Edgar Filing: CODORUS VALLEY BANCORP INC

Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2016

☐ 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: 0-15536

	CODORUS VALLEY BANCORP, INC.
(Exact name of registrant as specified in its charter)

	Pennsylvania		23-2428543
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

	105 Leader Heights Road, P.O. Box 2887, York, Pennsylvania 17405
	(Address of principal executive offices) (Zip code)

	717-747-1519
(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year,

if changed since the last report.)

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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See 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 ☒
	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 ☒

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. On April 29, 2016, 7,962,658 shares of common stock, par value $2.50, were outstanding.

- 1 -

Codorus Valley Bancorp, Inc.

Form 10-Q Index

PART I – FINANCIAL INFORMATION		Page #

Item 1.	Financial statements (unaudited):
	Consolidated balance sheets	3
	Consolidated statements of income	4
	Consolidated statements of comprehensive income	5
	Consolidated statements of cash flows	6
	Consolidated statements of changes in shareholders’ equity	7
	Notes to consolidated financial statements	8

Item 2.	Management’s discussion and analysis of financial condition and results of operations	38

Item 3.	Quantitative and qualitative disclosures about market risk	54

Item 4.	Controls and procedures	55

PART II – OTHER INFORMATION

Item 1.	Legal proceedings	56

Item 1A.	Risk factors	56

Item 2.	Unregistered sales of equity securities and use of proceeds	56

Item 3.	Defaults upon senior securities	56

Item 4.	Mine safety disclosures	56

Item 5.	Other information	56

Item 6.	Exhibits	57

SIGNATURES		58

- 2 -

Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Codorus Valley Bancorp, Inc.

Consolidated Balance Sheets


	(Unaudited)
	March 31,			December 31,
(dollars in thousands, except per share data)	2016			2015
Assets
Interest bearing deposits with banks	$	1,919		$	44,496
Cash and due from banks		10,518			12,989
Total cash and cash equivalents		12,437			57,485
Securities, available-for-sale		199,916			213,470
Restricted investment in bank stocks, at cost		5,371			5,028
Loans held for sale		1,499			564
Loans (net of deferred fees of $2,910 - 2016 and $2,701 - 2015)		1,150,147			1,123,211
Less-allowance for loan losses		(13,090	)		(12,704	)
Net loans		1,137,057			1,110,507
Premises and equipment, net		24,796			24,606
Goodwill		2,301			2,301
Other assets		43,645			42,373
Total assets	$	1,427,022		$	1,456,334

Liabilities
Deposits
Noninterest bearing	$	168,510		$	162,982
Interest bearing		952,323			931,167
Total deposits		1,120,833			1,094,149
Short-term borrowings		26,586			74,510
Long-term debt		120,310			120,310
Other liabilities		9,276			8,224
Total liabilities		1,277,005			1,297,193

Shareholders’ equity
Preferred stock, par value $2.50 per share; $1,000 liquidation preference, 1,000,000 shares authorized; Series B shares issued and outstanding:
0 at March 31, 2016 and 12,000 at December 31, 2015		0			12,000
Common stock, par value $2.50 per share; 15,000,000 shares authorized; shares issued: 7,963,528 at March 31, 2016 and 7,957,145 at December 31, 2015; and shares outstanding: 7,962,658 at March 31, 2016 and 7,957,145 at December 31, 2015		19,909			19,893
Additional paid-in capital		97,566			97,338
Retained earnings		30,305			28,539
Accumulated other comprehensive income		2,239			1,371
Treasury stock, at cost; 870 shares at March 31, 2016		(2	)		0
Total shareholders’ equity		150,017			159,141
Total liabilities and shareholders’ equity	$	1,427,022		$	1,456,334

See accompanying notes.

- 3 -

Table of Contents

Codorus Valley Bancorp, Inc.

Consolidated Statements of Income

Unaudited


	Three months ended
	March 31,
(dollars in thousands, except per share data)	2016		2015
Interest income
Loans, including fees	$	13,811	$	12,307
Investment securities:
Taxable		702		780
Tax-exempt		425		422
Dividends		68		158
Other		8		19
Total interest income		15,014		13,686

Interest expense
Deposits		1,510		1,640
Federal funds purchased and other short-term borrowings		54		41
Long-term debt		485		327
Total interest expense		2,049		2,008
Net interest income		12,965		11,678
Provision for loan losses		800		1,000
Net interest income after provision for loan losses		12,165		10,678

Noninterest income
Trust and investment services fees		617		601
Income from mutual fund, annuity and insurance sales		259		156
Service charges on deposit accounts		837		757
Income from bank owned life insurance		174		171
Other income		189		150
Gain on sales of loans held for sale		115		151
Gain on sales of securities		194		371
Total noninterest income		2,385		2,357

Noninterest expense
Personnel		5,997		5,260
Occupancy of premises, net		897		800
Furniture and equipment		725		678
Postage, stationery and supplies		173		163
Professional and legal		163		174
Marketing		469		219
FDIC insurance		166		175
Debit card processing		297		202
Charitable donations		741		724
Telephone		162		161
External data processing		333		282
Merger related		0		425
Foreclosed real estate including losses on sales		40		117
Other		295		209
Total noninterest expense		10,458		9,589
Income before income taxes		4,092		3,446
Provision for income taxes		1,275		1,012
Net income		2,817		2,434
Preferred stock dividends		16		30
Net income available to common shareholders	$	2,801	$	2,404
Net income per common share, basic	$	0.35	$	0.39
Net income per common share, diluted	$	0.35	$	0.39

See accompanying notes.

- 4 -

Table of Contents

Codorus Valley Bancorp, Inc.

Consolidated Statements of Comprehensive Income

Unaudited


	Three months ended
	March 31,
(dollars in thousands)	2016			2015
Net income	$	2,817		$	2,434
Other comprehensive income (loss):
Securities available for sale:
Net unrealized holding gains arising during the period (net of tax expense of $513 and $276, respectively)		996			536
Reclassification adjustment for gains included in net income (net of tax expense of $66 and $126, respectively) (a) (b)		(128	)		(245	)
Net unrealized gains		868			291
Comprehensive income	$	3,685		$	2,725

(a)

Amounts are included in net gain on sales of securities on the Consolidated Statements of Income within noninterest income.

(b)

Income tax amounts are included in provision for income taxes on the Consolidated Statements of Income.

See accompanying notes.

- 5 -

Table of Contents

Codorus Valley Bancorp, Inc.

Consolidated Statements of Cash Flows

Unaudited


	Three months ended
	March 31,
*(dollars in thousands)*		2016			2015
Cash flows from operating activities
Net income	$	2,817		$	2,434
Adjustments to reconcile net income to net cash provided by operations:
Depreciation/amortization		574			557
Net amortization of premiums on securities		220			251
Amortization of deferred loan origination fees and costs		(236	)		(197	)
Provision for loan losses		800			1,000
Provision for losses on foreclosed real estate		0			59
Increase in bank owned life insurance		(174	)		(171	)
Originations of loans held for sale		(8,805	)		(7,885	)
Proceeds from sales of loans held for sale		7,985			7,100
Gain on sales of loans held for sale		(115	)		(151	)
Net gain on disposal of premises and equipment		2			0
Gain on sales of securities, available-for-sale		(194	)		(371	)
Net loss on sales of foreclosed real estate		1			9
Stock-based compensation		123			71
Decrease (increase) in interest receivable		72			(27	)
Decrease in other assets		228			510
Increase in interest payable		42			10
Increase (decrease) in other liabilities		1,044			(168	)
Net cash provided by operating activities		4,384			3,031
Cash flows from investing activities
Purchases of securities, available-for-sale		(12,156	)		(19,082	)
Maturities, repayments and calls of securities, available-for-sale		14,096			8,148
Sales of securities, available-for-sale		12,903			7,170
Purchase of restricted investment in bank stock		(343	)		0
Net proceeds from acquisition		0			21,091
Proceeds from acquired receivables of sold investment settlements		0			15,256
Net increase in loans made to customers		(27,114	)		(24,004	)
Purchases of premises and equipment		(762	)		(1,004	)
Investment in bank owned life insurance		(1,987	)		0
Proceeds from sale of premises and equipment		0			18
Proceeds from sales of foreclosed real estate		133			95
Net cash (used in) provided by investing activities		(15,230	)		7,688
Cash flows from financing activities
Net increase in demand and savings deposits		24,905			16,571
Net increase (decrease) in time deposits		1,779			(17,958	)
Net decrease in short-term borrowings		(47,924	)		(13,023	)
Repayment of long-term debt		0			(23	)
Cash dividends paid to preferred shareholder		(46	)		(30	)
Cash dividends paid to common shareholders		(1,035	)		(729	)
Redemption of preferred stock		(12,000	)		0
Issuance of common stock		119			201
Net cash used in financing activities		(34,202	)		(14,991	)
Net decrease in cash and cash equivalents		(45,048	)		(4,272	)
Cash and cash equivalents at beginning of year		57,485			31,094
Cash and cash equivalents at end of period	$	12,437		$	26,822

See accompanying notes.

- 6 -

Table of Contents

Codorus Valley Bancorp, Inc.

Consolidated Statements of Changes in Shareholders’ Equity

Unaudited


												Accumulated
						Additional						Other
	Preferred			Common		Paid-in			Retained			Comprehensive		Treasury
*(dollars in thousands, except per share data)*	Stock			Stock		Capital			Earnings			Income		Stock			Total

Balance, January 1, 2016	$	12,000		$	19,893	$	97,338		$	28,539		$	1,371	$	0		$	159,141
Net income										2,817								2,817
Other comprehensive income, net of tax													868					868
Common stock cash dividends ($0.13 per share)										(1,035	)							(1,035	)
Preferred stock cash dividends										(16	)							(16	)
Redemption of preferred stock		(12,000	)															(12,000	)
Stock-based compensation including related tax benefit							123											123
Forfeiture of restricted stock							4								(4	)		0
Issuance and reissuance of common stock including related tax benefit:
5,378 shares under the dividend reinvestment and stock purchase plan					13		94											107
704 shares under the stock option plan							10								2			12
1,005 shares of stock-based compensation awards					3		(3	)										0

Balance, March 31, 2016	$	0		$	19,909	$	97,566		$	30,305		$	2,239	$	(2	)	$	150,017

Balance, January 1, 2015	$	12,000		$	14,577	$	62,713		$	26,483		$	2,667	$	0		$	118,440
Net income										2,434								2,434
Other comprehensive income, net of tax													291					291
Common stock cash dividends ($0.119 per share, adjusted)										(729	)							(729	)
Preferred stock cash dividends										(30	)							(30	)
Stock-based compensation including related tax benefit							71											71
Forfeiture of restricted stock							6								(6	)		0
Issuance and reissuance of common stock including related tax benefit:
5,133 shares under the dividend reinvestment and stock purchase plan					13		87											100
8,568 shares under the stock option plan					21		80											101

Balance, March 31, 2015	$	12,000		$	14,611	$	62,957		$	28,158		$	2,958	$	(6	)	$	120,678

See accompanying notes.

- 7 -

Table of Contents

Note 1—Summary of Significant Accounting Policies

Nature of Operations and Basis of Presentation

The accompanying consolidated balance sheet at December 31, 2015 has been derived from audited financial statements, and the unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, the instructions to Form 10-Q, and FASB Accounting Standards Codification (ASC) 270. Accordingly, the interim financial statements do not include all of the financial information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the interim consolidated financial statements include all adjustments necessary to present fairly the financial condition and results of operations for the reported periods, and all such adjustments are of a normal and recurring nature.

Codorus Valley Bancorp, Inc. (“Corporation” or “Codorus Valley”) is a one-bank holding company headquartered in York, Pennsylvania that provides a full range of banking services through its subsidiary, PeoplesBank, A Codorus Valley Company (“PeoplesBank” or “Bank”). PeoplesBank operates two wholly-owned subsidiaries, Codorus Valley Financial Advisors, Inc., which sells nondeposit investment products, and SYC Settlement Services, Inc., which provides real estate settlement services. In addition, PeoplesBank may periodically create nonbank subsidiaries for the purpose of temporarily holding foreclosed properties pending the liquidation of these properties. PeoplesBank operates under a state charter and is subject to regulation by the Pennsylvania Department of Banking and Securities, and the Federal Deposit Insurance Corporation. The Corporation is subject to regulation by the Federal Reserve Board and the Pennsylvania Department of Banking and Securities.

The consolidated financial statements include the accounts of Codorus Valley and its wholly-owned bank subsidiary, PeoplesBank, and two wholly-owned nonbank subsidiaries, SYC Realty Company, Inc. and CVLY Corp. SYC Realty is primarily used to hold foreclosed properties obtained by PeoplesBank and was inactive during the period ended March 31, 2016. CVLY Corp. was formed to facilitate the acquisition of Madison Bancorp, Inc. (“Madison”) and may be used, as needed, for the financial and legal management of future acquisition transactions. The accounts of CVB Statutory Trust No. 1 and No. 2 are not included in the consolidated financial statements as discussed in Note 8—Short-Term Borrowings and Long-Term Debt. All significant intercompany account balances and transactions have been eliminated in consolidation. The accounting and reporting policies of Codorus Valley and subsidiaries conform to accounting principles generally accepted in the United States of America and have been followed on a consistent basis.

These consolidated statements should be read in conjunction with the notes to the audited consolidated financial statements contained in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2015.

The results of operations for the three months ended March 31, 2016 are not necessarily indicative of the results to be expected for the full year.

In accordance with FASB ASC 855, the Corporation evaluated the events and transactions that occurred after the balance sheet date of March 31, 2016 and through the date these consolidated financial statements were issued, for items of potential recognition or disclosure.

- 8 -

Table of Contents

Loans

Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at their outstanding unpaid principal balances less amounts charged off, net of an allowance for loan losses and any deferred fees or costs. Interest income is accrued on the unpaid principal balance. Generally, loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (interest income) over the contractual life of the loan. The loans receivable portfolio is segmented into commercial and consumer loans. Commercial loans consist of the following industry classes: builder & developer, commercial real estate investor, residential real estate investor, hotel/motel, wholesale & retail, agriculture, manufacturing and all other. Consumer loans consist of the following classes: residential mortgage, home equity and all other.

For all classes of loans receivable, the accrual of interest is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan may be currently performing. A past due loan may remain on accrual status if it is in the process of collection and well secured. When a loan is placed on nonaccrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against the allowance for loan losses. Interest received on nonaccrual loans, including impaired loans, generally is either applied against principal or reported as interest income, according to the Corporation’s judgment as to the collectability of principal. Generally, nonaccrual 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.

Acquired Loans

Acquired loans are initially recorded at their acquisition date fair values. The carryover of allowance for loan losses is prohibited as any credit losses in the loans are included in the determination of the fair value of the loans at the acquisition date. Fair values for acquired loans are based on a discounted cash flow methodology that involves assumptions and judgments as to credit risk, prepayment risk, liquidity risk, default rates, loss severity, payment speeds, collateral values and discount rate.

For acquired loans that are not deemed impaired at acquisition, credit discounts representing principal losses expected over the life of the loan are a component of the initial fair value and amortized over the life of the asset. Subsequent to the acquisition date, the methods used to estimate the required allowance for loan losses on these loans is similar to originated loans. However, the Corporation records a provision for loan losses only when the required allowance for loan losses exceeds any remaining credit discount. The remaining differences between the acquisition date fair value and the unpaid principal balance at the date of acquisition are recorded in interest income over the life of the loan.

