Citizens Financial Services, Inc. — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. The company is a Pennsylvania-based bank holding company whose principal business is community banking through First Citizens Community Bank. The June 16 acquisition of HV Bancorp expanded the company into southeastern Pennsylvania and Burlington County, New Jersey.
Financial performance and position
Amounts below are in millions of dollars unless otherwise stated. Comparisons are with the corresponding 2022 period or December 31, 2022, as applicable.
- Q2 earnings: Net loss was $4.144 million, or $1.01 per diluted share, versus net income of $6.901 million, or $1.72 per share, in Q2 2022. The loss included $8.402 million of merger and acquisition expense and $4.591 million of acquisition-date provision for acquired non-PCD loans.
- First-half earnings: Net income was $2.723 million, or $0.67 per diluted share, down from $13.641 million, or $3.40 per share. Management attributed the decline primarily to one-time HV Bancorp acquisition costs. Annualized first-half return on assets was 0.23% and return on equity was 2.22%.
- Net interest income and margin: Q2 net interest income was $17.921 million, up 1.0%; first-half net interest income was $36.001 million, up 5.9%. On a tax-equivalent basis, net interest margin declined to 3.17% for Q2 from 3.43%, and to 3.23% for the first half from 3.35%. Higher asset yields were offset by rising deposit and borrowing costs.
- Credit costs: Q2 and first-half provision for credit losses were each $4.853 million, including the $4.591 million acquisition-date provision. Excluding that acquisition provision, management said the first-half provision was lower than a year earlier. The June 30 allowance was $21.652 million for loans and $1.391 million for off-balance-sheet exposures.
- Noninterest income and expense: Q2 noninterest income was $2.280 million versus $2.304 million; first-half income was $4.454 million versus $4.735 million. Q2 noninterest expense rose to $20.680 million from $11.200 million; first-half expense rose to $32.458 million from $21.431 million, largely reflecting acquisition costs. Salaries, benefits and FDIC insurance expense also increased.
- Cash flow: First-half operating cash flow was $2.901 million, versus $15.072 million in 2022. Investing activities provided $128.692 million, including $86.504 million from AFS security sales and a reported net decrease in loans. Financing activities used $113.095 million. Cash and cash equivalents ended at $44.709 million, up from $26.211 million at year-end.
- Balance sheet: Total assets were $2.892 billion, up $558.4 million from year-end, primarily due to the acquisition. Net loans were $2.141 billion, deposits $2.266 billion, borrowed funds $318.2 million and stockholders’ equity $263.2 million. The company issued 693,858 shares and paid $16.5 million cash as acquisition consideration; goodwill increased to $84.758 million, including $53.382 million from the acquisition.
- Dividends: Cash dividends were $0.480 per share in Q2 and $0.961 per share for the first half. First-half dividends of $3.891 million exceeded reported net income.
Material changes and credit quality
- HV Bancorp added $475.3 million of loans, $533.4 million of deposits and $58.6 million of borrowings at acquisition-date fair values. Reported balances and year-over-year results therefore include acquisition effects; the acquired company’s results are included only from June 16 through quarter-end.
- Excluding acquired deposits, deposits declined $111.5 million from year-end, which management attributed to customer transfers to higher-yielding alternatives and seasonal municipal outflows. Excluding acquired loans, management reported a $40.1 million decline in loans, primarily due to student-loan paydowns.
- Nonperforming loans increased to $13.212 million from $6.945 million at year-end; nonperforming assets were $13.638 million. Nonaccrual loans were 0.60% of loans versus 0.40% at year-end. Six customer relationships represented 61.2% of nonperforming loans and required $1.020 million of specific reserves.
- Adoption of CECL on January 1, 2023 increased retained earnings by $1.766 million net of tax. The reported loan allowance was affected by a $3.3 million reduction from adoption, acquisition-related allowances and subsequent provisions; comparisons with prior periods are not fully comparable.
- AFS securities had $44.731 million of gross unrealized losses at June 30, 2023. The company reported a $30.980 million accumulated other comprehensive loss, including securities and other components. It sold approximately $86.6 million of securities during the first half, with a $51,000 net loss.
Outlook, risks and contingencies
- The filing provides no specific earnings or financial guidance. Management said first-half performance is not necessarily indicative of full-year results and described liquidity as adequate based on cash, core deposits, borrowing capacity and maturing assets.
- Management identified interest-rate changes, economic deterioration, loan delinquencies, deposit competition and funding costs, acquisition integration, fraud, regulatory changes, and regional agricultural and natural-gas-related exposures as risks. The filing also highlights market sensitivity to bank failures and depositor confidence.
- At June 30, 43.5% of deposits, or $986.4 million, exceeded the FDIC insurance limit; management noted that $577.6 million was covered through arrangements such as reciprocal deposits or collateralization. Brokered deposits were $42.2 million, including $36.2 million acquired and scheduled to mature before year-end.
- Available capacity included approximately $881.3 million of FHLB borrowing capacity, with $345.6 million outstanding; $34.0 million of undrawn federal funds lines; a $54.5 million undrawn Bank Term Funding Program line; and a $20.0 million company credit line, of which $7.5 million was used. The Bank’s CBLR leverage ratio was 9.70%, above the 9.0% well-capitalized threshold.
- Off-balance-sheet commitments to extend credit and standby letters of credit totaled $613.880 million. Management reported no material pending litigation and no material change to previously disclosed risk factors, while noting that regulatory examinations could require additional credit-loss reserves.
- Management’s June 30 interest-rate simulation estimated prospective one-year net interest income would decline 2.64% under a +100-basis-point shock and 10.79% under +400 basis points; actual outcomes may differ materially because the model relies on assumptions.
Important facts for investors to verify
- How much of the acquisition-related expenses and credit provision are nonrecurring, and what integration costs or savings remain?
- Whether deposit outflows continue, how acquired brokered deposits mature, and how uninsured or otherwise concentrated deposits behave.
- Credit performance of the acquired and legacy portfolios, including the six relationships comprising 61.2% of nonperforming loans and the adequacy of reserves.
- Effects of deposit repricing, borrowing costs and interest-rate changes on margins, liquidity and securities values.
- Final acquisition fair-value adjustments during the provisional period, and the assumptions supporting goodwill and acquired-loan valuations.
- Ability to sustain dividends and maintain capital ratios as integration proceeds and reported earnings recover.