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, 1998
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
November 5, 1998 2,773,434 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 September 30, 1998 and
December 31, 1997 1
Consolidated Statement of Income for the Three Months and
Nine Months Ended September 30, 1998 and 1997 2
Consolidated Statement of Comprehensive Income for the Three
Months and Nine Months Ended September 30, 1998 and 1997 3
Consolidated Statement of Cash Flows for the Nine Months Ended
September 30, 1998 and 1997 4
Notes to Consolidated Financial Statements 5
Item 2-Management's Discussion and Analysis of Financial Condition
and Results of Operations 6-16
Item 3-Quantitative and Qualitative Disclosure About Market Risk 16
Part II OTHER INFORMATION AND SIGNATURES
Item 1-Legal Proceedings 17
Item 2-Changes in Securities 17
Item 3-Defaults upon Senior Securities 17
Item 4-Submission of Matters to a Vote of Security Holders 17
Item 5-Other Information 17
Item 6-Exhibits and Reports on Form 8-K 17
Signatures 18
CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
September 30, December 31,
1998 1997
ASSETS:
Cash and due from banks:
Noninterest-bearing $ 7,717,279 $ 6,099,972
Interest-bearing 4,096,320 242,387
Total cash and cash equivalents 11,813,599 6,342,359
Available-for-sale securities 24,492,406 24,826,551
Held-to-maturity securities (estimated
market value 1998,$65,331,000;
December 31, 1997, $64,490,000) 63,584,815 63,734,826
Loans (net of allowance for loan
losses 1998, $2,232,000; December 31, 1997,
$2,138,000) 196,786,163 189,909,615
Foreclosed assets held for sale 514,372 238,284
Premises and equipment 5,606,656 5,754,026
Accrued interest receivable 2,399,621 2,426,512
Other assets 1,740,881 1,578,335
TOTAL ASSETS $306,938,513 $294,810,508
LIABILITIES:
Deposits:
Noninterest-bearing $ 21,173,112 $ 19,015,857
Interest-bearing 247,592,513 237,766,917
Total deposits 268,765,625 256,782,774
Borrowed funds 7,260,903 6,864,195
Accrued interest payable 2,142,376 2,331,439
Commitment to purchase
investment securities 1,980,556
Other liabilities 1,466,933 928,638
TOTAL LIABILITIES 279,635,837 268,887,602
STOCKHOLDERS' EQUITY:
Common Stock
$1.00 par value; authorized 10,000,000
shares in 1998 and 5,000,000 shares
in 1997; issued and outstanding
2,773,434 shares in 1998 and
2,746,564 in 1997, respectively 2,773,434 2,746,564
Additional paid-in capital 7,912,967 7,180,760
Retained earnings 16,549,135 15,652,872
TOTAL 27,235,536 25,580,196
Net unrealized holding gains on
available-for-sale securities 67,140 342,710
TOTAL STOCKHOLDERS' EQUITY 27,302,676 25,922,906
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $306,938,513 $294,810,508
The accompanying notes are an integral part of these financial statements.
1
CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
INTEREST INCOME:
Interest and fees on loans $4,499,398 $4,421,811 $13,146,207 $12,816,020
Interest on interest-bearing deposits
with banks 88,916 104,231 219,363 174,600
Interest and dividends on investments:
Taxable 1,097,238 1,287,853 3,463,044 3,916,910
Nontaxable 143,110 12,567 313,670 37,642
Dividends 28,133 20,525 73,368 59,292
Total interest and dividends on investments 1,268,481 1,320,945 3,850,082 4,013,844
TOTAL INTEREST INCOME 5,856,795 5,846,987 17,215,652 17,004,464
INTEREST EXPENSE:
Deposits 2,924,090 2,841,474 8,578,299 8,262,069
Borrowed funds 110,108 116,682 328,284 396,176
TOTAL INTEREST EXPENSE 3,034,198 2,958,156 8,906,583 8,658,245
NET INTEREST INCOME 2,822,597 2,888,831 8,309,069 8,346,219
Provision for loan losses 52,500 52,500 157,500 157,500
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 2,770,097 2,836,331 8,151,569 8,188,719
OTHER OPERATING INCOME:
Service charge 287,203 211,926 769,131 637,779
Trust 90,809 78,912 257,039 236,712
Other 68,004 80,210 212,669 196,478
Realized securities gains, net 201,929 0 374,306 0
Arbitration settlement 0 61,232 111,548 945,240
TOTAL OTHER OPERATING INCOME 647,945 432,280 1,724,693 2,016,209
OTHER OPERATING EXPENSES:
Salaries and employee benefits 1,036,812 995,750 2,909,638 3,018,029
Occupancy 134,191 128,699 396,825 387,698
Furniture and equipment 173,132 209,040 530,566 507,464
Other 731,168 698,625 2,231,553 2,000,349
TOTAL OTHER OPERATING EXPENSES 2,075,303 2,032,114 6,068,582 5,913,540
Income before provision for income taxes 1,342,739 1,236,497 3,807,680 4,291,388
Provision for income taxes 374,672 359,133 1,078,083 1,325,559
NET INCOME $ 968,067 $ 877,364 $ 2,729,597 2,965,829
Earnings per share $0.35 $0.32 $0.98 $1.07
Cash dividend declared $0.130 0 $0.385 $0.230
Weighted average number of shares outstanding 2,773,434 2,773,434 2,773,434 2,773,434
The accompanying notes are an integral part of these financial statements.