Acquired loans that have evidence of deterioration in credit quality since origination and for which it is probable, at acquisition, that the Corporation will be unable to collect all contractually required payments are accounted for as impaired loans under ASC 310-30. The excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized into interest income over the remaining life of the loans. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the non-accretable discount. The non-accretable discount represents estimated future credit losses expected to be incurred over the life of the loan. Subsequent decreases to the expected cash flows require the Corporation to evaluate the need for an allowance for loan losses on these loans. Subsequent improvements in expected cash flows result in the reversal of a corresponding amount of the non-accretable discount which the Corporation then reclassifies as an accretable discount that is recognized into interest income over the remaining life of the loans using the interest method.

- 9 -

Table of Contents

The following is a summary of acquired impaired loans from the merger, as discussed in Note 2-Merger with Madison Bancorp, Inc.:


(dollars in thousands)	January 16, 2015
Contractually required principal and interest at acquisition	$	1,961
Contractual cash flows not expected to be collected		1,185
Expected cash flows at acquisition		776
Interest component of expected cash flows		160
Basis in acquired loans at acquisition - estimated fair value	$	616

Allowance for Loan Losses

The allowance for loan losses represents the Corporation’s estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectable are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. While the Corporation attributes a portion of the allowance to individual loans and groups of loans that it evaluates and determines to be impaired, the allowance is available to cover all charge-offs that arise from the loan portfolio.

The allowance for loan losses is maintained at a level considered by management to be adequate to provide for losses that can be reasonably anticipated. The Corporation 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.

- 10 -

Table of Contents

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as impaired, generally substandard and nonaccrual loans. For loans that are classified as impaired, an allowance is established when the collateral value (or discounted cash flows or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers pools of loans by loan class, including commercial loans not considered impaired, as well as smaller balance homogeneous loans such as residential real estate, home equity and other consumer loans. These pools of loans are evaluated for loss exposure based upon historical loss rates for each of these classes of loans, adjusted for qualitative (environmental) risk factors. Historical loss rates are based on a two year rolling average of net charge-offs. Qualitative risk factors that supplement historical losses in the evaluation of loan pools are shown below. Each factor is assigned a value to reflect improving, stable or declining conditions based on the Corporation’s best judgment using relevant information available at the time of the evaluation.

Changes in national and local economies and business conditions

Changes in the value of collateral for collateral dependent loans

Changes in the level of concentrations of credit

Changes in the volume and severity of classified and past due loans

Changes in the nature and volume of the portfolio

Changes in collection, charge-off, and recovery procedures

Changes in underwriting standards and loan terms

Changes in the quality of the loan review system

Changes in the experience/ability of lending management and key lending staff

Regulatory and legal regulations that could affect the level of credit losses

Other pertinent environmental factors

The unallocated component is maintained to cover uncertainties that could affect the Corporation’s estimate of probable losses. For example, increasing credit risks and uncertainties, not yet reflected in current leading indicators, associated with prolonged low economic growth, or recessionary business conditions for certain industries or the broad economy, or the erosion of real estate values, represent risk factors, the occurrence of any or all of which can adversely affect a borrowers’ ability to service their loans. The unallocated component of the allowance also reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the loan portfolio, including the unpredictable timing and amounts of charge-offs and related historical loss averages, and specific-credit or broader portfolio future cash flow value and collateral valuation uncertainties which could negatively impact unimpaired portfolio loss factors.

As disclosed in Note 5—Loans, the Corporation engages in commercial and consumer lending. Loans are made within the Corporation’s primary market area and surrounding areas, and include the purchase of whole loan or participation interests in loans from other financial institutions or private equity companies. Commercial loans, which pose the greatest risk of loss to the Corporation, whether originated or purchased, are generally secured by real estate. Within the broad commercial loan segment, the builder & developer and commercial real estate investor loan classes generally present a higher level of risk than other commercial loan classifications. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effect of general economic conditions on income producing properties, unstable real estate prices and the dependency upon successful construction and sale or operation of the real estate project. Within the consumer loan segment, junior (i.e., second) liens present a higher risk to the Corporation because economic and housing market conditions can adversely affect the underlying value of the collateral, which could render the Corporation under-secured or unsecured. In addition, economic and housing market conditions can adversely affect the ability of borrowers to service their debt.

- 11 -

Table of Contents

A loan is considered 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 in determining impairment include payment status 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. The Corporation 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 the shortfall in relation to the principal and interest owed. Loans that are deemed impaired are evaluated for impairment loss based on the net realizable value of the collateral, as applicable. Loans that are not collateral dependent will rely on the present value of expected future cash flows discounted at the loan’s effective interest rate to determine impairment loss. Large groups of smaller balance homogeneous loans such as residential mortgage loans, home equity loans and other consumer loans are collectively evaluated for impairment, unless they are classified as impaired.

An allowance for loan losses is established for an impaired commercial loan if its carrying value exceeds its estimated fair value. For commercial loans secured by real estate, estimated fair values are determined primarily through third-party appraisals of the underlying collateral. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the most recent appraisal and the condition of the property. Appraisals are generally discounted to provide for selling costs and other factors to determine an estimate of the net realizable value of the property. For commercial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets. In instances when specific consumer related loans become impaired, they may be partially or fully charged off, which obviates the need for a specific allowance.

Loans whose terms are modified are classified as troubled debt restructurings if the Corporation grants borrowers experiencing financial difficulties concessions that it would not otherwise consider. Concessions granted under a troubled debt restructuring may involve an interest rate that is below the market rate given the associated credit risk of the loan or an extension of a loan’s stated maturity date. Loans classified as troubled debt restructurings are designated as impaired. Non-accrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for a reasonable period of time, generally six consecutive months after modification and future payments are reasonably assured.

Banking regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses and may require the Corporation to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to the Corporation. Based on an analysis of the loan portfolio, the Corporation believes that the level of the allowance for loan losses at March 31, 2016 is adequate.

Foreclosed Real Estate

Foreclosed real estate, included in other assets, is comprised of property acquired through a foreclosure proceeding or property that is acquired through in-substance foreclosure. Foreclosed real estate is initially recorded at fair value minus estimated costs to sell at the date of foreclosure, establishing a new cost basis. Any difference between the carrying value and the new cost basis is charged against the allowance for loan losses. Appraisals, obtained from an independent third party, are generally used to determine fair value. After foreclosure, management reviews valuations at least quarterly and adjusts the asset to the lower of cost or fair value minus estimated costs to sell through a valuation allowance or a write-down. Costs related to the improvement of foreclosed real estate are generally capitalized until the real estate reaches a saleable condition subject to fair value limitations. Revenue and expense from operations and changes in the valuation allowance are included in noninterest expense. When a foreclosed real estate asset is ultimately sold, any gain or loss on the sale is included in the income statement as a component of noninterest expense. At March 31, 2016, foreclosed real estate, net of allowance, was $2,779,000, compared to $2,913,000 at December 31, 2015. Included within loans receivable as of March 31, 2016, was a recorded investment of $224,000 of consumer mortgage loans secured by residential real estate properties, for which formal foreclosure proceedings were in process according to local requirements of the applicable jurisdiction.

- 12 -

Table of Contents

Goodwill and Core Deposit Intangible Assets

Goodwill arising from acquisitions is not amortized, but is subject to an annual impairment test. This test consists of a qualitative analysis. If the Corporation determines events or circumstances indicate that it is more likely than not that goodwill is impaired, a quantitative analysis must be completed. Analyses may also be performed between annual tests. Significant judgment is applied when goodwill is assessed for impairment. This judgment includes developing cash flow projections, selecting appropriate discount rates, identifying relevant market comparables, incorporating general economic and market conditions, and selecting an appropriate control premium. The Corporation completes its annual goodwill impairment test on October 1^st of each year. Based upon a qualitative analysis of goodwill, the Corporation concluded that the amount of recorded goodwill was not impaired as of October 1, 2015.

Core deposit intangibles represent the value assigned to demand, interest checking, money market, and savings accounts acquired as part of an acquisition. The core deposit intangible value represents the future economic benefit of potential cost savings from acquiring core deposits as part of an acquisition compared to the cost of alternative funding sources and the alternative cost to grow a similar core deposit base. The core deposit intangible asset resulting from the merger with Madison Bancorp, Inc. was determined to have a definite life and is being amortized using the sum of the years’ digits method over ten years. All intangible assets must be evaluated for impairment if certain events or changes in circumstances occur. Any impairment write-downs would be recognized as expense on the consolidated statements of income.

At March 31, 2016, the Corporation does not have any indicators of potential impairment of either goodwill or core deposit intangibles.

Per Common Share Data

All per share computations include the effect of stock dividends distributed. The computation of net income per common share is provided in the table below.


	Three months ended March 31,
(in thousands, except per share data)	2016		2015
Net income available to common shareholders	$	2,801	$	2,404

Weighted average shares outstanding (basic)		7,960		6,128
Effect of dilutive stock options		64		80
Weighted average shares outstanding (diluted)		8,024		6,208

Basic earnings per common share	$	0.35	$	0.39
Diluted earnings per common share	$	0.35	$	0.39

Anti-dilutive stock options excluded from the
computation of earnings per share		74		37

- 13 -

Table of Contents

Comprehensive Income

Accounting principles generally accepted in the United States require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the shareholders’ equity section of the balance sheet, such items, along with net income, are components of comprehensive income.

Cash Flow Information

For purposes of the statements of cash flows, the Corporation considers interest bearing deposits with banks, cash and due from banks, and federal funds sold to be cash and cash equivalents.

Supplemental cash flow information is provided in the table below.


	Three months ended March 31,
(dollars in thousands)	2016		2015
Cash paid during the period for:
Income taxes	$	80	$	350
Interest	$	2,007	$	1,998

Recent Accounting Pronouncements

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718). This standard introduces amendments intended to simplify the accounting for stock compensation. Specifically, the ASU requires all excess tax benefits and tax deficiencies (including tax benefits of dividends on share-based payment awards) to be recognized as income tax expense or benefit in the income statement. The new standard is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption is permitted. The Corporation is currently evaluating the impact of the adoption of this guidance on its consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases. From the lessee’s perspective, the new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for lessees. From the lessor’s perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating. A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing lease. If the lessor does not convey risks and rewards or control, an operating lease results. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. A modified retrospective transition approach is required for lessors for sales-type, direct financing, and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Corporation is currently evaluating the impact of the adoption of this guidance on its consolidated financial statements.

- 14 -

Table of Contents

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). This standards update provides a framework that replaces most existing revenue recognition guidance. The guidance requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. ASU 2014-09 is effective for interim and annual reporting periods beginning after December 15, 2017, with earlier adoption permitted. The Corporation is currently evaluating the impact of the adoption of this guidance on its consolidated financial statements.

Note 2-Merger with Madison Bancorp, Inc.

On July 22, 2014, the Corporation entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Madison Bancorp, Inc., a Maryland corporation (“Madison”), and CVLY Corp., a Pennsylvania corporation and wholly-owned subsidiary of the Corporation (“Acquisition Subsidiary”). Pursuant to the Merger Agreement, Madison agreed to cause its wholly-owned subsidiary, Madison Square Federal Savings Bank (“MSFSB”), to merge with and into the Corporation’s wholly-owned bank subsidiary, PeoplesBank, with PeoplesBank being the surviving bank in the Bank Merger.

The acquisition of Madison and MSFSB was completed on January 16, 2015, as reported on a Form 8-K filed on the same date. Pursuant to the Merger Agreement, each share of Madison common stock was converted into the right to receive $22.90 in cash, without interest, and each outstanding option to purchase Madison common stock was converted into the right to receive cash based on a formula set forth in the Merger Agreement. Total consideration paid was $14,425,000, which included the purchase of 608,116 shares of Madison common stock as well as the cash out of 41,270 options to purchase Madison common stock with an average exercise price of $10.81 per share.

The merger was accounted for using acquisition accounting, which requires the Corporation to allocate total consideration transferred to the assets acquired and liabilities assumed, based on their respective fair value at the merger date, with any remaining excess consideration being recorded as goodwill. The table below presents the detail of the total acquisition cost as well as a summary of the assets acquired and liabilities assumed recorded at their estimated fair value, as of the January 16, 2015 acquisition date.



(in thousands, except per share data)	January 16, 2015
Cash paid for outstanding shares of Madison common stock and outstanding options			$	14,425

Assets Acquired:
Cash and due from banks	$	35,516
Securities, available for sale		1,396
Loans		77,228
Premises and equipment		2,601
Other assets		17,567
Total assets acquired				134,308
Liabilities Assumed:
Deposits		120,545
Other liabilities		1,639
Total liabilities assumed				122,184

Net goodwill resulting from merger			$	2,301

- 15 -

Table of Contents

The fair value of total assets acquired as a result of the merger totaled $134,308,000, which included $1,396,000 of securities which were subsequently sold in the first quarter of 2015. Additionally, other assets of $17,567,000 included $15,256,000 of receivables related to investment securities sold prior to the merger, pending receipt of sales proceeds, which were subsequently collected. The transaction also resulted in a core deposit intangible of $39,000 and goodwill of $2,301,000. Goodwill arising from the acquisition consists largely of synergies and the cost savings expected to result from the combining of operations and is not expected to be deductible for income tax purposes.

The following table presents unaudited pro forma information as if the merger between PeoplesBank and MSFSB had been completed on January 1, 2014. The pro forma information does not necessarily reflect the results of operations that would have occurred had MSFSB merged with PeoplesBank at the beginning of 2014. The pro forma financial information does not include the impact of possible business model changes, nor does it consider any potential impacts of current market conditions or revenues, cost savings, or other factors.



(in thousands, except per share data)	Pro forma for the year ended December 31, 2014
Net interest income	$	44,598
Noninterest income		8,246
Net income available to common shareholders		10,972

Pro forma earnings per share:
Basic	$	1.87
Diluted	$	1.83

- 16 -

Table of Contents

Note 3-Securities

A summary of securities available-for-sale at March 31, 2016 and December 31, 2015 is provided below. The securities available-for-sale portfolio is generally comprised of high quality debt instruments, principally obligations of the United States government or agencies thereof and investments in the obligations of states and municipalities. The majority of municipal bonds in the portfolio are general obligation bonds, which can draw upon multiple sources of revenue, including taxes, for payment. Only a few bonds are revenue bonds, which are dependent upon a single revenue stream for payment, but they are for critical services such as water and sewer. In many cases, municipal debt issues are insured or, in the case of school districts of selected states, backed by specific loss reserves. At March 31, 2016, the fair value of the municipal bond portfolio was concentrated in the states of Pennsylvania at 64 percent and Texas at 12 percent.


	Amortized		Gross Unrealized					Fair
*(dollars in thousands)*	Cost		Gains		Losses			Value
March 31, 2016
Debt securities:
U.S. agency	$	14,071	$	8	$	(19	)	$	14,060
U.S. agency mortgage-backed, residential		104,240		2,473		0			106,713
State and municipal		78,213		1,011		(81	)		79,143
Total debt securities	$	196,524	$	3,492	$	(100	)	$	199,916
December 31, 2015
Debt securities:
U.S. agency	$	17,554	$	0	$	(140	)	$	17,414
U.S. agency mortgage-backed, residential		119,266		1,472		(157	)		120,581
State and municipal		74,573		937		(35	)		75,475
Total debt securities	$	211,393	$	2,409	$	(332	)	$	213,470

The amortized cost and estimated fair value of debt securities at March 31, 2016 by contractual maturity are shown below. Actual maturities may differ from contractual maturities if call options on select debt issues are exercised in the future. Mortgage-backed securities are included in the maturity categories based on average expected life.


