UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005
Or
[ ] 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 0-13222
CITIZENS FINANCIAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2265045
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
First Citizens National Bank
15 South Main Street
Mansfield, Pennsylvania 16933
(Address of principal executive offices)(Zip Code)
Registrant's telephone number, including area code: (570) 662-2121
Indicate by checkmark whether the registrant (1) has filed all reports to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes__X___ No_____
Indicate by checkmark whether the registrant is an accelerated filer (as described in Rule 12b-2 of the Exchange Act). Yes____ No __X__
Indicate by checkmark whether the registrant is a shell company (as described in Rule 12b-2 of the Exchange Act). Yes____ No __X__
The number of shares outstanding of the Registrant's Common Stock, as of November 1, 2005, 2,846,542 shares of Common Stock, par value $1.00.
Citizens Financial Services, Inc.
Form 10-Q
INDEX
PAGE | |
Part I FINANCIAL INFORMATION | |
Item I - Financial Statements (unaudited) | |
Consolidated Balance Sheet as of September 30, 2005 and December 31, 2004 | 1 |
Consolidated Statement of Income for the Three Months and Nine Months Ended September 30, 2005 and 2004 | 2 |
Consolidated Statement of Comprehensive Income for the Three Months and Nine Months Ended September 30, 2005 and 2004 | 3 |
Consolidated Statement of Cash Flows for the Nine Months Ended September 30, 2005 and 2004 | 4 |
Notes to Consolidated Financial Statements | 5-7 |
Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations | 8-21 |
Item 3 - Quantitative and Qualitative Disclosure About Market Risk | 22 |
Item 4 - Controls and Procedures | 22 |
Part II OTHER INFORMATION | |
Item 1 - Legal Proceedings | 23 |
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds | 23 |
Item 3 - Defaults upon Senior Securities | 23 |
Item 4 - Submission of Matters to a Vote of Security Holders | 23 |
Item 5 - Other Information | 23 |
Item 6 - Exhibits and Reports on Form 8-K | 24 |
Signatures | 25 |
CITIZENS FINANCIAL SERVICES, INC. | |||||||
CONSOLIDATED BALANCE SHEET | |||||||
(UNAUDITED) | |||||||
September 30 | December 31 | ||||||
(in thousands) | 2005 | 2004 | |||||
ASSETS: | |||||||
Cash and due from banks: | |||||||
Noninterest-bearing | $ | 7,868 | $ | 9,162 | |||
Interest-bearing | 540 | 177 | |||||
Total cash and cash equivalents | 8,408 | 9,339 | |||||
Available-for-sale securities | 90,512 | 95,747 | |||||
Loans (net of allowance for loan losses of $3,666 and $3,919) | 371,852 | 355,774 | |||||
Premises and equipment | 12,316 | 11,833 | |||||
Accrued interest receivable | 2,037 | 1,736 | |||||
Goodwill | 8,605 | 8,605 | |||||
Core deposit intangible | 828 | 1,262 | |||||
Bank owned life insurance | 7,669 | 7,449 | |||||
Other assets | 7,356 | 7,602 | |||||
TOTAL ASSETS | $ | 509,583 | $ | 499,347 | |||
LIABILITIES: | |||||||
Deposits: | |||||||
Noninterest-bearing | $ | 52,246 | $ | 46,866 | |||
Interest-bearing | 378,436 | 372,208 | |||||
Total deposits | 430,682 | 419,074 | |||||
Borrowed funds | 32,814 | 34,975 | |||||
Accrued interest payable | 1,627 | 1,870 | |||||
Commitment to purchase investment securities | 300 | - | |||||
Other liabilities | 2,718 | 2,639 | |||||
TOTAL LIABILITIES | 468,141 | 458,558 | |||||
STOCKHOLDERS' EQUITY: | |||||||
Common Stock | |||||||
$1.00 par value; authorized 10,000,000 shares; | |||||||
issued 2,965,257 shares in 2005 and 2,937,519 in 2004, respectively | 2,965 | 2,938 | |||||
Additional paid-in capital | 11,359 | 10,804 | |||||
Retained earnings | 30,472 | 28,894 | |||||
TOTAL | 44,796 | 42,636 | |||||
Accumulated other comprehensive (loss) income | (880 | ) | 164 | ||||
Less: Treasury Stock, at cost | |||||||
118,715 shares for 2005 and 97,262 for 2004, respectively | (2,474 | ) | (2,011 | ) | |||
TOTAL STOCKHOLDERS' EQUITY | 41,442 | 40,789 | |||||
TOTAL LIABILITIES AND | |||||||
STOCKHOLDERS' EQUITY | $ | 509,583 | $ | 499,347 | |||
The accompanying notes are an integral part of these unaudited consolidated financial statements. |
1
CITIZENS FINANCIAL SERVICES, INC. | |||||||||||||
CONSOLIDATED STATEMENT OF INCOME | |||||||||||||
(UNAUDITED) | |||||||||||||
Three Months Ended | Nine Months Ended | ||||||||||||
September 30, | September 30, | ||||||||||||
(in thousands, except per share data) | 2005 | 2004 | 2005 | 2004 | |||||||||
INTEREST INCOME: | |||||||||||||
Interest and fees on loans | $ | 6,362 | $ | 5,851 | $ | 18,386 | $ | 16,647 | |||||
Interest-bearing deposits with banks | 3 | 1 | 2 | 9 | |||||||||
Investment securities: | |||||||||||||
Taxable | 698 | 846 | 2,240 | 2,590 | |||||||||
Nontaxable | 153 | 76 | 394 | 223 | |||||||||
Dividends | 50 | 81 | 156 | 210 | |||||||||
TOTAL INTEREST INCOME | 7,266 | 6,855 | 21,178 | 19,679 | |||||||||
INTEREST EXPENSE: | |||||||||||||
Deposits | 2,416 | 2,126 | 6,840 | 6,081 | |||||||||
Borrowed funds | 383 | 253 | 1,140 | 684 | |||||||||
TOTAL INTEREST EXPENSE | 2,799 | 2,379 | 7,980 | 6,765 | |||||||||
NET INTEREST INCOME | 4,467 | 4,476 | 13,198 | 12,914 | |||||||||
Provision for loan losses | 30 | - | 30 | - | |||||||||
NET INTEREST INCOME AFTER | |||||||||||||
PROVISION FOR LOAN LOSSES | 4,437 | 4,476 | 13,168 | 12,914 | |||||||||
NON-INTEREST INCOME: | |||||||||||||
Service charges | 784 | 783 | 2,203 | 2,265 | |||||||||
Trust | 161 | 86 | 368 | 332 | |||||||||
Brokerage | 45 | 40 | 138 | 152 | |||||||||
Insurance | 61 | 61 | 205 | 150 | |||||||||
Gains on loans sold | 24 | 17 | 45 | 37 | |||||||||
Investment securities gains, net | - | - | - | 491 | |||||||||
Earnings on bank owned life insurance | 71 | 75 | 220 | 233 | |||||||||
Other | 85 | 91 | 289 | 262 | |||||||||
TOTAL NON-INTEREST INCOME | 1,231 | 1,153 | 3,468 | 3,922 | |||||||||
NON-INTEREST EXPENSES: | |||||||||||||
Salaries and employee benefits | 1,993 | 1,905 | 5,888 | 5,677 | |||||||||
Occupancy | 262 | 259 | 846 | 812 | |||||||||
Furniture and equipment | 156 | 181 | 491 | 517 | |||||||||
Professional fees | 132 | 131 | 408 | 443 | |||||||||
Amortization of intangibles | 145 | 145 | 434 | 362 | |||||||||
Other | 1,133 | 1,159 | 3,439 | 3,314 | |||||||||
TOTAL NON-INTEREST EXPENSES | 3,821 | 3,780 | 11,506 | 11,125 | |||||||||
Income before provision for income taxes | 1,847 | 1,849 | 5,130 | 5,711 | |||||||||
Provision for income taxes | 529 | 426 | 1,232 | 1,328 | |||||||||
NET INCOME | $ | 1,318 | $ | 1,423 | $ | 3,898 | $ | 4,383 | |||||
Earnings Per Share | $ | 0.46 | $ | 0.50 | $ | 1.36 | $ | 1.53 | |||||
Cash Dividends Per Share | $ | 0.205 | $ | 0.195 | $ | 0.610 | $ | 0.580 | |||||
Weighted average number of shares outstanding | 2,846,542 | 2,867,995 | 2,859,980 | 2,868,177 | |||||||||
The accompanying notes are an integral part of these unaudited consolidated financial statements. |
2
CITIZENS FINANCIAL SERVICES, INC. | |||||||||||||||||||||||||
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME | |||||||||||||||||||||||||
(UNAUDITED) | |||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | ||||||||||||||||||||||||
September 30 | September 30 | ||||||||||||||||||||||||
(in thousands) | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||||
Net income | $ | 1,318 | $ | 1,423 | $ | 3,898 | $ | 4,383 | |||||||||||||||||
Other comprehensive income: | |||||||||||||||||||||||||
Unrealized gains (losses) on available for sale securities | (739 | ) | 1,605 | (1,580 | ) | (771 | ) | ||||||||||||||||||
Less: Reclassification adjustment for gain included in net income | - | - | - | (491 | ) | ||||||||||||||||||||
Other comprehensive income (loss) before tax | (739 | ) | 1,605 | (1,580 | ) | (1,262 | ) | ||||||||||||||||||
Income tax expense (benefit) related to other comprehensive income | (251 | ) | 546 | (537 | ) | (429 | ) | ||||||||||||||||||
Other comprehensive (loss) income, net of tax | (488 | ) | 1,059 | (1,043 | ) | (833 | ) | ||||||||||||||||||
Comprehensive income | $ | 830 | $ | 2,482 | $ | 2,855 | $ | 3,550 | |||||||||||||||||
