CITIZENS FINANCIAL SERVICES INC (CZFS) FY 2023 MD&A

ITEM 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

CAUTIONARY STATEMENT

We have made forward-looking statements in this document, and in documents that we incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include
information concerning possible or assumed future results of operations of the Company, the Bank, First Citizens Insurance, Realty or the Company on a consolidated basis. When we use words such as “believes,” “expects,” “anticipates,” or similar
expressions, we are making forward-looking statements.  Forward-looking statements may prove inaccurate. For a variety of reasons, actual results could differ materially from those contained in or implied by forward-looking statements:

Additional factors are discussed in this Annual Report on Form 10-K under “Item 1A. Risk Factors.”  These risks and uncertainties should be considered in
evaluating forward-looking statements and undue reliance should not be placed on such statements.  Forward-looking statements speak only as of the date they are made and the Company does not undertake to update forward-looking statements to
reflect circumstances or events that occur after the date of the forward-looking statements or to reflect the occurrence of unanticipated events. Accordingly, past results and trends should not be used by investors to anticipate future results or
trends.

INTRODUCTION

The following is management’s discussion and analysis of the significant changes in financial condition, the results of operations, capital resources and liquidity presented in the accompanying
consolidated financial statements for the Company. The Company’s consolidated financial condition and results of operations consist almost entirely of the Bank’s financial condition and results of operations. Management’s discussion and analysis
should be read in conjunction with the audited consolidated financial statements and related notes. Except as noted, tabular information is presented in thousands of dollars.

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The Company engages in the general business of banking throughout our service area of Potter, Tioga, Clinton, Bradford and Centre counties in north central Pennsylvania, Lebanon, Berks,
Schuylkill, Lancaster and Chester counties in south central Pennsylvania and Allegany County in southern New York and with the MidCoast acquisition, the Cities of Wilmington and Dover, Delaware. We also have a limited branch office in Union
county, Pennsylvania, which primarily serves agricultural and commercial customers in the central Pennsylvania market. With the recently completed HVBC acquisition, we have expanded further into southeast
Pennsylvania, including Montgomery, Bucks and Philadelphia Counties as well as Burlington County, New Jersey through the acquisition of five full service branches, four mortgage centers and one business banking facility. We maintain our
central office in Mansfield, Pennsylvania. Presently we operate 48 banking facilities, 39 of which operate as bank branches.  In Pennsylvania, the Company has full service offices located in Mansfield, Blossburg, Ulysses, Genesee, Wellsboro,
Troy, Sayre, Canton, Gillett, Millerton, LeRaysville, Towanda, Rome, the Mansfield Wal-Mart Super Center, Mill Hall, Schuylkill Haven, Friedensburg, Mt. Aetna, Fredericksburg, Mount Joy, Ephrata, Fivepointville, State College, Kennett Square,
Warrington, Plumsteadville, Philadelphia, two branches near the city of Lebanon and two branches in Huntington Valley. The limited branch office is located in Winfield, Pennsylvania. In New York, our office is in Wellsville. In Delaware, we have
three branches in Wilmington and one in Dover. The mortgage centers acquired as part of the acquisition are located in Montgomeryville, PA, Huntington Valley, PA, Philadelphia, PA and Mount Laurel, NJ. The business banking facility is located in
Philadelphia, PA. In the fourth quarter of 2023, we opened a branch in Williamsport, Pennsylvania.

Risk identification and management are essential elements for the successful management of the Company.  In the normal course of business, the Company is subject to various types of risk,
including interest rate, credit, liquidity, reputational and regulatory risk.

Interest rate risk is the sensitivity of net interest income and the market value of financial instruments to the direction and frequency of changes in interest rates.  Interest rate risk results
from various re-pricing frequencies and the maturity structure of the financial instruments owned by the Company.  The Company uses its asset/liability and funds management policies to control and manage interest rate risk.

Credit risk represents the possibility that a customer may not perform in accordance with contractual terms.  Credit risk results from loans with customers and the purchasing of securities.  The
Company’s primary credit risk is in the loan portfolio.  The Company manages credit risk by adhering to an established credit policy and through a disciplined evaluation of the adequacy of the allowance for credit losses.  Also, the investment
policy limits the amount of credit risk that may be taken in the investment portfolio.

Liquidity risk represents the inability to generate or otherwise obtain funds at reasonable rates to satisfy commitments to borrowers and obligations to depositors.  The Company has established
guidelines within its asset/liability and funds management policy to manage liquidity risk.  These guidelines include, among other things, contingent funding alternatives.