	Available-for-sale
	Amortized		Fair
*(dollars in thousands)*	Cost		Value
Due in one year or less	$	14,558	$	14,636
Due after one year through five years		127,334		129,886
Due after five years through ten years		43,763		44,340
Due after ten years		10,869		11,054
Total debt securities	$	196,524	$	199,916

- 17 -

Table of Contents

Gross realized gains and losses on sales of securities available-for-sale are shown below. Realized gains and losses are computed on the basis of specific identification of the adjusted cost of each security and are shown net as a separate line item in the income statement.


	Three months ended
	March 31,
*(dollars in thousands)*	2016		2015
Realized gains	$	194	$	371
Realized losses		0		0
Net gains	$	194	$	371

Securities, issued by agencies of the federal government, with a carrying value of $138,871,000 and $186,097,000 on March 31, 2016 and December 31, 2015, respectively, were pledged to secure public and trust deposits, repurchase agreements and other short-term borrowings.

The table below shows gross unrealized losses and fair value, aggregated by investment category and length of time, for securities that have been in a continuous unrealized loss position, at March 31, 2016 and December 31, 2015.


	Less than 12 months							12 months or more							Total
	Number of		Fair		Unrealized			Number of		Fair		Unrealized			Number of		Fair		Unrealized
*(dollars in thousands)*	Securities		Value		Losses			Securities		Value		Losses			Securities		Value		Losses
March 31, 2016
Debt securities:
U.S. agency		2	$	5,986	$	(19	)		0	$	0	$	0			2	$	5,986	$	(19	)
State and municipal		22		12,357		(76	)		2		1,036		(5	)		24		13,393		(81	)
Total temporarily impaired debt securities, available-for-sale		24	$	18,343	$	(95	)		2	$	1,036	$	(5	)		26	$	19,379	$	(100	)
December 31, 2015
Debt securities:
U.S. agency		6	$	17,414	$	(140	)		0	$	0	$	0			6	$	17,414	$	(140	)
U.S. agency mortgage-backed, residential		8		18,991		(157	)		0		0		0			8		18,991		(157	)
State and municipal		27		11,272		(26	)		4		1,886		(9	)		31		13,158		(35	)
Total temporarily impaired debt securities, available-for-sale		41	$	47,677	$	(323	)		4	$	1,886	$	(9	)		45	$	49,563	$	(332	)

Securities available-for-sale are analyzed quarterly for possible other-than-temporary impairment. The analysis considers, among other factors: 1) whether the Corporation has the intent to sell its securities prior to market recovery or maturity; 2) whether it is more likely than not that the Corporation will be required to sell its securities prior to market recovery or maturity; 3) default rates/history by security type; 4) third-party securities ratings; 5) third-party guarantees; 6) subordination; 7) payment delinquencies; 8) nature of the issuer; and 9) current financial news.

The Corporation believes that unrealized losses at March 31, 2016 were primarily the result of changes in market interest rates and that the Corporation has the ability to hold these investments for a time necessary to recover the amortized cost. Through March 31, 2016, the Corporation has collected all interest and principal on its investment securities as scheduled. The Corporation believes that collection of the contractual principal and interest is probable and, therefore, all impairment is considered to be temporary.

- 18 -

Table of Contents

Note 4—Restricted Investment in Bank Stocks

Restricted stock, which represents required investments in the common stock of correspondent banks, is carried at cost and, as of March 31, 2016 and December 31, 2015, consisted primarily of the common stock of the Federal Home Loan Bank of Pittsburgh (FHLBP) and, to a lesser degree, Atlantic Community Bankers Bank (ACBB). Under the FHLBP’s Capital Plan, PeoplesBank is required to maintain a minimum member stock investment, as a condition of becoming and remaining a member and as a condition of obtaining borrowings from the FHLBP. The FHLBP uses a formula to determine the minimum stock investment, which is based on the volume of loans outstanding, unused borrowing capacity and other factors.

The FHLBP paid dividends during the periods ended March 31, 2016 and 2015. The FHLBP restricts the repurchase of the excess capital stock of member banks. The amount of excess capital stock that can be repurchased from any member is currently the lesser of five percent of the member’s total capital stock outstanding or its excess capital stock outstanding.

Management evaluates the restricted stock for impairment in accordance with FASB ASC Topic 942. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. Using the FHLBP as an example, the determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as: (1) the significance of the decline in net assets of the FHLBP as compared to the capital stock amount for the FHLBP and the length of time this situation has persisted; (2) commitments by the FHLBP to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLBP; and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the FHLBP. Management believes no impairment charge was necessary related to the restricted stock during the periods ended March 31, 2016 and 2015.

- 19 -

Table of Contents

Note 5—Loans

Loan Portfolio Composition

The table below provides the composition of the loan portfolio at March 31, 2016 and December 31, 2015. The portfolio is comprised of two segments, commercial and consumer loans. The commercial loan segment is disaggregated by industry class which allows the Corporation to monitor risk and performance. Those industries representing the largest dollar investment and most risk are listed separately. The “Other” commercial loans category is comprised of various industries. The consumer related segment is comprised of residential mortgages, home equity and other consumer loans. The Corporation has not engaged in sub-prime residential mortgage originations.


	March 31,		% Total		December 31,		% Total
*(dollars in thousands)*	2016		Loans		2015		Loans
Builder & developer	$	141,923		12.3	$	133,978		11.9
Commercial real estate investor		210,016		18.3		191,994		17.1
Residential real estate investor		158,813		13.8		161,144		14.3
Hotel/Motel		83,589		7.3		84,171		7.5
Wholesale & retail		77,645		6.7		77,694		6.9
Manufacturing		32,988		2.9		30,325		2.7
Agriculture		41,366		3.6		41,217		3.7
Other		218,670		19.0		215,891		19.2
Total commercial related loans		965,010		83.9		936,414		83.4
Residential mortgages		68,418		5.9		70,094		6.2
Home equity		86,136		7.5		86,408		7.7
Other		30,583		2.7		30,295		2.7
Total consumer related loans		185,137		16.1		186,797		16.6
Total loans	$	1,150,147		100.0	$	1,123,211		100.0

Loan Risk Ratings

The Corporation’s internal risk rating system follows regulatory guidance as to risk classifications and definitions. Every approved loan is assigned a risk rating. Generally, risk ratings for commercial related loans and residential mortgages held for investment are determined by a formal evaluation of risk factors performed by the Corporation’s underwriting staff. For consumer loans, and commercial loans up to $750,000, the Corporation uses third-party credit scoring software models for risk rating purposes. The loan portfolio is monitored on a continuous basis by loan officers, loan review personnel and senior management. Adjustments of loan risk ratings are generally performed by the Special Asset Committee, which includes senior management. The Committee, which meets monthly, makes changes, as appropriate, to risk ratings when it becomes aware of credit events such as payment delinquency, cessation of a business or project, bankruptcy or death of the borrower, or changes in collateral value.

- 20 -

Table of Contents

The Corporation uses ten risk ratings to grade loans. The first seven ratings, representing the lowest risk, are combined and given a “pass” rating. A pass rating is a satisfactory credit rating, which applies to a loan that is expected to perform in accordance with the loan agreement and has a low probability of loss. A loan rated “special mention” has a potential weakness which may, if not corrected, weaken the loan or inadequately protect the Corporation’s position at some future date. A loan rated “substandard” is inadequately protected by the current net worth or paying capacity of the borrower or of the collateral pledged. A substandard loan has a well-defined weakness or weaknesses that could jeopardize liquidation of the loan, which exposes the Corporation to loss if the deficiencies are not corrected. A loan classified “doubtful” has all the weaknesses inherent in one classified substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and value highly improbable and the possibility of loss extremely high. When circumstances indicate that collection of the loan is doubtful, the loan is risk rated “nonaccrual,” the accrual of interest income is discontinued, and any unpaid interest previously credited to income is reversed. The table below does not include the regulatory classification of “doubtful,” which is subsumed within the nonaccrual risk rating category, nor does it include the regulatory classification of “loss” because the Corporation promptly charges off known loan losses.

The table below presents a summary of loan risk ratings by loan class at March 31, 2016 and December 31, 2015.


			Special
*(dollars in thousands)*	Pass		Mention		Substandard		Nonaccrual		Total
March 31, 2016
Builder & developer	$	131,096	$	6,888	$	3,847	$	92	$	141,923
Commercial real estate investor		203,806		388		5,822		0		210,016
Residential real estate investor		150,934		6,605		863		411		158,813
Hotel/Motel		83,178		0		0		411		83,589
Wholesale & retail		69,121		8,496		0		28		77,645
Manufacturing		29,586		2,776		626		0		32,988
Agriculture		40,627		349		0		390		41,366
Other		215,757		1,284		862		767		218,670
Total commercial related loans		924,105		26,786		12,020		2,099		965,010
Residential mortgage		68,121		0		97		200		68,418
Home equity		85,711		74		0		351		86,136
Other		30,189		118		129		147		30,583
Total consumer related loans		184,021		192		226		698		185,137
Total loans	$	1,108,126	$	26,978	$	12,246	$	2,797	$	1,150,147

December 31, 2015
Builder & developer	$	122,919	$	6,775	$	3,873	$	411	$	133,978
Commercial real estate investor		185,621		396		5,957		20		191,994
Residential real estate investor		153,072		6,601		874		597		161,144
Hotel/Motel		83,751		0		0		420		84,171
Wholesale & retail		69,973		7,678		0		43		77,694
Manufacturing		26,705		2,990		630		0		30,325
Agriculture		40,795		0		0		422		41,217
Other		212,971		1,131		855		934		215,891
Total commercial related loans		895,807		25,571		12,189		2,847		936,414
Residential mortgage		69,930		0		97		67		70,094
Home equity		85,690		516		0		202		86,408
Other		29,973		75		130		117		30,295
Total consumer related loans		185,593		591		227		386		186,797
Total loans	$	1,081,400	$	26,162	$	12,416	$	3,233	$	1,123,211

- 21 -

Table of Contents

Impaired Loans

The table below presents a summary of impaired loans at March 31, 2016 and December 31, 2015. Generally, impaired loans are loans risk rated substandard and nonaccrual. An allowance is established for individual commercial loans where the Corporation has doubt as to full recovery of the outstanding principal balance. The recorded investment represents outstanding unpaid principal loan balances adjusted for charge-offs.


	With No Allowance				With A Related Allowance						Total
	Recorded		Unpaid		Recorded		Unpaid		Related		Recorded		Unpaid
*(dollars in thousands)*	Investment		Principal		Investment		Principal		Allowance		Investment		Principal
March 31, 2016
Builder & developer	$	3,939	$	4,074	$	0	$	0	$	0	$	3,939	$	4,074
Commercial real estate investor		5,822		5,837		0		0		0		5,822		5,837
Residential real estate investor		462		1,186		812		854		192		1,274		2,040
Hotel/Motel		411		411		0		0		0		411		411
Wholesale & retail		293		293		0		0		0		293		293
Manufacturing		626		626		0		0		0		626		626
Agriculture		0		0		390		390		263		390		390
Other commercial		1,629		1,744		0		0		0		1,629		1,744
Total impaired commercial related loans		13,182		14,171		1,202		1,244		455		14,384		15,415
Residential mortgage		297		339		0		0		0		297		339
Home equity		351		391		0		0		0		351		391
Other consumer		276		293		0		0		0		276		293
Total impaired consumer related loans		924		1,023		0		0		0		924		1,023
Total impaired loans	$	14,106	$	15,194	$	1,202	$	1,244	$	455	$	15,308	$	16,438

December 31, 2015
Builder & developer	$	4,284	$	4,917	$	0	$	0	$	0	$	4,284	$	4,917
Commercial real estate investor		5,977		5,991		0		0		0		5,977		5,991
Residential real estate investor		649		1,199		822		864		142		1,471		2,063
Hotel/Motel		420		420		0		0		0		420		420
Wholesale & retail		309		309		0		0		0		309		309
Manufacturing		630		630		0		0		0		630		630
Agriculture		0		0		422		422		263		422		422
Other commercial		1,789		1,904		0		0		0		1,789		1,904
Total impaired commercial related loans		14,058		15,370		1,244		1,286		405		15,302		16,656
Residential mortgage		164		188		0		0		0		164		188
Home equity		202		242		0		0		0		202		242
Other consumer		247		265		0		0		0		247		265
Total impaired consumer related loans		613		695		0		0		0		613		695
Total impaired loans	$	14,671	$	16,065	$	1,244	$	1,286	$	405	$	15,915	$	17,351

- 22 -

Table of Contents

The table below presents a summary of average impaired loans and related interest income that was included in net income for the three months ended March 31, 2016 and 2015.


	With No Related Allowance						With A Related Allowance							Total
	Average		Total		Cash Basis		Average		Total			Cash Basis		Average		Total		Cash Basis
	Recorded		Interest		Interest		Recorded		Interest			Interest		Recorded		Interest		Interest
*(dollars in thousands)*	Investment		Income		Income		Investment		Income			Income		Investment		Income		Income
Three months ended March 31, 2016
Builder & developer	$	4,111	$	59	$	0	$	0	$	0		$	0	$	4,111	$	59	$	0
Commercial real estate investor		5,899		76		0		0		0			0		5,899		76		0
Residential real estate investor		555		5		0		817		7			0		1,372		12		0
Hotel/Motel		416		2		2		0		0			0		416		2		2
Wholesale & retail		301		3		0		0		0			0		301		3		0
Manufacturing		628		10		0		0		0			0		628		10		0
Agriculture		0		0		0		406		0			0		406		0		0
Other commercial		1,709		18		4		0		0			0		1,709		18		4
Total impaired commercial related loans		13,619		173		6		1,223		7			0		14,842		180		6
Residential mortgage		230		0		0		0		0			0		230		0		0
Home equity		277		1		1		0		0			0		277		1		1
Other consumer		261		3		2		0		0			0		261		3		2
Total impaired consumer related loans		768		4		3		0		0			0		768		4		3
Total impaired loans	$	14,387	$	177	$	9	$	1,223	$	7		$	0	$	15,610	$	184	$	9

Three months ended March 31, 2015
Builder & developer	$	3,946	$	60	$	1	$	2,045	$	0		$	0	$	5,991	$	60	$	1
Commercial real estate investor		4,474		296		249		1,876		32			32		6,350		328		281
Residential real estate investor		1,077		16		0		795		(3	)		0		1,872		13		0
Hotel/Motel		515		3		3		0		0			0		515		3		3
Wholesale & retail		392		5		2		0		0			0		392		5		2
Manufacturing		652		10		0		0		0			0		652		10		0
Agriculture		0		0		0		428		7			0		428		7		0
Other commercial		1,299		24		2		237		0			0		1,536		24		2
Total impaired commercial related loans		12,355		414		257		5,381		36			32		17,736		450		289
Residential mortgage		175		2		3		0		0			0		175		2		3
Home equity		125		0		0		0		0			0		125		0		0
Other consumer		390		6		4		0		0			0		390		6		4
Total impaired consumer related loans		690		8		7		0		0			0		690		8		7
Total impaired loans	$	13,045	$	422	$	264	$	5,381	$	36		$	32	$	18,426	$	458	$	296

- 23 -

Table of Contents

Past Due and Nonaccrual

The performance and credit quality of the loan portfolio is also monitored by using an aging schedule that shows the length of time a loan is past due. The table below presents a summary of past due loans, nonaccrual loans and current loans by loan segment and class at March 31, 2016 and December 31, 2015.


