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, 2012

¨ 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x 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 definition of “large accelerated filer,” accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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)

12,255,383 Shares Outstanding on November 1, 2012

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

CITIZENS & NORTHERN CORPORATION

Index

Part I. Financial Information

Item 1. Financial Statements

Consolidated Balance Sheets (Unaudited) – September 30, 2012 and December 31, 2011		Page 3

Consolidated Statements of Operations (Unaudited) – Three Months and Nine Months Ended September 30, 2012 and 2011		Page 4

Consolidated Statements of Comprehensive Income (Unaudited) – Three Months and Nine Months Ended September 30, 2012 and 2011		Page 5

Consolidated Statements of Cash Flows (Unaudited) – Nine Months Ended September 30, 2012 and 2011		Page 6

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) - Nine Months Ended September 30, 2012 and 2011		Page 7

Notes to Unaudited Consolidated Financial Statements		Pages 8 – 37

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations		Pages 38 – 58

Item 3. Quantitative and Qualitative Disclosures About Market Risk		Pages 59 – 61

Item 4. Controls and Procedures		Page 61

Part II. Other Information		Pages 62 – 63

Signatures		Page 64

Exhibit 31.1. Rule 13a-14(a)/15d-14(a) Certification - Chief Executive Officer		Page 65

Exhibit 31.2. Rule 13a-14(a)/15d-14(a) Certification - Chief Financial Officer		Page 66

Exhibit 32. Section 1350 Certifications		Page 67

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

PART 1. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS (Unaudited)

(In Thousands, Except Share Data)	September 30,			December 31,
	2012			2011
ASSETS
Cash and due from banks:
Noninterest-bearing	$	20,567		$	17,618
Interest-bearing		21,929			42,957
Total cash and due from banks		42,496			60,575
Available-for-sale securities, at fair value		487,314			481,685
Loans held for sale		3,846			939

Loans receivable		698,149			708,315
Allowance for loan losses		(7,792	)		(7,705	)
Loans, net		690,357			700,610
Bank-owned life insurance		21,236			20,889
Accrued interest receivable		4,927			4,797
Bank premises and equipment, net		19,010			19,028
Foreclosed assets held for sale		839			1,235
Deferred tax asset, net		2,122			6,173
Intangible asset - Core deposit intangibles		156			212
Intangible asset - Goodwill		11,942			11,942
Other assets		25,764			15,650
TOTAL ASSETS	$	1,310,009		$	1,323,735

LIABILITIES
Deposits:
Noninterest-bearing	$	187,920		$	193,595
Interest-bearing		825,090			824,611
Total deposits		1,013,010			1,018,206
Short-term borrowings		19,657			4,950
Long-term borrowings		89,954			125,363
Accrued interest and other liabilities		7,242			7,831
TOTAL LIABILITIES		1,129,863			1,156,350

STOCKHOLDERS' EQUITY
Preferred stock, $1,000 par value; authorized 30,000 shares; $1,000 liquidation preference per share; no shares issued at September 30, 2012 and December 31, 2011		0			0
Common stock, par value $1.00 per share; authorized 20,000,000 shares in 2012 and 2011; issued 12,506,759 at September 30, 2012 and 12,460,920 at December 31, 2011		12,507			12,461
Paid-in capital		68,215			67,568
Retained earnings		91,811			82,302
Treasury stock, at cost; 252,000 shares at September 30, 2012 and 305,391 shares at December 31, 2011		(4,213	)		(5,106	)
Sub-total		168,320			157,225
Accumulated other comprehensive income:
Unrealized gains on available-for-sale securities		12,278			10,791
Defined benefit plans		(452	)		(631	)
Total accumulated other comprehensive income		11,826			10,160
TOTAL STOCKHOLDERS' EQUITY		180,146			167,385
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY	$	1,310,009		$	1,323,735

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

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

CONSOLIDATED STATEMENTS OF OPERATIONS	3 Months Ended					Fiscal Year To Date
(In Thousands, Except Per Share Data) (Unaudited)	Sept. 30,		Sept. 30,			9 Months Ended Sept. 30,
	2012		2011			2012			2011
INTEREST INCOME
Interest and fees on loans	$	9,996	$	10,790		$	30,604		$	32,485
Interest on balances with depository institutions		31		13			90			45
Interest on loans to political subdivisions		395		372			1,147			1,119
Interest on loans held for sale		42		9			74			36
Income from available-for-sale and held-to-maturity securities:
Taxable		2,019		2,784			7,197			8,326
Tax-exempt		1,275		1,285			3,803			3,860
Dividends		78		64			226			187
Total interest and dividend income		13,836		15,317			43,141			46,058
INTEREST EXPENSE
Interest on deposits		1,158		1,775			3,779			6,610
Interest on short-term borrowings		2		6			6			20
Interest on long-term borrowings		1,068		1,327			3,346			4,122
Total interest expense		2,228		3,108			7,131			10,752
Net interest income		11,608		12,209			36,010			35,306
Provision (credit) for loan losses		236		(37	)		421			(198	)
Net interest income after provision (credit) for loan losses		11,372		12,246			35,589			35,504
OTHER INCOME
Service charges on deposit accounts		1,290		1,230			3,707			3,586
Service charges and fees		239		218			694			643
Trust and financial management revenue		873		785			2,762			2,608
Interchange revenue from debit card transactions		477		490			1,460			1,427
Net gains from sale of loans		625		263			1,263			677
Increase in cash surrender value of life insurance		111		127			347			381
Insurance commissions, fees and premiums		62		66			169			192
Impairment loss on limited partnership investment		0		0			0			(948	)
Other operating income		426		820			1,555			1,661
Sub-total		4,103		3,999			11,957			10,227
Total other-than-temporary impairment losses on available-for-sale securities		0		0			(67	)		0
Portion of (gain) loss recognized in other comprehensive loss (before taxes)		0		0			0			0
Net impairment losses recognized in earnings		0		0			(67	)		0
Realized gains on available-for-sale securities, net		2,430		26			2,698			2,028
Net realized gains on available-for-sale securities		2,430		26			2,631			2,028
Total other income		6,533		4,025			14,588			12,255
OTHER EXPENSES
Salaries and wages		3,594		3,451			10,755			10,321
Pensions and other employee benefits		982		1,020			3,438			3,344
Occupancy expense, net		610		641			1,874			2,038
Furniture and equipment expense		475		498			1,418			1,435
FDIC assessments		165		174			468			688
Pennsylvania shares tax		339		345			1,011			984
Loss on prepayment of debt		2,190		0			2,333			0
Other operating expense		2,042		1,923			5,897			5,299
Total other expenses		10,397		8,052			27,194			24,109
Income before income tax provision		7,508		8,219			22,983			23,650
Income tax provision		2,014		2,230			6,217			6,423
NET INCOME	$	5,494	$	5,989		$	16,766		$	17,227
NET INCOME PER SHARE - BASIC	$	0.45	$	0.49		$	1.37		$	1.42
NET INCOME PER SHARE - DILUTED	$	0.45	$	0.49		$	1.37		$	1.42

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

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In Thousands) (Unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2012			2011			2012			2011
Net income	$	5,494		$	5,989		$	16,766		$	17,227

Unrealized gains on available-for-sale securities:
Unrealized holding gains on available-for-sale securities		3,597			5,310			5,168			17,384
Reclassification adjustment for gains realized in income		(2,430	)		(26	)		(2,631	)		(2,028	)
Other comprehensive gain on available-for-sale securities		1,167			5,284			2,537			15,356

Unfunded pension and postretirement obligations:
Change in items from defined benefit plans included in accumulated other comprehensive income		0			0			200			(122	)
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost		20			14			60			41
Other comprehensive gain (loss) on unfunded retirement obligations		20			14			260			(81	)

Other comprehensive income before income tax		1,187			5,298			2,797			15,275
Income tax related to other comprehensive income		(415	)		(1,800	)		(1,131	)		(5,190	)

Net other comprehensive income		772			3,498			1,666			10,085

Total comprehensive income	$	6,266		$	9,487		$	18,432		$	27,312

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

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

CONSOLIDATED STATEMENTS OF CASH FLOWS	Nine Months Ended Sept. 30,
(In Thousands) (Unaudited)	2012			2011
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	16,766		$	17,227
Adjustments to reconcile net income to net cash provided by operating activities: Provision (credit) for loan losses		421			(198	)
Realized gains on available-for-sale securities, net		(2,631	)		(2,028	)
Loss on prepayment of debt		2,333			0
Gain on disposition of premises and equipment		(271	)		(324	)
Loss (gain) on sale of foreclosed assets, net		99			(8	)
Depreciation expense		1,444			1,584
Accretion and amortization on securities, net		1,022			1,045
Accretion and amortization on loans, deposits and borrowings, net		(40	)		(27	)
Amortization of mortgage servicing rights		69			48
Impairment loss on limited partnership interest		0			948
Increase in cash surrender value of life insurance		(347	)		(381	)
Stock-based compensation		487			386
Amortization of core deposit intangibles		56			86
Deferred income taxes		2,920			2,936
Gains on sales of mortgage loans, net		(1,263	)		(677	)
Origination of mortgage loans for sale		(42,571	)		(15,166	)
Proceeds from sales of mortgage loans		40,665			19,683
(Increase) decrease in accrued interest receivable and other assets		(1,266	)		888
(Decrease) increase in accrued interest payable and other liabilities		(545	)		1,280
Net Cash Provided by Operating Activities		17,348			27,302
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of certificates of deposit		(1,060	)		0
Proceeds from sales of available-for-sale securities		14,804			16,696
Proceeds from calls and maturities of available-for-sale securities		81,595			79,813
Purchase of available-for-sale securities		(107,483	)		(108,327	)
Redemption of Federal Home Loan Bank of Pittsburgh stock		1,222			1,164
Net decrease in loans		9,141			22,150
Proceeds from bank-owned life insurance		0			1,442
Purchase of premises and equipment		(1,428	)		(666	)
Proceeds from disposition of premises and equipment		455			3,060
Purchase of investment in limited liability entity		(538	)		(200	)
Return of principal on limited liability entity investments		80			93
Proceeds from sale of foreclosed assets		1,120			640
Net Cash (Used in) Provided by Investing Activities		(2,092	)		15,865
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in deposits		(5,202	)		(8,632	)
Net increase in short-term borrowings		14,707			821
Repayments of long-term borrowings		(37,742	)		(20,471	)
Purchase of treasury stock		0			(983	)
Sale of treasury stock		219			16
Tax benefit from compensation plans		83			48
Common dividends paid		(6,460	)		(4,513	)
Net Cash Used in Financing Activities		(34,395	)		(33,714	)
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(19,139	)		9,453
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR		56,815			46,301
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	37,676		$	55,754

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Assets acquired through foreclosure of real estate loans	$	737		$	1,691
Interest paid	$	7,392		$	10,817
Income taxes paid	$	4,150		$	2,300

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

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

Consolidated Statements of Changes in Stockholders' Equity

Nine Months Ended September 30, 2012 and 2011

(In Thousands Except Share and Per Share Data)

(Unaudited)