Reputational risk, or the risk to our business, earnings, liquidity, and capital from negative public opinion, could result from our actual or alleged conduct in a variety of areas, including
legal and regulatory compliance, lending practices, corporate governance, litigation, ethical issues, or inadequate protection of customer information, which could include identify theft, or theft of customer information through third parties. We
expend significant resources to comply with regulatory requirements. Failure to comply could result in reputational harm or significant legal or remedial costs. Damage to our reputation could adversely affect our ability to retain and attract new
customers, and adversely impact our earnings and liquidity.

Regulatory risk represents the possibility that a change in law, regulations or regulatory policy may have a material effect on the business of the Company and its subsidiary.  We cannot predict
what legislation might be enacted or what regulations might be adopted, or if adopted, the effect thereof on our operations.

Readers should carefully review the risk factors described in other documents the Company files with the SEC, including the annual reports on Form 10-K, the quarterly reports on Form 10-Q and any
current reports on Form 8-K filed by us.

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SELECTED FINANCIAL DATA

The following table sets forth certain financial data as of and for each of the years in the five-year period ended December 31, 2023:

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TRUST AND INVESTMENT SERVICES; OIL AND GAS SERVICES

Our Investment and Trust Division is committed to helping our customers meet their financial goals.  The Trust Division offers professional trust administration, investment management services,
estate planning and administration, custody of securities and individual retirement accounts. In addition to traditional trust and investment services offered, we assist our customers through various oil and
gas specific leasing matters from lease negotiations to establishing a successful approach to personal wealth management. Assets held by the Bank in a fiduciary or agency capacity for its customers are
not included in the consolidated financial statements since such items are not assets of the Bank. As of December 31, 2023, and 2022, assets owned and invested by customers of the Bank through the Bank’s investment representatives totaled
$329.4 million and $283.5 million, respectively.  Additionally, as summarized in the table below, the Trust Department had assets under management as of December 31, 2023 and 2022 of $167.9 million and $150.0 million, respectively. During the
year ended December 31, 2023, $1.4 million of new trust accounts were opened, $7.9 million of additional contributions to trust accounts, $10.1 million distributed from trust accounts, and $8.1 million of accounts were closed. As a result of
market fluctuations, the fair value of the trust accounts increased approximately $26.0 million during the year ended December 31, 2023. The following table reflects trust accounts by investment type and structure:

Our financial consultants offer full service brokerage and financial planning services throughout the Bank’s market areas.  Appointments can be made at any Bank branch.  Products such as mutual
funds, annuities, health and life insurance are made available through our insurance subsidiary, First Citizens Insurance Agency, Inc.

RESULTS OF OPERATIONS

Net income for the year ended December 31, 2023 was $17,811,000, which represents a decrease of $11,249,000, or 38.7%, when compared to 2022 due primarily to the one-time costs associated with
the HVBC acquisition.  Net income for the year ended December 31, 2022 was $29,060,000, which represents a decrease of $58,000, or 0.2%, when compared to 2021. Basic and diluted earnings per share were $4.06,
$7.25 and $7.24 for 2023, 2022 and 2021, respectively.

Net income is influenced by five key components: net interest income, provision for credit losses, non-interest income, non-interest expenses, and the provision for income taxes.

Net Interest Income

The most significant source of revenue is net interest income; the amount by which interest earned on interest-earning assets exceeds interest paid on interest-bearing liabilities.  Factors that
influence net interest income are changes in volume of interest-earning assets and interest-bearing liabilities as well as changes in the associated interest rates.

The following table sets forth the Company’s average balances of, and the interest earned or incurred on, each principal category of assets, liabilities and stockholders’ equity, the related
rates, net interest income and rate “spread” created.

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For purposes of the comparison, as well as the discussion that follows, this presentation facilitates performance comparisons between taxable and tax-free assets by increasing the
tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Federal statutory rate for the corresponding year. Accordingly, tax equivalent adjustments for investments and loans
have been made accordingly to the previous table for the years ended December 31, 2023, 2022 and 2021, respectively (in thousands):

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The following table shows the tax-equivalent effect of changes in volume and rates on interest income and expense (in thousands):

2023 vs. 2022

Tax equivalent net interest income for 2023 was $81,315,000 compared to $73,137,000 for 2022, an increase of $8,178,000 or 11.2%. Total interest income increased $43,813,000,
as loan interest income increased $41,912,000, and total investment income increased $1,901,000. Interest expense increased $35,635,000 from 2022.

