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 September 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) 8,102,757 Shares Outstanding November 3, 2004
CITIZENS & NORTHERN CORPORATION
Index
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheet - September 30, 2004 and
December 31, 2003 Page 3
Consolidated Statement of Income - Three Months and
Nine Months Ended September 30, 2004 and 2003 Page 4
Consolidated Statement of Cash Flows - Nine Months
Ended September 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 28
Item 4. Controls and Procedures Page 28
Part II. Other Information Pages 28 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)
SEPTEMBER 30, DECEMBER 31,
2004 2003
(UNAUDITED) (NOTE)
------------- ------------
ASSETS
Cash and due from banks:
Noninterest-bearing $ 13,200 $ 13,938
Interest-bearing 1,082 1,233
----------- -----------
Total cash and cash equivalents 14,282 15,171
Available-for-sale securities 499,572 483,032
Held-to-maturity securities 437 560
Loans, net 564,867 518,800
Bank-owned life insurance 17,936 17,473
Accrued interest receivable 5,817 5,632
Bank premises and equipment, net 15,985 12,482
Foreclosed assets held for sale 552 101
Other assets 15,985 13,650
----------- -----------
TOTAL ASSETS $ 1,135,433 $ 1,066,901
=========== ===========
LIABILITIES
Deposits:
Noninterest-bearing $ 79,348 $ 75,616
Interest-bearing 593,527 582,449
----------- -----------
Total deposits 672,875 658,065
Dividends payable 1,783 1,763
Short-term borrowings 42,061 37,763
Long-term borrowings 279,091 235,190
Accrued interest and other liabilities 10,619 8,777
----------- -----------
TOTAL LIABILITIES 1,006,429 941,558
----------- -----------
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 22,457 20,104
Retained earnings 90,411 84,940
----------- -----------
Total 121,175 115,434
Accumulated other comprehensive income 10,235 12,037
Unamortized stock compensation (68) (54)
Treasury stock, at cost:
204,548 shares at September 30, 2004 (2,338)
211,408 shares at December 31, 2003 (2,074)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 129,004 125,343
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,135,433 $ 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
-------------------------- --------------------------
SEPT. 30, SEPT. 30, 9 MONTHS ENDED SEPT. 30,
2004 2003 2004 2003
(CURRENT) (PRIOR YEAR) (CURRENT) (PRIOR YEAR)
---------- ------------ ---------- ------------
INTEREST INCOME
Interest and fees on loans $ 8,620 $ 8,164 $ 25,181 $ 24,049
Interest on balances with depository institutions 3 1 7 8
Interest on loans to political subdivisions 260 206 713 572
Interest on federal funds sold 4 -- 8 8
Income from available-for-sale and
held-to-maturity securities:
Taxable 3,499 3,027 10,256 10,571
Tax-exempt 1,844 1,859 5,717 5,421
Dividends 343 296 1,049 797
---------- ---------- ---------- ----------
Total interest and dividend income 14,573 13,553 42,931 41,426
---------- ---------- ---------- ----------
INTEREST EXPENSE
Interest on deposits 3,086 3,470 9,394 11,201
Interest on short-term borrowings 122 121 371 362
Interest on long-term borrowings 2,457 2,064 7,096 6,424
---------- ---------- ---------- ----------
Total interest expense 5,665 5,655 16,861 17,987
---------- ---------- ---------- ----------
Interest margin 8,908 7,898 26,070 23,439
Provision for loan losses 350 250 1,050 850
---------- ---------- ---------- ----------
Interest margin after provision for loan losses 8,558 7,648 25,020 22,589
---------- ---------- ---------- ----------
OTHER INCOME
Service charges on deposit accounts 463 452 1,337 1,307
Service charges and fees 78 91 209 210
Trust and financial management income 453 413 1,483 1,258
Insurance commissions, fees and premiums 108 63 327 220
Increase in cash surrender value of life insurance 151 175 463 552
Fees related to credit card operation 159 207 568 564
Other operating income 215 304 720 762
---------- ---------- ---------- ----------
Total other income before realized gains on securities, net 1,627 1,705 5,107 4,873
Realized gains on securities, net 459 660 1,744 3,289
---------- ---------- ---------- ----------
Total other income 2,086 2,365 6,851 8,162
---------- ---------- ---------- ----------
OTHER EXPENSES
Salaries and wages 2,906 2,356 8,306 7,129
Pensions and other employee benefits 866 777 2,678 2,437
Occupancy expense, net 450 310 1,187 967
Furniture and equipment expense 437 345 1,161 1,029
Pennsylvania shares tax 212 196 635 588
Other operating expense 1,867 1,352 5,288 4,074
---------- ---------- ---------- ----------
Total other expenses 6,738 5,336 19,255 16,224
---------- ---------- ---------- ----------
Income before income tax provision 3,906 4,677 12,616 14,527
Income tax provision 501 759 1,816 2,617
---------- ---------- ---------- ----------
NET INCOME $ 3,405 $ 3,918 $ 10,800 $ 11,910
========== ========== ========== ==========
PER SHARE DATA:
Net income - basic $ 0.42 $ 0.48 $ 1.33 $ 1.47
Net income - diluted $ 0.42 $ 0.48 $ 1.32 $ 1.46
---------- ---------- ---------- ----------
Dividend per share $ 0.22 $ 0.21 $ 0.66 $ 0.63
---------- ---------- ---------- ----------
Number of shares used in computation - basic 8,101,833 8,090,861 8,104,964 8,088,632
Number of shares used in computation - diluted 8,145,950 8,151,281 8,154,129 8,135,712
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)
9 MONTHS ENDED
-------------------------
SEPT. 30, SEPT. 30,
2004 2003
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 10,800 $ 11,910
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 1,050 850
Realized gains on securities, net (1,744) (3,289)
Gain on sale of foreclosed assets, net (34) (83)
Depreciation expense 1,077 815
Accretion and amortization, net 575 1,124
Increase in cash surrender value of life insurance (463) (552)
Amortization of restricted stock 66 77
Increase in accrued interest receivable and other assets (1,535) (79)
Increase in accrued interest payable and other liabilities 2,841 2,903
--------- ---------
Net Cash Provided by Operating Activities 12,633 13,676
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturity of held-to-maturity securities 120 140