The accompanying notes are an integral part of these unaudited consolidated financial statements. |
3
CITIZENS FINANCIAL SERVICES, INC. | |||||||
CONSOLIDATED STATEMENT OF CASH FLOWS | |||||||
(UNAUDITED) | Nine Months Ended | ||||||
September 30, | |||||||
(in thousands) | 2005 | 2004 | |||||
CASH FLOWS FROM OPERATING ACTIVITIES: | |||||||
Net income | $ | 3,898 | $ | 4,383 | |||
Adjustments to reconcile net income to net | |||||||
cash provided by operating activities: | |||||||
Provision for loan losses | 30 | - | |||||
Depreciation and amortization | 1,091 | 1,060 | |||||
Amortization and accretion of investment securities | 552 | 705 | |||||
Deferred income taxes | 224 | 1 | |||||
Investment securities gains, net | - | (491 | ) | ||||
Realized gains on loans sold | (45 | ) | (37 | ) | |||
Earnings on banked owned life insurance | (220 | ) | (233 | ) | |||
Originations of loans held for sale | (3,566 | ) | (2,080 | ) | |||
Proceeds from sales of loans held for sale | 3,611 | 2,118 | |||||
Increase in accrued interest receivable | (301 | ) | (172 | ) | |||
Decrease in accrued interest payable | (243 | ) | (203 | ) | |||
Other, net | 126 | (353 | ) | ||||
Net cash provided by operating activities | 5,157 | 4,698 | |||||
CASH FLOWS FROM INVESTING ACTIVITIES: | |||||||
Available-for-sale securities: | |||||||
Proceeds from sales of available-for-sale securities | - | 14,045 | |||||
Proceeds from maturity and principal repayments of securities | 13,149 | 20,193 | |||||
Purchase of securities | (10,046 | ) | (30,122 | ) | |||
Proceeds from redemption of Regulatory Stock | 1,888 | 962 | |||||
Purchase of Regulatory Stock | (1,347 | ) | (1,197 | ) | |||
Net increase in loans | (16,454 | ) | (8,985 | ) | |||
Purchase of loans | - | (27,340 | ) | ||||
Purchases of premises and equipment | (169 | ) | (2,126 | ) | |||
Proceeds from sale of premises and equipment | 200 | 30 | |||||
Proceeds from sale of foreclosed assets held for sale | 372 | 229 | |||||
Property purchased for future expansion | (927 | ) | - | ||||
Deposit acquisition premium | - | (2,200 | ) | ||||
Net cash used in investing activities | (13,334 | ) | (36,511 | ) | |||
CASH FLOWS FROM FINANCING ACTIVITIES: | |||||||
Net increase in deposits | 11,608 | 2,658 | |||||
Proceeds from long-term borrowings | 8,063 | 1,334 | |||||
Repayments of long-term borrowings | (3,208 | ) | (1,261 | ) | |||
Net increase (decrease) in short-term borrowed funds | (7,016 | ) | 8,385 | ||||
Purchase of Treasury Stock | (463 | ) | (7 | ) | |||
Dividends paid | (1,738 | ) | (1,642 | ) | |||
Deposits of acquired branches | - | 20,663 | |||||
Net cash provided by financing activities | 7,246 | 30,130 | |||||
Net decrease in cash and cash equivalents | (931 | ) | (1,683 | ) | |||
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD | 9,339 | 9,951 | |||||
CASH AND CASH EQUIVALENTS AT END OF PERIOD | $ | 8,408 | $ | 8,268 | |||
Supplemental Disclosures of Cash Flow Information: | |||||||
Interest paid | $ | 8,198 | $ | 6,734 | |||
Income taxes paid | $ | 860 | $ | 1,450 | |||
The accompanying notes are an integral part of these unaudited consolidated financial statements. |
4
CITIZENS FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - Basis of Presentation
Citizens Financial Service, Inc., (individually and collectively, the “Company”) is a Pennsylvania corporation organized as the holding company of its wholly owned subsidiary, First Citizens National Bank (the “Bank”), and its subsidiary, First Citizens Insurance Agency, Inc. All material inter-company balances and transactions have been eliminated in consolidation.
The accompanying consolidated financial statements have been prepared pursuant to rules and regulations of the Securities and Exchange Commission (SEC) and in compliance with accounting principles generally accepted in the United States of America. Because this report is based on an interim period, certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted.
In the opinion of Management of the registrant, the accompanying interim financial statements for the quarters ended September 30, 2005 and 2004 include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the financial condition and the results of operations for the period. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. The financial performance reported for the Company for the nine-month period ended September 30, 2005 is not necessarily indicative of the results to be expected for the full year. This information should be read in conjunction with the Company’s Annual Report to shareholders and Form 10-K for the period ended December 31, 2004.
Note 2 - Earnings per Share
The following table sets forth the computation of earnings per share. Earnings per share calculations give retroactive effect to stock dividends declared by the Company. The Company has no dilutive securities.
Three months ended | Nine months ended | ||||||||||||
September 30, | September 30, | ||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||
Net income applicable to common stock | $ | 1,318,000 | $ | 1,423,000 | $ | 3,898,000 | $ | 4,383,000 | |||||
Weighted average common shares outstanding | 2,846,542 | 2,867,995 | 2,859,980 | 2,868,177 | |||||||||
Earnings per share | $ | 0.46 | $ | 0.50 | $ | 1.36 | $ | 1.53 |
Note 3 - Income Tax Expense
Income tax expense is less than the amount calculated using the statutory tax rate, primarily the result of tax-exempt income earned from state and municipal securities and loans and investment in tax credits.
Note 4 - Employee Benefit Plans
Components of Net Periodic Benefit Cost - Defined Benefit Plans
For a detailed disclosure on the Company’s pension and employee benefit plans, please refer to Note 8 of the Company’s Consolidated Financial Statements included in the 2004 Annual Report on Form 10-K.
5
The following sets forth the components of net periodic benefit costs of the defined benefit plans for the three months and nine months ended September 30, 2005 and 2004, respectively (dollars presented in thousands):
Three Months Ended | Nine Months Ended | ||||||||||||
September 30, | September 30, | ||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||
Service cost | $ | 101 | $ | 84 | $ | 260 | $ | 252 | |||||
Interest cost | 91 | 74 | 235 | 221 | |||||||||
Expected return on plan assets | (105 | ) | (83 | ) | (271 | ) | (249 | ) | |||||
Net amortization and deferral | 16 | 6 | 42 | 18 | |||||||||
Net periodic benefit cost | $ | 103 | $ | 81 | $ | 266 | $ | 242 |
The Company has contributed $382,000 to its defined benefit pension plan as of September 30, 2005. No further contributions in 2005 are expected.
Defined Contribution Plan
The Company also sponsors a defined contribution plan covering substantially all of its employees. The Company contributes three percent of applicable salaries into the plan. Through September 30, 2005, the Company contributed $145,000 into the defined contribution plan.
Note 5 - Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (FAS No. 123R). FAS No. 123R revised FAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. FAS No. 123R will require compensation costs related to share-based payment transactions to be recognized in the financial statement (with limited exceptions). The amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. Compensation cost will be recognized over the period that an employee provides service in exchange for the award.
In April, the Securities and Exchange Commission adopted a new rule that amends the compliance dates for FAS No. 123R. The Statement requires that compensation cost relating to share-based payment transactions be recognized in financial statements and that this cost be measured based on the fair value of the equity or liability instruments issued. FAS No. 123R covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. The Company will adopt FAS No. 123R on January 1, 2006 and is currently evaluating the impact the adoption of the standard will have on the Company’s results of operations.
