,494
Corporate bonds	1,000	41	0	1,041
Trust preferred securities issued by individual institutions	7,043	0	(1,025)	6,018
Collateralized debt obligations:
Pooled trust preferred securities - senior tranches	11,383	0	(3,184)	8,199
Pooled trust preferred securities - mezzanine tranches	266	0	(151)	115
Other collateralized debt obligations	690	0	0	690
Total debt securities	391,688	8,307	(10,369)	389,626
Marketable equity securities	5,367	1,295	0	6,662
Total	$397,055	$9,602	($10,369)	$396,288

HELD-TO-MATURITY SECURITIES,
Obligations of the U.S. Treasury	$300	$2	$0	$302

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 June 30, 2010 and December 31, 2009.

June 30, 2010	Less Than 12 Months		12 Months or More		Total
(In Thousands)	Fair	Unrealized	Fair	Unrealized	Fair	Unrealized
	Value	Losses	Value	Losses	Value	Losses

AVAILABLE-FOR-SALE SECURITIES:
Obligations of states and political subdivisions	$16,120	($331)	$37,345	($3,846)	$53,465	($4,177)
Collateralized mortgage obligations,
Issued by U.S. Government agencies	18,545	(33)	0	0	18,545	(33)
Trust preferred securities issued by individual institutions	0	0	5,543	(685)	5,543	(685)
Collateralized debt obligations,
Pooled trust preferred securities - senior tranches	0	0	8,000	(3,047)	8,000	(3,047)
Total debt securities	34,665	(364)	50,888	(7,578)	85,553	(7,942)
Marketable equity securities	898	(98)	0	0	898	(98)
Total temporarily impaired available-for-sale
securities	$35,563	($462)	$50,888	($7,578)	$86,451	($8,040)

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

December 31, 2009	Less Than 12 Months		12 Months or More		Total
(In Thousands)	Fair	Unrealized	Fair	Unrealized	Fair	Unrealized
	Value	Losses	Value	Losses	Value	Losses

AVAILABLE-FOR-SALE SECURITIES:
Obligations of other U.S. Government agencies	$17,796	($87)	$0	$0	$17,796	($87)
Obligations of states and political subdivisions	19,001	(422)	36,939	(5,184)	55,940	(5,606)
Mortgage-backed securities	3,544	(21)	20	(1)	3,564	(22)
Collateralized mortgage obligations:
Issued by U.S. Government agencies	18,229	(273)	0	0	18,229	(273)
Private label	0	0	3,219	(21)	3,219	(21)
Trust preferred securities issued by individual institutions	0	0	5,218	(1,025)	5,218	(1,025)
Collateralized debt obligations:
Pooled trust preferred securities - senior tranches	0	0	8,199	(3,184)	8,199	(3,184)
Pooled trust preferred securities - mezzanine tranches	0	0	115	(151)	115	(151)
Total temporarily impaired available-for-sale
securities	$58,570	($803)	$53,710	($9,566)	$112,280	($10,369)

Management evaluates securities for OTTI at least on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether the Corporation intends to sell the security or more likely than not will be required to sell the security before its anticipated recovery. The Corporation recognized net impairment losses in earnings, as follows:

(In Thousands)	3 Months Ended		6 Months Ended
	June 30,	June 30,	June 30,	June 30,
	2010	2009	2010	2009
Trust preferred securities issued by individual institutions	$0	$0	($320)	$0
Pooled trust preferred securities - mezzanine tranches	(2)	(19,176)	(103)	(30,281)
Marketable equity securities (bank stocks)	0	(604)	(10)	(6,179)
Net impairment losses recognized in earnings	($2)	($19,780)	($433)	($36,460)

A summary of information management considered in evaluating debt and equity securities for OTTI at June 30, 2010 is provided below.

Debt Securities

At June 30, 2010, management performed an assessment for possible OTTI of the Corporation’s debt securities on an issue-by-issue basis, relying on information obtained from various sources, including publicly available financial data, ratings by external agencies, brokers and other sources. The extent of individual analysis applied to each security depended on the size of the Corporation’s investment, as well as management’s perception of the credit risk associated with each security. Except as reflected in the table above and described below, based on the results of the assessment, management believes impairment of these debt securities, including the municipal bonds with no external ratings, at June 30, 2010 to be temporary.