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Total tax equivalent interest income from investment securities increased $1,565,000 in 2023 from 2022. The average balance of investment securities increased $3.0 million, but
the average balance of tax-exempt securities decreased $7.8 million, which had an effect of decreasing interest income by $12,000 due to volume. During 2023, the Bank had limited investment activity, excluding the sales of investments obtained as
part of the HVBC acquisition. The average tax-effected yield on our investment portfolio increased from 1.90% in 2022 to 2.20% in 2023. The increase in the tax-effected yield is attributable to purchases made during 2022 and 2023, which were made
in a higher rate environment. As a result of the yield on investment securities increasing 30 basis points (bps) to 2.20%, interest income on investment securities increased $1,577,000, with the increase related to taxable securities.The investment strategy for 2023 was to utilize cashflows from the investment portfolio to repay overnight borrowings. The decrease in the investment portfolio was due to long-term interest rates increasing in the
first nine months of 2023 compared to December 31, 2022 and investment repayments and maturities. We continually monitor interest rate trading ranges and seek to time investment security purchases when rates are in the top third of the trading
range. The Company believes its investment strategy has appropriately mitigated its interest rate risk exposure for various rate environments, including a rising rate environment, while providing sufficient cashflows to meet liquidity needs.

In total, loan interest income increased $41,912,000 in 2023 from 2022.  The average balance of our loan portfolio increased by $410.7 million in 2023 compared to 2022, which
resulted in an increase in interest income of $22,985,000 due to volume, primarily due to the HVBC acquisition completed in June 2023. The average tax-effected yield on our loan portfolio was 5.81% for 2023 compared to 4.68% for 2022 resulting in
an increase in loan interest income of $18,927,000. The tax-effected yield increased during 2023 due to a rise in market interest rates.

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Total interest expense increased $35,635,000 in 2023 compared to 2022.  The majority of the increase was due to an increase in the average rate paid on interest bearing
liabilities of 165 basis points to 2.34%. This increase resulted in an increase in interest expense of $27,607,000. The increase in rates was driven by the Federal Reserve’s response to inflation during 2022 and 2023 by increasing interest rates.
The average rate on money markets increased from 0.58% to 2.39% resulting in an increase in interest expense of $6,579,000. The average rate paid on savings accounts increased 28 bps and resulted in an increase in interest expense of $900,000.
The average rate paid on NOW accounts increased from 0.47% to 2.01% resulting in an increase in interest expense of $10,118,000.  The average rate paid on certificates of deposits increased from 0.82% to 2.52% resulting in an increase interest
expense of $5,544,000. The average rate paid on other borrowed funds increased from 2.61% to 4.64% resulting in an increase in interest expense of $4,466,000.

Average interest-bearing liabilities increased $367.4 million in 2023, with average interest-bearing deposits increasing $190.5 million and average other borrowings increasing
$176.9 million. As a result of the increase in average deposits, interest expense increased $1,242,000 as result of the change in volume. Increases in average deposits, which were primarily driven by the HVBC acquisition, included NOW accounts of
$145.6 million, money market accounts of $21.1 million and certificates of deposits $29.4 million. The average balance of other borrowed funds increased $176.9million due to the HVBC acquisition and funding growth, which corresponds to an
increase in interest expense of $6,786,000.

Our tax equivalent net interest margin for 2023 was 3.21% compared to 3.41% for 2022, with the change attributable to the yield of interest-earning assets increasing less than the cost from
interest-bearing liabilities during 2023. Interest rates continued to increase during the first half of 2023 as the Federal Reserve continued to respond to inflation and to aggressively tighten monetary policy. The year began with inflation
remaining significantly above the Federal Reserve’s targets and ended with inflation decreasing but remaining above the target of 2%.  The yield curve remained inverted throughout 2023 with some of the highest inversion seen in decades. In the
second of half of 2023, the market expected the Federal reserve to start decreasing rates in the first half of 2024. As a result, U.S. Treasury yields ended the year well below the peak.

2022 vs. 2021

Tax equivalent net interest income for 2022 was $73,137,000 compared to $67,035,000 for 2021, an increase of $6,102,000 or 9.1%. Total interest income increased $10,220,000,
as loan interest income increased $7,907,000, and total investment income increased $2,313,000. Interest expense increased $4,118,000 from 2021.

Total tax equivalent interest income from investment securities increased $2,360,000 in 2022 from 2021. The average balance of investment securities increased $136.2 million,
which had an effect of increasing interest income by $2,424,000 due to volume. The majority of the increase in volume was in taxable securities, which experienced an increase in the average balance of $120.0 million. The average tax-effected
yield on our investment portfolio decreased from 1.96% in 2021 to 1.90% in 2022. The decrease in the tax-effected yield is attributable to purchases made prior to 2022, which were made in a lower rate environment. As a result of the yield on
investment securities decreasing 6 basis points (bps) to 1.90%, interest income on investment securities decreased $64,000, with the decrease related to tax-exempt securities.  The investment strategy for 2022 was to utilize excess cash,
cashflows from the investment portfolio and deposit inflows to purchase U.S. treasury securities, due to a limited spread between US treasuries and agencies, mortgage backed securities issued by government sponsored entities and obligations of
state and political securities. The increase in the investment portfolio was in response to the deposit inflows that occurred in 2021 and the first half of 2022.

