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, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ___________
Commission file number: 0-16084
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
----- -----
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934).
Yes No X
----- -----
(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) 8,220,791 Shares Outstanding October 28, 2005
1
CITIZENS & NORTHERN CORPORATION
Index
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheet - September 30, 2005 and
December 31, 2004 Page 3
Consolidated Statement of Income - Three Months and Nine
Months Ended September 30, 2005 and 2004 Page 4
Consolidated Statement of Cash Flows - Nine Months
Ended September 30, 2005 and 2004 Pages 5 through 6
Notes to Consolidated Financial Statements Pages 7 through 12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations Pages 12 through 25
Item 3. Quantitative and Qualitative Disclosures About
Market Risk Pages 26 through 28
Item 4. Controls and Procedures Page 28
Part II. Other Information Pages 29 through 30
Signatures Page 31
Exhibit 31.1. Rule 13a-14(a)/15d-14(a) Certification -
Chief Executive Officer Page 32
Exhibit 31.2. Rule 13a-14(a)/15d-14(a) Certification -
Chief Financial Officer Page 33
Exhibit 32. Section 1350 Certifications Page 34
2
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEET
(In Thousands Except Share Data)
SEPT. 30, DEC. 31,
2005 2004
(UNAUDITED) (NOTE)
----------- ----------
ASSETS
Cash and due from banks:
Noninterest-bearing $ 19,439 $ 14,845
Interest-bearing 12,394 4,108
---------- ----------
Total cash and cash equivalents 31,833 18,953
Available-for-sale securities 449,059 475,085
Held-to-maturity securities 424 433
Loans, net 637,646 572,826
Bank-owned life insurance 18,500 18,083
Accrued interest receivable 5,371 5,094
Bank premises and equipment, net 21,679 16,725
Foreclosed assets held for sale 153 497
Intangible asset - core deposit intangible, net 526 --
Intangible asset - goodwill 2,944 --
Other assets 15,464 15,306
---------- ----------
TOTAL ASSETS $1,183,599 $1,123,002
========== ==========
LIABILITIES
Deposits:
Noninterest-bearing $ 99,033 $ 80,378
Interest-bearing 653,975 596,167
---------- ----------
Total deposits 753,008 676,545
Dividends payable 1,891 1,864
Short-term borrowings 41,805 34,178
Long-term borrowings 246,499 270,827
Accrued interest and other liabilities 8,928 8,003
---------- ----------
TOTAL LIABILITIES 1,052,131 991,417
---------- ----------
STOCKHOLDERS' EQUITY
Common stock, par value $1.00 per share; authorized 20,000,000 shares,
issued 8,389,418 in 2005 and 8,307,305 in 2004 8,389 8,307
Stock dividend distributable -- 2,188
Paid-in capital 24,893 22,456
Retained earnings 94,697 90,484
---------- ----------
Total 127,979 123,435
Accumulated other comprehensive income 5,510 10,535
Unamortized stock compensation (74) (46)
Treasury stock, at cost:
168,927 shares at September 30, 2005 (1,947)
204,659 shares at December 31, 2004 (2,339)
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 131,468 131,585
---------- ----------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $1,183,599 $1,123,002
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
Note: The balance sheet at December 31, 2004 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 9 MONTHS ENDED
------------------------- -------------------------
SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30,
2005 2004 2005 2004
(CURRENT) (PRIOR YEAR) (CURRENT) (PRIOR YEAR)
---------- ------------ ---------- ------------
INTEREST INCOME
Interest and fees on loans $ 10,003 $ 8,620 $ 28,327 $ 25,181
Interest on balances with depository institutions 11 3 24 7
Interest on loans to political subdivisions 293 260 808 713
Interest on federal funds sold 31 4 61 8
Income from available-for-sale and
held-to-maturity securities:
Taxable 3,580 3,499 10,859 10,256
Tax-exempt 1,419 1,844 4,306 5,717
Dividends 234 343 787 1,049
---------- ---------- ---------- ----------
Total interest and dividend income 15,571 14,573 45,172 42,931
---------- ---------- ---------- ----------
INTEREST EXPENSE
Interest on deposits 3,870 3,086 10,924 9,394
Interest on short-term borrowings 337 122 894 371
Interest on long-term borrowings 2,219 2,457 6,720 7,096
---------- ---------- ---------- ----------
Total interest expense 6,426 5,665 18,538 16,861
---------- ---------- ---------- ----------
Interest margin 9,145 8,908 26,634 26,070
Provision for loan losses 375 350 1,125 1,050
---------- ---------- ---------- ----------
Interest margin after provision for loan losses 8,770 8,558 25,509 25,020
---------- ---------- ---------- ----------
OTHER INCOME
Service charges on deposit accounts 457 463 1,182 1,337
Service charges and fees 92 78 288 209
Trust and financial management revenue 539 453 1,589 1,483
Insurance commissions, fees and premiums 221 108 405 327
Increase in cash surrender value of life insurance 138 151 417 463
Fees related to credit card operation 264 159 712 568
Other operating income 438 215 1,148 720
---------- ---------- ---------- ----------
Total other income before realized gains on securities, net 2,149 1,627 5,741 5,107
Realized gains on securities, net 393 459 2,388 1,744
---------- ---------- ---------- ----------
Total other income 2,542 2,086 8,129 6,851
---------- ---------- ---------- ----------
OTHER EXPENSES
Salaries and wages 3,249 2,906 9,172 8,306
Pensions and other employee benefits 893 866 2,878 2,678
Occupancy expense, net 446 450 1,371 1,187
Furniture and equipment expense 624 437 1,922 1,161
Pennsylvania shares tax 196 212 608 635
Other operating expense 1,895 1,867 5,653 5,288
---------- ---------- ---------- ----------
Total other expenses 7,303 6,738 21,604 19,255
---------- ---------- ---------- ----------
Income before income tax provision 4,009 3,906 12,034 12,616
Income tax provision 722 501 2,154 1,816
---------- ---------- ---------- ----------
NET INCOME $ 3,287 $ 3,405 $ 9,880 $ 10,800
========== ========== ========== ==========
PER SHARE DATA:
Net income - basic $ 0.40 $ 0.42 $ 1.20 $ 1.32
Net income - diluted $ 0.40 $ 0.41 $ 1.19 $ 1.31
---------- ---------- ---------- ----------
Dividend per share $ 0.23 $ 0.22 $ 0.69 $ 0.66
---------- ---------- ---------- ----------
Number of shares used in computation - basic 8,215,365 8,182,851 8,206,438 8,186,014
Number of shares used in computation - diluted 8,283,770 8,226,968 8,270,940 8,235,179
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,
------------------------
2005 2004
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 9,880 $ 10,800
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 1,125 1,050
Realized gains on securities, net (2,388) (1,744)
Gain on sale of foreclosed assets, net (133) (34)
Depreciation expense 1,687 1,077
Accretion and amortization of securities, net 223 575
Increase in cash surrender value of life insurance (417) (463)
Amortization of restricted stock 69 66
Amortization of core deposit intangible 21 --
Increase in accrued interest receivable and other assets (1,566) (1,535)
Increase in accrued interest payable and other liabilities 2,952 2,841
--------- ---------
Net Cash Provided by Operating Activities 11,453 12,633
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturity of held-to-maturity securities 7 120
Proceeds from sales of available-for-sale securities 134,919 67,809
Proceeds from calls and maturities of available-for-sale securities 45,117 72,022
Purchase of available-for-sale securities (150,012) (157,929)
Purchase of Federal Home Loan Bank of Pittsburgh stock (3,883) (2,813)
Redemption of Federal Home Loan Bank of Pittsburgh stock 5,390 1,779
Net increase in loans (42,671) (47,627)
Purchase of premises and equipment (5,172) (4,580)
Proceeds from sale of foreclosed assets 791 93
Proceeds from acquisition of Canisteo Valley Corporation, net 202 --
--------- ---------
Net Cash Used in Investing Activities (15,313) (71,126)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 38,455 14,810
Net increase in short-term borrowings 7,627 4,298
Proceeds from long-term borrowings 18,163 73,943
Repayments of long-term borrowings (42,491) (30,042)
Purchase of treasury stock (59) (575)
Sale of treasury stock 652 527
Tax benefit from compensation plans 60 --
Dividends paid (5,667) (5,357)
--------- ---------
Net Cash Provided by Financing Activities 16,740 57,604
--------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 12,880 (889)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 18,953 15,171
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 31,833 $ 14,282
========= =========
5
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS) (UNAUDITED) (CONTINUED)
9 MONTHS ENDED SEPT. 30,
------------------------
2005 2004
------- -------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Assets acquired through foreclosure of real estate loans $ 268 $ 510
Interest paid $16,019 $13,300
Income taxes paid $ 2,092 $ 2,438
ACQUISITION OF CANISTEO VALLEY CORPORATION:
Cash and cash equivalents received $ 7,136 $ --
Cash paid for acquisition (6,934) --
------- -------
Net cash received on acquisition $ 202 $ --
======= =======
NONCASH ASSETS RECEIVED AND LIABILITIES ASSUMED FROM
ACQUISITION OF CANISTEO VALLEY CORPORATION:
Assets received:
Available for sale securities $ 9,439 $ --
Loans 23,542 --
Premises and equipment 1,469 --
Foreclosed assets 46 --
Intangible asset - core deposit intangible 547 --
Intangible asset - goodwill 2,944 --
Other assets 446 --
------- -------
Total noncash assets received $38,433 $ --
======= =======
Liabilities assumed:
Deposits $38,008 $ --
Other liabilities 627 --
------- -------
Total noncash liabilities assumed $38,635 $ --
======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
6
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, 2004, 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,
2005 might not be indicative of the results for the year ending December 31,
2005.