					≥ 90 Days
	30-59		60-89		Past Due				Total Past
	Days		Days		and				Due and				Total
*(dollars in thousands)*	Past Due		Past Due		Accruing		Nonaccrual		Nonaccrual		Current		Loans
March 31, 2016
Builder & developer	$	570	$	0	$	307	$	92	$	969	$	140,954	$	141,923
Commercial real estate investor		215		0		0		0		215		209,801		210,016
Residential real estate investor		0		0		0		411		411		158,402		158,813
Hotel/Motel		0		0		0		411		411		83,178		83,589
Wholesale & retail		119		138		0		28		285		77,360		77,645
Manufacturing		0		0		0		0		0		32,988		32,988
Agriculture		0		0		200		390		590		40,776		41,366
Other		0		0		193		767		960		217,710		218,670
Total commercial related loans		904		138		700		2,099		3,841		961,169		965,010
Residential mortgage		271		0		79		200		550		67,868		68,418
Home equity		156		54		75		351		636		85,500		86,136
Other		150		59		12		147		368		30,215		30,583
Total consumer related loans		577		113		166		698		1,554		183,583		185,137
Total loans	$	1,481	$	251	$	866	$	2,797	$	5,395	$	1,144,752	$	1,150,147

December 31, 2015
Builder & developer	$	398	$	308	$	0	$	411	$	1,117	$	132,861	$	133,978
Commercial real estate investor		216		396		0		20		632		191,362		191,994
Residential real estate investor		0		304		0		597		901		160,243		161,144
Hotel/Motel		0		0		0		420		420		83,751		84,171
Wholesale & retail		0		119		0		43		162		77,532		77,694
Manufacturing		0		0		0		0		0		30,325		30,325
Agriculture		0		0		0		422		422		40,795		41,217
Other		324		0		198		934		1,456		214,435		215,891
Total commercial related loans		938		1,127		198		2,847		5,110		931,304		936,414
Residential mortgage		0		0		249		67		316		69,778		70,094
Home equity		485		71		0		202		758		85,650		86,408
Other		171		163		37		117		488		29,807		30,295
Total consumer related loans		656		234		286		386		1,562		185,235		186,797
Total loans	$	1,594	$	1,361	$	484	$	3,233	$	6,672	$	1,116,539	$	1,123,211

- 24 -

Table of Contents

Troubled Debt Restructurings

Loans classified as troubled debt restructurings (TDRs) are designated impaired and arise when the Corporation grants borrowers experiencing financial difficulties concessions that it would not otherwise consider. Concessions granted with respect to these loans generally involve an extension of the maturity date or a below market interest rate relative to new debt with similar credit risk. Generally, these loans are secured by real estate. If repayment of the loan is determined to be collateral dependent, the loan is evaluated for impairment loss based on the fair value of the collateral. For loans that are not collateral dependent, the present value of expected future cash flows, discounted at the loan’s original effective interest rate, is used to determine any impairment loss.

A nonaccrual TDR represents a nonaccrual loan, as previously defined, which includes an economic concession. Nonaccrual TDRs are restored to accrual status if principal and interest payments, under the modified terms, are current for six consecutive payments after the modification and future principal and interest payments are reasonably assured. In contrast, an accruing TDR represents a loan that, at the time of the modification, has a demonstrated history of payments and management believes that future loan payments are reasonably assured under the modified terms.

There were no loans whose terms have been modified under TDRs during the three months ended March 31, 2016 and 2015. There were no defaults during the three months ended March 31, 2016 for TDRs entered into during the previous 12 month period.

- 25 -

Table of Contents

NOTE 6 – Allowance for Loan Losses

The table below shows the activity in and the composition of the allowance for loan losses by loan segment and class detail as of and for the three months ended March 31, 2016 and 2015.


	Allowance for Loan Losses
	January 1, 2016										March 31, 2016
*(dollars in thousands)*	Balance		Charge-offs			Recoveries		Provision			Balance
Builder & developer	$	1,934	$	0		$	0	$	129		$	2,063
Commercial real estate investor		2,337		0			0		270			2,607
Residential real estate investor		2,101		(186	)		0		252			2,167
Hotel/Motel		837		0			0		(5	)		832
Wholesale & retail		701		0			1		(10	)		692
Manufacturing		223		(140	)		0		228			311
Agriculture		548		0			0		1			549
Other commercial		2,054		(42	)		0		124			2,136
Total commercial related loans		10,735		(368	)		1		989			11,357
Residential mortgage		67		(24	)		0		30			73
Home equity		161		0			0		1			162
Other consumer		261		(27	)		4		(27	)		211
Total consumer related loans		489		(51	)		4		4			446
Unallocated		1,480		0			0		(193	)		1,287
Total	$	12,704	$	(419	)	$	5	$	800		$	13,090


	Allowance for Loan Losses
	January 1, 2015										March 31, 2015
*(dollars in thousands)*	Balance		Charge-offs			Recoveries		Provision			Balance
Builder & developer	$	2,236	$	0		$	0	$	(113	)	$	2,123
Commercial real estate investor		2,204		0			0		407			2,611
Residential real estate investor		1,484		(489	)		2		485			1,482
Hotel/Motel		671		0			0		17			688
Wholesale & retail		691		0			14		7			712
Manufacturing		201		0			0		(6	)		195
Agriculture		329		0			0		9			338
Other commercial		1,554		(190	)		0		56			1,420
Total commercial related loans		9,370		(679	)		16		862			9,569
Residential mortgage		64		(28	)		20		92			148
Home equity		176		(40	)		0		67			203
Other consumer		216		(23	)		7		(16	)		184
Total consumer related loans		456		(91	)		27		143			535
Unallocated		1,336		0			0		(5	)		1,331
Total	$	11,162	$	(770	)	$	43	$	1,000		$	11,435

- 26 -

Table of Contents

The table below shows the allowance amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment at March 31, 2016 and 2015 and December 31, 2015.



	Allowance for Loan Losses						Loans
	Individually		Collectively				Individually		Collectively
	Evaluated For		Evaluated For				Evaluated For		Evaluated For
(dollars in thousands)	Impairment		Impairment		Balance		Impairment		Impairment		Balance
March 31, 2016
Builder & developer	$	0	$	2,063	$	2,063	$	3,939	$	137,984	$	141,923
Commercial real estate investor		0		2,607		2,607		5,822		204,194		210,016
Residential real estate investor		192		1,975		2,167		1,274		157,539		158,813
Hotel/Motel		0		832		832		411		83,178		83,589
Wholesale & retail		0		692		692		293		77,352		77,645
Manufacturing		0		311		311		626		32,362		32,988
Agriculture		263		286		549		390		40,976		41,366
Other commercial		0		2,136		2,136		1,629		217,041		218,670
Total commercial related		455		10,902		11,357		14,384		950,626		965,010
Residential mortgage		0		73		73		297		68,121		68,418
Home equity		0		162		162		351		85,785		86,136
Other consumer		0		211		211		276		30,307		30,583
Total consumer related		0		446		446		924		184,213		185,137
Unallocated		0		1,287		1,287		-		-		-
Total	$	455	$	12,635	$	13,090	$	15,308	$	1,134,839	$	1,150,147

December 31, 2015
Builder & developer	$	0	$	1,934	$	1,934	$	4,284	$	129,694	$	133,978
Commercial real estate investor		0		2,337		2,337		5,977		186,017		191,994
Residential real estate investor		142		1,959		2,101		1,471		159,673		161,144
Hotel/Motel		0		837		837		420		83,751		84,171
Wholesale & retail		0		701		701		309		77,385		77,694
Manufacturing		0		223		223		630		29,695		30,325
Agriculture		263		285		548		422		40,795		41,217
Other commercial		0		2,054		2,054		1,789		214,102		215,891
Total commercial related		405		10,330		10,735		15,302		921,112		936,414
Residential mortgage		0		67		67		164		69,930		70,094
Home equity		0		161		161		202		86,206		86,408
Other consumer		0		261		261		247		30,048		30,295
Total consumer related		0		489		489		613		186,184		186,797
Unallocated		0		1,480		1,480		-		-		-
Total	$	405	$	12,299	$	12,704	$	15,915	$	1,107,296	$	1,123,211

March 31, 2015
Builder & developer	$	703	$	1,420	$	2,123	$	6,009	$	120,628	$	126,637
Commercial real estate investor		800		1,811		2,611		6,149		155,486		161,635
Residential real estate investor		113		1,369		1,482		2,006		109,491		111,497
Hotel/Motel		0		688		688		509		80,932		81,441
Wholesale & retail		0		712		712		390		77,065		77,455
Manufacturing		0		195		195		649		32,446		33,095
Agriculture		100		238		338		424		43,425		43,849
Other commercial		0		1,420		1,420		1,625		191,952		193,577
Total commercial related		1,716		7,853		9,569		17,761		811,425		829,186
Residential mortgage		0		148		148		204		74,461		74,665
Home equity		0		203		203		141		83,488		83,629
Other consumer		0		184		184		388		32,924		33,312
Total consumer related		0		535		535		733		190,873		191,606
Unallocated		0		1,331		1,331		-		-		-
Total	$	1,716	$	9,719	$	11,435	$	18,494	$	1,002,298	$	1,020,792

- 27 -

Table of Contents

Note 7—Deposits

The composition of deposits as of March 31, 2016 and December 31, 2015 is shown below.


	March 31,		December 31,
*(dollars in thousands)*	2016		2015
Noninterest bearing demand	$	168,510	$	162,982
NOW		105,607		102,943
Money market		373,689		360,983
Savings		73,653		69,646
Time deposits less than $100,000		238,014		238,392
Time deposits $100,000 to $250,000		123,488		122,730
Time deposits $250,000 or more		37,872		36,473
Total deposits	$	1,120,833	$	1,094,149

Note 8—Short-Term Borrowings and Long-Term Debt

Short-term borrowings consist of securities sold under agreements to repurchase, federal funds purchased and other borrowings. At March 31, 2016, the balance of securities sold under agreements to repurchase was $19,922,000 compared to $74,510,000 at December 31, 2015. At March 31, 2016, the balance of other short-term borrowings was $6,664,000. At December 31, 2015 there were no other short-term borrowings.

The following table presents a summary of long-term debt as of March 31, 2016 and December 31, 2015. PeoplesBank’s long-term debt obligations to the FHLBP are fixed rate instruments. Under terms of a blanket collateral agreement with the FHLBP, the obligations are secured by FHLBP stock and PeoplesBank qualifying loan receivables, principally real estate secured loans.


	March 31,		December 31,
*(dollars in thousands)*	2016		2015
PeoplesBank’s obligations:
Federal Home Loan Bank of Pittsburgh (FHLBP)
Due July 2016, 2.35%		5,000		5,000
Due September 2016, 1.18%		10,000		10,000
Due October 2016, 1.06%		10,000		10,000
Due October 2016, 1.10%		10,000		10,000
Due April 2017, 0.97%		10,000		10,000
Due November 2017, 1.19%		5,000		5,000
Due March 2018, 1.17%		10,000		10,000
Due June 2018, 1.87%		5,000		5,000
Due November 2018, 1.62%		5,000		5,000
Due June 2019, 2.10%		5,000		5,000
Due June 2019, 1.64%		5,000		5,000
Due June 2020, 1.87%		15,000		15,000
Due June 2021, 2.14%		15,000		15,000
Total FHLBP		110,000		110,000
Codorus Valley Bancorp, Inc. obligations:
Junior subordinated debt
Due 2034, 2.65%, floating rate based on 3 month
LIBOR plus 2.02%, callable quarterly		3,093		3,093
Due 2036, 2.16% floating rate based on 3 month
LIBOR plus 1.54%, callable quarterly		7,217		7,217
Total long-term debt	$	120,310	$	120,310

- 28 -

Table of Contents

In June 2006, Codorus Valley formed CVB Statutory Trust No. 2, a wholly-owned special purpose subsidiary whose sole purpose was to facilitate a pooled trust preferred debt issuance of $7,217,000. In November 2004, Codorus Valley formed CVB Statutory Trust No. 1 to facilitate a pooled trust preferred debt issuance of $3,093,000. The Corporation owns all of the common stock of these nonbank subsidiaries, and the debentures are the sole assets of the Trusts. The accounts of both Trusts are not consolidated for financial reporting purposes in accordance with FASB ASC 810. For regulatory capital purposes, all of the Corporation’s trust preferred securities qualified as Tier 1 capital for all reported periods. Trust preferred securities are subject to capital limitations under the FDIC’s risk-based capital guidelines. The Corporation used the net proceeds from these offerings to fund its operations.

Note 9—Regulatory Matters

Codorus Valley and PeoplesBank are subject to various regulatory capital requirements. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if imposed, could have a material adverse effect on Codorus Valley’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Codorus Valley and PeoplesBank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators.

On July 2, 2013, the Board of Governors of the Federal Reserve System finalized its rule implementing the Basel III regulatory capital framework, which the FDIC adopted on July 9, 2013. Under the rule, minimum requirements increased both the quantity and quality of capital held by banking organizations. Consistent with the Basel III framework, the rule included a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5 percent, and a common equity Tier 1 conservation buffer of 2.5 percent of risk-weighted assets, that applies to all supervised financial institutions, which is to be phased in over a four year period beginning January 1, 2016, with the full 2.5 percent required as of January 1, 2019. The rule also raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4 percent to 6 percent, and includes a minimum leverage ratio of 4 percent for all banking organizations. The new rule also increased the risk weights for past-due loans, certain commercial real estate loans, and some equity exposures, and makes selected other changes in risk weights and credit conversion factors. The rule for smaller, less complex institutions, including the Corporation, took effect January 1, 2015.

- 29 -

Table of Contents

As of March 31, 2016, Codorus Valley and PeoplesBank met the minimum requirements of the Basel III framework, and PeoplesBank’s capital ratios exceeded the amount to be considered “well capitalized” as defined in the regulations. The table below provides a comparison of the Corporation’s and PeoplesBank’s risk-based capital ratios and leverage ratios to the minimum regulatory requirement for the periods indicated.


						Minimum for					Well Capitalized
	Actual					Capital Adequacy (1)					Minimum (2)
*(dollars in thousands)*	Amount		Ratio			Amount		Ratio			Amount		Ratio
*Codorus Valley Bancorp, Inc. (consolidated)*
at March 31, 2016
Capital ratios:
Common equity Tier 1	$	145,460		12.55	%	$	59,388		5.125	%		n/a		n/a
Tier 1 risk based		155,460		13.42			76,770		6.625			n/a		n/a
Total risk based		168,550		14.55			99,946		8.625			n/a		n/a
Leverage		155,460		10.99			56,560		4.00			n/a		n/a

at December 31, 2015
Capital ratios:
Common equity Tier 1	$	143,456		12.56	%	$	51,395		4.50	%		n/a		n/a
Tier 1 risk based		165,456		14.49			68,527		6.00			n/a		n/a
Total risk based		178,160		15.60			91,370		8.00			n/a		n/a
Leverage		165,456		11.73			56,398		4.00			n/a		n/a

PeoplesBank, A Codorus Valley Company
at March 31, 2016
Capital ratios:
Common equity Tier 1	$	152,053		13.16	%	$	59,214		5.125	%	$	75,101		6.50	%
Tier 1 risk based		152,053		13.16			76,545		6.625			92,432		8.00
Total risk based		165,143		14.29			99,653		8.625			115,540		10.00
Leverage		152,053		10.78			56,425		4.00			70,532		5.00

at December 31, 2015
Capital ratios:
Common equity Tier 1	$	149,073		13.10	%	$	51,227		4.50	%	$	73,994		6.50	%
Tier 1 risk based		149,073		13.10			68,302		6.00			91,070		8.00
Total risk based		161,777		14.21			91,070		8.00			113,837		10.00
Leverage		149,073		10.60			56,248		4.00			70,310		5.00

(1) Minimum amounts and ratios as of March 31, 2016 include the first year phase in of the capital conservation buffer of 0.625 percent required by the Basel III framework. The conservation buffer is to be phased in over a four year period beginning January 1, 2016, with the full 2.5 percent required as of January 1, 2019.