In March 2005, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 107 ("SAB No. 107"), Share-Based Payment, providing guidance on option valuation methods, the accounting for income tax effects of share-based payment arrangements upon adoption of FAS No. 123R, and the disclosures in MD&A subsequent to the adoption. The Company will provide SAB No. 107 required disclosures upon adoption of FAS No. 123R on January 1, 2006 and is currently evaluating the impact the adoption of the standard will have on the Company’s financial condition, results of operations, and cash flows.
In December 2004, FASB issued FAS No. 153, Exchanges of Nonmonetary Assets - An Amendment of APB Opinion No. 29. The guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that Opinion, however, included certain exceptions to that principle. FAS No. 153 amends Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The provisions of FAS No. 153 are effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Early application is permitted and companies must apply the standard prospectively. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.
6
In June 2005, the FASB issued FAS No. 154, Accounting Changes and Errors Corrections, a replacement of APB Opinion No. 20 and FAS No. 3. The Statement applies to all voluntary changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle. FAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impractical. APB Opinion No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. FAS No.154 improves the financial reporting because its requirements enhance the consistency of financial reporting between periods. The provisions of FAS No. 154 are effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.
Note 6 - Pending Acquisition
The Company has entered into a Purchase and Assumption Agreement, dated August 22, 2005 (and subsequently amended September 13, 2005) with Fulton Savings Bank, a New York state-chartered mutual savings bank headquartered in Fulton, New York, to acquire the Hannibal Branch of Fulton Savings Bank.
Subject to regulatory approval, the Company intends to purchase certain assets and assume certain liabilities of the Hannibal branch. Immediately following the branch transaction, and again subject to regulatory approval, the Company intends to close and relocate the Hannibal branch to Wellsville, New York. The Company anticipates that the proposed transaction will be consummated during the fourth quarter of 2005. It is expected that the total acquisition costs of approximately $200,000 will be recognized in the fourth quarter.
7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Cautionary Statement
Forward-looking statements may prove inaccurate. We have made forward-looking statements in this document, and in documents that we incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of operations of Citizens Financial Services, Inc., First Citizens National Bank, First Citizens Insurance Agency, Inc. or the combined company. When we use such words as "believes," "expects,” "anticipates," or similar expressions, we are making forward-looking statements. For a variety of reasons, actual results could differ materially from those contained in or implied by forward-looking statements. The Company would like to caution readers that the following important factors, among others, may have affected and could in the future affect the Company’s actual results and could cause the Company’s actual results for subsequent periods to differ materially from those expressed in any forward looking statement:
· | The effects of changing economic conditions in both the market areas served by the Company and nationally. |
· | Interest rates could change more rapidly or more significantly than we expect. |
· | The economy could change significantly in an unexpected way, which would cause the demand for new loans and the ability of borrowers to repay outstanding loans to change in ways that our models do not anticipate. |
· | The stock and bond markets could suffer a significant disruption, which may have a negative effect on our financial condition and that of our borrowers, and on our ability to raise money by issuing new securities. |
· | It could take us longer than we anticipate implementing strategic initiatives designed to increase revenues or manage expenses, or we may be unable to implement those initiatives at all. |
· | Acquisitions and dispositions of assets could affect us in ways that management has not anticipated. |
· | We may become subject to new legal obligations or the resolution of litigation may have a negative effect on our financial condition. |
· | We may become subject to new and unanticipated accounting, tax, or regulatory practices, regulations or requirements, including the costs of compliance with such changes. |
Introduction
The following is management's discussion and analysis of the significant changes in the results of operations, capital resources and liquidity presented in its accompanying consolidated financial statements for Citizens Financial Service, Inc., a bank holding company and its subsidiary (the Company). Our Company's consolidated financial condition and results of operations consist almost entirely of our wholly owned subsidiary’s (First Citizens National Bank) financial condition and results of operations. Management’s discussion and analysis should be read in conjunction with the preceding September 30, 2005 financial information. The results of operations for the three and nine months ended September 30, 2005 and 2004 are not necessarily indicative of the results you may expect for the full year.
Our Company currently engages in the general business of banking throughout our service area of Potter, Tioga and Bradford counties in North Central Pennsylvania and Allegany, Steuben, Chemung and Tioga counties in Southern New York. Our lending and deposit products and investment services are offered primarily within the vicinity of our service area.
The market area that First Citizens National Bank operates is rural in nature. The customer makeup consists of small businesses and individuals. The state of the economy in the region is mixed with unemployment rates generally running above the state and national averages at this time.
8
Risk identification and management are essential elements for the successful management of the Company. In the normal course of business, the Company is subject to various types of risk including interest rate, credit and liquidity risk.
Interest rate risk is the sensitivity of net interest income and the market value of financial instruments to the direction and frequency of changes in interest rates. Interest rate risk results from various re-pricing frequencies and the maturity structure of the financial instruments owned by the Company. The Company uses its asset/liability management policy to control and manage interest rate risk.
Credit risk represents the possibility that a customer may not perform in accordance with contractual terms. Credit risk results from loans with customers and purchasing of securities. The Company’s primary credit risk is in the loan portfolio. The Company manages credit risk by adhering to an established credit policy and through a disciplined evaluation of the adequacy of the allowance for loan losses. Also, the investment policy limits the amount of credit risk that may be taken in the investment portfolio.
Liquidity risk represents the inability to generate or otherwise obtain funds at reasonable rates to satisfy commitments to borrowers and obligations to depositors. The Company has established guidelines within its asset/liability policy to manage liquidity risk. These guidelines include contingent funding alternatives.
Readers should carefully review the risk factors described in other documents our Company files, from time to time, with the Securities and Exchange Commission, including the Annual Report on Form 10-K for the year ended December 31, 2004, filed by our Company and any current reports on Form 8-K filed by our Company.
We face strong competition in the communities we serve from other commercial banks, savings banks, savings and loan associations and credit unions, some of which are substantially larger institutions than our subsidiary. In addition, insurance companies, investment-counseling firms, and other business firms and individuals offer personal and corporate trust services. We also compete with credit unions, issuers of money market funds, securities brokerage firms, consumer finance companies and mortgage brokers. These entities are strong competitors for virtually all types of financial services.
In recent years, the financial services industry has experienced tremendous change to competitive barriers between bank and non-bank institutions. We not only must compete with traditional financial institutions, but also with other business corporations that have begun to deliver competing financial services. Competition for banking services is based on price, nature of product, quality of service, and in the case of certain activities, convenience of location.
Trust and Investment Services
Our Trust and Investment Department services range from professional estate settlement services through management of complex trust accounts to investment management and custody of securities. Our Trust and Investment Department manages retirement accounts for many area companies and individuals. We also manage many individual IRAs, both rollover and contributory.
The Investment Department offers full service brokerage services in selected locations throughout the Bank’s market area and appointments can be made in any First Citizens National Bank branch.
The Bank offers life and health insurance, as well as annuities through our insurance subsidiary, First Citizens Insurance Agency, Inc.
Financial Condition
Total assets (shown in the Consolidated Balance Sheet) have increased 2.0% since year-end 2004 to $509.6 million. Total loans increased 4.4% to $375.5 million and investment securities decreased 5.5% to $90.5 million since year-end 2004. Total deposits increased 2.8% to $430.7 million since year-end 2004. Explanations of variances will be described within the following appropriate sections.
9
Cash and Cash Equivalents
Cash and cash equivalents totaled $8,408,000 at September 30, 2005 compared to $9,339,000 on December 31, 2004. Noninterest-bearing cash decreased $1,294,000 since year-end 2004, while interest-bearing cash increased $363,000 during that same period. We believe the liquidity needs of the Company are satisfied by the current balance of cash and cash equivalents, the availability of traditional funding sources, and the portion of the investment and loan portfolios that mature within one year. These sources of funds will enable the Company to meet cash obligations and off-balance sheet commitments as they come due.
