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 March 31, 1996 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 of other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 15 South Main Street, Mansfield, Pennsylvania 16933 (Address of principal executive offices ) (Zip Code) Registrant's telephone number, including area code: (717) 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_____ The number of shares outstanding of the Registrant's Common Stock, as of May 1, 1996, 1,347,323 shares of Common Stock, par value $1.00. Citizens Financial Services, Inc. Form 10-Q INDEX Page Part I FINANCIAL INFORMATION (UNAUDITED) Item 1-Financial Statements Consolidated Balance Sheet as of March 31, 1996 and December 31, 1995 1 Consolidated Statement of Income for the Three Months Ended March 31, 1996 and 1995 2 Consolidated Statement of Cash Flows for the Three months Ended March 31, 1996 and 1995 3 Notes to Consolidated Financial Statements 4 Item 2-Management's Discussion and Analysis of Financial Condition and Results of Operations 4-11 Part II OTHER INFORMATION AND SIGNATURES Item 1-Legal Proceedings 12 Item 2-Changes in Securities 12 Item 3-Defaults upon Senior Securities 12 Item 4-Submission of Matters to a Vote of Security Holders 12 Item 5-Other Information 12 Item 6-Exhibits and Reports on Form 8-K 12 Signatures 13 CITIZENS FINANCIAL SERVICES, INC. CONSOLIDATED BALANCE SHEET (UNAUDITED) March 31, December 31, 1996 1995 ASSETS: Cash and due from banks: Noninterest-bearing $ 5,442,663 $ 5,535,712 Interest-bearing 2,030,934 36,949 Total cash and cash equivalents 7,473,597 5,572,661 Available-for-sale securities 22,171,582 21,444,353 Held-to-maturity securities (estimated market value 1996,$52,462,000; December 31, 1995, $53,539,000) 52,075,609 52,271,151 Loans (net of allowance for possible loan losses 1996, $1,879,509; December 31, 1995, $1,833,115) 159,780,130 159,793,794 Foreclosed assets held for sale 151,674 207,959 Premises and equipment 4,132,523 4,175,459 Accrued interest receivable and other assets 4,047,746 3,629,072 TOTAL ASSETS $249,832,861 $247,094,449 LIABILITIES: Deposits: Noninterest-bearing $ 16,033,672 $ 15,140,360 Interest-bearing 201,859,329 198,175,933 Total deposits 217,893,001 213,316,293 Borrowed funds 7,148,757 8,855,044 Accrued interest payable 1,591,934 2,106,036 Dividends payable 0 579,349 Other liabilities 1,393,713 940,461 TOTAL LIABILITIES 228,027,405 225,797,183 STOCKHOLDERS' EQUITY: Common Stock $1.00 par value; authorized 5,000,000 shares; issued and outstanding 1,347,323 shares 1,347,323 1,347,323 Additional paid-in capital 6,512,129 6,512,129 Retained earnings 13,814,334 13,089,281 TOTAL 21,673,786 20,948,733 Unrealized holding gains on available-for-sale securities 131,670 348,533 TOTAL STOCKHOLDERS' EQUITY 21,805,456 21,297,266 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $249,832,861 $247,094,449 The accompanying notes are an integral part of these financial statements. 1 CITIZENS FINANCIAL SERVICES, INC. CONSOLIDATED STATEMENT OF INCOME (UNAUDITED) Three Months Ended March 31, 1996 1995 INTEREST INCOME: Interest and fees on loans $3,791,274 $3,551,640 Interest on interest-bearing deposits with banks 36,816 495 Interest and dividends on investments: Taxable 1,140,013 1,005,650 Nontaxable 19,442 52,425 Dividends 17,306 17,165 Total interest and dividends on investments 1,176,761 1,075,240 TOTAL INTEREST INCOME 5,004,851 4,627,375 INTEREST EXPENSE: Interest on deposits 2,414,438 2,109,416 Interest on borrowed funds 113,678 203,737 TOTAL INTEREST EXPENSE 2,528,116 2,313,153 NET INTEREST INCOME 2,476,735 2,314,222 Provision for possible loan losses 47,500 50,000 NET INTEREST INCOME AFTER PROVISION FOR POSSIBLE LOAN LOSSES 2,429,235 2,264,222 OTHER OPERATING INCOME: Service charge income 179,802 163,339 Trust income 68,268 76,542 Other income 53,494 48,340 Realized securities gains, net 19,264 4,700 TOTAL OTHER OPERATING INCOME 320,828 292,921 OTHER OPERATING EXPENSES: Salaries and employee benefits 806,788 807,990 Occupancy expenses 113,955 108,250 Furniture and equipment expenses 136,209 139,747 FDIC insurance expense 29,929 110,849 Other expenses 586,339 542,094 TOTAL OTHER OPERATING EXPENSES 1,673,220 1,708,930 Income before provision for income taxes 1,076,843 848,213 Provision for income taxes 351,789 240,000 NET INCOME $ 725,054 $ 608,213 Earnings per share $0.54 $0.45 Cash dividend declared $0.00 $0.00 Weighted average number of shares outstanding 1,347,323 1,347,323 The accompanying notes are an integral part of these financial statements. 