The credit rating agencies have withdrawn their ratings on numerous municipal bonds held by the Corporation. At June 30, 2010, the total amortized cost basis of municipal bonds with no external credit ratings totaled $27,016,000, with an aggregate unrealized loss of $2,374,000. At the time of purchase, each of these bonds was considered investment grade and had been rated by at least one credit rating agency. The bonds for which the ratings were removed were almost all insured by an entity that has reported significant financial problems and declines in its regulatory capital ratios. However, the insurance remains in effect on the bonds, and none of the affected municipal bonds has failed to make a scheduled interest payment.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

The following table provides information related to trust preferred securities issued by individual institutions as of June 30, 2010:

(In Thousands)

Moody's/

Cumulative

S&P/

Unrealized

Realized

Fitch

Amortized

Fair

Gain

Credit

Name of Issuer

Issuer's Parent Company

Cost

Value

(Loss)

Losses

Ratings

Astoria Capital Trust I

Astoria Financial Corporation

$5,228

$4,646

($582)

Baa3/BB-/BB-

Carolina First Mortgage Loan Trust

The South Financial Group, Inc.

240

(1,769)

Patriot Capital Trust I

Susquehanna Bancshares, Inc.

1,000

897

(103)

Total

$6,468

$5,783

($685)

($1,769)

NR = not rated.

Management assesses each of the trust preferred securities issued by individual institutions for the possibility of OTTI by reviewing financial information that is publicly available. Neither Astoria Financial Corporation nor Susquehanna Bancshares, Inc. has deferred or defaulted on payments associated with the Corporation’s securities. In 2009, the Corporation recorded OTTI of $3,209,000 on the Carolina First Mortgage Loan Trust security, and in 2010, The South Financial Group, Inc. deferred on payments on the security. In April 2010, the Corporation sold half of its investment in the security, and in the first quarter 2010 recorded OTTI of $320,000 to further write down amortized cost based on the selling price of the April transaction.

Pooled trust-preferred securities are very long-term (usually 30-year maturity) instruments with characteristics of both debt and equity, mainly issued by banks. The Corporation’s investments in pooled trust-preferred securities are each made up of companies with geographic and size diversification. Almost all of the Corporation’s pooled trust-preferred securities are composed of debt issued by banking companies, with lesser amounts issued by insurance companies and real estate investment trusts. Some of the issuers of trust-preferred securities that are included in the Corporation’s pooled investments have elected to defer payment of interest on these obligations (trust-preferred securities typically permit deferral of quarterly interest payments for up to five years), and some issuers have defaulted.

As of each quarter-end in 2009 and 2010, management evaluated pooled trust-preferred securities for OTTI by estimating the cash flows expected to be received from each security, taking into account estimated levels of deferrals and defaults by the underlying issuers. In determining cash flows, management assumed all issuers currently deferring or in default would make no future payments, and assigned estimated future default levels for the remaining issuers in each security based on financial strength ratings assigned by a national ratings service. Management calculated the present value of each security based on the current book yield, adjusted for future changes in 3-month LIBOR (which is the index rate on the Corporation’s adjustable-rate pooled trust-preferred securities) based on the applicable forward curve.

In the third quarter 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. Management selected several of the trust preferred offerings in which the Corporation holds securities, and analyzed the change in deferral or default status, and the change in financial strength rating from the national ratings service used in its quarterly analyses, over the period starting in the third quarter 2008 (which was the first quarter in which the Corporation performed the detailed cash flow analysis for each security) through the second quarter 2009. Management believes the results of its analysis of the securities selected to be similar to the results that would be produced in an analysis of all of the Corporation’s pooled trust-preferred securities. The analysis demonstrated that significant credit deterioration had occurred over the previous four quarterly periods, as evidenced in the data by average higher deferrals and defaults, and lower financial strength ratings. In determining how to apply the results of this analysis, management made two critical assumptions: (1) the deteriorating trend will continue at approximately the same rate over the next four quarters, and (2) every issuer (bank) that would be assumed to defer payment within the next four quarters, based on the trend reflected in the data, would eventually default with no recovery. At June 30, 2010, management’s assumptions regarding future deferrals and defaults were consistent with the revisions established in the third quarter 2009.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Management’s estimates of cash flows used to evaluate other-than-temporary impairment of pooled trust-preferred securities were based on sensitive assumptions regarding the timing and amounts of defaults that may occur, and changes in those assumptions could produce different conclusions for each security.

