SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 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)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to section 12(g) of the Act:
COMMON STOCK Par Value $1.00
Indicate by check mark whether the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one:) Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer
[ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The aggregate market value of the registrant's common stock held by
non-affiliates at June 30, 2005, the registrant's most recently completed second
fiscal quarter, was $256,509,172.
The number of shares of common stock outstanding at February 28, 2006 was
8,295,569.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's proxy statement for the annual meeting of its
shareholders to be held April 18, 2006 are incorporated by reference into Parts
III and IV of this report.
1
PART I
ITEM 1. BUSINESS
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"). 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 and Bucktail Life
Insurance Company ("Bucktail"). 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 the Bank.
C&N Bank is a Pennsylvania banking institution that was formed by the
consolidation of Northern National Bank of Wellsboro and Citizens National Bank
of Towanda on October 1, 1971. Subsequent mergers included: First National Bank
of Ralston in May 1972; Sullivan County National Bank in October 1977; Farmers
National Bank of Athens in January 1984; and First National Bank of East
Smithfield in May 1990. C&N Bank has held its current name since May 6, 1975, at
which time C&N Bank changed its charter from a national bank to a Pennsylvania
bank.
C&N Bank and First State Bank (collectively, the "Banks") provide an extensive
range of banking services, including deposit and loan products for personal and
commercial customers. C&N Bank also maintains a trust division that provides a
wide range of financial services, such as 401(k) plans, retirement planning,
estate planning, estate settlements and asset management. In January 2000, C&N
Bank formed a subsidiary, C&N Financial Services Corporation ("C&NFSC"). C&NFSC
is a licensed insurance agency that provides insurance products to individuals
and businesses. In 2001, C&NFSC added a broker-dealer division, which offers
mutual funds, annuities, educational savings accounts and other investment
products through registered agents. C&NFSC's operations are not significant in
relation to the total operations of the Corporation. Management is currently
exploring several options for offering Trust, insurance and brokerage services
in New York State.
All phases of the Banks' business are competitive. The Banks primarily compete
in Tioga, Bradford, Sullivan and Lycoming counties in Pennsylvania, and Steuben
and Allegany counties in New York. The Banks compete with local commercial banks
headquartered in our market area as well as other commercial banks with branches
in our market area. Some of the banks that have branches in the Banks' market
area are larger in overall size than the Banks. With respect to lending
activities and attracting deposits, the Banks also compete with savings banks,
savings and loan associations, insurance companies, regulated small loan
companies and credit unions. Also, the Banks compete with mutual funds for
deposits. C&N Bank competes with insurance companies, investment counseling
firms, mutual funds and other business firms and individuals for trust,
investment management, brokerage and insurance services. The Banks are generally
competitive with all financial institutions in our service area with respect to
interest rates paid on time and savings deposits, service charges on deposit
accounts and interest rates charged on loans. The Banks serve a diverse customer
base, and are not economically dependent on any small group of customers or on
any individual industry.
Major initiatives over the last 5 years included the following:
- - expanded trust and financial services capabilities, including investment
management, employee benefits and insurance services;
- - purchased and remodeled a former bank operations center in Williamsport,
PA, and began offering trust and financial management, commercial lending,
branch banking and other services, in 2004;
- - opened a branch office at a leased facility in South Williamsport, PA in
2004;
- - replaced the core banking computer system in 2004;
- - constructed and opened a branch facility in Jersey Shore, PA in 2005;
- - closed on the merger with Canisteo Valley Corporation in 2005;
2
- - began construction on 2 new buildings, a branch facility in Old Lycoming
Township, PA, and an administration building in Wellsboro, PA, both of
which are expected to open in March 2006.
At December 31, 2005, C&N Bank had total assets of $1,096,809,000, total
deposits of $721,102,000, net loans outstanding of $623,474,000 and 334
full-time equivalent employees. At December 31, 2005, First State Bank had total
assets of $44,476,000, total deposits of $37,093,000, net loans outstanding of
$21,464,000 and 20 full-time equivalent employees.
Most of the activities of the Corporation and its subsidiaries are regulated by
federal or state agencies. The primary regulatory relationships are described as
follows:
- - The Corporation is a bank holding company formed under the provisions of
Section 3 of the Federal Reserve Act. The Corporation is under the direct
supervision of the Federal Reserve and must comply with the reporting
requirements of the Federal Bank Holding Company Act.
- - C&N Bank is a state-chartered, nonmember bank, supervised by the Federal
Deposit Insurance Corporation and the Pennsylvania Department of Banking.
- - Canisteo Valley Corporation is the holding company for First State Bank.
The Federal Reserve is the primary regulator for Canisteo Valley
Corporation.
- - First State Bank is a state-chartered, nonmember bank, supervised by the
Federal Deposit Insurance Corporation and the New York State Department of
Banking.
- - C&NFSC is a Pennsylvania corporation. The Pennsylvania Department of
Insurance regulates C&NFSC's insurance activities. Brokerage products are
offered through a third party networking agreement between the Bank and
UVEST Financial Services, Inc.
- - Bucktail is incorporated in the state of Arizona and supervised by the
Arizona Department of Insurance.
A copy of the Corporation's annual report on Form 10-K, quarterly reports on
Form 10-Q, current events reports on Form 8-K, and amendments to these reports,
will be furnished without charge upon written request to the Corporation's
Treasurer at P.O. Box 58, Wellsboro, PA 16901. Copies of these reports will be
furnished as soon as reasonably possible, after they are filed electronically
with the Securities and Exchange Commission. The information is also available
through the Corporation's web site at www.cnbankpa.com.
ITEM 1A. RISK FACTORS
The Corporation is subject to the many risks and uncertainties applicable to all
banking companies, as well as risks specific to the Corporation's geographic
locations. Although the Corporation seeks to effectively manage risks, and
maintains a level of equity that exceeds the banking regulatory agencies'
thresholds for being considered "well capitalized" (see Note 21 to the
consolidated financial statements), management cannot predict the future and
cannot eliminate the possibility of credit, operational or other losses.
Accordingly, actual results may differ materially from management's
expectations. Some of the Corporation's significant risks and uncertainties are
discussed below.
CREDIT RISK FROM LENDING ACTIVITIES - A significant source of risk is the
possibility that losses will be sustained because borrowers, guarantors and
related parties may fail to perform in accordance with the terms of their loan
agreements. Most of the Corporation's loans are secured, but some loans are
unsecured. With respect to secured loans, the collateral securing the repayment
of these loans may be insufficient to cover the obligations owed under such
loans. Collateral values may be adversely affected by changes in economic,
environmental and other conditions, including declines in the value of real
estate, changes in interest rates, changes in monetary and fiscal policies of
the federal government, wide-spread disease, terrorist activity, environmental
contamination and other external events. In addition, collateral appraisals that
are out of date or that do not meet industry recognized standards may create the
impression that a loan is adequately collateralized when it is not. The
Corporation has adopted underwriting and credit monitoring procedures and
policies, including regular reviews of appraisals and borrower financial
statements, that management believes are appropriate to mitigate the risk of
loss. Also, as discussed further in the "Provision and Allowance for Loan
Losses" section of Management's Discussion and Analysis, the Corporation
attempts to estimate the amount of losses that may be inherent in the portfolio
through a quarterly evaluation process that includes several members of
management and that addresses specifically identified problem loans, as well as
other quantitative data and qualitative factors. Such risk management and
accounting policies and procedures, however, may not prevent unexpected losses
that could have a material adverse effect on the Corporation's financial
condition, results of operations or liquidity.
3
INTEREST RATE RISK - Business risk arising from changes in interest rates is an
inherent factor in operating a banking organization. The Corporation's assets
are predominantly long-term, fixed rate loans and debt securities. Funding for
these assets comes principally from shorter-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. Significant fluctuations in interest rates could have a material adverse
effect on the Corporation's financial condition, results of operations or
liquidity. For additional information regarding interest rate risk, see Part II,
Item 7A, "Quantitative and Qualitative Disclosures About Market Risk."
EQUITY SECURITIES RISK - The Corporation's equity securities portfolio consists
primarily of investments in stocks of banks and bank holding companies, mainly
based in Pennsylvania. Investments in bank stocks are subject to the risk
factors affecting the banking industry, and that could cause a general market
decline in the value of bank stocks. 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 its holdings in Pennsylvania
banks, these investments could decline in value if there were a downturn in the
state's economy. These factors could have a material adverse effect on the
Corporation's financial condition, results of operations or liquidity. For
additional information regarding equity securities risk, see Part II, Item 7A,
"Quantitative and Qualitative Disclosures About Market Risk."
BREACH OF INFORMATION SECURITY AND TECHNOLOGY DEPENDENCE - The Corporation
relies on software, communication, and information exchange on a variety of
computing platforms and networks and over the Internet. Despite numerous
safeguards, the Corporation cannot be certain that all of its systems are
entirely free from vulnerability to attack or other technological difficulties
or failures. The Corporation relies on the services of a variety of vendors to
meet its data processing and communication needs. If information security is
breached or other technology difficulties or failures occur, information may be
lost or misappropriated, services and operations may be interrupted and the
Corporation could be exposed to claims from customers. Any of these results
could have a material adverse effect on the Corporation's financial condition,
results of operations or liquidity.
LIMITED GEOGRAPHIC DIVERSIFICATION - The Corporation grants commercial,
residential and personal loans to customers primarily in the Pennsylvania
Counties of Tioga, Bradford, Sullivan and Lycoming, and in Steuben and Allegany
Counties in New York State. Although the Corporation has a diversified loan
portfolio, a significant portion of its debtors' ability to honor their
contracts is dependent on the local economic conditions within the region.
Deterioration in economic conditions could adversely affect the quality of the
Corporation's loan portfolio and the demand for its products and services, and
accordingly, could have a material adverse effect on the Corporation's financial
condition, results of operations or liquidity.
GROWTH STRATEGY - In recent years, the Corporation has expanded its operations
by adding new branches in Lycoming County, Pennsylvania, and by acquiring
Canisteo Valley Corporation in the southern tier of New York State. The
Corporation's future financial performance will depend on its ability to execute
its strategic plan and manage its future growth. Failure to execute these plans
could have a material adverse effect on the Corporation's financial condition,
results of operations or liquidity.
COMPETITION - All phases of the Corporation's business are competitive. Some
competitors are much larger in total assets and capitalization than the
Corporation, have greater access to capital markets and can offer a broader
array of financial services. There can be no assurance that the Corporation will
be able to compete effectively in its markets. Furthermore, developments
increasing the nature or level of competition could have a material adverse
effect on the Corporation's financial condition, results of operations or
liquidity.
GOVERNMENT REGULATION AND MONETARY POLICY - The Corporation and the banking
industry are subject to extensive regulation and supervision under federal and
state laws and regulations. The restrictions imposed by such laws and
regulations limit the manner in which the Corporation conducts its business,
undertakes new investments and activities and obtains financing. These
regulations are designed primarily for the protection of the deposit insurance
funds and consumers and not to benefit the Corporation's shareholders. Financial
institution regulation has been the subject of significant legislation in recent
years and may be the subject of further significant legislation in the future,
none of which is in the control of the Corporation. Significant new laws or
changes in, or repeals of, existing laws could have a material adverse effect on
the Corporation's financial condition, results of operations or liquidity.
Further, federal monetary policy, particularly as implemented through the
Federal Reserve System, significantly affects short-term interest rates and
credit conditions, and any unfavorable change in these conditions could have a
material adverse effect on the Corporation's financial condition, results of
operations or liquidity.
4
BANK SECRECY ACT AND RELATED LAWS AND REGULATIONS - These laws and regulations
have significant implications for all financial institutions. They increase due
diligence requirements and reporting obligations for financial institutions,
create new crimes and penalties, and require the federal banking agencies, in
reviewing merger and other acquisition transactions, to consider the
effectiveness of the parties to such transactions in combating money laundering
activities. Even innocent noncompliance and inconsequential failure to follow
the regulations could result in significant fines or other penalties, which
could have a material adverse impact on the Corporation's financial condition,
results of operations or liquidity.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
The Banks owns each of their properties, except for the facilities located at 68
Main Street, Wellsboro, and 2 East Mountain Avenue, South Williamsport, which
are leased. All of the properties are in good condition. None of the owned
properties are subject to encumbrance.
A listing of properties is as follows:
Main administrative office:
90-92 Main Street
Wellsboro, PA 16901
Branch offices - C&N Bank:
428 S. Main Street
Athens, PA 18810
111 Main Street
Dushore, PA 18614
Main Street
East Smithfield, PA 18817
104 Main Street
Elkland, PA 16920
230-232 Railroad Street
Jersey Shore, PA 17740
102 E. Main Street
Knoxville, PA 16928
Main Street
Laporte, PA 18626
Main Street
Liberty, PA 16930
1085 S. Main Street
Mansfield, PA 16933
Route 220
Monroeton, PA 18832
3461 Route 405 Highway
Muncy, PA 17756
Thompson Street
Ralston, PA 17763
503 N. Elmira Street
Sayre, PA 18840
2 East Mountain Avenue
South Williamsport, PA 17702
41 Main Street
Tioga, PA 16946
428 Main Street
Towanda, PA 18848
Courthouse Square
Troy, PA 16947
90-92 Main Street
Wellsboro, PA 16901
130 Court Street
Williamsport, PA 17701
Route 6
Wysox, PA 18854
Other C&N Bank offices:
Bankcard Services
11822 Route 6
Wellsboro, PA 16901
C&N Financial Services Corp.
68 Main Street
Wellsboro, PA 16901
Internal Audit
Water Street
Wellsboro, PA 16901
First State Bank offices:
3 Main Street
Canisteo, NY 14823
111 Main Street
Hornell, NY 14843
5
ITEM 3. LEGAL PROCEEDINGS
The Corporation and the Banks 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2005, no matters were submitted to a vote of
security holders, through the solicitation of proxies or otherwise.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
QUARTERLY SHARE DATA
Trades of the Corporation's stock are executed through various brokers who
maintain a market in the Corporation's stock. Effective January 13, 2005, the
Corporation's stock began to be listed on the NASDAQ SmallCap Market with the
trading symbol CZNC. Previously, the Corporation's stock was available through
the Over-The-Counter Bulletin Board. As of December 31, 2005, there were 2,425
shareholders of record of the Corporation's common stock.
The following table sets forth the approximate high and low sales prices of the
common stock during 2005 and 2004.
2005 2004
-------------------------- ---------------------------------
Dividend Dividend
Declared Declared
per per
High Low Quarter High Low Quarter
------ ------ -------- ------ ------ ---------------
First quarter $32.25 $26.50 $0.23 $27.00 $25.00 $0.22
Second quarter 33.85 25.80 0.23 25.50 24.45 0.22
Third quarter 37.51 25.22 0.23 25.90 24.20 0.22
Fourth quarter 29.46 24.49 0.24 27.00 24.80 0.23
plus 1% plus 1%
stock stock dividend
dividend
While the Corporation expects to continue its policy of regular quarterly
dividend payments, future dividend payments will depend upon maintenance of a
strong financial condition, future earnings and capital and regulatory
requirements. Also, the Corporation, C&N Bank and First State Bank are subject
to restrictions on the amount of dividends that may be paid without approval of
banking regulatory authorities. These restrictions are described in Note 21 to
the consolidated financial statements.
Known "market makers" who handle Citizens & Northern Corporation stock
transactions are:
Boenning & Scattergood, Inc.
4 Tower Bridge, Suite 300
200 Barr Harbor Drive
West Conshohocken, PA 19428
Ferris, Baker, Watts, Inc.
100 Light Street - Eighth Floor
Baltimore, MD 21201
Hill Thompson Magid, L.P.
15 Exchange Place
Suite 800
Jersey City, NJ 07302
Monroe Securities, Inc.
343 West Erie
Suite 410
Chicago, IL 60610
Knight Equity Markets, LP
Newport Tower
525 Washington Blvd
Jersey City, NJ 07310
Pershing Trading Company, LP
1 Pershing Plaza
Jersey City, NJ 07399
RBC Capital Markets Corp.
60 South 6th St.
P.O. Box 1160
Minneapolis, MN 55402
Ryan Beck & Co.
18 Columbia Turnpike
Florham Park, NJ 07932
Sandler, O'Neill & Partners, LP
919 Third Avenue
Sixth Floor
New York, NY 10022
6
Janney Montgomery Scott, LLC
1801 Market Street
Philadelphia, PA 19103
Schwab Capital Markets, LP
111 Pavonia Avenue
East Jersey City, NJ 07310
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth information concerning the Stock Incentive Plan
and Independent Directors Stock Incentive Plan, both of which have been approved
by the Corporation's shareholders. The figures shown in the table below are as
of December 31, 2005.
NUMBER OF
NUMBER OF WEIGHTED- SECURITIES
SECURITIES TO BE AVERAGE REMAINING
ISSUED UPON EXERCISE FOR FUTURE
EXERCISE OF PRICE OF ISSUANCE UNDER
OUTSTANDING OUTSTANDING EQUITY COMPEN-
OPTIONS OPTIONS SATION PLANS
---------------- ----------- --------------
EQUITY COMPENSATION PLANS
APPROVED BY SHAREHOLDERS 203,993 $21.51 161,882
EQUITY COMPENSATION PLANS
NOT APPROVED BY SHAREHOLDERS 0 N/A 0
More details related to the Corporation's equity compensation plans are provided
in Notes 1 and 15 to the consolidated financial statements.
SALES OF UNREGISTERED SECURITIES
During the year ended December 31, 2005, the Corporation issued 38,814 shares of
common stock held in treasury upon the exercise of stock options by employees
and directors under the Corporation's equity compensation plans. Exercise prices
for the stock options ranged from $13.33 to $26.59 per share and resulted in
aggregate cash proceeds to the Corporation of $726,732. Treasury shares were
issued upon exercise of options by a small number of employees and directors in
reliance upon the private placement exemption from registration under Section
4(2) of the Securities Act of 1933.
7
ITEM 6. SELECTED FINANCIAL DATA
2005 2004 2003 2002 2001
----------- ----------- ----------- ----------- -----------
INCOME STATEMENT (IN THOUSANDS)
Interest income $ 61,108 $ 57,922 $ 55,223 $ 57,285 $ 54,661
Interest expense 25,687 22,606 23,537 26,315 28,356
----------- ----------- ----------- ----------- -----------
Interest margin 35,421 35,316 31,686 30,970 26,305
Provision for loan losses 2,026 1,400 1,100 940 600
----------- ----------- ----------- ----------- -----------
Interest margin after provision for loan losses 33,395 33,916 30,586 30,030 25,705
Other income 7,636 6,922 6,595 6,624 6,120
Securities gains 1,802 2,877 4,799 2,888 1,920
Gain from sale of credit card loans 1,906 -- -- -- -
Other expenses 28,962 26,001 22,114 20,849 18,671
----------- ----------- ----------- ----------- -----------
Income before income tax provision 15,777 17,714 19,866 18,693 15,074
Income tax provision 2,793 2,851 3,609 3,734 3,022
----------- ----------- ----------- ----------- -----------
Net income $ 12,984 $ 14,863 $ 16,257 $ 14,959 $ 12,052
=========== =========== =========== =========== ===========
BALANCE SHEET AT YEAR END (IN THOUSANDS)
Total securities (1) $ 433,244 $ 479,626 $ 484,825 $ 513,597 $ 437,398
Gross loans, excluding unearned discount 653,299 579,613 524,897 451,145 379,228
Total assets 1,162,954 1,123,002 1,066,901 1,018,768 866,999
Total deposits 757,065 676,545 658,065 640,304 576,274
Stockholders' equity, excluding accumulated
other comprehensive income (3) 127,270 121,050 113,306 103,691 94,903
Total stockholders' equity 131,968 131,585 125,343 115,837 100,187
AVERAGE BALANCE SHEET (IN THOUSANDS)
Total securities, at amortized cost (1) 446,845 485,183 474,406 470,764 412,654
Gross loans, excluding unearned discount 618,344 551,352 485,150 410,670 346,353
Earning assets 1,065,189 1,036,535 959,556 881,434 759,007
Total assets 1,144,619 1,114,041 1,034,720 943,001 805,229
Total assets, excluding unrealized gains/
losses (4) 1,133,422 1,097,859 1,014,424 930,539 798,590
Total deposits 702,404 669,307 651,026 613,392 544,579
Stockholders' equity, excluding accumulated
other comprehensive income (4) 125,076 117,695 108,876 99,361 91,703
Stockholders' equity 132,465 128,374 122,271 107,595 96,021
COMMON STOCK AND PER SHARE DATA
Net income per share - basic $ 1.57 $ 1.80 $ 1.97 $ 1.81 $ 1.46
Net income per share - diluted 1.55 1.79 1.96 1.81 1.45
Cash dividends declared per share 0.93 0.89 0.85 0.77 0.71
Stock dividend 1% 1% 1% 1% 1%
Stockholders' equity per share (2) 15.89 15.92 15.18 14.04 12.14
Stockholders' equity per share, excluding
accumulated other comprehensive
income (loss) (2), (4) 15.33 14.65 13.72 12.57 11.50
Weighted average shares outstanding - basic 8,292,141 8,267,321 8,252,358 8,251,861 8,266,563
Weighted average shares outstanding - diluted 8,350,926 8,315,847 8,301,073 8,273,749 8,288,451
Number of shares outstanding at year-end 8,220,791 8,102,646 8,014,625 5,285,606 5,234,800
Number of shares authorized 20,000,000 20,000,000 10,000,000 10,000,000 10,000,000
8
2005 2004 2003 2002 2001
----- ----- ----- ----- -----
FINANCIAL RATIOS
Return on stockholders' equity, excluding
accumulated other comprehensive income (3), (4) 10.38% 12.63% 14.93% 15.06% 13.14%
Return on stockholders' equity (3) 9.80% 11.58% 13.30% 13.90% 12.55%
Return on assets (3) 1.13% 1.33% 1.57% 1.59% 1.50%
Stockholders' equity to assets, excluding
accumulated other comprehensive income (3), (4) 11.04% 10.72% 10.73% 10.68% 11.48%
Stockholders' equity to assets (3) 11.57% 11.52% 11.82% 11.41% 11.92%
Stockholders' equity to loans (3) 21.42% 23.28% 25.20% 26.20% 27.72%
Net income to:
Total interest income 21.25% 25.66% 29.44% 26.11% 22.05%
Interest margin 36.66% 42.09% 51.31% 48.30% 45.82%
Dividends as a % of net income 58.85% 48.54% 41.96% 41.17% 46.08%
(1) Includes available-for-sale and held-to-maturity securities, and
interest-bearing cash and due from banks.