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In total, loan interest income increased $7,907,000 in 2022 from 2021.  The average balance of our loan portfolio increased by $168.6 million in 2022 compared to 2021, which
resulted in an increase in interest income of $8,224,000 due to volume.  The increase in the average balance of loans was driven by in large part by growth in the Delaware market during 2022. While the Bank’s other markets experienced loan
growth, it was not to the extent experienced in Delaware. The average tax-effected yield on our loan portfolio was 4.68% for both 2022 and 2021 and a small decrease in loan interest income of $317,000 was due to rate. The tax-effected yield
remained steady due to 2021 benefitting from additional PPP loan amortization of $2,061,000 compared to 2022, otherwise the yield on loans 2022 would have exceeded 2021.

Total interest expense increased $4,118,000 in 2022 compared to 2021.  The majority of the increase was due to an increase in the average rate paid on interest bearing liabilities
of 20 basis points to 0.69%. This increase resulted in an increase in interest expense of $2,708,000. The increase in rates was driven by the Federal Reserve’s response to inflation during 2022 by increasing interest rates. The average rate on
money markets increased from 0.27% to 0.58% resulting in an increase in interest expense of $1,035,000. The average rate paid on savings accounts increased 2 bps and resulted in an increase in interest expense of $59,000. The average rate paid on
NOW accounts increased from 0.30% to 0.47% resulting in an increase in interest expense of $823,000. The average rate paid on other borrowed funds increased from 1.50% to 2.61% resulting in an increase in interest expense of $1,296,000. The
average rate on certificates of deposit decreased from 0.98% to 0.82% resulting in a decrease in interest expense of $505,000.

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Average interest-bearing liabilities increased $195.5 million in 2022, with average interest-bearing deposits increasing $130.5 million and average other borrowings increasing
$65.0 million. As a result of the increase in average deposits, interest expense increased $67,000 as result of the change in volume. Increases in average deposits, which were primarily driven by organic growth across all markets of the Bank,
included NOW accounts of $63.7 million, savings accounts of $33.6 million and money market accounts of $85.4 million. Certificates of deposits decreased $52.2 million as maturing balances were not placed into term products. The average balance of
other borrowed funds increased $60.5 million due to funding loan growth, which corresponds to an increase in interest expense of $1,343,000.

Our tax equivalent net interest margin for 2022 was 3.41% compared to 3.52% for 2021, with the change attributable to the yield of interest-earning assets increasing less than the cost from
interest-bearing liabilities during 2022. Interest rates increased dramatically in 2022 in response to historically high inflation forcing the Federal Reserve to aggressively tighten monetary policy at a pace and levels not seen in decades.

PROVISION FOR CREDIT LOSSES

For the year ended December 31, 2023, we recorded a provision for credit losses of $5,528,000. The provision for 2023 was $3,845,000, or 228.5%, higher than the provision in 2022.
The provision for 2023 includes $4,591,000 associated with the HVBC acquisition and $36,000 as a provision for off-balance sheet items. Excluding these items, the provision for 2023 is $782,000 less than the comparable period in 2022 and is due
to limited organic loan activity in 2023. (see also “Financial Condition – Allowance for Credit Losses - Loans and Credit Quality Risk”).

For the year ended December 31, 2022, we recorded a provision for credit losses of $1,683,000. The provision for 2022 was $133,000, or 8.6%, higher than the provision in 2021. The
increase in the provision for credit losses was primarily due to organic loan growth in 2022 compared to 2021 offset by the improved economic outlook compared to 2021 that was impacted more by the Covid-19 pandemic. (see also “Financial Condition
– Allowance for Credit Losses - Loans and Credit Quality Risk”).

NON-INTEREST INCOME

The following table reflects non-interest income by major category for the years ended December 31 (dollars in thousands):

2023 vs. 2022

Non-interest income increased $1,867,000 in 2023 from 2022, or 19.2%.  We experienced a $51,000 net loss on available for sale securities in 2023 compared to net loss totaling $14,000 in 2022.
During 2023, we sold $10.0 million of municipal securities for a pre-tax loss of $51,000. Additionally, $76.5 million of securities obtained as part of the HVBC acquisition were sold for no gain or loss during
the second quarter of 2023. During 2022, we sold $7.5 million of US Agency securities for a pre-tax loss of $14,000. During 2023, net equity security losses
amounted to $144,000 as a result of market conditions experienced in 2023 compared to losses of $247,000 last year.

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Gains on loans sold increased $1,194,000 compared to last year. The increase in gains on loans sold is attributable to the HVBC acquisition and activity
acquired as part of the acquisition. The increase in service charges of $293,000 for 2023 is attributable to an increase in customer spending in 2022 compared to 2021. The increase in earnings on bank owned life insurance is due to the HVBC
acquisition and the passing of a former employee of the Company during 2023.

