BUSINESS COMBINATION AND

PENDING ACQUISITION

Business Combination – Acquisition of Monument Bancorp, Inc.

April 1, 2019,

the Corporation completed its acquisition of

100%

of the common stock of Monument. Monument was the parent company of Monument Bank, a commercial bank which operated

two

community bank offices and

one

lending office in Bucks County, Pennsylvania. Pursuant to the merger, Monument was merged into Citizens & Northern Corporation and Monument Bank was merged into C&N Bank. Management believes the acquisition provides an opportunity to leverage the Corporation’s capital and deposits in a higher growth market and aligns with the Corporation’s focus to proactively deploy capital to enhance long-term shareholder value.

The consolidated financial statements include the formerly separate Monument operations from

April 1, 2019

through

December 31, 2019.

Since the activities of the former Monument operations have been combined with those of the Corporation, separate disclosure of Monument-related financial information included in the consolidated financial statements is

not

practicable.

Total purchase consideration was

$42,651,000,

including cash paid to former Monument shareholders totaling

$9,517,000

and

1,279,825

shares of Corporation common stock issued with a value of

$32,953,000,

(net of costs directly related to stock issuance of

$181,000

included in the cash portion of merger consideration transferred in the table below).

The merger was accounted for using the acquisition method of accounting and, accordingly, purchased assets, including identifiable intangible assets, and assumed liabilities were recorded at their respective acquisition date fair values. The fair value measurements of assets acquired and liabilities assumed are subject to refinement for up to

one

year after the closing date of the acquisition as additional information relative to closing date fair values become available. In the

fourth

quarter

2019,

the Corporation recorded an adjustment to the initial fair value measurements of miscellaneous receivables and accrued liabilities made as of

April 1, 2019.

The adjustment resulted in an increase in other assets of

$216,000

and a decrease in other liabilities of

$14,000,

with a corresponding reduction in goodwill of

$230,000.

The fair value of assets acquired (as adjusted in the

fourth

quarter

2019

), excluding goodwill, totaled

$375,138,000,

while the fair value of liabilities assumed totaled

$348,933,000.

Goodwill represents consideration transferred in excess of the fair value of the net assets acquired. At

December 31, 2019,

goodwill associated with the acquisition was

$16,446,000.

The goodwill resulting from the acquisition represents the value expected from the expansion of the Corporation’s market into Southeastern Pennsylvania. Goodwill acquired in the Monument merger is

not

deductible for tax purposes as the acquisition is accounted for as a tax-free exchange for tax purposes.

The following table summarizes the consideration paid for Monument and the estimated fair values of the assets acquired and liabilities assumed at the acquisition date:

( In Thousands)
Fair value of consideration transferred:
Cash	$	9,698
Common stock issued		32,953
Total consideration transferred	$	42,651

Estimated fair values of assets acquired and (liabilities) assumed:

(I n Thousands)
Cash and cash equivalents	$	7,920
Available-for-sale debt securities		94,568
Loans receivable		259,295
Accrued interest receivable		1,593
Bank premises and equipment		1,465
Foreclosed assets held for sale		1,064
Deferred tax asset, net		771
Core deposit intangible		1,461
Goodwill		16,446
Other assets		7,001
Deposits		(223,303	)
Short-term borrowings		(111,568	)
Subordinated debt		(12,375	)
Accrued interest and other liabilities		(1,687	)
Estimated excess fair value of assets acquired over liabilities assumed	$	42,651

In the consolidated statements of cash flows, noncash investing and financing activities include the issuance of common stock as part of the merger consideration as well as the following categories of assets acquired and liabilities assumed from Monument as reflected in the table above: available-for-sale debt securities, loans receivable, bank premises and equipment, foreclosed assets held for sale, core deposit intangible, goodwill, Federal Home Loan Bank of Pittsburgh stock of

$5,478,000

(included in other assets above), deposits, short-term borrowings and subordinated debt.

Acquisition date fair values for available-for-sale securities were determined using Level

inputs consistent with the methods discussed further in Note

21.

The Corporation sold the acquired securities in

April 2019

for approximately

realized gain or loss.

The determination of estimated fair values of the acquired loans required the Corporation to make certain estimates about discount rates, future expected cash flows, market conditions and other future events that are highly subjective in nature. Based on such factors as past due status, nonaccrual status, bankruptcy status, and credit risk ratings, the acquired loans were evaluated, and

four

loans (from

three

relationships) displayed evidence of credit quality deterioration. These loans are accounted for under ASC

310

(purchased credit impaired, or “PCI”). The majority of the purchased loans did

not

display evidence of impairment, and thus are accounted for under ASC

310

20.

Expected cash flows, both principal and interest, were estimated based on key assumptions covering such factors as prepayments, default rates and severity of loss given default. These assumptions were developed based on the portfolio characteristics as of the acquisition date as well as available market research. The fair value estimates for acquired loans were based on the amount and timing of expected principal, interest and other cash flows, including expected prepayments, discounted at prevailing market interest rates applicable to the types of acquired loans, which the Corporation considers Level

fair value measurements.