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 SEPTEMBER 30, 2005
Earnings per share - basic $ 9,880,000 8,206,438 $1.20
Dilutive effect of potential common stock
arising from stock options:
Exercise of outstanding stock options 215,283
Hypothetical share repurchase at $30.55 (150,781)
----------- --------- -----
Earnings per share - diluted $ 9,880,000 8,270,940 $1.19
=========== ========= =====
NINE MONTHS ENDED SEPTEMBER 30, 2004
Earnings per share - basic $10,800,000 8,186,014 $1.32
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 8,235,179 $1.31
=========== ========= =====
7
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
WEIGHTED-
AVERAGE EARNINGS
NET COMMON PER
INCOME SHARES SHARE
---------- --------- --------
QUARTER ENDED SEPTEMBER 30, 2005
Earnings per share - basic $3,287,000 8,215,365 $0.40
Dilutive effect of potential common stock
arising from stock options:
Exercise of outstanding stock options 211,805
Hypothetical share repurchase at $31.51 (143,400)
---------- --------- -----
Earnings per share - diluted $3,287,000 8,283,770 $0.40
========== ========= =====
QUARTER ENDED SEPTEMBER 30, 2004
Earnings per share - basic $3,405,000 8,182,851 $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 8,226,968 $0.41
========== ========= =====
3. STOCK COMPENSATION PLANS
The Corporation uses the intrinsic value method of accounting for stock
compensation plans, under Accounting Principles Board Opinion No. 25 (APB
Opinion 25), and as permitted by Statement of Financial Accounting Standards
(SFAS) No. 123. 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.
8
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
The following table illustrates the effect on net income and earnings per share
if the Corporation had applied the fair value provisions of SFAS No. 123 to
stock options.
3 MONTHS ENDED 9 MONTHS ENDED
SEPT. 30, SEPT. 30,
--------------- ----------------
(NET INCOME IN THOUSANDS) 2005 2004 2005 2004
- ------------------------- ------ ------ ------ -------
Net income, as reported $3,287 $3,405 $9,880 $10,800
Deduct: Total stock option compensation
expense determined under fair value
method for all awards, net of tax effects -- (5) (69) (96)
------ ------ ------ -------
Pro forma net income $3,287 $3,400 $9,811 $10,704
====== ====== ====== =======
Earnings per share-basic
As reported $ 0.40 $ 0.42 $ 1.20 $ 1.32
Pro forma $ 0.40 $ 0.42 $ 1.20 $ 1.31
Earnings per share-diluted
As reported $ 0.40 $ 0.41 $ 1.19 $ 1.31
Pro forma $ 0.40 $ 0.41 $ 1.19 $ 1.30
In December 2004, the Financial Accounting Standards Board issued SFAS No. 123R,
which replaces SFAS No. 123 and supersedes APB Opinion 25. SFAS No. 123R will
require the Corporation to record stock option expense based on estimated fair
value calculated using an option valuation model. As issued, SFAS No. 123R would
have applied to new awards granted, and to modifications of existing awards, on
or after July 1, 2005. In April 2005, however, the Securities and Exchange
Commission extended the date for mandatory implementation of SFAS No. 123R,
effectively requiring the Corporation to apply SFAS No. 123R in the first
quarter 2006. The Corporation does not plan early implementation of the
provisions of SFAS No. 123R.
4. COMPREHENSIVE INCOME
U.S. generally accepted accounting principles generally require that recognized
revenue, expenses, gains and losses be included in net income. Although
unrealized gains and losses on available-for-sale securities are reported as a
separate component of the equity section of the balance sheet, changes in
unrealized gains and losses on available-for-sale securities, along with net
income, are components of comprehensive income (loss).
The components of comprehensive income, and the related tax effects, are as
follows:
3 MONTHS ENDED 9 MONTHS ENDED
--------------------- ---------------------
SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30,
(IN THOUSANDS) 2005 2004 2005 2004
- -------------- --------- --------- --------- ---------
Net income $ 3,287 $ 3,405 $ 9,880 $10,800
Unrealized holding (losses) gains on available-for-sale securities (4,104) 9,760 (5,226) (988)
Reclassification adjustment for gains realized in income (393) (459) (2,388) (1,744)
------- ------- ------- -------
Other comprehensive (loss) income before income tax (4,497) 9,301 (7,614) (2,732)
Income tax related to other comprehensive income/loss 1,529 (3,163) 2,589 930
------- ------- ------- -------
Other comprehensive (loss) income (2,968) 6,138 (5,025) (1,802)
------- ------- ------- -------
Comprehensive income $ 319 $ 9,543 $ 4,855 $ 8,998
======= ======= ======= =======
9
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
5. SECURITIES
Amortized cost and fair value of securities at September 30, 2005 are summarized
as follows:
SEPTEMBER 30, 2005
-----------------------
GROSS GROSS
UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING FAIR
(IN THOUSANDS) COST GAINS LOSSES VALUE
- -------------- --------- ---------- ---------- --------
AVAILABLE-FOR-SALE SECURITIES:
Obligations of the U.S. Treasury $ 502 $ -- $ (1) $ 501
Obligations of other U.S. Government agencies 45,999 -- (386) 45,613
Obligations of states and political subdivisions 128,277 2,820 (1,013) 130,084
Other securities 96,855 1,565 (1,136) 97,284
Mortgage-backed securities 146,324 190 (2,943) 143,571
-------- ------- ------- --------
Total debt securities 417,957 4,575 (5,479) 417,053
Marketable equity securities 22,754 9,596 (344) 32,006
-------- ------- ------- --------
Total $440,711 $14,171 $(5,823) $449,059
======== ======= ======= ========
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury $ 314 $ 13 $ -- $ 327
Obligations of other U.S. Government agencies 98 9 -- 107
Mortgage-backed securities 12 -- -- 12
-------- ------- ------- --------
Total $ 424 $ 22 $ -- $ 446
======== ======= ======= ========
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,
2005.
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 $ 501 $ (1) $ -- $ -- $ 501 $ (1)
Obligations of other U.S. Government agencies 40,140 (360) 1,474 (26) 41,614 (386)
Obligations of states and political subdivisions 39,204 (660) 8,677 (353) 47,881 (1,013)
Other securities 51,196 (805) 13,994 (331) 65,190 (1,136)
Mortgage-backed securities 60,900 (880) 73,764 (2,063) 134,664 (2,943)
-------- ------- ------- ------- -------- -------
Total debt securities 191,941 (2,706) 97,909 (2,773) 289,850 (5,479)
Marketable equity securities 3,763 (108) 2,090 (236) 5,853 (344)
-------- ------- ------- ------- -------- -------
Total temporarily impaired available-for-sale
securities $195,704 $(2,814) $99,999 $(3,009) $295,703 $(5,823)
======== ======= ======= ======= ======== =======
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 $ -- $ -- $ -- $ -- $ -- $ --
-------- ------- ------- ------- -------- -------
10
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 September 30, 2005 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.
In addition, 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. Recently, the Corporation has
determined that prescription drug benefits provided under the postretirement
plan are actuarially equivalent to benefits that will be available under the
Medicare Prescription Drug, Improvement and Modernization Act ("Medicare Part
D"). Management has not yet determined the effects of future reimbursements to
the Plan on the liability balance. Accordingly, the financial statement amounts
and disclosures related to the postretirement benefits plan do not reflect the
effects of changes that may result from Medicare Part D.