2
CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
Net income $ 968,067 $ 877,364 $ 2,729,597 $2,965,829
Other comprehensive income:
Unrealized gains on securities:
Gain (loss) arising during the year $ 3,677 $ 231,393 $ (43,224) $ 176,467
Reclassification adjustment (201,929) - (374,306) -
Other comprehensive income before tax (198,252) 231,393 (417,530) 176,467
Income tax expense related to other
comprehensive income (67,406) 78,673 (141,960) 59,999
Other comprehensive income, net of tax (130,846) 152,720 (275,570) 116,468
Comprehensive income $ 837,221 $ 1,030,084 $ 2,454,027 $3,082,297
The accompanying notes are an integral part of these financial statements.
3
CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
Nine months Ended
September 30,
CASH FLOWS FROM OPERATING ACTIVITIES: 1998 1997
Net income $ 2,729,597 $ 2,965,829
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 157,500 157,500
Provision for depreciation and amortization 567,707 403,411
Amortization and accretion of investment
securities 249,361 277,576
Deferred income taxes 5,976 (15,629)
Realized gains on securities (374,306) 0
Realized gains on loans sold (50,413) (10,908)
Originations of loans held for sale (2,879,886) (788,250)
Proceeds from sales of loans held for sale 2,930,299 799,158
Loss (gain) on sale of foreclosed assets
held for sale 6,629 (10,197)
(Increase) decrease in accrued interest receivable
and other assets (81,246) 263,777
Increase in accrued interest
payable and other liabilities 346,177 241,177
Net cash provided by operating activities 3,607,395 4,283,444
CASH FLOWS FROM INVESTING ACTIVITIES:
Available-for-sale securities:
Proceeds from sales of securities 12,962,002 0
Proceeds from maturity and principal
repayments of securities 4,051,175 4,200,000
Purchase of securities (16,794,848) (4,949,641)
Held-to-maturity securities:
Proceeds from maturity and principal
repayments of securities 7,440,375 6,810,469
Purchase of securities (9,444,636) (9,108,961)
Net increase in loans (7,371,561) (6,437,735)
Capital expenditures (338,761) (1,172,986)
Proceeds from sale of foreclosed assets held
for sale 54,796 119,500
Net cash used by
investing activities (9,441,458) (10,539,354)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 11,982,851 15,130,336
Proceeds from long-term borrowings 742,180 957,184
Repayments of long-term borrowings (515,520) (1,056,402)
Net increase (decrease) in short-term
borrowed funds 170,050 (8,147,883)
Dividends paid (1,074,258) (1,253,159)
Net cash provided by
financing activities 11,305,303 5,630,076
Net increase in cash and cash
equivalents 5,471,240 (625,834)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 6,342,359 6,458,707
CASH AND CASH EQUIVALENTS AT END OF PERIOD $11,813,599 $ 5,832,873
Supplemental Disclosures of Cash Flow Information:
Interest paid $ 9,095,646 $ 8,874,487
Income taxes paid $ 980,000 $ 1,305,000
The accompanying notes are an integral part of these financial statements.
4
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 inter-company 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 September 30, 1998, 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, 1997.
In July 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard Statement No. 130, "Reporting Comprehensive
Income. Statement No. 130 establishes standards for reporting and presentation
of comprehensive income and its components (revenues, expenses, gains and
losses) in a full set of general-purpose financial statements. It requires
that all items that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement that
is presented with the same prominence as other financial statements.
Statement No. 130 requires that companies (1) classify items of other
comprehensive income by their nature in a financial statement and (2) display
paid-in capital in the equity section of the statement of financial condition.
Statement No.130 is effective for fiscal years beginning after December 15,
1997. Reclassification of financial statements for earlier periods provided
for comprehensive purposes is required, as stated in the Consolidated
Statement of Comprehensive Income on page 3 of this report.
