Citizens Financial Services, Inc. — Q3 2022 Form 10-Q
Reporting period: Three and nine months ended September 30, 2022. The company is a Pennsylvania-based banking holding company operating through First Citizens Community Bank and related subsidiaries. Unless otherwise stated, amounts below are in millions of dollars.
Financial performance and condition
- Third-quarter results: Net interest income was $18.8 million, up 13.6% year over year; provision for loan losses was $0.7 million, compared with $0.4 million. Net income increased 6.8% to $7.5 million; diluted EPS was $1.90 versus $1.77.
- Nine-month results: Net interest income rose 7.3% to $52.8 million, while net income declined 4.5% to $21.2 million and diluted EPS fell to $5.34 from $5.56. Return on assets was 1.27% and return on equity 12.77%, versus 1.49% and 14.66% in the prior-year period.
- Revenue, expenses and margin: Third-quarter noninterest income was $2.7 million, down 5.6%; noninterest expense was $11.6 million, up 11.7%. For nine months, noninterest income fell 24.2% to $7.4 million and expenses rose 7.8% to $33.0 million. Tax-equivalent net interest margin was 3.44% for the quarter (3.47% prior year) and 3.39% for nine months (3.55% prior year).
- Balance sheet: Assets were $2.35 billion, up $205.8 million from year-end 2021. Net loans rose $295.4 million to $1.72 billion; deposits increased $32.6 million to $1.87 billion. Cash and cash equivalents fell $149.7 million to $23.1 million. Borrowed funds increased $184.9 million to $258.9 million.
- Cash flow: Nine-month operating cash flow was $24.3 million, versus $32.4 million in 2021. Investing activities used $384.7 million, primarily reflecting $295.1 million of net loan growth; financing activities provided $210.6 million. Ending cash was $23.1 million.
- Credit quality: The allowance for loan losses was $18.3 million, or 1.05% of loans, versus $17.3 million, or 1.20%, at year-end 2021. Nonperforming loans were $7.2 million, down $0.5 million; total nonperforming assets were $8.1 million. Three borrower relationships represented 61.2% of nonperforming loans.
- Capital and securities: Stockholders’ equity was $191.4 million, down $21.1 million from year-end, primarily due to a $35.7 million increase in accumulated other comprehensive loss, largely associated with falling available-for-sale securities values as rates rose. The Bank’s 8.67% leverage ratio was below the 9% Community Bank Leverage Ratio threshold; the Bank reported risk-based capital ratios above prompt-corrective-action well-capitalized thresholds.
Material changes and unusual items
- Loan growth was concentrated in commercial real estate, construction and consumer loans, with expansion particularly in Delaware. Consumer loans increased $98.5 million from year-end, primarily due to student lending. Commercial real estate loans increased $170.0 million.
- Higher loan balances and investment balances supported interest income, while rising rates increased borrowing costs. Average borrowed funds and their cost rose; third-quarter interest expense increased 67.6% year over year.
- Nine-month noninterest income was affected by lower gains on loan sales, market losses on equity securities, lower bank-owned life insurance earnings, and the absence of the prior-year $1.2 million death benefit. Service charges increased.
- The $50.2 million gross unrealized loss on available-for-sale securities was attributed by management to market and rate changes; management stated the securities were not other-than-temporarily impaired. The accumulated loss is reported in equity rather than current-period net income.
- During the first nine months, net charge-offs were $0.4 million, primarily related to one customer bankruptcy. The company recorded three troubled-debt restructurings in Q3 with post-modification balances totaling $1.1 million.
Outlook, transactions and risks
- The filing provides no formal earnings or revenue guidance. Management cautions that interim results are not necessarily indicative of full-year performance.
- On October 18, 2022, after quarter-end, the company agreed to acquire HV Bancorp. Consideration is cash of $30.50 per share or 0.40 Citizens shares per HV Bancorp share, with cash limited to no more than 20% of HV Bancorp shares. Closing was expected in the first half of 2023, subject to regulatory and shareholder approvals. A $2.8 million termination fee may apply in specified circumstances.
- Management said available liquidity sources include core deposits, FHLB funding, correspondent-bank lines, and maturing investments and loans. At quarter-end, FHLB borrowing capacity was approximately $833.8 million, with $269.0 million outstanding; $34.0 million of federal funds lines were undrawn.
- Key disclosed risks include interest-rate and funding-cost changes, economic deterioration and borrower repayment capacity, regional agricultural and dairy conditions, natural-gas-related activity, loan concentrations, fraud and cyber risks, competition, regulatory changes, and execution of strategic initiatives and acquisitions.
- The company expects to adopt CECL (ASC 326) on January 1, 2023. It had not estimated the adoption effect and warned it could affect the allowance, equity and regulatory capital. Management reported effective disclosure controls and no material change in internal control during the quarter. No material litigation was reported.
Most important facts for investors to verify
- How loan growth, deposit pricing and increased short-term borrowing affect net interest margin, liquidity and funding costs.
- The Bank’s capital position following its move out of the CBLR framework, including capital implications of CECL adoption and the proposed HV Bancorp acquisition.
- Whether unrealized securities losses remain primarily rate-related and how they may affect capital, liquidity or securities-sale decisions.
- Credit trends in commercial real estate, agriculture and student loans, including the status and collateral coverage of the three large nonperforming relationships.
- HV Bancorp transaction approvals, final consideration mix, timing, integration costs and any potential termination provisions.