Citizens & Northern Corporation — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. This annual filing includes quarterly results; the principal comparisons below are full-year 2019 versus 2018.
Business context
Citizens & Northern is a Pennsylvania community banking holding company operating primarily through Citizens & Northern Bank. Its services include commercial, residential and consumer lending, deposits, trust and financial management, brokerage and insurance. In 2019, the company expanded into southeastern Pennsylvania by acquiring Monument Bancorp on April 1 and into southcentral Pennsylvania by opening a York lending office.
Financial performance and condition
| Metric | 2019 | 2018 |
|---|---|---|
| Interest and dividend income | $64.8 million | $50.3 million |
| Net interest income | $54.5 million | $45.7 million |
| Provision for loan losses | $0.8 million | $0.6 million |
| Noninterest income | $19.3 million | $20.6 million |
| Noninterest expense | $49.5 million | $39.5 million |
| Income before taxes | $23.4 million | $26.3 million |
| Net income | $19.5 million | $22.0 million |
| Diluted earnings per share | $1.46 | $1.79 |
- Net interest margin was 3.86%, down from 3.90%; the interest rate spread declined to 3.56% from 3.72%. Average earning assets grew 19.3% to $1.438 billion, led by acquired and originated loans.
- Return on average assets was 1.27% versus 1.72%; return on average equity was 8.50% versus 11.72%. The efficiency ratio increased to 60.73% from 59.69%.
- At year-end, total assets were $1.654 billion, net loans $1.172 billion, deposits $1.253 billion, borrowings and subordinated debt $144.8 million, and stockholders’ equity $244.5 million. The allowance for loan losses was $9.8 million, or 0.83% of loans, versus 1.12% a year earlier.
- Credit measures improved: nonperforming loans were 0.88% of loans (1.94% in 2018), and nonperforming assets were 0.80% of assets (1.37%). Net charge-offs were 0.03% of average loans, compared with 0.02%.
- Operating cash flow was $22.5 million, versus $25.9 million. Investing activities provided $22.7 million, compared with using $21.6 million; financing activities used $46.8 million, compared with $8.4 million. Cash and cash equivalents ended the year at $31.1 million, down from $32.8 million.
- Year-end capital remained above regulatory thresholds: the bank’s total risk-based capital ratio was 18.75%, Tier 1 risk-based ratio 17.83%, and Tier 1 leverage ratio 12.24%. Its capital conservation buffer was 10.75%.
- For the fourth quarter, net income was $5.5 million and diluted EPS was $0.40, compared with $5.7 million and $0.46 in fourth-quarter 2018. Net interest income was $14.3 million versus $12.0 million.
Material changes versus 2018
- Monument added $259.3 million of loans, $223.3 million of deposits, and $111.6 million of short-term borrowings at acquisition. The $42.7 million purchase consideration included $33.0 million in stock and approximately $9.7 million in cash; Monument shareholders held about 9.4% of the company’s shares immediately after closing.
- Gross loans increased 42.9% to $1.182 billion, with commercial loans up 63.7% and residential mortgage loans up 28.4%. Total assets rose to $1.654 billion from $1.291 billion.
- Net interest income increased 19.2% on a fully taxable-equivalent basis, primarily from loan growth and Monument. Interest expense more than doubled to $10.3 million as deposit and borrowing costs rose.
- Noninterest expense rose 25.5%, including $4.1 million of merger-related costs versus $0.3 million. Excluding merger costs, expenses increased 16.0%, reflecting expansion, staffing and data-processing costs.
- Net income declined 11.4%. Management reported adjusted, non-GAAP earnings of $22.8 million, or $1.70 per diluted share, excluding merger costs and securities gains or losses; comparable 2018 adjusted earnings were $20.7 million, or $1.68 per share. These measures are not GAAP results.
- Noninterest income excluding securities gains and losses rose 3.7%. The 2018 comparison included a $2.3 million gain on Visa Class B stock; securities gains were $23,000 in 2019 versus a $288,000 net loss in 2018.
Outlook, commentary, risks and unusual items
- The company agreed in December 2019 to acquire Covenant Financial for an approximately $77 million transaction value, with 25% of Covenant shares to be purchased for cash and 75% converted to Citizens & Northern shares. Covenant reported $516 million in assets at year-end. Closing was expected in the third quarter of 2020, subject to shareholder and regulatory approvals. Management estimated about $8 million of pretax merger costs, most expected in third-quarter 2020.
- Management said liquidity was strong. At year-end, total credit facilities were $611.8 million, of which $475.4 million was available; this included $416.1 million available from the Federal Home Loan Bank of Pittsburgh. Management also identified securities available for sale as a potential liquidity source.
- Key exposures include borrower and collateral risk, concentrated regional economies, interest-rate sensitivity from long-duration assets funded partly by shorter-term deposits, competitive pressure, technology and cybersecurity, regulation, and execution and integration risks from acquisitions. The company noted that local economic deterioration could affect loan quality and demand.
- Special-mention loans increased to $19.7 million from $7.4 million. Foreclosed assets rose to $2.9 million from $1.7 million, including $0.9 million acquired with Monument. Management identified a $1.3 million commercial construction loan with a $0.7 million specific allowance and described costs related to a commercial workout.
- Residential mortgages sold and serviced through the MPF programs totaled $178.4 million. The company had repurchased $1.8 million of loans for identified noncompliance; its maximum MPF Original credit-enhancement obligation was $4.6 million, with a $0.3 million related allowance.
- The auditor gave an unqualified opinion on the financial statements and concluded internal control over financial reporting was effective. The audit and management assessment excluded Monument’s controls, representing approximately 19.8% of consolidated assets and 14.3% of interest and noninterest income; integration of Monument controls was still ongoing at year-end.
- Management stated pending and threatened legal proceedings were not expected to materially affect financial position or results. The filing provides no specific earnings or revenue guidance for 2020.
Important facts for investors to verify
- Track Covenant’s approval, expected closing, financing mix, integration costs and realized synergies.
- Assess whether loan growth and acquisition contributions can sustain net interest income as funding costs and the margin evolve.
- Review credit quality beneath headline ratios, especially special-mention commercial exposures, workouts, foreclosed properties and the allowance’s coverage of acquired loans.
- Monitor liquidity and reliance on FHLB borrowings, including the availability and terms of contingent funding facilities.
- Evaluate the completion of Monument control integration and confirm future reporting includes the acquired operations’ controls.
- Consider dividend sustainability: 2019 declared dividends were $1.18 per share, and the filing notes payments remain subject to earnings, capital and regulatory restrictions.