(2) For purposes of this computation, the number of outstanding shares has been
increased for the effects of a 3-for-2 stock split issued in April 2003 and
for 1% stock dividends issued in January following each year-end.
(3) Ratios calculated using average balance sheet data.
(4) Generally accepted accounting principles ("GAAP") require that
available-for-sale securities be reported at fair value, with unrealized
gains and losses excluded from earnings and reported separately through
stockholders' equity, net of tax. Management believes there is an inherent
mismatch between the income statement and balance sheet related to
unrealized gains/losses that may create a material inconsistency in
earnings-based ratios. Further, the amount of unrealized gains/losses may
vary widely from period-to-period, depending on the financial markets as a
whole and interest rate movements. Therefore, management has provided these
"non-GAAP" amounts and ratios because we believe they provide meaningful
information for evaluating the Corporation's financial position and results
of operations.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements in this section and elsewhere in this Annual Report on Form
10-K 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:
- - 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.
9
EARNINGS OVERVIEW
2005 VS. 2004
Net income in 2005 totaled $12,984,000, or $1.57 per share - basic, and $1.55
per share - diluted. Net income for 2005 was down 12.6% from 2004. The
Corporation's lower 2005 earnings results reflected the impact of a flat yield
curve, a significant increase in noninterest expense, and other factors. Despite
substantial loan growth, the net interest margin increased only slightly in 2005
over 2004 (as noted in the "Net Interest Margin" section of Management's
Discussion and Analysis, when calculated on a fully taxable equivalent basis,
net interest income was lower by $651,000 in 2005 than in 2004). Increases in
short-term interest rates contributed to a 13.6% increase in interest expense,
while relatively flat (and at times, declining) long-term rates dampened the
positive earnings effect of the growth in loans. The impact of rising interest
costs became especially apparent in the fourth quarter, as the interest margin
fell to $8,787,000 from $9,145,000 in the third quarter. Further, in light of
the flat yield curve, the opportunities were very limited for earning a positive
spread from maintaining borrowed funds and holding investment securities.
Accordingly, the December 31, 2005 balance of available-for-sale securities was
$47,787,000 lower than the year-end 2004 balance, and the December 31, 2005
balance of short-term and long-term borrowings was $38,066,000 lower than
year-end 2004.
Noninterest expense increased $2,961,000 (11.4%) in 2005 over 2004. Total
salaries and benefit expenses increased $1,483,000, or 10.1% in 2005 over 2004,
primarily due to new hires to accommodate expansion into new branches and for
several support functions. Furniture and equipment expense increased $859,000,
or 47.6%, mainly due to depreciation and maintenance costs associated with the
new core banking software system, which was implemented in the fourth quarter
2004.
The provision for loan losses increased $626,000 in 2005 over 2004, mainly due
to estimates of possible future charge-offs on several large commercial loans,
as well as volume-related increases in the portions of the provision determined
based on historical net charge-off and subjective factors.
In the fourth quarter 2005, the Corporation realized a gain from the sale of
credit card receivables of $1,906,000. After the sale, the Corporation continues
to offer credit cards through C&N Bank, but now as an agent for a national
credit card issuer. Also in the fourth quarter 2005, the Corporation had net
losses from sales of securities of $586,000, contributing to a $1,075,000
reduction in net securities gains in 2005 as compared to 2004. The fourth
quarter 2005 losses were mainly from sales of securities that were purchased in
2003 and 2004, when market yields were lower than current conditions.
Other (noninterest) income totaled $7,636,000 in 2005, an increase of $714,000,
or 10.3%, over 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 $175,000; dividends from Federal Home
Loan Bank of Pittsburgh stock of $152,000; and debit card fees of $100,000.
2004 VS. 2003
Net income in 2004 was $14,863,000, or $1.80 per share - basic and $1.79 per
share - diluted. Net income for 2004 was 8.6%, lower than the $16,257,000 ($1.97
per share - basic and $1.96 per share - diluted) recorded in 2003. Realized
securities gains, net of realized losses, decreased $1,922,000 to $2,877,000 in
2004 from $4,799,000 in 2003. In both 2004 and 2003. the Corporation sold
selected bank stocks that management believed to be fully valued, generating
substantial realized gains. Assuming an income tax rate of 34%, the lower
securities gains in 2004 reduced net income for 2004 by $1,269,000 from 2003.
Excluding the effects of lower securities gains, net income for 2004 was
approximately 1% lower than the amount recorded in 2003. The interest margin
increased $3,630,000, or 11.5% in 2004 from $31,686,000 in 2003. Higher interest
income, primarily from growth in loans, combined with lower interest expense,
combined to drive the increase in the interest margin. Other (noninterest)
operating expenses increased $1,363,000, or 25.9%, in 2004 over 2003. Overall,
the increase in noninterest expenses resulted from start-up of the Williamsport
and South Williamsport facilities, the implementation of the core computer
system conversion and other activities that resulted in more expense incidental
to additional personnel and technology costs.
10
OUTLOOK FOR 2006
Earnings for 2005 were impacted by 2 significant factors that will probably
continue to have an effect in 2006: (1) continuation of a flat yield curve, for
at least the first 3-4 months of 2006, and (2) start-up costs associated with
our recent expansion and new facilities.
Continuing tightening by the Federal Reserve (eight 1/4% increases in the Fed
Funds target rate in 2005, and another in January 2006) have driven up interest
costs on deposits and borrowings, and will continue to do so for at least the
first few months of 2006. As the short end of the yield curve has been rising,
the long end has fallen slightly. Accordingly, competitive rates for loans and
debt securities have not increased commensurately with the increase in funding
costs.
Management expects the expansion and investments in new markets to provide
future, continuing opportunities for earnings growth. In 2006, however, expenses
associated with new facilities, personnel and other start-up costs, will affect
earnings. The estimated increase in salaries and benefit expenses associated
with having a full year of operations in Jersey Shore (which opened in August
2005), and an estimated 10 months of operations in the new facility in Old
Lycoming Township, is $364,000. Further, depreciation and other occupancy
expenses in 2006 from the new administration building in Wellsboro and the Old
Lycoming Township facility, are estimated at approximately $400,000.
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 2006.
Total capital purchases for 2006 are estimated to total approximately $4.3
million, including approximately $1.7 million to complete the Wellsboro
administration and Old Lycoming Township facilities.
CRITICAL ACCOUNTING POLICIES
The presentation of financial statements in conformity with U.S. generally
accepted accounting principles requires management to make estimates and
assumptions that affect many of the reported amounts and disclosures. Actual
results could differ from these estimates.
A material estimate that is particularly susceptible to significant change is
the determination of the allowance for loan losses. Management believes that the
allowance for loan losses is adequate and reasonable. The Corporation's
methodology for determining the allowance for loan losses is described in a
separate section later in Management's Discussion and Analysis. Given the very
subjective nature of identifying and valuing loan losses, it is likely that
well-informed individuals could make materially different assumptions, and
could, therefore calculate a materially different allowance value. While
management uses available information to recognize losses on loans, changes in
economic conditions may necessitate revisions in future years. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Corporation's allowance for loan losses. Such agencies
may require the Corporation to recognize adjustments to the allowance based on
their judgments of information available to them at the time of their
examination.
Another material estimate is the calculation of fair values of the Corporation's
debt securities. The Corporation receives estimated fair values of debt
securities from an independent valuation service, or from brokers. In developing
these fair values, the valuation service and the brokers use estimates of cash
flows, based on historical performance of similar instruments in similar
interest rate environments. Based on experience, management is aware that
estimated fair values of debt securities tend to vary among brokers and other
valuation services. Accordingly, when selling debt securities, management
typically obtains price quotes from more than one source. As described in Note 1
to the consolidated financial statements, 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).
11
NET INTEREST MARGIN
2005/2004/2003
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 I, II and III include
information regarding the Corporation's net interest margin in 2005, 2004 and
2003. In each of these tables, the amounts of interest income earned on
tax-exempt securities and loans have been adjusted to a fully taxable-equivalent
basis. Accordingly, the net interest margin amounts presented in these tables
exceed the amounts presented in the consolidated financial statements. The
discussion that follows is based on amounts in the Tables.
The net interest margin, on a tax-equivalent basis, was $38,567,000 in 2005,
down $651,000, or 1.7%, from 2004. As reflected in Table III, interest rate
changes had the effect of decreasing net interest income $2,310,000 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 III 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 $1,659,000 in 2005 compared to 2004. As presented in Table II,
the "Interest Rate Spread" (excess of average rate of return on interest-bearing
assets over average cost of funds on interest-bearing liabilities) was 3.22% in
2005, compared to 3.43% in 2004.
In 2004, the net interest margin was $39,218,000, an increase of $3,736,000 or
10.5%, over 2003. As reflected in Table III, increased interest income from
higher volumes of earning assets exceeded increases in interest expense
attributable to higher volumes of interest-bearing liabilities by $2,830,000 in
2004 compared to 2003. Table III also shows that interest rate changes had the
effect of increasing net interest income $906,000 in 2004 compared to 2003. As
shown in Table II, the Interest Rate Spread of 3.43% in 2004 was up from 3.31%
in 2003.
INTEREST INCOME AND EARNING ASSETS
Interest income increased 3.9%, to $64,254,000 in 2005 from $61,824,000 in 2004.
Interest and fees from loans increased $4,748,000, or 13.3%, while income from
available-for-sale securities decreased $2,426,000, or 9.3%. 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 II, average available-for-sale securities in 2005 amounted
to $442,525,000, a decrease of 8.3% from 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 5.35% for 2005, slightly lower than the 5.41% rate of return for
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 $123,295,000 in 2005 from $151,049,000 in 2004.
Management decided to reduce the Corporation's investment in municipal bonds in
order to reduce the potential for an alternative minimum tax liability that
would otherwise have been expected for 2005.
The average balance of gross loans increased 12.2% in 2005 over 2004, to
$618,344,000 from $551,352,000. The acquisition of loans from First State Bank,
which were added to the Corporation's balance sheet for the last 4 months of
2005 contributed $7,804,000 (1.4%) of the growth in average loans. 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 6.53% in 2005, as compared to 6.47% in 2004.
As reflected in Table II, the average balance of available-for-sale securities
increased $11,043,000, or 2.3% in 2004 over 2003, while the average yield of
5.41% was comparable to the 2003 average yield of 5.43%. Average loans increased
$66,202,000, or 13.6%, in 2004 over 2003, reflecting growth in commercial
lending that continued into 2005. The average yield on loans was 6.47%,
significantly lower than the average yield in 2003 of 6.88%. The lower average
yield on loans in 2004 resulted from significant levels of mortgage refinancings
that occurred in 2003, and by lower average yields on commercial loans with
variable or adjustable rates.
12
INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES
Interest expense rose $3,081,000, or 13.6%, to $25,687,000 in 2005 from
$22,606,000 in 2004. Table II reflects the current trend in interest rates
incurred on liabilities, as the overall cost of funds on interest-bearing
liabilities rose to 2.81% in 2005, from 2.53% in 2004. In Table II, 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 2.20% in 2005 from 1.31% in 2004, (2) certificates of deposit
(CDs), which increased to an average rate of 3.26% from 2.85%, (3) short-term
borrowings, which rose to an average rate of 2.80% from 1.37%, and (4) interest
checking accounts, which increased to an average interest rate of 1.15% from
0.59%. Helping to offset some of the impact of rising short-term market rates
were passbook Individual Retirement Accounts (IRAs), for which the average rate
fell to 3.46% from 3.75%, and long-term borrowings, for which the average rate
fell to 3.47% from 3.55%. 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 3.60% 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.
As you can calculate from Table II, total average deposits (interest-bearing and
noninterest-bearing) increased to $702,404,000 in 2005 from $669,307,000 in
2004, an increase of 4.9%. Fluctuations in deposits of nonprofit and municipal
customers impacted average deposit balances significantly in 2005, as the
Corporation has both lost and gained customers with average balances exceeding
$10 million. The acquisition of deposits from First State Bank contributed
$13,405,000, or 2.0%, of the increase in average deposits.
Average total short-term and long-term borrowed funds amounted to $299,254,000
in 2005, down from $307,669,000 in 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 slightly,
to $34,734,000 at December 31, 2005 from $34,178,000 at December 31, 2004, and
total long-term borrowings decreased to $232,205,000 at December 31, 2005 from
$270,827,000 at December 31, 2004.
Interest expense fell to $22,606,000 in 2004 from $23,537,000 in 2003. As
reflected in Table III, lower average rates had the effect of lowering interest
expense $3,161,000 in 2004. The impact of lower rates more than offset the
effects on interest expense of higher average balances of interest-bearing
liabilities in 2004 than in 2003. Because of eliminating the 5% floor on
passbook IRAs, as noted above, the average rate incurred on IRAs fell to 3.75%
in 2004 from 4.88% in 2003. Also, the average rate incurred on CDs was 2.85% in
2004, down from 3.14% in 2003.
13
TABLE I - ANALYSIS OF INTEREST INCOME AND EXPENSE
YEAR ENDED DECEMBER 31, INCREASE(DECREASE)
--------------------------- ------------------
2005 2004 2003 05/04 04/03
------- ------- ------- ------- -------
(IN THOUSANDS)
INTEREST INCOME
Available-for-sale securities:
Taxable $15,407 $15,415 $14,823 $ (8) $ 592
Tax-exempt 8,290 10,708 10,768 (2,418) (60)
------- ------- ------- ------- ------
Total available-for-sale securities 23,697 26,123 25,591 (2,426) 532
------- ------- ------- ------- ------
Held-to-maturity securities,
Taxable 25 27 31 (2) (4)
Interest-bearing due from banks 34 11 10 23 1
Federal funds sold 97 10 8 87 2
Loans:
Taxable 38,768 34,251 32,235 4,517 2,016
Tax-exempt 1,633 1,402 1,144 231 258
------- ------- ------- ------- ------
Total loans 40,401 35,653 33,379 4,748 2,274
------- ------- ------- ------- ------
Total Interest Income 64,254 61,824 59,019 2,430 2,805
------- ------- ------- ------- ------
INTEREST EXPENSE
Interest checking 535 232 266 303 (34)
Money market 4,148 2,514 2,712 1,634 (198)
Savings 303 283 425 20 (142)
Certificates of deposit 6,428 5,135 5,959 1,293 (824)
Individual Retirement Accounts 4,184 4,376 5,182 (192) (806)
Other time deposits 6 5 17 1 (12)
Short-term borrowings 1,239 542 487 697 55
Long-term borrowings 8,844 9,519 8,489 (675) 1,030
------- ------- ------- ------- ------
Total Interest Expense 25,687 22,606 23,537 3,081 (931)
------- ------- ------- ------- ------
Net Interest Income $38,567 $39,218 $35,482 $ (651) $3,736
======= ======= ======= ======= ======
(1) Interest income from tax-exempt securities and loans has been adjusted to a
fully taxable-equivalent basis, using the Corporation's marginal federal
income tax rate of 34%.
(2) Fees on loans are included with interest on loans and amounted to $915,000
in 2005, $987,000 in 2004 and $1,323,000 in 2003.
14
TABLE II - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES
2005 2004 2003
-------------------- -------------------- --------------------
RATE OF RATE OF RATE OF
RETURN/ RETURN/ RETURN/
COST OF COST OF COST OF
AVERAGE FUNDS AVERAGE FUNDS AVERAGE FUNDS
BALANCE % BALANCE % BALANCE %
---------- ------- ---------- ------- ---------- -------
(DOLLARS IN THOUSANDS)
EARNING ASSETS
Available-for-sale securities, at amortized cost:
Taxable $ 319,230 4.83% $ 331,447 4.65% $ 325,082 4.56%
Tax-exempt 123,295 6.72% 151,049 7.09% 146,371 7.36%
---------- ---- ---------- ---- ---------- ----
Total available-for-sale securities 442,525 5.35% 482,496 5.41% 471,453 5.43%
---------- ---- ---------- ---- ---------- ----
Held-to-maturity securities,
Taxable 427 5.85% 460 5.87% 604 5.13%
Interest-bearing due from banks 1,293 2.63% 1,449 0.76% 1,669 0.60%
Federal funds sold 2,600 3.73% 778 1.29% 680 1.18%
Loans:
Taxable 592,227 6.55% 530,045 6.46% 468,501 6.88%
Tax-exempt 26,117 6.25% 21,307 6.58% 16,649 6.87%
---------- ---- ---------- ---- ---------- ----
Total loans 618,344 6.53% 551,352 6.47% 485,150 6.88%
---------- ---- ---------- ---- ---------- ----
Total Earning Assets 1,065,189 6.03% 1,036,535 5.96% 959,556 6.15%
Cash 9,014 14,273 13,583
Unrealized gain/loss on securities 11,197 16,182 20,296
Allowance for loan losses (7,297) (6,523) (5,908)
Bank premises and equipment 19,247 14,953 11,090
Intangible Asset - Core Deposit Intangible 169 -- --
Intangible Asset - Goodwill 983 -- --
Other assets 46,117 38,621 36,103
---------- ---------- ----------
Total Assets $1,144,619 $1,114,041 $1,034,720
========== ========== ==========
INTEREST-BEARING LIABILITIES
Interest checking $ 46,408 1.15% $ 39,188 0.59% $ 37,647 0.71%
Money market 188,507 2.20% 192,450 1.31% 190,161 1.43%
Savings 60,203 0.50% 57,439 0.49% 54,789 0.78%
Certificates of deposit 197,165 3.26% 180,332 2.85% 190,019 3.14%
Individual Retirement Accounts 121,013 3.46% 116,622 3.75% 106,216 4.88%
Other time deposits 1,152 0.52% 1,275 0.39% 1,666 1.02%
Short-term borrowings 44,267 2.80% 39,458 1.37% 7,033 1.29%
Long-term borrowings 254,987 3.47% 268,211 3.55% 242,358 3.67%
---------- ---- ---------- ---- ---------- ----
Total Interest-bearing Liabilities 913,702 2.81% 894,975 2.53% 829,889 2.84%
Demand deposits 87,956 82,001 70,528
Other liabilities 10,496 8,691 12,032
---------- ---------- ----------
Total Liabilities 1,012,154 985,667 912,449
---------- ---------- ----------
Stockholders' equity, excluding other
comprehensive income/loss 125,076 117,695 108,876
Other comprehensive income/loss 7,389 10,679 13,395
Total Stockholders' Equity 132,465 128,374 122,271
---------- ---------- ----------
Total Liabilities and Stockholders' Equity $1,144,619 $1,114,041 $1,034,720
========== ========== ==========
Interest Rate Spread 3.22% 3.43% 3.31%
Net Interest Income/Earning Assets 3.62% 3.78% 3.70%
(1) Rates of return on tax-exempt securities and loans are calculated on a
fully-taxable equivalent basis, using the Corporation's marginal federal
income tax rate of 34%.
(2) Nonaccrual loans are included in the loan balances above.
15
TABLE III - THE EFFECT OF VOLUME AND RATE CHANGES ON INTEREST INCOME AND
INTEREST EXPENSE
YEAR ENDED 12/31/05 VS. 04 YEARS ENDED 12/31/04 VS. 03
--------------------------- ---------------------------
CHANGE CHANGE CHANGE CHANGE
IN IN TOTAL IN IN TOTAL
VOLUME RATE CHANGE VOLUME RATE CHANGE
------- ------- ------- ------ ------- -------
(IN THOUSANDS)
EARNING ASSETS
Available-for-sale securities:
Taxable $ (579) $ 571 $ (8) $ 426 $ 166 $ 592
Tax-exempt (1,888) (530) (2,418) 338 (398) (60)
------- ------- ------- ------ ------- -------
Total available-for-sale securities (2,467) 41 (2,426) 764 (232) 532
------- ------- ------- ------ ------- -------
Held-to-maturity securities,
Taxable (2) -- (2) (8) 4 (4)
Interest-bearing due from banks (1) 24 23 (1) 2 1
Federal funds sold 48 39 87 1 1 2
Loans:
Taxable 4,066 451 4,517 3,996 (1,980) 2,016
Tax-exempt 304 (73) 231 308 (50) 258
------- ------- ------- ------ ------- -------
Total loans 4,370 378 4,748 4,304 (2,030) 2,274
------- ------- ------- ------ ------- -------
Total Interest Income 1,948 2,430 5,060 2,805 482 (2,255)
------- ------- ------- ------ ------- -------
INTEREST-BEARING LIABILITIES
Interest checking 50 253 303 11 (45) (34)
Money market (53) 1,687 1,634 33 (231) (198)
Savings 14 6 20 20 (162) (142)
Certificates of deposit 506 787 1,293 (294) (530) (824)
Individual Retirement Accounts 161 (353) (192) 473 (1,279) (806)
Other time deposits -- 1 1 (3) (9) (12)
Short-term borrowings 73 624 697 1 8 9
Long-term borrowings (462) (213) (675) 1,989 (913) 1,076
------- ------- ------- ------ ------- -------
Total Interest Expense 289 2,792 3,081 2,230 (3,161) (931)
------- ------- ------- ------ ------- -------
Net Interest Income $ 1,659 $(2,310) $ (651) $2,830 $ 906 $ 3,736
======= ======= ======= ====== ======= =======
(1) Changes in interest income on tax-exempt securities and loans are 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 amounts of the change in each.