In February 1998, the Financial Accounting Standards Board issued
Statement No. 132, (SFAS No. 132), "Employers' Disclosure about Pensions and
Other Postretirement Benefits." This Statement revises employers' disclosures
about pension and other Postretirement benefit plans. It standardizes the
disclosure requirements for these plans to extent practicable, requires
additional information on changes in the benefit obligation and fair values
of plan assets, eliminates certain previously required disclosures. The
Company does not expect the provisions of this statement to have a material
effect on the liquidity, results of operations, or capital resources of the
Company when it becomes effective.
In June 1998, the Financial Accounting Standards Board issued Statement
No. 133, (SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." This Statement establishes accounting and reporting standards for
derivative instruments and for hedging activities. The Company implemented
this statement effective October 1, 1998 and has reclassified all of its
securities as available-for-sale. The impact of the reclassification will
result in a significant change in net unrealized holding gains on available-
for-sale securities (currently a net gain after the restructuring).
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 2,773,434 for 1998 and 1997,
respectively.
5
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 that have affected the Company's financial position and
operating results during the periods indicated in the accompanying consolidated
financial statements. The results of operations for the nine months ended
September 30, 1998 and 1997 are not necessarily indicative of the results to be
expected for the full year.
In addition to historical information, this quarterly report contains
forward-looking statements. The forward-looking statements contained herein
are subject to certain risks and uncertainties that could cause actual results
to differ materially from those projected in the forward-looking statements.
Important factors that might cause such a material difference include, but are
not limited to, those discussed in the section entitled "Management's Discussion
and Analysis of Financial Condition and Results of Operations".
The following items are among the factors that could cause actual results
to differ materially from the forward-looking statements: general economic
conditions, including their impact on capital expenditures; business conditions
in the banking industry; the regulatory environment; rapidly changing
technology and evolving banking industry standards; competitive standards;
competitive factors, including increase competition with community, regional
and national financial institutions; new service and product offerings by
competitors and price pressures; and like items. Readers are cautioned not
to place undue reliance on these forward-looking statements, which reflect
management's analysis only as of the date thereof. The Company undertakes no
obligation to publicly revise or update these forward-looking statements to
reflect events or circumstances that arise after the date hereof. Readers
should carefully review the risk factors described in other documents the
Company files from time to time with the Securities and Exchange Commission,
including the quarterly reports on Form 10-Q and any current reports on
Form 8-K filed by the Company.
The Bank currently engages in the general business of banking throughout
its service area of Potter, Tioga and Bradford counties in North Central
Pennsylvania and Allegany, Steuben, Chemung and Tioga counties in Southern New
York. The Bank maintains its central office in Mansfield, Pennsylvania and
presently operates banking facilities in Mansfield, Blossburg, Ulysses,
Genesee, Wellsboro, Troy, Sayre, Canton, Gillett and the Wellsboro Weis Market
store as well as automatic teller machines located in Soldiers and Sailors
Memorial Hospital in Wellsboro, Mansfield Wal-Mart and at Mansfield University.
The Bank's lending and deposit products are offered primarily within the
vicinity of its service area.
The Company faces strong competition in the communities it serves from
other commercial banks, savings banks, and savings and loan associations, some
of which are substantially larger institutions than the Company's subsidiary.
In addition, personal and corporate trust services are offered by insurance
companies, investment counseling firms, and other business firms and
individuals. The Company also competes with credit unions, issuers of money
market funds, securities brokerage firms, consumer finance companies, mortgage
brokers and insurance companies. 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. The
Company 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.
6
LOANS
Historically loans have been originated by the Bank to customers in North
Central Pennsylvania and the Southern Tier of New York. Loans have been
originated primarily through direct loans to our existing customer base with
new customers generated by referrals from real estate brokers, building
contractors, attorneys, accountants and existing customers. The Bank also
does a limited amount of indirect loans though new and used car dealers in
the primary lending area.
All lending is governed by a lending policy which is developed and
maintained by management and approved by the board of directors. The Bank's
lending policy regarding real estate loans is that the maximum mortgage granted
on owner occupied residential property is 80% of the appraised value or purchase
price (whichever is lower) when secured by the first mortgage on the property
(home equity, lines of credit or installments). Home equity lines of credit or
second mortgage loans are normally originated subject to maximum mortgage liens
against the property of 80% of the current appraised value. However, our recent
home equity loan promotion allowed some borrowers with outstanding credit to
borrow 100% of the appraised value. The maximum term for mortgage loans is 25
years for one-to four- family residential property and 20 years for commercial
and vacation property.
DEPOSITS
The Company tiers interest-bearing transaction and savings accounts by
deposit size (larger balances receive higher rates). The Company has been
offering a wide variety of deposit instruments, as have its competitors. Limited
transaction deposit accounts with interest rates that vary as often as daily,
unlimited transaction interest-bearing accounts, Premier 55 Club, Premier 55
Plus Club, Gold Club, individual retirement accounts, longer-term certificates
of deposit (generally of five-year maturity),promotional 30-month, 66-month and
Roll-Up certificates of deposit (allows the customer to adjust the interest rate
up once during the term by a maximum of 100 basis points).