(2) To be “well capitalized” under the prompt corrective action provisions in the Basel III framework. “Well capitalized” applies to PeoplesBank only.

- 30 -

Table of Contents

Note 10—Shareholders’ Equity

Public Offering of Common Stock

On December 15, 2015, the Corporation completed a public offering of 1,519,000 shares of common stock at a price of $19.75 per share. On December 23, 2015, the Corporation announced that the underwriters of the previously closed public offering had exercised in full their option to purchase an additional 227,850 shares of the Corporation’s common stock at a public offering price of $19.75 per share.

The Corporation raised net proceeds of approximately $32,500,000, resulting from the gross amount of the public offering transaction and the exercise of the purchase options of $34,500,000, less related underwriting discounts, commissions and offering expense of approximately $2,000,000. Approximately $19,800,000 of the net proceeds from the public offering were invested in the Corporation’s Bank subsidiary, PeoplesBank. A portion of the proceeds were used to redeem the remaining $12,000,000 of Series B preferred held by the United States Department of Treasury on February 18, 2016. The remaining proceeds were used for general corporate purposes.

Preferred Stock Issued under the US Treasury’s Small Business Lending Fund Program

The U.S. Department of the Treasury (“Treasury”) had a capital investment in the Corporation pursuant to the Corporation’s participation in the Treasury’s Small Business Lending Funding Program (“SBLF Program”). In August 2011, the Corporation sold to the Treasury, for an aggregate purchase price of $25,000,000, 25,000 shares of non-cumulative, perpetual preferred stock, Series B, $1,000 liquidation value, $2.50 par value. On May 30, 2014, the Corporation redeemed 13,000 of the 25,000 outstanding shares of the Corporation’s preferred stock that had been issued to the Treasury, leaving 12,000 outstanding shares representing $12,000,000 of preferred stock. On February 18, 2016, the Corporation redeemed the remaining $12,000,000 of Series B preferred stock issued to the Treasury as reported on Form 8-K filed on February 19, 2016.

The annualized dividend rate on the preferred stock issued under the SBLF Program was 1 percent for the three months ended March 31, 2016 and 2015.

Common Stock Dividend

Periodically, the Corporation distributes stock dividends on its common stock. The Corporation distributed a 5 percent stock dividend on December 8, 2015 and December 9, 2014 which resulted in the issuance of 294,161 and 275,900 additional common shares, respectively.

Note 11—Contingent Liabilities

There are no legal proceedings pending against Codorus Valley Bancorp, Inc. or any of its subsidiaries which are expected to have a material impact upon the consolidated financial position and/or operating results of the Corporation, other than routine litigation incidental to the business. Management is not aware of any proceedings known or contemplated by government authorities.

- 31 -

Table of Contents

Note 12—Guarantees

Codorus Valley does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Standby letters of credit are written conditional commitments issued by PeoplesBank to guarantee the performance of a customer to a third party. Generally, all letters of credit, when issued, have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers. The Corporation generally holds collateral and/or personal guarantees supporting these commitments. The Corporation had $18,210,000 of standby letters of credit outstanding on March 31, 2016, compared to $19,037,000 on December 31, 2015. Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payments required under the corresponding letters of credit. The amount of the liability as of March 31, 2016 and December 31, 2015, for guarantees under standby letters of credit issued, was not material. Many of the commitments are expected to expire without being drawn upon and, therefore, generally do not present significant liquidity risk to the Corporation or PeoplesBank.

Note 13—Fair Value of Assets and Liabilities

The Corporation uses its best judgment in estimating the fair value of the Corporation’s assets and liabilities; however, there are inherent weaknesses in any estimation technique. Therefore, the fair value estimates herein are not necessarily indicative of the amounts that could be realized in sales transactions on the dates indicated. The estimated fair value amounts have been measured as of their respective period-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values subsequent to the respective reporting dates may be different than the amounts reported at each period end.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date. GAAP establishes a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following three levels:

Level 1: Inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

Level 2: Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets; inputs to the valuation methodology include quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs to the valuation methodology that utilize model-based techniques for which all significant assumptions are observable in the market.

Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement; inputs to the valuation methodology that utilize model-based techniques for which significant assumptions are not observable in the market; or inputs to the valuation methodology that require significant management judgment or estimation, some of which may be internally developed.

Since management maximizes the use of observable inputs and minimizes the use of unobservable inputs when determining fair value, an asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Management reviews and updates the fair value hierarchy classifications on a quarterly basis.

- 32 -

Table of Contents

Assets Measured at Fair Value on a Recurring Basis

Securities available-for-sale

The fair values of investment securities were measured using information from a third-party pricing service. The pricing service uses quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique, used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities, but rather, by relying on the securities’ relationship to other benchmark quoted prices. At least annually, the Corporation reviews a random sample of the pricing information received from the third-party pricing service by comparing it to price quotes from third-party brokers. Historically, price deviations have been immaterial.


			Fair Value Measurements
			(Level 1)		(Level 2)		(Level 3)
			Quoted Prices in		Significant Other		Significant Other
			Active Markets for		Observable		Unobservable
*(dollars in thousands)*	Total		Identical Assets		Inputs		Inputs
March 31, 2016
Securities available-for-sale:
U.S. agency	$	14,060	$	0	$	14,060	$	0
U.S. agency mortgage-backed, residential		106,713		0		106,713		0
State and municipal		79,143		0		79,143		0

December 31, 2015
Securities available-for-sale:
U.S. agency	$	17,414	$	0	$	17,414	$	0
U.S. agency mortgage-backed, residential		120,581		0		120,581		0
State and municipal		75,475		0		75,475		0

Assets Measured at Fair Value on a Nonrecurring Basis

Impaired loans

Impaired loans are those that are accounted for under FASB ASC Topic 310, in which the Corporation has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These loans are included as Level 3 fair values, based on the lowest level of input that is significant to the fair value measurements. At March 31, 2016, the fair value of impaired loans with a valuation allowance or charge-off was $1,396,000, which is net of valuation allowances of $455,000 and charge-offs of $958,000. At December 31, 2015 the fair value of impaired loans with a valuation allowance or charge-off was $1,846,000, which is net of valuation allowances of $405,000 and charge-offs of $1,262,000.

Foreclosed Real Estate

Other real estate property acquired through foreclosure is initially recorded at fair value of the property at the transfer date less estimated selling cost. Subsequently, other real estate owned is carried at the lower of its carrying value or the fair value less estimated selling cost. Fair value is usually determined based upon an independent third-party appraisal of the property or occasionally upon a recent sales offer. At March 31, 2016, the fair value of foreclosed real estate with a valuation allowance or write-down was $1,857,000, which is net of valuation allowances of $920,000 and no write-downs. At December 31, 2015, the carrying value of foreclosed real estate with a valuation allowance or write-down was $2,003,000, which is net of valuation allowances of $981,000 and write-downs of $34,000.

- 33 -

Table of Contents


			Fair Value Measurements
			(Level 1)				(Level 3)
			Quoted Prices in		(Level 2)		Significant Other
			Active Markets for		Significant Other		Unobservable
*(dollars in thousands)*	Total		Identical Assets		Observable Inputs		Inputs
March 31, 2016
Impaired loans	$	1,396	$	0	$	0	$	1,396
Foreclosed real estate		1,857		0		0		1,857

December 31, 2015
Impaired loans	$	1,846	$	0	$	0	$	1,846
Foreclosed real estate		2,003		0		0		2,003

The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which the Corporation has utilized Level 3 inputs to determine fair value:


		Quantitative Information about Level 3 Fair Value Measurements
		Fair Value	Valuation		Unobservable		Weighted
*(dollars in thousands)*		Estimate	Techniques		Input	Range	Average
March 31, 2016
Impaired loans	$	1,396	Appraisal	(1)	Appraisal adjustments (2)	15% - 25%	18%
Foreclosed real estate		1,857	Appraisal	(1)	Appraisal adjustments (2)	12% - 25%	14%

December 31, 2015
Impaired loans	$	1,846	Appraisal	(1)	Appraisal adjustments (2)	15% - 25%	16%
Foreclosed real estate		2,003	Appraisal	(1)	Appraisal adjustments (2)	7% - 38%	34%

(1)

Fair value is generally determined through independent appraisals, which generally include various level 3 inputs that are not identifiable.

(2)

Appraisals may be adjusted downward by the Corporation’s management for qualitative factors such as economic conditions and estimated liquidation expenses. The range of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

Disclosures about Fair Value of Financial Instruments

The following methods and assumptions were used to estimate the fair value of the Corporation’s financial instruments as of March 31, 2016 and December 31, 2015:

Cash and cash equivalents

The carrying amount is a reasonable estimate of fair value.

Securities available for sale

The fair value of securities available for sale is determined in accordance with the methods described under FASB ASC Topic 820 as described above.

Restricted investment in bank stocks

The carrying amount of restricted investment in bank stocks is a reasonable estimate of fair value. The Corporation is required to maintain minimum investment balances in these stocks. These stocks are not actively traded and, therefore, have no readily determinable market value.

- 34 -

Table of Contents

Loans held for sale

The fair value of loans held for sale is determined, when possible, using quoted secondary-market prices. If no such quoted prices exist, the fair value of a loan is determined using quoted prices for a similar loan or loans, adjusted for the specific attributes of that loan.

Loans, net

The fair value of loans, excluding all impaired loans, is estimated using discounted cash flow analyses using the current interest rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Loans were first segregated by type such as commercial, real estate, and consumer, and were further segmented into fixed and variable rate. Projected future cash flows are calculated based on contractual maturity or call dates. For variable rate loans that reprice frequently and have no significant change in credit risk, fair value is based on carrying value.

Interest receivable

The carrying value of interest receivable is a reasonable estimate of fair value.

Deposits

The fair value of demand deposits, savings accounts and money market deposits is the amount payable on demand at the reporting date. The fair values of time deposits are estimated using a discounted cash flow analyses. The discount rates used are based on rates currently offered for deposits with similar remaining maturities. The fair values of variable rate time deposits that reprice frequently are based on carrying value. The fair values of time deposit liabilities do not take into consideration the value of the Corporation’s long-term relationships with depositors, which may have significant value.

Short-term borrowings

For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

Long-term debt

Long-term debt includes FHLBP advances (Level 2) and junior subordinated debt (Level 3). The fair value of FHLBP advances is estimated using discounted cash flow analysis, based on quoted prices for new FHLBP advances with similar credit risk characteristics, terms and remaining maturity. These prices are obtained from this active market and represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party. The fair value of junior subordinated debt is estimated using discounted cash flow analysis, based on market rates and spread characteristics of similar debt with similar credit risk characteristics, terms and remaining maturity.

Interest payable

The carrying value of interest payable is a reasonable estimate of fair value.

Off-balance sheet instruments

Off-balance sheet instruments consist of lending commitments and letters of credit are based on fees currently charged in the market to enter into similar arrangements, taking into account the remaining terms of the agreements and counterparties’ credit standing. These amounts were not considered material.

- 35 -

Table of Contents

The following presents the carrying amounts and estimated fair values of the Corporation’s financial instruments as of March 31, 2016 and December 31, 2015.


					Fair Value Estimates
					(Level 1)		(Level 2)		(Level 3)
					Quoted Prices		Significant		Significant
					in Active		Other		Other
	Carrying		Estimated		Markets for		Observable		Unobservable
*(dollars in thousands)*	Amount		Fair Value		Identical Assets		Inputs		Inputs
March 31, 2016
Financial assets
Cash and cash equivalents	$	12,437	$	12,437	$	12,437	$	0	$	0
Securities available-for-sale		199,916		199,916		0		199,916		0
Restricted investment in bank stocks		5,371		5,371		0		5,371		0
Loans held for sale		1,499		1,516		0		1,516		0
Loans, net		1,137,057		1,147,759		0		0		1,147,759
Interest receivable		3,931		3,931		0		3,931		0

Financial liabilities
Deposits	$	1,120,833	$	1,121,809	$	0	$	1,121,809	$	0
Short-term borrowings		26,586		26,586		0		26,586		0
Long-term debt		120,310		118,018		0		111,120		6,898
Interest payable		510		510		0		510		0

Off-balance sheet instruments		0		0		0		0		0

December 31, 2015
Financial assets
Cash and cash equivalents	$	57,485	$	57,485	$	57,485	$	0	$	0
Securities available-for-sale		213,470		213,470		0		213,470		0
Restricted investment in bank stocks		5,028		5,028		0		5,028		0
Loans held for sale		564		574		0		574		0
Loans, net		1,110,507		1,119,758		0		0		1,119,758
Interest receivable		4,003		4,003		0		4,003		0

Financial liabilities
Deposits	$	1,094,149	$	1,092,819	$	0	$	1,092,819	$	0
Short-term borrowings		74,510		74,510		0		74,510		0
Long-term debt		120,310		117,041		0		110,195		6,846
Interest payable		468		468		0		468		0

Off-balance sheet instruments		0		0		0		0		0

- 36 -

Table of Contents

Note 14—Assets and Liabilities Subject to Offsetting

Securities Sold Under Agreements to Repurchase

PeoplesBank enters into agreements with customers in which it sells securities subject to an obligation to repurchase the same securities (“repurchase agreements”). The contractual maturity of the repurchase agreement is overnight and continues until either party terminates the agreement. These repurchase agreements are accounted for as a collateralized financing arrangement (i.e., secured borrowings) and not as a sale and subsequent repurchase of securities. The obligation to repurchase the securities is reflected as a liability (short-term borrowings) in the Corporation’s consolidated financial statements of condition, while the securities underlying the repurchase agreements are appropriately segregated for safekeeping purposes and remain in the respective securities asset accounts. Thus, there is no offsetting or netting of the securities with the repurchase agreement liabilities.


								Gross amounts Not Offset in
			Gross		Net Amounts		the Statements of Condition
	Gross		Amounts		of Liabilities		Financial Instruments
	Amounts of		Offset in the		Presented in		U.S. agency					Cash
	Recognized		Statements		the Statements		mortgage-backed,					Collateral		Net
*(dollars in thousands)*	Liabilities		of Condition		of Condition		residential		U.S. agency			Pledged		Amount
March 31, 2016
Repurchase Agreements	$	19,922	$	0	$	19,922	$	(19,922)		0		$	0	$	0

December 31, 2015
Repurchase Agreements	$	74,510	$	0	$	74,510		(63,162)		(11,348	)	$	0	$	0

As of March 31, 2016 and December 31, 2015, the fair value of securities pledged in connection with repurchase agreements was $37,489,000 and $75,094,000, respectively.

- 37 -

Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s discussion and analysis of the significant changes in the results of operations, capital resources and liquidity presented in the accompanying consolidated financial statements for Codorus Valley Bancorp, Inc. (Codorus Valley or the Corporation), a bank holding company, and its wholly-owned subsidiary, PeoplesBank, A Codorus Valley Company (PeoplesBank), are provided below. Codorus Valley’s consolidated financial condition and results of operations consist almost entirely of PeoplesBank’s financial condition and results of operations. Current performance does not guarantee, and may not be indicative of, similar performance in the future.

Forward-looking Statements

Management of the Corporation has made forward-looking statements in this Form 10-Q. These forward-looking statements may be subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of operations of the Corporation and its subsidiaries. When words such as “believes,” “expects,” “anticipates” or similar expressions occur in the Form 10-Q, management is making forward-looking statements.