														Accum. Other
	Common		Treasury			Common		Paid-in			Retained			Comprehensive			Treasury
	Shares		Shares			Stock		Capital			Earnings			Income (Loss)			Stock			Total
Nine Months Ended September 30, 2012:
Balance, December 31, 2011		12,460,920		305,391		$	12,461	$	67,568		$	82,302		$	10,160		$	(5,106	)	$	167,385
Net income												16,766									16,766
Other comprehensive income, net															1,666						1,666
Cash dividends declared on common stock, $.60 per share												(7,331	)								(7,331	)
Shares issued for dividend reinvestment plan		45,839					46		825												871
Shares issued from treasury related to exercise of stock options				(14,399	)				(22	)								241			219
Restricted stock granted				(42,552	)				(711	)								711			0
Forfeiture of restricted stock				3,560					59									(59	)		0
Stock-based compensation expense									487												487
Tax benefit of stock options									9												9
Tax benefit from employee benefit plan												74									74
Balance, September 30, 2012		12,506,759		252,000		$	12,507	$	68,215		$	91,811		$	11,826		$	(4,213	)	$	180,146

Nine Months Ended September 30, 2011:
Balance, December 31, 2010		12,408,212		254,614		$	12,408	$	66,648		$	65,920		$	(1,601	)	$	(4,431	)	$	138,944
Net income												17,227									17,227
Other comprehensive income, net															10,085						10,085
Cash dividends declared on common stock, $.42 per share												(5,110	)								(5,110	)
Shares issued for dividend reinvestment plan		39,007					39		558												597
Treasury stock purchased				68,410														(983	)		(983	)
Shares issued from treasury related to exercise of stock options				(1,108	)				(3	)								19			16
Restricted stock granted				(15,622	)				(272	)								272			0
Forfeiture of restricted stock				295					5									(5	)		0
Stock-based compensation expense									386												386
Tax benefit from employee benefit plan												48									48
Balance, September 30, 2011		12,447,219		306,589		$	12,447	$	67,322		$	78,085		$	8,484		$	(5,128	)	$	161,210

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

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

Notes to Unaudited 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, 2011, 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, comprehensive income, 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 a complete set of financial statements. Certain 2011 information has been reclassified for consistency with the 2012 presentation.

Operating results reported for the three-month and nine-month periods ended September 30, 2012 might not be indicative of the results for the year ending December 31, 2012. The Corporation evaluates subsequent events through the date of filing with the Securities and Exchange Commission.

2. PER COMMON SHARE DATA

Net income per share is based on the weighted-average number of shares of common stock outstanding. The following data show the amounts used in computing basic and diluted net income per share. As shown in the table that follows, diluted earnings per share is 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 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.

			Weighted-
			Average			Earnings
	Net		Common			Per
	Income		Shares			Share
Nine Months Ended September 30, 2012
Earnings per share – basic	$	16,766,000		12,225,895		$	1.37
Dilutive effect of potential common stock arising from stock options:
Exercise of outstanding stock options				202,199
Hypothetical share repurchase at $19.35				(175,737	)
Earnings per share – diluted	$	16,766,000		12,252,357		$	1.37

Nine Months Ended September 30, 2011
Earnings per share – basic	$	17,227,000		12,167,563		$	1.42
Dilutive effect of potential common stock arising from stock options:
Exercise of outstanding stock options				92,786
Hypothetical share repurchase at $15.57				(89,738	)
Earnings per share – diluted	$	17,227,000		12,170,611		$	1.42

Quarter Ended September 30, 2012
Earnings per share – basic	$	5,494,000		12,244,797		$	0.45
Dilutive effect of potential common stock arising from stock options:
Exercise of outstanding stock options				198,863
Hypothetical share repurchase at $19.35				(172,975	)
Earnings per share – diluted	$	5,494,000		12,270,685		$	0.45

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

			Weighted-
			Average			Earnings
	Net		Common			Per
	Income		Shares			Share
Quarter Ended September 30, 2011
Earnings per share – basic	$	5,989,000		12,150,910		$	0.49
Dilutive effect of potential common stock arising from stock options:
Exercise of outstanding stock options				91,843
Hypothetical share repurchase at $15.56				(88,892	)
Earnings per share – diluted	$	5,989,000		12,153,861		$	0.49

Stock options that were anti-dilutive were excluded from net income per share calculations. Weighted-average common shares available from anti-dilutive instruments totaled 146,295 shares in the nine-month period ended September 30, 2012, 224,651 shares in the nine-month period ended September 30, 2011, 143,866 shares in the third quarter 2012 and 223,463 shares in the third quarter 2011.

3. COMPREHENSIVE INCOME

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

(In Thousands)	Before-Tax			Income Tax			Net-of-Tax
	Amount			Effect			Amount
Nine Months Ended September 30, 2012
Unrealized gains on available-for-sale securities:
Unrealized holding gains on available-for-sale securities	$	5,168		$	(1,971	)	$	3,197
Reclassification adjustment for gains realized in income		(2,631	)		921			(1,710	)
Other comprehensive gain on available-for-sale securities		2,537			(1,050	)		1,487

Unfunded pension and postretirement obligations:
Change in items from defined benefit plans included in accumulated other comprehensive income		200			(61	)		139
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost		60			(20	)		40
Other comprehensive gain on unfunded retirement obligations		260			(81	)		179

Total other comprehensive income	$	2,797		$	(1,131	)	$	1,666

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

	Before-Tax			Income Tax			Net-of-Tax
	Amount			Effect			Amount
Nine Months Ended September 30, 2011
Unrealized gains on available-for-sale securities:
Unrealized holding gains on available-for-sale securities	$	17,384		$	(5,908	)	$	11,476
Reclassification adjustment for gains realized in income		(2,028	)		690			(1,338	)
Other comprehensive gain on available-for-sale securities		15,356			(5,218	)		10,138

Unfunded pension and postretirement obligations:
Change in items from defined benefit plans included in accumulated other comprehensive income		(122	)		41			(81	)
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost		41			(13	)		28
Other comprehensive loss on unfunded retirement obligations		(81	)		28			(53	)

Total other comprehensive income	$	15,275		$	(5,190	)	$	10,085

	Before-Tax			Income Tax			Net-of-Tax
	Amount			Effect			Amount
Quarter Ended September 30, 2012
Unrealized gains on available-for-sale securities:
Unrealized holding gains on available-for-sale securities	$	3,597		$	(1,259	)	$	2,338
Reclassification adjustment for gains realized in income		(2,430	)		851			(1,579	)
Other comprehensive gain on available-for-sale securities		1,167			(408	)		759

Unfunded pension and postretirement obligations:
Change in items from defined benefit plans included in accumulated other comprehensive income		0			0			0
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost		20			(7	)		13
Other comprehensive gain on unfunded retirement obligations		20			(7	)		13

Total other comprehensive income	$	1,187		$	(415	)	$	772

	Before-Tax			Income Tax			Net-of-Tax
	Amount			Effect			Amount
Quarter Ended September 30, 2011
Unrealized gains on available-for-sale securities:
Unrealized holding gains on available-for-sale securities	$	5,310		$	(1,805	)	$	3,505
Reclassification adjustment for gains realized in income		(26	)		9			(17	)
Other comprehensive gain on available-for-sale securities		5,284			(1,796	)		3,488

Unfunded pension and postretirement obligations:
Change in items from defined benefit plans included in accumulated other comprehensive income		0			0			0
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost		14			(4	)		10
Other comprehensive gain on unfunded retirement obligations		14			(4	)		10

Total other comprehensive income	$	5,298		$	(1,800	)	$	3,498

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

Changes in the components of accumulated other comprehensive income are as follows:

(In Thousands)

							Accumulated
	Unrealized			Unfunded			Other
	Holding Gains			Retirement			Comprehensive
	on Securities			Obligations			Income
Nine Months Ended September 30, 2012
Balance, beginning of period	$	10,791		$	(631	)	$	10,160
Change during nine months ended September 30, 2012		1,487			179			1,666
Balance, end of period	$	12,278		$	(452	)	$	11,826

Nine Months Ended September 30, 2011
Balance, beginning of period	$	(1,351	)	$	(250	)	$	(1,601	)
Change during nine months ended September 30, 2011		10,138			(53	)		10,085
Balance, end of period	$	8,787		$	(303	)	$	8,484

Quarter Ended September 30, 2012
Balance, beginning of period	$	11,519		$	(465	)	$	11,054
Change during three months ended September 30, 2012		759			13			772
Balance, end of period	$	12,278		$	(452	)	$	11,826

Quarter Ended September 30, 2011
Balance, beginning of period	$	5,299		$	(313	)	$	4,986
Change during three months ended September 30, 2011		3,488			10			3,498
Balance, end of period	$	8,787		$	(303	)	$	8,484

4. CASH AND DUE FROM BANKS

Cash and due from banks at September 30, 2012 and December 31, 2011 include the following:

(In thousands)	Sept. 30,		Dec. 31,
	2012		2011
Cash and cash equivalents	$	37,676	$	56,815
Certificates of deposit		4,820		3,760
Total cash and due from banks	$	42,496	$	60,575

Certificates of deposit are issues by U.S. banks with original maturities greater than three months. Each certificate of deposit is fully FDIC-insured. The Corporation maintains cash and cash equivalents with certain financial institutions in excess of the FDIC insurance limit.

The Corporation is required to maintain reserves against deposit liabilities in the form of cash and balances with the Federal Reserve Bank. The reserves are based on deposit levels, account activity, and other services provided by the Federal Reserve Bank. Required reserves were $12,118,000 at September 30, 2012 and $14,035,000 at December 31, 2011.

5. FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS

The Corporation measures certain assets at fair value. 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” 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.

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.

The Corporation monitors and evaluates available data relating to fair value measurements on an ongoing basis and recognizes transfers among the levels of the fair value hierarchy as of the date of an event or change in circumstances that affects the valuation method chosen. Examples of such changes may include the market for a particular asset becoming active or inactive, changes in the availability of quoted prices, or changes in the availability of other market data.