Proceeds from sales of available-for-sale securities 67,809 46,876
Proceeds from calls and maturities of available-for-sale securities 72,022 153,160
Purchase of available-for-sale securities (157,929) (168,755)
Purchase of Federal Home Loan Bank of Pittsburgh stock (2,813) (1,178)
Redemption of Federal Home Loan Bank of Pittsburgh stock 1,779 168
Net increase in loans (47,627) (55,671)
Purchase of premises and equipment (4,580) (2,505)
Proceeds from sale of foreclosed assets 93 233
--------- ---------
Net Cash Used in Investing Activities (71,126) (27,532)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 14,810 12,424
Net increase in short-term borrowings 4,298 1,532
Proceeds from long-term borrowings 73,943 46,000
Repayments of long-term borrowings (30,042) (37,518)
Purchase of treasury stock (575) (174)
Sale of treasury stock 527 141
Dividends paid (5,357) (4,991)
--------- ---------
Net Cash Provided by Financing Activities 57,604 17,414
--------- ---------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (889) 3,558
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 15,171 14,900
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 14,282 $ 18,458
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Assets acquired through foreclosure of real estate loans $ 510 $ 172
Interest paid $ 13,300 $ 14,352
Income taxes paid $ 2,438 $ 2,570
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 nine-month periods ended September 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
------------- ----------- --------
NINE MONTHS ENDED SEPT. 30, 2004
Earnings per share - basic $ 10,800,000 8,104,964 $1.33
Dilutive effect of potential common stock
arising from stock options:
Exercise of outstanding stock options 190,915
Hypothetical share repurchase at $25.38 (141,750)
------------- --------- -----
Earnings per share - diluted $ 10,800,000 8,154,129 $1.32
============= ========= =====
NINE MONTHS ENDED SEPT. 30, 2003
Earnings per share - basic $ 11,910,000 8,088,632 $1.47
Dilutive effect of potential common stock
arising from stock options:
Exercise of outstanding stock options 197,322
Hypothetical share repurchase at $23.68 (150,242)
------------- --------- -----
Earnings per share - diluted $ 11,910,000 8,135,712 $1.46
============= ========= =====
6
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
WEIGHTED-
AVERAGE EARNINGS
NET COMMON PER
INCOME SHARES SHARE
------------- ---------- --------
QUARTER ENDED SEPT. 30, 2004
Earnings per share - basic $ 3,405,000 8,101,833 $0.42
Dilutive effect of potential common stock
arising from stock options:
Exercise of outstanding stock options 184,187
Hypothetical share repurchase at $24.83 (140,070)
------------ --------- -----
Earnings per share - diluted $ 3,405,000 8,145,950 $0.42
============ ========= =====
QUARTER ENDED SEPT. 30, 2003
Earnings per share - basic $ 3,918,000 8,090,861 $0.48
Dilutive effect of potential common stock
arising from stock options:
Exercise of outstanding stock options 216,930
Hypothetical share repurchase at $26.01 (156,510)
------------ --------- -----
Earnings per share - diluted $ 3,918,000 8,151,281 $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)
FISCAL YEAR-TO-DATE
3 MONTHS ENDED 9 MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
2004 2003 2004 2003
------ ------ ------- ------
Net income, as reported $3,405 $3,918 $10,800 $11,910
Deduct: Total stock option compensation
expense determined under fair value
method for all awards, net of tax effects (5) (9) (96) (115)
------ ------ ------- -------
Pro forma net income $3,400 $3,909 $10,704 $11,795
====== ====== ======= =======
Earnings per share-basic
As reported $ 0.42 $ 0.48 $ 1.33 $ 1.47
Pro forma $ 0.42 $ 0.48 $ 1.32 $ 1.46
Earnings per share-diluted
As reported $ 0.42 $ 0.48 $ 1.32 $ 1.46
Pro forma $ 0.42 $ 0.48 $ 1.31 $ 1.45
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:
(IN THOUSANDS)
3 MONTHS ENDED 9 MONTHS ENDED
------------------------------- --------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
------------ ------------- ------------- ------------
Net income $ 3,405 $ 3,918 $ 10,800 $ 11,910
Other comprehensive income (loss):
Unrealized holding gains (losses) on available-for-sale
securities:
Gains (losses) arising during the period 9,760 (4,199) (988) 2,291
Reclassification adjustment for realized gains (459) (660) (1,744) (3,289)
---------- ---------- ---------- ----------
Other comprehensive income (loss) before income tax
9,301 (4,859) (2,732) (998)
Income tax related to other comprehensive income (loss) (3,163) 1,651 929 339
---------- ---------- ---------- ----------
Other comprehensive income (loss) 6,138 (3,208) (1,802) (659)
---------- ---------- ---------- ----------
Comprehensive income $ 9,543 $ 710 $ 8,998 $ 11,251
========== ========== ========== ==========
8
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
5. SECURITIES
Amortized cost and fair value of securities at September 30, 2004 are summarized
as follows:
(IN THOUSANDS)
SEPTEMBER 30, 2004
------------------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING FAIR
COST GAINS LOSSES VALUE
----------- ------------ ------------ -------
AVAILABLE-FOR-SALE SECURITIES:
Obligations of the U.S. Treasury $ - $ - $ - $ -
Obligations of other U.S. Government agencies 50,337 268 (499) 50,106
Obligations of states and political subdivisions 134,792 4,597 (678) 138,711
Other securities 76,890 2,793 (805) 78,878
Mortgage-backed securities 191,246 1,488 (2,060) 190,674
--------- --------- -------- ---------
Total debt securities 453,265 9,146 (4,042) 458,369
Marketable equity securities 30,800 11,589 (1,186) 41,203
--------- --------- -------- ---------
Total $ 484,065 $ 20,735 $ (5,228) $ 499,572
========= ========= ======== =========
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury $ 317 $ 20 $ - $ 337
Obligations of other U.S. Government agencies 98 13 - 111
Mortgage-backed securities 22 1 - 23
--------- --------- -------- ---------
Total $ 437 $ 34 $ - $ 471
========= ========= ======== =========
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 September 30,
2004.
