SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2004
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: 0-16084
CITIZENS & NORTHERN CORPORATION
(Exact name of Registrant as specified in its charter)
Pennsylvania 23-2451943
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
90-92 Main Street
Wellsboro, Pa. 16901
(Address of principal executive offices) (Zip code)
570-724-3411
(Registrant's telephone number including area code)
Not applicable
(Former name, former address, and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [X] No [ ]
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
Title Outstanding
Common Stock ($1.00 par value) 8,101,507 Shares Outstanding August 3, 2004
1
CITIZENS & NORTHERN CORPORATION
Index
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheet - June 30, 2004 and December 31, 2003 Page 3
Consolidated Statement of Income - Three Months and Six Months Ended June 30, 2004 and 2003 Page 4
Consolidated Statement of Cash Flows - Six Months Ended June 30, 2004 and 2003 Page 5
Notes to Consolidated Financial Statements Pages 6 through 11
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Pages 11 through 25
Item 3. Quantitative and Qualitative Disclosures About Market Risk Pages 25 through 27
Item 4. Controls and Procedures Page 27
Part II. Other Information Pages 27 through 29
Signatures Page 30
Exhibit 31.1. Rule 13a-14(a)/15d-14(a) Certification - Chief Executive Officer Page 31
Exhibit 31.2. Rule 13a-14(a)/15d-14(a) Certification - Chief Financial Officer Page 32
Exhibit 32. Section 1350 Certifications Page 33
2
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEET
(In Thousands Except Share Data)
JUNE 30, DECEMBER 31,
2004 2003
(UNAUDITED) (NOTE)
ASSETS
Cash and due from banks:
Noninterest-bearing $ 14,569 $ 13,938
Interest-bearing 765 1,233
----------- -----------
Total cash and cash equivalents 15,334 15,171
Available-for-sale securities 503,700 483,032
Held-to-maturity securities 445 560
Loans, net 545,360 518,800
Bank-owned life insurance 17,785 17,473
Accrued interest receivable 6,035 5,632
Bank premises and equipment, net 14,909 12,482
Foreclosed assets held for sale 53 101
Other assets 15,518 13,650
----------- -----------
TOTAL ASSETS $ 1,119,139 $ 1,066,901
=========== ===========
LIABILITIES
Deposits:
Noninterest-bearing $ 79,860 $ 75,616
Interest-bearing 590,238 582,449
----------- -----------
Total deposits 670,098 658,065
Dividends payable 1,782 1,763
Short-term borrowings 40,753 37,763
Long-term borrowings 279,353 235,190
Accrued interest and other liabilities 5,996 8,777
----------- -----------
TOTAL LIABILITIES 997,982 941,558
----------- -----------
STOCKHOLDERS' EQUITY
Common stock, par value $1.00 per share; authorized 20,000,000 shares in 2004
and 10,000,000 shares in 2003; issued 8,307,305 in 2004 and 8,226,033 in 2003 8,307 8,226
Stock dividend distributable - 2,164
Paid-in capital 22,431 20,104
Retained earnings 88,789 84,940
----------- -----------
Total 119,527 115,434
Accumulated other comprehensive income 4,097 12,037
Unamortized stock compensation (90) (54)
Treasury stock, at cost:
207,965 shares at June 30, 2004 (2,377)
211,408 shares at December 31, 2003 (2,074)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 121,157 125,343
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,119,139 $ 1,066,901
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
Note: The balance sheet at December 31, 2003 has been derived from the audited
financial statements at that date but does not include all the information and
notes required by U.S. generally accepted accounting principles for complete
financial statements.
3
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
CONSOLIDATED STATEMENT OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
3 MONTHS ENDED FISCAL YEAR TO DATE
JUNE 30, JUNE 30, 6 MONTHS ENDED JUNE 30,
2004 2003 2004 2003
(CURRENT) (PRIOR YEAR) (CURRENT) (PRIOR YEAR)
INTEREST INCOME
Interest and fees on loans $ 8,326 $ 8,023 $ 16,561 $ 15,885
Interest on balances with depository institutions 1 5 4 7
Interest on loans to political subdivisions 239 199 453 366
Interest on federal funds sold 3 5 4 8
Income from available-for-sale and
held-to-maturity securities:
Taxable 3,493 3,598 6,757 7,544
Tax-exempt 1,938 1,820 3,873 3,562
Dividends 343 293 706 501
---------- ---------- ---------- ----------
Total interest and dividend income 14,343 13,943 28,358 27,873
---------- ---------- ---------- ----------
INTEREST EXPENSE
Interest on deposits 2,965 3,815 6,308 7,731
Interest on short-term borrowings 126 99 249 241
Interest on long-term borrowings 2,402 2,175 4,639 4,360
---------- ---------- ---------- ----------
Total interest expense 5,493 6,089 11,196 12,332
---------- ---------- ---------- ----------
Interest margin 8,850 7,854 17,162 15,541
Provision for loan losses 350 250 700 600
---------- ---------- ---------- ----------
Interest margin after provision for loan losses 8,500 7,604 16,462 14,941
---------- ---------- ---------- ----------
OTHER INCOME
Service charges on deposit accounts 453 446 874 855
Service charges and fees 55 50 131 119
Trust and financial management income 573 467 1,030 845
Insurance commissions, fees and premiums 110 77 219 157
Increase in cash surrender value of life insurance 153 183 312 377
Fees related to credit card operation 225 195 409 357
Other operating income 286 210 505 458
---------- ---------- ---------- ----------
Total other income before realized gains on
securities, net 1,855 1,628 3,480 3,168
Realized gains on securities, net 321 908 1,285 2,629
---------- ---------- ---------- ----------
Total other income 2,176 2,536 4,765 5,797
---------- ---------- ---------- ----------
OTHER EXPENSES
Salaries and wages 2,729 2,325 5,400 4,773
Pensions and other employee benefits 828 796 1,812 1,660
Occupancy expense, net 360 317 737 657
Furniture and equipment expense 388 352 724 684
Pennsylvania shares tax 211 196 423 392
Other operating expense 1,773 1,370 3,421 2,722
---------- ---------- ---------- ----------
Total other expenses 6,289 5,356 12,517 10,888
---------- ---------- ---------- ----------
Income before income tax provision 4,387 4,784 8,710 9,850
Income tax provision 698 864 1,315 1,858
---------- ---------- ---------- ----------
NET INCOME $ 3,689 $ 3,920 $ 7,395 $ 7,992
========== ========== ========== ==========
PER SHARE DATA:
Net income - basic $ 0.46 $ 0.48 $ 0.91 $ 0.99
Net income - diluted $ 0.45 $ 0.48 $ 0.91 $ 0.98
---------- ---------- ---------- ----------
Dividend per share $ 0.22 $ 0.21 $ 0.44 $ 0.42
---------- ---------- ---------- ----------
Number of shares used in computation - basic 8,101,024 8,087,875 8,106,541 8,087,502
Number of shares used in computation - diluted 8,148,139 8,137,454 8,158,157 8,127,510
The accompanying notes are an integral part of these consolidated financial
statements.
4
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS) (UNAUDITED)
6 MONTHS ENDED JUNE 30,
2004 2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 7,395 $ 7,992
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 700 600
Realized gains on securities, net (1,285) (2,629)
Gain on sale of foreclosed assets, net (36) (45)
Depreciation expense 669 590
Accretion and amortization, net 383 643
Increase in cash surrender value of life insurance (312) (377)
Amortization of restricted stock 44 51
Increase in accrued interest receivable and other assets (1,283) (5,172)
Increase in accrued interest payable and other liabilities 1,378 1,186
--------- ---------
Net Cash Provided by Operating Activities 7,653 2,839
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturity of held-to-maturity securities 113 120
Proceeds from sales of available-for-sale securities 27,902 38,881
Proceeds from calls and maturities of available-for-sale securities 54,967 101,624
Purchase of available-for-sale securities (114,664) (120,791)
Purchase of Federal Home Loan Bank of Pittsburgh stock (2,813) (1,176)
Redemption of Federal Home Loan Bank of Pittsburgh stock 1,779 168
Net increase in loans (27,260) (32,005)
Purchase of premises and equipment (3,096) (789)
Proceeds from sale of foreclosed assets 84 143
--------- ---------
Net Cash Used in Investing Activities (62,988) (13,825)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 12,033 16,772
Net increase (decrease) in short-term borrowings 2,990 (2,878)
Proceeds from long-term borrowings 63,943 34,500
Repayments of long-term borrowings (19,780) (27,512)
Purchase of treasury stock (575) (174)
Sale of treasury stock 462 119
Dividends paid (3,575) (3,308)
--------- ---------
Net Cash Provided by Financing Activities 55,498 17,519
--------- ---------
INCREASE IN CASH AND CASH EQUIVALENTS 163 6,533
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 15,171 14,900
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 15,334 $ 21,433
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Accrued purchase of available-for-sale securities $ - $ 10,000
Assets acquired through foreclosure of real estate loans $ - $ 121
Interest paid $ 8,643 $ 9,895
Income taxes paid $ 1,773 $ 1,920
The accompanying notes are an integral part of these consolidated financial
statements.
5
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF INTERIM PRESENTATION
The financial information included herein, with the exception of the
consolidated balance sheet dated December 31, 2003, is unaudited; however, such
information reflects all adjustments (consisting solely of normal recurring
adjustments) that are, in the opinion of management, necessary for a fair
presentation of the financial position, results of operations and cash flows for
the interim periods.
Results reported for the three-month and six-month periods ended June 30, 2004
might not be indicative of the results for the year ending December 31, 2004.