At September 30, 2012 and December 31, 2011, assets measured at fair value and the valuation methods used are as follows:

			September 30, 2012
	Quoted Prices		Other
	in Active		Observable		Unobservable			Total
	Markets		Inputs		Inputs			Fair
(In Thousands)	(Level 1)		(Level 2)		(Level 3)			Value

Recurring fair value measurements
AVAILABLE-FOR-SALE SECURITIES:
Obligations of U.S. Government agencies	$	0	$	23,844	$	0		$	23,844
Obligations of states and political subdivisions:
Tax-exempt		0		141,519		0			141,519
Taxable		0		22,244		0			22,244
Mortgage-backed securities		0		90,357		0			90,357
Collateralized mortgage obligations, Issued by U.S. Government agencies		0		191,945		0			191,945
Trust preferred securities issued by individual institutions		0		6,221		0			6,221
Collateralized debt obligations:
Pooled trust preferred securities - senior tranches		0		0		2,496			2,496
Other collateralized debt obligations		0		660		0			660
Total debt securities		0		476,790		2,496			479,286
Marketable equity securities		8,028		0		0			8,028
Total available-for-sale securities		8,028		476,790		2,496			487,314
Servicing rights		0		0		568			568
Total recurring fair value measurements	$	8,028	$	476,790	$	3,064		$	487,882

Nonrecurring fair value measurements
Impaired loans with a valuation allowance	$	0	$	0	$	4,119		$	4,119
Valuation allowance		0		0		(1,468	)		(1,468	)
Impaired loans, net		0		0		2,651			2,651
Foreclosed assets held for sale		0		0		839			839
Total nonrecurring fair value measurements	$	0	$	0	$	3,490		$	3,490

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

			December 31, 2011
	Quoted Prices		Other
	in Active		Observable		Unobservable			Total
	Markets		Inputs		Inputs			Fair
(In Thousands)	(Level 1)		(Level 2)		(Level 3)			Value

Recurring fair value measurements
AVAILABLE-FOR-SALE SECURITIES:
Obligations of U.S. Government agencies	$	0	$	25,587	$	0		$	25,587
Obligations of states and political subdivisions:
Tax-exempt		0		132,962		0			132,962
Taxable		0		14,334		0			14,334
Mortgage-backed securities		0		121,769		0			121,769
Collateralized mortgage obligations, Issued by U.S. Government agencies		0		165,131		0			165,131
Trust preferred securities issued by individual institutions		0		8,146		0			8,146
Collateralized debt obligations:
Pooled trust preferred securities - senior tranches		0		0		4,638			4,638
Pooled trust preferred securities - mezzanine tranches		0		0		730			730
Other collateralized debt obligations		0		660		0			660
Total debt securities		0		468,589		5,368			473,957
Marketable equity securities		7,728		0		0			7,728
Total available-for-sale securities		7,728		468,589		5,368			481,685
Servicing rights		0		0		375			375
Total recurring fair value measurements	$	7,728	$	468,589	$	5,743		$	482,060

Nonrecurring fair value measurements
Impaired loans with a valuation allowance	$	0	$	0	$	3,433		$	3,433
Valuation allowance		0		0		(1,126	)		(1,126	)
Impaired loans, net		0		0		2,307			2,307
Foreclosed assets held for sale		0		0		1,235			1,235
Total nonrecurring fair value measurements	$	0	$	0	$	3,542		$	3,542

Management determined there have been few trades of pooled trust-preferred securities since 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, the Corporation follows a method of valuing pooled trust-preferred securities using a Level 3 methodology, based on discounted cash flows.

Management has calculated the fair value of the Corporation’s pooled trust-preferred securities by applying a discount rate to the estimated cash flows. Management used the cash flow estimates determined using the process described in Note 6 for evaluating pooled trust-preferred securities for other-than-temporary impairment (OTTI). 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 rate, management considered: (1) the implied discount rates as of the end of 2007, prior to the market for trust-preferred securities becoming inactive; (2) an adjustment to the year-end 2007 discount rates for the change in the spread between indicative market rates and corresponding risk-free rates; and (3) an additional adjustment for liquidity risk. Management considered the adjustment for liquidity risk necessary in order to give some consideration to price estimates based on trades made under distressed conditions, as reported by brokers and pricing services.

Loans are classified as impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Foreclosed assets held for sale consist of real estate acquired by foreclosure. For impaired commercial loans secured by real estate and foreclosed assets held for sale, estimated fair values are determined primarily using values from third-party appraisals less estimated selling costs.

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

Management’s evaluation and selection of valuation techniques and the unobservable inputs used in determining the fair values of assets valued using Level 3 methodologies include sensitive assumptions. Other market participants might use substantially different assumptions, which could result in calculations of fair values that would be substantially different than the amount calculated by management. The following table shows quantitative information regarding significant techniques and inputs used at September 30, 2012 for assets measured using unobservable inputs (Level 3 methodologies) on a recurring basis:

	Fair Value at
	9/30/12		Valuation	Unobservable	Method or Value As of
Asset	(In Thousands)		Technique	Input(s)	9/30/12
Pooled trust preferred securities - senior tranches	$	2,496	Discounted cash flow	Issuer defaults		46.15	%	Actual deferrals and defaults as % of outstanding collateral
						18.33	%	Expected additional net deferrals and defaults as % of performing collateral
				Issuer prepayments		50.15	%	Expected issuer prepayments as % of performing collateral
				Discount rate		11.70	%	Implied 7.57% discount rate at 12/31/07 plus 4.13% spread for credit and liquidity risk
Servicing rights		568	Discounted cash flow	Discount rate		12.00	%	Rate used through modeling period
				Loan prepayment speeds		260.00	%	Weighted-average PSA
				Servicing fees		0.25	%	of loan balances
						5.00	%	of payments are late
						5.00	%	late fees assessed
					$	1.94		Miscellaneous fees per account per month
				Servicing costs	$	5.50		Monthly servicing cost per account
					$	22.00		Additional monthly servicing cost per loan on loans more than 30 days delinquent
						1.50	%	of loans more than 30 days delinquent
						3.00	%	annual increase in servicing costs

Increases (decreases) in actual or expected issuer defaults tend to decrease (increase) the fair value of the Corporation’s pooled trust preferred securities. The fair value of servicing rights is affected by expected future interest rates. Increases (decreases) in future expected interest rates tend to increase (decrease) the fair value of the Corporation’s servicing rights because of changes in expected prepayment behavior by the borrowers on the underlying loans.

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

Following is a reconciliation of activity for Level 3 assets measured at fair value on a recurring basis:

	Three Months Ended September 30, 2012												Nine Months Ended September 30, 2012
	Pooled Trust			Pooled Trust									Pooled Trust			Pooled Trust
	Preferred			Preferred									Preferred			Preferred
	Securities -			Securities -									Securities -			Securities -
	Senior			Mezzanine			Servicing						Senior			Mezzanine			Servicing
	Tranches			Tranches			Rights			Total			Tranches			Tranches			Rights			Total
Balance, beginning of period	$	2,386		$	1,146		$	460		$	3,992		$	4,638		$	730		$	375		$	5,743
Issuances of servicing rights		0			0			133			133			0			0			262			262
Accretion and amortization, net		(1	)		0			0			(1	)		(6	)		0			0			(6	)
Proceeds from sales and calls		0			(1,781	)		0			(1,781	)		(2,515	)		(1,835	)		0			(4,350	)
Realized gains, net		0			1,781			0			1,781			40			1,835			0			1,875
Unrealized losses included in earnings		0			0			(25	)		(25	)		0			0			(69	)		(69	)
Unrealized gains (losses) included in other comprehensive income		111			(1,146	)		0			(1,035	)		339			(730	)		0			(391	)
Balance, end of period	$	2,496		$	0		$	568		$	3,064		$	2,496		$	0		$	568		$	3,064

	Three Months Ended September 30, 2011												Nine Months Ended September 30, 2011
	Pooled Trust			Pooled Trust									Pooled Trust			Pooled Trust
	Preferred			Preferred									Preferred			Preferred
	Securities -			Securities -									Securities -			Securities -
	Senior			Mezzanine			Servicing						Senior			Mezzanine			Servicing
	Tranches			Tranches			Rights			Total			Tranches			Tranches			Rights			Total
Balance, beginning of period	$	7,207		$	0		$	315		$	7,522		$	7,400		$	0		$	204		$	7,604
Issuances of servicing rights		0			0			50			50			0			0			190			190
Accretion and amortization, net		0			0			0			0			(34	)		0			0			(34	)
Proceeds from sales and calls		0			(24	)		0			(24	)		(2,035	)		(74	)		0			(2,109	)
Realized gains, net		0			24			0			24			25			74			0			99
Unrealized losses included in earnings		0			0			(19	)		(19	)		0			0			(48	)		(48	)
Unrealized (losses) gains included in other comprehensive income		(104	)		0			0			(104	)		1,747			0			0			1,747
Balance, end of period	$	7,103		$	0		$	346		$	7,449		$	7,103		$	0		$	346		$	7,449

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.

CERTIFICATES OF DEPOSIT - Fair values for certificates of deposit, included in cash and due from banks in the consolidated balance sheet, are based on quoted market prices for certificates of similar remaining maturities.

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 HELD FOR SALE - Fair values of loans held for sale are determined based on applicable sale prices available under the Federal Home Loan Banks’ MPF Xtra program.

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

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.

SERVICING RIGHTS - The fair value of servicing rights, included in other assets in the consolidated balance sheet, is determined through a discounted cash flow valuation. Significant inputs include expected net servicing income, the discount rate and the expected prepayment speeds of the underlying loans.

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 September 30, 2012 and December 31, 2011. The fair value of time deposits, such as certificates of deposit and Individual Retirement Accounts, 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.

OFF-BALANCE SHEET COMMITMENTS - The Corporation has commitments to extend credit and has issued standby letters of credit. Standby letters of credit are conditional guarantees of performance by a customer to a third party. Estimates of the fair value of these off-balance sheet items were not made because of the short-term nature of these arrangements and the credit standing of the counterparties.

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

(In Thousands)	Valuation	September 30, 2012				December 31, 2011
	Method(s)	Carrying		Fair		Carrying		Fair
	Used	Amount		Value		Amount		Value
Financial assets:
Cash and cash equivalents	Level 1	$	37,676	$	37,676	$	56,815	$	56,815
Certificates of deposit	Level 2		4,820		4,858		3,760		3,683
Available-for-sale securities	See Above		487,314		487,314		481,685		481,685
Restricted equity securities (included in Other Assets)	Level 2		5,551		5,551		6,773		6,773
Loans held for sale	Level 1		3,846		3,846		939		939
Loans, net	Level 3		690,357		711,553		700,610		718,670
Accrued interest receivable	Level 1		4,927		4,927		4,797		4,797
Servicing rights	Level 3		568		568		375		375

Financial liabilities:
Deposits with no stated maturity	Level 1		677,100		677,100		677,461		677,461
Time deposits	Level 3		335,910		339,060		340,745		344,936
Short-term borrowings	Level 3		19,657		19,684		4,950		4,897
Long-term borrowings	Level 3		89,954		103,009		125,363		145,641
Accrued interest payable	Level 1		163		163		358		358

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

6. SECURITIES

Amortized cost and fair value of available-for-sale securities at September 30, 2012 and December 31, 2011 are summarized as follows:

			September 30, 2012
			Gross		Gross
			Unrealized		Unrealized
	Amortized		Holding		Holding			Fair
(In Thousands)	Cost		Gains		Losses			Value

Obligations of U.S. Government agencies	$	23,181	$	663	$	0		$	23,844
Obligations of states and political subdivisions:
Tax-exempt		134,651		7,084		(216	)		141,519
Taxable		21,766		522		(44	)		22,244
Mortgage-backed securities		85,750		4,607		0			90,357
Collateralized mortgage obligations, Issued by U.S. Government agencies		188,169		3,777		(1	)		191,945
Trust preferred securities issued by individual institutions		6,173		48		0			6,221
Collateralized debt obligations:
Pooled trust preferred securities - senior tranches		2,515		0		(19	)		2,496
Other collateralized debt obligations		660		0		0			660
Total debt securities		462,865		16,701		(280	)		479,286
Marketable equity securities		5,562		2,506		(40	)		8,028
Total	$	468,427	$	19,207	$	(320	)	$	487,314

			December 31, 2011
			Gross		Gross
			Unrealized		Unrealized
	Amortized		Holding		Holding			Fair
(In Thousands)	Cost		Gains		Losses			Value