The Company also offers a wide variety of IRA products including the new
Roth and Educational IRAs.
In most community offices, lobby and drive-up hours include Wednesday
afternoons as well as Saturday hours. The supermarket office is open seven days
a week with extended hours on weekdays. The Company has eleven automated teller
machines, which are part of the MAC regional and PLUS national network.
Management recently implemented a MasterMoney debit card program.
In addition, the Company has a telephone voice response system to provide
customers a convenient method of accessing account information and transferring
funds 24 hours a day.
TRUST SERVICES
Traditional trust, investment management and estate settlement services are
offered by the Bank.
FINANCIAL CONDITION
For the nine month period ended September 30, 1998, the total assets of the
Company had an increase of $12.1 million to $306.9 million compared with an
increase of $9 million for the same period in 1997.
Cash and cash equivalents increased $5.5 million in 1998 compared with a
decrease of $.6 million for the same period in 1997. Excess funds (funds
awaiting investment in longer term assets) from deposit growth and investment
sales and maturities in 1998 were temporarily placed in short-term interest
bearing investments.
7
Total investment securities decreased $.5 million during the first nine
months of 1998 compared with an increase of $2.9 million for the same period in
1997. The decrease reflects $24.5 million consisting of security sales (U S
Treasury securities available-for-sale), normal maturities and principal
repayments. The purchase of $26 million securities were primarily obligations
of state and political subdivisions ($9.4 million), mortgage-backed securities
($7.7 million), corporate bonds ($7.7 million) and equities ($1.5 million).
These transactions represent a restructuring of the investment portfolio to
include investment grade securities other that U S treasuries that will improve
the total portfolio yield.
Net loan balances of $196.8 million increased $6.9 million or 3.6% compared
to an increase of $6.1 million or 3.4% for the first nine months of 1998 and
1997, respectively. This modest growth was conditioned by continued rate
competition from other competing institutions.
During the remainder of 1998, management expects that loan demand will
continue to be moderate as a result of the continued aggressive competitions
even though we are experiencing a generally healthy local economy. This
competition will be especially evident in the Mansfield area with a new branch
bank having been constructed by a local competitor and another new branch bank
in the planning stages.
The major concentrations of loans continue to be in residential real
estate, primarily consisting of home equity loans, lines of credit,
installments, and first mortgages . The Bank also expects to be active in
lending to local state and political subdivisions during the remainder of 1998.
The loan portfolio consists of the following (in thousands):
September 30, December 31, September 30,
1998 1997 1997
Real estate loans - residential $129,990 $123,054 $ 122,354
Real estate loans - commercial 25,578 27,480 24,741
Real estate loans - agricultural 7,757 8,769 8,947
Loans to individuals for household,
family and other purchases 14,088 13,905 13,582
Commercial and other loans 11,708 9,485 9,672
State and political subdivision
loans 9,969 9,457 9,506
Total 199,090 192,150 188,802
Less: unearned income on loans 72 102 116
Loans, net of unearned income $199,018 $192,048 $188,686
Deposit growth increased by $12 million or 4.7% compared to the first nine
months of 1997 when deposits increased by $15.1 million or 6.3%. Deposit growth
slowed primarily because of the competitive interest rate environment and
alternative investment vehicles available to our customer.
Borrowed funds increased $.4 million during the first nine months of 1998
compared with a decrease of $8.3 million in 1997. The large decrease in 1997
resulted from repayments of short-term borrowing to the Federal Home Loan Bank
as a result of strong deposit growth and modest loan increases. The Company's
daily cash requirements or short-term investments are met by using the financial
instruments available through the Federal Home Loan Bank.
8
CAPITAL
The Company has computed its risk-based capital ratios as follows (dollars
in thousands):
September 30, December 31,
1998 1997
Tier I - Total stockholders' equity $ 27,303 $ 25,923
Less: Unrealized holding gains (losses)
on available-for-sale securities 67 343
Goodwill and core deposit intangible 755 836
Unrealized losses on available-for-sale
equity securities 72 0
Tier I, net 26,409 24,744
Tier II - Allowance for loan losses(1) 2,232 2,123
Total qualifying capital $ 28,641 $ 26,867
Risk-adjusted on-balance sheet assets $176,075 $161,940
Risk-adjusted off-balance sheet
exposure (2) 12,296 7,919
Total risk-adjusted assets $188,371 $169,859
September 30, December 31,
Ratios: 1998 1997
Tier I risk-based capital ratio 14.0% 14.6%
Federal minimum required 4.0 4.0
Total risk-based capital ratio 15.2% 15.8%
Federal minimum required 8.0 8.0
Leverage ratio (3) 8.7% 8.5%
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.