Investments
The total investment portfolio is held as available for sale. Investments available for sale are accounted for at fair value with unrealized gains and losses, net of deferred taxes, reported as a component of stockholders’ equity. The amortized cost and estimated fair value of investment securities at September 30, 2005 and December 31, 2004 were as follows (in thousands):
Gross | Gross | Estimated | |||||||||||
Amortized | Unrealized | Unrealized | Fair | ||||||||||
September 30, 2005 | Cost | Gains | Losses | Value | |||||||||
Available-for-sale securities: | |||||||||||||
U.S. Agency securities | $ | 5,779 | $ | - | $ | (134 | ) | $ | 5,645 | ||||
Obligations of state and | |||||||||||||
political subdivisions | 17,220 | 149 | (116 | ) | 17,253 | ||||||||
Corporate obligations | 8,495 | 186 | - | 8,681 | |||||||||
Mortgage-backed securities | 57,251 | 98 | (1,184 | ) | 56,165 | ||||||||
Equity securities | 3,099 | - | (331 | ) | 2,768 | ||||||||
Total available-for-sale | $ | 91,844 | $ | 433 | $ | (1,765 | ) | $ | 90,512 | ||||
Gross | Gross | Estimated | |||||||||||
Amortized | Unrealized | Unrealized | Fair | ||||||||||
December 31, 2004 | Cost | Gains | Losses | Value | |||||||||
Available-for-sale securities: | |||||||||||||
U.S. Agency securities | $ | 5,829 | $ | - | $ | (17 | ) | $ | 5,812 | ||||
Obligations of state and | |||||||||||||
political subdivisions | 7,203 | 249 | - | 7,452 | |||||||||
Corporate obligations | 8,523 | 412 | - | 8,935 | |||||||||
Mortgage-backed securities | 70,845 | 204 | (600 | ) | 70,449 | ||||||||
Equity securities | 3,099 | - | - | 3,099 | |||||||||
Total available-for-sale | $ | 95,499 | $ | 865 | $ | (617 | ) | $ | 95,747 |
Our investment portfolio decreased by $5,235,000 or 5.5% from December 31, 2004 to September 30, 2005. So far in 2005, we have purchased approximately $9.6 million of municipal bonds. Given current interest rates, we have focused on purchasing higher coupon, longer-term municipals in an effort to extend the portfolio. Offsetting these purchases is approximately $13.1 million of principal repayments from our mortgage backed securities portfolio, which we continue to receive approximately $1.5 million per month. These principal repayments have been used to fund investment purchases and loan growth.
Management monitors the earnings performance and the effectiveness of the liquidity of the investment portfolio on a regular basis. Through active balance sheet management and analysis of the securities portfolio, the Company maintains sufficient liquidity to satisfy depositor requirements and various credit needs of its customers.
Loans
The Company’s lending is focused in the north central Pennsylvania market and the southern tier of New York. The composition of our loan portfolio consists principally of retail lending, which includes single-family residential mortgages and other consumer lending, and commercial lending primarily to locally owned small businesses. New loans are generated primarily from direct loans to our existing customer base, with new customers generated by referrals from real estate brokers, building contractors, attorneys, accountants and existing customers.
10
As shown in the tables below (dollars in thousands), total loans increased approximately $15.8 million or 4.4% during the first nine months of 2005. Municipal loans increased $3.4 million due to the addition of one large municipal loan in the second quarter. Residential and commercial real estate loans increased $5.9 million and $4.8 million, respectively.
We continue to be optimistic that loan demand will increase for the remainder of the year. We emphasize branch office personnel training, customer flexibility and responsive “turn around times” that will continue to aid in growing our loan portfolio through exceptional customer service. The Company’s team of strong, experienced business development officers enables us to meet the needs of commercial and agricultural customers within our service area.
Additionally, our proposed acquisition of a branch of Fulton Savings Bank in Hannibal, New York (see Note 6 of the Consolidated Financial Statements) and subsequent relocation to Wellsville, New York, subject to regulatory approval, should open further growth opportunities in the southern tier of New York State. Wellsville is a natural extension of our existing business in Potter County, Pennsylvania, and will compliment our efforts for loan growth in Allegany County, New York.
September 30, 2005/ | |||||||||||||||||||
September 30, | December 31, | December 31, 2004 | |||||||||||||||||
2005 | 2004 | Change | |||||||||||||||||
Amount | % | Amount | % | Amount | % | ||||||||||||||
Real estate: | |||||||||||||||||||
Residential | $ | 195,695 | 52.2 | $ | 189,803 | 52.8 | $ | 5,892 | 3.1 | ||||||||||
Commercial | 79,998 | 21.3 | 75,228 | 20.9 | 4,770 | 6.3 | |||||||||||||
Agricultural | 11,977 | 3.2 | 11,564 | 3.2 | 413 | 3.6 | |||||||||||||
Construction | 8,418 | 2.2 | 7,282 | 2.0 | 1,136 | 15.6 | |||||||||||||
Loans to individuals | |||||||||||||||||||
for household, family and other purchases | 12,901 | 3.4 | 12,657 | 3.5 | 244 | 1.9 | |||||||||||||
Commercial and other loans | 28,054 | 7.5 | 28,069 | 7.8 | (15 | ) | -0.1 | ||||||||||||
State & political subdivision loans | 38,475 | 10.2 | 35,090 | 9.8 | 3,385 | 9.6 | |||||||||||||
Total loans | 375,518 | 100.0 | 359,693 | 100.0 | 15,825 | 4.4 | |||||||||||||
Less allowance for loan losses | 3,666 | 3,919 | (253 | ) | -6.5 | ||||||||||||||
Net loans | $ | 371,852 | $ | 355,774 | $ | 16,078 | 4.5 |
Allowance for Loan Losses
As shown in the following table (dollars in thousands), the Allowance for Loan Losses as a percentage of loans was .98% and 1.09%, at September 30, 2005 and December 31, 2004, respectively. The dollar amount of the reserve decreased $253,000, since year-end 2004. The decrease is due to a $30,000 charge to the provision, less net charge-offs of $283,000. Asset quality continues to remain strong, such that no provision was recorded for the first two quarters of the year and only $30,000 recorded for the recently ended third quarter due primarily to loan growth. The adequacy of the allowance for loan losses is subject to a formal analysis by management of the Company. Management deems the allowance to be adequate to absorb inherent losses in the portfolio as of September 30, 2005. The Company has disclosed in its annual report on Form 10-K the process and methodology supporting the loan loss provision.
11
September 30, | December 31, | |||||||||||||||
2005 | 2004 | 2003 | 2002 | 2001 | ||||||||||||
Balance, at beginning of period | $ | 3,919 | $ | 3,620 | $ | 3,621 | $ | 3,250 | $ | 2,777 | ||||||
Provision charged to income | 30 | - | 435 | 435 | 445 | |||||||||||
Increase related to acquisition | - | 290 | - | - | - | |||||||||||
Recoveries on loans previously | ||||||||||||||||
charged against the allowance | 39 | 324 | 116 | 115 | 175 | |||||||||||
3,988 | 4,234 | 4,172 | 3,800 | 3,397 | ||||||||||||
Loans charged against the allowance | (322 | ) | (315 | ) | (552 | ) | (179 | ) | (147 | ) | ||||||
Balance, at end of year | $ | 3,666 | $ | 3,919 | $ | 3,620 | $ | 3,621 | $ | 3,250 | ||||||
Allowance for loan losses as a percent | ||||||||||||||||
of total loans | 0.98 | % | 1.09 | % | 1.14 | % | 1.21 | % | 1.20 | % | ||||||
Allowance for loan losses as a percent | ||||||||||||||||
of non-performing loans | 168.32 | % | 176.53 | % | 134.62 | % | 119.94 | % | 149.56 | % |
Bank Owned Life Insurance
The Company has elected to purchase bank owned life insurance to offset future employee benefit costs. As of September 30, 2005 the cash surrender value of this life insurance is $7,669,000, an increase of $220,000 since year end. The use of life insurance policies provides the bank with an asset that will generate earnings to partially offset the current costs of benefits, and eventually (at the death of the insured’s) provide partial recovery of cash outflows associated with the benefits.
Deposits
Traditional deposits continue to be the most significant source of funds for the Company. As shown in the following tables (dollars in thousands), deposits increased $11,608,000 or 2.8%, since December 31, 2004. As of September 30, 2005, non-interest-bearing deposits increased $5,380,000. The Company continues to emphasize service and convenience as a low cost deposit gathering strategy. Money market deposits increased by $11,215,000, primarily due to a new deposit from a local, non-profit state and political organization. NOW and savings accounts decreased by $904,000 and $361,000, respectively. Certificates of Deposit decreased by $3,722,000 since December 31, 2004.
We anticipate that we will be able to grow our deposit base with our proposed Wellsville, New York location, subject to regulatory approval (see Note 6 to the Consolidated Financial Statements), as we expand our operations directly into Allegany County, New York.
September 30, 2005/ | |||||||||||||||||||
September 30, | December 31, | December 31, 2004 | |||||||||||||||||
2005 | 2004 | Change | |||||||||||||||||
Amount | % | Amount | % | Amount | % | ||||||||||||||
Non-interest-bearing deposits | $ | 52,246 | 12.1 | $ | 46,866 | 11.2 | $ | 5,380 | 11.5 | ||||||||||
NOW accounts | 73,542 | 17.1 | 74,446 | 17.7 | (904 | ) | (1.2 | ) | |||||||||||
Savings deposits | 39,275 | 9.1 | 39,636 | 9.5 | (361 | ) | (0.9 | ) | |||||||||||
Money market deposit accounts | 53,564 | 12.5 | 42,349 | 10.1 | 11,215 | 26.5 | |||||||||||||
Certificates of deposit | 212,055 | 49.2 | 215,777 | 51.5 | (3,722 | ) | (1.7 | ) | |||||||||||
Total | $ | 430,682 | 100.0 | $ | 419,074 | 100.0 | $ | 11,608 | 2.8 |
12
Borrowed Funds
Borrowed funds decreased $2,161,000 during the first nine months of 2005. The majority of this decrease is due to using principal repayments from our mortgage backed securities portfolio to reduce overnight borrowings through the Federal Home Loan Bank (FHLB). The Company's daily cash requirements or short-term investments are met by using the financial instruments available through the FHLB.