Obligations of U.S. Government agencies	$	24,877	$	710	$	0		$	25,587
Obligations of states and political subdivisions:
Tax-exempt		129,401		4,891		(1,330	)		132,962
Taxable		14,004		334		(4	)		14,334
Mortgage-backed securities		116,602		5,167		0			121,769
Collateralized mortgage obligations, Issued by U.S. Government agencies		161,818		3,350		(37	)		165,131
Trust preferred securities issued by individual institutions		7,334		865		(53	)		8,146
Collateralized debt obligations:
Pooled trust preferred securities - senior tranches		4,996		0		(358	)		4,638
Pooled trust preferred securities - mezzanine tranches		0		730		0			730
Other collateralized debt obligations		660		0		0			660
Total debt securities		459,692		16,047		(1,782	)		473,957
Marketable equity securities		5,643		2,186		(101	)		7,728
Total	$	465,335	$	18,233	$	(1,883	)	$	481,685

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

The following table presents gross unrealized losses and fair value of available-for-sale securities with unrealized loss positions that are not deemed to be other-than-temporarily impaired, aggregated by length of time that individual securities have been in a continuous unrealized loss position at September 30, 2012 and December 31, 2011:

September 30, 2012	Less Than 12 Months					12 Months or More					Total
(In Thousands)	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses

Obligations of states and political subdivisions:
Tax-exempt	$	5,161	$	(85	)	$	4,800	$	(131	)	$	9,961	$	(216	)
Taxable		2,722		(44	)		0		0			2,722		(44	)
Collateralized mortgage obligations, Issued by U.S. Government agencies		0		0			514		(1	)		514		(1	)
Collateralized debt obligations, Pooled trust preferred securities - senior tranches		0		0			2,496		(19	)		2,496		(19	)
Total debt securities		7,883		(129	)		7,810		(151	)		15,693		(280	)
Marketable equity securities		93		(8	)		68		(32	)		161		(40	)
Total temporarily impaired available-for-sale securities	$	7,976	$	(137	)	$	7,878	$	(183	)	$	15,854	$	(320	)

December 31, 2011	Less Than 12 Months					12 Months or More					Total
(In Thousands)	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses

Obligations of states and political subdivisions:
Tax-exempt	$	4,301	$	(34	)	$	20,692	$	(1,296	)	$	24,993	$	(1,330	)
Taxable		927		(2	)		244		(2	)		1,171		(4	)
Collateralized mortgage obligations, Issued by U.S. Government agencies		6,886		(36	)		5,075		(1	)		11,961		(37	)
Trust preferred securities issued by individual institutions		0		0			947		(53	)		947		(53	)
Collateralized debt obligations,Pooled trust preferred securities - senior tranches		0		0			4,638		(358	)		4,638		(358	)
Total debt securities		12,114		(72	)		31,596		(1,710	)		43,710		(1,782	)
Marketable equity securities		776		(44	)		98		(57	)		874		(101	)
Total temporarily impaired available-for-sale securities	$	12,890	$	(116	)	$	31,694	$	(1,767	)	$	44,584	$	(1,883	)

Gross realized gains and losses from available-for-sale securities (including OTTI losses in gross realized losses) and the related income tax provision were as follows:

(In Thousands)	3 Months Ended				9 Months Ended
	Sept. 30,		Sept. 30,		Sept. 30,			Sept. 30,
	2012		2011		2012			2011
Gross realized gains	$	2,430	$	26	$	2,747		$	2,035
Gross realized losses		0		0		(116	)		(7	)
Net realized gains	$	2,430	$	26	$	2,631		$	2,028
Income tax provision related to net realized gains	$	851	$	9	$	921		$	690

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

The amortized cost and fair value of available-for-sale debt securities by contractual maturity are shown in the following table as of September 30, 2012. Actual maturities may differ from contractual maturities because counterparties may have the right to call or prepay obligations with or without call or prepayment penalties.

	Amortized		Fair
(In Thousands)	Cost		Value

Due in one year or less	$	11,135	$	11,200
Due from one year through five years		50,186		51,753
Due from five years through ten years		39,869		40,891
Due after ten years		87,756		93,140
Subtotal		188,946		196,984
Mortgage-backed securities		85,750		90,357
Collateralized mortgage obligations, Issued by U.S. Government agencies		188,169		191,945
Total	$	462,865	$	479,286

The Corporation’s mortgage-backed securities and collateralized mortgage obligations have stated maturities that may differ from actual maturities due to borrowers’ ability to prepay obligations. Cash flows from such investments are dependent upon the performance of the underlying mortgage loans and are generally influenced by the level of interest rates. In the table above, mortgage-backed securities and collateralized mortgage obligations are shown in one period.

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 no impairment losses in earnings in the three-month period ended September 30, 2012. The Corporation recognized an impairment loss in earnings totaling $67,000 in the nine-month period ended September 30, 2012, which was related to a bank stock. No impairment losses were recognized in the three-month or nine-month periods ended September 30, 2011.

A summary of information management considered in evaluating debt and equity securities for OTTI at September 30, 2012 is provided below.

Debt Securities

At September 30, 2012, 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. Based on the results of the assessment, management believes impairment of these debt securities, including municipal bonds with no external ratings, at September 30, 2012 to be temporary.

The credit rating agencies have withdrawn their ratings on numerous municipal bonds held by the Corporation. At September 30, 2012, the total amortized cost basis of municipal bonds with no external credit ratings was $21,999,000, with an aggregate unrealized gain of $273,000. 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, and most of the ratings were removed in the fourth quarter 2009. 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 September 30, 2012:

(In Thousands)												Moody's/
										Cumulative		S&P/
										Realized		Fitch
		Par Amount		Amortized		Fair		Unrealized		Credit		Credit
Name of Issuer	Issuer's Parent Company	Outstanding		Cost		Value		Gain		Losses		Ratings
Astoria Capital Trust I	Astoria Financial Corporation	$	5,000	$	5,173	$	5,195	$	22	$	0		Ba1/BB/B+
Patriot Capital Trust I	Susquehanna Bancshares, Inc.		1,000		1,000		1,026		26		0		NR
Total		$	6,000	$	6,173	$	6,221	$	48	$	0

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.

The Corporation recognized OTTI charges in 2009 and 2010 related to its holding of a trust preferred security issued by Carolina First Mortgage Loan Trust, a subsidiary of The South Financial Group, Inc. In the fourth quarter 2010, The Toronto-Dominion Bank acquired The South Financial Group, Inc. After the acquisition, The Toronto-Dominion Bank made a payment for the full amount of previously deferred interest and resumed quarterly payments on the security. The Corporation recognized a material change in the expected cash flows in the fourth quarter 2010. The security had a face amount of $2,000,000 and matured in May 2012. Because the security matured, the Corporation recorded no accretion income in the three-month period ended September 30, 2012 but has recorded accretion income (included in interest income) totaling $855,000 in the nine-month period ended September 30, 2012. The Corporation recorded accretion income totaling $229,000 in the three-month period ended September 30, 2011 and $500,000 in the nine-month period ended September 30, 2011. For the year ended December 31, 2011, the Corporation recorded accretion income totaling $825,000.

Pooled trust-preferred securities are very long-term (usually 30-year maturity) instruments, 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 a lesser amount issued by insurance companies. Trust-preferred securities typically permit deferral of quarterly interest payments for up to five years, and 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. Some issuers have defaulted.

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’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 the assumptions used could produce different conclusions for each security. Additional information regarding these assumptions is included in Note 5.

During the third quarter 2012, management sold the Corporation’s holdings of the mezzanine tranches of U.S. Capital Funding II, Ltd. The securities were sold for aggregate pretax proceeds of $1,754,000, which was recorded as a gain on the sale of securities in the third quarter.

The following table provides detailed information related to ALESCO Preferred Funding IX, Ltd., which is the only mezzanine tranche pooled trust preferred security held by the Corporation as of September 30, 2012:

(In Thousands)

Tranche		C-1
Par Amount Outstanding	$	3,000
Amortized Cost	$	0
Fair Value	$	0
Unrealized Gain	$	0
Cumulative OTTI	$	(2,988	)

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

As of September 30, 2012, the Corporation’s investment in the senior tranche of MMCAPS Funding I, Ltd. is the only senior tranche pooled trust preferred security held by the Corporation. The security, with an amortized cost of $2,515,000, has an investment grade rating and has been subjected to impairment analysis based on estimated cash flows (using the process described above). Management determined that impairment was temporary as of September 30, 2012. The following table provides detailed information related to this security:

Number of Issuers Currently Performing	9
Moody's/Fitch Credit Ratings	A3/A
Actual Deferrals and Defaults as % of Outstanding Collateral	46.15	%
Expected Additional Net Deferrals and Defaults as % of Performing Collateral	18.33	%
Excess Subordination as % of Performing Collateral	57.60	%
Expected Issuer Prepayments as % of Performing Collateral	50.15	%

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 the Corporation’s investment)/Total face value of performing collateral.

The Excess Subordination Ratio measures the extent to which there may be tranches within the pooled trust preferred structure available to absorb credit losses before the Corporation’s security would be impacted. A positive Excess Subordination Ratio signifies there is available support from subordinate tranches to absorb losses before the Corporation’s investment would be impacted. A negative Excess Subordination Ratio signifies there is no available support from subordinate tranches to absorb losses before the Corporation’s securities would be impacted. The Excess Subordination Ratio is not definitive, in isolation, for determining OTTI or whether the Corporation will receive future payments on 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, who typically pay higher rates of interest than are paid out to the note holders.

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 recorded no OTTI losses related to pooled trust-preferred securities in the three-month and nine-month periods ended September 30, 2012 and 2011.

Equity Securities

The Corporation’s marketable equity securities at September 30, 2012 and December 31, 2011 consisted exclusively of stocks of banking companies. The Corporation recognized an impairment loss in earnings related to a bank stock of $67,000 in the first quarter 2012. Management’s decision to recognize an impairment loss on this security followed an evaluation of the issuer’s published financial results in which management determined that the recovery of the Corporation’s cost basis within the foreseeable future was uncertain. As a result of this determination, the Corporation recognized an impairment loss to write the stock down to the most recent trade price at March 31, 2012. The Corporation recognized no OTTI losses related to bank stocks in the second or third quarters of 2012. The Corporation recorded no OTTI losses related to bank stocks in the three-month or nine-month periods ended September 30, 2011. At September 30, 2012, management did not intend to sell impaired bank stocks, and based on the intent to hold the securities for the foreseeable future and other factors specific to the securities, has determined that none of the Corporation’s bank stock holdings at September 30, 2012 were other than temporarily impaired.

Realized gains from sales of bank stocks totaled $538,000 in the three-month and nine-month periods ended September 30, 2012. During the three months ended September 30, 2011, the Corporation did not sell any bank stocks and did not realize any gains or losses. Realized gains from sales of bank stocks totaled $91,000 in the nine months ended September 30, 2011.

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

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. There is no active market for FHLB-Pittsburgh stock, and it must ordinarily be redeemed by FHLB-Pittsburgh in order to be liquidated. C&N Bank’s investment in FHLB-Pittsburgh stock, included in Other Assets in the consolidated balance sheet, was $5,421,000 at September 30, 2012 and $6,643,000 at December 31, 2011. The Corporation evaluated its holding of FHLB-Pittsburgh stock for impairment and deemed the stock to not be impaired at September 30, 2012 and December 31, 2011. 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.

7. LOANS

The loans receivable portfolio is segmented into residential mortgage, commercial and consumer loans. The residential mortgage segment includes the following classes: first and junior lien residential mortgages, home equity lines of credit and residential construction loans. The most significant classes of commercial loans are commercial loans secured by real estate, non-real estate secured commercial and industrial loans, loans to political subdivisions, commercial construction and land loans, and loans secured by farmland.