This document has not been reviewed or confirmed for accuracy or relevance by
the Federal Deposit Insurance Corporation or any other regulatory agency.
2. PER SHARE DATA
Net income per share is based on the weighted-average number of shares of common
stock outstanding. The number of shares used in calculating net income and cash
dividends per share reflect the retroactive effect of stock splits and dividends
for all periods presented. The following data show the amounts used in computing
net income per share and the weighted average number of shares of dilutive stock
options. As shown in the table that follows, diluted earnings per share is
computed using weighted average common shares outstanding, plus weighted-average
common shares available from the exercise of all dilutive stock options, less
the number of shares that could be repurchased with the proceeds of stock option
exercises based on the average share price of the Corporation's common stock
during the period.
WEIGHTED-
AVERAGE EARNINGS
NET COMMON PER
INCOME SHARES SHARE
SIX MONTHS ENDED JUNE 30, 2004
Earnings per share - basic $ 7,395,000 8,106,541 $0.91
Dilutive effect of potential common stock
arising from stock options:
Exercise of outstanding stock options 227,141
Hypothetical share repurchase at $25.65 (175,525)
------------ --------- -----
Earnings per share - diluted $ 7,395,000 8,158,157 $0.91
============ ========= =====
SIX MONTHS ENDED JUNE 30, 2003
Earnings per share - basic $ 7,992,000 8,087,502 $0.99
Dilutive effect of potential common stock
arising from stock options:
Exercise of outstanding stock options 199,628
Hypothetical share repurchase at $22.52 (159,620)
------------ --------- -----
Earnings per share - diluted $ 7,992,000 8,127,510 $0.98
============ ========= =====
6
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
WEIGHTED-
AVERAGE EARNINGS
NET COMMON PER
INCOME SHARES SHARE
QUARTER ENDED JUNE 30, 2004
Earnings per share - basic $ 3,689,000 8,101,024 $0.46
Dilutive effect of potential common stock
arising from stock options:
Exercise of outstanding stock options 223,023
Hypothetical share repurchase at $25.06 (175,908)
------------ --------- -----
Earnings per share - diluted $ 3,689,000 8,148,139 $0.45
============ ========= =====
QUARTER ENDED JUNE 30, 2003
Earnings per share - basic $ 3,920,000 8,087,875 $0.48
Dilutive effect of potential common stock
arising from stock options:
Exercise of outstanding stock options 197,145
Hypothetical share repurchase at $24.09 (147,566)
------------ --------- -----
Earnings per share - diluted $ 3,920,000 8,137,454 $0.48
============ ========= =====
3. STOCK COMPENSATION PLANS
As permitted by Accounting Principles Board Opinion No. 25, the Corporation uses
the intrinsic value method of accounting for stock compensation plans. Utilizing
the intrinsic value method, compensation cost is measured by the excess of the
quoted market price of the stock as of the grant date (or other measurement
date) over the amount an employee or director must pay to acquire the stock.
Stock options issued under the Corporation's stock option plans have no
intrinsic value, and accordingly, no compensation cost is recorded for them.
The Corporation has also made awards of restricted stock. Compensation cost
related to restricted stock is recognized based on the market price of the stock
at the grant date over the vesting period.
The following table illustrates the effect on net income and earnings per share
if the Corporation had applied the fair value provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-based
Compensation," to stock options.
7
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
(NET INCOME IN THOUSANDS)
3 MONTHS ENDED FISCAL YEAR-TO-DATE
JUNE 30, 6 MONTHS ENDED JUNE 30,
2004 2003 2004 2003
Net income, as reported $ 3,689 $ 3,920 $ 7,395 $ 7,992
Deduct: Total stock option compensation
expense determined under fair value
method for all awards, net of tax effects (42) (47) (91) (106)
--------- --------- --------- ---------
Pro forma net income $ 3,647 $ 3,873 $ 7,304 $ 7,886
========= ========= ========= =========
Earnings per share-basic:
As reported $ 0.46 $ 0.48 $ 0.91 $ 0.99
Pro forma $ 0.45 $ 0.48 $ 0.90 $ 0.98
Earnings per share-diluted:
As reported $ 0.45 $ 0.48 $ 0.91 $ 0.98
Pro forma $ 0.45 $ 0.48 $ 0.90 $ 0.97
4. COMPREHENSIVE INCOME
Accounting principles generally accepted in the United States of America require
that recognized revenue, expenses, gains and losses be included in net income.
Although certain changes in assets and liabilities, such as unrealized gains and
losses on available-for-sale securities, are reported as a separate component of
the equity section of the balance sheet, such items, along with net income, are
components of comprehensive income (loss).
Comprehensive income (loss) is calculated as follows:
3 MONTHS ENDED 6 MONTHS ENDED
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
(IN THOUSANDS) 2004 2003 2004 2003
Net income $ 3,689 $ 3,920 $ 7,395 $ 7,992
Other comprehensive income:
Unrealized holding (losses) gains on available-for-sale
securities:
(Losses) gains arising during the period (15,613) 3,322 (10,748) 6,491
Reclassification adjustment for realized gains (321) (908) (1,285) (2,629)
-------- -------- -------- --------
Other comprehensive (loss) income before income tax (15,934) 2,414 (12,033) 3,862
Income tax related to other comprehensive income 5,419 (822) 4,093 (1,313)
-------- -------- -------- --------
Other comprehensive (loss) income (10,515) 1,592 (7,940) 2,549
-------- -------- -------- --------
Comprehensive (loss) income $ (6,826) $ 5,512 $ (545) $ 10,541
======== ======== ======== ========
8
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
5. SECURITIES
Amortized cost and fair value of securities at June 30, 2004 are summarized as
follows:
JUNE 30, 2004
GROSS GROSS
UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING FAIR
(IN THOUSANDS) COST GAINS LOSSES VALUE
AVAILABLE-FOR-SALE SECURITIES:
Obligations of the U.S. Treasury $ - $ - $ - $ -
Obligations of other U.S. Government agencies 62,258 140 (1,372) 61,026
Obligations of states and political subdivisions 157,500 1,828 (3,558) 155,770
Other securities 63,444 1,779 (703) 64,520
Mortgage-backed securities 183,992 1,311 (3,580) 181,723
-------- -------- -------- --------
Total debt securities 467,194 5,058 (9,213) 463,039
Marketable equity securities 30,300 11,498 (1,137) 40,661
-------- -------- -------- --------
Total $497,494 $ 16,556 $(10,350) $503,700
======== ======== ======== ========
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury $ 318 $ 20 $ - $ 338
Obligations of other U.S. Government agencies 98 13 - 111
Mortgage-backed securities 29 1 - 30
-------- -------- -------- --------
Total $ 445 $ 34 $ - $ 479
======== ======== ======== ========
The following table presents gross unrealized losses and fair value of
investments aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position at June 30, 2004.
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
(IN THOUSANDS) VALUE LOSSES VALUE LOSSES VALUE LOSSES
AVAILABLE-FOR-SALE SECURITIES:
Obligations of the U.S. Treasury $ - $ - $ - $ - $ - $ -
Obligations of other U.S. Government agencies 37,082 (511) 9,128 (861) 46,210 (1,372)
Obligations of states and political subdivisions 70,497 (2,866) 8,928 (692) 79,425 (3,558)
Other securities 16,525 (641) 5,045 (62) 21,570 (703)
Mortgage-backed securities 134,835 (3,580) - - 134,835 (3,580)
--------- --------- --------- --------- --------- ---------
Total debt securities 258,939 (7,598) 23,101 (1,615) 282,040 (9,213)
Marketable equity securities 740 (64) 4,937 (1,073) 5,677 (1,137)
--------- --------- --------- --------- --------- ---------
Total temporarily impaired available-for-sale
securities $ 259,679 $ (7,662) $ 28,038 $ (2,688) $ 287,717 $ (10,350)
========= ========= ========= ========= ========= =========
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury $ - $ - $ - $ - $ - $ -
Obligations of other U.S. Government agencies - - - - - -
Mortgage-backed securities - - - - - -
--------- --------- --------- --------- --------- ---------
Total temporarily impaired held-to-maturity
securities $ - $ - $ - $ - $ - $ -
========= ========= ========= ========= ========= =========
9
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
The unrealized losses on debt securities are primarily the result of volatility
in interest rates. Based on the credit worthiness of the issuers, which are
almost exclusively U.S. Government agencies or state and political subdivisions,
management believes the Corporation's debt securities at June 30, 2004 were not
other-than-temporarily impaired.
Of the total $1,137,000 unrealized losses on equity securities at June 30, 2004,
$949,000 was from a preferred stock issued by an U.S. Government agency.
Management believes this security's fair value is affected primarily by
volatility in interest rates, and that there is very little credit risk
associated with this security. For the remaining equity securities for which
fair value was less than cost at June 30, 2004, management believes the
financial condition and near-term prospects of those issuers indicate those
securities were not other-than-temporarily impaired.
6. DEFINED BENEFIT PLANS
The Corporation has a noncontributory defined benefit pension plan for all
employees meeting certain age and length of service requirements. Benefits are
based primarily on years of service and the average annual compensation during
the highest five consecutive years within the final ten years of employment.
Also, the Corporation sponsors a defined benefit health care plan that provides
postretirement medical benefits and life insurance to employees who meet certain
age and length of service requirements. This plan contains a cost-sharing
feature, which causes participants to pay for all future increases in costs
related to benefit coverage. Accordingly, actuarial assumptions related to
health care cost trend rates do not affect the liability balance and will not
affect the Corporation's future expenses.
The Corporation uses a December 31 measurement date for its plans.