Note that many factors, some of which are discussed elsewhere in this report and in the documents that are incorporated by reference, could affect the future financial results of the Corporation and its subsidiaries, both individually and collectively, and could cause those results to differ materially from those expressed in the forward-looking statements contained or incorporated by reference in this Form 10-Q. These factors include, but are not limited to, the following:

Operating, legal and regulatory risks;

Credit risk, including an increase in nonperforming assets requiring loss provisions and the incurrence of carrying costs related to nonperforming assets;

Interest rate fluctuations which could increase our cost of funds or decrease our yield on earning assets and therefore reduce our net interest income;

Declines in the market value of investment securities considered to be other-than-temporary;

Unavailability of capital when needed, or availability at less than favorable terms;

Unauthorized disclosure of sensitive or confidential client or customer information, whether through a breach of our computer systems or otherwise, which may adversely affect the Corporation’s operations, net income or reputation;

Inability to achieve merger-related synergies, and difficulties in integrating the business and operations of acquired institutions;

A prolonged economic downturn;

Political and competitive forces affecting banking, securities, asset management and credit services businesses;

The effects of and changes in the rate of FDIC premiums, including special assessments;

Future legislative or administrative changes to U.S. governmental capital programs;

Enacted financial reform legislation, e.g., Dodd-Frank Wall Street Reform and Consumer Protection Act, may have a significant impact on the Corporation’s business and results of operations; and

The risk that management’s analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.

The Corporation undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this report.

- 38 -

Table of Contents

Critical Accounting Policies

The Corporation’s critical accounting policies, as summarized in Note 1—Summary of Significant Accounting Policies, include those related to the allowance for loan losses, valuation of foreclosed real estate, evaluation of other-than-temporary impairment of securities, and determination of acquisition-related goodwill and fair value adjustments, which require management to make significant judgments, estimates and assumptions that have a material impact on the carrying value of the respective assets and liabilities. For this Form 10-Q, there were no material changes made to the Corporation’s critical accounting policies, which are more fully disclosed in Item 7 of the Corporation’s previously filed Annual Report on Form 10-K for the year ended December 31, 2015.

Three Months Ended March 31, 2016 vs. Three Months Ended March 31, 2015

Financial Highlights

The Corporation’s net income available to common shareholders (earnings) was $2,801,000 for the quarter ended March 31, 2016, as compared to $2,404,000 for the quarter ended March 31, 2015, an increase of $397,000 or 17 percent.

Net interest income for the first quarter of 2016 increased $1,287,000 or 11 percent above the same period in 2015, primarily due to increased interest income from a higher volume of commercial loans in the first quarter of 2016 as compared to the first quarter of 2015.

The provision for loan losses for the first quarter of 2016 was $800,000, representing a $200,000 decrease as compared to a provision of $1,000,000 for the first quarter of 2015. The decrease in the provision for loan losses was attributable to a $313,000 reduction in net charge-offs in the first quarter of 2016 as compared to the same period in 2015. The allowance as a percentage of total loans was 1.14 percent at March 31, 2016, as compared to 1.13 percent at December 31, 2015, and 1.12 percent at March 31, 2015.

Noninterest income for the first quarter of 2016 increased $28,000 or 1 percent compared to the first quarter of 2015. While noninterest income was relatively flat, there were increases in both wealth management income and service fees on deposit accounts, which were offset by a decrease in gains from sales of mortgage loans and securities.

Noninterest expenses in the first quarter of 2016 were $869,000 or 9 percent higher than the first quarter of 2015. Personnel costs, which include compensation and benefit expenses, accounted for the majority of the increase. The higher costs are due to a combination of normal business growth and 2016 including a full quarter impact of the Corporation’s January 2015 acquisition of Madison Bancorp, Inc. Marketing costs increased $250,000 due to planned initiatives related to the continued expansion of the franchise along with initial expenses associated with the acquisition of the naming rights to the facility that houses a local independent league baseball team.

The provision for income taxes for the first quarter of 2016 increased by $263,000 or 26 percent as compared to the first quarter of 2015. Pre-tax income in the first quarter of 2016 was 19 percent more than the first quarter of 2015. The increase is also due to a higher effective tax rate resulting from a lower level of tax-exempt investment income in the first quarter of 2016 as compared to the prior year.

The Corporation’s net interest margin (tax-equivalent basis) for the first quarter of 2016 was 3.95 percent, compared to 3.93 percent for the first quarter of 2015. PeoplesBank continues to have success in growing low cost core deposits and reducing the cost of time deposits, while maintaining reasonable loan yields in a highly competitive low interest rate environment.

- 39 -

Table of Contents

The schedule below presents selected performance metrics for the first quarter of both 2016 and 2015. Per share computations include the effect of stock dividends, including the 5 percent common stock dividend declared and distributed in the fourth quarter of 2015.


	Three months ended March 31,
		2016			2015
Basic earnings per common share	$	0.35		$	0.39
Diluted earnings per common share	$	0.35		$	0.39
Cash dividend payout ratio		36.93	%		30.32	%
Return on average assets		0.79	%		0.75	%
Return on average equity		7.22	%		8.18	%
Net interest margin (tax equivalent basis)		3.95	%		3.93	%
Net overhead ratio		2.33	%		2.33	%
Efficiency ratio		67.33	%		68.19	%
Average equity to average assets		11.00	%		9.13	%

A more detailed analysis of the factors and trends affecting the Corporation’s earnings and financial position follows.

Income Statement Analysis

Net Interest Income

Net interest income for the quarter ended March 31, 2016 was $12,965,000, an increase of $1,287,000 or 11 percent compared to net interest income of $11,678,000 for the first quarter of 2015. The increase was driven by an increase in the average volume of interest earning assets, primarily commercial loans. The Corporation’s net interest margin, computed as net interest income (tax-equivalent basis) annualized as a percentage of average interest earning assets for the quarter, was 3.95 percent for the first quarter of 2016, compared to the 3.93 percent net interest margin for the first quarter of 2015. The slight increase was primarily a result of growing low cost core deposits and reducing the cost of time deposits, while maintaining reasonable loan yields in a highly competitive low rate environment.

Total interest income for the first quarter of 2016 was $15,014,000, an increase of $1,328,000 or 10 percent above the amount of total interest income for the first quarter of 2015. The increase was primarily a result of a significant increase in loan income, partially offset by a decline in investment income.

Interest income on loans increased $1,504,000 or 12 percent in the first quarter of 2016 compared to the same period in 2015. The average volume of loans increased approximately $139,546,000 or 14 percent in the first quarter of 2016 compared to the same quarter in 2015, reflecting core commercial loan growth over the past year. The impact of the increased loan volume on interest income was slightly offset by a decrease in the overall tax-equivalent yield on loans for the first quarter of 2016, which declined by 13 basis points compared to the first quarter of 2015. Maturing loans had slightly higher yields, on average, than new loans as a result of the continuing low interest rates and competitive market pricing.

- 40 -

Table of Contents

Investment income for the first quarter of 2016 decreased $165,000 or 12 percent compared to the first quarter of 2015. Contributing to the decrease, the tax-equivalent yield on investments for the first quarter of 2016 was 2.70 percent or 30 basis points lower than the taxable-equivalent investment yield of 3.00 percent for the first quarter of 2015. Yields on maturing investments, primarily tax-exempt municipal securities and mortgage-backed securities, were generally higher than yields on new investments purchased in the current lower interest rate environment. Also, the average balance of investment securities decreased 1 percent when comparing the first quarter of 2016 to the same period in 2015, as some funds from investment maturities and sales were not fully reinvested, but were used for other purposes, including providing funds to support loan growth and normal business operations.

Total interest expense for the first quarter of 2016 totaled $2,049,000, an increase of $41,000 or 2 percent as compared to total interest expense of $2,008,000 for the first quarter of 2015. An increase in both the average volume and cost of long-term borrowings, used to fund commercial loans of a similar duration, more than offset a favorable decrease in the cost of deposits.

Interest expense on deposits decreased $130,000 or 8 percent in the first quarter of 2016 compared to the same period in 2015. The decrease was attributable to an increase in lower cost core deposits and a reduction in higher cost time deposits. The average rate paid on interest-bearing deposits in the first quarter of 2016 was 0.65 percent, a decrease from the average rate of 0.72 percent paid on interest-bearing deposits during the first quarter of 2015. The average balance of interest-bearing deposits for the first quarter of 2016 increased by $9,378,000 or 1 percent compared to the first quarter of 2015, primarily in lower cost core deposits. Also, the Corporation experienced a favorable increase in noninterest-bearing deposits, with the average balance for the first quarter of 2016 increasing to $161,299,000 as compared to $128,255,000 for the first quarter of 2015.

Interest expense on borrowings for the first quarter of 2016 increased by $171,000 or 46 percent compared to the first quarter of 2015, due primarily to an increase in the average balance of long-term debt. Outstanding long-term borrowings averaged $120,310,000 for the first quarter of 2016, compared to an average balance of approximately $90,397,000 for the first quarter of 2015. The increase related primarily to new FHLBP advances totaling $35,000,000 obtained in June 2015. The advances obtained in 2015 are borrowings with intermediate term bullet maturities to supplement deposits for funding expected loan growth, and to provide a partial hedge against rising market interest rates by having maturities similar to the amortization of fixed rate commercial loans in the Corporation’s portfolio. The average long-term borrowings rate for the first quarter of 2016 was 1.62 percent, an increase, as compared to the rate of 1.47 percent for the first quarter of 2015.

- 41 -

Table of Contents


*Table 1-Average Balances and Interest Rates (tax equivalent basis)*

	Three months ended March 31,
			2016								2015
	Average					Yield/			Average					Yield/
*(dollars in thousands)*	Balance		Interest			Rate			Balance		Interest			Rate

Assets
Interest bearing deposits with banks	$	4,170	$	8			0.77	%	$	29,988	$	19			0.26	%
Investment securities:
Taxable		135,075		770			2.29			146,127		938			2.60
Tax-exempt		73,790		633			3.45			65,709		630			3.89
Total investment securities		208,865		1,403			2.70			211,836		1,568			3.00

Loans:
Taxable (1)		1,114,673		13,680			4.94			971,494		12,126			5.06
Tax-exempt		18,578		197			4.26			22,211		270			4.93
Total loans		1,133,251		13,877			4.93			993,705		12,396			5.06
Total earning assets		1,346,286		15,288			4.57			1,235,529		13,983			4.59
Other assets (2)		72,054								68,721
Total assets	$	1,418,340							$	1,304,250
Liabilities and Shareholders’ Equity
Deposits:
Interest bearing demand	$	463,089	$	415			0.36	%	$	415,620	$	332			0.32	%
Savings		70,941		18			0.10			62,670		15			0.10
Time		397,356		1,077			1.09			443,717		1,293			1.18
Total interest bearing deposits		931,386		1,510			0.65			922,007		1,640			0.72
Short-term borrowings		41,722		54			0.52			35,252		41			0.47
Long-term debt		120,310		485			1.62			90,397		327			1.47
Total interest bearing liabilities		1,093,418		2,049			0.75			1,047,656		2,008			0.78

Noninterest bearing deposits		161,299								128,255
Other liabilities		7,556								9,300
Shareholders’ equity		156,067								119,039

Total liabilities and
shareholders’ equity	$	1,418,340							$	1,304,250
Net interest income (tax equivalent basis)			$	13,238							$	11,975
Net interest margin (3)							3.95	%							3.93	%
Tax equivalent adjustment				(273	)							(297	)
Net interest income			$	12,965							$	11,678

(1)	Average balance includes average nonaccrual loans of $3,083,000 for 2016 and $9,168,000 for 2015. Interest includes net loan fees of $705,000 for 2016 and $509,000 for 2015.

(2)	Average balance includes average bank owned life insurance, foreclosed real estate and unrealized holding gains (losses) on investment securities.

(3)	Net interest income (tax equivalent basis) annualized as a percentage of average earning assets.

- 42 -

Table of Contents


*Table 2-Rate/Volume Analysis of Changes in Net Interest Income (tax equivalent basis)*

	Three months ended March 31, 2016 vs. 2015
	Increase (decrease) due to change in*
*(dollars in thousands)*	Volume			Rate			Net

Interest Income
Interest bearing deposits with banks	$	(16	)	$	5		$	(11	)
Investment securities:
Taxable		3			(171	)		(168	)
Tax-exempt		77			(74	)		3
Loans:
Taxable		2,049			(495	)		1,554
Tax-exempt		(45	)		(28	)		(73	)
Total interest income		2,068			(763	)		1,305
Interest Expense
Deposits:
Interest bearing demand		45			38			83
Savings		3			0			3
Time		(135	)		(81	)		(216	)
Short-term borrowings		(2	)		15			13
Long-term debt		104			54			158
Total interest expense		15			26			41
Net interest income	$	2,053		$	(789	)	$	1,264

*Changes which are due to both volume and rate are allocated in proportion to their relationship to the amount of change attributed directly to volume or rate.

Provision for Loan Losses

The provision for loan losses is an expense charged to earnings to cover the estimated losses attributable to uncollectible loans. The provision reflects management’s judgment of an appropriate level for the allowance for loan losses. For the first quarter of 2016, the provision for loan losses was $800,000 as compared to a provision of $1,000,000 for the first quarter of 2015. Despite the comparatively lower provision for the first quarter of 2016 versus the same period in 2015, the allowance as a percentage of total loans was 1.14 percent at March 31, 2016, as compared to 1.13 percent at December 31, 2015, and 1.12 percent at March 31, 2015. The decreased provision for the first quarter of 2016 as compared to the first quarter of 2015 was impacted by a reduction in the net charge-offs of $313,000.

More information about the allowance for loan losses can be found in this report under the caption Allowance for Loan Losses on page 52.

- 43 -

Table of Contents

Noninterest Income

The following table presents the components of total noninterest income for the first quarter of 2016, compared to the first quarter of 2015.


*Table 3 - Noninterest income*

	Three months ended March 31,				Change Increase (Decrease)
*(dollars in thousands)*	2016		2015		$			%

Trust and investment services fees	$	617	$	601	$	16			3	%
Income from mutual fund, annuity and insurance sales		259		156		103			66
Service charges on deposit accounts		837		757		80			11
Income from bank owned life insurance		174		171		3			2
Other income		189		150		39			26
Gain on sales of loans held for sale		115		151		(36	)		(24	)
Gain on sales of securities		194		371		(177	)		(48	)
Total noninterest income	$	2,385	$	2,357	$	28			1	%

The discussion that follows addresses changes in selected categories of noninterest income.

Income from mutual fund, annuity and insurance sales—The $103,000 or 66 percent increase in income from the sale of mutual fund, annuity and insurance products by Codorus Valley Financial Advisors, Inc. (“CVFA”), a subsidiary of PeoplesBank, was due to the higher volume of assets under management during the first quarter of 2016 and the success of recently hired commissioned sales representatives.

Service charges on deposit accounts—The $80,000 or 11 percent increase in service charge income on deposit accounts was due to an increase in the volume of demand deposit accounts subject to fees as well as fee schedule increases implemented during the first quarter 2015. These increased fees were in effect during the entire first quarter of 2016.

Gain on sales of loans held for sale—The $36,000 or 24 percent decrease in gains from the sale of residential mortgage loans held for sale reflects a reduction in the sale price per loan due to PeoplesBank retaining the servicing of sold loans beginning in January 2016.

Gain on sales of securities—The first quarter of 2016 included $194,000 in gains from the sales of four securities. This represents a $177,000 or 48 percent decrease from the $371,000 recognized in the first quarter of 2015. Securities sold included those where market pricing provided a favorable return at the time of the sale, versus holding the respective securities to maturity. Sales in the first quarter of 2016 provided cash to meet short-term liquidity needs.