2 CITIZENS FINANCIAL SERVICES, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) Three months Ended March 31, CASH FLOWS FROM OPERATING ACTIVITIES: 1996 1995 Net income $ 725,054 $ 608,213 Adjustments to reconcile net income to net cash provided by operating activities: Provision for possible loan losses 47,500 50,000 Provision for depreciation 92,100 107,388 Amortization and accretion of investment securities 75,971 55,609 Deferred income taxes 28,449 (8,229) Realized gains on securities (19,264) (4,700) Realized gains on loans sold (435) (2,155) Gain on sale of foreclosed assets held for sale (10,315) 0 Increase in accrued interest receivable and other assets (335,405) (323,149) (Decrease) increase in accrued interest payable and other liabilities (60,851) 59,531 Net cash provided by operating activities 542,804 542,508 CASH FLOWS FROM INVESTING ACTIVITIES: Available-for-sale securities: Proceeds from sales of securities 16,047 0 Proceeds from maturity of securities 0 0 Purchase of securities (1,080,625) 0 Held-to-maturity securities: Proceeds from maturity and principal repayments of securities 2,316,040 941,068 Purchase of securities (2,168,438) (40,700) Net increase in loans (33,401) (443,615) Capital expenditures (49,163) (48,865) Proceeds from sales of premises and equipment 0 0 Proceeds from sale of foreclosed assets held for sale 66,600 0 Net cash (used by) provided by investing activities (922,940) 407,888 CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposits 4,576,708 6,259,934 Proceeds from long-term borrowings 79,200 440,358 Repayments of long-term borrowings (42,705) (75,369) Net decrease in short-term borrowed funds (1,742,782) (7,223,602) Dividends paid (579,349) (547,163) Net cash provided by (used by) financing activities 2,291,072 (1,145,842) Net increase (decrease) in cash and cash equivalents 1,900,936 (195,446) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 5,572,661 5,511,300 CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 7,473,597 $ 5,315,854 The accompanying notes are an integral part of these financial statements. 3 CITIZENS FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1 - Basis of Presentation The consolidated financial statements include the accounts of Citizens Financial Services, Inc. and its wholly-owned subsidiary, First Citizens National Bank (the "Bank"), (collectively, the "Company"). All material intercompany balances and transactions have been eliminated in consolidation. The accompanying interim financial statements have been prepared by the Company without audit and, in the opinion of management, reflect all adjustments (which include only normal recurring adjustments) necessary to present fairly the Company's financial position as of March 31, 1996, and the results of operations for the interim periods presented. 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. Actual results could differ significantly from those estimates. For further information refer to the consolidated financial statements and footnotes thereto incorporated by reference in the Company's Annual Report on Form 10-K for the year ended December 31, 1995. Information contained herein should be read in conjunction with the Form 10-K for the year ended December 31, 1995. The results of operations for the three months ended March 31, 1996 and 1995 are not necessarily indicative of the results to be expected for the full year. Note 2 - Earnings per Share Earnings per share calculations give retroactive effect to stock dividends declared by the Company. The number of shares used in the earnings per share and dividends per share calculation was 1,347,323 for 1996 and 1995. Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is management's discussion and analysis of certain significant factors which have affected the Company's financial position and operating results during the periods indicated in the accompanying consolidated financial statements. Financial Condition For the three month period ended March 31, 1996, the assets of the Company have increased by $2.7 million or 1.1% versus a decrease of $.3 million for the same period in 1995. Cash and cash equivalents increased $1.9 million in 1996 compared to a decrease of $.2 million for the same period in 1995. Total security investments increased $.5 million in 1996 compared to an increase of $5.1 million for the same period in 1995. During the first three months of 1996, securities totaling $2.3 million matured. During the same period $3.2 million U. S Treasury securities were purchased with maturities of five years ($2.1 million classified as held-to-maturity and $1.1 million as available-for-sale). Net loan balances remained the same for the current period as compared to a slight increase of $.3 million increase for the first three months of 1995. Lower loan demand continues to be the primary reason for the stagnant loan growth. The Bank's mortgage loan growth was lower during 1995 because of less demand in our local market area. The primary concentration of loans continues to be in residential real estate-consisting of loans to purchase and improve real estate, debt consolidation and home equity lines of credit. 4 During the remainder of 1996, management expects that loan demand will improve as the result of the attractive interest rates the Bank is currently promoting. The Bank also expects to be successful in lending to local state and political subdivisions during the first half of 1996. The loan portfolio consists of the following (in thousands): March 31, December 31, March 31, 1996 1995 1995 Real estate loans - residential $ 97,177 $ 97,612 $ 97,522 Real estate loans - commercial 24,607 24,167 22,729 Real estate loans - agricultural 7,525 8,027 7,020 Loans to individuals for household, family and other purchases 13,425 13,198 12,430 Commercial and other loans 11,024 10,535 10,220 State and political subdivision loans 8,122 8,347 7,500 Total 161,880 161,886 157,421 Less: unearned income on loans 220 259 490 Loans, net of unearned income $161,660 $161,627 $156,931 Deposit growth continues to be strong increasing by $4.6 million or 9% following an increase of $6.3 million during the first three months of 1995 as the result of competitive pricing of certificates of deposit. During 1995, as the result of a nearly flat yield curve, the Company priced its certificates of deposit competitively resulting in the interest cost of certificates of deposit to remain high while the interest rate paid on interest-bearing transaction and savings accounts declined. The Company has experienced a decline of net interest income as the result of declining spreads. Recently, however, long-term rates have begun to rise resulting in a more normal (steeper) yield curve. Management expects to be able to continue to attract deposits at a reasonable interest cost during 1996. Borrowed funds decreased by a repayment of $1.7 million during the first three months of 1996 (made possible by the deposit growth discussed above) compared to a decrease of $6.9 million in 1995. This decrease was the result of a repayment of the short-term borrowing from the Federal Home Loan Bank. The Company's daily cash requirements or short-term investments are now being met by using the financial instruments available through the Federal Home Loan Bank rather than using federal funds market. The modest increase in loan demand as well as a significant increase in deposits for this period resulted in the elimination of short term borrowings. Capital The Company has computed its risk-based capital ratios as follows (dollars in thousands): March 31, December 31, 1996 1995 Tier I - Total stockholders' equity $ 21,806 $ 21,297 Less: Unrealized holding gains (losses) on available-for-sale securities 132 349 Tier I, net 21,674 20,948 Tier II - Allowance for loan losses(1) 1,722 1,719 Total qualifying capital $ 23,396 $ 22,667 Risk-adjusted on-balance sheet assets $131,147 $131,247 Risk-adjusted off-balance sheet exposure (2) 6,607 6,242 Total risk-adjusted assets $137,754 $137,489 5 March 31, December 31, Ratios: 1996 1995 Tier I risk-based capital ratio 15.7% 15.2% Federal minimum required 4.0 4.0 Total risk-based capital ratio 17.0% 16.5% Federal minimum required 8.0 8.0 Leverage ratio (3) 8.8% 8.7% Federal minimum required 4.0 4.0 (1) Allowance for loan losses is limited to 1.25% of total risk-adjusted assets. (2) Off-balance sheet exposure is caused primarily by standby letters of credit and loan commitments with a remaining maturity exceeding one year. These obligations have been converted to on-balance sheet credit equivalent amounts and adjusted for risk. (3) Tier I capital