In December 2003, the Company formed a special purpose entity, Citizens Financial Statutory Trust I (“the Entity”), to issue $7,500,000 of floating rate obligated mandatory redeemable securities as part of a pooled offering. The rate is determined quarterly and floats based on the 3 month LIBOR plus 2.80%. At September 30, 2005, the rate was 6.69%. The Entity may redeem them, in whole or in part, at face value after December 17, 2008. The Company borrowed the proceeds of the issuance from the Entity in December 2003 in the form of a $7,500,000 note payable, which is included within borrowed funds in the liabilities section of the Company’s balance sheet. Under current accounting rules, the Company’s minority interest in the Entity was recorded at the initial investment amount and is included in the other assets section of the balance sheet. The Entity is not consolidated as part of the Company’s consolidated financial statements.
Stockholder’s Equity
We evaluate stockholders’ equity in relation to total assets and the risk associated with those assets. The greater the capital resources, the more likely a corporation is able to meet its cash obligations and absorb unforeseen losses. For these reasons, capital adequacy has been, and will continue to be, of paramount importance.
Total Stockholders’ Equity was $41,442,000, at September 30, 2005 compared to $40,789,000, at December 31, 2004, an increase of $653,000 or 1.6%. Excluding accumulated other comprehensive income, stockholder’s equity increased $1,697,000, or 4.2%. In the first nine months, the Company had net income of $3,898,000 and declared dividends of $1,738,000 a dividend payout ratio of 44.6% of net income.
All of the Company’s investment securities are classified as available-for-sale making this portion of the Company’s balance sheet more sensitive to the changing market value of investments. Accumulated other comprehensive income decreased $1,044,000 compared to December 31, 2004 primarily as a result of interest rate movements and current year portfolio activity.
On June 17, 2005, the Company privately purchased 21,453 shares of stock from an individual shareholder. This had the effect of increasing treasury stock $463,000 during the year.
The Company has also complied with standards of well capitalized mandated by the banking regulators. The Company’s primary regulators have established “risk-based” capital requirements designed to measure capital adequacy. Risk-based capital ratios reflect the relative risks associated with various assets entities hold in their portfolios. A weight category of 0% (lowest risk assets), 20%, 50%, or 100% (highest risk assets), is assigned to each asset on the balance sheet. The Company’s computed risk-based capital ratios are as follows (dollars in thousands):
13
September 30, | December 31, | ||||||||||||
2005 | 2004 | ||||||||||||
Total capital (to risk-weighted assets) | Amount | Ratio | Amount | Ratio | |||||||||
Company | $ | 43,820 | 12.84 | % | $ | 42,156 | 12.86 | % | |||||
For capital adequacy purposes | 27,302 | 8.00 | % | 26,215 | 8.00 | % | |||||||
To be well capitalized | 34,128 | 10.00 | % | 32,768 | 10.00 | % | |||||||
Tier I capital (to risk-weighted assets) | |||||||||||||
Company | $ | 40,153 | 11.77 | % | $ | 38,236 | 11.67 | % | |||||
For capital adequacy purposes | 13,651 | 4.00 | % | 13,107 | 4.00 | % | |||||||
To be well capitalized | 20,477 | 6.00 | % | 19,661 | 6.00 | % | |||||||
Tier I capital (to average assets) | |||||||||||||
Company | $ | 40,153 | 8.03 | % | $ | 38,236 | 7.84 | % | |||||
For capital adequacy purposes | 20,001 | 4.00 | % | 19,504 | 4.00 | % | |||||||
To be well capitalized | 25,001 | 5.00 | % | 24,379 | 5.00 | % |
Off Balance Sheet Activities
Some financial instruments, such as loan commitments, credit lines, and letters of credit, are issued to meet customer financing needs. The contractual amount of financial instruments with off-balance sheet risk was as follows at September 30, 2005:
Commitments to extend credit | $ | 63,868 | ||
Standby letters of credit | 1,485 | |||
$ | 65,353 |
Results of Operations
Overview of the income Statement
The Company had net income of $1,318,000 and $3,898,000 for the third quarter and first nine months of 2005, respectively. Earnings per share, for the respective periods were $0.46 and $1.36. Net income was $1,423,000 and $4,383,000 for the third quarter and first nine months of 2004, which equates to earnings per share of $0.50 and $1.53, respectively. The annualized return on average assets and the return on average equity, for the first nine months of 2005, were 1.03% and 12.53%, respectively. Details outlining the results of operations are discussed on the following pages.
Net Interest Income
Net interest income, the most significant component of earnings, is the amount by which interest generated from earning assets exceeds interest expense on interest-bearing liabilities.
Net interest income, after provision for loan losses, totaled $4,437,000 in the third quarter, a decrease of $39,000 or .9%, compared to the third quarter of 2004 and totaled $13,168,000 for the first nine months of 2005, an increase of $254,000 or 2.0% over the prior year. The Bank experienced an increase in earning assets in the past twelve months of 6.0%, due to our continued efforts to grow our existing offices.
The following table sets forth the average balances of, and the interest earned or incurred on, each principal category of assets, liabilities and stockholders’ equity, the related rates, net interest income and rate “spread” created:
14
Analysis of Average Balances and Interest Rates (1) | ||||||||||
September 30, 2005 | September 30, 2004 | September 30, 2003 | ||||||||
Average | Average | Average | Average | Average | Average | |||||
Balance (1) | Interest | Rate | Balance (1) | Interest | Rate | Balance (1) | Interest | Rate | ||
(dollars in thousands) | $ | $ | % | $ | $ | % | $ | $ | % | |
ASSETS | ||||||||||
Short-term investments: | ||||||||||
Interest-bearing deposits at banks | $133 | $2 | 2.01 | $1,227 | $9 | 0.98 | $3,615 | $27 | 1.00 | |
Total short-term investments | 133 | 2 | 2.01 | 1,227 | 9 | 0.98 | 3,615 | 27 | 1.00 | |
Investment securities: | ||||||||||
Taxable | 84,808 | 2,432 | 3.82 | 98,668 | 2,864 | 3.87 | 82,572 | 2,774 | 4.48 | |
Tax-exempt (3) | 12,795 | 597 | 6.22 | 6,772 | 338 | 6.65 | 10,851 | 550 | 6.76 | |
Total investment securities | 97,603 | 3,029 | 4.14 | 105,440 | 3,202 | 4.05 | 93,423 | 3,324 | 4.74 | |
Loans: | ||||||||||
Residential mortgage loans | 200,203 | 10,249 | 6.84 | 190,899 | 9,949 | 6.97 | 179,926 | 9,855 | 7.32 | |
Commercial & farm loans | 117,033 | 6,148 | 7.02 | 93,648 | 4,767 | 6.81 | 76,503 | 4,354 | 7.61 | |
Loans to state & political subdivisions | 38,730 | 1,734 | 5.99 | 36,092 | 1,653 | 6.12 | 34,307 | 1,616 | 6.30 | |
Other loans | 12,507 | 822 | 8.79 | 12,330 | 827 | 8.97 | 12,692 | 867 | 9.13 | |
Loans, net of discount (2)(3)(4) | 368,473 | 18,953 | 6.88 | 332,969 | 17,196 | 6.90 | 303,428 | 16,692 | 7.36 | |
Total interest-earning assets | 466,209 | 21,984 | 6.30 | 439,636 | 20,407 | 6.21 | 400,466 | 20,043 | 6.69 | |
Cash and due from banks | 8,699 | 8,473 | 9,549 | |||||||
Bank premises and equipment | 12,085 | 10,927 | 11,048 | |||||||
Other assets | 18,693 | 18,283 | 14,754 | |||||||
Total non-interest earning assets | 39,477 | 37,683 | 35,351 | |||||||
Total assets | $505,686 | $477,319 | $435,817 | |||||||
LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||||
Interest-bearing liabilities: | ||||||||||
NOW accounts | $70,416 | 445 | 0.84 | $61,880 | 174 | 0.38 | $54,525 | 165 | 0.40 | |
Savings accounts | 40,279 | 85 | 0.28 | 39,323 | 83 | 0.28 | 35,963 | 98 | 0.36 | |
Money market accounts | 47,745 | 649 | 1.82 | 44,322 | 335 | 1.01 | 47,679 | 392 | 1.10 | |
Certificates of deposit | 213,469 | 5,661 | 3.55 | 208,811 | 5,489 | 3.51 | 203,954 | 5,850 | 3.83 | |
Total interest-bearing deposits | 371,909 | 6,840 | 2.46 | 354,336 | 6,081 | 2.29 | 342,121 | 6,505 | 2.54 | |