The components of net periodic benefit costs from these defined benefit plans
are as follows:
PENSION POSTRETIREMENT
6 MONTHS ENDED 6 MONTHS ENDED
JUNE 30, JUNE 30,
(IN THOUSANDS) 2004 2003 2004 2003
Service cost $ 238 $ 198 $ 22 $ 16
Interest cost 310 296 32 30
Expected return on plan assets (374) (308) - -
Amortization of transition (asset) obligation (12) (12) 18 18
Recognized net actuarial loss 32 44 2 -
----- ----- ----- -----
Net periodic benefit cost $ 194 $ 218 $ 74 $ 64
===== ===== ===== =====
PENSION POSTRETIREMENT
3 MONTHS ENDED 3 MONTHS ENDED
JUNE 30, JUNE 30,
(IN THOUSANDS) 2004 2003 2004 2003
Service cost $ 119 $ 99 $ 11 $ 8
Interest cost 155 148 16 15
Expected return on plan assets (187) (154) - -
Amortization of transition (asset) obligation (6) (6) 9 9
Recognized net actuarial loss 16 22 1 -
----- ----- ----- -----
Net periodic benefit cost $ 97 $ 109 $ 37 $ 32
===== ===== ===== =====
The Corporation funded its total defined benefit pension contribution for 2004
of $328,000 in April 2004. In the first six months of 2004, the Corporation
funded postretirement contributions totaling $26,000. The estimated total
(annual) amount of 2004 postretirement contributions is $60,000.
10
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
7. CONTINGENCIES
In the normal course of business, the Corporation may be subject to pending and
threatened lawsuits in which claims for monetary damages could be asserted. In
management's opinion, the Corporation's financial position and results of
operations would not be materially affected by the outcome of such pending legal
proceedings.
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
PART I - FINANCIAL INFORMATION (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
FORWARD-LOOKING STATEMENTS
Certain statements in this section and elsewhere in Form 10-Q are
forward-looking statements. Citizens & Northern Corporation and its wholly-owned
subsidiaries (collectively, the Corporation) intend such forward-looking
statements to be covered by the safe harbor provisions for forward-looking
statements contained in the Private Securities Reform Act of 1995.
Forward-looking statements, which are based on certain assumptions and describe
future plans, business objectives and expectations, and are generally not
historical facts, are identifiable by the use of words such as, "believe",
"expect", "intend", "anticipate", "estimate", "project", and similar
expressions. These forward-looking statements are subject to risks and
uncertainties that are difficult to predict, may be beyond management's control
and could cause results to differ materially from those currently anticipated.
Factors which could have a material adverse impact on the operations and future
prospects of the Corporation include, but are not limited to, the following:
- - changes in monetary and fiscal policies of the Federal Reserve Board and
the U. S. Government, particularly related to changes in interest rates
- - changes in general economic conditions
- - legislative or regulatory changes
- - downturn in demand for loan, deposit and other financial services in the
Corporation's market area
- - increased competition from other banks and non-bank providers of financial
services
- - technological changes and increased technology-related costs
- - changes in accounting principles, or the application of generally accepted
accounting principles.
These risks and uncertainties should be considered in evaluating forward-looking
statements and undue reliance should not be placed on such statements.
REFERENCES TO 2004 AND 2003
Unless otherwise noted, all references to "2004" in the following discussion of
operating results are intended to mean the six months ended June 30, 2004, and
similarly, references to "2003" are intended to mean the six months ended June
30, 2003.
EARNINGS OVERVIEW
Net income for 2004 was $7,395,000, or $.91 per share - basic and diluted. This
represents a decrease of 8.1% in net income per share - basic and 7.1% in net
income per share - diluted as compared to 2003. Return on average assets was
1.35% in 2004, down from 1.57% in 2003. Return on average equity decreased to
11.52% in 2004 from 13.33% in 2003.
The most significant income statement changes between 2004 and 2003 were as
follows:
- Net realized gains on securities were $1,285,000 in 2004, compared
to $2,629,000 in 2003. In both years, the gains were mainly from
sales of bank stocks. These sales resulted from circumstances
specific to each underlying company, and the proceeds have been
reinvested in other bank stocks. Total gains from sales of bank
stocks amounted to $1,086,000 in 2004 and $1,572,000 in 2003. Other
security gains from debt securities amounted to $199,000 in 2004 and
$1,057,000 in 2003, and consisted mainly of sales and calls of
Municipal and U.S. Agency bonds.
11
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
- Other (noninterest) expenses increased $1,629,000, or 15.0%, in 2004
compared to 2003. The increase reflects increases in payroll costs,
employee benefits and other expenses. In addition to increases in
expenses related to additional employees and other items, the
Corporation incurred noninterest expenses totaling approximately
$500,000 related to two significant initiatives in the first six
months of 2004: (1) start-up expenses associated with the
Williamsport branch, which opened in May, and (2) non-payroll
expenses related to conversion to new core computer software
(expected to be completed in the 4th quarter 2004). Increases in
other expenses are described in the "Noninterest Expense" section of
Management's Discussion and Analysis.
- The interest margin increased $1,621,000, or 10.4%, to $17,162,000
in 2004 from $15,541,000 in 2003. The Corporation has experienced
significant growth in loans, which has more than offset the effects
of lower yields in 2004. Also, average interest rates on deposits
and borrowed funds have been substantially lower in 2004 than in
2003. Changes in the net interest margin are discussed in more
detail later in Management's Discussion and Analysis.
- The income tax provision decreased to $1,315,000 in 2004 from
$1,858,000 in 2003. While pre-tax income has decreased, the
Corporation's effective tax rate has also fallen to 15.1% in 2004
from 18.9% in 2003. This lower effective tax rate resulted mainly
from management's decision to increase the weighting of tax-exempt
obligations of states and political subdivisions, as a percentage of
total assets.
SECOND QUARTER 2004
Net income for the second quarter 2004 was $3,689,000, a decrease of $231,000
(5.9%) from the second quarter 2003. Net income per share was $0.46 - Basic and
$0.45 - Diluted for the second quarter 2004, as compared to $0.48 (Basic and
Diluted) for the second quarter 2003.
Net Income for the second quarter 2004 was down $17,000 (0.5%) from the first
quarter 2004. As shown in Table I, net realized security gains amounted to
$321,000 in the second quarter 2004, down from $964,000 in the first quarter
2004. The interest margin increased $538,000 in the second quarter 2004 as
compared to the first quarter 2004, primarily due to higher average balances of
loans and available-for-sale securities.
TABLE I - QUARTERLY FINANCIAL DATA
(IN THOUSANDS)
JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
2004 2004 2003 2003 2003 2003
Interest income $14,343 $14,015 $13,797 $13,553 $13,943 $13,930
Interest expense 5,493 5,703 5,550 5,655 6,089 6,243
------- ------- ------- ------- ------- -------
Interest margin 8,850 8,312 8,247 7,898 7,854 7,687
Provision for loan losses 350 350 250 250 250 350
------- ------- ------- ------- ------- -------
Interest margin after provision for loan losses 8,500 7,962 7,997 7,648 7,604 7,337
Other income 1,855 1,625 1,722 1,705 1,628 1,540
Securities gains 321 964 1,510 660 908 1,721
Other expenses 6,289 6,228 5,890 5,336 5,356 5,532
------- ------- ------- ------- ------- -------
Income before income tax provision 4,387 4,323 5,339 4,677 4,784 5,066
Income tax provision 698 617 992 759 864 994
------- ------- ------- ------- ------- -------
Net income $ 3,689 $ 3,706 $ 4,347 $ 3,918 $ 3,920 $ 4,072
======= ======= ======= ======= ======= =======
Net income per share - basic $ 0.46 $ 0.46 $ 0.54 $ 0.48 $ 0.48 $ 0.50
======= ======= ======= ======= ======= =======
Net income per share - diluted $ 0.45 $ 0.45 $ 0.53 $ 0.48 $ 0.48 $ 0.50
======= ======= ======= ======= ======= =======
The number of shares used in calculating net income per share for each quarter
presented in Table I reflects the retroactive effect of stock splits and
dividends.
12
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
PROSPECTS FOR THE REMAINDER OF 2004
Overall, management believes earnings prospects for the remainder of 2004 to be
relatively comparable to results for the first half of the year. Loan growth is
expected to continue, with a great deal of commercial loan activity currently
ongoing. Net loans are up 14.4% as of June 30, 2004 compared to June 30, 2003.
As you can see in Table I, the interest margin has grown slightly in each of the
last 5 quarters, to $8,850,000 in the 2nd quarter 2004 from $7,687,000 in the
1st quarter of 2003. Interest rates have been rising recently and management
anticipates continued rising rates over the remainder of 2004, including
increases in short-term rates. The Federal Reserve raised the Federal Funds
target rate, a key economic indicator, .25% to 1.25% on June 29, 2004. The
impact of rising rates would likely be a slight "squeeze" on the net interest
margin, as (on average) deposits and borrowings would be expected to reprice
faster than loans and debt securities. The Corporation's interest rate risk is
discussed in more detail in Item 3 of Form 10-Q.
Another major variable that could affect 2004 earnings is securities gains and
losses. The Corporation's management makes decisions regarding sales of
securities based on a variety of factors, with an overall goal of maximizing
portfolio return over a long-term horizon. Therefore, it is difficult to
predict, with much precision, the amounts of securities gains and losses that
may be realized over the remainder of 2004.