(IN THOUSANDS)
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL
----------------------- ---------------------- ----------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES VALUE LOSSES
------- ---------- ------ ---------- ------- ----------
AVAILABLE-FOR-SALE SECURITIES:
Obligations of the U.S. Treasury $ - $ - $ - $ - $ - $ -
Obligations of other U.S. Government agencies 5,020 (26) 9,516 (473) 14,536 (499)
Obligations of states and political subdivisions 16,248 (405) 9,799 (273) 26,047 (678)
Other securities 13,558 (556) 4,850 (249) 18,408 (805)
Mortgage-backed securities 112,934 (1,698) 16,355 (362) 129,289 (2,060)
-------- ------- -------- ------- -------- -------
Total debt securities 147,760 (2,685) 40,520 (1,357) 188,280 (4,042)
Marketable equity securities 3,616 (111) 5,032 (1,075) 8,648 (1,186)
-------- ------- -------- ------- -------- -------
Total temporarily impaired available-for-sale
securities $151,376 $(2,796) $ 45,552 $(2,432) $196,928 $(5,228)
======== ======= ======== ======= ======== =======
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 with unrealized losses at
September 30, 2004 were not other-than-temporarily impaired.
Of the total $1,186,000 unrealized losses on equity securities at September 30,
2004, $885,000 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. Accordingly, management believes this preferred
stock was not other-than-temporarily impaired at September 30, 2004. Also, for
the remaining equity securities for which fair value was less than cost at
September 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:
(IN THOUSANDS)
PENSION POSTRETIREMENT
9 MONTHS ENDED 9 MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
2004 2003 2004 2003
Service cost $ 357 $ 297 $ 33 $ 24
Interest cost 465 444 48 45
Expected return on plan assets (561) (462) - -
Amortization of transition (asset) obligation (18) (18) 27 27
Recognized net actuarial loss 48 66 3 -
------ ------ ----- -----
Net periodic benefit cost $ 291 $ 327 $ 111 $ 96
====== ====== ===== =====
(IN THOUSANDS)
PENSION POSTRETIREMENT
3 MONTHS ENDED 3 MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
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 nine months of 2004, the Corporation
funded postretirement contributions totaling $36,000. 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 the 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:
o changes in monetary and fiscal policies of the Federal Reserve Board and
the U. S. Government, particularly related to changes in interest rates
o changes in general economic conditions
o legislative or regulatory changes
o downturn in demand for loan, deposit and other financial services in the
Corporation's market area
o increased competition from other banks and non-bank providers of financial
services
o technological changes and increased technology-related costs
o 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 nine months ended September 30, 2004,
and similarly, references to "2003" are intended to mean the nine months ended
September 30, 2003.
EARNINGS OVERVIEW
Net income for 2004 was $10,800,000, or $1.33 per share - basic and $1.32 per
share diluted. This represents a decrease in net income of 9.3% from 2003.
Return on average assets was 1.30% in 2004, down from 1.54% in 2003. Return on
average equity decreased to 11.28% in 2004 from 13.10% in 2003.
The most significant income statement changes between 2004 and 2003 were as
follows:
o In 2004, two significant initiatives affected profitability: (1)
pre-tax losses of $539,000 from start-up expenses and operations of
two new branches - the Williamsport branch, which opened June 4, and
the South Williamsport branch, which opened in September, and (2)
non-payroll expenses of $512,000 related to conversion to new core
banking software (implemented in October 2004).
11
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
o Other (noninterest) expenses increased $3,031,000, or 18.7%, in 2004
compared to 2003. In addition to the effects of the new branches and
computer system, payroll costs increased substantially, primarily from
the addition of several new employees for Lending, Trust and Financial
Management, Employee Training and other duties. Also, building-related
expenses and other computer-related expenses were up in the first nine
months of 2004 compared to the same period in 2003. Increases in other
expenses are described in the "Noninterest Expense" section of
Management's Discussion and Analysis.
o Net realized gains on securities were $1,744,000 in 2004, compared to
$3,289,000 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
$1,259,000 in 2004 and $1,972,000 in 2003. Net security gains from
debt securities amounted to $485,000 in 2004 and $1,317,000 in 2003,
and consisted mainly of sales and calls of Municipal and U.S. Agency
bonds.
o The interest margin increased $2,631,000, or 11.2%, to $26,070,000 in
2004 from $23,439,000 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.
o The income tax provision decreased to $1,816,000 in 2004 from
$2,617,000 in 2003. While pre-tax income has decreased, the
Corporation's effective tax rate has also fallen to 14.4% in 2004 from
18.0% in 2003. This lower effective tax rate was affected by higher
tax-exempt interest from obligations of states and political
subdivisions, as a percentage of total revenue.
THIRD QUARTER 2004
Net income for the third quarter 2004 was $3,405,000, a decrease of $513,000
(13.1%) from the third quarter 2003. Net income per share was $0.42 (Basic and
Diluted) for the third quarter 2004, as compared to $0.48 (Basic and Diluted)
for the third quarter 2003.
Net Income for the third quarter 2004 was down $284,000 (7.7%) from the second
quarter 2004. As shown in Table I, other expenses increased $449,000 in the
third quarter 2004, as compared to the second quarter. Non-payroll related core
banking system expenses amounted to $329,000 in the third quarter 2004. Also,
other income fell $228,000 in the third quarter from the previous quarter. Trust
and Financial Management revenue was $120,000 lower in the third quarter than in
the second quarter, primarily because of timing issues (June 30 and December 31
are the most common billing dates for Trust services). Credit card fees and
other operating income were also lower in the third quarter 2004 than in the
previous quarter.