Other borrowed funds | 41,192 | 1,140 | 3.70 | 34,966 | 684 | 2.62 | 12,942 | 223 | 2.30 | |
Total interest-bearing liabilities | 413,101 | 7,980 | 2.58 | 389,302 | 6,765 | 2.33 | 355,063 | 6,728 | 2.53 | |
Demand deposits | 46,551 | 44,553 | 40,325 | |||||||
Other liabilities | 4,552 | 4,591 | 3,591 | |||||||
Total non-interest-bearing liabilities | 51,103 | 49,144 | 43,916 | |||||||
Stockholders' equity | 41,482 | 38,873 | 36,838 | |||||||
Total liabilities & stockholders' equity | $505,686 | $477,319 | $435,817 | |||||||
Net interest income | $14,004 | $13,642 | $13,315 | |||||||
Net interest spread (5) | 3.72% | 3.88% | 4.16% | |||||||
Net interest income as a percentage | ||||||||||
of average interest-earning assets | 4.02% | 4.15% | 4.45% | |||||||
Ratio of interest-earning assets | ||||||||||
to interest-bearing liabilities | 1.13 | 1.13 | 1.13 | |||||||
(1) Averages are based on daily averages. | ||||||||||
(2) Includes loan origination and commitment fees. | ||||||||||
(3) Tax exempt interest revenue is shown on a tax equivalent basis for proper comparison using | ||||||||||
a statutory federal income tax rate of 34%. | ||||||||||
(4) Income on non-accrual loans is accounted for on a cash basis, and the loan balances are included in interest-earning assets. | ||||||||||
(5) Interest rate spread represents the difference between the average rate earned on interest-earning assets | ||||||||||
and the average rate paid on interest-bearing liabilities. |
15
The following table represents the adjustment to convert net interest income to net interest on a fully taxable equivalent basis for the nine months ending September 30, 2005 and 2004:
For the Nine Months | |||||||
Ended September 30, | |||||||
2005 | 2004 | ||||||
Total interest income | $ | 21,178 | $ | 19,679 | |||
Total interest expense | 7,980 | 6,765 | |||||
Net interest income | 13,198 | 12,914 | |||||
Tax equivalent adjustment | 806 | 728 | |||||
Net interest income (fully taxable equivalent) | $ | 14,004 | $ | 13,642 |
Compared to the first nine months of 2004 and 2003, our net interest spread has decreased 16 and 44 basis points, respectively, primarily due to the flattening of the yield curve. The Federal Reserve has raised the Federal Funds Rate 300 basis points since last June 2004. During this same period, long-term interest rates have remained relatively stable. As a result, our cost of funds (interest paid on deposits and borrowings) has increased while the rates earned on interest earning assets have increased only moderately during the same time period. We continue to review various pricing, investment and funding strategies to improve the current interest margin, given the extended period of a flattened yield curve.
The following table shows the effect of changes in volume and rate on interest income and expense. Tax-exempt interest revenue is shown on a tax-equivalent basis for proper comparison using a statutory federal income tax rate of 34%:
2005 vs. 2004 (1) | 2004 vs. 2003 (1) | ||||||||||||||||||
Change in | Change | Total | Change in | Change | Total | ||||||||||||||
Volume | in Rate | Change | Volume | in Rate | Change | ||||||||||||||
Interest Income: | |||||||||||||||||||
Short-term investments: | |||||||||||||||||||
Interest-bearing deposits at banks | $ | (12 | ) | $ | 5 | $ | (7 | ) | $ | (17 | ) | $ | (1 | ) | $ | (18 | ) | ||
Investment securities: | |||||||||||||||||||
Taxable | (397 | ) | (35 | ) | (432 | ) | 497 | (407 | ) | 90 | |||||||||
Tax-exempt | 282 | (23 | ) | 259 | (204 | ) | (8 | ) | (212 | ) | |||||||||
Total investments | (115 | ) | (58 | ) | (173 | ) | 293 | (415 | ) | (122 | ) | ||||||||
Loans: | |||||||||||||||||||
Residential mortgage loans | 479 | (179 | ) | 300 | 585 | (491 | ) | 94 | |||||||||||
Commercial & farm loans | 1,234 | 147 | 1,381 | 906 | (493 | ) | 413 | ||||||||||||
Loans to state & political subdivisions | 119 | (38 | ) | 81 | 83 | (46 | ) | 37 | |||||||||||
Other loans | 11 | (16 | ) | (5 | ) | (23 | ) | (17 | ) | (40 | ) | ||||||||
Total loans, net of discount | 1,843 | (86 | ) | 1,757 | 1,551 | (1,047 | ) | 504 | |||||||||||
Total Interest Income | 1,716 | (139 | ) | 1,577 | 1,827 | (1,463 | ) | 364 | |||||||||||
Interest Expense: | |||||||||||||||||||
Interest-bearing deposits: | |||||||||||||||||||
NOW accounts | 20 | 251 | 271 | 21 | (12 | ) | 9 | ||||||||||||
Savings accounts | 2 | - | 2 | 9 | (24 | ) | (15 | ) | |||||||||||
Money Market accounts | 23 | 291 | 314 | (44 | ) | (13 | ) | (57 | ) | ||||||||||
Certificates of deposit | 124 | 48 | 172 | 137 | (498 | ) | (361 | ) | |||||||||||
Total interest-bearing deposits | 169 | 590 | 759 | 123 | (547 | ) | (424 | ) | |||||||||||
Other borrowed funds | 83 | 373 | 456 | 436 | 25 | 461 | |||||||||||||
Total interest expense | 252 | 963 | 1,215 | 559 | (522 | ) | 37 | ||||||||||||
Net interest income | $ | 1,464 | $ | (1,102 | ) | $ | 362 | $ | 1,268 | $ | (941 | ) | $ | 327 | |||||
(1) The portion of the total change attributable to both volume and rate changes during the year has been allocated | |||||||||||||||||||
to volume and rate components based upon the absolute dollar amount of the change in each component prior to allocation. |
16
As can be seen from the preceding tables, tax equivalent net interest income went from $13,315,000, in 2003, to $13,642,000 in 2004, and increased to $14,004,000 through September 2005. Our overall spread decreased from 3.88% on September 30, 2004 to 3.72% on September 30, 2005. The increased volume of interest-earning assets generated an increase in interest income of $1,716,000 while increased volume of interest-bearing liabilities produced $252,000 of interest expense, resulting in a net increase of $1,464,000 in net interest income. The net change in rate resulted in a negative $1,102,000 of net interest income. Combined, there was a net increase of $362,000. The yield on interest-earning assets increased 9 basis points from 6.21% to 6.30% and the average interest rate on interest-bearing liabilities increased 25 basis points, from 2.33% to 2.58%, because of the previously described flattening of the yield curve.
Provision For Loan Losses
The Company recorded a provision for loan losses for the three months and nine months ended September 30, 2005 of $30,000. This compares to $0 recorded to the provision for the comparable periods of 2004. Management's quarterly review of the allowance for loan losses is based on the following information: migration analysis of delinquent and non-accrual loans, estimated future losses on loans, recent review of large problem credits, local and national economic conditions, historical loss experience, OCC qualitative adjustments and peer comparisons.
Non-interest Income
Non-interest income, as detailed below, increased $78,000 or 6.8% for the three months ended and decreased $454,000 or 11.6% for the nine months ended September 30, 2005 when compared to the same periods in 2004.
Most of the year to date decrease is attributable to the lack of investment securities gains. Through the first nine months of 2005, we have not recognized any gains, primarily due to management’s decision to retain higher yielding investments with unrealized market gains. This compares to with $491,000 of gains realized through the first nine months of 2004. Service charge income continues to be the primary source of non-interest income. For the first nine months, account service charges totaled $2,203,000 compared to $2,265,000 last year. Most of this $62,000 decrease is attributable to the loss of several large customer accounts which had significant account fees as well as a decrease in non-sufficient funds fees charged to customers. While brokerage income is down $14,000 for the first nine months compared to last year, trust and insurance revenue is up $36,000 and $55,000, respectively.
For the three months ended September 30, 2005, non-interest income increased $78,000, or 6.8%. Most of this increase is due to a large estate settlement fee received during the third quarter of 2005.