Total capital purchases for 2004 are estimated to range from $5 million to $7
million, depending on the timing of possible building projects and equipment
purchases. As indicated in the consolidated statement of cash flows, total
purchases of premises and equipment for the first 6 months of 2004 amounted to
more than $3 million. In 2004, the Corporation paid more than $1 million for
equipment and to complete the renovation of the facility on Market Street in
Williamsport, and also paid more than $1 million for software licenses and
equipment related to the new core computer software. Trust and Financial
Management, Commercial Lending and a few other personnel moved into the
Williamsport facility in February 2004, and the branch operations opened June 4,
2004. Total capitalized costs incurred in 2003 and 2004 to purchase, renovate
and equip the start-up of operations in Williamsport amounted to $2,972,000. In
March 2004, management selected a new core processing system from Open
Solutions, Inc. Management expects the core system implementation to be
completed by year-end 2004 at a total capitalized cost of approximately $2.5
million.
In June 2004, the Corporation entered into a 5-year lease agreement, with
opportunities to renew, to add an additional branch office located in South
Williamsport. Rent expense for the first year of the lease will amount to
$18,000, and renovation costs are estimated at approximately $140,000.
Management expects this office to open for business later this year.
Although the amount of capitalized spending expected for 2004 is high by the
Corporation's normal historic standards, it is not expected to have a material,
adverse impact on the Corporation's financial position or results of operations
in 2004.
CRITICAL ACCOUNTING POLICIES
The presentation of financial statements in conformity with U.S. generally
accepted accounting principles requires management to make estimates and
assumptions that affect many of the reported amounts and disclosures. Actual
results could differ from these estimates.
A material estimate that is particularly susceptible to significant change is
the determination of the allowance for loan losses. Management believes that the
allowance for loan losses is adequate and reasonable. The Corporation's
methodology for determining the allowance for loan losses is described in a
separate section later in Management's Discussion and Analysis. Given the very
subjective nature of identifying and valuing loan losses, it is likely that
well-informed individuals could make materially different assumptions, and
could, therefore, calculate a materially different allowance value. While
management uses available information to recognize losses on loans, changes in
economic conditions may necessitate revisions in future years. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Corporation's allowance for loan losses. Such agencies
may require the Corporation to recognize adjustments to the allowance based on
their judgments of information available to them at the time of their
examination.
Another material estimate is the calculation of fair values of the Corporation's
debt securities. The Corporation receives estimated fair values of debt
securities from an independent valuation service, or from brokers. In developing
these fair values, the valuation service and the brokers use estimates of cash
flows, based on historical performance of similar instruments in similar
interest rate environments. Based on experience, management is aware that
estimated fair values of debt securities tend to vary among brokers and other
valuation services. Accordingly, when selling debt securities, management
typically obtains price quotes from more than one source. The large majority of
the Corporation's securities are classified as available-for-sale. Accordingly,
these securities are carried at fair value on the consolidated balance
13
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
sheet, with unrealized gains and losses excluded from earnings and reported
separately through accumulated other comprehensive income (included in
stockholders' equity).
NET INTEREST MARGIN
The Corporation's primary source of operating income is represented by the net
interest margin. The net interest margin is equal to the difference between the
amounts of interest income and interest expense. Tables II, III and IV include
information regarding the Corporation's net interest margin for 2004 and 2003.
In each of these tables, the amounts of interest income earned on tax-exempt
securities and loans have been adjusted to a fully taxable-equivalent basis.
Accordingly, the net interest margin amounts reflected in these tables exceed
the amounts presented in the consolidated financial statements. The discussion
that follows is based on amounts in the Tables.
The net interest margin, on a tax-equivalent basis, was $19,222,000 in 2004, an
increase of $1,855,000, or 10.7%, over 2003. As reflected in Table IV, the
increase in net interest margin was caused primarily by the growth in volume.
Increased interest income from higher volumes of earning assets exceeded
increases in interest expense attributable to higher volumes of interest-bearing
liabilities by $1,597,000 in 2004 compared to 2003. Table IV also shows that
interest rate changes had the effect of increasing net interest income $258,000
in 2004 compared to 2003. As presented in Table III, the "Interest Rate Spread"
(excess of average rate of return on interest-bearing assets over average cost
of funds on interest-bearing liabilities) was 3.45% for the 1st six months of
2004, compared to 3.31% for the year ended December 31, 2003 and 3.30% for the
1st six months of 2003.
INTEREST INCOME AND EARNING ASSETS
Interest income increased slightly to $30,418,000 in 2004 from $29,699,000 in
2003. Income from available-for-sale securities decreased $75,000, or 0.6%,
while interest from loans increased $807,000 or 4.9%. Overall, the majority of
the increase in interest income resulted from higher volumes of loans, which
more than offset the effect of lower interest rates.
As indicated in Table III, average available-for-sale securities in 2004
amounted to $481,226,000, an increase of 0.7% over 2003. The average rate of
return on available-for-sale securities was 5.50% for the 1st six months of
2004, slightly lower than the 5.59% level in the 1st six months of 2003, but
higher than the rate of return for the year ended December 31, 2003 of 5.43%.
Table III also shows changes in the composition of the available-for-sale
securities portfolio. Municipal bonds were a larger portion of the portfolio in
the 1st six months of 2004 than in the 1st six months of 2003. The average
balance of municipal bonds grew to $161,064,000 or 33.5% of the portfolio, in
the 1st six months of 2004 from $138,811,000, or 29.1% of the portfolio, in the
1st six months of 2003. On a taxable equivalent basis, municipal bonds are the
highest yielding category of available-for-sale security. The Corporation
determines the levels of its municipal bond holdings based on income tax
planning and other considerations.
The average balance of gross loans increased 14.7% in 2004 over the 1st six
months of 2003, to $535,160,000 from $466,686,000. The largest area of growth
was real estate secured loans, with substantial increases in both residential
and commercial mortgages. The average rate of return on loans fell to 6.47% in
2004 from 7.10% in the 1st six months of 2003, due to lower market rates.
INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES
Interest expense fell $1,136,000, or 9.2%, to $11,196,000 in 2004 from
$12,332,000 in 2003. Overall, the impact of lower interest rates was more than
twice the impact of higher volumes of interest-bearing liabilities in 2004
compared to 2003. In Table IV, you can see the impact of lower interest rates on
the Corporation's major categories of interest-bearing deposits - principally,
CDs, money market accounts and IRA's. At the beginning of the second quarter of
2004, the Corporation lowered the interest rate on most of the 18-month IRAs
from 5% to 3.5%, reducing interest expense approximately $388,000 for the
quarter ended June 30, 2004.
14
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
As you can calculate from Table III, total average deposits (interest-bearing
and noninterest-bearing) increased to $660,129,000 in the 1st six months of 2004
from $647,580,000 in the 1st six months of 2003. This represents an increase of
1.9%. The largest growth categories were demand deposits, which increased
$10,249,000, or 15.3%, and IRAs, which increased $11,908,000, or 11.5%. Average
Certificates of Deposit fell 5.7% to $184,181,000 in the 1st six months of 2004
from $195,256,000 in the 1st six months of 2003. Overall, average deposit growth
has been slow in recent months. Management believes the return to positive U.S.
stock market performance has motivated some customers to move funds out of the
Bank to mutual funds and other equity securities. Also, deposits from a few of
the Corporation's Municipal and not-for-profit customers have fallen over the
last several months due to the customers' use of the funds for building projects
and other purposes. Table III reflects the downward trend in interest rates
incurred on liabilities, as the overall cost of funds on interest-bearing
liabilities fell to 2.55% for the 1st six months of 2004, from 2.84% for the
year ended December 31, 2003 and 3.02% for the 1st six months of 2003.
Average total short-term and long-term borrowed funds increased $55,633,000 to
$298,644,000 in the 1st six months of 2004 from $243,011,000 in the 1st six
months of 2003. The Corporation has utilized borrowings to fund security
purchases and to help fund loan growth during these periods of low deposit
growth.
15
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE II - ANALYSIS OF INTEREST INCOME AND EXPENSE
SIX MONTHS ENDED
JUNE 30, INCREASE/
(IN THOUSANDS) 2004 2003 (DECREASE)
INTEREST INCOME
Available-for-sale securities:
U.S. Treasury securities $ - $ - $ -
Securities of other U.S. Government agencies
and corporations 1,335 1,651 (316)
Mortgage-backed securities 3,804 4,194 (390)
Obligations of states and political subdivisions 5,720 5,219 501
Equity securities 706 501 205
Other securities 1,605 1,680 (75)
------- ------- -------
Total available-for-sale securities 13,170 13,245 (75)
------- ------- -------
Held-to-maturity securities:
U.S. Treasury securities 8 9 (1)
Securities of other U.S. Government agencies
and corporations 4 8 (4)
Mortgage-backed securities 1 2 (1)
------- ------- -------
Total held-to-maturity securities 13 19 (6)
------- ------- -------
Interest-bearing due from banks 4 7 (3)
Federal funds sold 4 8 (4)
Loans:
Real estate loans 14,123 13,278 845
Consumer 1,314 1,445 (131)
Agricultural 92 98 (6)
Commercial/industrial 1,012 1,028 (16)
Other 18 33 (15)
Political subdivisions 666 535 131
Leases 2 3 (1)
------- ------- -------
Total loans 17,227 16,420 807
------- ------- -------
Total Interest Income 30,418 29,699 719
------- ------- -------
INTEREST EXPENSE
Interest checking 114 146 (32)
Money market 1,110 1,527 (417)
Savings 139 264 (125)
Certificates of deposit 2,558 3,244 (686)
Individual Retirement Accounts 2,384 2,543 (159)
Other time deposits 3 7 (4)
Federal funds purchased 50 31 19
Other borrowed funds 4,838 4,570 268
------- ------- -------
Total Interest Expense 11,196 12,332 (1,136)
------- ------- -------
Net Interest Income $19,222 $17,367 $ 1,855
======= ======= =======
Note: Interest income from tax-exempt securities and loans has been adjusted to
a fully tax-equivalent basis, using the Corporation's marginal federal income
tax rate of 34%.
