Citizens Financial Services, Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; unaudited. Citizens is a Pennsylvania bank holding company whose operations are conducted principally through First Citizens Community Bank. The December 2015 acquisition of The First National Bank of Fredericksburg (FNB) affects comparability with Q1 2015. Amounts below are in U.S. dollars; financial statement amounts are in millions unless noted.
Financial performance
| Metric | Q1 2016 | Q1 2015 | Change / context |
|---|---|---|---|
| Net interest income | $9.205 | $7.587 | Up 21.3%; growth primarily reflected FNB and prior-year loan growth. |
| Provision for loan losses | $0.135 | $0.120 | Higher amid increased past-due and special-mention loans. |
| Noninterest income | $1.916 | $1.728 | Up 10.9%; service charges and brokerage/insurance income increased, while securities gains declined. |
| Noninterest expense | $6.912 | $5.335 | Up 29.6%, mainly due to FNB, higher personnel costs and other expenses. |
| Net income | $3.283 | $3.120 | Up 5.2%. |
| Basic and diluted EPS | $0.99 | $1.03 | Down 3.9%; weighted-average shares rose to 3.324 million from 3.026 million. |
| Net interest margin, tax-equivalent | 3.64% | 3.89% | Down 25 basis points; acquired assets and new securities carried lower yields. |
| Annualized return on assets / equity | 1.11% / 10.81% | 1.36% / 12.38% | Both declined. |
| Cash dividends per share | $0.415 | $0.405 | Cash dividends paid were $1.377 million. |
Financial position, cash flow and capital
- Assets: $1,192.6 million at March 31, up 2.5% from year-end 2015. Net loans were $692.4 million, up $4.5 million; available-for-sale securities were $371.9 million, up $12.2 million.
- Deposits and borrowings: Deposits rose $29.8 million to $1,017.8 million, including a $39.3 million increase in local municipal deposits following resolution of Pennsylvania’s budget impasse. Borrowed funds fell $1.6 million to $40.0 million.
- Liquidity: Cash and cash equivalents were $37.4 million, compared with $24.4 million at year-end. Management cited core deposits, loan and securities cash flows, FHLB access and other available lines as funding sources. FHLB borrowing capacity was about $298.8 million, with $16.5 million outstanding; a $10 million federal funds line and an approximately $8.1 million Federal Reserve line were undrawn.
- Cash flows: Operating activities provided $2.4 million (versus $3.1 million); investing activities used $15.3 million (versus providing $4.0 million); financing activities provided $25.9 million (versus $0.2 million). Deposits funded much of the financing inflow, while securities purchases drove investing outflows. Cash increased $13.0 million to $37.4 million.
- Credit quality: Allowance for loan losses was $7.275 million, or 1.04% of loans, versus $7.106 million, or 1.02%, at year-end. Nonperforming loans increased to $7.603 million from $7.154 million; nonperforming assets were $8.773 million. Net recoveries were $34,000 in Q1.
- Capital and equity: Stockholders’ equity was $122.0 million, up 1.9% from year-end. The company reported a 16.58% total risk-based capital ratio, 14.44% common equity Tier 1 ratio and 9.42% Tier 1 leverage ratio; management said the company and bank were well capitalized.
Material changes and management commentary
- FNB’s acquisition, completed December 11, 2015, added seven branches and contributed to higher average earning assets, deposits, fee income and operating expenses. Q1 2016 included the acquired operations; Q1 2015 did not.
- Loan growth was modest overall. State and political subdivision loans rose $10.6 million, while construction loans fell $6.3 million. Management described commercial and agricultural loan demand as soft in the quarter.
- Tax-equivalent net interest income rose, but the margin narrowed as asset yields declined. Management’s rate-shock model projected one-year net interest income declines of 1.40% under a +100-basis-point shock and 5.86% under +400 basis points; it cautioned that actual results could differ.
- Management reported increased allowance qualitative factors for delinquencies and classified loans in residential, consumer and commercial real estate, and for agricultural industry conditions, citing lower product prices and higher feed costs.
- Noninterest expenses included a $100,000 Pennsylvania EITC contribution delayed from Q4 2015 due to the state budget impasse, acquisition-related costs, and increased charges associated with customer accounts compromised by fraud. No Q1 2016 TDR modifications were reported.
- Management expected to contribute $500,000 to pension plans in 2016 and received approval to open an office in Winfield, Pennsylvania, aimed primarily at agricultural customers. No earnings or revenue guidance was provided; management cautioned that quarterly results are not necessarily indicative of full-year results.
Risks, contingencies and unusual items
- Credit exposure is concentrated in the company’s regional markets, including agriculture and businesses connected to natural-gas activity. Management noted low natural-gas prices and sensitivity of agricultural borrowers to product prices and input costs.
- Three customer relationships represented approximately 54.9% of nonperforming loans. One large commercial relationship was subject to bankruptcy proceedings and litigation over reduced payments; another borrower serving the natural-gas industry had a $128,000 specific reserve.
- Nonperforming loans rose partly because a residential mortgage relationship was placed on nonaccrual. Management said the allowance was adequate but warned that economic deterioration, collateral-value declines, or regulatory examination could require additional provisions.
- Interest-rate, liquidity, credit, regulatory, competition, cybersecurity/fraud, acquisition-integration and regional economic risks were identified. Management said risk factors had not materially changed from the 2015 Form 10-K. It reported no litigation expected to have a material adverse effect and no material control changes during the quarter.
Important facts for investors to verify
- How much of the year-over-year earnings and balance-sheet growth is attributable to FNB, and whether integration benefits can offset the higher expense base.
- Whether the narrower net interest margin and modeled sensitivity to rate changes persist as assets and deposits reprice.
- Trends in past-due, nonperforming and classified loans, especially the concentrated commercial relationships and agricultural and natural-gas-related exposures.
- The stability and mix of municipal deposits, and the company’s liquidity and borrowing needs as those balances change.
- Whether elevated noninterest expenses, including fraud-related charges and acquisition-related costs, continue; and progress on the planned Winfield office and pension contributions.