As of June 30, 2010, the Corporation’s investment in a senior tranche security (the senior tranche of MM Caps Funding I, Ltd., for which the Corporation also owns an investment in the mezzanine tranche security) has an investment grade rating. The senior tranche security, with an amortized cost of $11,047,000, has been subjected to impairment analysis based on estimated cash flows (using the process described above), and management has determined that impairment was temporary as of June 30, 2010.

The following table provides detailed information related to pooled trust preferred securities – mezzanine tranches held as of June 30, 2010:

Pooled Trust Preferred Securities -
Mezzanine Tranches
(In Thousands)				OTTI in	OTTI in
				3 Months	6 Months
				Ended	Ended
	Amortized	Fair	Unrealized	June 30,	June 30,	Cumulative
Description	Cost	Value	Gain	2010	2010	OTTI
MMCAPS Funding I, Ltd.	$0	$0	$0	($2)	($2)	($5,833)
U.S. Capital Funding II, Ltd. (B-1)	0	0	0	0	(40)	(1,992)
U.S. Capital Funding II, Ltd. (B-2)	0	0	0	0	(61)	(2,973)
ALESCO Preferred Funding VI, Ltd.	0	0	0	0	0	(2,018)
ALESCO Preferred Funding IX, Ltd.	0	0	0	0	0	(2,988)
Preferred Term Securities XVIII, Ltd.	0	0	0	0	0	(7,293)
Preferred Term Securities XXI, Ltd.	0	0	0	0	0	(1,502)
Preferred Term Securities XXIII, Ltd. (C-1)	0	0	0	0	0	(3,466)
Preferred Term Securities XXIII, Ltd. (D-1)	0	0	0	0	0	(5,024)
Tropic CDO III, Ltd.	0	0	0	0	0	(6,970)
Total	$0	$0	$0	($2)	($103)	($40,059)

The table that follows provides additional information related to the senior tranche and mezzanine tranche pooled trust-preferred securities that had not been completely written off prior to the second quarter 2010:

				Expected
			Actual	Additional
			Deferrals	Net Deferrals
			and	and	Excess
	Number	Moody's/	Defaults	Defaults	Subordination
	of Banks	Fitch	as % of	as % of	as % of
	Currently	Credit	Outstanding	Performing	Performing
Description	Performing	Ratings (1)	Collateral	Collateral	Collateral
MMCAPS Funding I, Ltd. - Senior Tranche	21	A3/A (2)	21.6%	47.1%	26.2%
MMCAPS Funding I, Ltd. - Mezzanine	21	Ca/C	21.6%	47.1%	-13.2%

(1) The table above presents ratings information as of June 30, 2010.

(2) Fitch has placed the Senior Tranche security on Negative Watch.

In the table above, “Excess Subordination as % of Performing Collateral” (Excess Subordination Ratio) was calculated as follows: (Total face value of performing collateral – Face value of all outstanding note balances not subordinate to our investment)/Total face value of performing collateral.

The Excess Subordination Ratio measures the extent to which there may be tranches within each pooled trust preferred structure available to absorb credit losses before the Corporation’s securities would be impacted. The positive Excess Subordination Ratio for the senior tranche security signifies there is some support from subordinate tranches available to absorb losses before the Corporation’s investment would be impacted, while the negative Excess Subordination Ratio for the mezzanine tranche security indicates there is no support. A negative Excess Subordination Ratio is not definitive, in isolation, for determining whether or not OTTI should be recorded for a pooled trust preferred security. Other factors affect the timing and amount of cash flows available for payments to the note holders (investors), including the excess interest paid by the issuers (the issuers typically pay higher rates of interest than are paid out to the note holders).

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

The Corporation separates OTTI related to the trust-preferred securities into (a) the amount of the total impairment related to credit loss, which is recognized in the statement of earnings, and (b) the amount of the total impairment related to all other factors, which is recognized in other comprehensive income. The Corporation measures the credit loss component of OTTI based on the difference between: (1) the present value of estimated cash flows, at the book yield in effect prior to recognition of any OTTI, as of the most recent balance sheet date, and (2) the present value of estimated cash flows as of the previous quarter-end balance sheet date based on management’s cash flow assumptions at that time.