16
NONINTEREST INCOME
2005/2004/2003
Total noninterest income increased $1,545,000, or 15.8%, in 2005 as compared to
2004. In 2004, total noninterest income decreased $1,595,000, or 14.0%, compared
to 2003. The gain from sale of credit card loans, and fluctuations in amounts of
net realized security gains in 2005, 2004 and 2003 are discussed in the
"Earnings Overview" section of Management's Discussion and Analysis. Excluding
the effect of the credit card sale and net securities gains, noninterest income
increased $714,000, or 10.3%, in 2005 over 2004, and $327,000, or 5.0%, in 2004
over 2003. Items of significance related to changes in other income are as
follows:
2005 VS. 2004
- Service charges on deposit accounts fell slightly, to $1,689,000 in
2005 from $1,717,000 in 2004. Throughout much of the first half of
2005, 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 worked 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 for 2005, on an annual
basis, to a level almost as high as in 2004.
- Other service charges and fees increased $59,000, or 19.2%, in 2005
over 2004, primarily from higher volumes of transactions, including
letters of credit, ATM surcharges and other transactions.
- Trust and financial management revenue decreased 0.8%, to $2,088,000
in 2005 from $2,105,000 in 2004. The small decrease in revenue for
2005 occurred mainly because revenue for 2004 included more fees
collected from settlements of estates. Much of the trust fees are
determined based on the amount of assets under management, which have
increased 9.2% as of December 31, 2005 as compared to one year
earlier, to $418,259,000.
- Insurance commissions, fees and premiums increased $52,000, or 11.8%,
in 2005 over 2004. In the third quarter 2005, Bucktail recorded a
"catch-up" adjustment to recognize revenue 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 $50,000, or
8.2%, 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
$175,000, or 22.4%, in 2005 over 2004, primarily because of higher
volumes and rates on merchant processing and interchange transactions.
Within this category, the largest increase was in interchange fees,
which increased $123,000 in 2005, to $758,000. This source of revenue
will not recur after 2005, due to the sale of the credit card
portfolio. The second largest source of revenue within this category,
merchant processing fees, increased $57,000 in 2005, to $141,000. The
Corporation did not sell its merchant services as part of the credit
card portfolio sale, and will continue to provide merchant processing
services in 2006.
- Other operating income increased $523,000, or 53.9%, 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, which
increased $152,000 to $325,000
- debit card fees, which increased $100,000 to $358,000
- broker dealer revenues, which increased $87,000 to $297,000, and
- training grant revenue of $65,000, with none received in 2004.
2004 VS. 2003
- - Trust and financial management revenue rose $372,000, or 21.5% for 2004
compared to 2003. Trust and financial management revenue for 2004 included
the effects of some large estate settlements, and also reflected 16.2%
growth in assets under management at December 31, 2004, as compared to
December 31, 2003.
17
- - The increase in cash surrender value of life insurance fell $105,000 to
$610,000 in 2004 from $715,000 in 2003. As in 2005, lower earnings on the
policy were reflective of lower earnings from the pooled separate trust
fund's holdings of debt securities.
TABLE IV - COMPARISON OF NONINTEREST INCOME
2005 % CHANGE 2004 % CHANGE 2003
------- -------- ------ -------- -------
(IN THOUSANDS)
Service charges on deposit accounts $ 1,689 (1.6) $1,717 (1.7) $ 1,746
Service charges and fees 367 19.2 308 7.3 287
Trust and financial management revenue 2,088 (0.8) 2,105 21.5 1,733
Insurance commissions, fees and premiums 491 11.8 439 12.3 391
Increase in cash surrender value of life
insurance 560 (8.2) 610 (14.7) 715
Fees related to credit card operation 948 22.6 773 (1.4) 784
Other operating income 1,493 53.9 970 3.3 939
------- ---- ------ ----- -------
Total other income before gain on sale of credit card
loans and realized gains on securities, net 7,636 10.3 6,922 5.0 6,595
Gain on sale of credit card loans 1,906 -- --
Realized gains on securities, net 1,802 (37.4) 2,877 (40.1) 4,799
------- ---- ------ ----- -------
Total Other Income $11,344 15.8 $9,799 (14.0) $11,394
======= ==== ====== ===== =======
OTHER NONINTEREST EXPENSE
2005/2004/2003
Total noninterest expense increased $2,961,000, or 11.4%, in 2005 over 2004, to
$28,962,000. Noninterest expense from Canisteo Valley Corporation and First
State Bank totaled $577,000, or 2.2%, of the 2005 increase. In 2004, total
noninterest expense increased $3,887,000, or 17.6%, over 2003.
2005 VS. 2004
Salaries and wages increased $1,135,000, or 10.1%, 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 354 as of December 31, 2005, up 9.3% from one year earlier.
Pensions and other employee benefit expenses increased $348,000, or 10.2%, in
2005 over 2004. In the aggregate, total pensions and other employee benefits
expense, as a percentage of salaries and wages, was 30.3%, the same as in 2004.
Increases in numbers of employees drove up expenses for health insurance,
contributions to the savings and retirement (401(k)) plan and payroll taxes.
Helping to mitigate some of the expense increases within this category were
reductions in expense associated with the defined benefit plan and professional
fees related to employee benefit plan matters. More detail concerning the
Corporation's retirement plans is provided in Note 15 to the consolidated
financial statements.
Occupancy expense increased $178,000, or 10.7%, in 2005 over 2004, primarily as
a result of higher depreciation and maintenance costs associated with new
facilities.
Furniture and equipment expense increased $859,000, or 47.6%, in 2005 over 2004.
Depreciation expense within this category increased $586,000, to $1,601,000 in
2005 from $1,015,000 in 2004, including an increase of $468,000 in 2005 from the
new core banking software system that was placed in service during the fourth
quarter 2004. Similarly, maintenance and repair expense within this category
increased $241,000 in 2005 over 2004, primarily because of inclusion of a full
year of maintenance costs associated with the new core banking software system
of approximately $377,000 in 2005, up from 2 months' of costs totaling $60,000
in 2004.
18
Other operating expense increased $435,000, or 6.6%, 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.
Total other operating expense incurred by Canisteo Valley Corporation and First
State Bank in the final 4 months of 2005 totaled $281,000, or 4.2% of the total
increase. The most significant increases within this category were: (1) expenses
associated with maintaining and preparing other real estate properties for sale,
which increased $210,000 in 2005 to $304,000; (2) attorney fees, which increased
$164,000 in 2005 to $203,000, mainly because of collection activities on a large
commercial credit, and (3) Bucktail expenses, which increased $117,000 to
$323,000, due to a larger volume of claims. Helping to reduce the overall
increase in this category was a decrease in professional fees of $530,000, to
$215,000 in 2005. In 2004, the Corporation incurred a significant amount of
professional fees expense associated with the core banking system conversion.
2004 VS. 2003
Salaries and wages increased $1,552,000, or 16.0%, for 2004 compared to 2003.
The number of full-time equivalent employees (FTEs) increased 10.6%, to 324 at
December 31, 2004 from 293 at December 31, 2003. The increased number of
employees included personnel for the new Willamsport and South Williamsport
branches opened in 2004, as well as new positions added in 2004 for Trust,
Commercial Lending, Loan Administration, Accounting and Employee Training
functions, as well as 5 Management Trainees who worked primarily on the core
computer system conversion. In addition, paid overtime increased approximately
$90,000 in 2004 over 2003, mainly due to core system conversion efforts.
Pensions and other employee benefits increased $87,000, or 2.6%, in 2004 over
2003. As a percentage of salaries and wages, pensions and other employee
benefits fell to 30.3% in 2004 from 34.2% in 2003. In 2004, employer
contributions to the 401(k) profit sharing plan totaled 6.7% of salaries and
wages, down from 7.8% in 2003. The lower percentage of profit sharing
contributions in 2004 reflected a higher proportion of new employees hired in
2004, as the new hires began to qualify for contributions in 2005. Other expense
reductions in 2004 included professional fees related to employee benefit
matters, which decreased $89,000 to $167,000, defined benefit pension plan
expense, which decreased $45,000 to $388,000 and supplemental executive
retirement plan expense, which fell $41,000 to $4,000.
Occupancy expense increased $369,000, or 28.5%, in 2004 over 2003. The greatest
portion of the increase in occupancy expense was attributable to increased costs
of $112,000 for building maintenance and repairs. Depreciation expense also rose
$93,000 from 2003's level, as the Corporation recorded depreciation on the new
Williamsport facility and on building renovation costs for several locations.
Total energy costs increased $68,000, primarily due to higher utility rates in
several locations, as well as the initial expenses associated with the
Williamsport and South Williamsport facilities during 2004.
Furniture and equipment expense increased $433,000, or 31.6%, in 2004 compared
to 2003. The largest increase within this category was in depreciation expense,
which increased $283,000. The depreciation expense related to the Corporation's
Management Information Systems function increased $180,000 in 2004, including
$143,000 related to software and hardware for the new core system that was
placed in service in October 2004. Depreciation expense also increased due to
the addition of computer equipment and furniture for the Williamsport and South
Williamsport locations. In addition to the increase in depreciation, maintenance
and repairs expense increased $121,000 in 2004, mainly due to maintenance
contracts associated with the new software and hardware.
In total, other operating expense increased $1,363,000, or 25.9%, in 2004 over
2003. This category includes many different types of expenses. The most
significant changes within this category are as follows:
- Bank professional fees increased $374,000, to $745,000. Included in
this category was approximately $347,000 in expenses for training and
other professional services related to the core banking software
implementation.
- Supplies expense increased $204,000, to $645,000 in 2004. This
increase included costs associated with new locations and an increased
number of employees as well as supplies used in the new core system
training.
- Travel, lodging and meal expenses increased $171,000 to $284,000
mainly from costs related to teams of employees who traveled to the
vendor's headquarters for training on the new core system.
- Fees paid to Corporation, Bank and Advisory Board Directors increased
$106,000 in 2004, to $406,000. This reflected increases in rates paid
for meeting fees, and retainers, based on recommendations from a
competitive survey completed by a consultant early in 2004. Prior to
2004, no Director fee rates had increased since 1999.
- Software-related expense increased $101,000 in 2004, to $250,000. This
increase was mainly attributable to costs associated with a new Human
Resources Information System that was installed in 2004.
19
- Advertising expense increased $90,000 in 2004, to $464,000, mainly due
to advertising programs in the Williamsport marketplace.
TABLE V - COMPARISON OF NONINTEREST EXPENSE
2005 % CHANGE 2004 % CHANGE 2003
------- -------- ------- -------- -------
(IN THOUSANDS)
Salaries and wages $12,383 10.1 $11,248 16.0 $ 9,696
Pensions and other employee benefits 3,752 10.2 3,404 2.6 3,317
Occupancy expense, net 1,842 10.7 1,664 28.5 1,295
Furniture and equipment expense 2,664 47.6 1,805 31.6 1,372
Expenses related to credit card operation 462 11.6 414 7.5 385
Pennsylvania shares tax 804 (5.0) 846 6.8 792
Other operating expense 7,055 6.6 6,620 25.9 5,257
------- ---- ------- ---- -------
Total Other Expense $28,962 11.4 $26,001 17.6 $22,114
======= ==== ======= ==== =======
INCOME TAXES
The income tax provision was $2,793,000, or 17.70% of pre-tax income, in 2005,
as compared to 16.09% in 2004 and 18.17% in 2003. The increase in the tax
provision/pre-tax income rate in 2005 over 2004 reflected lower average holdings
of tax-exempt securities. Management decided to reduce the Corporation's
investment in municipal bonds in order to reduce the potential for an
alternative minimum tax liability that would otherwise have been expected for
2005. In contrast, the lower income tax expense rate in 2004 than in 2003
resulted from lower pre-tax income in 2004, as well as higher average holdings
of tax-exempt securities and loans. These factors contributed to the Corporation
incurring an alternative minimum tax liability of $352,000 in 2004.
A more complete analysis of income taxes is presented in Note 16 to the
consolidated financial statements.
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. That discussion provides useful
information regarding changes in the Corporation's balance sheet over the 2-year
period ended December 31, 2005, including discussions of available-for-sale
securities, loans, deposits and borrowings. The acquisition of Canisteo Valley
Corporation was effective at the end of August 2005. That transaction was an
all-cash acquisition, which had the effect of increasing the Corporation's
assets and liabilities. At December 31, 2005, total consolidated assets of
Canisteo Valley Corporation amounted to $44,476,000, including net loans of
$21,464,000, while deposits totaled $37,015,000. Other significant balance sheet
items - the allowance for loan losses and stockholders' equity - are discussed
in separate sections of Management's Discussion and Analysis.
Table VI shows the composition of the investment portfolio at December 31, 2005,
2004 and 2003. Comparison of the amortized cost totals of available-for-sale
securities at each year-end presented reflects a reduction from $464,793,000 at
December 31, 2003 to $459,123,000 at December 31, 2004, and then a further
reduction to $420,185,000 at December 31, 2005. Management's decision to reduce
the size of the securities portfolio was attributable to 2 primary factors: (1)
substantial loan growth, and (2) the need to manage interest rate risk within
acceptable parameters. Specifically, in light of the flat yield curve, the
opportunities have been very limited for earning a positive spread from
maintaining borrowed funds and holding investment securities, and because there
is almost no difference between short-term and long-term rates, the Corporation
faces the risk that excessive holdings of long-term, fixed rate securities could
result in future losses or diminished net interest margin results when the yield
curve "normalizes." Accordingly, management has utilized proceeds from principal
repayments and sales of securities to help fund loan growth. The Corporation's
liquidity position is discussed in a separate section of Management's Discussion
and Analysis, and interest rate risk is discussed in more detail in Part II,
Item 7A.
As described in the Net Interest Margin section of Management's Discussion and
Analysis, loans outstanding grew substantially in both 2005 and 2004. In fact,
as reflected in Table VII, the year-end balance of loans, net of the allowance
for loan losses, has grown more than 10% compared to the previous year-end, for
each of the last 4 years. Table VIII presents a table of loan maturities. Fixed
rate loans are included in Table VIII based on their contractually scheduled
principal repayments, while variable rate loans are included based on
contractual principal repayments, with the remaining balance reflected in the
Table as of the date of the next change in rate. Table VIII shows that the
majority ($464,962,000
20
or 71%) of the loan portfolio is fixed rate, including $178,818,000 or 27% fixed
rate beyond 5 years. This substantial investment in long-term, fixed rate loans
is one of the major concerns management attempts to address through interest
rate risk management practices. See Part II, Item 7A for a more detailed
discussion of the Corporation's interest rate risk.
Premises and equipment, net of accumulated depreciation, increased to
$22,605,000 at December 31, 2005 from $16,725,000 at December 31, 2004 and
$12,482,000 at December 31, 2003. A portion of the increase in premises in
equipment in 2005 was related to the acquisition of Canisteo Valley Corporation,
which had a balance of $1,429,000 at December 31, 2005. The total cost of
premises and equipment purchases (excluding the Canisteo acquisition) was
$6,712,000 in 2005, $5,830,000 in 2004 and $3,360,000 in 2003. The major capital
purchases in 2005 were building-related. The total cost for land, building
construction and furnishings for the Jersey Shore branch, which opened in August
2005, was just over $2 million, including approximately $1.6 million of
expenditures in 2005. Construction in progress at December 31, 2005 had a
balance of $4,237,000, including $3,768,000 related to the Wellsboro
administration and Old Lycoming Township building projects. In 2004, capital
purchases for Management Information System purposes totaled $2,624,000,
including the new core banking software, as well as related software, network
servers and other equipment. Also in 2004, the Corporation completed the
renovation of the Williamsport facility, and opened the branch in early June
(Trust and Commercial Lending staff moved in a few months prior to the opening
of the branch). Total cost allocated to the Williamsport land and building
amounted to $2,428,000, of which approximately $1,800,000 was incurred in 2003
with the remainder in 2004. Capital purchases for furniture and equipment for
operations in the Williamsport facility amounted to $461,000 in 2004. In 2003,
the most significant projects included remodeling and addition to the Sayre
facility, remodeling of the Elkland facility, and purchases of an additional 80
thin client computer stations for teller lines throughout the branch network.
Depreciation expense increased to $2,301,000 in 2005, from $1,587,000 in 2004
and $1,211,000 in 2003.
Total capital purchases for 2006 are estimated at approximately $4.3 million. In
light of the Corporation's strong capital position and ample sources of
liquidity, management does not expect capital expenditures to have a material,
detrimental effect on the Corporation's financial condition in 2006. As
discussed in the "Outlook for 2006" section of Management's Discussion and
Analysis, depreciation and other occupancy expenses in 2006 from the new
administration building in Wellsboro and the Old Lycoming Township facility, are
estimated at approximately $400,000, and the Corporation will incur payroll and
other start-up costs associated with its new branch locations. The overall
impact on the Corporation's earnings in 2006 and thereafter will depend on the
Corporation's ability to build market share and produce profitable results from
those locations, and how long that will take.
TABLE VI - INVESTMENT SECURITIES
AS OF DECEMBER 31,
------------------------------------------------------------------
2005 2004 2003
-------------------- -------------------- --------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
--------- -------- --------- -------- --------- --------
AVAILABLE-FOR-SALE SECURITIES:
Obligations of the U.S. Treasury $ 501 $ 500 $ -- $ -- $ -- $ --
Obligations of other U.S. Government agencies 43,999 43,339 37,009 36,312 61,437 61,070
Obligations of states and political subdivisions 116,241 117,709 125,809 129,370 159,128 162,418
Other securities 94,849 95,157 100,871 103,107 45,992 47,648
Mortgage-backed securities 140,562 137,327 169,046 168,033 168,285 169,208
-------- -------- -------- -------- -------- --------
Total debt securities 396,152 394,032 432,735 436,822 434,842 440,344
Marketable equity securities 24,033 33,266 26,388 38,263 29,951 42,688
-------- -------- -------- -------- -------- --------
Total $420,185 $427,298 $459,123 $475,085 $464,793 $483,032
======== ======== ======== ======== ======== ========
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury $ 313 $ 324 $ 316 $ 339 $ 319 $ 349
Obligations of other U.S. Government agencies 98 106 98 112 199 216
Mortgage-backed securities 11 11 19 20 42 44
-------- -------- -------- -------- -------- --------
Total $ 422 $ 441 $ 433 $ 471 $ 560 $ 609
======== ======== ======== ======== ======== ========
21
TABLE VII - FIVE-YEAR SUMMARY OF LOANS BY TYPE
2005 % 2004 % 2003 % 2002 % 2001 %
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
(IN THOUSANDS)
Real estate - construction $ 5,552 0.85 $ 4,178 0.72 $ 2,856 0.54 $ 103 0.02 $ 1,814 0.48
Real estate - residential mortgage 361,857 55.39 347,705 59.98 330,807 63.03 292,136 64.76 245,997 64.87
Real estate - commercial mortgage 153,661 23.52 128,073 22.10 100,240 19.10 78,317 17.36 60,267 15.89
Consumer 31,559 4.83 31,702 5.47 33,977 6.47 31,532 6.99 29,284 7.72
Agricultural 2,340 0.36 2,872 0.50 2,948 0.56 3,024 0.67 2,344 0.62
Commercial 69,396 10.62 43,566 7.52 34,967 6.66 30,874 6.84 24,696 6.51
Other 1,871 0.29 1,804 0.31 1,183 0.23 2,001 0.44 1,195 0.32
Political subdivisions 27,063 4.14 19,713 3.40 17,854 3.40 13,062 2.90 13,479 3.55
Lease receivables -- 0.00 -- 0.00 65 0.01 96 0.02 152 0.04
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total 653,299 100.00 579,613 100.00 524,897 100.00 451,145 100.00 379,228 100.00
Less: allowance for loan losses (8,361) (6,787) (6,097) (5,789) (5,265)
-------- -------- -------- -------- --------
Loans, net $644,938 $572,826 $518,800 $445,356 $373,963
======== ======== ======== ======== ========
TABLE VIII - LOAN MATURITY DISTRIBUTION
AS OF DECEMBER 31, 2005
-----------------------------------------------------------------------------------------
FIXED RATE LOANS: VARIABLE OR ADJUSTABLE RATE LOANS:
------------------------------------------- -------------------------------------------
GREATER GREATER
1 YEAR OR THAN 1 YEAR OR THAN
LESS 1-5 YEARS >5 YEARS TOTAL LESS 1-5 YEARS 5 YEARS TOTAL
--------- --------- -------- -------- --------- --------- -------- --------
(IN THOUSANDS)
Real Estate $63,036 $137,364 $ 92,164 $292,564 $ 68,488 $51,993 $3,009 $123,490
Commercial 11,571 40,902 82,557 135,030 59,387 682 456 60,525
Consumer 14,231 19,040 4,097 37,368 4,256 66 -- 4,322
------- -------- -------- -------- -------- ------- ------ --------
$88,838 $197,306 $178,818 $464,962 $132,131 $52,741 $3,465 $188,337
======= ======== ======== ======== ======== ======= ====== ========
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level which, in management's
judgment, is adequate to absorb credit losses inherent in the loan portfolio.
The amount of the allowance is based on management's evaluation of the
collectibility of the loan portfolio. In evaluating collectibility, management
considers a number of factors, including the status of specific impaired loans,
trends in historical loss experience, delinquency trends, credit concentrations,
comparison of historical loan loss data to that of other financial institutions
and economic conditions within the Corporation's market area. Allowances for
impaired loans are determined based on collateral values or the present value of
estimated cash flows. The allowance is increased by a provision for loan losses,
which is charged to expense, and reduced by charge-offs, net of recoveries.
Each quarter, management performs a detailed assessment of the allowance and
provision for loan losses. For C&N Bank, this assessment is conducted under the
direction of the Chief Financial Officer and Executive Vice President in charge
of Commercial Lending, with input from the Credit Administration Department,
other Branch and Lending Staff, and the Chief Executive Officer. The assessment
process includes review of identified risk elements in the loan portfolio,
including the "Watch List", past due reports and other information. The "Watch
List" is a collection of loans that have a history of delinquency, collateral
deficiency, cash flow problems, or other factors that have come to management's
attention to create the need for special monitoring. One of the key aspects of
the quarterly assessment is the evaluation of each Watch List relationship with
an outstanding balance of $200,000 or more. This evaluation includes an updated
assessment of collection activities and planning for each such relationship, as
well as evaluation of the probable loss (if any). For First State Bank, the
fourth quarter 2005 assessment was performed for all Watch List relationships of
$50,000 or more.