The following tables show the breakdown of non-interest income for the three months and nine months ended September 30, 2005 and 2004(dollars in thousands):
17
Three months ended | |||||||||||||
September 30, | Change | ||||||||||||
2005 | 2004 | Amount | % | ||||||||||
Service charges | $ | 784 | $ | 783 | $ | 1 | 0.1 | ||||||
Trust | 161 | 86 | 75 | 87.2 | |||||||||
Brokerage | 45 | 40 | 5 | 12.5 | |||||||||
Insurance | 61 | 61 | - | - | |||||||||
Gains on loans sold | 24 | 17 | 7 | 41.2 | |||||||||
Investment securities gains, net | - | - | - | - | |||||||||
Earnings on bank owned life insurance | 71 | 75 | (4 | ) | (5.3 | ) | |||||||
Other | 85 | 91 | (6 | ) | (6.6 | ) | |||||||
Total | $ | 1,231 | $ | 1,153 | $ | 78 | 6.8 |
Nine months ended | |||||||||||||
September 30, | Change | ||||||||||||
2005 | 2004 | Amount | % | ||||||||||
Service charges | $ | 2,203 | $ | 2,265 | $ | (62 | ) | (2.7 | ) | ||||
Trust | 368 | 332 | 36 | 10.8 | |||||||||
Brokerage | 138 | 152 | (14 | ) | (9.2 | ) | |||||||
Insurance | 205 | 150 | 55 | 36.7 | |||||||||
Gains on loans sold | 45 | 37 | 8 | 21.6 | |||||||||
Investment securities gains, net | - | 491 | (491 | ) | (100.0 | ) | |||||||
Earnings on bank owned life insurance | 220 | 233 | (13 | ) | (5.6 | ) | |||||||
Other | 289 | 262 | 27 | 10.3 | |||||||||
Total | $ | 3,468 | $ | 3,922 | $ | (454 | ) | (11.6 | ) |
We continue to evaluate means of increasing non-interest income. Our approach is to apply service charges on business transaction accounts by charging fees on transaction activity, reduced by earnings credit based on customers' balances, to more equitably recover costs. We continue to analyze our schedule of fees based on competitive analyses and other opportunities to enhance non-interest income. Management is also focused on growing our trust and brokerage area through our approach to examine and develop a complete customer relationship.
Non-interest expense
Total non-interest expense, as detailed below, increased $41,000 or 1.1%, for the third quarter of 2005 and $381,000 or 3.4% in the first nine months of 2005 when compared to the same periods in 2004:
· | Salaries and benefits increased $211,000 or 3.7% for the nine months ended September 30, 2005 compared to last year. This is attributable primarily due to 2005 overall salary increases and a slight increase in full time equivalents. |
· | Occupancy expenses have increased $34,000 in 2005 due to additional expenses related to the Elmira Street building in Sayre purchased in July, 2004. Additionally, real estate taxes and general maintenance expenses have increased costs compared to last year. |
· | Amortization of intangibles has increased $72,000 for the nine months of 2005 due to an increase in the core deposit intangible related to the Legacy branch acquisition in June of 2004. |
· | Professional fees have decreased for the nine months ended September 30, 2005 compared to the comparable period last year due to the overall reduced level of consulting fees. |
· | Other expenses increased $125,000 in 2005 compared to the first nine months of 2004. This includes the loss on sale of assets of approximately $34,000, as well as decreased levels of reimbursement for loan appraisal and recording fees due to competitive loan pricing. |
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The following tables reflect the breakdown of non-interest expense and professional fees for the three months ended September 30, 2005 and 2004(dollars in thousands):
Three months ended | |||||||||||||
September 30, | Change | ||||||||||||
2005 | 2004 | Amount | % | ||||||||||
Salaries and employee benefits | $ | 1,993 | $ | 1,905 | $ | 88 | 4.6 | ||||||
Occupancy | 262 | 259 | 3 | 1.2 | |||||||||
Furniture and equipment | 156 | 181 | (25 | ) | (13.8 | ) | |||||||
Professional fees | 132 | 131 | 1 | 0.8 | |||||||||
Amortization of intangibles | 145 | 145 | - | - | |||||||||
Other | 1,133 | 1,159 | (26 | ) | (2.2 | ) | |||||||
Total | $ | 3,821 | $ | 3,780 | $ | 41 | 1.1 | ||||||
Three months ended | |||||||||||||
September 30, | Change | ||||||||||||
2005 | 2004 | Amount | % | ||||||||||
Other professional fees | $ | 73 | $ | 85 | $ | (12 | ) | (14.1 | ) | ||||
Legal fees | 23 | 10 | 13 | 130.0 | |||||||||
Examinations and audits | 36 | 36 | - | - | |||||||||
Total | $ | 132 | $ | 131 | $ | 1 | 0.8 |
The following tables reflect the breakdown of non-interest expense and professional fees for the nine months ended September 30, 2005 and 2004(dollars in thousands):
Nine months ended | |||||||||||||
September 30, | Change | ||||||||||||
2005 | 2004 | Amount | % | ||||||||||
Salaries and employee benefits | $ | 5,888 | $ | 5,677 | $ | 211 | 3.7 | ||||||
Occupancy | 846 | 812 | 34 | 4.2 | |||||||||
Furniture and equipment | 491 | 517 | (26 | ) | (5.0 | ) | |||||||
Professional fees | 408 | 443 | (35 | ) | (7.9 | ) | |||||||
Amortization of intangibles | 434 | 362 | 72 | 19.9 | |||||||||
Other | 3,439 | 3,314 | 125 | 3.8 | |||||||||
Total | $ | 11,506 | $ | 11,125 | $ | 381 | 3.4 | ||||||
Nine months ended | |||||||||||||
September 30, | Change | ||||||||||||
2005 | 2004 | Amount | % | ||||||||||
Other professional fees | $ | 223 | $ | 274 | $ | (51 | ) | (18.6 | ) | ||||
Legal fees | 72 | 60 | 12 | 20.0 | |||||||||
Examinations and audits | 113 | 109 | 4 | 3.7 | |||||||||
Total | $ | 408 | $ | 443 | $ | (35 | ) | (7.9 | ) |
PROVISION FOR INCOME TAXES
The provision for income taxes was $529,000 for the third quarter of 2005 compared to $426,000 in the third quarter of 2004. For the nine-month period comparisons, the provision for income taxes was $1,232,000 in 2005 and $1,328,000 in 2004. On a year to date basis, the effective tax rate is 24.0% compared to 23.3% last year. The increase is attributable to recording a valuation allowance of approximately $180,000 in the third quarter of 2005 recorded against deferred tax assets related to certain unrealized capital loss carrybacks that will not be utilized.
We had previously entered into two limited partnership agreements to establish low-income housing projects in our market area. We expect to recognize a total of approximately $1,296,000 of tax credits over a ten year period. For tax purposes, we have recognized $456,600 out of a total $911,000 from one project and $144,300 out of a total $385,000 on the second project. Additionally, we entered into a third limited partnership agreement for low-income housing in the second quarter of 2005, which we expect to recognize $492,900 in tax credits over a ten year period beginning in 2006.
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LIQUIDITY
Liquidity is a measure of our Company's ability to efficiently meet normal cash flow requirements of both borrowers and depositors. To maintain proper liquidity, we use funds management policies along with our investment policies to assure we can meet our financial obligations to depositors, credit customers and stockholders. Liquidity is needed to meet depositors' withdrawal demands, extend credit to meet borrowers' needs, provide funds for normal operating expenses and cash dividends, and fund other capital expenditures.
Our Company's historical activity in this area can be seen in the Consolidated Statement of Cash Flows from investing and financing activities.
Cash generated by operating activities, investing activities and financing activities influences liquidity management. The most important source of funds is the deposits that are primarily core deposits (deposits from customers with other relationships). Short-term debt from the Federal Home Loan Bank supplements our Company's availability of funds. Another source of short-term liquidity is the sale of loans if needed.
Our Company's use of funds is shown in the investing activity section of the Consolidated Statement of Cash Flows, where the net loan activity is presented. Other significant uses of funds include capital expenditures. Surplus funds are then invested in investment securities.
Capital expenditures during the first nine months of 2005 were $1,096,000 of which $927,000 is attributable to the purchase of property for possible future expansion. This compares to $2,126,000 for the same period in 2004 which was mainly due to the acquisition of the Elmira St. property in Sayre at a cost of $1,450,000.
Our Company achieves additional liquidity primarily from temporary or short-term investments in the Federal Home Loan Bank of Pittsburgh, PA, and investments that mature in less than one year. The Company also has a maximum borrowing capacity at the Federal Home Loan Bank of approximately $211 million as an additional source of liquidity.
Apart from those matters described above, management does not currently believe that there are any current trends, events or uncertainties that would have a material impact on capital.