12
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE I - QUARTERLY FINANCIAL DATA
(IN THOUSANDS)
SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
2004 2004 2004 2003 2003 2003 2003
--------- -------- -------- -------- --------- -------- --------
Interest income $14,573 $14,343 $14,015 $13,797 $13,553 $13,943 $13,930
Interest expense 5,665 5,493 5,703 5,550 5,655 6,089 6,243
------- ------- ------- ------- ------- ------- -------
Interest margin 8,908 8,850 8,312 8,247 7,898 7,854 7,687
Provision for loan losses 350 350 350 250 250 250 350
------- ------- ------- ------- ------- ------- -------
Interest margin after provision for loan losses 8,558 8,500 7,962 7,997 7,648 7,604 7,337
Other income 1,627 1,855 1,625 1,722 1,705 1,628 1,540
Securities gains 459 321 964 1,510 660 908 1,721
Other expenses 6,738 6,289 6,228 5,890 5,336 5,356 5,532
------- ------- ------- ------- ------- ------- -------
Income before income tax provision 3,906 4,387 4,323 5,339 4,677 4,784 5,066
Income tax provision 501 698 617 992 759 864 994
------- ------- ------- ------- ------- ------- -------
Net income $ 3,405 $ 3,689 $ 3,706 $ 4,347 $ 3,918 $ 3,920 $ 4,072
======= ======= ======= ======= ======= ======= =======
Net income per share - basic $ 0.42 $ 0.46 $ 0.46 $ 0.54 $ 0.48 $ 0.48 $ 0.50
======= ======= ======= ======= ======= ======= =======
Net income per share - diluted $ 0.42 $ 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.
PROSPECTS FOR THE REMAINDER OF 2004
Management believes earnings prospects for the remainder of 2004 to be
relatively comparable to results for the first three quarters of the year. Loan
growth is expected to continue, with a great deal of commercial loan origination
activity currently ongoing. Net loans are up 13.0% as of September 30, 2004
compared to September 30, 2003. As you can see in Table I, the interest margin
has grown slightly in each of the last 6 quarters, to $8,908,000 in the 3rd
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 by .25% in June, August and September, to
its current level of 1.75%. The impact of rising rates would likely cause (on
average) deposits and borrowings 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 exceed $5 million. As
indicated in the consolidated statement of cash flows, total purchases of
premises and equipment for the first 9 months of 2004 amounted to more than $4.5
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
paid approximately $2 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 approximately $3 million. The new core computer system,
which was implemented in mid-October 2004, is expected to result in a total
capitalized cost of approximately $2.5 million. In the fourth quarter 2004,
depreciation expense will increase by approximately $100,000 as a result of the
new computer system.
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 through September 30, 2004 amounted to
approximately $92,000. This office opened for business late in the third
quarter.
13
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
In October 2004, the Corporation acquired real estate in Wellsboro for the
purpose of building an administrative facility. The purchase price included the
exchange of a building (that had been used by the Facilities Management staff)
with a book value of $105,000 at September 30, 2004 and cash of approximately
$284,000. The total project cost, including acquisition of the real estate and
the construction of the building, is estimated at between $1.3 to $2 million and
expected to be completed in 2005.
The amount of capitalized spending for 2004 is high by the Corporation's normal
historical standards. For example, average annual capital purchases from
2001-2003 amounted to $2,335,000. Management believes the expansion in Lycoming
County (Williamsport and South Williamsport) will result in future opportunities
for growth and positive contributions to net income. Further, management
believes the investments in the new computer system, and in the new
administrative facility in Wellsboro, are necessary for support of an overall
growth strategy. On a net basis, these investments may reduce earnings in 2005;
however, the effect on earnings is not expected to be material.
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 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 $29,131,000 in 2004, an
increase of $2,893,000, or 11.0%, 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 $2,287,000 in 2004 compared to 2003. Table IV also shows that
interest rate changes had the effect of increasing net interest income $606,000
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 3.44% for the 1st nine months of
2004, compared to 3.31% for the year ended December 31, 2003 and 3.29% for the
1st nine months of 2003.
14
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
INTEREST INCOME AND EARNING ASSETS
Interest income increased slightly to $45,992,000 in 2004 from $44,225,000 in
2003. Income from available-for-sale securities increased $434,000, or 2.2%, and
interest from loans increased $1,341,000 or 5.4%. 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 $484,300,000, an increase of 1.7% over 2003. The average rate of
return on available-for-sale securities was 5.44% for the 1st nine months of
2004, just slightly higher than the 5.42% level in the 1st nine months of 2003,
and 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 nine months of 2004 than in the 1st nine months of 2003. The average
balance of municipal bonds grew to $158,842,000 or 32.8% of the portfolio, in
the 1st nine months of 2004 from $142,813,000, or 30.0% of the portfolio, in the
1st nine 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 14.3% in 2004 over the 1st nine
months of 2003, to $543,700,000 from $475,830,000. 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 6.44% in
2004 from 6.99% in the 1st nine months of 2003, due to lower market rates.
INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES
Interest expense fell $1,126,000, or 6.3%, to $16,861,000 in 2004 from
$17,987,000 in 2003. Overall, the impact of lower interest rates was
significantly larger than 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.
Total average deposits (interest-bearing and noninterest-bearing) increased to
$665,713,000 in the 1st nine months of 2004 from $650,396,000 in the 1st nine
months of 2003. This represents an increase of 2.4%. The largest growth
categories were demand deposits, which increased $9,249,000, or 13.4%, and IRAs,
which increased $11,117,000, or 10.6%. Average Certificates of Deposit fell 5.3%
to $182,151,000 in the 1st nine months of 2004 from $192,405,000 in the 1st nine
months of 2003, as 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 2.52% for the 1st
nine months of 2004, from 2.84% for the year ended December 31, 2003 and 2.90%
for the 1st nine months of 2003.
Average total short-term and long-term borrowed funds increased $58,025,000 to
$304,561,000 in the 1st nine months of 2004 from $246,536,000 in the 1st nine
months of 2003. The Corporation has utilized borrowings to fund security
purchases and to help fund loan growth during this period of relatively low
deposit growth.