Both C&N Bank and First State Bank also engage consulting firms, at least
annually, to perform independent credit reviews of large credit relationships.
Management gives substantial consideration to the classifications and
recommendations of the independent credit reviewers in determining the 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. The historical loan loss
experience
22
element is determined based on the ratio of net charge-offs to average loan
balances over a three-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). Prior to the fourth quarter 2005, C&N Bank had
utilized the ratio of net charge-offs to average balances over a five-year
period in calculating the historical loan loss experience portion of the
allowance portfolio. Management made the change to the three-year assumption,
which had very little effect on the allowance valuation as of December 31, 2005,
mainly because management believes net charge-off experience over a 3-year
period may be more representative of losses existing in the portfolio as of the
balance sheet date.
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 the following categories of lending activity:
commercial, mortgage, consumer and credit card. The management committee met
again in the third and fourth quarters and updated its analysis (excluding
credit card, for which substantially all of the loans were sold in the fourth
quarter 2005). Based on the results of these evaluations, allocations were made
to the components of the allowance shown in Table X. 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 X shows the amounts allocated to the allowance for commercial,
consumer mortgage and consumer loans at December 31, 2005 have increased in
comparison to the corresponding amounts at December 31, 2004, while the
unallocated portion of the allowance decreased to $0 at December 31, 2005 from
$2,578,000 at December 31, 2004.
As indicated in Table XI, total impaired loans amounted to $8,216,000 at
December 31, 2005, as compared to $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 $2,374,000 at December 31, 2005, up from $1,378,000 at
December 31, 2004 and $1,542,000 at December 31, 2003. Table XI also shows that
the amount of loans classified as nonaccrual amounted to $6,365,000 at December
31, 2005, as compared to $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 $2.8 million at December 31, 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 December 31, 2005, the valuation allowances related to
these loans totaled $689,000, up from $173,000 at December 31, 2004. There is
another commercial loan relationship with total outstanding balances of
approximately $1.6 million that was classified as impaired and nonaccrual
throughout most of 2004 and all of 2005, and for which the valuation allowance
was increased to $400,000 as of December 31, 2005 from $200,000 as of 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 estimated as of December 31, 2005. Management
continues to closely monitor these commercial loan relationships, and will
adjust its estimates of loss and decisions concerning nonaccrual status, if
appropriate.
The allowance for loan losses was $8,361,000 at December 31, 2005, an increase
of $1,574,000 from the balance of $6,787,000 at December 31, 2004. Table IX
shows that gross charge-offs totaled $984,000, and net charge-offs totaled
$829,000, in 2005. These amounts were higher than the corresponding totals for
2004 of $786,000 (gross charge-offs) and $710,000 (net charge-offs). Table IX
also shows that 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 First State Bank's Watch List as of the acquisition
date that management was monitoring, substantially all of these loans were
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 were classified individually as impaired. The provision for
loan losses amounted to $2,026,000 in 2005, $1,400,000 in 2004 and $1,100,000 in
2003. The amount of the provision in each year is determined based on the amount
required to maintain an appropriate allowance in light of the factors described
above.
Tables IX through XII present historical data related to the allowance for loan
losses.
23
TABLE IX - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
YEARS ENDED DECEMBER 31,
------------------------------------------
2005 2004 2003 2002 2001
------ ------ ------ ------ ------
(IN THOUSANDS)
Balance, beginning of year $6,787 $6,097 $5,789 $5,265 $5,291
------ ------ ------ ------ ------
Charge-offs:
Real estate loans 264 375 168 123 144
Installment loans 224 217 326 116 138
Credit cards and related plans 198 178 171 190 200
Commercial and other loans 298 16 303 123 231
------ ------ ------ ------ ------
Total charge-offs 984 786 968 552 713
------ ------ ------ ------ ------
Recoveries:
Real estate loans 14 3 75 30 6
Installment loans 61 32 52 30 27
Credit cards and related plans 30 23 17 18 20
Commercial and other loans 50 18 32 58 34
------ ------ ------ ------ ------
Total recoveries 155 76 176 136 87
------ ------ ------ ------ ------
Net charge-offs 829 710 792 416 626
Allowance for loan losses
recorded in acquisition 377 -- -- -- --
Provision for loan losses 2,026 1,400 1,100 940 600
------ ------ ------ ------ ------
Balance, end of year $8,361 $6,787 $6,097 $5,789 $5,265
====== ====== ====== ====== ======
TABLE X - ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES BY TYPE
2005 2004 2003 2002 2001
------ ------ ------ ------ ------
(IN THOUSANDS)
Commercial $2,705 $1,909 $1,578 $1,315 $1,837
Consumer mortgage 2,806 513 456 460 674
Impaired loans 2,374 1,378 1,542 1,877 73
Consumer 476 409 404 378 494
Unallocated -- 2,578 2,117 1,759 2,187
------ ------ ------ ------ ------
Total Allowance $8,361 $6,787 $6,097 $5,789 $5,265
====== ====== ====== ====== ======
The above allocation is based on estimates and subjective judgments and is not
necessarily indicative of the specific amounts or loan categories in which
losses may occur.
TABLE XI - PAST DUE AND IMPAIRED LOANS
2005 2004 2003
------ ------ ------
(IN THOUSANDS)
Impaired loans without a valuation allowance $ 910 $3,552 $ 114
Impaired loans with a valuation allowance 7,306 4,709 4,507
------ ------ ------
Total impaired loans $8,216 $8,261 $4,621
====== ====== ======
Valuation allowance related to impaired loans $2,374 $1,378 $1,542
Total nonaccrual loans $6,365 $7,796 $1,145
Total loans past due 90 days or more and
still accruing $1,369 $1,307 $2,546
24
TABLE XII - FIVE-YEAR HISTORY OF LOAN LOSSES
2005 2004 2003 2002 2001 AVERAGE
-------- -------- -------- -------- -------- --------
(IN THOUSANDS)
Average gross loans $618,344 $551,352 $485,150 $410,670 $346,353 $482,374
Year-end gross loans 653,299 579,613 524,897 451,145 379,228 517,636
Year-end allowance for loan losses 8,361 6,787 6,097 5,789 5,265 6,460
Year-end nonaccrual loans 6,365 7,796 1,145 1,252 1,050 3,522
Year-end loans 90 days or more
past due and still accruing 1,369 1,307 2,546 2,318 2,067 1,921
Net charge-offs 829 710 792 416 626 675
Provision for loan losses 2,026 1,400 1,100 940 600 1,213
Earnings coverage of charge-offs 15.7 20.9 20.5 36.0 19.3 21.1
Allowance coverage of charge-offs 10.1 9.6 7.7 13.9 8.4 9.6
Net charge-offs as a % of
provision for loan losses 40.92% 50.71% 72.00% 44.26% 104.33% 55.65%
Net charge-offs as a % of
average gross loans 0.13% 0.13% 0.16% 0.10% 0.18% 0.14%
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
Table XIII presents the Corporation's significant fixed and determinable
contractual obligations as of December 31, 2005, by payment date. The payment
amounts represent the principal amounts of time deposits and borrowings, and do
not include interest. Operating leases and software maintenance commitments are
presented at the amounts due to the recipients, and are not discounted to
present value.
TABLE XIII - CONTRACTUAL OBLIGATIONS
1 YEAR 1-3 3-5 OVER 5
CONTRACTUAL OBLIGATIONS OR LESS YEARS YEARS YEARS TOTAL
- ----------------------- -------- -------- ------- ------- --------
(IN THOUSANDS)
Time deposits $194,779 $118,729 $24,584 $ 36 $338,128
Short-term borrowings,
Federal Home Loan Bank of
Pittsburgh 7,000 -- -- -- 7,000
Long-term borrowings:
Federal Home Loan Bank of
Pittsburgh 57,700 102,567 5,432 19,786 185,485
Repurchase agreements 20,220 26,500 -- -- 46,720
Operating leases 171 101 13 -- 285
Software maintenance 360 720 300 -- 1,380
-------- -------- ------- ------- --------
Total $280,230 $248,617 $30,329 $19,822 $578,998
======== ======== ======= ======= ========
In addition to the amounts described in Table XIII, the Corporation has
obligations related to deposits without a stated maturity with outstanding
principal balances totaling $418,937,000 at December 31, 2005. The Corporation
also has obligations related to overnight customer repurchase agreements with
principal balances totaling $27,734,000 at December 31, 2005.
As described more fully in Note 19 to the consolidated financial statements, the
Corporation has a contingent obligation to pay additional licensing fees, based
on the Bank's asset size, through October 2009.
The Corporation's significant off-balance sheet arrangements consist of
commitments to extend credit and standby letters of credit. Off-balance sheet
arrangements are described in Note 18 to the consolidated financial statements.
25
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 various securities and
mortgage loans. At December 31, 2005, the Corporation had unused borrowing
availability with correspondent banks and FHLB - Pittsburgh totaling
approximately $150,000,000. Additionally, the Corporation uses repurchase
agreements placed with brokers to borrow funds secured by investment assets, and
uses "RepoSweep" arrangements to borrow funds from commercial banking customers
on an overnight basis.
Historically, one of the tools used to monitor a bank's longer-term liquidity
situation has been the loan-to-deposit ratio. As of December 31, 2005 and 2004,
this ratio was 85%, which is an average ratio by banking industry standards, but
higher than the Corporation's position had been in many years. The higher than
historical level of loans-to-deposits reflects the Corporation's very strong
loan growth over the past few years. The loan-to-deposit ratio was 79% at
December 31, 2003, 70% at December 31, 2002 and 65% at December 31, 2001.
Management believes the current, higher loan-to-deposit ratio provides
opportunities for a higher average yield on earning assets, but is an indicator
that some of the Corporation's historical liquidity "cushion" has been reduced;
however, the current position continues to provide sufficient funds for
maintenance of a substantial investment securities portfolio. If required to
raise cash in an emergency situation, the Corporation could sell non-pledged
investment securities to meet its obligations. At December 31, 2005, the
carrying value of non-pledged securities was $210,119,000.
Management believes the combination of its strong capital position (discussed in
the next section), ample available borrowing facilities and moderate loan to
deposit ratio have placed the Corporation in a position of minimal short-term
and long-term liquidity risk.
STOCKHOLDERS' EQUITY AND CAPITAL ADEQUACY
The Corporation and the Banks are subject to various regulatory capital
requirements administered by the federal banking agencies. For many years, the
Corporation and C&N Bank have maintained extremely strong capital positions, and
First State Bank is also well capitalized. Details concerning the Corporation's
and the Banks' regulatory capital amounts and ratios are presented in Note 21 to
the consolidated financial statements. As reflected in Note 21, at December 31,
2005 and 2004, the ratios of total capital to risk-weighted assets, tier 1
capital to risk-weighted assets and tier 1 capital to average total assets are
well in excess of regulatory capital requirements.
The Corporation's total stockholders' equity is affected by fluctuations in the
fair values of available-for-sale securities. The difference between amortized
cost and fair value of available-for-sale securities, net of deferred income
tax, is classified as "Accumulated Other Comprehensive Income" within
stockholders' equity. Changes in accumulated other comprehensive income are
excluded from earnings and directly increase or decrease stockholders' equity.
COMPREHENSIVE INCOME
Comprehensive income is a measure of all changes in the equity of a corporation,
excluding transactions with owners in their capacity as owners (such as proceeds
from issuances of stock and dividends). The difference between net income and
comprehensive income is termed "Other Comprehensive Income". For the
Corporation, other comprehensive income consists of unrealized gains and losses
on available-for-sale securities, net of deferred income tax. Comprehensive
income should not be construed to be a measure of net income. The amount of
unrealized gains or losses reflected in comprehensive income may vary widely
from period-to-period, depending on the financial markets as a whole and how the
portfolio of available-for-sale securities is affected by interest rate
movements. Total comprehensive income was $7,147,000 in 2005, $13,361,000 in
2004 and $16,148,000 in 2003. Other comprehensive (loss) amounted to
($5,837,000) in 2005, ($1,502,000) in 2004 and ($109,000) in 2003.
INFLATION
The Corporation is significantly affected by the Federal Reserve Board's efforts
to control inflation through changes in interest rates. As discussed in the
"Earnings Overview" section of Management's Discussion and Analysis, rising
short-term interest rates, which were triggered by the Federal Reserve's actions
to increase the fed funds target rate several times, hurt the Corporation's
operating results for 2005. Further concerns over the possibility of inflation
could lead to further increases in the fed funds target rate, which management
believes would continue to "squeeze" the net interest margin. Although
management cannot predict future changes in the rates of inflation, management
monitors the impact of economic trends, including any indicators of inflationary
pressures, in managing interest rate and other financial risks.
26
RECENT ACCOUNTING PRONOUNCEMENTS
In March 2004, the FASB issued Emerging Issues Task Force (EITF) Issue 03-1, The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments. This statement provides guidance for evaluating whether an
investment is other-than-temporarily impaired and was effective for the
other-than-temporary impairment evaluations made in the reporting periods
beginning after June 15, 2004. The FASB staff had issued a proposed
Board-directed FASB Staff Position, FSP EITF Issue 03-1-a, Implementation
Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1. The
proposed FSP would have provided implementation guidance with respect to debt
securities that are impaired solely due to interest rates and/or sector spreads
and analyzed for other-than-temporary impairment under paragraph 16 of Issue
03-1. In September 2004, based on comment letters received by constituents, the
Board decided to further consider whether application guidance was necessary for
all securities analyzed for impairment under paragraphs 10-20 of Issue 03-1. In
November 2005, the FASB issued FSP 115-1 and FAS 124-1, which nullified much of
the detailed implementation guidance that had been included in FSP EITF Issue
03-1-a, and carried forward the rest of the existing requirements for evaluating
securities for impairment and providing disclosures related to impaired
securities.
In December 2004, the FASB issued SFAS 123R, which replaces SFAS 123, Accounting
for Stock-Based Compensation, and supersedes APB Opinion 25, Accounting for
Stock Issued to Employees. SFAS 123R will require the Corporation to record
stock option expense based on estimated fair value determined using an option
valuation model. SFAS No. 123R will require the Corporation to record stock
option expense based on estimated fair value calculated using an option
valuation model. Since all of the Corporation's stock options are exercisable at
December 31, 2005, SFAS No. 123R will only apply to new awards, starting in
2006. In recent years, stock options have been awarded to directors and selected
officers in January, based on performance in the previous year. In January 2006,
it was determined that no awards were to be made based on 2005's results;
accordingly, SFAS No. 123R is not expected to have an impact on the
Corporation's results of operations in 2006, but to the extent future awards are
made, will impact future years.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error
Corrections that changes the requirements for the accounting for and reporting
of a change in accounting principle. SFAS No. 154 replaces APB Opinion No. 20,
Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim
Financial Statements. APB Opinion No. 20 previously required that most voluntary
changes in accounting principle be recognized by including in net income of the
period of the change the cumulative effect of changing to the new accounting
principle. SFAS No. 154 requires retrospective application to prior periods'
financial statements of changes in accounting principle, unless impracticable to
determine either the period-specific effects or the cumulative effect of the
change. This statement also redefines "restatement" to include the revision of
previously issued financial statements to reflect the correction of an error.
This statement is effective for accounting changes and error corrections made in
fiscal years beginning after December 15, 2005.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
The Corporation's two major categories of market risk, interest rate risk and
equity securities risk, are discussed in the following sections.
INTEREST RATE RISK
Business risk arising from changes in interest rates is an inherent 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
shorter-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
27
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. As the
table shows, as of December 31, 2005, the decline in net interest income and
market value exceed the policy threshold marks if interest rates were to
immediately rise 200 or 300 basis points. The table also shows that, at December
31, 2004, the changes in net interest income and market value were within the
policy threshold for all calculations except that the market value decline
exceeded the limit in the +300 basis point scenario. These "out of policy"
positions are a reflection of the Corporation's liability sensitive position (on
average, deposits and borrowings reprice more quickly than loans and debt
securities). Management has reviewed these positions with the Board of Directors
monthly throughout 2004 and 2005, and management will continue to evaluate
whether to make changes to asset and liability holdings in an effort to reduce
exposure to rising interest rates.
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.
28
TABLE XIV - THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES
DECEMBER 31, 2005 DATA
PERIOD ENDING DECEMBER 31, 2006
----------------------------------------------------------
INTEREST INTEREST NET INTEREST NII NII
BASIS POINT CHANGE IN RATES INCOME EXPENSE INCOME (NII) % CHANGE RISK LIMIT
- --------------------------- -------- -------- ------------ -------- ----------
(IN THOUSANDS)
+300 $66,381 $43,764 $22,617 -24.8% 20.0%
+200 64,649 39,466 25,183 -16.3% 15.0%
+100 62,850 35,168 27,682 -7.9% 10.0%
0 60,942 30,871 30,071 0.0% 0.0%
- -100 58,178 26,573 31,605 5.1% 10.0%
- -200 55,000 23,098 31,902 6.1% 15.0%
- -300 51,805 19,877 31,928 6.2% 20.0%
MARKET VALUE OF PORTFOLIO EQUITY
AT DECEMBER 31, 2005
--------------------------------
PRESENT PRESENT PRESENT
VALUE VALUE VALUE
BASIS POINT CHANGE IN RATES EQUITY % CHANGE RISK LIMIT
- --------------------------- -------- -------- ----------
+300 $ 54,493 -56.8% 45.0%
+200 77,762 -38.3% 35.0%
+100 102,136 -19.0% 25.0%
0 126,029 0.0% 0.0%
- -100 142,377 13.0% 25.0%
- -200 151,148 19.9% 35.0%
- -300 160,867 27.6% 45.0%
DECEMBER 31, 2004 DATA
PERIOD ENDING DECEMBER 31, 2005
----------------------------------------------------------
INTEREST INTEREST NET INTEREST NII NII
BASIS POINT CHANGE IN RATES INCOME EXPENSE INCOME (NII) % CHANGE RISK LIMIT
- --------------------------- -------- -------- ------------ -------- ----------
(IN THOUSANDS)
+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%
29
EQUITY SECURITIES RISK
The Corporation's equity securities portfolio consists primarily of investments
in stocks of banks and bank holding companies, mainly based 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 $1,997,000 at December 31, 2005 and
$6,130,000 at December 31, 2004.
Investments in bank stocks are subject to the risk factors affecting the banking
industry generally, including competition from non-bank entities, credit risk,
interest rate risk and other factors that 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 its holdings in Pennsylvania banks, these investments could
decline in value if there were a downturn in the state's economy.
The Corporation's management monitors its risk associated with its equity
securities holdings by reviewing its holdings on a detailed, individual security
basis, at least monthly, considering all of the factors described above.
Equity securities held as of December 31, 2005 and 2004 are as follows:
HYPOTHETICAL HYPOTHETICAL
10% 20%
DECLINE IN DECLINE IN
FAIR MARKET MARKET
AT DECEMBER 31, 2005 COST VALUE VALUE VALUE
- -------------------- ------- ------- ------------ ------------
(IN THOUSANDS)
Banks and bank holding companies $20,010 $28,879 $(2,888) $(5,776)
Other equity securities 4,023 4,387 (439) (877)
------- ------- ------- -------
Total $24,033 $33,266 $(3,327) $(6,653)
======= ======= ======= =======
HYPOTHETICAL HYPOTHETICAL
10% 20%
DECLINE IN DECLINE IN
FAIR MARKET MARKET
AT DECEMBER 31, 2005 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)
======= ======= ======= =======
30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED BALANCE SHEET
DECEMBER 31, DECEMBER 31,
2005 2004
------------ ------------
(In Thousands Except Share Data)
ASSETS
Cash and due from banks:
Noninterest-bearing $ 20,922 $ 14,845
Interest-bearing 5,524 4,108
---------- ----------
Total cash and cash equivalents 26,446 18,953
Available-for-sale securities 427,298 475,085
Held-to-maturity securities 422 433
Loans, net 644,938 572,826
Bank-owned life insurance 18,643 18,083
Accrued interest receivable 5,500 5,094
Bank premises and equipment, net 22,605 16,725
Foreclosed assets held for sale 194 497
Intangible Asset - Core deposit intangible 464 --
Intangible Asset - Goodwill 2,919 --
Other assets 13,525 15,306
---------- ----------
TOTAL ASSETS $1,162,954 $1,123,002
========== ==========
LIABILITIES
Deposits:
Noninterest-bearing $ 96,644 $ 80,378
Interest-bearing 660,421 596,167
---------- ----------
Total deposits 757,065 676,545
Dividends payable 1,973 1,864
Short-term borrowings 34,734 34,178
Long-term borrowings 232,205 270,827
Accrued interest and other liabilities 5,009 8,003
---------- ----------
TOTAL LIABILITIES 1,030,986 991,417
---------- ----------
STOCKHOLDERS' EQUITY
Common stock, par value $1.00 per share; authorized 20,000,000 shares
in 2005 and 2004; issued 8,389,418 in 2005 and 8,307,305 in 2004 8,389 8,307
Stock dividend distributable 2,183 2,188
Paid-in capital 24,964 22,456
Retained earnings 93,728 90,484
---------- ----------
Total 129,264 123,435
Accumulated other comprehensive income 4,698 10,535
Unamortized stock compensation (50) (46)
Treasury stock, at cost:
168,627 shares at December 31, 2005 (1,944)
204,659 shares at December 31, 2004 (2,339)
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 131,968 131,585
---------- ----------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $1,162,954 $1,123,002
========== ==========
The accompanying notes are an integral part of the consolidated financial
statements.