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
9 MONTHS ENDED 9 MONTHS ENDED
SEPT. 30, SEPT. 30,
-------------- --------------
(IN THOUSANDS) 2005 2004 2005 2004
- -------------- ----- ----- ---- ----
Service cost $ 356 $ 357 $ 35 $ 33
Interest cost 464 465 50 48
Expected return on plan assets (595) (561) -- --
Amortization of transition (asset) obligation (17) (18) 27 27
Recognized net actuarial loss 29 48 2 3
----- ----- ---- ----
Net periodic benefit cost $ 237 $ 291 $114 $111
===== ===== ==== ====
PENSION POSTRETIREMENT
3 MONTHS ENDED 3 MONTHS ENDED
SEPT. 30, SEPT. 30,
-------------- --------------
(IN THOUSANDS) 2005 2004 2005 2004
- -------------- ----- ----- ---- ----
Service cost $ 118 $ 119 $11 $11
Interest cost 155 155 17 16
Expected return on plan assets (198) (187) -- --
Amortization of transition (asset) obligation (5) (6) 9 9
Recognized net actuarial loss 10 16 1 1
----- ----- ---- ----
Net periodic benefit cost $ 80 $ 97 $38 $37
===== ===== ==== ====
Management intends to include employees of First State Bank in coverage under
the defined benefit pension and postretirement plans, effective September 1,
2005 (see Note 8 for more information concerning the acquisition). Currently,
management has not determined the effect, if any, on 2005 funding requirements
or financial statement amounts that may result from providing coverage to the
First State Bank employees; however, the impact is not expected to be
significant in relation to the Corporation's total obligations. Excluding
possible adjustment for the addition of First State Bank employees, the
Corporation funded its total expected defined benefit pension contribution for
2005 of $178,000 in April 2005. In the first nine months of 2005, the
Corporation funded postretirement contributions totaling $39,000. The estimated
total (annual) amount of 2005 postretirement contributions is $52,000.
11
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.
8. ACQUISITION
Effective at 11:59 p.m. on August 31, 2005, Citizens & Northern Corporation
acquired 100% of Canisteo Valley Corporation in an all-cash merger transaction.
Accordingly, the results of operations for Canisteo Valley Corporation have been
included in the accompanying consolidated financial statements from that date
forward. Canisteo Valley Corporation is the parent company of First State Bank,
a New York State chartered commercial bank with offices in Canisteo and South
Hornell, NY. The acquisition of Canisteo Valley Corporation and First State Bank
permits expansion of Citizens & Northern Corporation's banking operations into
communities located in the southern tier of New York State, in close proximity
to many of the northern Pennsylvania branch locations, and provides First State
Bank with the administrative and credit management resources of a larger
organization.
The Corporation is still in the process of obtaining final valuations on loans,
intangible assets, premises and equipment, deposits and other liabilities;
accordingly, allocation of the purchase price is subject to modification in the
future. Information regarding the purchase price and estimated fair values of
assets acquired and liabilities assumed as of the acquisition date is provided
as supplemental information in the consolidated statement of cash flows. The pro
forma effect of Canisteo Valley Corporation's (including First State Bank's)
revenues and operating results on the Corporation's financial statements for all
periods presented in this Form 10-Q would not be significant.
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
Citizens & Northern Corporation ("Corporation") is a holding company whose
principal activity is community banking. The Corporation's principal office is
located in Wellsboro, Pennsylvania. The largest subsidiary is Citizens &
Northern Bank ("C&N Bank"), which had total assets of $1,107,963,000 at
September 30, 2005. In the third quarter 2005, the Corporation completed the
acquisition of Canisteo Valley Corporation and its subsidiary, First State Bank,
a New York State chartered commercial bank with offices in Canisteo and South
Hornell, NY. The acquisition of Canisteo Valley Corporation and First State Bank
permits expansion of Citizens & Northern Corporation's banking operations into
communities located in the southern tier of New York State, in close proximity
to many of the northern Pennsylvania branch locations, and provides First State
Bank with the administrative and credit management resources of a larger
organization. The Corporation's other wholly-owned subsidiaries are Citizens &
Northern Investment Corporation, Bucktail Life Insurance Company ("Bucktail")
and Canisteo Valley Corporation. Citizens & Northern Investment Corporation was
formed in 1999 to engage in investment activities. Bucktail reinsures credit and
mortgage life and accident and health insurance on behalf of C&N Bank.
FORWARD-LOOKING STATEMENTS
Certain statements in this section and elsewhere in this quarterly report on
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 not historical facts, are based on
certain assumptions and describe future plans, business objectives and
expectations, and are generally identifiable by the use of words such as,
"should", "likely", "expect", "plan", "anticipate", "target", "forecast", and
"goal". 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 expressed or implied by such
forward-looking statements. 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:
12
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
- - 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 2005 AND 2004
Unless otherwise noted, all references to "2005" in the following discussion of
operating results are intended to mean the nine months ended September 30, 2005,
and similarly, references to "2004" are intended to mean the nine months ended
September 30, 2004.
EARNINGS OVERVIEW
Net income in 2005 was $9,880,000, or $1.20 per share (basic) and $1.19 per
share (diluted). This represents a decrease of 8.5% from 2004. Return on average
assets was 1.16% in 2005, as compared to 1.30% in 2004. Return on average equity
was 9.95% in 2005, as compared to 11.28% in 2004.
The most significant income statement changes between 2005 and 2004 were as
follows:
- The interest margin of $26,634,000 in 2005 was $564,000, or 2.2%,
higher than in 2004. Average (gross) loans outstanding increased 11.8%
as compared to one year earlier, to $607,981,000 in 2005. The increase
in loan volume has been the major reason for the slight growth in the
interest margin in 2005 over 2004. As described in the Net Interest
Margin section of Management's Discussion and Analysis, on a fully
taxable equivalent basis, the interest margin is slightly lower in
2005 than in 2004.
- Net realized gains from securities amounted to $2,388,000 in 2005, up
$644,000 from 2004. The Corporation's volume of investment security
sales was high by historical standards during the first nine months of
2005, as management identified several bank stocks that were deemed
fully valued and also sold selected debt securities in an effort to
manage its interest rate risk position.
- Other (noninterest) income increased $634,000 (12.4%) in 2005 as
compared to 2004. This category includes several sources of revenue.
The sources of revenue with the largest increases in 2005 included the
following: fees related to credit card operations of $144,000;
dividends from Federal Home Loan Bank of Pittsburgh stock of $122,000;
and Trust and Financial Management revenues of $106,000. Other changes
in noninterest income are discussed in more detail later in
Management's Discussion and Analysis.
- Other (noninterest) expense increased $2,349,000 (12.2%) in 2005 as
compared to 2004. Total salaries and benefit expenses increased
$1,066,000, or 9.7% in 2005 over 2004, primarily due to new hires to
accommodate expansion into new branches (Williamsport and South
Williamsport in 2004, Jersey Shore in August 2005, and Canisteo and
South Hornell, NY, in September 2005), and from the addition of new
employees for support functions, such as Risk Management, Finance and
Training. Furniture and equipment expense increased $761,000, or
65.6%, mainly due to depreciation and maintenance costs associated
with the new core banking software system, which was implemented in
the fourth quarter 2004.
- The income tax provision increased to $2,154,000 in 2005 from
$1,816,000 in 2004. The Corporation's effective tax rate rose to 17.9%
in 2005 from 14.4% in 2004. This higher effective tax rate resulted
mainly from management's decision to decrease the weighting of
tax-exempt obligations of states and political subdivisions, as a
percentage of total assets, to avoid or reduce what would have
otherwise been a substantial alternative minimum tax liability.
13
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
THIRD QUARTER 2005
Net Income in the third quarter 2005 was $3,287,000, which was 3.5% lower than
third quarter 2004 Net Income of $3,405,000. As you can see in Table I below,
Net Income for the third quarter 2005 was very flat in comparison to results for
each of the first two quarters. The interest margin increased $392,000 in the
third quarter 2005, as compared to the previous quarter, due to a higher average
loans outstanding and other factors, while net realized gains on securities fell
to $393,000 in the third quarter from $929,000 in the second quarter.