See the discussion of liquidity below for details regarding future expansion
plans and the impact on capital.
RESULTS OF OPERATIONS
Net income for the three month period ending September 30, 1998 was
$968,000 an increase of $91,000 or 10.4% over the $877,000 for the 1997 related
period. During the nine months period net income was $2,730,000 a decrease of
$236,000 from the 1997 related period. Earnings per share was $.98 during the
first nine months of 1998 compared with $1.07 during the comparable 1997 period.
The decrease was the result of a one time income increase in 1997 due to
arbitration settlement realized in the first quarter of 1997 discussed below.
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 current nine month period, after
provision for loan losses, was $8,152,000, a decrease of $37,000 or .5%
compared with an increase of $553,000 or 7.2% during the same period in 1997.
9
Analysis of Average Balances and Interest Rates (1)
September 30, 1998 September 30, 1997 September 30, 1996
Average Average Average Average Average Average
Balance Interest Rate Balance Interest Rate Balance Interest Rate
$ $ % $ $ % $ $ %
ASSETS
Short-term investments:
Interest-bearing deposits at banks 5,423 219 5.40 4,255 175 5.50 3,704 147 5.30
Investment securities:
Taxable 75,812 3,537 6.24 83,445 3,976 6.37 80,751 3,917 6.48
Tax-exempt(3) 8,750 476 7.27 604 58 12.84 854 81 12.67
Total investment securities 84,562 4,013 6.34 84,049 4,034 6.42 81,605 3,998 6.54
Loans:
Residential mortgage loans 125,158 8,350 8.92 118,003 8,149 9.23 101,744 7,055 9.26
Commercial & farm loans 45,312 3,231 9.53 43,669 3,161 9.68 41,553 3,071 9.87
Loans to state & political
subdivisions 10,375 668 8.61 9,666 614 8.49 9,391 613 8.72
Other loans 13,859 1,124 10.84 13,855 1,094 10.56 14,337 1,160 10.81
Loans, net of discount (2)(3)(4) 194,704 13,373 9.18 185,193 13,018 9.40 167,025 11,899 9.52
Total interest-earning assets 284,689 17,605 8.27 273,497 17,227 8.42 252,334 16,044 8.49
Cash and due from banks 6,536 4,002 3,317
Bank premises and equipment 5,722 4,950 4,260
FASB 115 adjustment 262 127 179
Other assets 1,510 4,831 6,046
Total noninterest-bearing assets 14,030 13,910 13,802
Total assets 298,719 287,407 266,136
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing deposits:
NOW accounts 33,120 536 2.16 32,488 586 2.41 28,735 491 2.28
Savings accounts 26,795 444 2.22 28,040 465 2.22 27,628 460 2.22
Money market accounts 36,754 1,343 4.89 27,812 941 4.52 27,074 884 4.36
Certificates of deposit 145,702 6,255 5.74 143,955 6,270 5.82 131,774 5,792 5.87
Total interest-bearing deposits 242,371 8,578 4.73 232,295 8,262 4.76 215,211 7,627 4.73
Other borrowed funds 7,025 328 6.24 8,542 396 6.20 8,830 405 6.13
Total interest-bearing liabilities 249,396 8,906 4.77 240,837 8,658 4.81 224,041 8,032 4.79
Demand deposits 19,549 18,887 17,114
Other liabilities 3,424 3,617 3,118
Total noninterest-bearing liabilities 22,973 22,504 20,232
Stockholders' equity 26,350 24,066 21,863
Total liabilities & stockholders'
equity 298,719 287,407 266,136
Net interest income 8,699 8,569 8,012
Net interest spread (5) 3.50% 3.61% 3.70%
Net interest income as a percentage
of average interest-earning assets 4.09% 4.19% 4.24%
Ratio of interest-earning assets
to interest-bearing liabilities 1.14 1.14 1.13
(1) Averages are based on daily balances.
(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.
As described in the table above, the yield on earning assets, on a tax-
equivalent basis, was 8.27% and 8.42% during the first nine months of 1998 and
1997, respectively (a decline of 15 basis points). The cost of funds was 4.77%
and 4.81% during the same nine month period (a decrease of 4 basis points).
10
In comparing the average interest cost of 1998 versus 1997, NOW accounts
decreased 25 basis points, savings accounts remained the same, and money market
accounts increased by 37 basis points (the result of an increase in higher
balance accounts). The interest rate on certificates of deposit decreased by 8
basis points.
As described above, the Company has experienced a narrowing interest margin
percentage during the nine months of 1998. The current flat yield curve has
limited the Company's opportunity to increase margin with new business as the
existing investments and loans mature or repay. The Company continues to review
various pricing and investment strategies to enhance deposit growth while
maintaining or expanding the current interest margin.