- 44 -

Table of Contents

Noninterest Expense

The following table presents the components of total noninterest expense for the first quarter of 2016, compared to the first quarter of 2015.


*Table 4 - Noninterest expense*

	Three months ended March 31,				Change Increase (Decrease)
*(dollars in thousands)*	2016		2015		$			%

Personnel	$	5,997	$	5,260	$	737			14	%
Occupancy of premises, net		897		800		97			12
Furniture and equipment		725		678		47			7
Postage, stationery and supplies		173		163		10			6
Professional and legal		163		174		(11	)		(6	)
Marketing		469		219		250			114
FDIC insurance		166		175		(9	)		(5	)
Debit card processing		297		202		95			47
Charitable donations		741		724		17			2
Telephone		162		161		1			1
External data processing		333		282		51			18
Merger related		0		425		(425	)		nm*
Foreclosed real estate including losses on sales		40		117		(77	)		(66	)
Other		295		209		86			41
Total noninterest expense	$	10,458	$	9,589	$	869			9	%

*nm – not meaningful

The discussion that follows addresses changes in selected categories of noninterest expense.

Personnel—The $737,000 or 14 percent increase in personnel expense was due largely to the addition of new employees to support the Corporation’s continued business growth, increased cost of health insurance and a full quarter impact of the Corporation’s January 2015 acquisition of Madison Bancorp, Inc.

Occupancy; furniture and equipment – The $144,000 or 10 percent increase in combined occupancy and furniture and equipment costs was due to PeoplesBank relocating the South Hanover Branch into a newly constructed facility and the completion of renovations to the administrative services center in December 2015. Two limited facility branches were also added with one opening during the fourth quarter of 2015 and the other during the first quarter of 2016.

Marketing—The $250,000 or 114 percent increase in marketing expenses was due to planned initiatives related to the continued expansion of our franchise along with the initial expenses associated with the acquisition of the naming rights to PeoplesBank Park, the facility that houses the York, Pennsylvania based York Revolution independent league baseball team.

Debit card processing—The $95,000 or 47 percent increase in debit card processing costs reflects higher debit card transaction volumes and the reissuance costs associated with upgrading PeoplesBank’s debit cards to EMV chip card technology.

- 45 -

Table of Contents

External data processing—The $51,000 or 18 percent increase in external data processing expenses reflects increased reliance on outsourcing transaction processing to specialized vendors, which is typically performed on their hosted and secure websites. The Corporation continues to expand and enhance electronic banking services provided to our clients and has outsourced statement printing and mailing services, resulting in higher external data processing costs.

Merger related expenses—The Corporation incurred $425,000 of merger related expenses in the first quarter of 2015 related to the acquisition of Madison Bancorp in January 2015. Merger-related integration activities were completed in the first half of 2015.

Foreclosed real estate including losses on sales—The first quarter of 2015 included provision expense incurred to adjust the expected net realizable value of certain foreclosed real estate. Similar expenses were not recognized in the first quarter of 2016, and the number of foreclosed real estate properties overall has decreased, resulting in a $77,000 or 66 percent decrease from the same period last year.

Other expenses—Other expenses, comprised of many underlying expenses, increased $86,000 or 41 percent due in part to an increase in charitable donations as well as increased costs related to franchise expansion.

Provision for Income Taxes

The provision for income taxes for the first quarter of 2016 was $1,275,000, an increase of $263,000 or 26 percent as compared to the first quarter of 2015. The increase reflected a higher level of pre-tax income and the impact of the lower level of tax-exempt investment income for the first quarter of 2016 versus the same period in 2015. For both periods, the Corporation’s statutory federal income tax rate was 35 percent. However, the effective income tax rate was 31 percent for the first quarter of 2016, compared to 29 percent for the first quarter of 2015. The effective tax rate differs from the statutory rate due to the impact and volume of tax-exempt income, including income from bank owned life insurance and certain municipal securities and loans. The Corporation’s income earned on tax-exempt investments and loans decreased in the first quarter of 2016 as compared to the first quarter of 2015, resulting in a decrease of the related tax benefit.

Preferred Stock Dividends

Preferred stock dividends for the first quarter of 2016 were $16,000 compared to $30,000 for the same period in 2015. Though an annualized dividend rate of 1 percent applied to both periods, the amount of preferred dividends for the first quarter of 2016 decreased because, on February 18, 2016, the Corporation completed the redemption of all 12,000 remaining shares of the Corporation’s Series B preferred stock issued in connection with the Small Business Lending Fund Program. This transaction was reported on a Form 8-K filed on February 19, 2016. The Information about the SBLF Program is provided in this report at Note 10-Shareholders’ Equity.

Balance Sheet Review

Interest Bearing Deposits with Banks

On March 31, 2016, interest bearing deposits with banks totaled $1,919,000, compared to $44,496,000 at year-end 2015. The reduction resulted from a decrease in short-term borrowings due to the loss of a repurchase agreement account relationship, as well as funding loan growth.

- 46 -

Table of Contents

Investment Securities (Available-for-Sale)

The Corporation’s entire investment securities portfolio is classified available-for-sale, and is comprised primarily of interest-earning debt securities. The overall composition of the Corporation’s investment securities portfolio is provided in Note 3—Securities. On March 31, 2016, the fair value of investment securities available-for-sale totaled $199,916,000, which represented a decrease of $13,544,000 as compared to the fair value of investment securities at year-end 2015. During the first three months of 2016, principal reductions from investment sales and maturities and mortgage-backed security payments temporarily exceeded new investments.

Loans

On March 31, 2016, total loans, net of deferred fees, were $1.15 billion which was $26,936,000 or 2 percent higher than the level at year-end 2015. The increase in volume was due primarily to an increase in commercial loans, particularly within the builder & developer and commercial real estate investor sectors. Commercial loans within the builder & developer, commercial real estate investor and residential real estate investor sectors each represented more than 10 percent of the total portfolio. The composition of the Corporation’s loan portfolio is provided in Note 5—Loans.

Deposits

Deposits are the Corporation’s principal source of funding for earning assets. On March 31, 2016, deposits totaled $1.12 billion, which reflected a $26,684,000 or 2 percent increase compared to the level at year-end 2015. The increase in total deposits was primarily within core deposits (noninterest bearing demand, NOW, money market and savings categories), while time deposits only had a slight increase. The composition of the Corporation’s total deposit portfolio is provided in Note 7—Deposits.

Short-term Borrowings

On March 31, 2016, short-term borrowings, which consist of securities sold under agreements to repurchase (repurchase agreements), federal funds purchased, and other short-term borrowings totaled $26,586,000, which reflected a $47,924,000 or 64 percent decrease compared to the level at year-end 2015. Repurchase agreements decreased $54,588,000 primarily due to the loss of a significant account relationship and other short-term borrowings increased $6,664,000 to fund normal business operations.

Long-term Debt

The Corporation uses long-term borrowings as a secondary funding source for asset growth. On March 31, 2016 and year-end 2015, long-term debt totaled $120,310,000. There were no new borrowings or principal repayments during the first quarter of 2016. A listing of outstanding long-term debt obligations is provided in Note 8—Short-Term Borrowings and Long-Term Debt.

Shareholders’ Equity and Capital Adequacy

Shareholders’ equity, or capital, enables Codorus Valley to maintain asset growth and absorb losses. Capital adequacy can be affected by a multitude of factors, including profitability, new stock issuances, corporate expansion and acquisitions, dividend policy and distributions, and regulatory mandates. The Corporation’s total shareholders’ equity was approximately $150,017,000 on March 31, 2016, a decrease of approximately $9,124,000 or 6 percent, compared to the level at year-end 2015. The decrease was primarily the result of the redemption of all 12,000 remaining shares of the Corporation’s Series B preferred stock issued in connection with the Small Business Lending Fund Program, as discussed below.

- 47 -

Table of Contents

Redemption of Preferred Stock and Preferred Stock Dividends

As previously announced on the Form 8-K filed on February 19, 2016, the Corporation redeemed the remaining $12,000,000 of the Corporation’s Preferred Stock, Series B that had been issued to the United States Treasury under its Small Business Lending Fund Program. For the three month periods ended March 31, 2016 and 2015, preferred stock dividends equated to an annualized dividend rate of 1 percent on the preferred stock outstanding.

Cash Dividends on Common Stock

The Corporation has historically paid cash dividends on its common stock on a quarterly basis. The Board of Directors determines the dividend rate after considering the Corporation’s capital requirements, current and projected net income, and other relevant factors. As recently announced, the Board of Directors declared a quarterly cash dividend of $0.13 per common share on April 12, 2016, payable on May 10, 2016, to common shareholders of record at the close of business on April 26, 2016. This cash dividend follows a $0.13 common stock dividend distributed in February 2016.

Capital Adequacy

The Corporation and PeoplesBank are subject to various regulatory capital requirements administered by banking regulators that involve quantitative guidelines and qualitative judgments. The regulatory capital measures for the Corporation and PeoplesBank as of March 31, 2016, and the quantitative measures established by regulators pertain to minimum capital ratios, are set forth in Note 9—Regulatory Matters to the financial statements. We believe that Codorus Valley and PeoplesBank were well capitalized on March 31, 2016.

Our capital adequacy as of March 31, 2016, reflects updated regulatory capital guidelines from the Board of Governors of the Federal Reserve System finalized rule which implemented the Basel III regulatory capital framework, and which became effective for the Corporation and PeoplesBank on January 1, 2015. Under the revised regulatory capital framework, minimum requirements increased both the quantity and quality of capital held by banking organizations. Additionally, a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5 percent and a common equity Tier 1 conservation buffer of risk-weighted assets applies to all supervised financial institutions. The rule also raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4 percent to 6 percent and includes a minimum leverage ratio of 4 percent for all banks. The new rule also increases the risk weights for past-due loans, certain commercial real estate loans and some equity exposures, and makes selected other changes in risk weights and credit conversion factors.

The new rule further provides that, in order to avoid restrictions on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold the 2.5 percent capital conservation buffer, which is to be phased in over a four year period beginning January 1, 2016, with the full 2.5 percent required as of January 1, 2019.

- 48 -

Table of Contents

The transition schedule for new ratios, including the capital conservation buffer, is as follows:


	As of January 1:
	2015			2016			2017			2018			2019
Minimum common equity Tier 1 capital ratio		4.5	%		4.5	%		4.5	%		4.5	%		4.5	%
Common equity Tier 1 capital conservation buffer		N/A			0.625	%		1.25	%		1.875	%		2.5	%
Minimum common equity Tier 1 capital ratio plus capital conservation buffer		4.5	%		5.125	%		5.75	%		6.375	%		7.0	%
Phase-in of most deductions from common equity Tier 1 capital		40	%		60	%		80	%		100	%		100	%
Minimum Tier 1 capital ratio		6.0	%		6.0	%		6.0	%		6.0	%		6.0	%
Minimum Tier 1 capital ratio plus capital conservation buffer		N/A			6.625	%		7.25	%		7.875	%		8.5	%
Minimum total capital ratio		8.0	%		8.0	%		8.0	%		8.0	%		8.0	%
Minimum total capital ratio plus capital conservation buffer		N/A			8.625	%		9.25	%		9.875	%		10.5	%

As fully phased in, a banking organization with a buffer greater than 2.5% would not be subject to limits on dividend payments or discretionary bonus payments; however, a banking organization with a buffer less than 2.5% would be subject to increasingly stringent limitations as the buffer approaches zero. The new rule also prohibits a banking organization from paying dividends or discretionary bonuses if its eligible net income is negative in that quarter and its capital conservation buffer ratio was less than 2.5% as of the beginning of that quarter. Eligible net income is defined as net income for the four calendar quarters preceding the current calendar quarter, net of any distributions and associated tax effects not already reflected in net income.

A summary of payout restrictions based on the capital conservation buffer is as follows:


Capital Conservation Buffer (as a % of risk-weighted assets)		Maximum Payout (as a % of eligible net income)
Greater than 2.5%		No payout limitation applies
≤2.5% and >1.875%		60%
≤1.875% and >1.25%		40%
≤1.25% and >0.625%		20%
≤0.625%		0%

Under the new rule as effective through the quarter ending March 31, 2016, the Corporation and PeoplesBank had no regulatory dividend restrictions and remained well capitalized by all regulatory capital measures (see Note 9—Regulatory Matters to the financial statements). The Corporation plans to manage its capital adequacy to ensure continued compliance with the new capital rules.

Risk Management

Credit Risk Management

Credit risk represents the possibility that a loan client, counterparty or issuer may not perform in accordance with contractual terms, posing one of the most significant risks of loss to the Corporation. Accordingly, the Corporation emphasizes the management of credit risk, and has established a lending policy which management believes is sound given the nature and scope of our operations. The Credit Risk Management section included in Item 7 of the Corporation’s previously filed Annual Report on Form 10-K as of December 31, 2015, provides a more detailed overview of the Corporation’s credit risk management process.

- 49 -

Table of Contents

Nonperforming Assets

The following table presents asset categories posing the greatest risk of loss and related ratios. We generally place a loan on nonaccrual status and cease accruing interest income (i.e., recognize interest income on a cash basis, as long as the loan is sufficiently collateralized) when loan payment performance is unsatisfactory and the loan is past due 90 days or more. Loans past due 90 days or more and still accruing interest represent loans that are contractually past due, but are well collateralized and in the process of collection. Foreclosed real estate represents real estate acquired to satisfy debts owed to PeoplesBank. Troubled debt restructurings pertain to loans whose terms have been modified to include a concession that we would not ordinarily consider due to the debtor’s financial difficulties. Concessions granted under a troubled debt restructuring typically involve a reduction of interest rate lower than the current market rate for new debt with similar risk, the deferral of payments or extension of the stated maturity date. Troubled debt restructurings are evaluated for impairment if they have been restructured during the most recent calendar year, or if they cease to perform in accordance with the modified terms. The paragraphs and table below address significant changes in the aforementioned categories as of March 31, 2016, compared to December 31, 2015.

Nonperforming assets are under the purview of in-house counsel, who continuously monitors and manages the collection of these accounts. Additionally, an internal asset quality control committee meets monthly to review nonperforming assets. We generally rely on appraisals performed by independent licensed appraisers to determine the value of real estate collateral for impaired collateral-dependent loans. Generally, an appraisal is performed when: an account reaches 90 days past due, unless a certified appraisal was completed within the past twelve months; market values have changed significantly; the condition of the property has changed significantly; or the existing appraisal is outdated based upon regulatory or policy requirements. In instances where the value of the collateral, net of costs to sell, is less than the net carrying amount for impaired commercial related loans, a specific loss allowance is established for the difference. When it is probable that some portion or an entire loan balance will not be collected, that amount is charged off as loss against the allowance.