divided by average total assets. Management does not anticipate that any of the equipment purchase discussed below will have a material negative impact on stockholder's equity during 1996. Results of Operations Net income for the three month period ending March 31, 1996 was $725,000 an increase of $117,000 over the 1995 related period, an increase of 19.2%. Earnings per share was $.54 during the first three months of 1996 compared to $.45 during the 1995 period. Net interest income, the most significant component of earnings, is the amount by which interest generated from earning assets exceeds interest expense on liabilities. Net interest income for the 1996 period, after provision for possible loan losses, was $2,429,000 an increase of $165,000 or 7.3% compared to an increase of $88,000 or 4% during the same time period in 1995. 6 Analysis of Average Balances and Interest Rates (1) March 31 March 31, 1996 1995 Average Average Average Average Balance Interest Rate Balance Interest Rate $ $ % $ $ % ASSETS Short-term investments: Interest-bearing deposits in other banks 2,743 37 5.43 36 1 5.59 Total short-term investments 2,743 37 5.43 36 1 5.59 Investment securities: Taxable 71,192 1,157 6.54 61,644 1,023 6.73 Tax-exempt (3) 931 29 12.53 2,533 79 12.61 Total investments 72,123 1,186 6.61 64,177 1,102 6.96 Loans: Residential mortgage loans 97,206 2,251 9.31 97,275 2,193 9.14 Commercial and farm loans 41,017 1,012 9.92 38,055 911 9.71 Loans to State & Political Subdivisions 8,267 181 8.81 7,368 155 8.55 Other loans 14,161 395 11.22 14,066 399 9.76 Loans-net of discount (2)(3)(4) 160,651 3,839 9.61 156,764 3,598 9.31 Total interest-earning assets 235,517 5,062 8.64 220,977 4,701 8.63 Cash and due for banks 4,991 4,825 Bank premises and equipment 4,162 4,115 Available-for-sale securities adjustment 482 (370) Other assets 3,312 2,875 Total non-interest bearing assets 12,947 11,445 Total assets 248,464 232,422 LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: NOW accounts 24,255 126 2.09 23,788 148 2.52 Savings accounts 25,919 144 2.23 25,957 170 2.66 Money Market accounts 24,288 267 4.44 21,302 248 4.72 Certificates of deposit 126,476 1,877 5.97 111,982 1,545 5.60 Total interest-bearing deposits 200,938 2,414 4.83 183,029 2,111 4.68 Other borrowed funds 7,284 114 6.29 13,422 203 6.13 Total interest-bearing liabilities 208,222 2,528 4.88 196,451 2,314 4.78 Demand deposits 15,178 14,150 Other liabilities 3,513 2,489 Total non-interest-bearing liabilities 18,691 16,639 Stockholders' equity 21,551 19,332 Total liabilities and stockholders' equity 248,464 232,422 Net interest income 2,534 2,387 Net interest spread (5) 3.76 3.85 Net interest income as a percentage of average interest-earning assets 4.33 4.38 Ratio of interest-earning assets to interest-bearing liabilities 1.13 1.12 (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. 7 The yield on earning assets, on a tax-equivalent basis, was nearly unchanged 8.64% and 8.63% in the first three months of 1996 and 1995, respectively. The cost of funds was 4.88% and 4.78%, in the first three months of 1996 and 1995, respectively, as the cost of funds increased 10 basis points. During the first three months of 1996, the interest rate on money market accounts declined by 30 basis points, however, the interest rate on certificates of deposit increased by 37 basis points and continued to be most effected by the upward pressure in interest rates. This trend reflects the significant increase in interest rates that occurred during 1994. The decline in market interest rates during 1995 did not reduce this pressure on interest margin and is reflected in the net interest spread decline of 5 basis points during the current period. As described above, the Company has continued to experience a slight narrowing of it's margin during the three months of 1996. The Company continues to review various pricing strategies to enhance deposit growth while maintaining or expanding the current interest margin. Provision for possible loan losses decreased $2,500 to $47,500 in 1996, compared to a provision of $50,000 in the same three month period of 1995. This decrease was appropriate given management's quarterly review of the allowance for loan and lease losses which 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 economic conditions, historical loss experience, OCC qualitative adjustments and peer comparisons. Total