Citizens & Northern Corporation — Q1 2018 Form 10-Q
Business context and period. Citizens & Northern Corporation is a bank holding company operating primarily through Citizens & Northern Bank. This unaudited filing covers the three months ended March 31, 2018; balance-sheet comparisons are with December 31, 2017. Unless stated otherwise, amounts below are in U.S. dollars.
Key financial results
| Metric | Q1 2018 | Comparable period / change |
|---|---|---|
| Net interest income | $10.90 million | Up 7.3% from Q1 2017; fully taxable-equivalent NII was $11.23 million, up 3.6% |
| Net interest margin | 3.84% | 3.78% in Q1 2017, fully taxable-equivalent basis |
| Provision for loan losses | $0.29 million | Down from $0.45 million |
| Noninterest income | $4.41 million | Up 14.0% excluding securities gains; no securities gains in Q1 2018 versus $0.15 million in Q1 2017 |
| Noninterest expense | $9.90 million | Up 6.4% |
| Income before tax / tax provision | $5.12 million / $0.74 million | Pre-tax income up 15.8%; effective tax rate 14.5% versus 22.3% |
| Net income / diluted EPS | $4.38 million / $0.36 | Net income up 27.4%; EPS was $0.28 in Q1 2017 |
| Annualized returns | ROAA 1.39%; ROAE 9.41% | As reported for Q1 2018 |
| Operating cash flow | $6.33 million | $4.18 million in Q1 2017 |
Financial position, liquidity and credit
- At March 31, 2018, total assets were $1.258 billion, down from $1.277 billion at year-end 2017. Gross loans were $817.35 million, up 0.2% since year-end and 7.3% year over year; deposits were $1.018 billion, up $9.63 million since year-end.
- Cash and cash equivalents ended the quarter at $34.34 million, compared with $37.00 million at year-end. Investing activities provided $10.59 million; financing activities used $19.58 million, including a $35.28 million reduction in short-term borrowings and $2.93 million of dividends paid.
- Total borrowings were $44.60 million, down from $70.96 million at year-end: short-term borrowings fell to $26.48 million, while long-term borrowings rose to $18.12 million. The company reported $379.36 million of available credit facilities and $188.29 million of unpledged available-for-sale securities beyond amounts required for pledging or repurchase arrangements. Management said it was well-positioned to meet obligations.
- Stockholders’ equity was $186.38 million. The available-for-sale debt portfolio had a fair value of $341.13 million and gross unrealized losses of $9.05 million; accumulated other comprehensive loss was $5.54 million, worsening from $1.51 million at year-end. Comprehensive income was $0.62 million versus $3.86 million in Q1 2017, principally reflecting the securities valuation decline.
- The allowance for loan losses was $9.05 million, or 1.11% of loans, versus $8.86 million at year-end. Nonperforming loans were $16.38 million (2.00% of loans); nonperforming assets were $17.48 million (1.39% of assets). Impaired loans increased to $10.21 million, while nonperforming assets declined from $18.73 million at year-end.
- Regulatory capital remained well above stated minimums: consolidated total capital to risk-weighted assets was 23.49% and the bank’s was 20.85%; consolidated and bank common equity tier 1 ratios were 22.33% and 19.69%, respectively. Management said capital should remain above well-capitalized standards over the next 12 months and foreseeable future.
Material changes and management commentary
- Management attributed stronger earnings to loan growth, improved earning-asset yield and lower taxes. Average loans rose 7.6% year over year, while average available-for-sale securities declined 9.0%. The average yield on earning assets increased to 4.18% from 4.11%; deposit costs increased, partly offset by lower average cost of borrowed funds.
- Noninterest income growth included trust and financial management revenue up 20.5%, service charges on deposit accounts up 9.4%, and debit-card interchange revenue up 11.3%. Trust assets under management were approximately $916.3 million.
- Expense increases reflected compensation and staffing, higher health-care claims, and implementation costs for a new loan origination system and telephone system. Management estimated 2018 stock-based compensation of $0.71 million, potentially increasing by about $0.19 million if specified executive ROAE targets are met.
- The lower federal corporate tax rate, effective January 1, 2018, benefited Q1 earnings. Management also noted Q4 2017 included an additional deferred-tax charge that reduced diluted EPS by $0.18. These tax effects make comparisons with Q4 2017 less representative of ongoing results.
- No formal earnings guidance was provided. Management cautioned that quarterly operating results may not indicate full-year results. It expects gradual federal-funds-rate increases as economic conditions improve; the filing’s interest-rate model showed projected NII declines of 1.4% under an immediate 100-basis-point increase and 4.6% under a 100-basis-point decrease, both within policy limits.
Risks, contingencies and unusual items
- Credit exposure is concentrated in the company’s Pennsylvania and New York market area, making borrowers’ repayment ability sensitive to regional economic conditions. Participation loans totaled $62.79 million, including $52.60 million to businesses outside the market area; leveraged participation loans totaled $13.98 million.
- Management identified the allowance for loan losses and securities fair values as material estimates subject to judgment and possible revision. It considered securities’ unrealized losses temporary and recorded no net impairment loss in earnings. The filing notes that $279.77 million of securities were in an unrealized loss position at March 31, 2018.
- Mortgage loan sale programs involve representations and warranties that may require repurchases or reimbursements. Repurchased loans outstanding were $1.79 million; the MPF Original program’s maximum credit enhancement obligation was $3.43 million, with a $0.29 million related allowance.
- Management stated pending and threatened legal proceedings were not expected to materially affect financial condition or results. It reported no significant concerns about off-balance-sheet loan commitments or standby letters of credit. No material changes to previously disclosed risk factors were reported.
- Adopted accounting updates included revenue recognition, equity-security measurement and presentation, and callable debt-security premium amortization; management reported no material revenue-recognition impact. The expected-credit-loss standard is scheduled to become effective in Q1 2020, and the company was assessing its effects.
Important facts for investors to verify
- Whether loan growth and higher net interest margin persist as deposit costs rise and interest rates change.
- Credit performance in regional and out-of-market participation lending, particularly leveraged loans, and the adequacy of the allowance as impaired loans increased.
- Whether securities-related unrealized losses remain temporary and how further rate movements affect equity, liquidity and reported comprehensive income.
- The sustainability of Q1 earnings after separating the benefit of tax-rate changes from recurring operating performance, and whether expenses tied to system projects continue.
- Future funding needs, borrowings and capital distributions, including the company’s stated capital outlook and available liquidity facilities.