15
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE II - ANALYSIS OF INTEREST INCOME AND EXPENSE
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
------------------- INCREASE/
2004 2003 (DECREASE)
------- ------- ----------
INTEREST INCOME
Available-for-sale securities:
U.S. Treasury securities $ -- $ -- $ --
Securities of other U.S. Government agencies
and corporations 1,977 2,461 (484)
Mortgage-backed securities 5,676 5,717 (41)
Obligations of states and political subdivisions 8,441 7,952 489
Equity securities 1,049 797 252
Other securities 2,584 2,366 218
------- ------- -------
Total available-for-sale securities 19,727 19,293 434
------- ------- -------
Held-to-maturity securities:
U.S. Treasury securities 13 13 --
Securities of other U.S. Government agencies
and corporations 6 11 (5)
Mortgage-backed securities 1 3 (2)
------- ------- -------
Total held-to-maturity securities 20 27 (7)
------- ------- -------
Interest-bearing due from banks 7 8 (1)
Federal funds sold 8 8 --
Loans:
Real estate loans 21,502 20,212 1,290
Consumer 1,943 2,177 (234)
Agricultural 138 148 (10)
Commercial/industrial 1,566 1,463 103
Other 28 45 (17)
Political subdivisions 1,050 839 211
Leases 3 5 (2)
------- ------- -------
Total loans 26,230 24,889 1,341
------- ------- -------
Total Interest Income 45,992 44,225 1,767
------- ------- -------
INTEREST EXPENSE
Interest checking 173 207 (34)
Money market 1,748 2,113 (365)
Savings 211 355 (144)
Certificates of deposit 3,839 4,653 (814)
Individual Retirement Accounts 3,418 3,858 (440)
Other time deposits 5 15 (10)
Federal funds purchased 70 67 3
Other borrowed funds 7,397 6,719 678
------- ------- -------
Total Interest Expense 16,861 17,987 (1,126)
------- ------- -------
Net Interest Income $29,131 $26,238 $ 2,893
======= ======= =======
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 III - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES
(DOLLARS IN THOUSANDS)
9 MONTHS YEAR 9 MONTHS
ENDED RATE OF ENDED RATE OF ENDED RATE OF
9/30/2004 RETURN/ 12/31/2003 RETURN/ 9/30/2003 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 58,022 4.55% 67,218 4.72% 68,743 4.79%
Mortgage-backed securities 179,015 4.24% 176,800 4.20% 181,935 4.20%
Obligations of states and political subdivisions 158,842 7.10% 146,371 7.36% 142,813 7.44%
Equity securities 30,200 4.64% 28,084 4.16% 27,321 3.90%
Other securities 58,221 5.93% 52,980 5.76% 55,284 5.72%
---------- ----- ---------- ----- ---------- -----
Total available-for-sale securities 484,300 5.44% 471,453 5.43% 476,096 5.42%
---------- ----- ---------- ----- ---------- -----
Held-to-maturity securities:
U.S. Treasury securities 317 5.48% 320 5.31% 320 5.43%
Securities of other U.S. Government agencies
and corporations 117 6.85% 220 5.00% 226 6.51%
Mortgage-backed securities 32 4.17% 64 4.69% 71 5.65%
---------- ----- ---------- ----- ---------- -----
Total held-to-maturity securities 466 5.73% 604 5.13% 617 5.85%
---------- ----- ---------- ----- ---------- -----
Interest-bearing due from banks 1,249 0.75% 1,669 0.60% 1,463 0.73%
Federal funds sold 894 1.20% 680 1.18% 890 1.20%
Loans:
Real estate loans 450,870 6.37% 399,353 6.79% 390,911 6.91%
Consumer 32,835 7.90% 32,386 8.75% 32,090 9.07%
Agricultural 2,838 6.50% 2,924 6.81% 2,859 6.92%
Commercial/industrial 35,267 5.93% 32,909 6.15% 32,720 5.98%
Other 608 6.15% 851 6.58% 904 6.66%
Political subdivisions 21,221 6.61% 16,649 6.87% 16,265 6.90%
Leases 61 6.57% 78 6.41% 81 8.25%
---------- ----- ---------- ----- ---------- -----
Total loans 543,700 6.44% 485,150 6.88% 475,830 6.99%
---------- ----- ---------- ----- ---------- -----
Total Earning Assets 1,030,609 5.96% 959,556 6.15% 954,896 6.19%
Cash 14,722 13,583 13,345
Unrealized gain/loss on securities 16,454 20,296 20,666
Allowance for loan losses (6,466) (5,908) (5,877)
Bank premises and equipment 14,428 11,090 10,696
Other assets 38,006 36,103 35,912
---------- ---------- ----------
Total Assets $1,107,753 $1,034,720 $1,029,638
========== ========== ==========
INTEREST-BEARING LIABILITIES
Interest checking $ 39,594 0.58% $ 37,647 0.71% $ 37,675 0.73%
Money market 191,363 1.22% 190,161 1.43% 189,751 1.49%
Savings 56,685 0.50% 54,789 0.78% 54,523 0.87%
Certificates of deposit 182,151 2.82% 190,019 3.14% 192,405 3.23%
Individual Retirement Accounts 116,315 3.93% 106,216 4.88% 105,198 4.90%
Other time deposits 1,453 0.46% 1,666 1.02% 1,941 1.03%
Federal funds purchased 6,978 1.34% 7,033 1.29% 6,778 1.32%
Other borrowed funds 297,583 3.32% 242,358 3.67% 239,758 3.75%
---------- ----- ---------- ----- ---------- -----
Total Interest-bearing Liabilities 892,122 2.52% 829,889 2.84% 828,029 2.90%
Demand deposits 78,152 70,528 68,903
Other liabilities 9,792 12,032 11,506
---------- ---------- ----------
Total Liabilities 980,066 912,449 908,438
---------- ---------- ----------
Stockholders' equity, excluding other comprehensive
income/loss 116,828 108,876 107,561
Other comprehensive income/loss 10,859 13,395 13,639
---------- ---------- ----------
Total Stockholders' Equity 127,687 122,271 121,200
---------- ---------- ----------
Total Liabilities and Stockholders' Equity $1,107,753 $1,034,720 $1,029,638
========== ========== ==========
Interest Rate Spread 3.44% 3.31% 3.29%
Net Interest Income/Earning Assets 3.78% 3.70% 3.67%
(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 9/30/04 VS. 9/30/03
------------------------------------
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 (368) (116) (484)
Mortgage-backed securities (89) 48 (41)
Obligations of states and political subdivisions 869 (380) 489
Equity securities 90 162 252
Other securities 130 88 218
------- ------- -------
Total available-for-sale securities 632 (198) 434