16
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE IIL - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES
(DOLLARS IN THOUSANDS)
6 MONTHS YEAR 6 MONTHS
ENDED RATE OF ENDED RATE OF ENDED RATE OF
6/30/2004 RETURN/ 12/31/2003 RETURN/ 6/30/2003 RETURN/
AVERAGE COST OF AVERAGE COST OF AVERAGE COST OF
BALANCE FUNDS % BALANCE FUNDS % BALANCE FUNDS %
EARNING ASSETS
Available-for-sale securities, at amortized cost:
U.S. Treasury securities $ - 0.00% $ - 0.00% $ - 0.00%
Securities of other U.S. Government agencies and corporations 58,370 4.60% 67,218 4.72% 67,609 4.92%
Mortgage-backed securities 179,091 4.27% 176,800 4.20% 187,774 4.50%
Obligations of states and political subdivisions 161,064 7.14% 146,371 7.36% 138,811 7.58%
Equity securities 29,998 4.73% 28,084 4.16% 25,490 3.96%
Other securities 52,703 6.12% 52,980 5.76% 58,022 5.84%
----------- ---- ---------- ---- ---------- ----
Total available-for-sale securities 481,226 5.50% 471,453 5.43% 477,706 5.59%
----------- ---- ---------- ---- ---------- ----
Held-to-maturity securities:
U.S. Treasury securities 318 5.06% 320 5.31% 321 5.65%
Securities of other U.S. Government agencies and corporations 126 6.38% 220 5.00% 240 6.72%
Mortgage-backed securities 35 5.75% 64 4.69% 77 5.24%
----------- ---- ---------- ---- ---------- ----
Total held-to-maturity securities 479 5.46% 604 5.13% 638 6.01%
----------- ---- ---------- ---- ---------- ----
Interest-bearing due from banks 1,147 0.70% 1,669 0.60% 1,626 0.87%
Federal funds sold 798 1.01% 680 1.18% 1,296 1.24%
Loans:
Real estate loans 443,325 6.41% 399,353 6.79% 383,049 6.99%
Consumer 33,029 8.00% 32,386 8.75% 32,166 9.06%
Agricultural 2,859 6.47% 2,924 6.81% 2,796 7.07%
Commercial/industrial 35,176 5.79% 32,909 6.15% 31,994 6.48%
Other 594 6.09% 851 6.58% 990 6.72%
Political subdivisions 20,113 6.66% 16,649 6.87% 15,605 6.91%
Leases 64 6.28% 78 6.41% 86 7.03%
----------- ---- ---------- ---- ---------- ----
Total loans 535,160 6.47% 485,150 6.88% 466,686 7.10%
----------- ---- ---------- ---- ---------- ----
Total Earning Assets 1,018,810 6.00% 959,556 6.15% 947,952 6.32%
Cash 14,325 13,583 12,886
Unrealized gain/loss on securities 18,619 20,296 21,606
Allowance for loan losses (6,336) (5,908) (5,839)
Bank premises and equipment 13,741 11,090 10,471
Other assets 37,810 36,103 35,449
----------- ---------- ----------
Total Assets $ 1,096,969 $1,034,720 $1,022,525
=========== ========== ==========
INTEREST-BEARING LIABILITIES
Interest checking $ 39,500 0.58% $ 37,647 0.71% $ 36,814 0.80%
Money market 186,101 1.20% 190,161 1.43% 189,570 1.62%
Savings 56,118 0.50% 54,789 0.78% 53,439 1.00%
Certificates of deposit 184,181 2.79% 190,019 3.14% 195,256 3.35%
Individual Retirement Accounts 115,706 4.14% 106,216 4.88% 103,798 4.94%
Other time deposits 1,232 0.49% 1,666 1.02% 1,661 0.85%
Federal funds purchased 8,298 1.21% 7,033 1.29% 4,212 1.48%
Other borrowed funds 290,346 3.35% 242,358 3.67% 238,799 3.86%
----------- ---- ---------- ---- ---------- ----
Total Interest-bearing Liabilities 881,482 2.55% 829,889 2.84% 823,549 3.02%
Demand deposits 77,291 70,528 67,042
Other liabilities 9,856 12,032 11,293
----------- ---------- ----------
Total Liabilities 968,629 912,449 901,884
----------- ---------- ----------
Stockholders' equity, excluding other comprehensive income/loss 116,052 108,876 106,382
Other comprehensive income/loss 12,288 13,395 14,259
----------- ---------- ----------
Total Stockholders' Equity 128,340 122,271 120,641
----------- ---------- ----------
Total Liabilities and Stockholders' Equity $ 1,096,969 $1,034,720 $1,022,525
=========== ========== ==========
Interest Rate Spread 3.45% 3.31% 3.30%
Net Interest Income/Earning Assets 3.79% 3.70% 3.69%
(1) Rates of return on tax-exempt securities and loans are presented on a fully
taxable-equivalent basis.
(2) Nonaccrual loans have been included with loans for the purpose of analyzing
net interest earnings.
17
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE IV - ANALYSIS OF VOLUME AND RATE CHANGES
(IN THOUSANDS)
YTD ENDED 6/30/04 VS. 6/30/03
CHANGE IN CHANGE IN TOTAL
VOLUME RATE CHANGE
EARNING ASSETS
Available-for-sale securities:
U.S. Treasury securities $ - $ - $ -
Securities of other U.S. Government agencies
and corporations (213) (103) (316)
Mortgage-backed securities (184) (206) (390)
Obligations of states and political subdivisions 814 (313) 501
Equity securities 98 107 205
Other securities (156) 81 (75)
------- ------- -------
Total available-for-sale securities 359 (434) (75)
------- ------- -------
Held-to-maturity securities:
U.S. Treasury securities - (1) (1)
Securities of other U.S. Government agencies
and corporations (4) - (4)
Mortgage-backed securities (1) - (1)
------- ------- -------
Total held-to-maturity securities (5) (1) (6)
------- ------- -------
Interest-bearing due from banks (2) (1) (3)
Federal funds sold (2) (2) (4)
Loans:
Real estate loans 2,005 (1,160) 845
Consumer 39 (170) (131)
Agricultural 2 (8) (6)
Commercial/industrial 99 (115) (16)
Other (12) (3) (15)
Political subdivisions 151 (20) 131
Leases (1) - (1)
------- ------- -------
Total loans 2,283 (1,476) 807
------- ------- -------
Total Interest Income 2,633 (1,914) 719
------- ------- -------
INTEREST-BEARING LIABILITIES
Interest checking 10 (42) (32)
Money market (27) (390) (417)
Savings 12 (137) (125)
Certificates of deposit (175) (511) (686)
Individual Retirement Accounts 276 (435) (159)
Other time deposits (2) (2) (4)
Federal funds purchased 26 (7) 19
Other borrowed funds 916 (648) 268
------- ------- -------
Total Interest Expense 1,036 (2,172) (1,136)
------- ------- -------
Net Interest Income $ 1,597 $ 258 $ 1,855
======= ======= =======
(1) Changes in income on tax-exempt securities and loans is presented on a fully
taxable-equivalent basis, using the Corporation's marginal federal income tax
rate of 34%.
(2) The change in interest due to both volume and rates has been allocated to
volume and rate changes in proportion to the relationship of the absolute dollar
amount of the change in each.
18
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE V - COMPARISON OF NONINTEREST INCOME
(IN THOUSANDS)
6 MONTHS ENDED
JUNE 30, JUNE 30,
2004 2003
Service charges on deposit accounts $ 874 $ 855
Service charges and fees 131 119
Trust and financial management revenue 1,030 845
Insurance commissions, fees and premiums 219 157
Increase in cash surrender value of life insurance 312 377
Fees related to credit card operation 409 357
Other operating income 505 458
------ ------
Total other operating income, before realized
gains on securities, net 3,480 3,168
Realized gains on securities, net 1,285 2,629
------ ------
Total Other Income $4,765 $5,797
====== ======
Total noninterest income decreased $1,032,000, or 17.8%, in 2004 compared to
2003. The most significant change - the decrease in net realized security gains
- - is discussed in the "Earnings Overview" section of Management's Discussion and
Analysis. Other items of significance are as follows:
- - Trust and financial management revenue increased $185,000, or 21.9%, for
2004 versus 2003. Trust and financial management revenue is affected
significantly by the market value of assets under management. As of June
30, 2004, the value of trust assets under management amounted to
$359,230,000, an increase of $55,007,000 or 18.1% from $304,223,000, as of
June 30, 2003.
- - Insurance commissions and fees rose $62,000, or 39.5%, for 2004 compared
to 2003. The increase in insurance-related revenues had 2 components: (1)
an increase in revenues of $45,000 from Bucktail Life Insurance Company
("Bucktail"), a subsidiary of the Corporation that reinsures credit and
mortgage life and accident and health insurance, and (2) an increase in
revenues of $17,000 from the insurance division of C & N Financial
Services Corporation ("C&NFSC"). C&NFSC insurance revenues amounted to
$75,000 in 2004 and $58,000 in 2003.
- - Credit card fee income has increased mainly due to the formation of a
"Reward Card Program" which pays users a rebate for using their credit
card. This program was started in April 2003 and has had the desired
effect of raising card usage. This, along with an increased rate on
interchange fees, has raised overall credit card fees $52,000 or 14.6% to
$409,000 in 2004 compared to $357,000 in 2003.