Analysis of Changes in Net Interest Income of a Tax Equivalent Basis (in
thousands)
1998 vs. 1997 (1) 1997 vs. 1996 (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 $ 47 $ (3) $ 44 $ 22 $ 6 $ 28
Investment securities:
Taxable (358) (81) (439) 126 (67) 59
Tax-exempt 432 (14) 418 (24) 1 (23)
Total investments 74 (95) (21) 102 (66) 36
Loans:
Residential mortgage loans 456 (255) 201 1,124 (30) 1,094
Commercial and farm loans 116 (46) 70 151 (61) 90
Loans to state & political
subdivisions 46 8 54 12 (11) 1
Other loans 0 30 30 (38) (28) (66)
Total loans - net of
discount (2)(3)(4) 618 (263) 355 1,249 (130) 1,119
Total interest income 739 (361) 378 1,373 (190) 1,183
Interest expense:
Interest bearing deposits:
NOW accounts 12 (62) (50) 67 28 95
Savings accounts (21) 0 (21) 7 (2) 5
Money market accounts 322 80 402 24 33 57
Certificates of deposit 82 (97) (15) 530 (52) 478
Total interest-bearing
deposits 395 (79) 316 628 7 635
Other borrowed funds (71) 3 (68) (13) 4 (9)
Total interest expense 324 (76) 248 615 11 626
Net interest income $ 415 $ (285) $ 130 $ 758 $ (201) $ 557
(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
The above table details the change in net interest income and shows an
increase of $739,000 resulting from volume changes in investments and loans. The
volume of interest expense increased the cost of interest-bearing deposits and
borrowings by $324,000. The positive gain from volume of $415,000 when combined
with decrease of income due to rate of $285,000 resulted in a net increase of
$130,000 compared to a net increase of $557,000 for the same period in 1997.
11
There has been a reduction in both interest volume and interest rate
1998/1997 compared to 1997/1996. Increasing competition has resulted in lower
deposit and loan volumes. The current flat yield curve continues to provide few
opportunities to increase margin spread.
In view of the narrowing of net interest margins discussed above,
management has begun to implement a number of long term growth strategies that
are expected to increase loan volumes and build other customer relationships.
The provision for loan losses was unchanged at $157,500 in both of the nine
month periods. This provision was appropriate given management's quarterly
review of the allowance for loan losses that 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, purchase of loans through acquisitions and peer comparisons.
Total other operating income decreased $292,000 compared with the same
period in 1997. Trust income increased $20,000, service charge income increased
$131,000 (as a result of additional business checking account, ATM and
MasterMoney Card charges), and other income increased $16,000. Net realized
securities gains increased by $374,000, during the current nine month period
compared to 1997, as there were no sales during the 1997 period. On February
27, 1997, the Bank reached an arbitration settlement with a vendor. The
settlement was for legal remedies associated with relationships with this
vendor. The Bank received $884,000 in cash and $250,000 in credits to be
applied to future expenditures, which if unused will expire within two years.
The amount received by the Bank is net of fees associated with the arbitration.
During the nine months ended September 30, 1998, arbitration settlement income
was $112,000.
Total other operating expense was $6,069,000 in the first nine months of
1998 reflecting an increase of $155,000 over the 1997 period. Salaries and
benefit's expense decreased by $108,000 for the current nine month period
reflecting normal merit increases offset by a reduction of profit sharing
expense during the same period in 1997 (an accrual to salaries and benefit
expense of $154,000 for profit sharing reflecting the additional arbitration
income).
Occupancy expense increased by $9,000 while furniture and equipment
expenses increased by $23,000, for the additional expenses relating to the
conversion to the new Jack Henry and Associates application software and IBM
AS\400 computer.
Other expenses increased $231,000 or 11.6% in the first nine months of 1998
over the 1997 related period. Increases in other professional fees of $68,000
reflect management's efforts to implement future strategic growth strategies.
Other expense increases also include software maintenance and expense
$27,000, telephone and data communication expense $34,000 that are other costs
associated with the new data processing system and network. Management expects
these costs to moderate over the remainder of 1998.
The provision for income taxes was $1,078,000 during the first nine months
of 1998 compared with $1,326,000 during the 1997 related period. Income before
taxes decreased $248,000 in the 1998 period over the same period in 1997
reflecting the change in income.
LIQUIDITY
Liquidity is a measure of the Company's ability to efficiently meet normal
cash flow requirements of both borrowers and depositors. 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, and fund other capital expenditures.
12
As detailed in the Consolidated Statement of Cash Flows, positive net cash
was provided from operating, investing and financing activities. The major
components have been discussed previously in the financial condition section
relating to investments, loans and deposits.
During the nine months of 1998 there was $339,000 of capital expenditures,
$834,000 less than the capital acquisitions (new core applications purchased)
during the same period in 1997.