------- ------- -------
Held-to-maturity securities:
U.S. Treasury securities -- -- --
Securities of other U.S. Government agencies
and corporations (6) 1 (5)
Mortgage-backed securities (1) (1) (2)
------- ------- -------
Total held-to-maturity securities (7) -- (7)
------- ------- -------
Interest-bearing due from banks (1) -- (1)
Federal funds sold -- -- --
Loans:
Real estate loans 2,954 (1,664) 1,290
Consumer 50 (284) (234)
Agricultural (1) (9) (10)
Commercial/industrial 114 (11) 103
Other (14) (3) (17)
Political subdivisions 247 (36) 211
Leases (1) (1) (2)
------- ------- -------
Total loans 3,349 (2,008) 1,341
------- ------- -------
Total Interest Income 3,973 (2,206) 1,767
------- ------- -------
INTEREST-BEARING LIABILITIES
Interest checking 11 (45) (34)
Money market 18 (383) (365)
Savings 13 (157) (144)
Certificates of deposit (237) (577) (814)
Individual Retirement Accounts 381 (821) (440)
Other time deposits (3) (7) (10)
Federal funds purchased 2 1 3
Other borrowed funds 1,501 (823) 678
------- ------- -------
Total Interest Expense 1,686 (2,812) (1,126)
------- ------- -------
Net Interest Income $ 2,287 $ 606 $ 2,893
======= ======= =======
(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)
9 MONTHS ENDED
----------------------------
SEPTEMBER 30, SEPTEMBER 30,
2004 2003
------------ -------------
Service charges on deposit accounts $1,337 $1,307
Service charges and fees 209 210
Trust and financial management revenue 1,483 1,258
Insurance commissions, fees and premiums 327 220
Increase in cash surrender value of life insurance 463 552
Fees related to credit card operation 568 564
Other operating income 720 762
------ ------
Total other operating income, before realized
gains on securities, net 5,107 4,873
Realized gains on securities, net 1,744 3,289
------ ------
Total Other Income $6,851 $8,162
====== ======
Total noninterest income decreased $1,311,000, or 16.1%, 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:
o Trust and financial management revenue increased $225,000, or 17.9%, for
2004 versus 2003. Trust and financial management revenue is affected
significantly by the market value of assets under management. As of
September 30, 2004, the value of trust assets under management amounted to
$358,349,000, an increase of $50,726,000 or 16.5% from $307,623,000, as of
September 30, 2003.
o Insurance commissions and fees rose $107,000, or 48.6%, for 2004 compared
to 2003. The increase in insurance-related revenues had 2 components: (1)
an increase in revenues of $79,000 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 $28,000 from the insurance division of C & N Financial Services
Corporation ("C&NFSC"). C&NFSC insurance revenues amounted to $113,000 in
2004 and $85,000 in 2003.
o The increase in cash surrender value of life insurance fell $89,000, or
16.1%, to $463,000 in 2004 from $552,000 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 reflects lower market yields on debt securities held in that trust
fund.
TABLE VI- COMPARISON OF NONINTEREST EXPENSE
(IN THOUSANDS)
9 MONTHS ENDED
-----------------------------
SEPTEMBER 30, SEPTEMBER 30,
2004 2003
------------ -------------
Salaries and wages $ 8,306 $ 7,129
Pensions and other employee benefits 2,678 2,437
Occupancy expense, net 1,187 967
Furniture and equipment expense 1,161 1,029
Pennsylvania shares tax 635 588
Other operating expense 5,288 4,074
------- -------
Total Other Expense $19,255 $16,224
======= =======
Salaries and wages increased $1,177,000, or 16.5%, 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 12.5% to 316 as of September 30, 2004 from 281 as
of September 30, 2003.
19
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Pensions and other employee benefits increased $241,000 or 9.9% in 2004 over
2003. The largest expense increases within this category were increases of
$96,000 in Savings & Retirement (401(k)) expense, $89,000 in health insurance
expense, $67,000 in payroll taxes, and $26,000 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 $220,000, or 22.8% 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 and South Williamsport
facilities. Building maintenance and repairs increased $75,000, or 45%, in 2004
over 2003. Light, fuel and water expense rose $63,000, or 37.8%, in 2004 over
2003. Depreciation expense rose $59,000, or 16.5%, due to higher depreciation
from branch remodeling projects that were completed in 2003.
Other Operating Expense increased $1,214,000 or 29.8% 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 and South
Williamsport facilities, 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:
o Professional fees, $331,000, $289,000 of which is directly related to
the core computer system conversion.
o Employee tuition and education, $169,000
o Office supplies, $163,000
o Expenses related to Bucktail Life Insurance Company, $148,000
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 only significant change in the Corporation's
consolidated balance sheet as of September 30, 2004 compared to December 31,
2003, other than the items addressed in those discussions, relates to
available-for-sale securities which rose to $499,572,000 at September 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 $78,878,000 at September 30, 2004 from $47,648,000 at December
31, 2003. The Corporation purchased approximately $34,000,000 of Trust Preferred
and CMO securities in 2004. Also mortgage-backed securities increased to
$190,674,000 at September 30, 2004 from $169,208,000 at December 31, 2003.
Obligations of state and political subdivisions (municipal bonds) fell to
$138,711,000 at September 30, 2004 from $162,418,000 at December 31, 2003.