31
CONSOLIDATED STATEMENT OF INCOME
YEARS ENDED DECEMBER 31,
---------------------------
2005 2004 2003
------- ------- -------
(IN THOUSANDS EXCEPT PER SHARE DATA)
INTEREST INCOME
Interest and fees on loans $38,768 $34,251 $32,235
Interest on balances with depository institutions 34 11 10
Interest on loans to political subdivisions 1,118 952 781
Interest on federal funds sold 97 10 8
Income from available-for-sale and held-to-maturity securities:
Taxable 14,351 13,999 13,686
Tax-exempt 5,659 7,256 7,335
Dividends 1,081 1,443 1,168
------- ------- -------
Total interest and dividend income 61,108 57,922 55,223
------- ------- -------
INTEREST EXPENSE
Interest on deposits 15,604 12,545 14,561
Interest on short-term borrowings 1,239 542 487
Interest on long-term borrowings 8,844 9,519 8,489
------- ------- -------
Total interest expense 25,687 22,606 23,537
------- ------- -------
Interest margin 35,421 35,316 31,686
Provision for loan losses 2,026 1,400 1,100
------- ------- -------
Interest margin after provision for loan losses 33,395 33,916 30,586
------- ------- -------
OTHER INCOME
Service charges on deposit accounts 1,689 1,717 1,746
Service charges and fees 367 308 287
Trust and financial management revenue 2,088 2,105 1,733
Insurance commissions, fees and premiums 491 439 391
Increase in cash surrender value of life insurance 560 610 715
Fees related to credit card operation 948 773 784
Gain from sale of credit card loans 1,906 -- --
Other operating income 1,493 970 939
------- ------- -------
Total other income before realized gains on securities, net 9,542 6,922 6,595
Realized gains on securities, net 1,802 2,877 4,799
------- ------- -------
Total other income 11,344 9,799 11,394
------- ------- -------
OTHER EXPENSES
Salaries and wages 12,383 11,248 9,696
Pensions and other employee benefits 3,752 3,404 3,317
Occupancy expense, net 1,842 1,664 1,295
Furniture and equipment expense 2,664 1,805 1,372
Expenses related to credit card operation 462 414 385
Pennsylvania shares tax 804 846 792
Other operating expense 7,055 6,620 5,257
------- ------- -------
Total other expenses 28,962 26,001 22,114
------- ------- -------
Income before income tax provision 15,777 17,714 19,866
Income tax provision 2,793 2,851 3,609
------- ------- -------
NET INCOME $12,984 $14,863 $16,257
======= ======= =======
NET INCOME PER SHARE - BASIC $ 1.57 $ 1.80 $ 1.97
======= ======= =======
NET INCOME PER SHARE - DILUTED $ 1.55 $ 1.79 $ 1.96
======= ======= =======
The accompanying notes are an integral part of the consolidated financial
statements
32
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
ACCUMULATED
OTHER
STOCK COMPRE- UNAMORTIZED
COMMON DIVIDEND PAID-IN RETAINED HENSIVE STOCK TREASURY
STOCK DISTRIBUTABLE CAPITAL EARNINGS INCOME COMPENSATION STOCK TOTAL
------ ------------- ------- -------- ----------- ------------ -------- --------
(IN THOUSANDS EXCEPT PER SHARE DATA)
BALANCE, DECEMBER 31, 2002 $5,431 $ 1,639 $21,153 $77,584 $12,146 $(49) $(2,067) $115,837
Comprehensive income:
Net income 16,257 16,257
Unrealized loss on securities,
net of reclassification adjustment
and tax effects (109) (109)
------- --------
Total comprehensive income 16,148
--------
Cash dividends declared, $0.85 per share (6,821) (6,821)
Treasury stock purchased (174) (174)
Amortization of restricted stock 102 102
Shares issued from treasury related to
exercise of stock options 78 119 197
Tax benefit from employee benefit plan 84 84
Stock dividend issued 53 (1,639) 1,556 (30)
3-for-2 stock split, April 2003 2,742 (2,742) --
Stock dividend declared, 1% 2,164 (2,164) --
Restricted stock granted 59 (107) 48 --
------ ------- ------- ------- ------- ----- ------- --------
BALANCE, DECEMBER 31, 2003 8,226 2,164 20,104 84,940 12,037 (54) (2,074) 125,343
Comprehensive income:
Net income 14,863 14,863
Unrealized loss on securities,
net of reclassification adjustment
and tax effects (1,502) (1,502)
------- --------
Total comprehensive income 13,361
--------
Cash dividends declared, $.89 per share (7,214) (7,214)
Treasury stock purchased (575) (575)
Shares issued from treasury related to
exercise of stock options 245 283 528
Amortization of restricted stock 85 85
Tax benefit from employee benefit plan 83 83
Stock dividend issued 81 (2,164) 2,057 (26)
Stock dividend declared, 1% 2,188 (2,188) --
Restricted stock granted 62 (99) 37 --
Forfeiture of restricted stock (12) 22 (10) --
------ ------- ------- ------- ------- ----- ------- --------
BALANCE, DECEMBER 31, 2004 8,307 2,188 22,456 90,484 10,535 (46) (2,339) 131,585
Comprehensive income:
Net income 12,984 12,984
Unrealized loss on securities,
net of reclassification adjustment
and tax effects (5,837) (5,837)
------- --------
Total comprehensive income 7,147
--------
Cash dividends declared, $.93 per share (7,641) (7,641)
Treasury stock purchased (59) (59)
Shares issued from treasury related to
exercise of stock options 244 412 656
Amortization of restricted stock 93 93
Tax benefit from employee benefit plan 84 84
Tax benefit from stock options 129 129
Stock dividend issued 82 (2,188) 2,080 (26)
Stock dividend declared, 1% 2,183 (2,183) --
Restricted stock granted 64 (111) 47 --
Forfeiture of restricted stock (9) 14 (5) --
------ ------- ------- ------- ------- ----- ------- --------
BALANCE, DECEMBER 31, 2005 $8,389 $ 2,183 $24,964 $93,728 $ 4,698 $ (50) $(1,944) $131,968
====== ======= ======= ======= ======= ===== ======= ========
The accompanying notes are an integral part of the consolidated financial
statements.
33
CONSOLIDATED STATEMENT OF CASH FLOWS
YEARS ENDED DECEMBER 31,
---------------------------------
2005 2004 2003
--------- --------- ---------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 12,984 14,863 16,257
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 2,026 1,400 1,100
Realized gains on securities, net (1,802) (2,877) (4,799)
Gain on sale of foreclosed assets, net (126) (9) (105)
Depreciation expense 2,301 1,587 1,211
Accretion and amortization of securities, net 417 718 1,241
Increase in cash surrender value of life insurance (560) (610) (715)
Amortization of restricted stock 93 85 102
Amortization of core deposit intangible 83 -- --
Deferred income taxes (640) 96 (25)
(Increase) decrease in accrued interest receivable and other
assets (971) (424) 487
Increase (decrease) in accrued interest payable and other
liabilities 310 78 (164)
--------- --------- ---------
Net Cash Provided by Operating Activities 14,115 14,907 14,590
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturity of held-to-maturity securities 8 122 145
Proceeds from sales of available-for-sale securities 187,029 111,585 53,562
Proceeds from calls and maturities of available-for-sale securities 56,909 96,265 178,682
Purchase of available-for-sale securities (194,332) (200,015) (199,705)
Purchase of Federal Home Loan Bank of Pittsburgh stock (4,672) (3,299) (1,855)
Redemption of Federal Home Loan Bank of Pittsburgh stock 7,369 2,514 482
Net increase in loans (50,943) (56,015) (74,824)
Purchase of premises and equipment (6,712) (5,830) (3,360)
Proceeds from sale of foreclosed assets 822 202 340
Proceeds from acquisition of Canisteo Valley Corporation, net 202 -- --
--------- --------- ---------
Net Cash Used in Investing Activities (4,320) (54,471) (46,533)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 42,512 18,480 17,761
Net increase (decrease) in short-term borrowings 556 (3,585) (5,872)
Proceeds from long-term borrowings 18,163 84,112 64,500
Repayments of long-term borrowings (56,785) (48,475) (37,524)
Purchase of treasury stock (59) (575) (174)
Sale of treasury stock 656 528 197
Tax benefit from compensation plans 213 -- --
Dividends paid (7,558) (7,139) (6,674)
--------- --------- ---------
Net Cash (Used In) Provided by Financing Activities (2,302) 43,346 32,214
--------- --------- ---------
INCREASE IN CASH AND CASH EQUIVALENTS 7,493 3,782 271
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 18,953 15,171 14,900
--------- --------- ---------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 26,446 $ 18,953 $ 15,171
========= ========= =========
34
CONSOLIDATED STATEMENT OF CASH FLOWS
YEARS ENDED DECEMBER 31,
---------------------------
2005 2004 2003
------- ------- -------
(IN THOUSANDS) (CONTINUED)
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Assets acquired through foreclosure of real estate loans $ 347 $ 589 $ 280
Interest paid $26,260 $22,070 $23,736
Income taxes paid $ 2,959 $ 2,999 $ 3,195
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 the consolidated financial
statements.
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF CONSOLIDATION - The consolidated financial statements include the
accounts of Citizens & Northern Corporation ("Corporation"), and its
subsidiaries, Citizens & Northern Bank ("C&N Bank"), Canisteo Valley Corporation
(acquired in 2005 - see Note 4), Bucktail Life Insurance Company and Citizens &
Northern Investment Corporation. The consolidated financial statements also
include the accounts of Canisteo Valley Corporation's wholly-owned subsidiary,
First State Bank, and C&N Bank's wholly-owned subsidiary, C&N Financial Services
Corporation. All material intercompany balances and transactions have been
eliminated in consolidation.
NATURE OF OPERATIONS - The Corporation is primarily engaged in providing a full
range of banking and mortgage services to individual and corporate customers in
Northcentral Pennsylvania and Southern New York State. Lending products include
mortgage loans, commercial loans, consumer loans and credit cards, as well as
specialized instruments such as commercial letters-of-credit. Deposit products
include various types of checking accounts, passbook and statement savings,
money market accounts, interest checking accounts, individual retirement
accounts and certificates of deposit. The Corporation also offers non-insured
"Repo Sweep" accounts.
The Corporation provides Trust and Financial Management services, including
administration of trusts and estates, retirement plans, and other employee
benefit plans, and investment management services. The Corporation offers a
variety of personal and commercial insurance products through C&N Financial
Services Corporation. C&N Financial Services Corporation also has a
broker-dealer division, which offers mutual funds, annuities, educational
savings accounts and other investment products through registered agents.
The Corporation is subject to competition from other financial institutions. It
is also subject to regulation by certain federal and state agencies and
undergoes periodic examination by those regulatory authorities.
USE OF ESTIMATES - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect 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. 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.
INVESTMENT SECURITIES - Investment securities are accounted for as follows:
HELD-TO-MATURITY SECURITIES - includes debt securities that the Corporation has
the positive intent and ability to hold to maturity. These securities are
reported at cost adjusted for amortization of premiums and accretion of
discounts, computed using the level-yield method.
AVAILABLE-FOR-SALE SECURITIES - includes debt securities not classified as
held-to-maturity and unrestricted equity securities. Such securities are
reported at fair value, with unrealized gains and losses excluded from earnings
and reported separately through accumulated other comprehensive income, net of
tax. Amortization of premiums and accretion of discounts on available-for-sale
securities are recorded using the level yield method over the remaining
contractual life of the securities, adjusted for actual prepayments. Realized
gains and losses on sales of available-for-sale securities are computed on the
basis of specific identification of the adjusted cost of each security.
RESTRICTED EQUITY SECURITIES - Restricted equity securities consist primarily of
Federal Home Loan Bank of Pittsburgh stock, and are carried at cost and
evaluated for impairment. Holdings of restricted equity securities are included
in Other Assets in the Consolidated Balance Sheet, and dividends received on
restricted securities are included in Other Income in the Consolidated Statement
of Income.
LOANS - Loans are stated at unpaid principal balances, less the allowance for
loan losses and net deferred loan fees. Loan origination and commitment fees, as
well as certain direct origination costs, are deferred and amortized as a yield
adjustment over the lives of the related loans using the interest method.
Amortization of deferred loan fees is discontinued when a loan is placed on
nonaccrual status.
36
Loans are placed on nonaccrual status when, in the opinion of management,
collection of interest is doubtful. Any unpaid interest previously accrued on
those loans is reversed from income. Interest income is not recognized on
specific impaired loans unless the likelihood of further loss is remote.
Interest payments received on loans for which the risk of further loss is
greater than remote are applied as a reduction of the loan principal balance.
Interest income on other nonaccrual loans is recognized only to the extent of
interest payments received.
The allowance for loan losses is maintained at a level which, in management's
judgment, is adequate to absorb credit losses inherent in the loan portfolio.
The amount of the allowance is based on management's evaluation of the
collectibility of the loan portfolio, based on factors such as credit
concentrations, past due or delinquency status, trends in historical loss
experience, specific impaired loans, and economic conditions. Past due or
delinquency status of loans is computed based on the contractual terms of the
loans. Allowances for impaired loans are determined based on collateral values
or the present value of estimated cash flows. The allowance is increased by a
provision for loan losses, which is charged to expense, and reduced by
charge-offs, net of recoveries. Loan balances are charged off when it becomes
evident that such balances are not fully collectible.
BANK PREMISES AND EQUIPMENT - Bank premises and equipment are stated at cost
less accumulated depreciation. Repair and maintenance expenditures which extend
the useful lives of assets are capitalized, and other repair and maintenance
expenditures are expensed as incurred. Depreciation expense is computed using
the straight-line method.
INTEREST COSTS - The Corporation capitalizes interest as a component of the cost
of premises and equipment constructed or acquired for its own use. In 2005,
total interest incurred was $25,755,000, of which $25,687,000 was charged to
expense and $68,000 was capitalized. In 2004, total interest incurred was
$22,649,000, of which $22,606,000 was charged to expense and $43,000 was
capitalized. Total interest incurred amounted to $23,537,000 in 2003, all of
which was charged to expense.
FORECLOSED ASSETS HELD FOR SALE - Foreclosed assets held for sale consist of
real estate acquired by foreclosure and are carried at estimated fair value,
less selling cost.
GOODWILL AND CORE DEPOSIT INTANGIBLE ASSETS - Goodwill represents the excess of
the cost of an acquisition over the fair value of the net assets acquired.
Goodwill will be tested at least annually for impairment. The core deposit
intangible is being amortized over a period of time that represents its expected
life using a method of amortization that reflects the pattern of economic
benefit. The core deposit intangible is subject to impairment testing whenever
events or changes in circumstances indicate its carrying amount may not be
recoverable.
INCOME TAXES - Provisions for deferred income taxes are made as a result of
temporary differences in financial and income tax methods of accounting. These
differences relate principally to loan losses, securities gains or losses,
depreciation, pension and other postretirement benefits, alternative minimum
tax, investments in limited partnerships, loan origination fees and costs and
differences arising from an acquisition.
STOCK COMPENSATION PLANS - The Corporation uses the intrinsic value method of
accounting for stock compensation plans, under Accounting Principles Board
Opinion 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.
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.
37
2005 2004 2003
------- ------- -------
(NET INCOME IN THOUSANDS)
Net income, as reported $12,984 $14,863 $16,257
Deduct: Total stock option compensation
expense determined under fair value
method for all awards, net of tax effects (69) (90) (124)
------- ------- -------
Pro forma net income $12,915 $14,773 $16,133
======= ======= =======
Earnings per share-basic
As reported $ 1.57 $ 1.80 $ 1.97
Pro forma $ 1.56 $ 1.79 $ 1.95
Earnings per share-diluted
As reported $ 1.55 $ 1.79 $ 1.96
Pro forma $ 1.55 $ 1.78 $ 1.94
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. Since all of the Corporation's
stock options are exercisable at December 31, 2005, SFAS No. 123R will only
apply to new awards, starting in 2006.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS - In the ordinary course of business,
the Corporation has entered into off-balance sheet financial instruments
consisting of commitments to extend credit and standby letters of credit. Such
financial instruments are recorded in the financial statements when they become
payable.
CASH FLOWS - The Corporation utilizes the net reporting of cash receipts and
cash payments for certain deposit and lending activities. The Corporation
considers all cash and amounts due from depository institutions,
interest-bearing deposits in other banks, and federal funds sold to be cash
equivalents.
TRUST ASSETS AND INCOME - Assets held by the Corporation in a fiduciary or
agency capacity for its customers are not included in the financial statements
since such items are not assets of the Corporation. Trust income is recorded on
a cash basis, which is not materially different from the accrual basis.
2. 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.
The components of other comprehensive income, and the related tax effects, are
as follows:
YEARS ENDED DECEMBER 31,
---------------------------
2005 2004 2003
------- ------- -------
(IN THOUSANDS)
Net income $12,984 $14,863 $16,257
Unrealized holding (losses) gains on available-for-sale securities (7,042) 600 4,636
Reclassification adjustment for gains realized in income (1,802) (2,877) (4,799)
------- ------- -------
Other comprehensive loss before income tax (8,844) (2,277) (163)
Income tax related to other comprehensive loss 3,007 775 54
------- ------- -------
Other comprehensive loss (5,837) (1,502) (109)
------- ------- -------
Comprehensive income $ 7,147 $13,361 $16,148
======= ======= =======
38
3. 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 a 3-for-2 stock split
issued in April 2003, as well as 1% stock dividends declared in the fourth
quarter of each year presented, payable in the first quarter of the following
year. The following data show the amounts used in computing basic and diluted
net income per share. 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
COMMON EARNINGS
NET INCOME SHARES PER SHARE
----------- --------- ---------
2005
Earnings per share - basic $12,984,000 8,292,141 $1.57
Dilutive effect of potential common stock
arising from stock options:
Exercise of outstanding stock options 212,323
Hypothetical share repurchase at $29.62 (153,538)
----------- --------- -----
Earnings per share - diluted $12,984,000 8,350,926 $1.55
=========== ========= =====
2004
Earnings per share - basic $14,863,000 8,267,321 $1.80
Dilutive effect of potential common stock
arising from stock options:
Exercise of outstanding stock options 188,514
Hypothetical share repurchase at $25.39 (139,988)
----------- --------- -----
Earnings per share - diluted $14,863,000 8,315,847 $1.79
=========== ========= =====
2003
Earnings per share - basic $16,257,000 8,252,358 $1.97
Dilutive effect of potential common stock
arising from stock options:
Exercise of outstanding stock options 195,624
Hypothetical share repurchase at $24.27 (146,909)
----------- --------- -----
Earnings per share - diluted $16,257,000 8,301,073 $1.96
=========== ========= =====
4. 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.
39
Following is a condensed balance sheet showing the fair values of the assets
acquired and the liabilities assumed as of the date of acquisition:
(IN THOUSANDS)
Assets received:
Cash and cash equivalents $ 7,136
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 assets received 45,569
-------
Liabilities assumed:
Deposits 38,008
Other liabilities 627
-------
Total liabilities assumed
38,635
-------
Net assets acquired $ 6,934
=======
The core deposit intangible is being amortized over the weighted-average useful
life of 3.7 years, with no estimated residual value. None of the goodwill
arising from the acquisition is deductible for income tax purposes.
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 2005 and 2004 would not be significant.
5. SALE OF CREDIT CARD LOANS
On November 30, 2005, the Corporation sold substantially all of its credit card
portfolio, with a total book value of $8.3 million, to a third party and
recognized a gain of $1.9 million. As part of the sale, the Corporation agreed
to continue to provide servicing for these credit cards through May 2006. The
Corporation recorded a $280,000 liability for the estimated direct costs of
providing these services net of a servicing fee to be received from the buyer.
The $1.9 million gain is net of the $280,000 liability. The liability was
reduced by $44,000 during December 2005 with offsetting reductions to salaries
and wages expense of $21,000 and other expenses of $23,000. The liability, which
is included in accrued interest and other liabilities, was $236,000 at December
31, 2005.
6. CASH AND DUE FROM BANKS
Banks are required to maintain reserves consisting of vault cash and deposit
balances with the Federal Reserve Bank in their district. The reserves are based
on deposit levels during the year and account activity and other services
provided by the Federal Reserve Bank. Average daily currency, coin, and cash
balances with the Federal Reserve Bank needed to cover reserves against deposits
for 2005 ranged from $1,775,000 to $6,616,000. For 2004, theses balances ranged
from $2,984,000 to $4,541,000. Average daily cash balances with the Federal
Reserve Bank required for services provided to the Bank were $2,600,000 in 2005
and $2,500,000 in 2004. Total balances restricted amounted to $6,616,000 at
December 31, 2005 and $6,248,000 at December 31, 2004.
Deposits with one financial institution are insured up to $100,000. The
Corporation maintains cash and cash equivalents with certain financial
institutions in excess of the insured amount.