Management is currently renting two properties as a temporary solution to
the space limitations it has experienced at the main office for the last seven
years. Management is evaluating what alternatives are available for the
locations of future new branch and/or operations center that may take place in
1999 with a total current estimated cost of approximately $3.5 million.
Management believes that it has sufficient resources to complete these
projects from its normal operations. It is anticipated that these changes will
have a long-term positive effect on revenues, efficiency and the capacity for
future growth.
Liquidity is achieved primarily from temporary or short-term investments in
the Federal Home Loan Bank of Pittsburgh, PA ("FHLB"), and investments that
mature less than one year. The Company also has a maximum borrowing capacity at
the FHLB of approximately $97.5 million as an additional source of liquidity.
There are no short-term borrowings from the FHLB as of September 30,1998.
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 nonperforming
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,
1998 1997 1996 1995 1994
Non accruing loans $ 1,650 $ 1,169 $ 844 $ 762 $ 1,557
Impaired loans 382 382 414 697
Accrual loans - 90 days or
more past due 18 170 723 689 267
Total nonperforming loans $ 2,050 $ 1,721 $ 1,981 $ 2,148 $ 1,824
Other real estate owned $ 514 $ 238 $ 164 $ 208 $ 168
Loans outstanding at end of
period $199,090 $192,150 $182,581 $161,886 $157,144
Unearned income 72 102 168 259 575
Loans, net of unearned income $199,018 $192,048 $182,413 $161,627 $156,569
Nonperforming loans as percent
of loans, net of unearned
income 1.03% 0.90% 1.09% 1.33% 1.16%
Total nonperforming assets as a
percent loans of net unearned
income 1.29% 1.02% 1.18% 1.46% 1.27%
13
Transactions in the allowance for loan losses were as follows (in thousands):
At September 30, Years Ended December 31,
1998 1997 1996 1995 1994
Balance, beginning of period $2,138 $1,995 $1,833 $1,721 $1,516
Charge-offs (87) (83) (64) (69) (68)
Recoveries 23 16 21 18 18
Provision for loan losses 158 210 205 163 255
Balance, end of period $2,232 $2,138 $1,995 $1,833 $1,721
Allowance for losses as a
percent of total loans 1.12% 1.11% 1.09% 1.13% 1.10%
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 establishes the level of the
allowance and the quarterly provision based on its evaluation of the loan
portfolio, current and projected economic conditions, the historical loan loss
experience, present and prospective financial condition of borrowers, the level
of nonperforming 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 does not accrue interest income on impaired 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.
YEAR 2000 COMPUTER PROBLEM
The following section contains forward-looking statements which involve
risks and uncertainties. The actual impact of the Year 2000 issue on the Bank
could materially differ from that which is anticipated in these forward-looking
statements as a result of certain factors identified below.
Company's State of Readiness
Management is aware of the possibility of exposure by banks to a computer
problem known as the "Year 2000 Problem" or the "Millennium Bug" (the inability
of some computer programs to distinguish between the year 1900 and the year
2000). If not corrected, some computer applications could fail or create
erroneous results by or at the Year 2000. This could cause entire system
failures, miscalculations, and disruptions of normal business operations
including, among other things, a temporary inability to process transactions,
sent statements, or engage in similar day to day business activities. The
extent of the potential impact of the Year 2000 Problem in not yet known, and if
not timely corrected, it could affect the global economy.
Management has assessed the extent of vulnerability of the Bank's computer
systems to the problem. The Company's conversion, in August 1997, to Jack Henry
and Associates (JHA) for core banking application software and the purchase of a
new IBM AS/400 hardware system on which to run the core processing software, has
greatly minimized our exposure to these problems. The JHA Silverlake System
software was certified by the Information Technology Association of America
(ITAA) on March 16, 1998 while the IBM AS\400 received the first ever Year 2000
certification by that organization. Some testing of critical systems has
already been completed, however, internal testing and validation for the primary
mission critical systems was scheduled for November, 1998 and management expect
that that process will be complete early in 1999.
14
Risk Assessment of Year 2000
The Company believes that, with modifications to existing software and
conversions to new software, the Year 2000 problem will not pose a significant
operational problem for the Company. However, because most computer systems
are, by their very nature, interdependent, it is possible that non-compliant
third party computers could impact the Company's computer systems.
Additionally, the Company has taken steps to communicate with the third parties,
such as wire transfer systems, telephone systems, electric companies and other
utility companies with which it deals to coordinate Year 2000 compliance but
could be adversely affected if it or the unrelated third parties are
unsuccessful. The Company is also assessing the impact, if any, the Year 2000
may have on its large loan (credit risk) and deposit customers.