Management sold Municipal Bonds with a carrying value of approximately
$20,000,000 in September 2004, and reinvested the proceeds in mortgage-backed
securities.
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.
20
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
As indicated in Table IX, total impaired loans amounted to $7,560,000 at
September 30, 2004. This amount of impaired loans is down from $8,322,000 at
June 30, 2004 and $8,722,000 at March 31, 2004, but still much higher than the
December 31, 2003 amount of $4,621,000. The decrease in impaired loans in the
third quarter 2004 resulted mainly from acquisition of real estate related to a
commercial loan, with a charge-off of $153,000 and transfer to foreclosed assets
of the estimated net realizable value of the real estate of $400,000, and from
principal payments totaling $514,000 from the work-out of another commercial
loan. Table IX also shows that total loans past due more than 90 days and still
accruing interest decreased to $1,589,000 at September 30, 2004, from $2,135,000
at June 30, 2004 and $5,591,000 at March 31, 2004. These fluctuations resulted
mainly from certain large commercial loan relationships, including one
commercial loan relationship with total outstanding loan balances of
approximately $3.7 million as of September 30, 2004. In the first quarter 2004,
loans to this commercial customer hit the 90-day past due category, contributing
significantly to the increase in total loans past due 90 days or more reflected
in Table IX. 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. 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 September 30, 2004. 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 $6,570,000 at September 30, 2004, an increase
of $473,000 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 $2,653,000 at September 30, 2004 from $2,117,000 at
December 31, 2003. The September 30, 2004 unallocated allowance was very
consistent with the June 30, 2004 unallocated balance of $2,701,000.
Management's decision to increase the unallocated allowance in 2004 resulted
primarily from the increase in impaired loans earlier in 2004, as discussed
above.
The provision for loan losses increased to $1,050,000 in 2004 from $850,000 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 $577,000 in the first nine
months of 2004, which is relatively comparable to 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)
9 MONTHS 9 MONTHS
ENDED ENDED YEARS ENDED DECEMBER 31,
SEPT. 30, SEPT. 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 337 162 168 123 144 272 81
Installment loans 156 299 326 116 138 77 138
Credit cards and related plans 132 137 171 190 200 214 192
Commercial and other loans 11 303 303 123 231 53 219
------ ------ ------ ------ ------ ------ ------
Total charge-offs 636 901 968 552 713 616 630
------ ------ ------ ------ ------ ------ ------
Recoveries:
Real estate loans 3 69 75 30 6 26 81
Installment loans 23 46 52 30 27 23 60
Credit cards and related plans 18 14 17 18 20 28 30
Commercial and other loans 15 31 32 58 34 23 10
------ ------ ------ ------ ------ ------ ------
Total recoveries 59 160 176 136 87 100 181
------ ------ ------ ------ ------ ------ ------
Net charge-offs 577 741 792 416 626 516 449
Provision for loan losses 1,050 850 1,100 940 600 676 760
------ ------ ------ ------ ------ ------ ------
Balance, end of period $6,570 $5,898 $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,
SEPT. 30, JUNE 30, ------------------------------------------------------
2004 2004 2003 2002 2001 2000 1999
--------- ------- ------ ------ ------ ------ ------
Commercial $1,838 $1,700 $1,578 $1,315 $1,837 $1,612 $2,081
Consumer mortgage 481 472 456 460 674 952 834
Impaired loans 1,198 1,340 1,542 1,877 73 273 609
Consumer 400 396 404 378 494 471 437
All other commitments -- -- -- -- -- -- 150
Unallocated 2,653 2,701 2,117 1,759 2,187 1,983 1,020
------ ------ ------ ------ ------ ------ ------
Total Allowance $6,570 $6,609 $6,097 $5,789 $5,265 $5,291 $5,131
====== ====== ====== ====== ====== ====== ======
TABLE IX - PAST DUE AND IMPAIRED LOANS
(IN THOUSANDS)
SEPT. 30, JUNE 30, MARCH 31, DEC. 31,
2004 2004 2004 2003
-------- -------- --------- --------
Impaired loans without a valuation allowance $3,685 $4,056 $3,861 $ 114
Impaired loans with a valuation allowance 3,875 4,266 4,861 4,507
------ ------ ------ ------
Total impaired loans $7,560 $8,322 $8,722 $4,621
====== ====== ====== ======
Valuation allowance related to impaired loans $1,198 $1,340 $1,667 $1,542
Total nonaccrual loans $7,655 $8,365 $1,359 $1,145
Total loans past due 90 days or more and
still accruing $1,589 $2,135 $5,591 $2,546
22
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE X - SUMMARY OF LOANS BY TYPE
(IN THOUSANDS)
AS OF AS OF DECEMBER 31,
SEPT. 30, -------------------------------------------------------------------------
2004 2003 2002 2001 2000 1999
--------- ---------- --------- ----------- --------- ---------
Real estate - construction $ 4,085 $ 2,856 $ 103 $ 1,814 $ 452 $ 649
Real estate - mortgage 470,578 431,047 370,453 306,264 263,325 247,604
Consumer 32,884 33,977 31,532 29,284 28,141 29,140
Agricultural 2,886 2,948 3,024 2,344 1,983 1,899
Commercial 36,654 34,967 30,874 24,696 20,776 18,050
Other 1,893 1,183 2,001 1,195 948 1,025
Political subdivisions 22,407 17,854 13,062 13,479 12,462 12,332
Lease receivables 50 65 96 152 218 222
-------- -------- -------- -------- -------- --------
Total 571,437 524,897 451,145 379,228 328,305 310,921
Less: unearned discount - - - - - (29)
-------- -------- -------- -------- -------- --------
571,437 524,897 451,145 379,228 328,305 310,892
Less: allowance for loan
losses (6,570) (6,097) (5,789) (5,265) (5,291) (5,131)
-------- -------- -------- -------- -------- --------
Loans, net $564,867 $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):
SEPT. 30, DEC. 31,
2004 2003
--------- ---------
Contractual amount of IPCDs (equal
to notional amount of Swap contracts) $ 4,035 $ 3,593
Carrying value of IPCDs 3,657 3,160
Carrying value of embedded derivative liabilities 305 298
Carrying value of Swap contract liabilities 62 130
9 MONTHS 9 MONTHS
ENDED ENDED
SEPT. 30, SEPT. 30,
2004 2003
--------- ---------
Interest expense $ 105 $ 89
Other expense 5 8
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 September 30, 2004, the
Corporation had unused borrowing availability with correspondent banks and the
Federal Home Loan Bank of Pittsburgh totaling approximately $136,887,000.