- - Other operating income rose $47,000 or 10.3% in 2004 compared to 2003. The
largest contributors to this increase were an increase in revenues from
C&NFSC's brokerage services to $109,000 in 2004, an increase of $64,000
over 2003.
- - The increase in cash surrender value of life insurance fell $65,000, or
17.2%, to $312,000 in 2004 from $377,000 in 2003. The Corporation's policy
return is determined, in part, by the earnings generated from a pooled
separate investment trust held by the life insurance company. In 2004, the
earnings on that pooled separate trust fund have been lower than in 2003,
which is reflective of lower market yields on debt securities.
19
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE VI- COMPARISON OF NONINTEREST EXPENSE
(IN THOUSANDS)
6 MONTHS ENDED
JUNE 30, JUNE 30,
2004 2003
Salaries and wages $ 5,400 $ 4,773
Pensions and other employee benefits 1,812 1,660
Occupancy expense, net 737 657
Furniture and equipment expense 724 684
Pennsylvania shares tax 423 392
Other operating expense 3,421 2,722
------- -------
Total Other Expense $12,517 $10,888
======= =======
Salaries and wages increased $627,000, or 13.1%, for 2004 compared to 2003. The
increase is mainly the result of annual merit raises, generally ranging from
2%-5%, and an increase in number of employees. The number of full-time
equivalent employees increased 10.8% to 298 as of June 30, 2004 from 269 as of
June 30, 2003.
Pensions and other employee benefits increased $152,000 or 9.2% in 2004 over
2003. The largest expense increases within this category were increases of
$62,000 in health insurance expense, $32,000 in payroll taxes, $28,000 in
Savings & Retirement (401(k)) expense, and $22,000 in unemployment compensation
expense. In addition to the impact of more employees and a higher salary base,
health care and unemployment rates were higher in 2004 than in 2003.
Occupancy Expense rose $80,000, or 12.2% in 2004 compared to 2003. The majority
of this increase is directly related to the general overall increase in utility
rates, coupled with the addition of the Williamsport facility. Light, fuel and
water expense rose $47,000, or 38.6%, in 2004 over 2003. Depreciation expense
rose $30,000, or 12.8%, due to higher depreciation from branch remodeling
projects that were completed in 2003.
Other Operating Expense increased $699,000 or 25.7% in 2004 compared to 2003.
Overall, the increase in Other Operating Expense resulted from higher volumes of
loans and other transactions, start-up of the Williamsport facility, the
implementation of the core computer system conversion and other activities that
have resulted in more expenses incidental to personnel and technology. The
largest increases in expenses within this category were as follows:
- Professional fees, $153,000, $114,000 of which is directly related
to the core computer system conversion.
- Expenses related to Bucktail Insurance Company, $88,000
- Employee tuition and education, $86,000
- Office supplies, $73,000
FINANCIAL CONDITION
Significant changes in the average balances of the Corporation's earning assets
and interest-bearing liabilities are described in the "Net Interest Margin"
section of Management's Discussion and Analysis. The allowance for loan losses
and stockholders' equity are discussed in separate sections of Management's
Discussion and Analysis. The following are significant changes in the
Corporation's consolidated balance sheet as of June 30, 2004 compared to
December 31, 2003, other than the items addressed in those discussions:
- - As reflected in the consolidated balance sheet, the carrying value of
available-for-sale securities rose to $503,700,000 at June 30, 2004 from
$483,032,000 at December 31, 2003. The largest increase in
available-for-sale securities has been in Other Securities, which
increased to a carrying value of $64,520,000 at June 30, 2004 from
$47,648,000 at December 31, 2003. The Corporation purchased approximately
$21,000,000 of Trust Preferred securities in 2004. Also mortgage-backed
securities increased to $181,723,000 at June 30, 2004 from $169,208,000 at
December 31, 2003. Management identified opportunities to purchase
mortgage-backed securities in 2004 and entered into long-term repurchase
agreements to fund them.
20
- - Accumulated other comprehensive income fell to $4,097,000 at June 30, 2004
from $12,037,000 at December 31, 2003. The balance in accumulated other
comprehensive income is equal to the amount of unrealized gains or losses
on available-for-sale securities, net of deferred income tax. Higher
interest rates caused the fair value of the Corporation's debt securities
(within the available-for-sale securities portfolio) to decline in the 2nd
quarter of 2004.
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses includes two components, allocated and
unallocated. The allocated component of the allowance for loan losses reflects
probable losses resulting from the analysis of individual loans and historical
loss experience, as modified for identified trends and concerns, for each loan
category. The historical loan loss experience element is determined based on the
ratio of net charge-offs to average loan balances over a five-year period, for
each significant type of loan, modified for risk adjustment factors identified
by management for each type of loan. The charge-off ratio is then applied to the
current outstanding loan balance for each type of loan (net of other loans that
are individually evaluated).
The unallocated portion of the allowance is determined based on management's
assessment of general economic conditions as well as specific economic factors
in the market area. This determination inherently involves a higher degree of
uncertainty and considers current risk factors that may not have yet manifested
themselves in the Bank's historical loss factors used to determine the allocated
component of the allowance, and it recognizes that management's knowledge of
specific losses within the portfolio may be incomplete.
As indicated in Table IX, total impaired loans increased substantially in the
first quarter 2004, to $8,722,000 at March 31, 2004 from $4,621,000 at December
31, 2003. Total impaired loans decreased slightly from the March 31, 2004
amount, to $8,322,000 at June 30, 2004. Table IX also shows that total loans
past due more than 90 days and still accruing interest increased to $5,591,000
at March 31, 2004 from $2,546,000 at December 31, 2003, then decreased to
$2,135,000 at June 30, 2004. These fluctuations resulted from management's
analysis of certain large commercial loan relationships, including one
commercial loan relationship, with total outstanding loan balances of
approximately $3.7 million as of June 30, 2004. Currently, management estimates
that payment of virtually all outstanding principal on this large relationship
will be received. Accordingly, the Corporation's allowance calculations reflect
no estimated loss as of June 30, 2004. During the second quarter 2004,
management moved the loans outstanding related to this large relationship, as
well as certain other commercial loans, into nonaccrual status. Management
believes it has been conservative in its decisions concerning identification of
impaired loans, estimates of loss and nonaccrual status. Management continues to
closely monitor these commercial loan relationships, and will adjust its
estimates of loss and decisions concerning nonaccrual status, if appropriate.
The allowance for loan losses was $6,609,000 at June 30, 2004, an increase of
$512,000 from the balance at December 31, 2003. As reflected in Table VIII, the
increase in the allowance resulted mainly from an increase in the unallocated
portion to $2,701,000 at June 30, 2004 from $2,117,000 at December 31, 2003.
Management's decision to increase the unallocated allowance resulted primarily
from the increase in impaired loans, as discussed above.
The provision for loan losses increased to $700,000 in 2004 from $600,000 in
2003. The amount of the provision in each period is determined based on the
amount required to maintain an appropriate allowance in light of the factors
described above. In 2004, the higher provision for loan losses resulted mainly
from the increase in the unallocated portion of the allowance.
As you can see in Table VII, net charge-offs totaled $188,000 in the first six
months of 2004, which is relatively low by the Corporation's recent historical
standards.
Tables VII, VIII, IX and X present an analysis of the allowance for loan losses,
the allocation of the allowance, information concerning impaired and past due
loans and a five-year summary of loans by type.