TABLE I - QUARTERLY FINANCIAL DATA
(IN THOUSANDS)
SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
(IN THOUSANDS) 2005 2005 2005 2004 2004 2004 2004
--------- -------- -------- -------- --------- -------- --------
Interest income $15,571 $14,908 $14,693 $14,991 $14,573 $14,343 $14,015
Interest expense 6,426 6,155 5,957 5,745 5,665 5,493 5,703
------- ------- ------- ------- ------- ------- -------
Interest margin 9,145 8,753 8,736 9,246 8,908 8,850 8,312
Provision for loan losses 375 375 375 350 350 350 350
------- ------- ------- ------- ------- ------- -------
Interest margin after provision for loan losses 8,770 8,378 8,361 8,896 8,558 8,500 7,962
Other income 2,149 1,889 1,703 1,815 1,627 1,855 1,625
Securities gains 393 929 1,066 1,133 459 321 964
Other expenses 7,303 7,173 7,128 6,746 6,738 6,289 6,228
------- ------- ------- ------- ------- ------- -------
Income before income tax provision 4,009 4,023 4,002 5,098 3,906 4,387 4,323
Income tax provision 722 725 707 1,035 501 698 617
------- ------- ------- ------- ------- ------- -------
Net income $ 3,287 $ 3,298 $ 3,295 $ 4,063 $ 3,405 $ 3,689 $ 3,706
======= ======= ======= ======= ======= ======= =======
Net income per share - basic $ 0.40 $ 0.40 $ 0.40 $ 0.50 $ 0.42 $ 0.45 $ 0.45
======= ======= ======= ======= ======= ======= =======
Net income per share - diluted $ 0.40 $ 0.40 $ 0.40 $ 0.49 $ 0.41 $ 0.45 $ 0.45
======= ======= ======= ======= ======= ======= =======
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 2005
An update on the Corporation's expansion projects is as follows:
- Expansion in Lycoming County, PA, continues. The Jersey Shore office
opened in August 2005, and construction has begun on a branch facility
in Old Lycoming Township, PA. We hope to open the Old Lycoming
Township office in the first quarter 2006.
- As reported earlier in Management's Discussion and Analysis, we closed
on the acquisition of Canisteo Valley Corporation, the parent company
of First State Bank of Canisteo, NY, in the third quarter 2005. This
transaction added two more banking locations, and increased assets by
approximately $38.6 million.
- Construction has begun on a new administrative building in Wellsboro,
within 2 blocks of the main office. We expect to move into this
facility in the first quarter 2006.
14
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Management expects the investments in new markets to provide future, continuing
opportunities for earnings growth. However, consistent with results for the
first nine months of 2005, noninterest expense for the year 2005 is expected to
be up significantly from the year 2004, mainly due to payroll and other start-up
costs related to the new branches, as well as costs from a full year of
depreciation and maintenance from the core computer system that was placed in
service in October 2004. Further, short-term interest rates have been rising
faster than long-term rates, causing a negative effect on the Corporation's net
interest margin. Thus far in 2005, loan demand has been good, and higher loan
volumes have allowed the Corporation to maintain its interest margin at a level
approximately equal with that of 2004. Management is concerned that recent
events, including substantial increases in prices of petroleum-based products in
2005, possibly exacerbated by the hurricanes in the U.S. Gulf Coast area, could
lead to a higher level of inflation than experienced in recent years. The
possibility of higher inflation could lead the Federal Reserve to continue to
increase its Federal Funds target rate, which could harm the Corporation's
operating results in two ways - by increasing the cost of funds, and by
dampening the economy (and therefore, demand for loans). The Corporation's
exposure to interest rate risk is discussed in more detail in Item 3.
Another major variable that affects the Corporation's earnings is securities
gains and losses. Management's decisions regarding sales of securities are based
on a variety of factors, with the overall goal of maximizing portfolio return
over a long-term horizon. It is difficult to predict, with much precision, the
amount of net securities gains and losses that will be realized in the fourth
quarter 2005.
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
investments in 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 2005 and 2004.
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.
15
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
The net interest margin, on a tax-equivalent basis, was $29,018,000 in 2005,
down $113,000, or 0.4%, from 2004. As reflected in Table IV, interest rate
changes had the effect of decreasing net interest income $954,000 in 2005 as
compared to 2004, as rising short-term interest rates caused increases in the
Corporation's interest expense on money market deposits, certificates of
deposits and short-term borrowings. Table IV also shows that increased interest
income from higher volumes of earning assets (primarily loans) exceeded
increases in interest expense attributable to higher volumes of interest-bearing
liabilities by $841,000 in 2005 compared to 2004. 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 3.29% for
the first nine months of 2005, compared to 3.43% for the year ended December 31,
2004 and 3.44% for the first nine months of 2004.
INTEREST INCOME AND EARNING ASSETS
Interest income increased 3.4%, to $47,556,000 in 2005 from $45,992,000 in 2004.
Interest and fees from loans increased $3,280,000, or 12.5%, while income from
available-for-sale securities decreased $1,785,000, or 9.0%. Overall, the
majority of the increase in interest income resulted from higher volumes of
loans, which more than offset the effect of the lower average volume of
available-for-sale securities.
As indicated in Table III, average available-for-sale securities in the first
nine months of 2005 amounted to $445,162,000, a decrease of 8.1% from the first
nine months of 2004. Proceeds from sales and maturities of securities have been
used, in part, to help fund the substantial growth in loans. Also, because
short-term interest rates have been rising faster than long-term rates, there
have been few opportunities to purchase mortgage-backed securities or other
bonds at spreads sufficient to justify the applicable interest rate risk. The
average rate of return on available-for-sale securities was 5.39% for first nine
months of 2005, slightly lower than the 5.44% level in the nine months of 2004,
and the 5.41% rate of return for the year ended December 31, 2004.
Tax-exempt securities (municipal bonds) were a smaller portion of the
Corporation's earning assets in 2005 than in 2004. The average balance of
municipal bonds shrunk to $121,618,000 in 2005 from $158,842,000 in the first
nine months of 2004. Management decided to reduce the Corporation's investment
in municipal bonds during the fourth quarter 2004, in order to reduce the
alternative minimum tax liability incurred in 2004, and reduce or eliminate the
potential for an alternative minimum tax liability that would otherwise have
been expected for 2005.
The average balance of gross loans increased 11.8% in the first nine months of
2005 over the first nine months of 2004, to $607,981,000 from $543,700,000. The
largest growth was in commercial loans, due in part to new personnel and
relationships in Williamsport and throughout Lycoming County, as well as from
growth in staffing and an increased emphasis on commercial lending throughout
the Corporation's market area over the last few years. The average rate of
return on loans was 6.49% in the first nine months of 2005, as compared to 6.44%
in the first nine months of 2004. The aggregate average interest rate on the
commercial loan portfolio has increased steadily over the second and third
quarters of 2005, as variable rates in the market (mainly Prime, 1-month LIBOR
and 3-month LIBOR) have increased.
INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES
Interest expense rose $1,677,000, or 9.9%, to $18,538,000 in 2005 from
$16,861,000 in 2004. Table III reflects the current trend in interest rates
incurred on liabilities, as the overall cost of funds on interest-bearing
liabilities rose to 2.72% for the first nine months of 2005, from 2.52% for the
first nine months of 2004. In Table III, you can see the impact of rising
short-term interest rates on some of the Corporation's largest sources of funds:
(1) money market accounts, which increased to an average rate of 1.98% in 2005
from 1.22% in the first nine months of 2004, (2) certificates of deposit, which
increased to an average rate of 3.20% from 2.82%, and (3) short-term borrowings,
which rose to an average rate of 2.55% from 1.29%. Helping to offset some of the
impact of rising short-term market rates were IRAs, for which the average rate
fell to 3.40% from 3.93%, and long-term borrowings, for which the average rate
fell to 3.46% from 3.56%. In the first quarter 2004, the average rate paid on
the majority of the Corporation's IRAs was 5%, which was the "floor" on 18-month
passbook IRAs that existed prior to October 1, 2003. Effective April 1, 2004,
the floor on those IRAs fell to 3%, and the Corporation's passbook IRA rate has
ranged from 3.25% to 3.50% thereafter. The decrease in average rate incurred on
long-term borrowings resulted from repayment of borrowings originated in earlier
interest rate cycles at higher rates.
16
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
As you can calculate from Table III, total average deposits (interest-bearing
and noninterest-bearing) increased to $687,363,000 in the first nine months of
2005 from $665,713,000 in the first nine months of 2004, an increase of 3.3%.