2022 vs. 2021

Non-interest income decreased $2,567,000 in 2022 from 2021, or 20.9%.  We experienced a $14,000 net loss on available for sale securities in 2022 compared to net gains totaling $212,000 in 2021.
During 2022, we sold $7.5 million of US Agency securities for a pre-tax loss of $14,000. During 2021, we sold $17.2 million of US treasury securities for a pre-tax
gain of $177,000 and $12.0 million of US Agency securities for a pre-tax gain of $35,000 to take advantage of market conditions at the time of the sales. During 2022, net equity security losses amounted
to $247,000 as a result of market conditions experienced in 2022 compared to gains of $339,000 last year.

Gains on loans sold decreased $1,025,000 compared to last year. The decrease in gains on loans sold is attributable to a $41.6 million, or 74.8% decrease in
the proceeds from the sale of residential mortgages loans as a result of the increase in mortgage interest rates. The increase in service charges of $591,000 for 2022 is attributable to an increase in customer spending in 2022 compared to 2021.
The decrease in other income is due to fees on offering derivative contracts for certain customers, that provided the customer with fixed rate loans, which generated fee income of $88,000 in 2022 compared to $494,000 in 2021. The decrease in earnings on bank owned life insurance is due to two former employees of the Company passing during the first quarter of 2021, which generated a death benefit payable to the Company of $1,155,000.
The increase in brokerage and insurance commissions was attributable to growth in our south central and north central, Pennsylvania markets.

Non-interest Expenses

The following tables reflect the breakdown of non-interest expense by major category for the years ended December 31 (dollars in thousands):

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2023 vs. 2022

Non-interest expenses for 2023 totaled $64,822,000, which represents an increase of $20,128,000, compared to 2022 expenses of $44,694,000. Salaries and
employee benefits increased $7,153,000 or 25.7%. The increase was due to merit increases effective at the beginning of 2023, additional full-time equivalent employees (FTE) of 47.8, which is an increase of 15.4%, and an increase in health care
expenses due to higher claims on the Company’s partially self-funded plan and the additional headcount. The additional headcount is due to the HVBC acquisition.

The increase in merger and acquisition expenses was due to fees associated with the acquisition of HVBC that closed in June 2023 and includes severance costs, change in control
payments, contract termination payments and various professional and consulting fees. The increase in ORE expenses was due to the sales of OREO properties in 2022 for a gain of $481,000. The increase in occupancy, furniture and fixtures,
amortization of intangibles and other expenses was due to the HVBC acquisition. The increase in FDIC insurance is due to the acquisition and organic growth.

2022 vs. 2021

Non-interest expenses for 2022 totaled $44,694,000, which represents an increase of $3,144,000, compared to 2021 expenses of $41,550,000. Salaries and employee
benefits increased $1,935,000 or 7.5%. The increase was due to merit increases effective at the beginning of 2022, additional headcount 14.7 FTEs added during 2022 and increased health care related expenses due to actual claims of employees.
Employee commissions related to brokerage and insurance commissions increased due to the increased sales in 2022 compared to 2021.

The increase in occupancy expenses is due to the additional branches opened during 2022 and higher utility and maintenance expenses. The increase in other expenses is additional marketing
expenses, primarily in the Delaware market, charge-offs associated with fraudulent customer account activity, appraisal fees, travel related expenses as the economy reopens from pandemic related issues and the Delaware franchise tax due to growth
in that market. The decrease in ORE expenses is due to gains on sales of ORE properties experienced during 2022.

Provision for Income Taxes

The provision for income taxes was $3,704,000, $6,435,000 and $6,199,000 for 2023, 2022 and 2021, respectively. The effective tax rates for 2023, 2022 and 2021 were 17.2%, 18.1% and 17.6%,
respectively.

The decrease in income tax expense of $2,731,000 in 2023 was due to the decrease of $13,980,000 in income before the provision for income taxes, which accounts for a decrease in tax expense of
$2,936,000 at a 21% tax rate.

The increase in income tax expense of $236,000 in 2022 was due earnings on bank owned life insurance being excluded from taxable income, which was higher in 2021 than 2022, which accounts for an
increase in income taxes of $205,000 at a 21% tax rate.

We are involved in seven limited partnership agreements that operate low-income housing projects in our market areas, two of which we entered into during 2022. During 2023 we recognized credits
on two of the seven projects. During 2022 and 2021, we recognized tax credits related to one of the seven partnerships. Tax credits associated with four of the partnerships were fully utilized by December 2022. We started recognizing credits on
two of the partnerships during 2023 and expect to recognized credits on the remaining project in 2024. We anticipate recognizing an aggregate of $9.0 million of tax credits over the next twelve years.