21
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE VII- ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
(IN THOUSANDS)
SIX MONTHS SIX MONTHS YEARS ENDED DECEMBER 31,
ENDED ENDED
JUNE 30, JUNE 30,
2004 2003 2003 2002 2001 2000 1999
Balance, beginning of year $6,097 $5,789 $5,789 $5,265 $5,291 $5,131 $4,820
------ ------ ------ ------ ------ ------ ------
Charge-offs:
Real estate loans 51 61 168 123 144 272 81
Installment loans 90 211 326 116 138 77 138
Credit cards and related plans 91 100 171 190 200 214 192
Commercial and other loans - 254 303 123 231 53 219
------ ------ ------ ------ ------ ------ ------
Total charge-offs 232 626 968 552 713 616 630
------ ------ ------ ------ ------ ------ ------
Recoveries:
Real estate loans 3 38 75 30 6 26 81
Installment loans 18 33 52 30 27 23 60
Credit cards and related plans 14 9 17 18 20 28 30
Commercial and other loans 9 17 32 58 34 23 10
------ ------ ------ ------ ------ ------ ------
Total recoveries 44 97 176 136 87 100 181
------ ------ ------ ------ ------ ------ ------
Net charge-offs 188 529 792 416 626 516 449
Provision for loan losses 700 600 1,100 940 600 676 760
------ ------ ------ ------ ------ ------ ------
Balance, end of year $6,609 $5,860 $6,097 $5,789 $5,265 $5,291 $5,131
====== ====== ====== ====== ====== ====== ======
TABLE VIII - ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES BY TYPE
(IN THOUSANDS)
AS OF AS OF AS OF DECEMBER 31,
JUNE 30, MARCH 31,
2004 2004 2003 2002 2001 2000 1999
Commercial $1,700 $1,606 $1,578 $1,315 $1,837 $1,612 $2,081
Consumer mortgage 472 460 456 460 674 952 834
Impaired loans 1,340 1,667 1,542 1,877 73 273 609
Consumer 396 399 404 378 494 471 437
All other commitments - - - - - - 150
Unallocated 2,701 2,238 2,117 1,759 2,187 1,983 1,020
------ ------ ------ ------ ------ ------ ------
Total Allowance $6,609 $6,370 $6,097 $5,789 $5,265 $5,291 $5,131
====== ====== ====== ====== ====== ====== ======
TABLE IX - PAST DUE AND IMPAIRED LOANS
(IN THOUSANDS)
JUNE 30, MARCH 31, DECEMBER 31,
2004 2004 2003
Impaired loans without a valuation allowance $4,056 $3,861 $ 114
Impaired loans with a valuation allowance 4,266 4,861 4,507
------ ------ ------
Total impaired loans $8,322 $8,722 $4,621
====== ====== ======
Valuation allowance related to impaired loans $1,340 $1,667 $1,542
Total nonaccrual loans $8,365 $1,359 $1,145
Total loans past due 90 days or more and
still accruing $2,135 $5,591 $2,546
22
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE X - SUMMARY OF LOANS BY TYPE
(IN THOUSANDS)
AS OF
JUNE 30, AS OF DECEMBER 31,
2004 2003 2002 2001 2000 1999
Real estate - construction $ 4,095 $ 2,856 $ 103 $ 1,814 $ 452 $ 649
Real estate - mortgage 453,540 431,047 370,453 306,264 263,325 247,604
Consumer 32,212 33,977 31,532 29,284 28,141 29,140
Agricultural 2,803 2,948 3,024 2,344 1,983 1,899
Commercial 34,717 34,967 30,874 24,696 20,776 18,050
Other 1,981 1,183 2,001 1,195 948 1,025
Political subdivisions 22,562 17,854 13,062 13,479 12,462 12,332
Lease receivables 59 65 96 152 218 222
--------- --------- --------- --------- --------- ---------
Total 551,969 524,897 451,145 379,228 328,305 310,921
Less: unearned discount - - - - - (29)
--------- --------- --------- --------- --------- ---------
551,969 524,897 451,145 379,228 328,305 310,892
Less: allowance for loan
losses (6,609) (6,097) (5,789) (5,265) (5,291) (5,131)
--------- --------- --------- --------- --------- ---------
Loans, net $ 545,360 $ 518,800 $ 445,356 $ 373,963 $ 323,014 $ 305,761
========= ========= ========= ========= ========= =========
DERIVATIVE FINANCIAL INSTRUMENTS
The Corporation utilizes derivative financial instruments related to a
certificate of deposit product called the "Index Powered Certificate of Deposit"
(IPCD). IPCDs have a term of 5 years, with interest paid at maturity based on
90% of the appreciation (as defined) in the S&P 500 index. There is no
guaranteed interest payable to a depositor of an IPCD - however, assuming an
IPCD is held to maturity, a depositor is guaranteed the return of his or her
principal, at a minimum.
Statement of Financial Accounting Standards No. 133 requires the Corporation to
separate the amount received from each IPCD issued into 2 components: (1) an
embedded derivative, and (2) the principal amount of each deposit. Embedded
derivatives are derived from the Corporation's obligation to pay each IPCD
depositor a return based on appreciation in the S&P 500 index. Embedded
derivatives are carried at fair value, and are included in other liabilities in
the consolidated balance sheet. Changes in fair value of the embedded derivative
are included in other expense in the consolidated income statement. The
difference between the contractual amount of each IPCD issued, and the amount of
the embedded derivative, is recorded as the initial deposit (included in
interest-bearing deposits in the consolidated balance sheet). Interest expense
is added to principal ratably over the term of each IPCD at an effective
interest rate that will increase the principal balance to equal the contractual
IPCD amount at maturity.
In connection with IPCD transactions, the Corporation has entered into Equity
Indexed Call Option (Swap) contracts with the Federal Home Loan Bank of
Pittsburgh (FHLB-Pittsburgh). Under the terms of the Swap contracts, the
Corporation must pay FHLB-Pittsburgh quarterly amounts calculated based on the
contractual amount of IPCDs issued times a negotiated rate. In return,
FHLB-Pittsburgh is obligated to pay the Corporation, at the time of maturity of
the IPCDs, an amount equal to 90% of the appreciation (as defined) in the S&P
500 index. If the S&P 500 index does not appreciate over the term of the related
IPCDs, the FHLB-Pittsburgh would make no payment to the Corporation. The effect
of the Swap contracts is to limit the Corporation's cost of IPCD funds to the
market rate of interest paid to FHLB-Pittsburgh. (In addition, the Corporation
pays a fee of 0.75% to a consulting firm at inception of each deposit. This fee
is amortized to interest expense over the term of the IPCDs.) Swap liabilities
are carried at fair value, and included in other liabilities in the consolidated
balance sheet. Changes in fair value of swap liabilities are included in other
expense in the consolidated income statement.
23
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Amounts recorded for IPCDs are as follows (in thousands):
JUNE 30, DEC. 31,
2004 2003
Contractual amount of IPCDs (equal
to notional amount of Swap contracts) $4,035 $3,593
Carrying value of IPCDs 3,621 3,160
Carrying value of embedded derivative liabilities 379 298
Carrying value of Swap contract liabilities 23 130
6 MONTHS 6 MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
2004 2003
Interest expense $ 69 $ 58
Other expense 1 -
LIQUIDITY
Liquidity is the ability to quickly raise cash at a reasonable cost. An adequate
liquidity position permits the Corporation to pay creditors, compensate for
unforeseen deposit fluctuations and fund unexpected loan demand. The Corporation
maintains overnight borrowing facilities with several correspondent banks that
provide a source of day-to-day liquidity. Also, the Corporation maintains
borrowing facilities with the Federal Home Loan Bank of Pittsburgh, secured by
mortgage loans and various investment securities. At June 30, 2004, the
Corporation had unused borrowing availability with correspondent banks and the
Federal Home Loan Bank of Pittsburgh totaling approximately $142,116,000.
Additionally, the Corporation uses repurchase agreements placed with brokers to
borrow funds secured by investment assets, and uses "RepoSweep" arrangements to
borrow funds from commercial banking customers on an overnight basis.
Historically, one of the tools used to monitor a bank's longer-term liquidity
situation has been the loan-to-deposit ratio. As of June 30, 2004, this ratio
was 81%, which is a moderate-to-low ratio by banking industry standards, but
higher than the Corporation's historical position in recent decades. The higher
than historical level of loans-to-deposits reflects the Corporation's very
strong loan growth over the past few years. The loan-to-deposit ratio was 79% at
December 31, 2003, 70% at December 31, 2002 and 65% at December 31, 2001.
Management believes the current, higher loan-to-deposit ratio is an indicator
that some of the Corporation's historical liquidity "cushion" has been reduced;
however, the current position continues to provide sufficient funds for
maintenance of a substantial investment securities portfolio. If required to
raise cash in an emergency situation, the Corporation could sell non-pledged
investment securities to meet its obligations. At June 30, 2004, the carrying
value of non-pledged securities was $331,491,000.
Management believes the combination of its strong capital position (discussed in
the next section), ample available borrowing facilities and moderate loan to
deposit ratio have placed the Corporation in a position of minimal short-term
and long-term liquidity risk.
STOCKHOLDERS' EQUITY AND CAPITAL ADEQUACY
The Corporation and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. For many years, the
Corporation and the Bank have maintained strong capital positions. The following
table presents consolidated capital ratios at June 30, 2004:
24
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Total capital to risk-weighted assets 19.40%
Tier 1 capital to risk-weighted assets 17.69%
Tier 1 capital to average total assets 10.67%
Management expects the Corporation and the Bank to maintain capital levels that
exceed the regulatory standards for well-capitalized institutions for the next
12 months and for the foreseeable future. Planned capital expenditures (as
discussed in the "Earnings Overview" section of Management's Discussion and
Analysis) during the next 12 months are not expected to have a detrimental
effect on capital ratios or results of operations.
INFLATION
Over the last several years, direct inflationary pressures on the Corporation's
payroll-related and other noninterest costs have been modest. The Corporation is
significantly affected by the Federal Reserve Board's efforts to control
inflation through changes in interest rates. Management monitors the impact of
economic trends, including indicators of inflationary pressure, in managing
interest rate and other financial risks.
PART I - FINANCIAL INFORMATION (CONTINUED)
ITEM 3. INTEREST RATE RISK AND MARKET RISK
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
The Corporation's two major categories of market risk, interest rate and equity
securities risk, are discussed in the following sections.
INTEREST RATE RISK
Business risk arising from changes in interest rates is a significant factor in
operating a bank. The Corporation's assets are predominantly long-term, fixed
rate loans and debt securities. Funding for these assets comes principally from
short-term deposits and borrowed funds. Accordingly, there is an inherent risk
of lower future earnings or decline in fair value of the Corporation's financial
instruments when interest rates change.
The Bank uses a simulation model to calculate the potential effects of interest
rate fluctuations on net interest income and the market value of portfolio
equity. Only assets and liabilities of the Bank are included in management's
monthly simulation model calculations. Since the Bank makes up more than 90% of
the Corporation's total assets and liabilities, and because the Bank is the
source of the most volatile interest rate risk, management does not consider it
necessary to run the model for the remaining entities within the consolidated
group. For purposes of these calculations, the market value of portfolio equity
includes the fair values of financial instruments, such as securities, loans,
deposits and borrowed funds, and the book values of nonfinancial assets and
liabilities, such as premises and equipment and accrued expenses. The model
measures and projects potential changes in net interest income, and calculates
the discounted present value of anticipated cash flows of financial instruments,
assuming an immediate increase or decrease in interest rates. Management
ordinarily runs a variety of scenarios within a range of plus or minus 50-300
basis points of current rates.