40
7. SECURITIES
Amortized cost and fair value of securities at December 31, 2005 and 2004 are
summarized as follows:
DECEMBER 31, 2005
----------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
(IN THOUSANDS)
AVAILABLE-FOR-SALE SECURITIES:
Obligations of the U.S. Treasury $ 501 $ -- $ (1) $ 500
Obligations of other U.S. Government agencies 43,999 43 (703) 43,339
Obligations of states and political subdivisions 116,241 2,598 (1,130) 117,709
Other securities 94,849 1,428 (1,120) 95,157
Mortgage-backed securities 140,562 165 (3,400) 137,327
-------- ------- ------- --------
Total debt securities 396,152 4,234 (6,354) 394,032
Marketable equity securities 24,033 9,494 (261) 33,266
-------- ------- ------- --------
Total $420,185 $13,728 $(6,615) $427,298
======== ======= ======= ========
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury $ 313 $ 11 $ -- $ 324
Obligations of other U.S. Government agencies 98 8 -- 106
Mortgage-backed securities 11 -- -- 11
-------- ------- ------- --------
Total $ 422 $ 19 $ -- $ 441
======== ======= ======= ========
DECEMBER 31, 2004
----------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
(IN THOUSANDS)
AVAILABLE-FOR-SALE SECURITIES:
Obligations of the U.S. Treasury $ -- $ -- $ -- $ --
Obligations of other U.S. Government agencies 37,009 67 (764) 36,312
Obligations of states and political subdivisions 125,809 4,147 (586) 129,370
Other securities 100,871 2,675 (439) 103,107
Mortgage-backed securities 169,046 1,002 (2,015) 168,033
-------- ------- ------- --------
Total debt securities 432,735 7,891 (3,804) 436,822
Marketable equity securities 26,388 12,874 (999) 38,263
-------- ------- ------- --------
Total $459,123 $20,765 $(4,803) $475,085
======== ======= ======= ========
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury $ 316 $ 23 $ -- $ 339
Obligations of other U.S. Government agencies 98 14 -- 112
Mortgage-backed securities 19 1 -- 20
-------- ------- ------- --------
Total $ 433 $ 38 $ -- $ 471
======== ======= ======= ========
The following table presents gross unrealized losses and fair value of
investments with unrealized loss positions that are not deemed to be
other-than-temporarily impaired, aggregated by length of time that individual
securities have been in a continuous unrealized loss position at December 31,
2005 and 2004:
41
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL
--------------------- -------------------- ---------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
DECEMBER 31, 2005 VALUE LOSSES VALUE LOSSES VALUE LOSSES
- ----------------- -------- ---------- ------- ---------- -------- ----------
(IN THOUSANDS)
AVAILABLE-FOR-SALE SECURITIES:
Obligations of the U.S. Treasury $ 501 $ (1) $ -- $ -- $ 501 $ (1)
Obligations of other U.S. Government agencies 35,752 (598) 4,895 (105) 40,647 (703)
Obligations of states and political subdivisions 37,213 (625) 6,737 (505) 43,950 (1,130)
Other securities 42,480 (328) 24,997 (792) 67,477 (1,120)
Mortgage-backed securities 66,147 (1,219) 60,899 (2,181) 127,046 (3,400)
-------- ------- ------- ------- -------- -------
Total debt securities 182,093 (2,771) 97,528 (3,583) 279,621 (6,354)
Marketable equity securities 3,598 (112) 1,132 (149) 4,730 (261)
-------- ------- ------- ------- -------- -------
Total temporarily impaired available-for-sale
Securities $185,691 $(2,883) $98,660 $(3,732) $284,351 $(6,615)
======== ======= ======= ======= ======== =======
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL
--------------------- -------------------- ---------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
DECEMBER 31, 2004 VALUE LOSSES VALUE LOSSES VALUE LOSSES
- ----------------- -------- ---------- ------- ---------- -------- ----------
(IN THOUSANDS)
AVAILABLE-FOR-SALE SECURITIES:
Obligations of the U.S. Treasury $ -- $ -- $ -- $ -- $ -- $ --
Obligations of other U.S. Government agencies 19,675 (325) 9,550 (439) 29,225 (764)
Obligations of states and political subdivisions 15,497 (260) 12,265 (326) 27,762 (586)
Other securities 41,837 (316) 4,975 (123) 46,812 (439)
Mortgage-backed securities 94,435 (1,440) 25,646 (575) 120,081 (2,015)
-------- ------- ------- ------- -------- -------
Total debt securities 171,444 (2,341) 52,436 (1,463) 223,880 (3,804)
Marketable equity securities 1,366 (52) 4,958 (947) 6,324 (999)
-------- ------- ------- ------- -------- -------
Total temporarily impaired available-for-sale
securities $172,810 $(2,393) $57,394 $(2,410) $230,204 $(4,803)
======== ======= ======= ======= ======== =======
Management evaluates securities for other-than-temporary impairment at least on
a quarterly basis, and more frequently when economic or market concerns warrant
such evaluation. Consideration is given to (1) the length of time and the extent
to which the fair value has been less than cost, (2) the financial condition and
near-term prospects of the issuer, and (3) the intent and ability of the
Corporation to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in fair value.
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-sponsored agencies or state and political
subdivisions, management believes the Corporation's debt securities at December
31, 2005 were not other-than-temporarily impaired.
The amortized cost and fair value of investment debt securities at December 31,
2005 follow. Maturities of debt securities (including mortgage-backed
securities) are presented based on contractual maturities. Expected maturities
differ from contractual maturities because monthly principal payments are
received from mortgage-backed securities, and because borrowers may have the
right to prepay obligations with or without prepayment penalties.
42
DECEMBER 31, 2005
--------------------
AMORTIZED FAIR
COST VALUE
--------- --------
(IN THOUSANDS)
AVAILABLE-FOR-SALE SECURITIES:
Due in one year or less $ 3,236 $ 3,226
Due after one year through five years 5,291 4,980
Due after five years through ten years 33,500 33,514
Due after ten years 354,125 352,312
-------- --------
Total $396,152 $394,032
======== ========
HELD-TO-MATURITY SECURITIES:
Due in one year or less $ -- $ --
Due after one year through five years 417 436
Due after five years through ten years -- --
Due after ten years 5 5
-------- --------
Total $ 422 $ 441
======== ========
The following table shows the amortized cost and maturity distribution of the
debt securities portfolio at December 31, 2005:
WITHIN ONE - FIVE - AFTER
ONE FIVE TEN TEN
YEAR YIELD YEARS YIELD YEARS YIELD YEARS YIELD TOTAL YIELD
------ ----- ------ ----- ------- ----- -------- ----- -------- -----
(IN THOUSANDS, EXCEPT FOR PERCENTAGES)
AVAILABLE-FOR-SALE SECURITIES:
Obligations of other U.S. Treasury $ 501 4.34% $ -- -- $ -- -- $ -- -- $ 501 4.34%
Obligations of other U.S. Government agencies 999 4.64% 1,500 4.85% 20,500 5.18% 21,000 5.12% 43,999 5.13%
Obligations of states and political subdivisions 1,736 3.99% 2,876 3.75% 1,690 4.67% 109,939 4.58% 116,241 4.55%
Other securities -- -- 915 4.80% 6,343 6.86% 87,591 5.60% 94,849 5.68%
Mortgage-backed securities -- -- -- -- 4,967 5.08% 135,595 4.51% 140,562 4.53%
------ ---- ------ ---- ------- ---- -------- ---- -------- ----
Total $3,236 4.24% $5,291 4.24% $33,500 5.46% $354,125 4.53% $396,152 4.88%
====== ==== ====== ==== ======= ==== ======== ==== ======== ====
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury $ -- -- $ 313 5.30% $ -- -- $ -- -- $ 313 5.30%
Obligations of other U.S. Government agencies -- -- 98 7.16% -- -- -- -- 98 7.16%
Mortgage-backed securities -- -- 6 6.22% -- -- 5 6.35% 11 6.28%
------ ---- ------ ---- ------- ---- -------- ---- -------- ----
Total $ -- -- $ 417 5.75% $ -- -- $ 5 6.35% $ 422 5.76%
====== ==== ====== ==== ======= ==== ======== ==== ======== ====
Investment securities carried at $129,692,000 at December 31, 2005 and
$89,158,000 at December 31, 2004, were pledged as collateral for public
deposits, trusts and certain other deposits as provided by law. Also, see Note
12 for information concerning securities pledged to secure borrowing
arrangements.
Gross realized gains and losses from the sales of available-for-sale securities,
and the income tax provision related to net realized gains, for 2005, 2004 and
2003 were as follows:
2005 2004 2003
------- ------- ------
(IN THOUSANDS)
Gross realized gains $ 4,683 $ 3,880 $4,860
Gross realized losses (2,881) (1,003) (61)
------- ------- ------
Net realized gains $ 1,802 $ 2,877 $4,799
======= ======= ======
Income tax provision related to net realized gains $ 613 $ 978 $1,632
======= ======= ======
43
8. LOANS
Major categories of loans and leases included in the loan portfolio are as
follows:
DECEMBER 31, % OF DECEMBER 31, % OF
2005 TOTAL 2004 TOTAL
------------ ------ ------------ ------
(IN THOUSANDS)
Real estate - construction $ 5,552 0.85% $ 4,178 0.72%
Real estate - residential mortgage 361,857 55.39% 347,705 59.98%
Real estate - commercial mortgage 153,661 23.52% 128,073 22.10%
Consumer 31,559 4.83% 31,702 5.47%
Agricultural 2,340 0.36% 2,872 0.50%
Commercial 69,396 10.62% 43,566 7.52%
Other 1,871 0.29% 1,804 0.31%
Political subdivisions 27,063 4.14% 19,713 3.40%
-------- ------ -------- ------
Total 653,299 100.00% 579,613 100.00%
Less: allowance for loan losses (8,361) (6,787)
-------- --------
Loans, net $644,938 $572,826
======== ========
Net unamortized loan fees of $1,508,000 at December 31, 2005 and $1,704,000 at
December 31, 2004 have been offset against the carrying value of loans.
There is no concentration of loans to borrowers engaged in similar businesses or
activities that exceed 10% of total loans at December 31, 2005.
The Corporation grants commercial, residential and personal loans to customers
primarily in the Pennsylvania Counties of Tioga, Bradford, Sullivan and
Lycoming, and in Steuben and Allegany Counties in New York State. Although the
Corporation has a diversified loan portfolio, a significant portion of its
debtors' ability to honor their contracts is dependent on the local economic
conditions within the region.
Transactions in the allowance for loan losses were as follows:
2005 2004 2003
------ ------ ------
(IN THOUSANDS)
Balance at beginning of year $6,787 $6,097 $5,789
Allowance for loan losses recorded in
acquisition 377 -- --
Provision charged to operations 2,026 1,400 1,100
Loans charged off (984) (786) (968)
Recoveries 155 76 176
------ ------ ------
Balance at end of year $8,361 $6,787 $6,097
====== ====== ======
Information related to impaired and nonaccrual loans, and loans past due 90 days
or more, as of December 31, 2005 and 2004 is as follows:
2005 2004 2003
------ ------ ------
(IN THOUSANDS)
Impaired loans without a valuation allowance $ 910 $3,552 $ 114
Impaired loans with a valuation allowance 7,306 4,709 4,507
------ ------ ------
Total impaired loans $8,216 $8,261 $4,621
====== ====== ======
Valuation allowance related to impaired loans $2,374 $1,378 $1,542
Total nonaccrual loans $6,365 $7,796 $1,145
Total loans past due 90 days or more and
still accruing $1,369 $1,307 $2,546
44
The following is a summary of information related to impaired loans for 2005,
2004 and 2003:
2005 2004 2003
------ ------ ------
(IN THOUSANDS)
Average investment in impaired loans $8,282 $7,458 $3,425
====== ====== ======
Interest income recognized on impaired loans $ 291 $ 352 $ 313
====== ====== ======
Interest income recognized on a cash basis
on impaired loans $ 291 $ 352 $ 313
====== ====== ======
No additional funds are committed to be advanced in connection with impaired
loans.
9. BANK PREMISES AND EQUIPMENT
Bank premises and equipment are summarized as follows:
DECEMBER 31,
-------------------
2005 2004
-------- --------
(IN THOUSANDS)
Land $ 2,118 $ 1,449
Buildings and improvements 19,296 15,734
Furniture and equipment 15,725 13,539
Construction in progress 4,237 874
-------- --------
Total 41,376 31,596
Less: accumulated depreciation (18,771) (14,871)
-------- --------
Net $ 22,605 $ 16,725
======== ========
Depreciation expense included in occupancy expense and furniture and equipment
expense was as follows:
2005 2004 2003
------ ------ ------
(IN THOUSANDS)
Occupancy expense $ 700 $ 572 $ 479
Furniture and equipment expense 1,601 1,015 732
------ ------ ------
Total $2,301 $1,587 $1,211
====== ====== ======
45
10. INTANGIBLE ASSETS
Information related to the core deposit intangible asset as of December 31, 2005
was as follows:
(IN THOUSANDS)
Gross amount $547
Less: accumulated amortization (83)
----
Net $464
====
Amortization expense for 2005 was $83,000. Estimated amortization expense for
each of the ensuing five years is as follows:
(IN THOUSANDS)
2006 $128
2007 85
2008 64
2009 48
2010 36
Changes in the carrying amount of goodwill in 2005 are summarized in the
following table:
(IN THOUSANDS)
Balance, beginning of year $ --
Goodwill arising in business combination (see
Note 4) 2,944
Reduction in valuation allowance on deferred tax
asset related to net operating loss (25)
------
Balance, end of year $2,919
======
11. DEPOSITS
At December 31, 2005, the scheduled maturities of time deposits are as follows:
(IN THOUSANDS)
2006 $194,779
2007 98,149
2008 20,580
2009 13,958
2010 10,626
THEREAFTER 36
--------
$338,128
========
Included in interest-bearing deposits are time deposits in the amount of
$100,000 or more. As of December 31, 2005, the remaining maturities or repricing
frequency of time deposits of $100,000 or more are as follows:
(IN THOUSANDS)
Three months or less $37,575
Over 3 months through 12 months 30,203
Over 1year through 3 years 23,055
Over 3 years 5,374
-------
Total $96,207
=======
Interest expense from deposits of $100,000 or more amounted to $2,975,000 in
2005, $2,214,000 in 2004 and $2,693,000 in 2003.
46
12. BORROWED FUNDS
SHORT-TERM BORROWINGS
Short-term borrowings include the following:
AT DECEMBER 31,
-----------------
2005 2004
------- -------
(IN THOUSANDS)
Federal Home Loan Bank of Pittsburgh borrowings (a) $ 7,000 $ 8,000
Customer repurchase agreements (b) 27,734 21,178
Other repurchase agreements (c) -- 5,000
------- -------
Total short-term borrowings $34,734 $34,178
======= =======
The weighted average interest rate on total short-term borrowings outstanding
was 2.80% at December 31, 2005 and 1.37% at December 31, 2004. The maximum
amount of total short-term borrowings outstanding at any month-end was
$60,037,000 in 2005 and $55,278,000 in 2004.
(a) Short-term FHLB - Pittsburgh loans are as follows:
AT DECEMBER 31,
---------------
2005 2004
------ ------
(IN THOUSANDS)
Fixed Rate 3.76% maturing April 26, 2006 $7,000 $ --
Fixed Rate 1.47% maturing February 23, 2005 3,000
Fixed Rate 2.67% maturing March 17, 2005 5,000
------ ------
Total short-term FHLB - Pittsburgh borrowings $7,000 $8,000
====== ======
Collateral for FHLB - Pittsburgh loans is described under the "Long-term
Borrowings" section of this note.
(b) Customer repurchase agreements mature overnight, and are collateralized by
securities with a carrying value of $34,521,000 at December 31, 2005 and
$26,336,000 at December 31, 2004.
(c) Other repurchase agreements included in short-term borrowings are as
follows:
AT DECEMBER 31,
---------------
2005 2004
------ ------
(IN THOUSANDS)
Fixed Rate 1.45% matures April 26, 2005 $-- $5,000
--- ------
Total other repurchase agreements $-- $5,000
=== ======
The terms and collateral related to repurchase agreements are described under
the "Long-term Borrowings" section of this note.
LONG-TERM BORROWINGS
Long-term borrowings are as follows:
AT DECEMBER 31,
-------------------
2005 2004
-------- --------
(IN THOUSANDS)
FHLB - Pittsburgh borrowings (d) $185,485 $208,441
Repurchase agreements (e) 46,720 62,386
-------- --------
Total long-term borrowings $232,205 $270,827
======== ========
47
(d) Long-term borrowings from FHLB - Pittsburgh are as follows:
AT DECEMBER 31,
-------------------
2005 2004
-------- --------
(IN THOUSANDS)
Loans maturing in 2006 with rates ranging from 2.07% to 4.83% $ 57,700 $ 50,700
Loans maturing in 2007 with rates ranging from 2.33% to 4.58% 79,067 74,067
Loans maturing in 2008 with rates ranging from 2.97% to 4.33% 23,500 19,500
Loans maturing in 2009 with rates ranging from 3.60% to 3.62% 5,432 6,384
Loan maturing in 2011 with a rate of 4.98% 5,000 5,000
Loan maturing in 2012 with a rate of 4.54% 10,000 10,000
Loan maturing in 2016 with a rate of 6.86% 428 453
Loan maturing in 2017 with a rate of 6.83% 55 58
Loan maturing in 2020 with rates ranging from 4.67% to 4.79% 2,850 2,279
Loan maturing in 2025 with a rate of 4.91% 1,453
-------- --------
Total long-term FHLB - Pittsburgh borrowings $185,485 $168,441
======== ========
The FHLB - Pittsburgh loan facilities are collateralized by qualifying
securities and mortgage loans with a book value totaling $299,353,000 at
December 31, 2005. Also, the FHLB - Pittsburgh loan facilities require the
Corporation to invest in established amounts of FHLB - Pittsburgh stock. The
carrying values of the Corporation's holdings of FHLB - Pittsburgh stock were
$10,128,000 at December 31, 2005 and $12,360,000 at December 31, 2004.
(e) Repurchase agreements included in long-term borrowings are as follows:
AT DECEMBER 31,
-----------------
2005 2004
------- -------
(IN THOUSANDS)
Agreements maturing in 2005 with rates ranging from 2.01% to 4.63% $ -- $15,666
Agreements maturing in 2006 with rates ranging from 2.02% to 4.63% 20,220 20,220
Agreements maturing in 2007 with rates ranging from 2.53% to 3.23% 14,500 14,500
Agreements maturing in 2008 with rates ranging from 3.00% to 3.60% 12,000 12,000
------- -------
Total long-term repurchase agreements $46,720 $62,386
======= =======
Securities sold under repurchase agreements were delivered to the broker-dealers
who arranged the transactions. The broker-dealers may have sold, loaned or
otherwise disposed of such securities to other parties in the normal course of
their operations, and have agreed to resell to the Corporation substantially
identical securities at the maturities of the agreements. The carrying value of
the underlying securities was $54,966,000 at December 31, 2005 and $70,528,000
at December 31, 2004. Average daily repurchase agreement borrowings amounted to
$51,022,000 in 2005, $58,663,000 in 2004 and $40,333,000 in 2003. During 2005,
2004 and 2003, the maximum amounts of outstanding borrowings under repurchase
agreements with broker-dealers were $67,386,000, $67,386,000 and $50,153,000.
The weighted average interest rate on repurchase agreements was 2.92% in 2005,
3.20% in 2004 and 3.68% in 2003.
13. 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
48
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 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 related to IPCDs are as follows (in thousands):
AT DECEMBER 31,
---------------
2005 2004
------ ------
Contractual amount of IPCDs (equal
to notional amount of Swap contracts) $3,952 $4,045
Carrying value of IPCDs 3,733 3,695
Carrying value of embedded derivative liabilities 558 297
Carrying value of Swap contract liabilities (346) 42
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
2005 2004 2003
---- ---- ----
Interest expense $156 $143 $112
Other expense 13 9 10
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of a financial instrument is the current amount that would be
exchanged between willing parties, other than in a forced liquidation. Fair
value is best determined based upon quoted market prices. However, in many
instances, there are no quoted market prices for the Corporation's financial
instruments. In cases where quoted market prices are not available, fair values
are based on estimates using present value or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. Accordingly, the fair value
estimates may not be realized in an immediate settlement of the instrument. SFAS
No. 107 excludes certain financial instruments and all nonfinancial instruments
from its disclosure requirements. Therefore, the aggregate fair value amounts
presented may not represent the underlying fair value of the Corporation.
The Corporation used the following methods and assumptions in estimating fair
value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS - The carrying amounts of cash and short-term
instruments approximate fair values.
SECURITIES - Fair values for securities, excluding restricted equity securities,
are based on quoted market prices. The carrying value of restricted equity
securities approximates fair value based on applicable redemption provisions.
LOANS - Fair values are estimated for portfolios of loans with similar financial
characteristics. Loans are segregated by type such as commercial, commercial
real estate, residential mortgage, credit card and other consumer. Each loan
category is further segmented into fixed and adjustable rate interest terms and
by performing and nonperforming categories. The fair value of performing loans,
except residential mortgage and credit card loans, is calculated by discounting
scheduled cash flows through the estimated maturity using estimated market
discount rates that reflect the
49
credit and interest rate risk inherent in the loans. The estimate of maturity is
based on the Corporation's historical experience with repayments for each loan
classification, modified, as required, by an estimate of the effect of current
economic and lending conditions. For performing residential mortgage loans, fair
value is estimated by discounting contractual cash flows adjusted for prepayment
estimates based on historical experience. For credit card loans, cash flows and
maturities are estimated based on contractual interest rates and historical
experience. Fair value of nonperforming loans is based on recent appraisals or
estimates prepared by the Corporation's lending officers.
DEPOSITS - The fair value of deposits with no stated maturity, such as
noninterest-bearing demand deposits, savings, money market and interest checking
accounts, is (by definition) equal to the amount payable on demand at December
31, 2005 and 2004. The fair value of all other deposit categories is based on
the discounted value of contractual cash flows. The discount rate is estimated
using the rates currently offered for deposits of similar remaining maturities.
The fair value estimates of deposits do not include the benefit that results
from the low-cost funding provided by the deposit liabilities compared to the
cost of borrowing funds in the market, commonly referred to as the core deposit
intangible.
BORROWED FUNDS - The fair value of borrowings is estimated using discounted cash
flow analyses based on rates currently available to the Corporation for similar
types of borrowing arrangements.
ACCRUED INTEREST - The carrying amounts of accrued interest receivable and
payable approximate fair values.
EMBEDDED DERIVATIVE LIABILITIES - IPCDS - The fair values of embedded
derivatives are calculated by a third party. Factors that affect the fair value
of embedded derivatives include term to maturity, market interest rates and
other market factors that affect the present value of the Corporation's
obligation to pay each IPCD depositor a return based on appreciation in the S&P
500 index.
EMBEDDED DERIVATIVE LIABILITIES - EQUITY OPTION SWAP CONTRACTS - The fair values
of equity option Swap contracts are calculated by a third party. Factors that
affect the fair value of equity option Swap contracts include: (1) the
negotiated rate associated with the Corporation's obligation to make quarterly
payments to the FHLB-Pittsburgh over the term of each IPCD; and (2) term to
maturity, market interest rates and other market factors that affect the present
value of the FHLB-Pittsburgh's obligation to pay the Corporation a return based
on appreciation in the S&P 500 index.