Average total short-term and long-term borrowed funds amounted to $306,596,000
in the first nine months of 2005, up slightly from $304,561,000 in the first
nine months of 2004. In 2004, the Corporation utilized borrowings to fund
security purchases and to help fund loan growth. In 2005, this trend has
changed, as management has begun to use proceeds from the securities portfolio
to help fund loan growth, and has either rolled over maturing long-term
borrowings into short-term borrowing instruments at lower rates, or "shrunk the
balance sheet" by paying off long-term borrowings as they mature, without
replacement. This change in trend is reflected in the consolidated balance
sheet, as total short-term borrowings increased to $41,805,000 at September 30,
2005 from $34,178,000 at December 31, 2004, and total long-term borrowings
decreased to $246,499,000 at September 30, 2005 from $270,827,000 at December
31, 2004.
TABLE II - ANALYSIS OF INTEREST INCOME AND EXPENSE
NINE MONTHS ENDED
SEPTEMBER 30,
----------------- INCREASE/
(IN THOUSANDS) 2005 2004 (DECREASE)
- -------------- ------- ------- ----------
INTEREST INCOME
Available-for-sale securities:
Taxable $11,627 $11,286 $ 341
Tax-exempt 6,315 8,441 (2,126)
------- ------- -------
Total available-for-sale securities 17,942 19,727 (1,785)
------- ------- -------
Held-to-maturity securities,
Taxable 19 20 (1)
Interest-bearing due from banks 24 7 17
Federal funds sold 61 8 53
Loans:
Taxable 28,327 25,180 3,147
Tax-exempt 1,183 1,050 133
------- ------- -------
Total loans 29,510 26,230 3,280
------- ------- -------
Total Interest Income 47,556 45,992 1,564
------- ------- -------
INTEREST EXPENSE
Interest checking 218 173 45
Money market 2,812 1,748 1,064
Savings 218 211 7
Certificates of deposit 4,576 3,839 737
Individual Retirement Accounts 3,095 3,418 (323)
Other time deposits 5 5 --
Short-term borrowings 894 371 523
Long-term borrowings 6,720 7,096 (376)
------- ------- -------
Total Interest Expense 18,538 16,861 1,677
------- ------- -------
Net Interest Income $29,018 $29,131 $ (113)
======= ======= =======
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%.
17
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
9/30/2005 RETURN/ 12/31/2004 RETURN/ 9/30/2004 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:
Taxable $ 323,544 4.80% $ 331,447 4.65% $ 325,458 4.63%
Tax-exempt 121,618 6.94% 151,049 7.09% 158,842 7.10%
---------- ---- ---------- ---------- ----
Total available-for-sale securities 445,162 5.39% 482,496 5.41% 484,300 5.44%
---------- ---- ---------- ---------- ----
Held-to-maturity securities,
Taxable 429 5.92% 460 5.87% 466 5.73%
Interest-bearing due from banks 1,355 2.37% 1,449 0.76% 1,249 0.75%
Federal funds sold 2,698 3.02% 778 1.29% 894 1.20%
Loans:
Taxable 582,967 6.50% 530,045 6.46% 522,479 6.44%
Tax-exempt 25,014 6.32% 21,307 6.58% 21,221 6.61%
---------- ---- ---------- ---------- ----
Total loans 607,981 6.49% 551,352 6.47% 543,700 6.44%
---------- ---- ---------- ---------- ----
Total Earning Assets 1,057,625 6.01% 1,036,535 5.96% 1,030,609 5.96%
Cash 9,077 14,273 14,722
Unrealized gain/loss on securities 12,823 16,182 16,454
Allowance for loan losses (7,100) (6,523) (6,466)
Bank premises and equipment 18,214 14,953 14,428
Other assets 45,793 38,621 38,006
---------- ---------- ----------
Total Assets $1,136,432 $1,114,041 $1,107,753
========== ========== ==========
INTEREST-BEARING LIABILITIES
Interest checking $ 40,301 0.72% $ 39,188 0.59% $ 39,594 0.58%
Money market 190,231 1.98% 192,450 1.31% 191,363 1.22%
Savings 58,431 0.50% 57,439 0.49% 56,685 0.50%
Certificates of deposit 191,352 3.20% 180,332 2.85% 182,151 2.82%
Individual Retirement Accounts 121,606 3.40% 116,622 3.75% 116,315 3.93%
Other time deposits 1,295 0.52% 1,275 0.39% 1,453 0.46%
Short-term borrowing 46,930 2.55% 39,458 1.37% 38,538 1.29%
Long-term borrowing 259,666 3.46% 268,211 3.55% 266,023 3.56%
---------- ---- ---------- ---------- ----
Total Interest-bearing Liabilities 909,812 2.72% 894,975 2.53% 892,122 2.52%
Demand deposits 84,147 82,001 78,152
Other liabilities 10,117 8,691 9,792
---------- ---------- ----------
Total Liabilities 1,004,076 985,667 980,066
---------- ---------- ----------
Stockholders' equity, excluding other
comprehensive income/loss 124,090 117,695 116,828
Other comprehensive income/loss 8,266 10,679 10,859
---------- ---------- ----------
Total Stockholders' Equity 132,356 128,374 127,687
---------- ---------- ----------
Total Liabilities and Stockholders'
Equity $1,136,432 $1,114,041 $1,107,753
========== ========== ==========
Interest Rate Spread 3.29% 3.43% 3.44%
Net Interest Income/Earning Assets 3.67% 3.78% 3.78%
(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.
18
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE IV - ANALYSIS OF VOLUME AND RATE CHANGES
(IN THOUSANDS)
YTD ENDED 9/30/05 VS. 9/30/04
--------------------------------
CHANGE IN CHANGE IN TOTAL
VOLUME RATE CHANGE
--------- --------- --------
EARNING ASSETS
Available-for-sale securities:
Taxable $ (68) $ 409 $ 341
Tax-exempt (1,944) (182) (2,126)
------- ------ -------
Total available-for-sale securities (2,012) 227 (1,785)
------- ------ -------
Held-to-maturity securities,
Taxable (2) 1 (1)
Interest-bearing due from banks 1 16 17
Federal funds sold 30 23 53
Loans:
Taxable 2,916 231 3,147
Tax-exempt 180 (47) 133
------- ------ -------
Total loans 3,096 184 3,280
------- ------ -------
Total Interest Income 1,113 451 1,564
------- ------ -------
INTEREST-BEARING LIABILITIES
Interest checking 3 42 45
Money market (10) 1,074 1,064
Savings 6 1 7
Certificates of deposit 200 537 737
Individual Retirement Accounts 149 (472) (323)
Other time deposits (1) 1 --
Short-term borrowings 95 428 523
Long-term borrowings (170) (206) (376)
------- ------ -------
Total Interest Expense 272 1,405 1,677
------- ------ -------
Net Interest Income $ 841 $ (954) $ (113)
======= ====== =======
(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.
19
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE V - COMPARISON OF NONINTEREST INCOME
(IN THOUSANDS)
9 MONTHS ENDED
---------------------
SEPT. 30, SEPT. 30,
2005 2004
--------- ---------
Service charges on deposit accounts $1,182 $1,337
Service charges and fees 288 209
Trust and financial management revenue 1,589 1,483
Insurance commissions, fees and premiums 405 327
Increase in cash surrender value of life insurance 417 463
Fees related to credit card operation 712 568
Other operating income 1,148 720
------ ------
Total other operating income, before realized
gains on securities, net 5,741 5,107
Realized gains on securities, net 2,388 1,744
------ ------
Total Other Income $8,129 $6,851
====== ======
Total noninterest income increased $1,278,000, or 18.7%, in 2005 compared to
2004, including an increase in net realized gains on securities of $644,000.
Securities gains are discussed in the Earnings Overview section of Management's
Discussion and Analysis. Other items of significance are as follows:
- - Service charges on deposit accounts fell $155,000, or 11.6%, in 2005 as
compared to 2004. Changes in deposit account processing resulting from the
new core banking system resulted in overdraft and other charges not being
assessed for some transactions that would have generated charges with the
former system. Management has been working with the core system vendor, and
during the third quarter 2005 was able to reestablish virtually all of the
remaining, significant overdraft and service charge routines. Those
changes, along with fee increases in overdraft and other services, helped
restore service charge revenue in the third quarter 2005 to a level almost
as high as in 2004 (as reflected in the consolidated income statement,
service charges on deposit accounts totaled $457,000 in the third quarter
2005, in comparison to $463,000 in the third quarter 2004).