The Bank's Board of Directors has established policy guidelines for acceptable
levels of interest rate risk, based on an immediate increase or decrease in
interest rates of 200 basis points. The policy limit for fluctuation in net
interest income is minus 20% from the baseline one-year scenario. The policy
limit for market value variance is minus 30% from the baseline one-year
scenario. The most sensitive scenario presented in Table XI below is the "+200
basis points" scenario. As Table XI shows, as of June 30, 2004, the Bank's net
interest income calculation is well within the policy threshold. However, if
interest rates were to immediately increase 200 basis points, the Bank's
calculations based on the model show that the market value of portfolio equity
would decrease 37.7%, which exceeds the policy threshold. Management continually
evaluates whether to make any changes to asset or liability holdings in an
effort to reduce exposure to decline in market value in a rising interest rate
environment.
The table that follows was prepared using the simulation model described above.
The model makes estimates, at each level of interest rate change, regarding cash
flows from principal repayments on loans and mortgage-backed securities
25
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
and call activity on other investment securities. Actual results could vary
significantly from these estimates, which could result in significant
differences in the calculations of projected changes in net interest margin and
market value of portfolio equity. Also, the model does not make estimates
related to changes in the composition of the deposit portfolio that could occur
due to rate competition and the table does not necessarily reflect changes that
management would make to realign the portfolio as a result of changes in
interest rates.
TABLE XI - THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES
PERIOD ENDING JUNE 30, 2005
(IN THOUSANDS)
JUNE 30, 2004 DATA
CURRENT PLUS 200 MINUS 200
INTEREST BASIS BASIS
RATES POINTS POINTS
SCENARIO AMOUNT % CHANGE AMOUNT % CHANGE
Interest income $ 56,563 $ 59,912 $ 51,543
Interest expense 22,237 27,964 17,690
--------- --------- ---------
Net Interest Income $ 34,326 $ 31,948 -6.9% $ 33,853 -1.4%
========= ========= ==== ========= ====
Market Value of Portfolio Equity at June 30, 2004 $ 124,604 $ 77,670 -37.7% $ 154,390 23.9%
========= ========= ==== ========= ====
PERIOD ENDING DECEMBER 31, 2004
(IN THOUSANDS)
DECEMBER 31, 2003 DATA
CURRENT PLUS 200 MINUS 200
INTEREST BASIS BASIS
RATES POINTS POINTS
SCENARIO AMOUNT % CHANGE AMOUNT % CHANGE
Interest income $ 54,126 $ 58,319 $ 48,386
Interest expense 20,676 26,047 16,343
--------- --------- ---------
Net Interest Income $ 33,450 $ 32,272 -3.5% $ 32,043 -4.2%
========= ========= ===== ========= ====
Market Value of Portfolio Equity at Dec. 31, 2003 $ 123,499 $ 79,649 -35.5% $ 152,462 23.5%
========= ========= ===== ========= ====
EQUITY SECURITIES RISK
The Corporation's equity securities portfolio consists primarily of investments
in stock of banks and bank holding companies located mainly in Pennsylvania. The
Corporation also owns some other stocks and mutual funds. Included in "Other
Equity Securities" in the table that follows are preferred stocks issued by U.S.
Government agencies with a fair value of $11,026,000 at June 30, 2004 and
$11,347,000 at December 31, 2003.
Investments in bank stocks are subject to the risk factors that affect the
banking industry in general, including competition from nonbank entities, credit
risk, interest rate risk and other factors, which could result in a decline in
market prices. Also, losses could occur in individual stocks held by the
Corporation because of specific circumstances related to each bank. Further,
because of the concentration of bank and bank holding companies located in
Pennsylvania, these investments could decline in market value if there is a
downturn in the state's economy.
Equity securities held as of June 30, 2004 and December 31, 2003 are presented
in Table XII.
26
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE XII - EQUITY SECURITIES
(IN THOUSANDS)
HYPOTHETICAL HYPOTHETICAL
10% 20%
DECLINE IN DECLINE IN
FAIR MARKET MARKET
AT JUNE 30, 2004 COST VALUE VALUE VALUE
Banks and bank holding companies $ 16,741 $ 27,482 $ (2,748) $ (5,496)
Other equity securities 13,559 13,179 (1,318) (2,636)
-------- -------- --------- ----------
Total $ 30,300 $ 40,661 $ (4,066) $ (8,132)
======== ======== ========= ==========
HYPOTHETICAL HYPOTHETICAL
10% 20%
DECLINE IN DECLINE IN
FAIR MARKET MARKET
AT DECEMBER 31, 2003 COST VALUE VALUE VALUE
Banks and bank holding companies $ 16,375 $ 29,288 $ (2,929) $ (5,858)
Other equity securities 13,576 13,400 (1,340) (2,680)
-------- -------- --------- ----------
Total $ 29,951 $ 42,688 $ (4,269) $ (8,538)
======== ======== ========= ==========
PART I - FINANCIAL INFORMATION (CONTINUED)
ITEM 4. CONTROLS AND PROCEDURES
The Corporation's Chief Executive Officer and Chief Financial Officer carried
out an evaluation of the design and effectiveness of the Corporation's
disclosure controls and procedures pursuant to Rule 13a-15(e) and Rule 15d-15(e)
of the Securities Exchange Act of 1934 as of the end of the period covered by
this report. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the Corporation's disclosure controls and
procedures are effective to ensure that information required to be disclosed in
reports the Corporation files or submits under the Securities Exchange Act of
1934 is recorded, processed, summarized and reported, within the time periods
specified in the Securities and Exchange Commission's rules and forms.
There were no significant changes in the Corporation's internal control over
financial reporting that occurred during the period covered by this report that
has materially affected, or that is reasonably likely to materially affect, our
internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Corporation and the Bank are involved in various legal proceedings
incidental to their business. Management believes the aggregate liability,
if any, resulting from such pending and threatened legal proceedings will
not have a material, adverse effect on the Corporation's financial
condition or results of operations.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities
e. Issuer Purchases of Equity Securities
27
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
The following table sets forth purchases by the Corporation (on the open
market) of its equity securities during the first 6 months of 2004.
TOTAL
NUMBER OF MAXIMUM
SHARES NUMBER OF
PURCHASED SHARES
AS PART OF THAT MAY YET
TOTAL AVERAGE PUBLICLY BE PURCHASED
NUMBER OF PRICE ANNOUNCED UNDER THE
SHARES PAID PER PLANS OR PLANS OR
PERIOD PURCHASED SHARE PROGRAMS PROGRAMS
- ------------------- --------- -------------- -------------- --------------
January 1-31, 2004 - Not applicable Not applicable Not applicable
February 1-29, 2004 - Not applicable Not applicable Not applicable
March 1-31, 2004 - Not applicable Not applicable Not applicable
April 1-30, 2004 18,900 $25.12 - Not applicable
May 1-31, 2004 - Not applicable Not applicable Not applicable
June 1-30, 2004 4,000 $25.06 - Not applicable
-------- -------------- -------------- --------------
Total 22,900 $25.11 - Not applicable
======== ============== ============== ==============
There have been no publicly announced plans or programs for repurchase of
the Corporation's stock.
Item 3. Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Shareholders of Citizens & Northern Corporation was held
on Tuesday, April 20, 2004. The Board of Directors fixed the close of business
on March 8, 2004 as the record date for the determination of stockholders
entitled to notice of and to vote at the Annual Meeting and at any adjournment
thereof. On this record date, there were outstanding and entitled to vote
8,118,529 shares of Common Stock.
The total number of votes cast was 6,089,869. 436,979 were voted in person by
owners or representatives and 5,652,890 were voted by proxy for the following
purposes and with the following results.
1. The election of the following as Class II Directors to serve for a term
of three years:
R. Bruce Haner
Total Votes in Favor 6,050,382
Total Votes Against 39,487
Susan E. Hartley
Total Votes in Favor 5,922,881
Total Votes Against 166,988
Leo F. Lambert
Total Votes in Favor 5,990,757
Total Votes Against 99,112
Edward L. Learn
Total Votes in Favor 6,061,965
Total Votes Against 27,904
28
CITIZENS AND NORTHERN CORPORATION - FORM 10 - Q
Leonard Simpson
Total Votes in Favor 6,008,388
Total Votes Against 81,481
2. The ratification and approval of the Director and Executive Officer
Indemnification Program:
Total Votes in Favor 5,572,155
Total Votes Against 365,569
Total Votes Abstained 152,145
3. The approval of the increase in the aggregate number of authorized
shares of the Corporation's common stock from 10,000,000 to
20,000,000:
Total Votes in Favor 5,803,301
Total Votes Against 168,969
Total Votes Abstained 117,599
4. The ratification of the action of the Board of Directors in the
appointment of the firm of Parente Randolph, PC as independent
auditors of the Corporation:
Total Votes in Favor 6,011,429
Total Votes Against 46,825
Total Votes Abstained 31,615
Item 5. Not Applicable
Item 6. Exhibits and Reports on Form 8 - K
a. Exhibits:
Page
Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification - Chief Executive Officer 31
Exhibit 31.2 Rule 13a-14(a)/15d-14(a) Certification - Chief Financial Officer 32
Exhibit 32 Section 1350 Certifications 33
b. A Current Report on Form 8-K under Items 7 and 12, dated April 9, 2004,
was furnished to report the Corporation's consolidated earnings results
for the quarterly period ended March 31, 2004.
29
CITIZENS AND NORTHERN CORPORATION - FORM 10 - Q
Signature Page
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CITIZENS & NORTHERN CORPORATION
August 5, 2004 By: Craig G. Litchfield /s/
Date -----------------------
Chairman, President and Chief Executive Officer
August 5, 2004 By: Mark A. Hughes /s/
Date ------------------
Treasurer and Chief Financial Officer
30