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 September 30, 2004, this
ratio was 84%, which is a moderate level 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 September 30, 2004, the
carrying value of non-pledged securities was $308,481,000.
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 September 30, 2004:
24
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Total capital to risk-weighted assets 18.92%
Tier 1 capital to risk-weighted assets 17.28%
Tier 1 capital to average total assets 10.72%
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 significantly
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. In September 2004, the Bank's policy was expanded to provide
policy limits at +/- 100, 200 and 300 basis points from current rates (the prior
policy included limits based on +/- 200 basis points change from current rates).
The new policy limits for fluctuations in net interest income are tiered from
the baseline one-year scenario. The new policy limits for market value variances
are also tiered from the baseline values based on current rates. The most
sensitive scenario presented in Table XI below is the "+300 basis points"
scenario. As Table XI shows, as of September 30, 2004, the Bank's net interest
income calculations are well within the policy threshold. However, if interest
rates were to immediately increase 300 basis points, the Bank's calculations
based on the model show that the market value of portfolio equity would decrease
47.3%, which slightly 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.
25
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
The December 31, 2003 data included in Table XI has been presented in comparison
to the new risk limits.
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 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
SEPTEMBER 30, 2004 DATA
(IN THOUSANDS)
PERIOD ENDING SEPTEMBER 30, 2005
-----------------------------------------------------------------------------
INTEREST INTEREST NET INTEREST NII NII
BASIS POINT CHANGE IN RATES INCOME EXPENSE INCOME (NII) % CHANGE RISK LIMIT
- --------------------------- ---------- ---------- -------------- ---------- ------------
+300 62,954 33,489 29,465 -15.7% 20.0%
+200 61,210 29,659 31,551 -9.7% 15.0%
+100 59,416 25,830 33,586 -3.9% 10.0%
0 57,477 22,544 34,933 0.0% 0.0%
-100 54,580 19,592 34,988 0.2% 10.0%
-200 51,973 17,230 34,743 -0.5% 15.0%
-300 49,505 16,499 33,006 -5.5% 20.0%
MARKET VALUE OF PORTFOLIO EQUITY
AT SEPTEMBER 30, 2004
---------------------------------------------
PRESENT PRESENT PRESENT
VALUE VALUE VALUE
BASIS POINT CHANGE IN RATES EQUITY % CHANGE RISK LIMIT
- --------------------------- -------- ---------- ------------
+300 74,160 -47.3% 45.0%
+200 96,252 -31.5% 35.0%
+100 119,233 -15.2% 25.0%
0 140,609 0.0% 0.0%
-100 151,990 8.1% 25.0%
-200 160,305 14.0% 35.0%
-300 171,393 21.9% 45.0%
26
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
DECEMBER 31, 2003 DATA
(IN THOUSANDS)
PERIOD ENDING DECEMBER 31, 2004
-----------------------------------------------------------------------------
INTEREST INTEREST NET INTEREST NII NII
BASIS POINT CHANGE IN RATES INCOME EXPENSE INCOME (NII) % CHANGE RISK LIMIT
- --------------------------- ---------- ---------- -------------- ---------- ------------
+300 60,287 29,227 31,060 -7.1% 20.0%
+200 58,319 26,047 32,272 -3.5% 15.0%
+100 56,293 23,003 33,290 -0.5% 10.0%
0 54,126 20,676 33,450 0.0% 0.0%
-100 50,844 18,349 32,495 -2.9% 10.0%
-200 48,386 16,343 32,043 -4.2% 15.0%
-300 46,232 15,645 30,587 -8.6% 20.0%
MARKET VALUE OF PORTFOLIO EQUITY
AT DECEMBER 31, 2003
---------------------------------------------
PRESENT PRESENT PRESENT
VALUE VALUE VALUE
BASIS POINT CHANGE IN RATES EQUITY % CHANGE RISK LIMIT
- --------------------------- -------- ---------- ------------
+300 59,637 -51.7% 45.0%
+200 79,649 -35.5% 35.0%
+100 101,318 -18.0% 25.0%
0 123,499 0.0% 0.0%
-100 138,591 12.2% 25.0%
-200 152,462 23.5% 35.0%
-300 171,534 38.9% 45.0%
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 $10,805,000 at September 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 September 30, 2004 and December 31, 2003 are
presented in Table XII.
27
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE XII - EQUITY SECURITIES
(IN THOUSANDS)
HYPOTHETICAL HYPOTHETICAL
10% 20%
DECLINE IN DECLINE IN
FAIR MARKET MARKET
AT SEPTEMBER 30, 2004 COST VALUE VALUE VALUE
- --------------------- -------- -------- ------------ ------------
Banks and bank holding companies $ 17,229 $ 28,294 $ (2,829) $ (5,659)
Other equity securities 13,571 12,909 (1,291) (2,582)
-------- -------- --------- ----------
Total $ 30,800 $ 41,203 $ (4,120) $ (8,241)
======== ======== ========= ==========
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. Unregistered Sales of Equity Securities and Use of Proceeds
None
28
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Item 3. Not Applicable
Item 4. Not Applicable
Item 5. Not Applicable
Item 6. 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
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
November 4, 2004 By: /s/ Craig G. Litchfield
- ---------------- -----------------------
Date Chairman, President and Chief Executive Officer
November 4, 2004 By: /s/ Mark A. Hughes
- ---------------- -----------------------
Date Treasurer and Chief Financial Officer
30