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FINANCIAL CONDITION

The following table presents ending balances (dollars in millions), the dollar amount of change and the percentage change during the past year:

Cash and Cash Equivalents

Cash and cash equivalents totaled $52.8 million at December 31, 2023 compared to $26.2 million at December 31, 2022. Management actively measures and evaluates the Company’s liquidity through
our Asset – Liability committee and believes its liquidity needs are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources, Federal Home Loan Bank financing, federal funds lines
with correspondent banks, brokered certificates of deposit and the portion of the investment and loan portfolios that mature within one year.  Management expects that these sources of funds will permit us to meet cash obligations and
off-balance sheet commitments as they come due.

Investments

The following table shows the year-end composition of the investment portfolio, at fair value, for the two years ended December 31 (dollars in thousands):

The Company’s investment portfolio decreased during 2023 by $22.2 million. This decreased was fueled by maturities and calls being used to repay borrowings from the FHLB during
2023. As part of the HVBC acquisition, $79.2 million of available for sale securities were acquired. Excluding the acquisition, $10.3 million of mortgage backed securities were purchased during 2023. During 2023, we experienced $12.4 million of
principal repayments and $22.6 million of calls and maturities. We sold $86.6 million of securities to deleverage the balance sheet during 2023 that included a loss of $51,000. The majority of the securities sold were acquired as part of the
HVBC acquisition. The fair value of our investment portfolio increased approximately $11.7 million in 2023 due to decreases in market interest rates in the fourth quarter of 2023 and a shortening of the portfolio duration. Excluding our
short-term investments consisting of monies held primarily at the Federal Reserve, the effective yield on our investment portfolio for 2023 was 2.20% compared to 1.90% for 2022 on a tax equivalent basis.

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The Federal Reserve continued with a tighten monetary policy in 2023 pushing the federal funds rate to 5.50% by July 2023 matching levels last seen in 2001. The year began with still elevated inflation but down
from the peak as supply chains improved and commodities prices stabilized at lower levels.  The Federal Reserve’s concern higher inflation could become entrenched in the economy maintained a higher for longer policy stance emphasizing its
willingness to bring inflation back to the 2% target.  The Treasury market was volatile with the failure of 3 large regional banks raising the specter of recession due to a systemic banking crisis.  The Fed’s actions calmed fears of a banking
crisis and the economy proved to be resilient in the face of restrictive monetary policy. The Bank closed on HVBC acquisition in June 2023 utilizing the Bank’s strong capital position. The Treasury yield curve remained inverted ending the
year with a 2 year to 10 year Treasury negative spread of 37 basis points.  In December the Federal Reserve pivoted away from a rate hiking bias to a neutral outlook with the market expecting the next move to be a rate cut.  After reaching a
peak in yields last reached in 2007, Treasury yields ended the year within 10 basis points of where it started and 120 basis points below the peak.  The labor market remains strong and economic growth continues to surprise to the upside
keeping the monetary policy unchanged for the foreseeable future.  As inflation moves closer to target level it is expected monetary policy will become less restrictive.  For 2023 the bank’s strategy was to increase capital and meet liquidity
needs in a volatile market. As liquidity and capital level permit the bank’s investment strategy will continue to mitigated its interest rate risk exposure for various rate environments, while providing sufficient cash flows to meet liquidity
needs.

At December 31, 2023, the Company did not own any securities, other than government-sponsored and government-guaranteed mortgage-backed securities, that had an aggregate book
value in excess of 10% of its consolidated stockholders’ equity at that date.

The expected principal repayments at amortized cost and average weighted yields for the investment portfolio (excluding equity securities) as of December 31, 2023, are shown below (dollars in
thousands). Expected principal repayments, which include prepayment speed assumptions for mortgage-backed securities, are significantly different than the contractual maturities detailed in Note 5 of the consolidated financial statements.
Yields on tax-exempt securities are presented on a fully taxable equivalent basis, assuming a 21% tax rate, which was the rate in effect at December 31, 2023.

At December 31, 2023, approximately 63.3% of the amortized cost of debt securities is expected to mature, call or pre-pay within five years or less.  The Company expects that earnings from
operations, the levels of cash held at the Federal Reserve and other correspondent banks, the high liquidity level of the available-for-sale securities, growth of deposits and the availability of borrowings from the Federal Home Loan Bank and
other third-party banks will be sufficient to meet future liquidity needs.

Loans Held for Sale

Loans held for sale increased $8.7 million to $9,379,000 as of December 31, 2023 from December 31, 2022. The increase in loans held for sale is primarily attributable to the HVBC acquisition
and the mortgage division acquired as part of the acquisition. The higher rate environment in 2023 continue to place pressure on refinancing activity as well as new home purchases.

