Citizens Financial Services, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. The company is a Pennsylvania bank holding company operating First Citizens Community Bank and related insurance, trust, and investment services, primarily in north-central Pennsylvania and southern New York. Financial amounts below are in millions unless stated otherwise.
Key financial metrics
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Interest income | $8.81 | $9.31 | $26.48 | $27.25 |
| Net interest income | $7.57 | $7.75 | $22.74 | $22.41 |
| Provision for loan losses | $0.15 | $0.09 | $0.48 | $0.32 |
| Noninterest income | $1.92 | $1.85 | $5.47 | $5.51 |
| Noninterest expense | $5.07 | $4.97 | $15.16 | $14.68 |
| Net income | $3.37 | $3.51 | $9.91 | $10.08 |
| Diluted EPS | $1.11 | $1.15 | $3.26 | $3.29 |
- Tax-equivalent net interest margin was 3.84% for Q3 versus 3.93% a year earlier, and 3.85% for the first nine months versus 3.89%. Nine-month return on assets was 1.46% and return on equity 13.64% (1.52% and 15.13% in 2013).
- At September 30, assets were $913.0, net loans $536.9, available-for-sale securities $308.3, and stockholders’ equity $99.2. Total deposits were $768.0, up $19.7 from year-end; borrowed funds were $37.7, down $29.2.
- Cash and cash equivalents were $11.3, versus $10.1 at year-end. Nine-month cash from operations was $11.3, compared with $12.9 in 2013; investing activities provided $5.2 versus using $40.1; financing activities used $15.2 versus providing $14.6.
- Regulatory capital exceeded “well-capitalized” thresholds: company total risk-based capital ratio was 18.28% and Tier 1 leverage ratio 10.78%; bank ratios were 17.98% and 10.59%, respectively.
Material changes versus comparable periods
- Net income fell 4.1% in Q3 and 1.7% year to date. Q3 net interest income declined 2.2%; management noted that Q3 2013 included $305,000 of interest recognized on payoff of a nonaccrual loan.
- For the first nine months, net interest income increased 1.5%, but the provision for credit losses rose by $165,000. Lower asset yields were partly offset by reduced funding costs; the reported average yield on earning assets fell to 4.43% from 4.67%, while the average cost of interest-bearing liabilities fell to 0.71% from 0.93%.
- Loans grew 0.6% from year-end, led by state and political subdivision lending; commercial real estate and construction balances declined. Deposits rose 2.6%, while borrowings decreased materially.
- Net charge-offs were $762,000 for the first nine months, versus $91,000 for all of 2013, largely reflecting two commercial relationships. The allowance for loan losses declined to $6.82 million, or 1.25% of loans, from $7.10 million, or 1.31%.
- Other comprehensive income was $2.74 million for the first nine months, versus a $5.45 million loss in 2013, primarily reflecting changes in unrealized gains and losses on available-for-sale securities.
Outlook, commentary, risks, and unusual items
- No specific earnings or financial guidance is provided. Management describes commercial loan demand as soft, with competitive pricing pressure. It notes that low interest rates have reduced yields and that natural-gas exploration activity in the region has slowed amid low gas prices.
- Management stated that liquidity was adequate, supported by core deposits, cash, maturing loans and securities, and borrowing facilities. Disclosed available facilities included FHLB capacity of approximately $262.3 million, a $10 million unused federal funds line, and an approximately $9 million unused Federal Reserve line.
- Interest-rate modeling estimated prospective one-year net interest income would decline 3.61% under a +100 basis-point shock and 13.32% under +400 basis points. Management cautioned that actual results may differ because of model assumptions.
- Credit risk remains relevant: nonperforming loans were $7.51 million, or 1.38% of loans, and nonperforming assets were $9.08 million. Three customer relationships represented about 64.2% of nonperforming loans; one borrower was in Chapter 11 bankruptcy. Management considered the allowance adequate but warned that economic weakness, collateral declines, or regulatory review could require higher provisions.
- The company declared a $0.60-per-share special cash dividend in Q3; nine-month dividends declared were $1.77 per share, with a 54.4% payout ratio. The company also had a $1.0 million agreement for construction of a new branch in Lock Haven.
- Commitments to extend credit and standby letters of credit totaled $129.7 million. Management reported no material change in risk factors from the 2013 Form 10-K, no material adverse litigation known, and no material changes in internal control over financial reporting.
Important facts for investors to verify
- Track whether net interest margin and earnings stabilize as low-rate asset repricing and competitive loan pricing continue.
- Review subsequent charge-offs, nonperforming loans, collateral values, and reserve adequacy, particularly for the concentrated commercial relationships and the borrower in bankruptcy.
- Assess deposit composition and funding costs alongside the substantial reduction in borrowed funds; reconcile the $37.7 million balance-sheet borrowing figure with management’s separately disclosed $24.1 million of FHLB advances outstanding.
- Confirm the sustainability of dividends, including the one-time $0.60-per-share special dividend, and the capital and liquidity effects of future distributions and branch construction.
- Review interest-rate exposure, securities portfolio valuation and unrealized gains, and the assumptions underlying management’s rate-shock estimates.