CREDIT QUALITY RISK
The following table identifies amounts of loan losses and non-performing loans. Past due loans are those that were contractually past due 90 days or more as to interest or principal payments (dollars in thousands):
September 30, | December 31, | |||||||||||||||
2005 | 2004 | 2003 | 2002 | 2001 | ||||||||||||
Non-performing loans: | ||||||||||||||||
Non-accruing loans | $ | 723 | $ | 722 | $ | 578 | $ | 1,064 | $ | 985 | ||||||
Impaired loans | 1,069 | 1,061 | 1,926 | 1,916 | 1,077 | |||||||||||
Accrual loans - 90 days or | ||||||||||||||||
more past due | 386 | 437 | 185 | 39 | 111 | |||||||||||
Total non-performing loans | 2,178 | 2,220 | 2,689 | 3,019 | 2,173 | |||||||||||
Foreclosed assets held for sale | 679 | 712 | 305 | 221 | 408 | |||||||||||
Total non-performing assets | $ | 2,857 | $ | 2,932 | $ | 2,994 | $ | 3,240 | $ | 2,581 | ||||||
Non-performing loans as a percent of loans | ||||||||||||||||
net of unearned income | 0.58 | % | 0.62 | % | 0.85 | % | 1.01 | % | 0.80 | % | ||||||
Non-performing assets as a percent of loans | ||||||||||||||||
net of unearned income | 0.76 | % | 0.82 | % | 0.94 | % | 1.09 | % | 0.95 | % |
Interest does not accrue on non-accrual loans. Subsequent cash payments received are applied to the outstanding principal balance or recorded as interest income, depending upon management's assessment of its ultimate ability to collect principal and interest. Asset quality continues to improve as non-performing assets as a percent of loans decreased from .82% as of December 31, 2004 to .76% as of September 30, 2005.
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INTEREST RATE AND MARKET RISK MANAGEMENT
The objective of interest rate sensitivity management is to maintain an appropriate balance between the stable growth of income and the risks associated with maximizing income through interest sensitivity imbalances and the market value risk of assets and liabilities.
Because of the nature of our operations, we are not subject to foreign currency exchange or commodity price risk and, since our Company has no trading portfolio, it is not subject to trading risk.
Currently, our Company has equity securities that represent only 3.0% of our investment portfolio and, therefore, equity risk is not significant.
The primary components of interest-sensitive assets include adjustable-rate loans and investments, loan repayments, investment maturities and money market investments. The primary components of interest-sensitive liabilities include maturing certificates of deposit, IRA certificates of deposit and short-term borrowings. Savings deposits, NOW accounts and money market investor accounts are considered core deposits and are not short-term interest sensitive (except for the top-tier money market investor accounts which are paid current market interest rates).
Gap analysis, one of the methods used by us to analyze interest rate risk, does not necessarily show the precise impact of specific interest rate movements on our Company's net interest income because the re-pricing of certain assets and liabilities is discretionary and is subject to competitive and other pressures. In addition, assets and liabilities within the same period may, in fact, be repaid at different times and at different rate levels. We have not experienced the kind of earnings volatility that might be indicated from gap analysis.
As such, our Company currently uses a computer simulation model to better measure the impact of interest rate changes on net interest income. We use the model as part of our risk management process that will effectively identify, measure, and monitor our Company's risk exposure. We use numerous interest rate simulations employing a variety of assumptions to evaluate our interest rate risk exposure. A shock analysis during the third quarter of 2005 indicated that a 200 basis point movement in interest rates in either direction would have a minor impact on our Company's anticipated net interest income over the next twenty-four months, well within our policy limits and ability to manage effectively. Various assumptions, including a flattened yield curve, were utilized resulting in a more realistic interest rate scenario in order to assess risks.
GENERAL
The majority of assets and liabilities of a financial institution are monetary in nature and, therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. However, inflation does have an important impact on the growth of total assets and on non-interest expenses, which tend to rise during periods of general inflation. The action by the Federal Reserve of increasing short-term interest rates will help ensure that the level of inflation remains at a relatively low level.
From time to time various pieces of legislation have been proposed and passed that have had an impact on the Company and its operations. Currently, the Pennsylvania General Assembly is addressing property tax reform. These proposals, although not clearly defined, would expand sales and use taxes on financial services, including bank fees, and would increase the Company’s compliance burden as well as increase costs on obtaining accounting and legal services.
Aside from those matters described above, we do not believe that there are any trends, events or uncertainties, which would have a material adverse impact on future operating results, liquidity or capital resources. We are not aware of any current recommendations by the regulatory authorities (except as described herein) which, if they were to be implemented, would have such an effect, although the general cost of compliance with numerous and multiple federal and state laws and regulations does have, and in the future may have, a negative impact on our Company's results of operations.
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Item 3-Quantitative and Qualitative Disclosure About Market Risk
In the normal course of conducting business activities, the Company is exposed to market risk, principally interest rate risk, through the operations of its banking subsidiary. Interest rate risk arises from market driven fluctuations in interest rates that affect cash flows, income, expense and values of financial instruments and was discussed previously in this Form 10-Q. Management and a committee of the board of directors manage interest rate risk.
No material changes in market risk strategy occurred during the current period. A detailed discussion of market risk is provided in the SEC Form 10-K for the period ended December 31, 2004.
Item 4-Control and Procedures
We maintain a system of controls and procedures designed to provide reasonable assurance as to the reliability of the financial statements and other disclosures included in this report, as well as to safeguard assets from unauthorized use or disposition. We evaluated the effectiveness of the design and operation of our disclosure controls and procedures under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, within 90 days prior to the filing date of this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic Securities and Exchange Commission filings. No significant changes were made to our internal controls or other factors that could significantly affect these controls subsequent to the date of their evaluation.
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PART II - OTHER INFORMATION AND SIGNATURES
Item 1 - Legal Proceedings
Management is not aware of any legal proceeding, which exceeds 10% of the current assets of the Company and its subsidiaries on a consolidated basis. In addition, management may from time to time be engaged in routine legal proceedings occurring in the ordinary course of business. Such routine legal proceedings, in the aggregate, are believed by management to be immaterial to the Company's financial condition and results of operations. Furthermore, management is not aware of any pending or contemplated proceedings by governmental authorities.
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
On June 17, 2005, the Company privately purchased 21,453 shares of stock from an individual. Through September 30, 2005, 118,715 shares out of a total of 135,000 shares approved have been purchased.
Item 3 - Defaults Upon Senior Securities
Not applicable.
Item 4 - Submission of Matters to a Vote of Security Holders
None
Item 5 - Other Information
None
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Item 6 - Exhibits and Reports on Form 8-K.
(a) Exhibits. |
(3)(i) - Articles of Incorporation of the Corporation, as amended. (Incorporated by Reference to Exhibit (3)(ii) to the Quarterly Report of Form 10-Q for the period ended December 31, 1999, as filed with the Commission on May 11,2000.) |
(3)(ii)- By-laws of the Corporation, (Incorporated by Reference to Exhibit (3)(ii) to the Quarterly Report of Form 10-Q for the period ended March 31, 2005, as filed with the Commission on May 5,2005.) |
(4) - Instruments Defining the Rights of Stockholders. (Incorporated by reference to the Registrant's Registration Statement No.2-89103 on Form S-14, as filed with the Commission on February 17, 1984.) |
(10.1) - Material Contracts. Consulting and Non-Compete Agreement with Richard E. Wilber, Former Executive Officer of our company. (Incorporated by Reference to Exhibit (10) to the Annual Report of Form 10-K for the fiscal year ended December 31, 2003, as filed with the Commission on March 18, 2004.) |
(10.2) - Directors’ Deferred Compensation Plan (Incorporated by Reference to Exhibit (10.2) to the Annual Report of Form 10-K for the fiscal year ended December 31, 2004, as filed with the Commission on March 15, 2005.) |
(10.3) - Directors’ Life Insurance Program (Incorporated by Reference to Exhibit (10.3) to the Annual Report of Form 10-K for the fiscal year ended December 31, 2004, as filed with the Commission on March 15, 2005.) |
(31.1) - 302 Certification of Principal Executive Officer |
(31.2) - 302 Certification of Principal Accounting Officer |
(32.1) - Certification of Principal Executive Officer |
(32.2) - Certification of Principal Accounting Officer |
(99.1) - Independent registered public accounting firm’s review of financial statements for the period ended September 30, 2005. |
(b) Reports on Form 8-K - Press release dated August 26, 2005 issued by Citizens Financial Services, Inc. titled “Citizens Financial Announces New York Branch Acquisition” filed August 26, 2005. Press release dated September 13, 2005 titled “Citizens Financial Amends Purchase and Assumption Agreement Related to the Previously Announced New York Branch Acquisition” filed September 13, 2005. Press release dated September 21, 2005 titled “First Citizens National Bank Enters the New York State Market” filed September 22, 2005. Press release dated October 26, 2005 titled “Citizens Financial Services, Inc. Reports Third Quarter Earnings” filed October 26, 2005. |
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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the undersigned Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
Citizens Financial Services, Inc.
(Registrant)
November 9, 2005 /s/ Randall E. Black
By: Randall E. Black
President and Chief Executive Officer
(Principal Executive Officer)
November 9, 2005 /s/ Mickey L. Jones
By: Mickey L. Jones
Chief Financial Officer
(Principal Accounting Officer)
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