Citizens & Northern Corporation — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Financial statements are unaudited, except the December 31, 2015 balance sheet. Amounts below are in millions of dollars unless stated otherwise.
Business context and financial performance
The Corporation is a Pennsylvania-based bank holding company operating through Citizens & Northern Bank, with lending concentrated in Pennsylvania and New York. Its primary operating income source is net interest income.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Interest and dividend income | $11.131 | $11.134 | $32.992 | $33.483 |
| Net interest income (GAAP) | $10.187 | $10.008 | $30.219 | $29.968 |
| Net interest margin (fully taxable-equivalent) | 3.74% | 3.66% | 3.77% | 3.69% |
| Provision for loan losses | $0.538 | $0.302 | $1.224 | $0.526 |
| Total other income, including securities gains | $4.468 | $4.040 | $12.569 | $12.564 |
| Other expenses | $8.579 | $8.117 | $26.186 | $25.524 |
| Net income | $4.087 | $4.234 | $11.531 | $12.406 |
| Diluted earnings per share | $0.34 | $0.35 | $0.95 | $1.01 |
For the first nine months, return on average assets was 1.25% and return on average equity was 8.16%. The effective tax rate was 26.20% for Q3 and 25.02% year to date.
Balance sheet, cash flow, debt and liquidity
- Assets and loans: Total assets were $1,245.3 at September 30, up from $1,223.4 at year-end 2015. Gross loans were $742.3, up 5.3% since year-end; net loans were $733.9. Available-for-sale securities were $409.8, down from $420.3.
- Deposits and borrowings: Deposits totaled $991.9, up $56.3 since year-end. Short-term borrowings fell to $14.6 from $53.5, while long-term borrowings were $38.5, nearly unchanged. Total borrowings were $53.1, versus $92.3 at year-end.
- Capital: Stockholders’ equity was $190.6, versus $187.5 at year-end. At September 30, consolidated total capital/risk-weighted assets was 23.56%, common equity tier 1 was 22.43%, and tier 1 capital/average assets was 14.17%. Management reported that the Corporation and Bank met capital requirements and expected to remain above regulatory well-capitalized standards.
- Cash flow, nine months: Operating cash flow was $13.8; investing cash flow was negative $22.4; financing cash flow was $5.3. Cash and cash equivalents ended at $30.1, down $3.2 from year-end. Financing included $56.3 of net deposit growth, $38.9 of net short-term borrowing repayments, and $8.3 of dividends paid.
- Available liquidity: The Corporation reported $377.5 of available credit facilities, including $315.7 available from the FHLB, and $193.5 of securities in excess of amounts required for pledging or repurchase obligations. Management said it was well positioned to meet short- and long-term obligations.
Material changes and credit quality
- Net income declined 3.5% in Q3 and 7.1% for the first nine months compared with 2015. Year-to-date net interest income rose modestly, but the higher loan-loss provision and higher operating expenses weighed on earnings.
- Loan growth and a lower cost of borrowings supported net interest margin. Average loans increased 10.7% year over year for the first nine months, while average available-for-sale securities fell 17.7%. Lower securities balances and yields reduced interest income.
- Year-to-date noninterest income was essentially flat. Securities gains were $1.089, including $0.837 from bank-stock sales; Q3 securities gains were $0.584. Management reported selling the remaining bank-stock investment in October 2016 for a pretax gain of $0.288.
- Year-to-date expenses rose 2.6% as reported, or 6.4% excluding the $0.910 debt-prepayment loss recorded in 2015. Higher salaries, professional fees, training, software and other operating expenses were partly offset by lower occupancy costs.
- Credit deterioration: Nonperforming loans were $20.0, or 2.70% of loans, versus $14.7 and 2.09% at year-end. Nonperforming assets were $22.3, or 1.79% of assets, versus $16.0 and 1.31%. Nonaccrual loans were $12.5; loans 90 days or more past due and still accruing were $7.5; foreclosed assets rose to $2.3.
- The allowance for loan losses was $8.421, or 1.13% of loans, compared with $7.889, or 1.12%, at year-end. Year-to-date net charge-offs were $0.692 versus $0.446 in 2015. The allowance covered 42.06% of nonperforming loans, down from 53.50% at year-end.
- Impaired loans totaled $11.1. The Q3 provision included a $0.528 specific allowance on a real-estate-secured commercial relationship; related loans totaled $3.347, with a $2.695 loan classified as impaired with a valuation allowance. Management noted that a limited number of commercial relationships can materially affect provisions and charge-offs.
Outlook, risks and contingencies
- The filing gives no specific earnings or revenue guidance. Management cautioned that interim results may not indicate full-year results, and said it expected regulatory capital levels to remain adequate for the next 12 months and foreseeable future.
- Management’s interest-rate simulation, based on July 31, 2016 data, projected one-year net interest income declines of 4.1% under an immediate 100-basis-point increase and 19.3% under a 400-basis-point increase; a 100-basis-point decrease projected a 5.5% decline. The scenarios were within internal policy limits, but management cautioned that actual results could differ materially from model estimates.
- Key stated risks include interest-rate and general economic changes, local demand and competition, regulatory or accounting changes, technology costs, and credit risk. Lending is geographically concentrated; participation loans totaled $48.7, including $14.7 of leveraged participations. The filing describes these leveraged borrowers as having limited tangible equity and collateral, despite strong recent cash flow performance.
- A $27.0 long-term repurchase-agreement borrowing, at 3.595%, has an effective maturity in December 2017 and is putable quarterly by the issuer. The filing discusses possible refinancing, repayment and collateral-replacement risks. The Corporation reported $315.7 in unused FHLB borrowing capacity.
- Management said debt securities with unrealized losses were not other-than-temporarily impaired at September 30. The securities portfolio’s net unrealized gain contributed to accumulated other comprehensive income of $5.4. Fair values and the loan-loss allowance depend on estimates and assumptions that may change.
- Ordinary-course litigation was not expected by management to materially affect financial condition or results. There were no material changes to previously disclosed risk factors. The Corporation had no unrecognized tax benefits.
Important facts for investors to verify
- Whether the rise in nonperforming loans and foreclosed assets, especially the identified commercial relationships, leads to further provision expense or charge-offs.
- Whether loan growth and deposit funding can sustain net interest income as rates, securities balances and funding costs change.
- The quality, underwriting and geographic exposure of participation and leveraged loans, and the performance of mortgage loans sold with credit-enhancement obligations.
- The sustainability of earnings excluding securities-sale gains, and the effect of ongoing compensation, technology and professional-fee increases.
- The quarterly put and collateral terms of the $27.0 repurchase agreement, and the sensitivity of securities values, liquidity and capital to interest-rate changes.