- - Other service charges and fees increased $79,000, or 37.8%, in 2005 over
2004, primarily from higher volumes of transactions, including letters of
credit, ATM surcharges and other transactions.
- - Trust and financial management revenue increased $106,000, or 7.1%, in 2005
over 2004. Much of the trust fees are determined based on the amount of
assets under management, which have increased 13.0% as of September 30,
2005 as compared to one year earlier, to $404,899,000.
- - Insurance commissions, fees and premiums increased $78,000, or 23.9%, in
2005 over 2004. In the third quarter 2005, Bucktail recorded a "catch-up"
adjustment to recognize revenue of approximately $100,000 for insurance
premiums associated with policies issued related to collateral mortgage
transactions. Overall, Bucktail's operations are not a significant
component of the Corporation's operations.
- - The increase in cash surrender value of insurance fell $46,000, or 9.9%, in
2005 as compared to 2004. The Corporation's policy return is determined, in
part, by the amount of earnings generated from a pooled separate investment
trust held by the life insurance company. In 2005, earnings from that
pooled separate trust fund were lower than in 2004, which is reflective of
lower market yields on debt securities.
- - Fees related to the Corporation's credit card operation increased $144,000,
or 25.4%, in 2005 over 2004, primarily because of higher volumes and rates
on merchant processing and interchange transactions.
- - Other operating income increased $428,000, or 59.4%, in 2005 over 2004.
Within this line item, the largest changes in 2005 were increases in the
following categories: dividends from Federal Home Loan Bank of Pittsburgh
stock of $122,000; gains from sales of foreclosed assets (other real
estate) of $79,000; debit card fees of $76,000; broker dealer revenues of
$75,000; and training grant revenue of $65,000.
20
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE VI- COMPARISON OF NONINTEREST EXPENSE
(IN THOUSANDS)
9 MONTHS ENDED
---------------------
SEPT. 30, SEPT. 30,
2005 2004
--------- ---------
Salaries and wages $ 9,172 $ 8,306
Pensions and other employee benefits 2,878 2,678
Occupancy expense, net 1,371 1,187
Furniture and equipment expense 1,922 1,161
Pennsylvania shares tax 608 635
Other operating expense 5,653 5,288
------- -------
Total Other Expense $21,604 $19,255
======= =======
Salaries and wages increased $866,000, or 10.4%, in 2005 over 2004. The increase
in salaries expense is primarily a reflection of a greater number of employees,
resulting from expansion into new branches and the addition of new employees for
support functions. The number of full-time equivalent employees was 338 as of
September 30, 2005, up 7.0% from one year earlier.
Occupancy expense increased $184,000, or 15.5%, in 2005 over 2004, primarily as
a result of higher depreciation and maintenance costs associated with new
facilities.
Furniture and equipment expense increased $761,000, or 65.5%, in 2005 over 2004.
Depreciation expense within this category increased $528,000, to $1,185,000 in
2005 from $657,000 in 2004, including approximately $450,000 of depreciation in
2005 from the new core banking software system. Similarly, maintenance and
repair expense within this category increased $216,000, to $619,000 in 2005 from
$403,000 in 2004, primarily because of maintenance costs associated with the new
core banking software system of approximately $270,000 in 2005.
Other operating expense increased $365,000, or 6.9%, in 2005 over 2004. Most of
the line items within this category increased in 2005, in part due to expansion
into more locations and the resulting higher volume of transactions and costs.
The most significant increases within this category were expenses associated
with maintaining and preparing other real estate properties for sale, which
increased $192,000 in 2005 to $242,000, and attorney fees, which increased
$160,000 in 2005 to $188,000, mainly because of collection activities on a large
commercial credit. Helping to reduce the overall increase in this category was a
decrease in professional fees of $477,000, to $139,000 in 2005. In 2004, the
Corporation incurred a significant amount of professional fees expense
associated with the core banking system conversion.
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. Also included in the Net
Interest Margin section is a discussion of a change in trend regarding
available-for-sale securities, short-term and long-term borrowings. As noted
earlier in Management's Discussion and Analysis, the acquisition of Canisteo
Valley Corporation increased total assets and total liabilities by approximately
$38.6 million each as of the August 31, 2005 purchase date. This acquisition did
not have a material impact on the Corporation's liquidity or capital position.
The allowance for loan losses and stockholders' equity are discussed in separate
sections of Management's Discussion and Analysis.
As discussed in the "Prospects for the Remainder of 2005" section of
Management's Discussion and Analysis, the Corporation completed construction of
a new branch in Jersey Shore in 2005, and is in the process of building a new
administrative building in Wellsboro and a branch in Old Lycoming Township. In
addition to the building projects, the Corporation will need to purchase
furniture, equipment and computer-related items on an ongoing basis for its
existing and new operations. In total, management expects 2005 capital purchases
to range between $6.5 and $7.5 million. As discussed in the Earnings Overview
section of Management's Discussion and Analysis, management expects the initial
depreciation and start-up costs associated with the new locations to have a
negative impact on 2005 earnings; however, in light of the Corporation's strong
capital position, the overall impact of 2005 capital purchases is not expected
to be materially adverse to the Corporation's financial condition.
21
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
PROVISION AND ALLOWANCE FOR LOAN LOSSES
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. For C&N Bank's
portfolio, 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 qualitative risk adjustment
factors identified by management for each type of loan. The charge-off ratio and
qualitative factors are then applied to the current outstanding loan balance for
each type of loan (net of other loans that are individually evaluated). For
First State Bank's portfolio, the process is identical to that described for C&N
Bank, except that the ratio of net charge-offs to average balances is determined
over a three-year period.
The allowance for loan losses was $7,643,000 at September 30, 2005, an increase
of $856,000 from the balance at December 31, 2004. The allowance for loan losses
recorded as part of the Canisteo Valley Corporation (First State Bank)
acquisition amounted to $377,000. Although there were loans included on the
First State Bank watch list as of the acquisition date that management is
monitoring, substantially all of these loans are commercial loans with low
balances, or consumer or residential mortgage loans that can be collectively
evaluated for impairment. Accordingly, there were no acquired loans that have
been classified individually as impaired. Net charge-offs amounted to $646,000
in the first nine months of 2005, while the provision for loan losses was
$1,125,000. In the first nine months of 2004, net charge-offs totaled $577,000,
and the provision was $1,050,000. 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 the second quarter 2005, management changed its process for determining and
disclosing the components of the allowance for loan losses. A management
committee evaluated several qualitative factors, including economic conditions,
lending policies, changes in the portfolio, risk profile of the portfolio,
competition and regulatory requirements, and other factors. This analysis was
performed separately for 4 categories of lending activity: commercial, mortgage,
consumer and credit card. The management committee met again in the third
quarter and updated its analysis. Based on the results of these evaluations,
allocations were made to the components of the allowance shown in Table VIII. In
periods prior to June 30, 2005, the portion of the allowance determined by
management's subjective assessment of economic conditions and other factors was
reflected completely in the unallocated component of the allowance. Primarily as
a result of this change in process, Table VIII shows the amounts allocated to
the allowance for commercial, consumer mortgage and consumer loans at September
30, 2005 and June 30, 2005 have increased in comparison to the corresponding
amounts at December 31, 2004, while the unallocated portion of the allowance
decreased to $0 at September 30, 2005 and $328,000 at June 30, 2005 from
$2,578,000 at December 31, 2004.
As indicated in Table IX, total impaired loans amounted to $8,010,000 at
September 30, 2005, as compared to $8,258,000 at June 30, 2005, $8,261,000 at
December 31, 2004 and $4,621,000 at December 31, 2003. In total, the valuation
allowance related to impaired loans amounted to $1,938,000 at September 30,
2005, up from $1,614,000 at June 30, 2005 and $1,378,000 at December 31, 2004.
Table IX also shows that the amount of loans classified as nonaccrual amounted
to $7,458,000 at September 30, 2005, as compared to $7,910,000 at June 30, 2005,
$7,796,000 at December 31, 2004 and $1,145,000 at December 31, 2003. The growth
in 2004 in past due and nonaccrual loans resulted mainly from certain large
commercial loan relationships, including one commercial loan relationship with
total outstanding loan balances of approximately $3.4 million at September 30,
2005, $3.6 million at June 30, 2005 and $3.7 million as of December 31, 2004. In
2004, management moved most of the loans outstanding related to this large
relationship to nonaccrual status. Also, in 2005, a large ($600,000) residential
mortgage loan to the principal owner of this relationship was moved to
nonaccrual. As of September 30, 2005, the Corporation increased the valuation
allowance to $657,000 from $570,000 at June 30, 2005 and $173,000 at December
31, 2004. There is another commercial loan relationship with total outstanding
balances of approximately $1.6 million that has been classified as impaired and
nonaccrual throughout most of 2004 and all of 2005 to date, and for which the
valuation allowance was increased to $400,000 as of September 30, 2005 from an
estimated amount of $200,000 as of June 30, 2005 and December 31, 2004.