- 50 -

Table of Contents

Table 5 - Nonperforming Assets


	March 31,			December 31,
(dollars in thousands)	2016			2015

Nonaccrual loans	$	2,609		$	3,045
Nonaccrual loans, troubled debt restructurings		188			188
Accruing loans 90 days or more past due		866			484
Total nonperforming loans		3,663			3,717
Foreclosed real estate, net of allowance		2,779			2,913
Total nonperforming assets	$	6,442		$	6,630
Accruing troubled debt restructurings	$	3,809		$	3,903

Total period-end loans, net of deferred fees	$	1,150,147		$	1,123,211
Allowance for loan losses (ALL)	$	13,090		$	12,704
ALL as a % of total period-end loans		1.14	%		1.13	%
Annualized net charge-offs as a % of average total loans		0.15	%		0.19	%
ALL as a % of nonperforming loans		357.34	%		341.78	%
Nonperforming loans as a % of total period-end loans		0.32	%		0.33	%
Nonperforming assets as a % of total period-end loans and net foreclosed real estate		0.56	%		0.59	%
Nonperforming assets as a % of total period-end assets		0.45	%		0.46	%
Nonperforming assets as a % of total period-end shareholders’ equity		4.29	%		4.17	%

The level of nonperforming assets as of March 31, 2016, has decreased by approximately $188,000 or 3 percent when compared to year-end 2015. The decrease was primarily a result of payments received on and the charge-off of nonaccrual commercial loan relationships. The decrease was partially offset by downgrades of other loan relationships. The Corporation regularly monitors large and criticized assets in its commercial loan portfolio recognizing that prolonged low economic growth, or a weakening economy, could have negative effects on these commercial borrowers.

Nonaccrual Loans

We evaluate the adequacy of the allowance for loan losses at least quarterly and have established a loss allowance for selected loan relationships where the net realizable value of the collateral is insufficient to repay the loan. In this regard, allowances, if applicable, are noted below within the description of the loan. Collection efforts, including modification of contractual terms for individual accounts based on prevailing market conditions and liquidation of collateral assets, are being employed to maximize recovery. Further provisions for loan losses may be required for nonaccrual loans as additional information becomes available or conditions change. There is also the potential for adjustment to the allowance as a result of regulatory examinations. A loan is returned to interest accruing status when we determine that circumstances have improved to the extent that all of the principal and interest amounts contractually due are current for at least six consecutive payments and future payments are reasonably assured.

- 51 -

Table of Contents

As of March 31, 2016, the nonperforming loan portfolio balance totaled $3,663,000, compared to $3,717,000 at year-end 2015. The decrease was primarily a result of payments received on and the charge-off of nonaccrual commercial loan relationships. The decrease was partially offset by downgrades of other loan relationships. For both periods, the nonperforming portfolio balance was comprised primarily of collateralized commercial loans. On March 31, 2016, the nonaccrual loan portfolio was comprised of twenty-three loan relationships with outstanding principal balances, net of specific charge-offs, ranging in size from $9,000 to $411,000. Two commercial relationships, which represent 29 percent of the nonperforming loan portfolio balance, are described below.

Loan no. 1—At March 31, 2016, the outstanding principal balance of this loan relationship was $390,000 and was collateralized by junior liens on several real estate properties. A $263,000 specific allowance was allocated for this relationship. During the first quarter of 2016, the Corporation collected $32,000 of cash payments as part of the workout process. Management is pursuing its legal remedies to recover the remaining amount due.

Loan no. 2—At March 31, 2016, the outstanding principal balance of the loan relationship was $411,000 with no specific allowance. The loan is collateralized by real estate including a motel and recreational complex. The Corporation’s balance represents a purchased participation of a larger loan relationship with another financial institution serving as the lead bank. The Corporation, in coordination with the lead bank, is presently pursuing its legal remedies to recover the amount due.

Foreclosed Real Estate

Foreclosed real estate is included in the Other Assets category on the Corporation’s balance sheet. The carrying amount of foreclosed real estate on March 31, 2016, net of allowance, totaled $2,779,000 and was comprised of four unrelated accounts ranging in size from $53,000 to $1,594,000. Total foreclosed real estate decreased by $134,000 or 5 percent from December 31, 2015 to March 31, 2016, with the decrease attributable to the sales of certain smaller properties during the first three months of 2016.

Two unrelated foreclosed real estate properties, which represent 90 percent of the foreclosed real estate portfolio balance, net of allowance, as of March 31, 2016, are described below. If a valuation allowance for probable loss has been established for a particular property, it is so noted in the property description below. Further valuation allowances may be required on any foreclosed property as additional information becomes available or conditions change.

Property no. 1— The carrying amount of this property at March 31, 2016 was $1,594,000, which is net of an $881,000 valuation allowance. The property is comprised of 130 approved residential building lots. Of this total, 22 lots are improved. During the first quarter of 2016, the Corporation realized $41,000 of net proceeds from the sale of one improved lot.

Property no. 2 – The carrying amount of this property at March 31, 2016 was $910,000. The property is comprised of an eight acre parcel improved for commercially developable sites. The property is under an agreement of sale and is expected to sell with a net realizable value that approximates the March 31, 2016 carrying value.

Allowance for Loan Losses

Although the Corporation believes that it maintains sound credit policies, certain loans deteriorate and must be charged off as losses. The allowance for loan losses is maintained to absorb losses inherent in the portfolio. The allowance is increased by provisions charged to expense and is reduced by loan charge-offs, net of recoveries. The allowance is based upon management’s continuous evaluation of the loan portfolio coupled with a formal review of adequacy on a quarterly basis, which is subject to review and approval by the Board.

- 52 -

Table of Contents

The allowance for loan losses consists primarily of three components: specific allowances for individually impaired commercial loans; allowances calculated for pools of loans; and an unallocated component, which reflects the margin of imprecision inherent in the assumptions that underlie the evaluation of the adequacy of the allowance. The Corporation uses an internal risk rating system to evaluate individual loans. Loans are segmented into industry groups or pools with similar characteristics, and an allowance for loan losses is allocated to each segment based on quantitative factors such as recent loss history (two-year rolling average of net charge-offs) and qualitative factors, such as the results of internal and external credit reviews, changes in the size and composition of the loan portfolio, adequacy of collateral, and general economic conditions. Determining the level of the allowance for probable loan losses at any given period is subjective, particularly during deteriorating or uncertain economic periods, and requires that we make estimates using assumptions. There is also the potential for adjustment to the allowance as a result of regulatory examinations.

The following table presents an analysis of the activity in the allowance for loan losses for the three months ended March 31, 2016 and 2015:

*Table 6 - Analysis of Allowance for Loan Losses*

*(dollars in thousands)*	2016			2015
Balance-January 1,	$	12,704		$	11,162

Provision charged to operating expense		800			1,000

Loans charged off:
Commercial, financial and agricultural		368			679
Real estate - residential mortgages		24			28
Consumer and home equity		27			63
Total loans charged off		419			770
Recoveries:
Commercial, financial and agricultural		1			16
Real estate - residential mortgages		0			21
Consumer and home equity		4			6
Total recoveries		5			43
Net charge-offs		414			727
Balance-March 31,	$	13,090		$	11,435

Ratios:
Allowance for loan losses as a % of total period-end loans		1.14	%		1.12	%
Annualized net charge-offs as a % of average total loans		0.15	%		0.29	%
Allowance for loan losses as a % of nonperforming loans		357.34	%		148.22	%

The allowance for loan losses increased $1,655,000 or 14 percent from March 31, 2015 to March 31, 2016. The increase in the allowance generally supported the $129,355,000 or 13 percent increase in loans, net of deferred fees, over the same 12 month period.

- 53 -

Table of Contents

Net charge-offs for the first three months of 2016 were $414,000 compared to $727,000 of net charge-offs for the same period of 2015. During the first quarter of 2015, two large charge-offs were taken on commercial credits as a result of confirmed losses identified through the collection and workout process. The risks and uncertainties associated with prolonged low growth, or weak economic and business conditions, or the erosion of real estate values, can adversely affect our borrowers’ ability to service their loans, causing significant fluctuations in the level of charge-offs and provision expense from one period to another. The provision for loan losses for the first three months of 2016 was $800,000, compared to $1,000,000 for the same period of 2015. The allowance as a percentage of total loans at March 31, 2016 was 1.14 percent, compared to 1.13 percent at December 31, 2015 and 1.12 percent as of March 31, 2015. The unallocated portion of the allowance was $1,287,000 or 10 percent of the total allowance as of March 31, 2016, as compared to $1,480,000 or 12 percent of the total allowance as of December 31, 2015, and $1,331,000 or 12 percent of the total allowance as of March 31, 2015.

Liquidity Risk Management

Maintaining adequate liquidity provides the Corporation with the ability to meet financial obligations to depositors, loan customers, employees, and shareholders on a timely and cost effective basis in the normal course of business. Additionally, adequate liquidity provides funds for growth and business opportunities as they arise. Liquidity is generated from transactions relating to both the Corporation’s assets and liabilities. The primary sources of asset liquidity are funds received from customer loan payments, investment maturities and cash inflows from mortgage-backed securities, and the net proceeds of asset sales. The primary sources of liability liquidity are deposit growth, and funds obtained from short-term borrowings and long-term debt. The Consolidated Statements of Cash Flows, included in this report, present the changes in cash from operating, investing and financing activities. At March 31, 2016, we believe that liquidity was adequate based upon the potential liquidation of unpledged available-for-sale securities with a fair value totaling approximately $60,255,000 and available credit from the Federal Home Loan Bank of Pittsburgh totaling approximately $271,758,000. The Corporation’s loan-to-deposit ratio was 103 percent as of March 31, 2016, as compared to a 103 percent loan-to-deposit ratio as of December 31, 2015, and a 95 percent loan-to-deposit ratio as of March 31, 2015.

Off-Balance Sheet Arrangements

The Corporation’s financial statements do not reflect various commitments that are made in the normal course of business, which may involve some liquidity risk. These commitments consist primarily of commitments to grant new loans, unfunded commitments under existing loan facilities, and letters of credit issued under the same standards as on-balance sheet instruments. Unused commitments on March 31, 2016, totaled $304,611,000 and consisted of $225,181,000 in unfunded commitments under existing loan facilities, $61,220,000 to grant new loans and $18,210,000 in letters of credit. Generally these commitments have fixed expiration dates or termination clauses and are for specific purposes. Accordingly, many of the commitments are expected to expire without being drawn upon and, therefore, generally do not present significant liquidity risk to the Corporation or PeoplesBank.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The most significant market risk to which the Corporation is exposed is interest rate risk. The primary business of the Corporation and the composition of its balance sheet consist of investments in interest earning assets (primarily loans and securities) which are funded by interest bearing liabilities (deposits and borrowings), all of which have varying levels of sensitivity to changes in market interest rates. Changes in rates also have an impact on the Corporation’s liquidity position and could affect its ability to meet obligations and continue to grow.

- 54 -

Table of Contents

The Corporation employs various management techniques to minimize its exposure to interest rate risk. An Asset Liability Management Committee, consisting of key financial and senior management personnel, meets on a regular basis. The Committee is responsible for reviewing the interest rate sensitivity and liquidity positions of the Corporation, reviewing projected sources and uses of funds, approving asset and liability management policies, monitoring economic conditions, and overseeing the formulation and implementation of strategies regarding balance sheet positions.

Simulation of net interest income is performed for the next twelve-month period. A variety of interest rate scenarios are used to measure the effects of sudden and gradual movements upward and downward in the yield curve. These results are compared to the results obtained in a flat or unchanged interest rate scenario. Simulation of net interest income is used primarily to measure the Corporation’s short-term earnings exposure to rate movements. A “shock” is an immediate upward or downward movement of interest rates. The shocks do not take into account changes in customer behavior that could result in changes to mix and/or volumes in the balance sheet, nor do they account for competitive pricing over the forward 12-month period. The Corporation applies these interest rate “shocks” to its financial instruments up and down 100, 200, 300, and 400 basis points. A 300 and 400 basis point decrease in interest rates cannot be simulated at this time due to the historically low interest rate environment.

The following table summarizes the expected impact of interest rate shocks on net interest income as well as the Corporation’s policy limits at each level. All scenarios were within policy limits at March 31, 2016.


Change in Interest Rates		Annual Change in Net			% Change in Net			% Change
(basis points)		Interest Income (in thousands)			Interest Income			Policy Limit
	+100	$	1,523			2.99	%		(5.00	)%
	-100	$	(329	)		(0.65	)%		(5.00	)%

	+200	$	3,149			6.19	%		(15.00	)%
	-200	$	(1,415	)		(2.78	)%		(15.00	)%

	+300	$	4,602			9.04	%		(25.00	)%

	+400	$	6,166			12.11	%		(35.00	)%

Item 4. Controls and Procedures

The Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Interim Treasurer, of the effectiveness of its disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon the evaluation, the Corporation’s Chief Executive Officer and Interim Treasurer concluded that, as of March 31, 2016, the Corporation’s disclosure controls and procedures were effective. The Corporation’s disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that information required to be disclosed in the Corporation’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. A control system, no matter how well conceived and operated, must reflect the fact that there are resource constraints and that the benefits of controls must be considered relative to their costs, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

There has been no change in the Corporation’s internal control over financial reporting that occurred during the three months ended March 31, 2016, that has materially affected or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

- 55 -

Table of Contents

Part II—OTHER INFORMATION

Item 1. Legal proceedings

The Corporation and PeoplesBank are involved in routine litigation incidental to their business. In the opinion of management, there are no legal proceedings pending against the Corporation or any of its subsidiaries which are expected to have a material impact upon the consolidated financial position and/or operating results of the Corporation. Management is not aware of any adverse proceedings known or contemplated by government authorities.

Item 1A. Risk factors

See Item 1A – Risk Factors – in our Annual Report on Form 10-K for the year ended December 31, 2015 for a detailed discussion of risk factors affecting the Corporation.

Item 2. Unregistered sales of equity securities and use of proceeds

The Corporation relies on its subsidiary PeoplesBank, A Codorus Valley Company, for dividend distributions, which are subject to restrictions as reported in Note 9—Regulatory Matters of the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2015.

The Corporation has a Share Repurchase Program (Program), which was authorized in 1995, and has been periodically amended, to permit the purchase of up to a maximum of 4.9 percent of the outstanding shares of the Corporation’s common stock at a price per share no greater than 200 percent of the latest quarterly published book value. For the three month period ended March 31, 2016 and the year ended December 31, 2015, the Corporation had not acquired any of its common stock under the Program.

Item 3. Defaults upon senior securities

None

Item 4. Mine safety disclosures

This Item 4 is not applicable to the Corporation.

Item 5. Other information

None

- 56 -

Table of Contents

Item 6. Exhibits

Exhibit Number		Description of Exhibit
3.1	Amended Articles of Incorporation (Incorporated by reference to Exhibit 3(i) to the Registrant’s Quarterly Report on Form 8-K, filed with the Commission on December 4, 2015)

3.2	Amended By-laws (Incorporated by reference to Exhibit 3(ii) to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 12, 2016)

10.1	Second Amendment to Employment Agreement of Larry J. Miller dated March 8, 2016 (Incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the Commission on March 8, 2016)

10.2	First Amendment to Employment Agreement of A. Dwight Utz dated April 14, 2016 (Incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the Commission on April 15, 2016)

31.1	Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2	Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32	Certification of Principal Executive Officer and Principal Financial Officer Pursuant to Section 906 of the Sarbanes- Oxley Act of 2002

101	Financial statements from the Quarterly Report on Form 10-Q of Codorus Valley Bancorp, Inc. for the quarter ended March 31, 2016, formatted in XBRL: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income (iii) the Consolidated Statements of Comprehensive Income (iv) the Consolidated Statements of Cash Flows, (v) the Consolidated Statements of Changes in Shareholder’s Equity, and (vi) the Notes to Consolidated Financial Statements– filed herewith.

- 57 -

Table of Contents

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned there unto duly authorized.

			Codorus Valley Bancorp, Inc.
			(Registrant)

May 5, 2016			/s/ Larry J. Miller
Date			Larry J. Miller
			Chairman, President
			and Chief Executive Officer
			(Principal Executive Officer)


May 5, 2016			/s/ Diane E. Baker
Date			Diane E. Baker, CPA
			Interim Treasurer
			(Principal Financial and Accounting Officer)

- 58 -