Loans outstanding at September 30, 2012 and December 31, 2011 are summarized as follows:

Summary of Loans by Type
(In Thousands)	Sept. 30,			% of			Dec. 31,			% of
	2012			Total			2011			Total
Residential mortgage:
Residential mortgage loans - first liens	$	317,734			45.51	%	$	331,015			46.73	%
Residential mortgage loans - junior liens		27,084			3.88	%		28,851			4.07	%
Home equity lines of credit		32,550			4.66	%		30,037			4.24	%
1-4 Family residential construction		13,038			1.87	%		9,959			1.41	%
Total residential mortgage		390,406			55.92	%		399,862			56.45	%
Commercial:
Commercial loans secured by real estate		163,773			23.46	%		156,388			22.08	%
Commercial and industrial		49,405			7.08	%		57,191			8.07	%
Political subdivisions		35,549			5.09	%		37,620			5.31	%
Commercial construction and land		27,307			3.91	%		23,518			3.32	%
Loans secured by farmland		10,328			1.48	%		10,949			1.55	%
Multi-family (5 or more) residential		6,109			0.88	%		6,583			0.93	%
Agricultural loans		3,181			0.46	%		2,987			0.42	%
Other commercial loans		329			0.05	%		552			0.08	%
Total commercial		295,981			42.40	%		295,788			41.76	%
Consumer		11,762			1.68	%		12,665			1.79	%
Total		698,149			100.00	%		708,315			100.00	%
Less: allowance for loan losses		(7,792	)					(7,705	)
Loans, net	$	690,357					$	700,610

The Corporation grants loans to individuals as well as commercial and tax-exempt entities. Commercial, residential and personal loans are made to customers geographically concentrated in the Pennsylvania and New York counties that comprise the market serviced by Citizens & Northern Bank. Although the Corporation has a diversified loan portfolio, a significant portion of its debtors’ ability to honor their contracts is dependent on the local economic conditions within the region. There is no concentration of loans to borrowers engaged in similar businesses or activities that exceed 10% of total loans at either September 30, 2012 or December 31, 2011.

The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and recorded as a reduction of the investment in loans. The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Corporation’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available. In the process of evaluating the loan portfolio, management also considers the Corporation’s exposure to losses from unfunded loan commitments. As of September 30, 2012 and December 31, 2011, management determined that no allowance for credit losses related to unfunded loan commitments was required.

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

Transactions within the allowance for loan losses, summarized by segment and class, for the three-month and nine-month periods ended September 30, 2012 and 2011 were as follows:

Nine Months Ended September 30, 2012	Dec. 31,										Sept. 30,
(In Thousands)	2011 Balance		Charge-offs			Recoveries		Provision (Credit)			2012 Balance
Allowance for Loan Losses:
Residential mortgage:
Residential mortgage loans - first liens	$	3,026	$	(222	)	$	18	$	154		$	2,976
Residential mortgage loans - junior liens		266		0			0		(14	)		252
Home equity lines of credit		231		0			0		20			251
1-4 Family residential construction		79		0			0		19			98
Total residential mortgage		3,602		(222	)		18		179			3,577
Commercial:
Commercial loans secured by real estate		2,004		0			0		(28	)		1,976
Commercial and industrial		946		(43	)		6		(232	)		677
Political subdivisions		0		0			0		0			0
Commercial construction and land		267		0			0		409			676
Loans secured by farmland		126		0			0		(6	)		120
Multi-family (5 or more) residential		66		0			0		(5	)		61
Agricultural loans		27		0			0		2			29
Other commercial loans		5		0			0		(2	)		3
Total commercial		3,441		(43	)		6		138			3,542
Consumer		228		(139	)		46		103			238
Unallocated		434		0			0		1			435

Total Allowance for Loan Losses	$	7,705	$	(404	)	$	70	$	421		$	7,792

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

Nine Months Ended September 30, 2011

	December 31,										Sept. 30,
(In Thousands)	2010 Balance		Charge- offs			Recoveries		Provision (Credit)			2011 Balance
Allowance for Loan Losses:
Residential mortgage:
Residential mortgage loans - first liens	$	2,745	$	(49	)	$	0	$	367		$	3,063
Residential mortgage loans - junior liens		334		(51	)		0		(6	)		277
Home equity lines of credit		218		0			0		13			231
1-4 Family residential construction		208		0			0		(130	)		78
Total residential mortgage		3,505		(100	)		0		244			3,649
Commercial:
Commercial loans secured by real estate		3,314		(535	)		1		(336	)		2,444
Commercial and industrial		862		(216	)		177		51			874
Political subdivisions		0		0			0		0			0
Commercial construction and land		590		0			0		(295	)		295
Loans secured by farmland		139		0			0		(17	)		122
Multi-family (5 or more) residential		63		0			0		5			68
Agricultural loans		32		0			0		(7	)		25
Other commercial loans		0		0			0		5			5
Total commercial		5,000		(751	)		178		(594	)		3,833
Consumer		289		(116	)		57		(3	)		227
Unallocated		313		0			0		155			468

Total Allowance for Loan Losses	$	9,107	$	(967	)	$	235	$	(198	)	$	8,177

Three Months Ended September 30, 2012

	June 30,										Sept. 30,
(In Thousands)	2012 Balance		Charge- offs			Recoveries		Provision (Credit)			2012 Balance
Allowance for Loan Losses:
Residential mortgage:
Residential mortgage loans - first liens	$	2,888	$	(34	)	$	0	$	122		$	2,976
Residential mortgage loans - junior liens		254		0			0		(2	)		252
Home equity lines of credit		245		0			0		6			251
1-4 Family residential construction		80		0			0		18			98
Total residential mortgage		3,467		(34	)		0		144			3,577
Commercial:
Commercial loans secured by real estate		1,976		0			0		0			1,976
Commercial and industrial		712		(8	)		1		(28	)		677
Political subdivisions		0		0			0		0			0
Commercial construction and land		606		0			0		70			676
Loans secured by farmland		117		0			0		3			120
Multi-family (5 or more) residential		64		0			0		(3	)		61
Agricultural loans		29		0			0		0			29
Other commercial loans		5		0			0		(2	)		3
Total commercial		3,509		(8	)		1		40			3,542
Consumer		245		(71	)		11		53			238
Unallocated		436		0			0		(1	)		435

Total Allowance for Loan Losses	$	7,657	$	(113	)	$	12	$	236		$	7,792

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

Three Months Ended September 30, 2011

	June 30,										Sept. 30,
(In Thousands)	2011 Balance		Charge- offs			Recoveries		Provision (Credit)			2011 Balance
Allowance for Loan Losses:
Residential mortgage:
Residential mortgage loans - first liens	$	3,050	$	(21	)	$	0	$	34		$	3,063
Residential mortgage loans - junior liens		293		0			0		(16	)		277
Home equity lines of credit		220		0			0		11			231
1-4 Family residential construction		67		0			0		11			78
Total residential mortgage		3,630		(21	)		0		40			3,649
Commercial:
Commercial loans secured by real estate		2,502		0			1		(59	)		2,444
Commercial and industrial		908		(17	)		0		(17	)		874
Political subdivisions		0		0			0		0			0
Commercial construction and land		281		0			0		14			295
Loans secured by farmland		134		0			0		(12	)		122
Multi-family (5 or more) residential		75		0			0		(7	)		68
Agricultural loans		29		0			0		(4	)		25
Other commercial loans		5		0			0		0			5
Total commercial		3,934		(17	)		1		(85	)		3,833
Consumer		275		(32	)		14		(30	)		227
Unallocated		430		0			0		38			468

Total Allowance for Loan Losses	$	8,269	$	(70	)	$	15	$	(37	)	$	8,177

In the evaluation of the loan portfolio, management determines two major components for the allowance for loan losses – (1) a specific component based on an assessment of certain larger relationships, mainly commercial purpose loans, on a loan-by-loan basis; and (2) a general component for the remainder of the portfolio based on a collective evaluation of pools of loans with similar risk characteristics. The general component is assigned to each pool of loans based on both historical net charge-off experience, and an evaluation of certain qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the above methodologies for estimating specific and general losses in the portfolio.

In determining the larger loan relationships for detailed assessment under the specific allowance component, the Corporation uses an internal risk rating system. Under the risk rating system, the Corporation classifies problem or potential problem loans as “Special Mention,” “Substandard,” or “Doubtful” on the basis of currently existing facts, conditions and values. Substandard loans include those characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected. Loans classified as Doubtful have all the weaknesses inherent in those classified as Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans that do not currently expose the Corporation to sufficient risk to warrant classification as Substandard or Doubtful, but possess weaknesses that deserve management’s close attention, are deemed to be Special Mention. Risk ratings are updated any time that conditions or the situation warrants. Loans not classified are included in the “Pass” column in the table below.

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

The following tables summarize the aggregate credit quality classification of outstanding loans by risk rating as of September 30, 2012 and December 31, 2011:

September 30, 2012:
(In Thousands)	Pass		Special Mention		Substandard		Doubtful		Total
Residential mortgage:
Residential mortgage loans - first liens	$	302,580	$	2,689	$	11,948	$	517	$	317,734
Residential mortgage loans - junior liens		25,693		437		954		0		27,084
Home equity lines of credit		31,990		98		462		0		32,550
1-4 Family residential construction		12,955		0		83		0		13,038
Total residential mortgage		373,218		3,224		13,447		517		390,406
Commercial:
Commercial loans secured by real estate		151,637		6,666		5,470		0		163,773
Commercial and industrial		42,146		3,057		3,998		204		49,405
Political subdivisions		35,436		113		0		0		35,549
Commercial construction and land		25,601		187		330		1,189		27,307
Loans secured by farmland		8,018		756		1,520		34		10,328
Multi-family (5 or more) residential		5,751		348		10		0		6,109
Agricultural loans		3,090		28		63		0		3,181
Other commercial loans		329		0		0		0		329
Total commercial		272,008		11,155		11,391		1,427		295,981
Consumer		11,537		13		212		0		11,762
Totals	$	656,763	$	14,392	$	25,050	$	1,944	$	698,149

December 31, 2011:
(In Thousands)	Pass		Special Mention		Substandard		Doubtful		Total
Residential mortgage:
Residential mortgage loans - first liens	$	314,900	$	2,955	$	12,956	$	204	$	331,015
Residential mortgage loans - junior liens		27,260		660		924		7		28,851
Home equity lines of credit		29,408		264		365		0		30,037
1-4 Family residential construction		9,959		0		0		0		9,959
Total residential mortgage		381,527		3,879		14,245		211		399,862
Commercial:
Commercial loans secured by real estate		143,247		7,385		5,046		710		156,388
Commercial and industrial		46,110		6,254		4,413		414		57,191
Political subdivisions		37,499		121		0		0		37,620
Commercial construction and land		21,668		211		1,639		0		23,518
Loans secured by farmland		8,040		1,341		1,531		37		10,949
Multi-family (5 or more) residential		6,200		369		14		0		6,583
Agricultural loans		2,765		164		58		0		2,987
Other commercial loans		552		0		0		0		552
Total commercial		266,081		15,845		12,701		1,161		295,788
Consumer		12,437		20		207		1		12,665

Totals	$	660,045	$	19,744	$	27,153	$	1,373	$	708,315

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

The general component of the allowance for loan losses covers pools of loans including commercial loans not considered individually impaired, as well as smaller balance homogeneous classes of loans, such as residential real estate, home equity lines of credit and other consumer loans. Accordingly, the Corporation generally does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are subject to a restructuring agreement. The pools of loans are evaluated for loss exposure based upon three-year average historical net charge-off rates for each loan class, adjusted for qualitative factors. Qualitative risk factors (described in the following paragraph) are evaluated for the impact on each of the three segments (residential mortgage, commercial and consumer) within the loan portfolio. Each qualitative factor is assigned a value to reflect improving, stable or declining conditions based on management’s judgment using relevant information available at the time of the evaluation. The adjustment for qualitative factors is applied as an increase or decrease to the three-year average net charge-off rate to each loan class within each segment.