Loans acquired from Monument were measured at fair value at the acquisition date with

carryover of an allowance for loan losses. The following table presents performing and PCI loans acquired, by loan segment and class, at

April 1, 2019:

(In Thousands)
	Performing		PCI		Total
Residential mortgage:
Residential mortgage loans - first liens	$	107,645	$	77	$	107,722
Residential mortgage loans - junior liens		2,433		0		2,433
Home equity lines of credit		2,674		0		2,674
1-4 Family residential construction		510		0		510
Total residential mortgage		113,262		77		113,339
Commercial:
Commercial loans secured by real estate		113,821		364		114,185
Commercial and industrial		7,571		0		7,571
Commercial construction and land		4,617		0		4,617
Loans secured by farmland		267		0		267
Multi-family (5 or more) residential		17,493		0		17,493
Other commercial loans		835		0		835
Total commercial		144,604		364		144,968
Consumer		988		0		988
Total	$	258,854	$	441	$	259,295

The following table presents the preliminary fair value adjustments made to the amortized cost basis of loans acquired at

April 1, 2019:

(In Thousands)
Gross amortized cost at acquisition	$	263,334
Market rate adjustment		(1,807	)
Credit fair value adjustment on non-credit impaired loans (accretable)		(1,914	)
Credit fair value adjustment on impaired loans (non-accretable)		(318	)
Estimated fair value of acquired loans	$	259,295

The market rate adjustment represents the movement in interest rates, irrespective of credit adjustments, compared to the contractual rates of the acquired loans. The credit adjustment made on non-PCI loans represents changes in credit quality of the underlying borrowers from loan inception to the acquisition date.

The credit adjustment on PCI loans is derived in accordance with ASC

310

and represents the portion of the loan balances that have been deemed uncollectible for each loan. The PCI loans are secured by real estate and the fair value of each loan was determined based on the estimated proceeds to be derived from selling the collateral, net of selling costs. The PCI loans were placed into nonaccrual status upon acquisition (and remained in nonaccrual status at

December 31, 2019)

as the Corporation cannot reasonably estimate cash flows expected to be collected in order to compute yield on the loans.

The Corporation recognized a core deposit intangible of

$1,461,000.

The core deposit intangible represents the estimated value of lower-cost funding provided by the nonmaturity deposits assumed in comparison with the Corporation’s estimated cost of borrowing funds in the market. The core deposit intangible will be amortized over a weighted-average life of

4.4

years.

Deposit liabilities assumed were segregated into

two

categories: (

) nonmaturity deposits (checking, savings and money market), and (

) time deposits (deposit accounts with a stated maturity). The fair values of both categories of deposits were determined using level

fair value measurements. For nonmaturity deposits, the acquisition date outstanding balance of the assumed demand deposit accounts approximates fair value. In determining the fair value of time deposits, the Corporation discounted the contractual cash flows of the deposit accounts using prevailing market interest rates for time deposit accounts of similar type and duration.

Short-term borrowings assumed consisted of advances from the Federal Home Loan Bank of Pittsburgh. The fair value of short-term borrowings was determined using Level

measurements by discounting the contractual cash flows of the borrowings using Federal Home Loan Bank interest rates available

April 1, 2019

for advances to the same maturities as those of the deposits assumed.

Subordinated debt assumed included

two

issues: (

) agreements with par values totaling

$5,375,000

which were redeemed on

April 1, 2019;

and (

) agreements with par values totaling

$7,000,000,

maturing

April 1, 2027

and which

may

be redeemed at par beginning

April 1, 2022.

The fair value of subordinated debt was determined using Level

measurements by comparing the interest rates on the debt to the rates on similar recent issues of comparable size by other similar-sized banking companies. In the

fourth

quarter

2019,

the Corporation redeemed subordinated debt with a par value of

$500,000,

resulting in a loss of

$10,000

(included in other noninterest expense in the consolidated statements of income).

Merger-related expenses associated with the Monument transaction totaled of

$3,812,000

2019

and

$328,000

2018.

Merger-related expenses include costs associated with termination of data processing contracts, conversion of Monument’s customer accounting data into the Corporation’s core system, severance and similar expenses, legal and other professional fees and various other costs.

The following table presents pro forma information as if the merger between the Corporation and Monument had been completed on

January 1, 2018.

The pro forma information does

not

necessarily reflect the results of operations that would have occurred had the merger taken place at the beginning of

2018.

The supplemental pro forma information excludes the after-tax cost of merger-related expenses totaling

$3,270,000

2019

and

$305,000

2018.

The pro forma information does

not

include the impact of possible business model changes nor does it consider any potential impacts of current market conditions or revenues, expense efficiencies or other factors.

(In Thousands Except Per Share Data)	Year Ended
	Dec. 31,		Dec. 31,
	2019		2018
Interest income	$	68,817	$	66,528
Interest expense		11,517		10,516
Net interest income		57,300		56,012
Provision for loan losses		894		1,059
Net interest income after provision for loan losses		56,406		54,953
Noninterest income		19,300		18,712
Net gains on securities		23		2,763
Other noninterest expenses		47,178		46,586
Income before income tax provision		28,551		29,842
Income tax provision		4,954		4,812
Net income	$	23,597	$	25,030

Earnings per common share - basic	$	1.65	$	1.84
Earnings per common share - diluted	$	1.64	$	1.84

Pending

Acquisition of Covenant

Financial

, Inc.

December 2019,

the Corporation announced a plan of merger to acquire Covenant Financial, Inc. (“Covenant”) in a transaction valued on

December 18, 2019

at approximately

$77

million. Under the terms of the definitive agreement, the Corporation will pay cash for

25%

of the Covenant shares and will convert

75%

of Covenant shares to the Corporation’s common stock. Covenant is the holding company for Covenant Bank, which operates banking offices in Bucks and Chester Counties of PA. Covenant had total assets of

$516

million, liabilities of

$474

million and stockholders’ equity of

$42

million at

December 31, 2019.

The merger is subject to satisfaction of customary closing conditions, including receipt of regulatory approvals and approval of Covenant’s shareholders. The merger is expected to close in the

third

quarter

2020.

2019,

the Corporation incurred merger-related expenses totaling

$287,000

related to the planned acquisition of Covenant. Management estimates pre-tax merger-related expenses associated with the Covenant acquisition will total approximately

million (

$6.6

million, net of tax), with most of the expenses expected to be incurred in the

third

quarter

2020.