Loans

The Bank’s lending efforts have historically focused on north central Pennsylvania and southern New York. With the acquisition of FNB and the opening of offices in Lancaster
County, this focus has grown to include Lebanon, Schuylkill, Berks and Lancaster County markets of south central, Pennsylvania. We have a limited branch office in Union County that is staffed by a lending team to primarily support agricultural
opportunities and offices in State College and Mill Hall to support commercial opportunities in central Pennsylvania, especially Centre and Clinton Counties. In April 2020, we completed the MidCoast acquisition, which expanded our markets into
the State of Delaware with activity centered around the cities of Wilmington and Dover, Delaware. In November of 2020, we opened a branch in Kennett Square, Pennsylvania, to further serve customers obtained as part of the MidCoast acquisition,
as well as to expand operations into Chester County, Pennsylvania. During 2022, expansion efforts continued in both Lancaster, Pennsylvania with the opening of an office in Ephrata, Pennsylvania and in Delaware with the opening of an office in
Greenville, Delaware, which is near Wilmington, Delaware. In June 2023, we completed the HVBC acquisition, which expanded our markets into south east Pennsylvania, including the counties of Montgomery, Bucks and Philadelphia. It also includes a
Mortgage production in Mount Laurel, New Jersey. The Bank has also opened a full-service branch in Williamsport, Pennsylvania in the fourth quarter of 2023.

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We originate loans primarily through direct loans to our existing customer base, with new customers generated through the strong relationships that our lending teams have with
their customers, as well as by referrals from real estate brokers, building contractors, attorneys, accountants, corporate and advisory board members, existing customers and the Bank’s website.  The Bank offers a variety of loans, although
historically most of our lending has focused on real estate loans including residential, commercial, agricultural, and construction loans.  As of December 31, 2023, approximately 87.3% of our loan portfolio consisted of real estate loans.  All
lending is governed by a lending policy that is developed and administered by management and approved by the Board of Directors.

The Bank primarily offers fixed rate residential mortgage loans with terms of up to 25 years and adjustable rate mortgage loans (with amortization schedules up to
30 years) with interest rates and payments that adjust based on one, three, five and 15 year fixed periods.  Loan to value ratios are usually 80% or less with exceptions for individuals with excellent credit and low debt to income and/or high
net worth. Adjustable rate mortgages are tied to a margin above the comparable Federal Home Loan Bank of Pittsburgh borrowing rate.  Home equity loans are written with terms of up to 15 years at fixed rates.  Home equity lines of
credit are variable rate loans tied to the Prime Rate generally with a ten year draw period followed by a ten year repayment period. Home equity loans are typically written with a maximum 80% loan to value.

Commercial real estate loan terms are generally 20 years or less, with one to five year adjustable interest rates.  The adjustable rates are typically tied to a margin above the
comparable Federal Home Loan Bank of Pittsburgh borrowing rate with a typical loan to value ratio of 80% or less. During 2023 and 2022, the Bank offered certain customers derivative contracts that allowed the customer to obtain a fixed interest
rate for a period up to 10 years.  Where feasible, the Bank participates in the United States Department of Agriculture’s (USDA) and Small Business Administration (SBA) guaranteed loan programs to offset credit risk and to further promote
economic growth in our market area.

Agriculture is an important industry throughout our market areas. Therefore, the Bank has not only developed an agriculture lending team with significant experience that has a
thorough understanding of this industry, but also continually looks for additional employees with a thorough understanding of agriculture. We have an agricultural loan policy to assist in underwriting agricultural loans.  Agricultural loans are
made to a diversified customer base that include dairy, swine and poultry farmers and their support businesses.  Agricultural loans focus on character, cash flow and collateral, while also considering the particular risks of the industry.  Loan
terms are generally 20 years or less, with one to five year adjustable interest rates.  The adjustable rates are typically tied to a margin above the comparable Federal Home Loan Bank of Pittsburgh borrowing rate with a typical loan to value of
less than 80%. We evaluate the financial strength of the integrators we have exposure to with our poultry and swine agricultural customers.  The Bank is a preferred lender under the USDA’s Farm Service Agency (FSA) and participates in the FSA
guaranteed loan program.

The Bank, as part of its commitment to the communities it serves, is an active lender for projects by our local municipalities and school districts. These loans range from short
term bridge financing to 20 year term loans for specific projects. These loans are typically written at rates that adjust at least every five years. Due to the size of certain municipal loans, we have developed participation lending
relationships with other community banks that allow us to meet regulatory compliance issues, while meeting the needs of the customer. At December 31, 2023, the aggregate balance of our participation loans, in which a portion was sold to other
lender’s totaled $387.4 million, of which $206.0 million was sold.