The qualitative factors used in the general component calculations are designed to address credit risk characteristics associated with each segment. The Corporation’s credit risk associated with all of the segments is significantly impacted by these factors, which include economic conditions within its market area, the Corporation’s lending policies, changes or trends in the portfolio, risk profile, competition, regulatory requirements and other factors. Further, the residential mortgage segment is significantly affected by the values of residential real estate that provide collateral for the loans. The majority of the Corporation’s commercial segment loans (approximately 70% at September 30, 2012) is secured by real estate, and accordingly, the Corporation’s risk for the commercial segment is significantly affected by commercial real estate values. The consumer segment includes a wide mix of loans for different purposes, primarily secured loans, including loans secured by motor vehicles, manufactured housing and other types of collateral.

Loans are classified as impaired, when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial loans, by the fair value of the collateral (if the loan is collateral dependent), by future cash flows discounted at the loan’s effective rate or by the loan’s observable market price.

The scope of loans evaluated individually for impairment include all loan relationships greater than $200,000 for which there is at least one extension of credit graded Special Mention, Substandard or Doubtful. Also, all loans classified as troubled debt restructurings (discussed in more detail below) and all loan relationships less than $200,000 in the aggregate, but with an estimated loss of $100,000 or more, are individually evaluated for impairment. Loans that are individually evaluated for impairment, but which are not determined to be impaired, are combined with all remaining loans that are not reviewed on a specific basis, and such loans are included within larger pools of loans based on similar risk and loss characteristics for purposes of determining the general component of the allowance. The loans that have been individually evaluated, but which have not been determined to be impaired, are included in the “Collectively Evaluated” column in the tables summarizing the allowance and associated loan balances as of September 30, 2012 and December 31, 2011.

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

The following tables present a summary of loan balances and the related allowance for loan losses summarized by portfolio segment and class for each impairment method used as of September 30, 2012 and December 31, 2011:

September 30, 2012	Loans:						Allowance for Loan Losses:
(In Thousands)
	Individually		Collectively				Individually		Collectively
	Evaluated		Evaluated		Totals		Evaluated		Evaluated		Totals
Residential mortgage:
Residential mortgage loans - first liens	$	2,469	$	315,265	$	317,734	$	517	$	2,459	$	2,976
Residential mortgage loans - junior liens		58		27,026		27,084		0		252		252
Home equity lines of credit		0		32,550		32,550		0		251		251
1-4 Family residential construction		0		13,038		13,038		0		98		98
Total residential mortgage		2,527		387,879		390,406		517		3,060		3,577
Commercial:
Commercial loans secured by real estate		1,920		161,853		163,773		147		1,829		1,976
Commercial and industrial		891		48,514		49,405		285		392		677
Political subdivisions		0		35,549		35,549		0		0		0
Commercial construction and land		1,476		25,831		27,307		441		235		676
Loans secured by farmland		925		9,403		10,328		34		86		120
Multi-family (5 or more) residential		10		6,099		6,109		0		61		61
Agricultural loans		40		3,141		3,181		0		29		29
Other commercial loans		0		329		329		0		3		3
Total commercial		5,262		290,719		295,981		907		2,635		3,542
Consumer		48		11,714		11,762		44		194		238
Unallocated												435

Total	$	7,837	$	690,312	$	698,149	$	1,468	$	5,889	$	7,792

December 31, 2011	Loans:						Allowance for Loan Losses:
(In Thousands)
	Individually		Collectively				Individually		Collectively
	Evaluated		Evaluated		Totals		Evaluated		Evaluated		Totals
Residential mortgage:
Residential mortgage loans - first liens	$	2,227	$	328,788	$	331,015	$	461	$	2,565	$	3,026
Residential mortgage loans - junior liens		137		28,714		28,851		11		255		266
Home equity lines of credit		93		29,944		30,037		0		231		231
1-4 Family residential construction		0		9,959		9,959		0		79		79
Total residential mortgage		2,457		397,405		399,862		472		3,130		3,602
Commercial:
Commercial loans secured by real estate		2,169		154,219		156,388		169		1,835		2,004
Commercial and industrial		942		56,249		57,191		361		585		946
Political subdivisions		0		37,620		37,620		0		0		0
Commercial construction and land		1,266		22,252		23,518		65		202		267
Loans secured by farmland		927		10,022		10,949		35		91		126
Multi-family (5 or more) residential		14		6,569		6,583		0		66		66
Agricultural loans		39		2,948		2,987		0		27		27
Other commercial loans		0		552		552		0		5		5
Total commercial		5,357		290,431		295,788		630		2,811		3,441
Consumer		50		12,615		12,665		24		204		228
Unallocated												434

Total	$	7,864	$	700,451	$	708,315	$	1,126	$	6,145	$	7,705

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

Summary information related to impaired loans as of September 30, 2012 and December 31, 2011 is as follows:

	As of		As of
(In Thousands)	Sept. 30,		Dec. 31,
	2012		2011
Impaired loans with a valuation allowance	$	4,119	$	3,433
Impaired loans without a valuation allowance		3,718		4,431
Total impaired loans	$	7,837	$	7,864
Valuation allowance related to impaired loans	$	1,468	$	1,126

The average balance of impaired loans and interest income recognized on impaired loans is as follows:

(In Thousands)	3 Months Ended				9 Months Ended
	September 30,				September 30,
	2012		2011		2012		2011
Average investment in impaired loans	$	7,325	$	7,288	$	7,175	$	7,654
Interest income recognized on impaired loans		90		86		228		172
Interest income recognized on a cash basis on impaired loans		90		86		228		172

Loans are placed on nonaccrual status for all classes of loans when, in the opinion of management, collection of interest is doubtful. Any unpaid interest previously accrued on those loans is reversed from income. Interest income is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on loans for which the risk of further loss is greater than remote are applied as a reduction of the loan principal balance. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectability of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans receivable is determined based on contractual due dates for loan payments. Also, the amortization of deferred loan fees is discontinued when a loan is placed on nonaccrual status.

The breakdown by portfolio segment and class of nonaccrual loans and loans past due ninety days or more and still accruing is as follows:

(In Thousands)	September 30, 2012				December 31, 2011
	Past Due				Past Due
	90+ Days and				90+ Days and
	Accruing		Nonaccrual		Accruing		Nonaccrual
Residential mortgage:
Residential mortgage loans - first liens	$	1,872	$	3,001	$	949	$	3,058
Residential mortgage loans - junior liens		42		11		11		67
Home equity lines of credit		55		0		0		0
Total residential mortgage		1,969		3,012		960		3,125
Commercial:
Commercial loans secured by real estate		106		1,312		75		1,595
Commercial and industrial		83		623		21		541
Commercial construction and land		0		1,328		139		978
Loans secured by farmland		52		925		53		927
Agricultural loans		0		40		0		0
Total commercial		241		4,228		288		4,041
Consumer		50		29		19		31

Totals	$	2,260	$	7,269	$	1,267	$	7,197

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

The amounts shown in the table immediately above include loans classified as troubled debt restructurings (described in more detail below), if such loans are past due ninety days or more or nonaccrual.

The table below presents a summary of the contractual aging of loans as of September 30, 2012 and December 31, 2011:

	As of September 30, 2012								As of December 31, 2011
	Current &								Current &
(In Thousands)	Past Due		Past Due		Past Due				Past Due		Past Due		Past Due
	Less than		30-89		90+				Less than		30-89		90+
	30 Days		Days		Days		Total		30 Days		Days		Days		Total
Residential mortgage:
Residential mortgage loans - first liens	$	310,500	$	4,136	$	3,098	$	317,734	$	321,907	$	6,723	$	2,385	$	331,015
Residential mortgage loans - junior liens		26,648		394		42		27,084		28,437		393		21		28,851
Home equity lines of credit		32,119		376		55		32,550		29,986		51		0		30,037
1-4 Family residential construction		13,038		0		0		13,038		9,959		0		0		9,959
Total residential mortgage		382,305		4,906		3,195		390,406		390,289		7,167		2,406		399,862
Commercial:
Commercial loans secured by real estate		161,994		965		814		163,773		155,025		343		1,020		156,388
Commercial and industrial		48,739		283		383		49,405		56,835		169		187		57,191
Political subdivisions		35,549		0		0		35,549		37,620		0		0		37,620
Commercial construction and land		25,792		215		1,300		27,307		22,323		1,056		139		23,518
Loans secured by farmland		9,274		77		977		10,328		9,973		33		943		10,949
Multi-family (5 or more) residential		6,109		0		0		6,109		6,583		0		0		6,583
Agricultural loans		3,141		0		40		3,181		2,945		3		39		2,987
Other commercial loans		329		0		0		329		552		0		0		552
Total commercial		290,927		1,540		3,514		295,981		291,856		1,604		2,328		295,788
Consumer		11,582		130		50		11,762		12,340		306		19		12,665

Totals	$	684,814	$	6,576	$	6,759	$	698,149	$	694,485	$	9,077	$	4,753	$	708,315

Nonaccrual loans are included in the contractual aging immediately above and on the previous page. A summary of the contractual aging of nonaccrual loans at September 30, 2012 and December 31, 2011 is as follows:

	Current &
(In Thousands)	Past Due		Past Due		Past Due
	Less than		30-89		90+
	30 Days		Days		Days		Total
September 30, 2012 Nonaccrual Totals	$	2,195	$	575	$	4,499	$	7,269
December 31, 2011 Nonaccrual Totals	$	2,532	$	1,179	$	3,486	$	7,197

Loans whose terms are modified are classified as Troubled Debt Restructurings (TDRs) if the Corporation grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty. Loans classified as TDRs are designated as impaired. The outstanding balance of loans subject to TDRs, as well as contractual aging information at September 30, 2012 and December 31, 2011 is as follows:

Troubled Debt Restructurings (TDRs)

	Current &
(In Thousands)	Past Due		Past Due		Past Due
	Less than		30-89		90+
	30 Days		Days		Days		Nonaccrual		Total
September 30, 2012 Totals	$	916	$	0	$	0	$	1,753	$	2,669
December 31, 2011 Totals	$	1,064	$	0	$	146	$	2,267	$	3,477

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

There were no TDRs that occurred during the third quarter 2012. TDRs that occurred during the nine-month period ended September 30, 2012, and during the three-month and nine-month periods ended September 30, 2011, are as follows:

Nine Months Ended September 30, 2012

Pre-

Post-

(Balances in Thousands)

Modification

Number

Outstanding

Recorded

Contracts

Investment

Commercial,

Commercial and industrial

3 Months Ended September 30, 2011

Pre-

Post-

(Balances in Thousands)

Modification

Number

Outstanding

Recorded

Contracts

Investment

Commercial,

Commercial loans secured by real estate

925

9 Months Ended September 30, 2011			Pre-		Post-
(Balances in Thousands)			Modification		Modification
	Number		Outstanding		Outstanding
	Of		Recorded		Recorded
	Contracts		Investment		Investment
Residential mortgage,
Home equity lines of credit		1	$	93	$	93

Commercial:
Commercial loans secured by real estate		11		1,941		1,941
Commercial and industrial		3		14		14
Commercial construction and land		5		1,238		1,238
Multi-family (5 or more) residential		1		15		15

The TDR in the nine-month period ended September 30, 2012 was an extension of the final maturity and lowering of monthly payments required on a commercial loan. There was no allowance for loan losses on this loan at September 30, 2012, and no change in the allowance for loan losses resulting from this TDR.