The Corporation’s pre-tax loss from pooled trust-preferred securities in the three months ended June 30, 2010 amounted to $2,000, with a pre-tax gain included in other comprehensive income of $2,000. Total OTTI from pooled trust-preferred securities in the six months ended June 30, 2010 amounted to $51,000, including a pre-tax loss reflected in earnings of $103,000, with a pre-tax other comprehensive gain of $52,000 included in other comprehensive income. In the three months ended June 30, 2009, total OTTI from pooled trust-preferred securities amounted to $17,370,000, including a pre-tax loss reflected in earnings of $19,176,000 and a pre-tax other comprehensive gain of $1,806,000. In the six months ended June 30, 2009, total OTTI from pooled trust-preferred securities was $36,776,000, including a pre-tax loss reflected in earnings of $30,281,000 and a pre-tax other comprehensive loss of $6,495,000.

A roll-forward of the credit losses from securities for which a portion of OTTI has been recognized in other comprehensive income is as follows:

(In Thousands)

	3 Months Ended		6 Months Ended
	June 30,	June 30,	June 30,	June 30,
	2010	2009	2010	2009
Balance of credit losses on debt securities for which a portion
of OTTI was recognized in other comprehensive income,
beginning of period (as measured effective January 1, 2009
upon adoption of ASC Topic 320)	($5,831)	($13,467)	($10,695)	($2,362)

Additional credit loss for which an OTTI was not previously
recognized	0	(5,197)	0	(23,020)

Reduction for securities losses realized during the period	5,833	9,311	10,798	9,311

Additional credit loss for which an OTTI was previously
recognized when the Corporation does not intend to sell
the security and it is not more likely than not the Corporation
will be required to sell the security before recovery of its
amortized cost basis	(2)	(13,979)	(103)	(7,261)

Balance of credit losses on debt securities for which a portion
of OTTI was recognized in other comprehensive income,
end of period	$0	($23,332)	$0	($23,332)

The line item labeled “Reduction for securities losses realized during the period” in the table immediately above includes OTTI write-downs associated with securities the Corporation continues to hold, but which have been deemed worthless.

Equity Securities

The Corporation’s marketable equity securities at June 30, 2010 and December 31, 2009 consisted exclusively of stocks of banking companies. The Corporation recorded no OTTI on bank stocks in the second quarter 2010 but recorded OTTI totaling $10,000 in the first six months of 2010. The Corporation recorded OTTI totaling $604,000 for the second quarter 2009 and $6,179,000 in the first six months of 2009. Management’s decision to record OTTI losses on bank stocks was based on a combination of: (1) significant market depreciation in market prices in the first quarter 2009 (with some improvement subsequent to March 31, 2009), and (2) management’s intent to sell some of the stocks to generate capital losses, which could be carried back and offset against capital gains generated in previous years to realize tax refunds.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Realized gains from sales of bank stocks totaled $134,000 in the three months ended June 30, 2010 including $42,000 of realized gains from sales of stocks for which an OTTI had been previously recognized. Realized gains from sales of bank stocks totaled $483,000 in the six months ended June 30, 2010 including $326,000 of realized gains from sales of stocks for which an OTTI had been previously recognized. Realized gains from sales of bank stocks totaled $755,000 in the three months ended June 30, 2009 including $261,000 of realized gains from sales of stocks for which an OTTI had been previously recognized. Realized gains from sales of bank stocks totaled $1,032,000 in the six months ended June 30, 2009 including $291,000 of realized gains from sales of stocks for which an OTTI had been previously recognized. Management evaluated all impaired bank stocks held at June 30, 2010 and determined that none of the Corporation’s holdings were other than temporarily impaired.