Activity associated with exploration for natural gas continued in 2023 in the Company’s north central Pennsylvania market. Certain entities drilled new wells and created new pad
sites and pipelines, while other companies only maintained their existing wells. While the Bank has loaned to companies that service the exploration activities, the Bank has not originated any loans to companies performing the actual drilling
and exploration activities. Loans made by the Company were to service industry customers which included trucking companies, stone quarries and other support businesses. We also originated loans to businesses and individuals for restaurants,
hotels and apartment rentals that were developed and expanded to meet the housing and living needs of the gas workers. Due to our understanding of the industry and its cyclical nature, the loans made for natural gas-related activities were
originated in a prudent and cautious manner and were subject to specific policies and procedures for lending to these entities, which included lower loan to value thresholds, shortened amortization periods, and expansion of our monitoring of
loan concentrations associated with this activity.

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The following table shows the year-end composition of the loan portfolio as of December 31, 2023 and 2022 (dollars in thousands):

Total loans grew $523.8 million in 2023 and total $2.25 billion at the end of 2023. The primary driver of growth during 2023 was the HVBC acquisition. Organic growth for 2023 was $44.0 million
and was driven by growth in construction real estate. This growth was offset by a decrease in consumer loans due to a decrease in student loans as of the end of the year.

Residential real estate loans increased $149.8 million primarily due to the acquisition of HVBC. During 2023, $91.1 million of residential real estate loans
were originated for sale on the secondary market, which compares to $10.0 million for 2022 and is due to the acquisition and the residential division acquired.  For loans sold on the secondary market, the Company recognizes fee income for
servicing these sold loans, which is included in non-interest income.

The following table presents the maturity distribution of our loan portfolio as of December 31, 2023 (in thousands).  The table does not include any estimate
of prepayments which significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below.  Demand loans having no stated schedule of repayments and no stated maturity are reported
as due in one year or less.

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The following table presents the portion of loans that have fixed interest rates or variable interest rates that fluctuate over the life of loans in accordance with changes in
the interest rate index that mature after December 31, 2024.

Allowance for Credit Losses – Loans and Credit Quality Risk

The allowance for credit losses – loans is maintained at a level which, in management’s judgment, is adequate to absorb probable future loan losses inherent in the loan portfolio.  The provision for credit losses
is charged against current income.  Loans deemed not collectable are charged-off against the allowance while subsequent recoveries increase the allowance.  The allowance for credit losses - loans was $21,153,000 or 0.94% of total loans as of
December 31, 2023 as compared to $18,552,000 or 1.08% of loans as of December 31, 2022. During the first quarter of 2023, the Company adopted CECL, which resulted in a decrease in the allowance for credit losses – loans of $3.3 million. As a
result of the acquisition, the Bank recorded a provision for credit losses for non-PCD loans of $4,591,000 and an allowance of $1,689,000 for PCD loans. An additional $901,000 of provision for credit losses-loans was recorded in 2023. Net
charge-offs for 2023 totaled $1,280,000, which was primarily associated with PCD loans acquired as part of the HVBC acquisition that were fully reserved for at the time of the acquisition.

The adequacy of the allowance for credit losses – loans is subject to a formal, quarterly analysis by management of the Company.  In order to better analyze the risks associated with the loan portfolio, the entire
portfolio is divided into several categories.  As stated above, commercial loans on non-accrual status are specifically reviewed and given a specific reserve, if appropriate. Historical credit loss experience provides the basis for the
estimation of expected credit losses. Adjustments to historical loss information are made for differences in current loan-specific risk characteristics such as differences in underwriting standards, changes in environmental conditions,
delinquency level, segment growth rates and changes in duration within new markets, or other relevant factors. For further information on the allowance for credit losses on loans, Note 1, "Summary of Significant Accounting Policies," and Note
6, "Loans," in the consolidated financial statements provides additional disclosure on the allowance for credit losses. As a result of the adoption of ASC 326 effective January 1, 2023, there is a lack of comparability in both the allowance and
provision for credit losses for the periods presented. Results for reporting periods beginning after January 1, 2023 are presented using the CECL methodology, while comparative period information continues to be reported in accordance with the
incurred loss methodology in effect for prior fiscal years. Note 1, "Summary of Significant Accounting Policies," in the consolidated financial statements provides additional disclosure on the adoption of ASC 326.

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The following table shows the distribution of the allowance for credit losses - loans and the percentage of loans compared to total loans by loan category (dollars in thousands) as of December 31:

The following tables presents the activity in the allowance for credit losses – loans, by portfolio segment, for 2023 (in thousands).

Prior to January 1, 2023, the Company calculated the allowance for loan losses using the probable incurred methodology. The activity in our allowance for loan losses was as follows during the
years ended December 31, 2022 and 2021:

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Index

The following table provides information related to credit loss experience and net (charge-offs) recoveries for 2023, 2022 and 2021.