The TDR in the third quarter 2011 in the table above stems from a forbearance agreement entered into with a commercial customer. The total principal balance of loans included in the forbearance agreement was $1,588,000, of which the Corporation had charged off $663,000 in the second quarter 2011, and subsequently charged off an additional $438,000 in the fourth quarter 2011. Under the terms of the forbearance agreement, the Corporation had agreed to accept payment of less than the total principal amount of the loans, assuming payment was received by dates specified within the forbearance agreement. In the first nine months of 2012, the loans were not repaid and the forbearance agreement expired. Accordingly, the Corporation’s concession terminated, and the loans were not classified as TDRs at September 30, 2012. The outstanding balance of the loans was $466,000 at September 30, 2012 and December 31, 2011. The loans were in nonaccrual status at September 30, 2012 and December 31, 2011. At September 30, 2012, the risk rating of the loans was Substandard, while the risk rating of the loans was Doubtful at December 31, 2011. Based on management’s estimate of the value of the underlying collateral, net of selling costs, the Corporation had no allowance for loan losses associated with these loans at September 30, 2012 and December 31, 2011.

Other TDRs in the nine-month period ended September 30, 2011 included extensions of terms and maturities at lower than current market rates and acceptance of interest-only payments for extended periods of time.

In the three-month and nine-month periods ended September 30, 2011, there were no changes in the allowance for loan losses resulting from the TDRs that occurred during those periods.

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

In the third quarter 2012, there were no defaults on loans for which modifications considered to be TDRs were entered into within the previous 12 months. In the nine-month period ended September 30, 2012, such defaults are as follows:

Nine Months Ended September 30, 2012

	Number
(Balances in Thousands)	of		Recorded
	Contracts		Investment
Commercial,
Commercial construction and land		1	$	950

The event of default in the table above resulted from the borrowers’ failure to make payments due at maturity, based on a loan maturity date that had been extended from the original due date. The allowance for loan losses on this loan was $277,000 at September 30, 2012, an increase of $212,000 over the allowance on the loan at December 31, 2011.

8. BORROWED FUNDS

SHORT-TERM BORROWINGS

Short-term borrowings include the following:

(In Thousands)	Sept. 30,		Dec. 31,
	2012		2011
FHLB-Pittsburgh borrowing	$	15,000	$	0
Customer repurchase agreements		4,657		4,950
Total short-term borrowings	$	19,657	$	4,950

The FHLB-Pittsburgh loan facilities are collateralized by qualifying loans secured by real estate with a book value totaling $515,545,000 at September 30, 2012 and $499,311,000 at December 31, 2011. Also, the FHLB-Pittsburgh loan facilities require the Corporation to invest in established amounts of FHLB-Pittsburgh stock. The carrying values of the Corporation’s holdings of FHLB-Pittsburgh stock (included in Other Assets) were $5,421,000 at September 30, 2012 and $6,643,000 at December 31, 2011.

The short-term borrowing from the FHLB-Pittsburgh matures in October 2012 and has an interest rate of 0.23%.

The Corporation engages in repurchase agreements with certain commercial customers. These agreements provide that the Corporation sells specified investment securities to the customers on an overnight basis and repurchases them on the following business day. The carrying value of the underlying securities was $11,347,000 at September 30, 2012 and $19,837,000 at December 31, 2011.

LONG-TERM BORROWINGS

Long-term borrowings are as follows:

(In Thousands)	Sept. 30,		Dec. 31,
	2012		2011
FHLB-Pittsburgh borrowings	$	21,954	$	40,363
Repurchase agreements		68,000		85,000
Total long-term borrowings	$	89,954	$	125,363

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

Long-term borrowings from FHLB-Pittsburgh are as follows:

(In Thousands)	Sept. 30,		Dec. 31,
	2012		2011

Loans that matured in 2012 with rates ranging from 4.46% to 4.54%	$	0	$	17,500
Loans maturing 4th quarter 2012 with rates ranging from 3.66% to 4.82%		5,992		6,007
Loans maturing in 2013 with rates ranging from 2.86% to 3.62%		3,297		3,553
Loan maturing in 2016 with a rate of 6.86%		206		236
Loans maturing in 2017 with rates ranging from 3.81% to 6.83%		10,028		10,032
Loans maturing in 2020 with rates ranging from 4.67% to 4.79%		1,334		1,892
Loan maturing in 2025 with a rate of 4.91%		1,097		1,143
Total long-term FHLB-Pittsburgh borrowings	$	21,954	$	40,363

Repurchase agreements included in long-term borrowings are as follows:

(In Thousands)	Sept. 30,		Dec. 31,
	2012		2011

Agreement maturing in 2013 with a rate of 3.13%, prepaid in 2012	$	0	$	5,000
Agreements maturing in 2017 with rates ranging from 3.60% to 4.27%		68,000		80,000
Total long-term repurchase agreements	$	68,000	$	85,000

The Corporation incurred losses totaling $2,333,000 from prepayment of repurchase agreement obligations in the nine-month period ended September 30, 2012, including: (1) a loss of $143,000 in the second quarter 2012 on prepayment of the agreement contractually scheduled to mature in 2013, and (2) a loss of $2,190,000 in the third quarter 2012 on prepayment of a total of $12,000,000 of the agreements contractually scheduled to mature in 2017.

In December 2007, the Corporation entered into two repurchase agreements of $40,000,000 each with embedded caps. These repurchase agreements mature in 2017. In the third quarter 2012, the Corporation paid off principal totaling $6,000,000 on each of these agreements, incurring the loss from prepayment noted above and leaving a balance of $34,000,000 outstanding for each agreement at September 30, 2012. One of these borrowings has an interest rate of 3.60% and became putable by the issuer at quarterly intervals starting in December 2010. The other borrowing has an interest rate of 4.27% and is putable by the issuer at quarterly intervals starting in December 2012. Each of these borrowings contain an embedded cap, providing that on the quarterly anniversary of the transaction settlement date, if three-month LIBOR is higher than 5.15%, the Corporation’s interest rate payable will decrease by twice the amount of the excess, down to a minimum rate of 0%. The embedded cap on one of the agreements expired on its initial put date in December 2010, and the embedded cap on the other agreement will expire on the initial put date in December 2012.

Securities sold under repurchase agreements were delivered to the broker-dealers who arranged the transactions. The broker-dealers may have sold, loaned or otherwise disposed of such securities to other parties in the normal course of their operations, and have agreed to resell to the Corporation substantially identical securities at the maturities of the agreements. The carrying value of the underlying securities was $89,040,000 at September 30, 2012 and $110,759,000 at December 31, 2011.

9. 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 significantly affect the liability balance at September 30, 2012 and December 31, 2011, and are not expected to significantly affect the Corporation's future expenses. The Corporation uses a December 31 measurement date for the postretirement plan.

In an acquisition in 2007, the Corporation assumed the Citizens Trust Company Retirement Plan, a defined benefit pension plan. This plan covers certain employees who were employed by Citizens Trust Company on December 31, 2002, when the plan was amended to discontinue admittance of any future participant and to freeze benefit accruals. Information related to the Citizens Trust Company Retirement Plan has been included in the tables that follow. The Corporation uses a December 31 measurement date for this plan.

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

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

Defined Benefit Plans
(In Thousands)	Pension						Postretirement
	Nine Months Ended						Nine Months Ended
	September 30,						September 30,
	2012			2011			2012		2011
Service cost	$	0		$	0		$	68	$	62
Interest cost		54			55			61		69
Expected return on plan assets		(54	)		(54	)		0		0
Amortization of transition (asset) obligation		0			0			27		27
Amortization of prior service cost		0			0			11		11
Recognized net actuarial loss		22			3			0		0
Net periodic benefit cost	$	22		$	4		$	167	$	169

Defined Benefit Plans
(In Thousands)	Pension						Postretirement
	Three Months Ended						Three Months Ended
	September 30,						September 30,
	2012			2011			2012		2011
Service cost	$	0		$	0		$	22	$	20
Interest cost		18			18			20		23
Expected return on plan assets		(18	)		(18	)		0		0
Amortization of transition (asset) obligation		0			0			9		9
Amortization of prior service cost		0			0			4		4
Recognized net actuarial loss		7			1			0		0
Net periodic benefit cost	$	7		$	1		$	55	$	56

In the first nine months of 2012, the Corporation funded postretirement contributions totaling $44,000, with estimated annual postretirement contributions of $60,000 expected in 2012 for the full year. The Corporation made a contribution to the defined benefit pension plan of $21,000 in the first quarter of 2012 for the 2011 plan year. Based upon the related actuarial reports, the Corporation made a $23,000 contribution in the second quarter 2012 for the 2012 plan year. No further contributions are required in 2012, though the Corporation may make additional discretionary contributions.

10. STOCK-BASED COMPENSATION PLANS

In January 2012, the Corporation granted options to purchase a total of 64,757 shares of common stock through its Stock Incentive and Independent Directors Stock Incentive Plans. In January 2011, the Corporation granted options to purchase a total of 93,674 shares of common stock. The exercise price for the 2012 awards is $18.54 per share, and the exercise price for the 2011 awards is $15.06 per share, based on the market price as of the date of grant. Stock option expense is recognized over the vesting period of each option. The Corporation expects total stock option expense for the year ending December 31, 2012 will be $247,000, and total stock option expense for the year ended December 31, 2011 was $279,000.

The Corporation records stock option expense based on estimated fair value calculated using an option valuation model. In calculating the 2012 and 2011 fair values, 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:

	2012			2011
Fair value of each option granted	$	5.15		$	4.26
Volatility		41	%		37	%
Expected option lives		7 Years			8 Years
Risk-free interest rate		1.53	%		3.10	%
Dividend yield		3.97	%		3.86	%

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

In calculating the estimated fair value of 2012 and 2011 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 expected option lives were based on management’s estimates of the average term for all options issued under both plans. In 2012 and 2011, management assumed a 33% 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 January 2012, the Corporation awarded a total of 42,552 shares of restricted stock under the Stock Incentive and Independent Directors Stock Incentive Plans. In January 2011, a total of 15,622 shares of restricted stock were awarded under the 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, the Corporation must meet an annual targeted return on average equity (“ROAE”) performance ratio, as defined, in order for participants to vest. Management has estimated restricted stock expense in the first nine months of 2012 based on an assumption that the ROAE target for 2012 will be met. 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.