other operating income increased by $28,000 compared to the same period in 1995. Trust income was down $8,000, service charge income was up $16,000, and other income was up $5,000 as was realized securities gains of $15,000 resulting for the sale of some stock of Federal Home Loan Mortgage Corporation. Total other operating expense was $1,673,000 in the first three months of 1996 which reflected a decrease of $36,000 or 2% over the 1995 period. Salaries and benefits expense was virtually unchanged for the current three month period reflecting normal merit increases offset by a reduction of full time equivalent employees(FTE). FTEs were reduced as a result of the operational efficiencies created from electronic check imaging. Occupancy expense increased by $6,000 or 5.3% and furniture and equipment expenses decreased 2.5% or $4,000. Federal Deposit Insurance Corporation(FDIC) insurance expense decreased $81,000 or 73% during the first three months of 1995. The Company currently is paying the minimum FDIC premium, however, the premium may increase in the future. Other expenses increased $44,000 or 8.2% in the first three months of 1996 over the 1995 related period representing an increase in marketing costs, other professional fees, printing expenses offset by reductions in postage (as result of the implementation of check imaging). The Company currently pays a premium to the FDIC for the Savings Association Insurance Fund (SAIF) as a result of the deposits obtained with the acquisition of Star Savings and Loan Association. Congress is currently evaluating proposals to recapitalize SAIF and, although it appears that no agreement will be reached between the House and Senate regarding recapitalization of the SAIF fund, the Company, as well as other financial institutions with SAIF deposits may be required, in the future, to pay a one-time special assessment that could approximate 85 basis points of SAIF deposits held or ($463,000). The special assessment, should it occur, will adversely effect earnings and liquidity. The provision for income taxes was $352,000 during the first three months of 1996 compared to $240,000 during the 1995 related period. Income before taxes increased $229,000 in the 1996 period as compared to the same time period in 1995. Liquidity Liquidity is a measure of the Company's ability to efficiently meet normal cash flow requirements of both borrowers and depositors. In order to maintain proper liquidity, the Company uses funds management policies along with its investment policies to assure it can meet its financial obligations to depositors, credit customers and shareholders. Liquidity is needed to meet depositors' withdrawal demands, extend credit to meet borrowers' needs, provide funds for normal operating expenses and cash dividends, as well as fund other capital expenditures. 8 Funds received from increase deposits (primarily certificates of deposit) were used to reduce the short-term borrowings at the Federal Home Loan Bank. The remaining funds were then used to invest in securities there being little increase in loans. Management projected that capital expenditures for 1996 would increase approximately $100,000 for repairs and improvements to branches and capital expenditures to keep pace with current technology needs. During the first three months of 1996 $49,000 was expended, the same as the capital acquisitions during 1995. Management is currently renting two properties as a temporary solution to the space limitations it has experienced at the main office. Efforts are continuing to evaluate various long term alternative solutions. Liquidity is achieved primarily by having temporary or short-term investments in the Federal Home Loan Bank of Pittsburgh, PA, federal funds sold and investments which mature in a relatively short time period (maturities under one year). The Company also maintains a credit line of approximately $8.5 million (currently with no balance) with the Federal Home Loan Bank as an additional source of liquidity. 