The estimated fair values, and related carrying amounts, of the Corporation's
financial instruments are as follows:
DECEMBER 31, 2005 DECEMBER 31, 2004
------------------- -------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- -------- -------- --------
(IN THOUSANDS)
Financial assets:
Cash and cash equivalents $ 26,446 $ 26,446 $ 18,953 $ 18,953
Available-for-sale securities 427,298 427,298 475,085 475,085
Held-to-maturity securities 422 441 433 471
Restricted equity securities 10,128 10,128 12,360 12,360
Loans, net 644,938 637,093 572,826 578,720
Accrued interest receivable 5,500 5,500 5,094 5,094
Equity option Swap contracts -
IPCDs 346 346 -- --
Financial liabilities:
Deposits 757,065 757,566 676,545 677,182
Short-term borrowings 34,734 33,930 34,178 34,133
Long-term borrowings 232,205 227,993 270,827 270,015
Accrued interest payable 1,128 1,128 1,639 1,639
Embedded derivative liabilities -
IPCDs 558 558 297 297
Equity option Swap contracts -
IPCDs -- -- 42 42
50
15. EMPLOYEE AND POSTRETIREMENT BENEFIT PLANS
DEFINED BENEFIT PLANS
The Corporation has a noncontributory defined benefit pension plan for all
employees meeting certain age and length of service requirements. Benefits are
based primarily on years of service and the average annual compensation during
the highest five consecutive years within the final ten years of employment.
Also, the Corporation sponsors a defined benefit health care plan that provides
postretirement medical benefits and life insurance to employees who meet certain
age and length of service requirements. This plan contains a cost-sharing
feature, which causes participants to pay for all future increases in costs
related to benefit coverage. Accordingly, actuarial assumptions related to
health care cost trend rates do not affect the liability balance at December 31,
2005 and 2004, and will not affect the Corporation's future expenses.
The Corporation uses a December 31 measurement date for its plans.
The following tables show the funded status and amounts recognized in the
consolidated balance sheet from these defined benefit plans:
PENSION POSTRETIREMENT
BENEFITS BENEFITS
----------------- ---------------
2005 2004 2005 2004
------- ------- ------ ------
(IN THOUSANDS)
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation at beginning of year $11,195 $10,086 $1,129 $1,029
Service cost 475 474 43 43
Interest cost 618 620 63 63
Plan participants' contributions -- -- 190 164
Actuarial loss (gain) (139) 478 18 46
Benefits paid (481) (463) (241) (216)
------- ------- ------ ------
Benefit obligation at end of year $11,668 $11,195 $1,202 $1,129
======= ======= ====== ======
2005 2004 2005 2004
------- ------- ------- -------
CHANGE IN PLAN ASSETS:
Fair value of plan assets at
beginning of year $ 9,313 $ 8,654 $ -- $ --
Actual return on plan assets 745 794 -- --
Employer contribution 178 328 51 52
Plan participants' contributions -- -- 190 164
Benefits paid (481) (463) (241) (216)
------- ------- ------- -------
Fair value of plan assets at end of year $ 9,755 $ 9,313 $ -- $ --
======= ======= ======= =======
Funded status $(1,913) $(1,882) $(1,202) $(1,129)
Unrecognized net actuarial loss (gain) 2,235 2,364 121 105
Unrecognized transition (asset) obligation (114) (137) 256 292
------- ------- ------- -------
Prepaid (accrued) benefit cost $ 208 $ 345 $ (825) $ (732)
======= ======= ======= =======
The accumulated benefit obligation for the defined benefit pension plan was
$9,442,000 at December 31, 2005 and $8,380,000 at December 31, 2004.
51
The components of net periodic benefit costs from these defined benefit plans
are as follows:
PENSION BENEFITS POSTRETIREMENT BENEFITS
--------------------- -----------------------
2005 2004 2003 2005 2004 2003
----- ----- ----- ---- ---- ----
(IN THOUSANDS)
Service cost $ 475 $ 474 $ 394 $ 43 $ 43 $ 32
Interest cost 618 620 590 63 63 60
Expected return on plan assets (793) (748) (615) -- -- --
Amortization of transition (asset) obligation (23) (23) (22) 36 36 37
Recognized net actuarial loss (gain) 38 65 86 2 2 1
----- ----- ----- ---- ---- ----
Net periodic benefit cost $ 315 $ 388 $ 433 $144 $144 $130
===== ===== ===== ==== ==== ====
The weighted-average assumptions used to determine benefit obligations as of
December 31, 2005 and 2004 are as follows:
PENSION POSTRETIREMENT
BENEFITS BENEFITS
----------- --------------
Discount rate 5.50% 6.00% 5.50% 6.00%
Expected return on plan assets 8.50% 8.50% N/A N/A
Rate of compensation increase 4.00% 4.50% N/A N/A
The expected return on pension plan assets is a significant assumption used in
the calculation of net periodic benefit cost. This assumption reflects the
average long-term rate of earnings expected on the funds invested or to be
invested to provide for the benefits included in the projected benefit
obligation. The selected rate considers the historical and expected future
investment trends of the present and expected future assets in the plan.
Management believes the assumed 8.50% return on plan assets, which was used for
net periodic benefit cost calculations in 2003, 2004 and 2005, is reasonable.
Management has calculated the average annual return on pension plan assets over
the period 1991-2005 to be 9.26%, with annual returns ranging from a low of
- -7.23% to a high of +19.87% over that period.
The Corporation's pension plan weighted-average asset allocations at December
31, 2005 and 2004 are as follows:
2005 2004
---- ----
Cash and cash equivalents 4% 5%
Debt securities 33% 34%
Equity securities 63% 61%
--- ---
Total 100% 100%
=== ===
The Bank's Trust and Financial Management Department manages the investment of
pension plan assets. The targeted asset allocation for the pension plan is 60%
equity securities, 35% debt securities and 5% cash. This targeted asset
allocation reflects a balanced approach, considering the need for growth of plan
assets to meet future demand, as well as the need for ongoing liquidity to fund
benefit payments. Specifically, the Trust Department attempts to match the
maturities of zero-coupon bonds with the estimated amounts of benefit payments
over the ensuing 10-year period. Within the equity portion of pension plan
investments, the Trust Department employs a strategy of diversification.
Holdings include large capitalization stocks from many different industries, as
well as mid-cap and foreign mutual funds. The pension plan's assets do not
include any shares of the Corporation's common stock.
The Corporation expects to contribute $380,000 to the defined benefit pension
plan, and $62,000 to the postretirement benefit plan, in 2005.
52
Estimated future benefit payments (including, for the postretirement plan, only
the estimated employer contributions), which reflect expected future service,
are as follows:
PENSION POSTRETIREMENT
BENEFITS BENEFITS
-------- --------------
(IN THOUSANDS)
2006 $ 430 $ 62
2007 437 62
2008 443 67
2009 485 69
2010 508 73
2011-2015 3,130 424
In December 2003, the Medicare Prescription Drug, Improvement and Modernization
Act (the "Act") was signed into law. The Act introduces a prescription drug
benefit under Medicare (Medicare Part D) as well as a federal subsidy to
sponsors of retiree health care benefit plans that provide a benefit that is at
least "actuarially equivalent" to Medicare Part D. The Corporation has been
informed that the Medicare program has determined that benefits provided under
the Corporation's postretirement plan for the plan year ending June 30, 2006 are
considered to be actuarially equivalent to benefits available under Medicare
Part D. However, it is uncertain whether plan benefits will be considered
actuarially equivalent after June 30, 2006, and therefore, the calculation of
the benefit obligation at December 31, 2005 has not been reduced for any future
reimbursements from the Medicare program.
PROFIT SHARING AND DEFERRED COMPENSATION PLANS
The Corporation has a profit sharing plan that incorporates the deferred salary
savings provisions of Section 401(k) of the Internal Revenue Code. The
Corporation's matching contributions to the Plan depend upon the tax deferred
contributions of employees. The Corporation's total basic and matching
contributions were $834,000 in 2005, $727,000 in 2004 and $728,000 in 2003.
The profit sharing/401(k) Plan includes an Employee Stock Ownership Plan (ESOP).
A portion of the Corporation's basic contributions to the Plan are made to the
ESOP, and the Plan uses these funds to purchase Corporation stock for the
accounts of Plan participants. These purchases are made on the market (not
directly from the Corporation), and employees are not permitted to purchase
Corporation stock under the Plan. The Plan includes a diversification feature
which permits Plan participants, upon reaching age 55 and 10 years of service
(as defined), to sell up to 50% of their Corporation shares back to the Plan
over a period of 6 years. As of December 31, 2005 and 2004, there were no shares
allocated for repurchase by the Plan.
Dividends paid on shares held by the ESOP are charged to retained earnings. All
Corporation shares owned through the ESOP are included in the calculation of
weighted-average shares outstanding for purposes of calculating earnings per
share - basic and diluted. The ESOP held 257,873 shares of Corporation stock at
December 31, 2005 and 275,064 shares at December 31, 2004, all of which had been
allocated to Plan participants. The Corporation's contributions to the ESOP
portion of the Plan (included in total contributions reported above) totaled
$433,000 in 2005, $385,000 in 2004 and $377,000 in 2003.
The Corporation also has a nonqualified supplemental deferred compensation
arrangement with its key officers. Charges to expense for officers' supplemental
deferred compensation were $32,000 in 2005, $4,000 in 2004 and $45,000 in 2003.
STOCK-BASED COMPENSATION PLANS
The Corporation has a Stock Incentive Plan for a selected group of senior
officers. A total of 400,000 shares of common stock may be issued under the
Stock Incentive Plan. Awards may be made under the Stock Incentive Plan in the
form of qualified options ("Incentive Stock Options," as defined in the Internal
Revenue Code), nonqualified options, stock appreciation rights or restricted
stock. Through 1999, all awards under the Stock Incentive Plan were Incentive
Stock Options, with exercise prices equal to the market price of the stock at
the date of grant, ratable vesting over 5 years and a contractual expiration of
10 years. In 2000, 2002, 2003, 2004 and 2005, there were awards of Incentive
Stock Options and restricted stock. The Incentive Stock Options granted in 2000,
2002, 2003, 2004 and 2005 have an exercise price equal to the market value of
the stock at the date of grant, vest after 6 months and expire after 10 years.
The restricted stock awards vest ratably over 3 years.
Also, the Corporation has an Independent Directors Stock Incentive Plan. This
plan permits awards of nonqualified stock options and/or restricted stock to
non-employee directors. A total of 75,000 shares of common stock may be issued
under
53
the Independent Directors Stock Incentive Plan. The recipients' rights to
exercise stock options under this plan expire 10 years from the date of grant.
The exercise prices of all stock options awarded under the Independent Directors
Stock Incentive Plan are equal to market value as of the dates of grant. The
restricted stock awards vest ratably over 3 years.
As described in Note 1, the Corporation applies Accounting Principles Board
Opinion 25 and related interpretations in accounting for stock options.
Accordingly, no compensation expense has been recognized for the stock options.
Had compensation cost for the stock options been determined based on the fair
value at the grant dates for awards consistent with the method of SFAS No. 123,
the effect on the Corporation's net income and earnings per share would have
been adjusted to the pro forma amounts indicated in the following table.
2005 2004 2003
------- ------- -------
(NET INCOME IN THOUSANDS)
Net income
As reported $12,984 $14,863 $16,257
Pro forma $12,915 $14,773 $16,133
Earnings per share-basic
As reported $ 1.57 $ 1.80 $ 1.97
Pro forma $ 1.56 $ 1.79 $ 1.95
Earnings per share-diluted
As reported $ 1.55 $ 1.79 $ 1.96
Pro forma $ 1.55 $ 1.78 $ 1.94
For purposes of the calculations of SFAS No. 123, the fair value of each option
grant is estimated on the date of grant using the Black-Scholes option-pricing
model with the following assumptions:
2005 2004 2003
------- ------- -------
Volatility 15% 15% 15%
Expected option lives 6 Years 6 Years 6 Years
Risk-free interest rate 3.93% 3.87% 3.55%
Dividend yield 4.73% 4.46% 4.30%
A summary of the status of the Corporation's stock option plans is presented
below:
2005 2004 2003
------------------ ------------------ ------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------- -------- ------- -------- ------- --------
Outstanding, beginning of year 212,463 $20.03 213,058 $18.81 180,722 $18.11
Granted 37,176 $27.00 33,249 $26.59 46,411 $20.73
Exercised (38,814) $18.72 (29,795) $18.32 (12,066) $16.28
Forfeited (6,832) $21.85 (4,049) $21.80 (2,009) $16.19
------- ------ ------- ------ ------- ------
Outstanding, end of year 203,993 $21.51 212,463 $20.03 213,058 $18.11
======= ====== ======= ====== ======= ======
Options exercisable at year-end 203,993 $21.51 212,463 $20.03 207,898 $18.82
Fair value of options granted $ 2.45 $ 2.57 $ 2.11
54
The following table summarizes information about stock options outstanding as of
December 31, 2005:
OUTSTANDING EXERCISABLE
AT REMAINING AT
DECEMBER 31, CONTRACTUAL DECEMBER 31,
EXERCISE PRICES 2005 LIFE IN YEARS 2005
- --------------- ------------ ------------- -------------
$17.00 2,550 1 2,550
$18.03-$22.17 12,540 2 12,540
$24.25-$24.33 18,225 3 18,225
$18.00-$22.08 21,150 4 21,150
$13.50-$16.67 14,310 5 14,310
$17.00 37,909 6 37,909
$20.73 35,329 7 35,329
$26.59 27,289 8 27,289
$27.00 34,691 9 34,691
------- -------
203,993 203,993
======= =======
The following table summarizes restricted stock awards in 2005, 2004 and 2003:
2005 2004 2003
------- ------- -------
Number of shares awarded 4,128 3,714 5,166
Market price of stock at date of grant $ 27.00 $ 26.59 $ 20.73
Compensation expense related to restricted stock was $93,000 in 2005, $85,000 in
2004 and $102,000 in 2003.
55
16. INCOME TAXES
The following temporary differences gave rise to the net deferred tax liability
at December 31, 2005 and 2004:
2005 2004
---- ----
(IN THOUSANDS)
Deferred tax liabilities:
Unrealized holding gains on securities $ 2,411 $ 5,427
Bank premises and equipment 1,445 1,151
Core deposit intangible 193 --
Realized gains on securities 136 75
Prepaid pension 72 120
Other deferred tax liabilities 75 24
------- -------
Total 4,332 6,797
------- -------
Deferred tax assets:
Allowance for loan losses (2,896) (2,375)
Credit for alternative minimum tax paid (352) (300)
Postretirement and sick benefits (308) (276)
Supplemental executive retirement plan (185) (178)
Net operating loss carryforward (138) --
Valuation allowance on net operating
loss carryforward 138 --
Investments in limited partnerships (131) (125)
Fair value discount on purchased loans (95) --
Loan fees and costs (80) (60)
Other deferred tax assets (151) (48)
------- -------
Total (4,198) (3,362)
------- -------
Deferred tax liability, net $ 134 $ 3,435
======= =======
2005 2004 2003
---- ---- ----
Currently payable $ 3,433 $ 2,755 $ 3,634
Deferred (640) 96 (25)
------- ------- -------
Total provision $ 2,793 $ 2,851 $ 3,609
======= ======= =======
2005 2004 2003
---------------- ---------------- ----------------
AMOUNT % AMOUNT % AMOUNT %
------- ------ ------- ------ ------- ------
Expected provision $ 5,522 35.00% $ 6,200 35.00% $ 6,953 35.00%
Tax-exempt interest income (2,301) (14.58) (2,790) (15.75) (2,766) (13.92)
Nondeductible interest expense 223 1.41 238 1.34 242 1.22
Dividends received deduction (254) (1.61) (347) (1.96) (284) (1.43)
Increase in cash surrender value of
life insurance (196) (1.24) (214) (1.21) (250) (1.26)
Surtax exemption (83) (0.53) (84) (0.47) (185) (0.93)
Other, net (118) (0.75) (152) (0.86) (101) (0.51)
------- ----- ------- ----- ------- -----
Effective income tax provision $ 2,793 17.70% $ 2,851 16.09% $ 3,609 18.17%
======= ===== ======= ===== ======= =====
The Corporation has available at December 31, 2005, an unused operating loss
carryforward of approximately $348,000 that was assumed in the acquisition of
Canisteo Valley Corporation. This operating loss carryforward may be applied
against future taxable income through its expiration in 2024; however, the
amount that may be utilized in any year is limited to the amount of taxable
income generated by Canisteo Valley Corporation. If in the future the deferred
tax asset related to the operating loss is realized, all of the associated
valuation allowance will be allocated to reduce goodwill.
56
17. RELATED PARTY TRANSACTIONS
Loans to executive officers, directors of the Corporation and its subsidiaries
and any associates of the foregoing persons are as follows:
BEGINNING NEW OTHER ENDING
BALANCE LOANS REPAYMENTS CHANGES BALANCE
--------- ------ ---------- ------- -------
(IN THOUSANDS)
13 directors, 5 executive officers 2005 $7,695 $3,220 $(2,513) $ 833 $9,235
13 directors, 5 executive officers 2004 7,193 1,501 (2,054) 1,055 7,695
13 directors, 5 executive officers 2003 6,623 612 (956) 914 7,193
The above transactions were made in the ordinary course of business on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other persons and do not
involve more than normal risks of collectibility. Other changes represent net
increases in existing lines of credit and transfers in and out of the related
party category.
Deposits from related parties held by the Corporation amounted to $2,900,000 at
December 31, 2005 and $1,887,000 at December 31, 2004.
18. OFF-BALANCE SHEET RISK
The Corporation is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financial needs of its customers.
These financial instruments include commitments to extend credit and financial
standby letters of credit. These instruments involve, to varying degrees,
elements of credit, interest rate or liquidity risk in excess of the amount
recognized in the consolidated balance sheet. The contract amounts of these
instruments express the extent of involvement the Corporation has in particular
classes of financial instruments.
The Corporation's exposure to credit loss from nonperformance by the other party
to the financial instruments for commitments to extend credit and financial
standby letters of credit is represented by the contractual amount of these
instruments. The Corporation uses the same credit policies in making commitments
and conditional obligations as it does for on-balance sheet instruments.
Financial instruments whose contract amounts represent credit risk at December
31, 2005 and 2004 are as follows:
2005 2004
-------- --------
(IN THOUSANDS)
Commitments to extend credit $123,463 $226,121
Standby letters of credit 19,582 17,049
Commitments to extend credit are legally binding agreements to lend to
customers. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of fees. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future liquidity requirements.
The Corporation evaluates each customer's creditworthiness on a case-by-case
basis. The amount of collateral obtained, if deemed necessary by the
Corporation, for extensions of credit is based on management's credit assessment
of the counterparty.
Financial standby letters of credit are conditional commitments issued by the
Corporation guaranteeing performance by a customer to a third party. Those
guarantees are issued primarily to support public and private borrowing
arrangements, including commercial paper, bond financing and similar
transactions. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
Some of the financial standby letters of credit are collateralized by real
estate or other assets, while others are unsecured. The extent to which proceeds
from liquidation of collateral would be expected to cover the maximum potential
amount of future payments related to financial standby letters of credit is not
estimable. The Corporation has recorded no liability associated with financial
standby letters of credit as of December 31, 2005 and 2004.
Financial standby letters of credit as of December 31, 2005 expire as follows:
57
Year of Expiration Amount
- ------------------ ------
(IN THOUSANDS)
2006 $17,701
2007 1,403
2008 424
2009 35
2010 19
-------
Total $19,582
=======
19. OPERATING LEASES AND OTHER PURCHASE COMMITMENTS
The Corporation leases facilities and office equipment under operating leases
expiring through 2009. Rental expense under operating leases totaled
approximately $213,000 in 2005 and $89,000in 2004. Minimum future rental
payments under non-cancelable operating leases having remaining terms in excess
of 1 year as of December 31, 2005 are as follows:
(IN THOUSANDS)
2006 $171
2007 73
2008 28
2009 13
2010
THEREAFTER
The facility leases contain renewal options for an additional 5-15 years at
rental amounts established in the leases.
In 2004, the Corporation purchased the license to utilize banking software, and
entered into contractual commitments to pay annual maintenance fees associated
with the software. Maintenance expense amounted to $360,000 in 2005 and $60,000
in 2004, and maintenance fees payable will be approximately $360,000 per year
through 2008 and $300,000 in 2009. Through October 2009, the Corporation would
also be required to pay additional software license fees, based on the Bank's
asset size, determined based on the following schedule (additional licensing
fees in thousands):
ASSET SIZE ADDITIONAL LICENSING FEE
---------- ------------------------
$1.75 BILLION TO $2 BILLION $250
$2 BILLION TO $2.25 BILLION 150 in addition to the $250 noted above
$2.25 BILLION TO $2.5 BILLION 250 in addition to the $400 noted above
ABOVE $2.5 BILLION Based on the vendor's then-current fee schedule
Effective in October 2007, the Corporation has the right to terminate its
contractual commitment to the software vendor, subject to payment of 25% of any
remaining annual maintenance fees.
The agreement between the software vendor and the Corporation contains options
for an unlimited number of additional 5-year renewals. The agreement includes
formulas to determine the amounts of maintenance fees and additional licensing
fees, if the Corporation exercises the renewal options.
20. CONTINGENCIES
In the normal course of business, the Corporation is subject to pending and
threatened litigation in which claims for monetary damages are asserted. In
management's opinion, the Corporation's financial position and results of
operations would not be materially affected by the outcome of these legal
proceedings.