Management believes it has been conservative in its decisions concerning
identification of impaired loans, estimates of loss and nonaccrual status.
However, the actual losses realized from these relationships could vary
materially from the allowances calculated as of September 30, 2005. Management
continues to closely monitor these commercial loan relationships, and will
adjust its estimates of loss and decisions concerning nonaccrual status, if
appropriate.
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.
22
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, ------------------------------------------
2005 2004 2004 2003 2002 2001 2000
--------- --------- ------ ------ ------ ------ ------
Balance, beginning of year $6,787 $6,097 $6,097 $5,789 $5,265 $5,291 $5,131
------ ------ ------ ------ ------ ------ ------
Charge-offs:
Real estate loans 225 337 375 168 123 144 272
Installment loans 138 156 217 326 116 138 77
Credit cards and related plans 177 132 178 171 190 200 214
Commercial and other loans 202 11 16 303 123 231 53
------ ------ ------ ------ ------ ------ ------
Total charge-offs 742 636 786 968 552 713 616
------ ------ ------ ------ ------ ------ ------
Recoveries:
Real estate loans 13 3 3 75 30 6 26
Installment loans 48 23 32 52 30 27 23
Credit cards and related plans 21 18 23 17 18 20 28
Commercial and other loans 14 15 18 32 58 34 23
------ ------ ------ ------ ------ ------ ------
Total recoveries 96 59 76 176 136 87 100
------ ------ ------ ------ ------ ------ ------
Net charge-offs 646 577 710 792 416 626 516
Allowance for loan losses
recorded in acquisition 377 -- -- -- -- -- --
Provision for loan losses 1,125 1,050 1,400 1,100 940 600 676
------ ------ ------ ------ ------ ------ ------
Balance, end of period $7,643 $6,570 $6,787 $6,097 $5,789 $5,265 $5,291
====== ====== ====== ====== ====== ====== ======
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, ------------------------------------------
2005 2005 2004 2003 2002 2001 2000
--------- -------- ------ ------ ------ ------ ------
Commercial $2,376 $2,212 $1,909 $1,578 $1,315 $1,837 $1,612
Consumer mortgage 2,653 2,304 513 456 460 674 952
Impaired loans 1,938 1,614 1,378 1,542 1,877 73 273
Consumer 676 579 409 404 378 494 471
Unallocated -- 328 2,578 2,117 1,759 2,187 1,983
------ ------ ------ ------ ------ ------ ------
Total Allowance $7,643 $7,037 $6,787 $6,097 $5,789 $5,265 $5,291
====== ====== ====== ====== ====== ====== ======
TABLE IX - PAST DUE AND IMPAIRED LOANS
(IN THOUSANDS)
SEPT. 30, JUNE 30, DEC. 31, DEC. 31, DEC. 31,
2005 2005 2004 2003 2002
--------- -------- -------- -------- --------
Impaired loans without a valuation allowance $1,024 $1,295 $3,552 $ 114 $ 675
Impaired loans with a valuation allowance 6,986 6,963 4,709 4,507 3,039
------ ------ ------ ------ ------
Total impaired loans $8,010 $8,258 $8,261 $4,621 $3,714
====== ====== ====== ====== ======
Valuation allowance related to impaired loans $1,938 $1,614 $1,378 $1,542 $1,877
Total nonaccrual loans $7,458 $7,910 $7,796 $1,145 $1,252
Total loans past due 90 days or more and
still accruing $1,316 $1,658 $1,307 $2,546 $2,318
23
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE X - SUMMARY OF LOANS BY TYPE
(IN THOUSANDS)
AS OF DECEMBER 31,
SEPT. 30, JUNE 30, ----------------------------------------------------
2005 2005 2004 2003 2002 2001 2000
--------- -------- -------- -------- -------- -------- --------
Real estate - construction $ 5,863 $ 4,125 $ 4,178 $ 2,856 $ 103 $ 1,814 $ 452
Real estate - residential mortgage 357,695 346,507 347,705 330,807 292,136 245,997 207,100
Real estate - commercial mortgage 141,046 136,634 128,073 100,240 78,317 60,267 56,225
Consumer 37,150 33,064 31,702 33,977 31,532 29,284 28,141
Agricultural 2,658 2,507 2,872 2,948 3,024 2,344 1,983
Commercial 73,299 63,672 43,566 34,967 30,874 24,696 20,776
Other 1,923 1,923 1,804 1,183 2,001 1,195 948
Political subdivisions 25,655 23,119 19,713 17,854 13,062 13,479 12,462
Lease receivables -- -- -- 65 96 152 218
-------- -------- -------- -------- -------- -------- --------
Total 645,289 611,551 579,613 524,897 451,145 379,228 328,305
Less: allowance for loan losses (7,643) (7,037) (6,787) (6,097) (5,789) (5,265) (5,291)
-------- -------- -------- -------- -------- -------- --------
Loans, net $637,646 $604,514 $572,826 $518,800 $445,356 $373,963 $323,014
======== ======== ======== ======== ======== ======== ========
DERIVATIVE FINANCIAL INSTRUMENTS
The Corporation has utilized 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. In 2004, the Corporation stopped originating new IPCDs,
but continues to maintain and account for IPCDs and the related derivative
contracts entered into between 2001 and 2004.
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
paid 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.
Amounts recorded as of September 30, 2005 and December 31, 2004, and for the
first nine months of 2005 and 2004, related to IPCDs are as follows (in
thousands):
24
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
SEPT. 30, SEPT. 30,
2005 2004
--------- ---------
Contractual amount of IPCDs (equal
to notional amount of Swap contracts) $3,959 $4,045
Carrying value of IPCDs 3,703 3,695
Carrying value of embedded derivative liabilities 490 297
Carrying value of Swap contract liabilities (255) 42
9 MOS. 9 MOS.
ENDED ENDED
SEPT. 30, SEPT. 30,
2005 2004
--------- ---------
Interest expense $117 $105
Other expense (4) 5
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 FHLB - Pittsburgh, secured by mortgage loans and
various investment securities. At September 30, 2005, the Corporation had unused
borrowing availability with correspondent banks and the FHLB - Pittsburgh
totaling approximately $139,783,000. 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. Further, if required to raise cash in
an emergency situation, the Corporation could sell non-pledged investment
securities to meet its obligations. At September 30, 2005, the carrying value of
non-pledged securities was $210,114,000. Management believes the combination of
its strong capital position (discussed in the next section), ample available
borrowing facilities and substantial non-pledged securities portfolio have
placed the Corporation in a position of minimal short-term and long-term
liquidity risk.
STOCKHOLDERS' EQUITY AND CAPITAL ADEQUACY
The Corporation, as well as C&N Bank and First State Bank, are subject to
various regulatory capital requirements administered by the federal banking
agencies. For many years, the Corporation and C&N Bank have maintained strong
capital positions. The following table presents consolidated capital ratios at
September 30, 2005:
Total capital to risk-weighted assets 17.52%
Tier 1 capital to risk-weighted assets 15.98%
Tier 1 capital to average total assets 10.71%
Management expects the Corporation, as well as C&N Bank and First State 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 "Financial Position"
section of Management's Discussion and Analysis) during the next 12 months are
not expected to have a detrimental effect on capital ratios.
INFLATION
The Corporation is significantly affected by the Federal Reserve Board's efforts
to control inflation through changes in interest rates. As alluded to in the
"Earnings Overview" section of Management's Discussion and Analysis, inflation
has been on the rise in 2005, led by substantial increases in prices of
petroleum-based products, with the potential for further price increases to come
as a result of hurricanes in the U.S. Gulf Coast area. High inflation data could
lead the Federal Reserve to continue to increase its Federal Funds target rate,
which could harm the Corporation's operating results by increasing the cost of
funds, and by dampening the economy (and therefore, demand for loans). Although
management cannot predict future changes in the rates of inflation, management
monitors the impact of economic trends, including indicators of inflationary
pressure, in managing interest rate and other financial risks.
25
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
PART I - FINANCIAL INFORMATION (CONTINUED)
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.