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. An asset or liability is considered to be interest-sensitive if the rate it yields or bears is subject to change within a predetermined time period. If interest-sensitive assets exceeds interest-sensitive liabilities during a prescribed time period, a positive gap results. Conversely, when interest- sensitive liabilities exceeds interest-sensitive assets during a time period, a negative gap results. A positive gap tends to indicate that earnings will be impacted favorably if interest rates rise during the period and negatively when interest rates fall during the time period. A negative gap tends to indicate that earnings will be effected inversely to interest rate changes. In other words, as interest rates fall, a negative gap should tend to produce a positive effect on earnings and when interest rates rise, a negative gap should tend to affect earnings negatively. 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 (individuals over 59 1/2 have the option to change), money market deposits, savings deposits, N.O.W. accounts and short-term borrowing. The Company's six to twelve-month asset/liability position at March 31, 1996, was again liability sensitive, with a negative dollar gap of $7.7 million or .93 (at December 31, 1995 the Company's liability sensitivity was a negative $9.8 million or .91). Management was able to move to within its policy range (positive 1.25 to negative .75) by the selection and pricing of assets and liabilities acquired. Gap analysis does not necessarily indicate the precise impact of specific interest rate movements on the Company's net interest income because the repricing 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, reprice at different times and at different rate levels. Another method used by the Company to measure the impact of interest rate changes on net interest income is to simulate the potential effects of changing interest rates through computer modeling. The Company is then able to evaluate strategies which would include an acceleration of a deposit rate reduction or rate increase and the related repricing strategies for loans. 9 Credit Quality Risk The following table identifies amounts of loan losses and non-performing loans. Past due loans are those which were contractually past due 90 days or more as to interest or principal payments (dollars in thousands). March 31, December 31, 1996 1995 1994 1993 1992 Nonaccruing loans $ 814 $ 763 $ 1,557 $ 1,566 $ 689 Impaired loans 696 696 Accrual loans - 90 days or more past due 366 689 267 418 439 Total non-performing loans $ 1,876 $ 2,148 $ 1,824 $ 1,984 $ 1,128 Other real estate owned $ 152 $ 208 $ 168 $ 231 $ 330 Loans outstanding at end of period $161,880 $161,886 $157,144 $143,218 $132,033 Unearned income 220 259 575 1,311 2,506 Loans, net of unearned income $161,660 $161,627 $156,569 $141,907 $129,527 Non-performing loans as percent of loans, net of unearned income 1.16% 1.33% 1.17% 1.40% .87% Total nonperforming assets as a percent loans of net unearned income 1.25% 1.46% 1.27% 1.56% 1.13% Transactions in the allowance for possible loan losses were as follows (in thousands): At March 31, Years Ended December 31, 1996 1995 1994 1993 1992 Balance, beginning of period $1,833 $1,721 $1,516 $1,201 $ 996 Charge-offs (8) (69) (68) (71) (151) Recoveries 7 18 18 71 32 Provision for loan losses 48 163 255 315 324 Balance, end of period $1,880 $1,833 $1,721 $1,516 $1,201 The allowance is maintained at a level to absorb potential future loan losses. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. Management's basis for the level of the allowance and the quarterly provision is its evaluation of the loan portfolio, current and projected economic conditions, the historical loan loss experience, present and prospective financial condition of the borrowers, the level of non-performing assets, and other relevant factors. While management evaluates all of this information quarterly, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, various regulatory agencies, as an integral part of their examination process, review the Company's allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their evaluation of information available to them at the time of their examination. Based on this process, management currently believes that the allowance is adequate to offset any exposure that may exist for under-collateralized or uncollectible loans. The Company has two loans as of March 31, 1996 that it considers impaired. Management believes that the liquidation of the collateral would exceed principal, plus interest and fees, thus no allowance reserve is required. Management continues to monitor the impaired loans and will liquidate the collateral as soon as legal constraints are past. The Company does not accrue interest income on impaired loans and subsequent cash payments received are applied to the outstanding principal balance or recorded as interest income, depending upon management's assessment of it's ultimate ability to collect principal and interest. 