C&N Bank is a member of the Federal Home Loan Bank of Pittsburgh (FHLB-Pittsburgh), which is one of 12 regional Federal Home Loan Banks. As a member, C&N Bank is required to purchase and maintain stock in FHLB-Pittsburgh in an amount determined based on outstanding advances, unused borrowing capacity and other factors. There is no active market for FHLB-Pittsburgh stock, and it must ordinarily be redeemed by FHLB-Pittsburgh in order to be liquidated. At June 30, 2010 and December 31, 2009, C&N Bank’s investment in FHLB-Pittsburgh stock, which was included in Other Assets in the consolidated balance sheet, was $8,585,000. The Corporation evaluated its holding of FHLB-Pittsburgh stock for impairment and deemed the stock to not be impaired at June 30, 2010 and December 31, 2009. In making this determination, management concluded that recovery of total outstanding par value, which equals the carrying value, is expected. The decision was based on review of financial information that FHLB-Pittsburgh has made publicly available.

6. DEFINED BENEFIT PLANS

The Corporation sponsors a defined benefit health care plan that provides postretirement medical benefits and life insurance to employees who meet certain age and length of service requirements. This plan contains a cost-sharing feature, which causes participants to pay for all future increases in costs related to benefit coverage. Accordingly, actuarial assumptions related to health care cost trend rates do not affect the liability balance at June 30, 2010 and December 31, 2009, and will not affect the Corporation's future expenses. The Corporation uses a December 31 measurement date for the postretirement plan.

In 2007, the Corporation assumed the Citizens Trust Company Retirement Plan, a defined benefit pension plan for which benefit accruals and participation were frozen in 2002. Information related to the Citizens Trust Company Retirement Plan has been included in the table that follows. The Corporation uses a December 31 measurement date for this plan.

The components of net periodic benefit costs from these defined benefit plans are as follows:

Defined Benefit Plans
(In Thousands)	Pension		Postretirement
	Six Months Ended		Six Months Ended
	June 30,		June 30,
	2010	2009	2010	2009
Service cost	$0	$0	$34	$37
Interest cost	34	0	45	47
Expected return on plan assets	(33)	0	0	0
Amortization of transition obligation	0	0	18	18
Amortization of prior service cost	0	0	7	7
Recognized net actuarial loss	2	0	0	0
Net periodic benefit cost	$3	$0	$104	$109

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Defined Benefit Plans
(In Thousands)	Pension		Postretirement
	Three Months Ended		Three Months Ended
	June 30,		June 30,
	2010	2009	2010	2009
Service cost	$0	$0	$17	$18
Interest cost	17	0	23	24
Expected return on plan assets	(16)	0	0	0
Amortization of transition obligation	0	0	9	9
Amortization of prior service cost	0	0	3	4
Recognized net actuarial loss	1	0	0	0
Net periodic benefit cost	$2	$0	$52	$55

In the first six months of 2010, the Corporation funded postretirement contributions totaling $31,000, with estimated annual postretirement contributions of $62,000 expected in 2010 for the full year. Based upon the related actuarial reports, the Corporation has no required contributions to the Citizens Trust Company Retirement Plan for the 2010 plan year; however, the Corporation may elect to make discretionary contributions later in 2010.

7. STOCK-BASED COMPENSATION PLANS

In 2010, the Corporation has made no awards of stock options. In the first quarter 2009, the Corporation granted options to purchase a total of 79,162 shares of common stock through its Stock Incentive and Independent Directors Stock Incentive Plans. The exercise price for the 2009 awards is $19.88 per share, based on the market price as of the date of grant.

The Corporation records stock option expense based on estimated fair value calculated using an option valuation model. In calculating the 2009 fair value, the Corporation utilized the Black-Scholes-Merton option-pricing model. The calculated fair value of each option granted, and significant assumptions used in the calculations, are as follows:

	2010	2009
Fair value of each option granted	Not applicable (N/A)	$4.21
Volatility	N/A	28%
Expected option lives	N/A	9 Years
Risk-free interest rate	N/A	3.15%
Dividend yield	N/A	3.94%

In calculating the estimated fair value of 2009 stock option awards, management based its estimates of volatility and dividend yield on the Corporation’s experience over the immediately prior period of time consistent with the estimated lives of the options. The risk-free interest rate was based on the published yield of zero-coupon U.S. Treasury strips with an applicable maturity as of the grant dates. The 9-year expected option life was based on management’s estimates of the average term for all options issued under both plans. Management assumed a 23% forfeiture rate for options granted under the Stock Incentive Plan, and a 0% forfeiture rate for the Directors Stock Incentive Plan. These estimated forfeiture rates were determined based on the Corporation’s historical experience.