C&N 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 C&N Bank are included in management's
monthly simulation model calculations. Since C&N Bank makes up more than 90% of
the Corporation's total assets and liabilities, and because C&N Bank is the
source of the most volatile interest rate risk, presently management does not
consider it necessary to run the model for the remaining entities within the
consolidated group. (Management intends to add First State Bank's data to the
model, beginning sometime in 2006.) 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.
C&N 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. C&N Bank's policy provides limits at +/- 100, 200 and 300 basis
points from current rates for fluctuations in net interest income from the
baseline (flat rates) one-year scenario. The policy also limits acceptable
market value variances from the baseline values based on current rates. The most
sensitive scenario presented in Table XI presented below is the "+300 basis
points" scenario. As the table shows, as of September 30, 2005, if interest
rates were to immediately rise 300 basis points, the Bank's calculations based
on the model show that although the change in net interest income is within the
policy threshold, the market value of portfolio equity would decrease 51.9%,
which exceeds the policy limit of 45%. Similarly, at December 31, 2004, the
change in net interest income was within the policy threshold, but the market
value of portfolio equity decrease of 49.2% exceeded the policy threshold.
Management will continue to evaluate whether to make any changes to asset or
liability holdings in an effort to reduce exposure to decline in market value or
net interest income 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 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.
26
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE XI - THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES
SEPTEMBER 30, 2005 DATA
(IN THOUSANDS)
12 MOS. ENDING SEPTEMBER 30, 2006
----------------------------------------------------------
INTEREST INTEREST NET INTEREST NII NII
BASIS POINT CHANGE IN RATES INCOME EXPENSE INCOME (NII) % CHANGE RISK LIMIT
- --------------------------- -------- -------- ------------ -------- ----------
+300 66,261 38,907 27,354 -18.5% 20.0%
+200 64,443 34,913 29,530 -12.0% 15.0%
+100 62,541 30,919 31,622 -5.7% 10.0%
0 60,471 26,925 33,546 0.0% 0.0%
- -100 57,361 22,994 34,367 2.4% 10.0%
- -200 54,053 19,948 34,105 1.7% 15.0%
- -300 50,830 17,119 33,711 0.5% 20.0%
MARKET VALUE OF PORTFOLIO EQUITY
AT SEPTEMBER 30, 2005
--------------------------------
PRESENT PRESENT PRESENT
VALUE VALUE VALUE
BASIS POINT CHANGE IN RATES EQUITY % CHANGE RISK LIMIT
- --------------------------- ------- -------- ----------
+300 63,519 -51.9% 45.0%
+200 85,968 -34.9% 35.0%
+100 109,405 -17.2% 25.0%
0 132,078 0.0% 0.0%
- -100 144,536 9.4% 25.0%
- -200 150,378 13.9% 35.0%
- -300 158,273 19.8% 45.0%
DECEMBER 31, 2004 DATA
(IN THOUSANDS)
12 MOS. ENDING DEC. 31, 2005
----------------------------------------------------------
INTEREST INTEREST NET INTEREST NII NII
BASIS POINT CHANGE IN RATES INCOME EXPENSE INCOME (NII) % CHANGE RISK LIMIT
- --------------------------- -------- -------- ------------ -------- ----------
+300 62,724 34,583 28,141 -16.8% 20.0%
+200 61,066 30,840 30,226 -10.7% 15.0%
+100 59,327 27,098 32,229 -4.7% 10.0%
0 57,343 23,510 33,833 0.0% 0.0%
- -100 54,581 20,676 33,905 0.2% 10.0%
- -200 51,800 17,924 33,876 0.1% 15.0%
- -300 49,090 16,850 32,240 -4.7% 20.0%
MARKET VALUE OF PORTFOLIO EQUITY
AT DECEMBER 31, 2004
--------------------------------
PRESENT PRESENT PRESENT
VALUE VALUE VALUE
BASIS POINT CHANGE IN RATES EQUITY % CHANGE RISK LIMIT
- --------------------------- ------- -------- ----------
+300 71,244 -49.2% 45.0%
+200 94,088 -32.9% 35.0%
+100 117,491 -16.2% 25.0%
0 140,168 0.0% 0.0%
- -100 153,026 9.2% 25.0%
- -200 162,400 15.9% 35.0%
- -300 171,463 22.3% 45.0%
27
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
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 $1,996,000 at September 30, 2005 and
$6,130,000 at December 31, 2004.
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, 2005 and December 31, 2004 are
presented in Table XII.
TABLE XII - EQUITY SECURITIES
(IN THOUSANDS)
HYPOTHETICAL HYPOTHETICAL
10% 20%
DECLINE IN DECLINE IN
FAIR MARKET MARKET
AT SEPTEMBER 30, 2005 COST VALUE VALUE VALUE
- --------------------- -------- ------- ------------ ------------
Banks and bank holding companies $18,744 $27,682 $(2,768) $(5,536)
Other equity securities 4,010 4,324 (432) (865)
------- ------- ------- -------
Total $22,754 $32,006 $(3,200) $(6,401)
======= ======= ======= =======
HYPOTHETICAL HYPOTHETICAL
10% 20%
DECLINE IN DECLINE IN
FAIR MARKET MARKET
AT DECEMBER 31, 2004 COST VALUE VALUE VALUE
- -------------------- -------- ------- ------------ ------------
Banks and bank holding companies $17,426 $29,880 $(2,988) $(5,976)
Other equity securities 8,962 8,383 (838) (1,677)
------- ------- ------- -------
Total $26,388 $38,263 $(3,826) $(7,653)
======= ======= ======= =======
PART I - FINANCIAL INFORMATION (CONTINUED)
ITEM 4. CONTROLS AND PROCEDURES
The Corporation's management, under the supervision of and with the
participation of the Corporation's Chief Executive Officer and Chief Financial
Officer, has carried out an evaluation of the design and effectiveness of the
Corporation's disclosure controls and procedures as defined in Rule 13a-15(e)
and Rule 15d-15(e) of the Securities Exchange Act of 1934 as of the end of
period covered by this report. Based upon that evaluation, the Chief Executive
Officer and Chief Financial Officer have concluded that, as of the end of such
period, the Corporation's disclosure controls and procedures are effective to
ensure that all material 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
have materially affected, or that are reasonably likely to affect, our internal
control over financial reporting.
28
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Corporation, C&N Bank and First State 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
c. Issuer Purchases of Equity Securities
The following table sets forth purchases by the Corporation (on the open market)
of its equity securities during the third quarter 2005:
TOTAL MAXIMUM
NUMBER OF DOLLAR VALUE
SHARES (IN THOUSANDS)
PURCHASED OF 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
- -------------------- --------- -------------- -------------- --------------
July 1-31, 2005 - Not applicable Not applicable Not applicable
August 1-31, 2005 - Not applicable Not applicable Not applicable
September 1-30, 2005 2,000 $29.60 2,000 $2,941
----- -------------- -------------- --------------
Total 2,000 $29.60 2,000 $2,941
===== ============== ============== ==============
NOTE: On August 19, 2005, the Corporation announced a plan to repurchase shares
of its outstanding common stock up to a total of $3 million over a time period
ending August 31, 2006. The Corporation's Board of Directors authorized
repurchases from time to time at the prevailing market prices in open market or
in privately negotiated transactions as, in management's sole opinion, market
conditions warrant and based on stock availability, price and the Company's
financial performance. The Corporation announced that it is anticipated such
purchases will be made during the next twelve months, although no assurance may
be given when such purchases will be made or the total number of shares that
will be purchased.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
29
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Item 6. Exhibits
3. (i) Articles of Incorporation Incorporated by reference to the exhibits
filed with the Corporation's registration
statement on Form S-4 on March 27, 1987.
3. (ii) By-laws Incorporated by reference to Exhibit 3.1 of
the Corporation's Form 8-K filed August 25,
2004
11. Statement re: computation of per share earnings Information concerning the computation of
earnings per share is provided in Note 2 to
the Consolidated Financial Statements, which
is included in Part I, Item 1 of Form 10-Q
31. Rule 13a-14(a)/15d-14(a) certifications:
31.1 Certification of Chief Executive Officer Filed herewith
31.2 Certification of Chief Financial Officer Filed herewith
32. Section 1350 certifications Filed herewith
30
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
November 7, 2005 By: /s/ Craig G. Litchfield
Date ------------------------------------
Chairman, President and Chief
Executive Officer
November 7, 2005 By: /s/ Mark A. Hughes
Date ------------------------------------
Treasurer and Chief Financial
Officer
31