Cost of Year 2000
As described above, our primary systems are Year 2000 compliant, therefore,
little programming costs will be incurred. Most of the costs incurred in
addressing this problem are related to planning and internal testing and
validation which are expected to be expensed as incurred. The financial impact
to the Company of Year 2000 compliance has not been and is not anticipated to be
material to the Company's financial position or results of operations for 1998
or 1999. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those plans. Specific
factors that might cause such material differences include, but are not limited
to, the availability and cost of personnel trained in this area, the replacement
of non-compliance of third party vendors, and similar uncertainties.
Contingency Plans
Management, in conjunction with its Year 2000 and Disaster Recovery
consultants, is in the process of modifying its disaster recover plans to
include the response to a Year 2000 problem in a most likely worst case
scenario. The Company's preliminary contingency plans involve the use of manual
labor to compensate for the loss temporary of certain automated computer systems
or third party vendors.
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 noninterest expenses, which tend to rise during periods of
general inflation. The level of inflation over the last few years has been
declining.
Various congressional bills have been enacted and other proposals have been
made for significant changes to the banking system, including provisions for:
limitation 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.
Recently, Pennsylvania enacted a law to permit State Chartered banking
institutions to sell insurance. The Company is currently evaluating its options
regarding the sale of insurance.
From time to time, various types of federal and state legislation have been
proposed that could result in additional regulation of, and restrictions on, the
business of the Company and the Bank. It cannot be predicted whether such
legislation will be enacted or, if enacted, how such legislation would affect
the business of the Company or the Bank. As the consequence of the extensive
regulation of commercial banking activities in the United States, the Company's
and the Bank's business is particularly susceptible to being affected by federal
legislation and regulations that may increase the costs of doing business.
15
Aside from those matters described above, management does 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, nor
is it 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 the Company's results of operations.
Further, the business of the Company is also affected by the state of the
financial services industry in general. As a result of legal and industry
changes, management predicts that the industry will continue to experience an
increase in consolidations and mergers as the financial services industry
strives for greater cost efficiencies and market share. Management also expects
increased diversification of financial products and services offered by the Bank
and its competitors. Management believes that such consolidations and mergers,
and diversification of products and services may enhance the Banks' competitive
position.
Item 3-Qualitative and Quantitative 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. Interest rate risk is managed by a management
and a committee of the board of directors.
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, 1997.
16
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 - Nothing to
report.
Item 5 - Other Information - Nothing to report.
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)(i) to the Annual Report of Form
10-K for the fiscal year ended December 31, 1995, as filed with the Commission
on March 26, 1996.)
(3)(ii)- By-laws of the Corporation, as amended. (Incorporated by Reference to
Exhibit (3)(ii) to the Annual Report of Form 10-K for the fiscal year ended
December 31, 1995, as filed with the Commission on March 26, 1996.)
(4) - Instruments Defining the Rights of Shareholders. (Incorporated by
reference to the Registrants Registration Statement No.2-89103 on Form S-14,
as filed with the Commission on February 17, 1984.)
(10) - Material Contracts. Employment Agreement between the Company and
Richard E. Wilber. (Incorporated by reference to the Registrants 1997 Form
10-K, Exhibit (10), as filed with the Commission on March 17, 1998.)
(11) - Computation of Earnings Per Share included on page 5 of this Form 10-Q.
(27) - Financial Data Schedules, which are submitted electronically to the
Securities and Exchange Commission for information only and not filed.
(b) Reports on Form 8-K - None.
17
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 5, 1998 /s/ Richard E. Wilber
By: Richard E. Wilber
President and Chief Financial Officer
(Principal Executive Officer)
November 5, 1998 /s/ Thomas C. Lyman
By: Thomas C. Lyman
Treasurer
(Principal Financial &
Accounting Officer
18
EXHIBITS INDEX
(3)(i) - Articles of Incorporation of the Corporation, as amended.
(Incorporated by Reference to Exhibit (3)(i) to the Annual Report of Form 10-K
for the fiscal year ended December 31, 1995, as filed with the Commission on
March 26, 1996.)
(3)(ii)- By-laws of the Corporation, as amended. (Incorporated by Reference to
Exhibit (3)(ii) to the Annual Report of Form 10-K for the fiscal year ended
December 31, 1995, as filed with the Commission on March 26, 1996.)
(4) - Instruments Defining the Rights of Shareholders. (Incorporated by
reference to the Registrants Registration Statement No.2-89103 on Form S-14,
as filed with the Commission on February 17, 1984.)
(10) - Material Contracts. Employment Agreement between the Company and
Richard E. Wilber. (Incorporated by reference to the Registrants 1997 Form
10-K, Exhibit (10), as filed with the Commission on March 17, 1998.)
(11) - Computation of Earnings Per Share included on page 5 of this Form 10-Q.
(27) - Financial Data Schedule, which are submitted electronically to the
Securities and Exchange Commission for information only and not filed.
19