In the first quarter 2010, the Corporation awarded 9,125 shares of restricted stock to the Chief Executive Officer under the Stock Incentive Plan. This award provides that vesting will occur upon the earliest of (i) the third anniversary of the date of grant, (ii) death or disability or (iii) the occurrence of a change in control of the Corporation. Also, vesting may not occur prior to the Corporation’s redemption of preferred stock issued to the U.S. Treasury under the TARP Capital Purchase Program. In the first quarter 2009, the Corporation awarded a total of 3,890 shares of restricted stock under the Stock Incentive and Independent Directors Stock Incentive Plans. Compensation cost related to restricted stock is recognized based on the market price of the stock at the grant date over the vesting period. For restricted stock awards granted under the Stock Incentive Plan in 2009 and 2008, the Corporation must meet an annual targeted return on average equity (“ROAE”) performance ratio, as defined, in order for participants to vest. The Corporation did not meet the ROAE target for the 2009 plan year, and accordingly, the participants did not vest in the applicable shares associated with 2009 and 2008 restricted stock awards. The Corporation met the ROAE target for the 2008 plan year, and accordingly, in January 2009, the participants vested in 1/3 of the restricted shares awarded in 2008. Management has estimated restricted stock expense in the first six months of 2010 based on assumptions that the Corporation will redeem the TARP preferred stock within three years, and that the ROAE target for 2010 will be met.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Total stock-based compensation expense is as follows:

(In Thousands)	Three Months Ended		Six Months Ended
	June 30,	June 30,	June 30,	June 30,
	2010	2009	2010	2009
Stock options	$0	$103	$0	$273
Restricted stock	19	21	32	41

Total	$19	$124	$32	$314

8. INCOME TAXES

The following temporary differences gave rise to the net deferred tax asset at June 30, 2010 and December 31, 2009:

(In Thousands)

	June 30,	Dec. 31,
	2010	2009
Deferred tax assets:
Unrealized holding losses on securities	$0	($247)
Defined benefit plans - FASB 158	(133)	(194)
Net realized losses on securities	(15,741)	(16,052)
Allowance for loan losses	(2,950)	(2,871)
Credit for alternative minimum tax paid	(3,573)	(3,495)
Low income housing tax credits	0	(685)
Other deferred tax assets	(1,131)	(1,097)
	(23,528)	(24,641)
Valuation allowance	148	373

Total deferred tax assets	(23,380)	(24,268)
Deferred tax liabilities:
Unrealized holding gains on securities	899	0
Bank premises and equipment	1,706	1,798
Core deposit intangibles	143	175
Other deferred tax liabilities	242	258
Total deferred tax liabilities	2,990	2,231
Deferred tax asset, net	$(20,390)	$(22,037)

Realization of deferred tax assets ultimately depends on the existence of sufficient taxable income, including taxable income in prior carryback years, as well as future taxable income. The deferred tax asset from realized losses on securities resulted primarily from OTTI charges for financial statement purposes that are not deductible for income tax reporting purposes through June 30, 2010. Of the total deferred tax asset from realized losses on securities, a portion is from securities that, if the Corporation were to sell them, would be classified as capital losses for income tax reporting purposes. The valuation allowance of $148,000 at June 30, 2010 and $373,000 at December 31, 2009 reflects the estimated amount of tax benefits associated with capital assets that is dependent upon realization of future capital gains.

The Corporation has available, unused tax credits arising from investments in low income and elderly housing projects. These tax credits may provide future benefits and if unused, would expire in varying annual amounts from 2024 through 2029. The reduction in the deferred tax asset associated with low income housing tax credits at June 30, 2010 to $0 from $685,000 at December 31, 2009 resulted from estimated realization of the credits based on management’s calculation of taxable income generated in the first six months of 2010. The amount of low income housing income tax credits realized in 2010, if any, will depend on the Corporation’s taxable income for the year ending December 31, 2010.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

The provision (credit) for income tax for the 3-month and 6-month periods ended June 30, 2010 and 2009 is based on the Corporation’s estimate of the effective tax rate expected to be applicable for the full year. The effective tax rates are as follows:

(In Thousands)

3 Months Ended		Fiscal Year To Date
June 30,	June 30,	6 Months Ended June 30,
2010	2009