58
21. REGULATORY MATTERS
The Corporation (on a consolidated basis) and the subsidiary Banks are subject
to various regulatory capital requirements administered by the federal banking
agencies. Failure to meet minimum capital requirements can initiate certain
mandatory - and possibly additional discretionary - actions by regulators that,
if undertaken, could have a direct material effect on the Corporation's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Corporation and the Banks must meet
specific capital guidelines that involve quantitative measures of their assets,
liabilities and certain off-balance sheet items as calculated under regulatory
accounting practices. The capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings and
other factors. Prompt corrective action provisions are not applicable to bank
holding companies.
Quantitative measures established by regulation to ensure capital adequacy
require the Corporation and the Banks to maintain minimum amounts and ratios
(set forth in the following table) of total and Tier I capital (as defined in
the regulations) to risk-weighted assets (as defined) and of Tier I capital (as
defined) to average assets (as defined). Management believes, as of December 31,
2005 and 2004, that the Corporation and the Banks meet all capital adequacy
requirements to which they are subject.
To be categorized as well capitalized, an institution must maintain minimum
total risk based, Tier I risk based and Tier I leverage ratios as set forth in
the following table. The Corporation's and the Banks' actual capital amounts and
ratios are also presented in the following table. (DOLLARS IN THOUSANDS)
MINIMUM TO BE WELL
MINIMUM CAPITALIZED UNDER
CAPITAL PROMPT CORRECTIVE
ACTUAL REQUIREMENT ACTION PROVISIONS
---------------- ------------------- -------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- ----- ------- --------- ------- ---------
DECEMBER 31, 2005:
Total capital to risk-
weighted assets:
Consolidated $136,403 18.19% $59,994 > or = 8% n/a N/a
C&N Bank 106,300 15.00% 56,708 > or = 8% $70,885 > or = 10%
First State Bank 3,940 16.05% 1,964 > or = 8% 2,455 > or = 10%
Tier 1 capital to risk-
weighted assets:
Consolidated 123,887 16.52% 29,997 > or = 4% n/a N/a
C&N Bank 96,128 13.56% 28,354 > or = 4% 42,531 > or = 6%
First State Bank 3,632 14.80% 982 > or = 4% 1,473 > or = 6%
Tier 1 capital to
average assets:
Consolidated 123,887 10.62% 46,665 > or = 4% n/a N/a
C&N Bank 96,128 8.72% 44,116 > or = 4% 55,145 > or = 5%
First State Bank 3,632 8.78% 1,655 > or = 4% 2,068 > or = 5%
DECEMBER 31, 2004:
Total capital to risk-
weighted assets:
Consolidated $133,181 18.89% $56,399 > or = 8% n/a n/a
C&N Bank 107,974 15.66% 55,172 > or = 8% $68,965 > or = 10%
Tier 1 capital to risk-
weighted assets:
Consolidated 121,050 17.17% 28,200 > or = 4% n/a n/a
C&N Bank 98,637 14.30% 27,586 > or = 4% 41,379 > or = 6%
Tier 1 capital to
average assets:
Consolidated 121,050 10.69% 45,276 > or = 4% n/a n/a
C&N Bank 98,637 8.95% 44,103 > or = 4% 55,129 > or = 5%
59
Restrictions imposed by Federal Reserve Regulation H limit dividend payments in
any year to the current year's net income plus the retained net income of the
prior two years without approval of the Federal Reserve Board. Accordingly, the
Corporation's dividends in 2006 may not exceed $12,992,000, plus consolidated
net income for 2006. Additionally, banking regulators limit the amount of
dividends that may be paid by the Banks to the Corporation. Retained earnings
against which dividends may be paid without prior approval of the banking
regulators amounted to approximately $86,145,000 at December 31, 2005, subject
to the minimum capital ratio requirements noted above.
Restrictions imposed by federal law prohibit the Corporation from borrowing from
the Banks unless the loans are secured in specific amounts. Such secured loans
to the Corporation are generally limited to 10% of the Banks' tangible
stockholder's equity (excluding accumulated other comprehensive income) or
$9,976,000 at December 31, 2005.
22. PARENT COMPANY ONLY
The following is condensed financial information for Citizens & Northern
Corporation.
CONDENSED BALANCE SHEET
DECEMBER 31,
-------------------
2005 2004
-------- --------
(IN THOUSANDS)
ASSETS
Cash $ 729 $ 725
Investment in subsidiaries:
Citizens & Northern Bank 98,007 104,989
Citizens & Northern Investment Corporation 25,682 25,270
Canisteo Valley Corporation 6,958 --
Bucktail Life Insurance Company 2,485 2,373
Other assets 81 99
-------- --------
TOTAL ASSETS $133,942 $133,456
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Dividends payable $ 1,973 $ 1,864
Other liabilities 1 7
Stockholders' equity 131,968 131,585
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $133,942 $133,456
======== ========
CONDENSED INCOME STATEMENT
YEARS ENDED DECEMBER 31,
---------------------------
2005 2004 2003
------- ------- -------
(IN THOUSANDS)
Dividends from Citizens & Northern Bank $13,805 $ 7,582 $ 6,870
Other dividend income and security gains 6 5 --
Expenses (162) (123) (183)
------- ------- -------
Income before equity in undistributed income
of subsidiaries 13,649 7,464 6,687
Equity in undistributed income of subsidiaries (665) 7,399 9,570
------- ------- -------
NET INCOME $12,984 $14,863 $16,257
======= ======= =======
60
CONDENSED STATEMENT OF CASH FLOWS
YEARS ENDED DECEMBER 31,
---------------------------
2005 2004 2003
------- ------- -------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $12,984 $14,863 $16,257
Adjustments to reconcile net income to net
cash provided by operating activities:
Equity in undistributed net income of
subsidiaries 665 (7,399) (9,570)
Amortization of restricted stock 93 85 102
Decrease (increase) in other assets 18 (45) (9)
(Decrease) increase in other liabilities (6) 78 68
------- ------- -------
Net Cash Provided by Operating Activities 13,754 7,582 6,848
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES,
Investment in subsidiary (7,002) -- (460)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of treasury stock 656 528 197
Tax benefit from compensation plans 213 -- --
Purchase of treasury stock (59) (575) (174)
Dividends paid (7,558) (7,139) (6,674)
------- ------- -------
Net Cash Used in Financing Activities (6,748) (7,186) (6,651)
------- ------- -------
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 4 396 (263)
CASH AND CASH EQUIVALENTS, BEGINNING
OF YEAR 725 329 592
------- ------- -------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 729 $ 725 $ 329
======= ======= =======
23. SUMMARY OF QUARTERLY CONSOLIDATED FINANCIAL DATA (UNAUDITED)
The following table presents summarized quarterly financial data for 2005 and
2004:
2005 QUARTER ENDED
------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
-------- -------- --------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Interest income $14,693 $14,908 $15,571 $15,936
Interest expense 5,957 6,155 6,426 7,149
------- ------- ------- -------
Interest margin 8,736 8,753 9,145 8,787
Provision for loan losses 375 375 375 901
------- ------- ------- -------
Interest margin after provision for loan losses 8,361 8,378 8,770 7,886
Other income 1,703 1,889 2,149 1,895
Gain from sale of credit card loans -- -- -- 1,906
Securities gains (losses) 1,066 929 393 (586)
Other expenses 7,128 7,173 7,303 7,358
------- ------- ------- -------
Income before income tax provision 4,002 4,023 4,009 3,743
Income tax provision 707 725 722 639
------- ------- ------- -------
Net income $ 3,295 $ 3,298 $ 3,287 $ 3,104
------- ------- ------- -------
Net income per share - basic $ 0.40 $ 0.40 $ 0.40 $ 0.37
======= ======= ======= =======
Net income per share - diluted $ 0.39 $ 0.39 $ 0.39 $ 0.37
======= ======= ======= =======
61
2005 QUARTER ENDED
------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
-------- -------- --------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Interest income $14,015 $14,343 $14,573 $14,991
Interest expense 5,703 5,493 5,665 5,745
------- ------- ------- -------
Interest margin 8,312 8,850 8,908 9,246
Provision for loan losses 350 350 350 350
------- ------- ------- -------
Interest margin after provision for loan losses 7,962 8,500 8,558 8,896
Other income 1,625 1,855 1,627 1,815
Securities gains (losses) 964 321 459 1,133
Other expenses 6,228 6,289 6,738 6,746
------- ------- ------- -------
Income before income tax provision 4,323 4,387 3,906 5,098
Income tax provision 617 698 501 1,035
------- ------- ------- -------
Net income $ 3,706 $ 3,689 $ 3,405 $ 4,063
======= ======= ======= =======
Net income per share - basic $ 0.45 $ 0.45 $ 0.41 $ 0.49
======= ======= ======= =======
Net income per share - diluted $ 0.44 $ 0.44 $ 0.41 $ 0.49
======= ======= ======= =======
62
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of Citizens & Northern Corporation:
We have audited the accompanying consolidated balance sheet of Citizens &
Northern Corporation and subsidiaries (collectively, the "Corporation") as of
December 31, 2005 and 2004, and the related consolidated statements of income,
changes in stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 2005. These financial statements are the
responsibility of the Corporation's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Citizens & Northern
Corporation and subsidiaries as of December 31, 2005 and 2004, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2005 in conformity with accounting principles
generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the
Corporation's internal control over financial reporting as of December 31, 2005,
based on criteria established in Internal Control - Integrated Framework issued
by the Committee on Sponsoring Organizations of the Treadway Commission (COSO),
and our report dated February 24, 2006 expressed an unqualified opinion on
management's assessment of internal control over financial reporting and an
unqualified opinion on the effectiveness of internal control over financial
reporting.
Parente Randolph, LLC /s/
Williamsport, Pennsylvania
February 24, 2006
63
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE 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
has materially affected, or that is reasonably likely to affect, our internal
control over financial reporting.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The Corporation's management is responsible for establishing and maintaining
adequate internal control over financial reporting, as that term is defined in
Exchange Act Rules 13a-15(f) and 15d-15(f). The Corporation's system of internal
control over financial reporting has been designed to provide reasonable
assurance to the Corporation's management and board of directors regarding the
reliability of financial reporting and the preparation and fair presentation of
financial statements for external purposes in accordance with accounting
principles generally accepted in the United States of America.
Any system of internal control over financial reporting, no matter how well
designed, has inherent limitations, including the possibility that a control can
be circumvented or overridden and misstatements due to error or fraud may occur
and not be detected. Also, because of changes in conditions, internal control
effectiveness may vary over time. Accordingly, even an effective system of
internal control will provide only reasonable assurance with respect to
financial statement preparation and presentation.
The Corporation's management has assessed the effectiveness of the Corporation's
internal control over financial reporting as of December 31, 2005. To make this
assessment, we used the criteria for effective internal control over financial
reporting described in Internal Control - Integrated Framework, issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Based on our
assessment and based on such criteria, we believe that, as of December 31, 2005,
the Corporation's internal control over financial reporting was effective.
Parente Randolph, LLC, the independent registered public accounting firm that
audited the Corporation's consolidated financial statements, has issued an audit
report on management's assessment of internal control over financial reporting
as of December 31, 2005. That report appears below.
FEBRUARY 8, 2006 BY: CRAIG G. LITCHFIELD /S/
DATE ------------------------------------
CHAIRMAN, PRESIDENT AND
CHIEF EXECUTIVE OFFICER
FEBRUARY 8, 2006 BY: MARK A. HUGHES /S/
DATE ------------------------------------
TREASURER AND
CHIEF FINANCIAL OFFICER
64
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of Citizens & Northern Corporation:
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control Over Financial Reporting, that Citizens
& Northern Corporation and subsidiaries maintained effective internal control
over financial reporting as of December 31, 2005, based on criteria established
in Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Citizens & Northern
Corporation's management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express an
opinion on management's assessment and an opinion on the effectiveness of the
company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
65
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that Citizens & Northern Corporation and
subsidiaries maintained effective internal control over financial reporting as
of December 31, 2005, is fairly stated, in all material respects, based on
criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also,
in our opinion, Citizens & Northern Corporation and subsidiaries maintained, in
all material respects, effective internal control over financial reporting as of
December 31, 2005, based on criteria established in Internal Control -
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheet of
Citizens & Northern Corporation and subsidiaries as of December 31, 2005 and
2004, and the related consolidated statements of income, changes in
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 2005, and our report dated February 24, 2006 expressed an
unqualified opinion.
Parente Randolph, LLC /s/
Williamsport, Pennsylvania
February 24, 2006
66
ITEM 9B. OTHER INFORMATION
There was no information the Corporation was required to disclose in a report on
Form 8-K during the fourth quarter 2005 that was not disclosed.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning Directors and Executive Officers is incorporated herein
by reference to disclosure under the captions "Proposal 1 - Election of
Directors," "Corporation's and Bank's Executive Officers," "Section 16(a)
Beneficial Ownership Reporting Compliance," "Board of Director Committees,
Attendance at Meetings and Compensation of Directors" and "Stockholder
Proposals" of the Corporation's proxy statement dated March 21, 2006 for the
annual meeting of stockholders to be held on April 18, 2006.
The Corporation's Board of Directors has adopted a Code of Ethics, available on
the Corporation's web site at www.cnbankpa.com for the Corporation's employees,
officers and directors. (The provisions of the Code of Ethics are also included
in the Corporation's employee handbook.)
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated herein by
reference to disclosure under the captions "Executive Compensation," "Stock
Incentive plan," "Option Grants," "Aggregated Stock Options Exercised During
2005 and Year-end Option Values," "Pension Plan," "Savings Plan," "Incentive
Award Plan" and "Change in Control Agreements" of the Corporation's proxy
statement dated March 21, 2006 for the annual meeting of stockholders to be held
on April 18, 2006.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED MATTERS
Information concerning security ownership of certain beneficial owners and
management is incorporated herein by reference to disclosure under the caption
"Security Ownership of Management" of the Corporation's proxy statement dated
March 21, 2006 for the annual meeting of stockholders to be held on April 18,
2006.
"Equity Compensation Plan Information" as required by Item 201(d) of Regulation
S-K is incorporated by reference herein from Item 5 (Market for Registrant's
Common Equity and Related Stockholder Matters) of this Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning loans and deposits with Directors and Executive Officers
is provided in Note 17 to the Consolidated Financial Statements, which is
included in Part II, Item 8 of this Annual Report on Form 10-K. Additional
information is incorporated herein by reference to disclosure appearing under
the caption "Certain Transactions" of the Corporation's proxy statement dated
March 21, 2006 for the annual meeting of stockholders to be held on April 18,
2006.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information concerning services provided by the Corporation's independent
auditors, Parente Randolph, LLC, the audit committee's pre-approval policies and
procedures for such services, and fees paid by the Corporation to that firm, is
incorporated herein by reference to disclosure under the caption "Audit
Committee" of the Corporation's proxy statement dated March 21, 2006 for the
annual meeting of stockholders to be held on April 18, 2006.
67
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1). The following consolidated financial statements are set forth in Part
II, Item 8:
Page
--------
Report of Independent Registered Public Accounting Firm 63
Financial Statements:
Consolidated Balance Sheet - December 31, 2005 and 2004 31
Consolidated Statement of Income - Years Ended
December 31, 2005, 2004 and 2003 32
Consolidated Statement of Changes in Stockholders' Equity -
Years Ended December 31, 2005, 2004 and 2003 33
Consolidated Statement of Cash Flows - Years Ended
December 31, 2005, 2004 and 2003 34 - 35
Notes to Consolidated Financial Statements 36 - 62
(a)(2) Financial statement schedules are not applicable or included in the
financial statements or related notes.
(a)(3) Exhibits (numbered as in Item 601 of Regulation S-K):
2. Plan of acquisition, Not applicable
reorganization, arrangement,
liquidation or succession
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
4. Instruments defining the rights of Not applicable
security holders, including
indentures
9. Voting trust agreement Not applicable
10. Material contracts:
10.1 Change in Control Agreement Filed herewith
dated July 21, 2005 between the
Corporation and Harold F. Hoose,
III
10.2 Form of Stock Option and Filed herewith
Restricted Stock Agreements dated
January 3, 2005 between the
Corporation and certain officers
pursuant to the Citizens &
Northern Corporation Stock
Incentive Plan
10.3 Form of Stock Option and Filed herewith
Restricted Stock Agreements dated
January 3, 2005 between the
Corporation and the Directors
pursuant to the Citizens &
Northern Corporation Independent
Directors Stock Incentive Plan
68
10.4 Form of Indemnification Incorporated by reference to Exhibit
Agreements dated May 2004 between 10.1 filed with the Corporation's Form
the Corporation and the Directors 10-K on March 11, 2005
and certain officers
10.5 Change in Control Agreement Incorporated by reference to Exhibit
dated December 31, 2003 between 10.2 filed with the Corporation's Form
the Corporation and Thomas L. 10-K on March 11, 2005
Rudy, Jr.
10.6 Change in Control Agreement Incorporated by reference to Exhibit
dated December 31, 2003 between 10.1 filed with the Corporation's Form
the Corporation and Craig G. 10-K on March 10, 2004
Litchfield
10.7 Change in Control Agreement Incorporated by reference to Exhibit
dated December 31, 2003 between 10.2 filed with the Corporation's Form
the Corporation and Mark A. Hughes 10-K on March 10, 2004
10.8 Change in Control Agreement Incorporated by reference to Exhibit
dated December 31, 2003 between 10.4 filed with the Corporation's Form
the Corporation and Deborah E. 10-K on March 10, 2004
Scott
10.9 Second Amendment to Citizens Incorporated by reference to Exhibit
& Northern Corporation Stock 10.5 filed with the Corporation's Form
Incentive Plan 10-K on March 10, 2004
10.10 First Amendment to Citizens Incorporated by reference to Exhibit
& Northern Corporation Stock 10.6 filed with the Corporation's Form
Incentive Plan 10-K on March 10, 2004
10.11 Citizens & Northern Incorporated by reference to Exhibit
Corporation Stock Incentive Plan 10.7 filed with the Corporation's Form
10-K on March 10, 2004
10.12 Citizens & Northern Incorporated by reference to Exhibit A
Corporation Independent Directors to the Corporation's proxy statement
Stock Incentive Plan dated March 19, 2001 for the annual
meeting of stockholders held on April
17, 2001.
10.13 Amendment #1 to Citizens & Incorporated by reference to Exhibit
Northern Bank Supplemental 10.2(b) filed with the Corporation's
Executive Retirement Plan Form 10-K on March 19, 2001
10.14 Amendment #2 to Citizens & Incorporated by reference to Exhibit
Northern Bank Supplemental 10.2(a) filed with the Corporation's
Executive Retirement Plan Form 10-K on March 19, 2001
10.15 Citizens & Northern Bank Incorporated by reference to Exhibit
Supplemental Executive Retirement 10.2 filed with the Corporation's Form
Plan 10-K on March 19, 2001
69
11. Statement re: computation of per Information concerning the computation
share earnings of earnings per share is provided in
Note 3 to the Consolidated Financial
Statements, which is included in Part
II, Item 8 of Form 10-K.
12. Statements re: computation of Not applicable
ratios
13. Annual report to security Not applicable
holders, Form 10-Q or quarterly
report to security holders
14. Code of ethics The Code of Ethics is available through
the Corporation's website at
www.cnbankpa.com. To access the Code of
Ethics, click on "Shareholder News &
Info.," followed by "Corporate
Governance" and "Code of Ethics."
16. Letter re: change in certifying Not applicable
accountant
18. Letter re: change in accounting Not applicable
principles
21. Subsidiaries of the registrant Filed herewith
22. Published report regarding Not applicable
matters submitted to vote of security
holders
23. Consents of experts and counsel Not applicable
24. Power of attorney Not applicable
31. Rule 13a-14(a)/15d-14(a)
certifications:
31.1 Certification of Chief Filed herewith
Executive Officer
31.2 Certification of Chief Filed herewith
Financial Officer
32. Section 1350 certifications Filed herewith
33. Report on assessment of Not applicable
compliance with servicing criteria
for asset-backed securities
34. Attestation report on assessment Not applicable
of compliance with servicing criteria
for asset-backed securities
99. Additional exhibits:
99.1 Additional information mailed Filed herewith
to stockholders with proxy
statement and Form 10-K on March
21, 2006
(b) Exhibits - The required exhibits are listed under Part IV, Item 15(a)(3) of
Form 10-K.
(c) Financial statement schedules are omitted because the required information
is not applicable or is included elsewhere in Form 10-K.
70
SIGNATURES
PURSUANT to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, Citizens & Northern Corporation has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized:
By: Craig G. Litchfield /s/
---------------------------------
Craig G. Litchfield
Chairman, President
and Chief Executive Officer
Date: March 3, 2006
By: Mark A. Hughes /s/
---------------------------------
Treasurer and
Principal Accounting Officer
Date: March 3, 2006
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
BOARD OF DIRECTORS
/s/ Dennis F. Beardslee /s/ Edward L. Learn
- ------------------------------------- ----------------------------------------
Dennis F. Beardslee Edward L. Learn
Date: March 3, 2006 Date: March 3, 2006
/s/ R. Robert DeCamp /s/ Craig G. Litchfield
- ------------------------------------- ----------------------------------------
R. Robert DeCamp Craig G. Litchfield
Date: March 3, 2006 Date: March 3, 2006
/s/ Jan E. Fisher /s/ Edward H. Owlett, III
- ------------------------------------- ----------------------------------------
Jan E. Fisher Edward H. Owlett, III
Date: March 3, 2006 Date: March 3, 2006
/s/ R. Bruce Haner /s/ Leonard Simpson
- ------------------------------------- ----------------------------------------
R. Bruce Haner Leonard Simpson
Date: March 3, 2006 Date: March 3, 2006
/s/ Susan E. Hartley /s/ James E. Towner
- ------------------------------------- ----------------------------------------
Susan E. Hartley James E. Towner
Date: March 3, 2006 Date: March 3, 2006
/s/ Karl W. Kroeck /s/ Ann M. Tyler
- ------------------------------------- ----------------------------------------
Karl W. Kroeck Ann M. Tyler
Date: March 3, 2006 Date: March 3, 2006
/s/ Leo F. Lambert
- -------------------------------------
Leo F. Lambert
Date: March 3, 2006
71