Total stock-based compensation expense is as follows:

(In Thousands)	Three Months Ended				Nine Months Ended
	Sept. 30,		Sept. 30,		Sept. 30,		Sept. 30,
	2012		2011		2012		2011
Stock options	$	0	$	0	$	247	$	279
Restricted stock		76		35		240		107

Total	$	76	$	35	$	487	$	386

11. INCOME TAXES

The net deferred tax asset at September 30, 2012 and December 31, 2011 represents the following temporary difference components:

	September 30,		December 31,
(In Thousands)	2012		2011
Deferred tax assets:
Defined benefit plans - ASC 835	$	243	$	324
Net realized losses on securities		1,217		3,175
Allowance for loan losses		2,727		2,697
Credit for alternative minimum tax paid		4,157		4,569
Net operating loss carryforwards		0		44
General business credit carryforwards		0		831
Other deferred tax assets		1,862		1,671
Total deferred tax assets		10,206		13,311

Deferred tax liabilities:
Unrealized holding gains on securities		6,609		5,559
Bank premises and equipment		1,346		1,357
Core deposit intangibles		55		74
Other deferred tax liabilities		74		148
Total deferred tax liabilities		8,084		7,138
Deferred tax asset, net	$	2,122	$	6,173

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

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 September 30, 2012. Of the total deferred tax asset from realized losses on securities, $339,000 is from securities that, if the Corporation were to sell them, would be classified as capital losses for income tax reporting purposes.

The provision for income tax for the three-month and nine-month periods ended September 30, 2012 and 2011 is based on the Corporation’s estimate of the effective tax rate expected to be applicable for the full year. The effective tax rates for the Corporation are as follows:

	Three Months Ended						Fiscal Year To Date
(In thousands)	Sept. 30,						Nine Months Ended Sept. 30,
	2012			2011			2012			2011
	(Current)			(Prior Year)			(Current)			(Prior Year)
Income before income tax provision	$	7,508		$	8,219		$	22,983		$	23,650
Income tax provision		2,014			2,230			6,217			6,423
Effective tax rate		26.82	%		27.13	%		27.05	%		27.16	%

The effective tax rate for each period presented differs from the statutory rate of 35% principally because of the effects of tax-exempt interest income.

The Corporation has no unrecognized tax benefits, nor pending examination issues related to tax positions taken in preparation of its income tax returns. With limited exceptions, the Corporation is no longer subject to examination by the Internal Revenue Service for years prior to 2009.

12. IMPAIRMENT OF LIMITED PARTNERSHIP INVESTMENT

In the first quarter 2011, the Corporation reported an impairment loss of $948,000 related to an investment in a real estate limited partnership. In addition to the limited partnership investment, the Corporation has a loan receivable from the limited partnership with an outstanding balance of $1,025,000 at September 30, 2012. Based on updated financial information, management prepared an estimated valuation based on cash flow analysis. That analysis showed the estimated return to the Corporation would be sufficient to repay the loan in full, but would not provide sufficient additional cash flow for return on the limited partnership investment. Accordingly, management made the decision to completely write-off the limited partnership investment in the first quarter 2011.

13. CONTINGENCIES

In the normal course of business, the Corporation may be subject to pending and threatened lawsuits in which claims for monetary damages could be asserted. In management’s opinion, the Corporation’s financial position and results of operations would not be materially affected by the outcome of such pending legal proceedings.

14. RECENT ACCOUNTING PRONOUNCEMENTS

The FASB issues Accounting Standards Updates (ASUs) to the FASB Accounting Standards Codification (ASC). This section provides a summary description of recent ASUs that have significant implications (elected or required) within the consolidated financial statements, or that management expects may have a significant impact on financial statements issued in the near future.

In April 2011, the FASB issued ASU 2011-02, Receivables (Topic 310) - A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The Update amends ASC Topic 310 to provide guidance in evaluating whether a restructuring constitutes a Troubled Debt Restructuring. The main provisions conclude that a creditor must separately conclude that both of the following exist – (1) the restructuring constitutes a concession, and (2) the debtor is experiencing financial difficulties. The amendments then provide guidance on a creditor’s evaluation of each of the requirements for a Troubled Debt Restructuring. For public entities, the Update was effective for the first interim or annual period beginning on or after June 15, 2011, including retrospective application to the beginning of the annual period of adoption. Note 7 provides disclosures required by this standard.

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820) – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this Update will result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. The Update includes various amendments, including amendments that: (1) clarify FASB’s intent about the application of existing fair value measurement and disclosure requirements, and (2) change some particular principles or requirements for measuring fair value or disclosing information about fair value measurements. There were no changes in the Corporation’s procedures for determining fair value measurements as a result of this Update, however additional quantitative disclosures about unobservable inputs used in fair value measurements categorized within Level 3 of the fair value hierarchy are provided. The amendments in this ASU are applied prospectively, and Note 5 includes disclosures required by this ASU.

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220) – Presentation of Comprehensive Income. The intent of this standard is to increase the prominence of comprehensive income in the financial statements. This standard requires the components of comprehensive income be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The single format includes the traditional income statement and the components of other comprehensive income, total other comprehensive income and total comprehensive income. In the two statement approach, the first statement is the traditional income statement, which would be immediately followed by a separate statement which would include the components of other comprehensive income, total other comprehensive income and total comprehensive income. The amendments in this ASU are applied retrospectively, and the Corporation has adopted the two statement approach as reflected in the accompanying financial statements.

In September 2011, the FASB issued ASU No. 2011-08, Intangibles – Goodwill and Other (Topic 350) – Testing Goodwill for Impairment. The amendments in this ASU permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. The amendments in this ASU are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011.

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

Certain statements in this section and elsewhere in this quarterly report on Form 10-Q are forward-looking statements. Citizens & Northern Corporation and its wholly-owned subsidiaries (collectively, the Corporation) intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995. Forward-looking statements, which are not historical facts, are based on certain assumptions and describe future plans, business objectives and expectations, and are generally identifiable by the use of words such as, "should", “likely”, "expect", “plan”, "anticipate", “target”, “forecast”, and “goal”. These forward-looking statements are subject to risks and uncertainties that are difficult to predict, may be beyond management’s control and could cause results to differ materially from those expressed or implied by such forward-looking statements. Factors which could have a material, adverse impact on the operations and future prospects of the Corporation include, but are not limited to, the following:

changes in monetary and fiscal policies of the Federal Reserve Board and the U. S. Government, particularly related to changes in interest rates

changes in general economic conditions

legislative or regulatory changes

downturn in demand for loan, deposit and other financial services in the Corporation’s market area

increased competition from other banks and non-bank providers of financial services

technological changes and increased technology-related costs

changes in accounting principles, or the application of generally accepted accounting principles.

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.

EARNINGS OVERVIEW

Net income was $5,494,000, or $0.45 per basic and diluted share, in the third quarter 2012, as compared to $0.46 per share for the second quarter 2012 and $0.49 per share for the third quarter 2011. For the first nine months of 2012, net income was $16,766,000, or $1.37 per basic and diluted share, as compared to $1.42 per share in the first nine months of 2011. Annualized return on average assets was 1.70% for the nine months ended September 30, 2012, and annualized return on average equity for the same period was 12.85%.

Some of the more significant fluctuations in the components of earnings are as follows:

In the third quarter 2012, the Corporation generated gains from sales of securities totaling $2,430,000, and also incurred a loss from prepayment of borrowings totaling $2,190,000. Security gains in the most recent quarter included a gain of $1,754,000 from sale of a pooled trust-preferred security (U.S. Cap Funding II) that had been written off in previous years. Also in the third quarter 2012, gains from sales of bank stocks totaled $538,000. In the most recent quarter, the Corporation prepaid principal of $12 million on long-term borrowings (repurchase agreements). The average rate on the borrowings that were partially prepaid was 3.93%, and management estimates the effect on the net interest margin for the next several quarters of prepaying the borrowings, as opposed to reinvesting in securities at current market yields, will be a benefit of approximately 0.05%. After the effect of the prepayment, the remaining balance of long-term borrowings under repurchase agreements was $68 million at September 30, 2012. For the nine months ended September 30, 2012, securities gains totaled $2,631,000, and the total loss from prepayment of borrowings was $2,333,000, while in the first nine months of 2011, securities gains totaled $2,028,000 and there were no losses from prepayment of borrowings.

In the third quarter 2012, net interest income was $520,000 lower than in the second quarter 2012, and $301,000 lower than in the third quarter 2011. For the first nine months of 2012, net interest income was $704,000 higher than for the first nine months of 2011. In the early months of 2012, the net interest margin was higher than in the corresponding periods of 2011, reflecting the impact of a lower cost of funds; however, the margin has declined in the second and third quarters of 2012, as yields on earning assets (mainly loans and securities) have dropped by more than the ongoing reductions in the cost of funds. For periods prior to the third quarter 2012, net interest income included the benefit of accretion from the recovery of a previous write-down on a security that matured in the second quarter 2012, with the Corporation receiving full repayment of principal. The Corporation recorded accretion of the previous security write-down of $398,000 in the second quarter 2012 and $229,000 in the third quarter 2011. For the nine months ended September 30, 2012, the Corporation recorded accretion of the previous security write-down of $855,000, as compared to $500,000 in the first nine months of 2011. The fully taxable equivalent (FTE) net interest margin, excluding the accretion benefit described above, was 4.09% in the third quarter 2012, as compared to 4.20% in the second quarter 2012 and 4.22% in the third quarter 2011. The FTE net interest margin, excluding the accretion benefit, was 4.18% for the first nine months of 2012, up from 4.12% for the first nine months of 2011.

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

The provision for loan losses was $236,000 in the third quarter 2012, as compared to a provision of $367,000 in the second quarter 2012 and a credit (reduction in expense) of $37,000 in the third quarter 2011. For the first nine months of 2012, the provision for loan losses was $421,000 as compared to a credit of $198,000 in the first nine months of 2011. The provision for loan losses in the third quarter and first nine months of 2012 included the effect of net increases in specific allowances on larger commercial loans, with a net increase of $165,000 in the third quarter 2012 and a net increase of $342,000 at September 30, 2012 as compared to December 31, 2011. The credits for loan losses in the third quarter and first nine months of 2011 resulted from lower charge-offs than had been estimated in the previous year in determining allowances on a few commercial loan relationships, and from reductions in the general component of the allowance due to lower outstanding loan balances.

Total noninterest revenue of $4,103,000 in the third quarter 2012 was comparable to the second quarter total of $4,095,000 and up $104,000 over the third quarter 2011. For the first nine months of 2012, total noninterest revenue of $11,957,000 was $1,730,000 higher than in the first nine months of 2011. The increases in noninterest revenue for both the most recent quarter and year-to-date 2012 included significant increases in gains from sales of residential mortgage loans, which totaled $625,000 in the third quarter 2012, up $252,000 over the second quarter 2012 and up $362,000 over the third quarter 2011. Year-to-date, gains from sales of mortgage loans totaled $1,263,000, an increase of $586,000 over the first nine months of 2011. Trust and brokerage revenues were up $256,000 (8.1%) for the first nine months of 2012 over the corresponding period in 2011. The net gain from premises and equipment of $1,000 in the third quarter 2012 was down from $270,000 in the second quarter 2012 and $324,000 in the third quarter 2011, with the