10 Branch Acquisition On April 20, 1996, the Bank purchased two branch offices of Meridian Bank of Pennsylvania (Canton and Gillett) comprising approximately $16.5 million of deposit liabilities; $3.5 million of loans and other assets. In consideration for the assumption of the deposit liabilities the Bank paid a premium of approximately $1 million. Loans were priced at fair value plus accrued but unpaid interest. Management believes that after a modest negative impact on earnings for 1996, a positive impact on future earning is expected from the acquisition. The branch acquisition has had a net positive impact to liquidity by the addition of deposits from the proceeds of the settlement discussed above. General In May of 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 122, "Accounting for Mortgage Servicing Rights," an amendment of SFAS No. 65. This Statement, which is required to be adopted during the first quarter of 1996, allows enterprises engaging in mortgage banking activities to recognize as separate assets rights to service mortgage loans for loans originated for sale by the enterprise. As the Company does not significantly engage in the sale of mortgage loans, the impact of this Statement has not had a material impact on the Company's results of operations or financial position. Various congressional bills have been passed and other proposals have been made for significant changes to the banking system, including provisions for: recapitalization by the FDIC of the SAIF as discussed previously; limitations on deposit insurance coverage; changing the timing and method financial institutions use to pay for deposit insurance; expanding the power of banks by removing restrictions on bank underwriting activities; tightening the regulation of bank derivatives activities; allowing commercial enterprises to own banks; and permitting bank holding companies or the bank to own or control affiliates that engage in securities, mutual funds and insurance activities. Except as previously discussed in the section on result of operations, management believes that the effect of the provisions of this legislation on liquidity, capital resources, and the results of operations of the company will not be material. Aside from those matters described above, management does not currently believe that there are any trends or uncertainties which would have a material impact on future operating results, liquidity or capital resources nor is it aware of any current recommendations by the regulatory authorities 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 the company's results of operations. 11 PART II - OTHER INFORMATION AND SIGNATURES Item 1 - Legal Proceedings Management is not aware of any litigation that would have a material adverse effect on the consolidated financial position of the Company. Any pending proceedings are ordinary, routine litigation incidental to the business of the Company and its subsidiary. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Company and its subsidiary by government authorities. Item 2 - Changes in Securities - Nothing to report. Item 3 - Defaults Upon Senior Securities - Nothing to report. Item 4 - Submission of Matters to a Vote of Security Holders: Results of the voting at the Annual Meeting of Shareholders April 16, 1996 held at 12:00 p.m. at the Tioga County Fairgrounds Youth Building, Whitneyville, Pennsylvania, 16901: 1. Election of Class 1 Directors whose term will expire in 1999 For Withhold Authority Carol J. Bond 914,384 22,553 R. Lowell Coolidge 914,384 22,553 Richard E. Wilber 913,958 22,979 John M. Thomas, M.D. 913,796 23,141 Larry J. Croft 914,384 22,553 Item 5 - Other Information - Nothing to report. Item 6 - Exhibits and reports on Form 8-K. (a) Exhibits - None. (b) Reports - None. 12 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) May 10, 1996 /s/ Richard E. Wilber _______________________ By: Richard E. Wilber President and Chief Financial Officer (Principal Executive Officer) May 10, 1996 /s/ Thomas C. Lyman _______________________ By: Thomas C. Lyman Treasurer (Principal Financial & Accounting Officer) 13