Citizens Financial Services, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. The company is a Pennsylvania bank holding company; its subsidiary bank operates across Pennsylvania and southern New York. Comparisons are affected by the December 2015 acquisition of The First National Bank of Fredericksburg (FNB), which added seven branches and expanded the company’s markets.
Financial performance and position
| Metric | Q3 2016 | Nine months 2016 | Comparable 2015 |
|---|---|---|---|
| Net interest income | $9.712 million | $28.088 million | $7.645 million / $22.793 million |
| Provision for loan losses | $0.500 million | $0.770 million | $0.120 million / $0.360 million |
| Net income | $3.153 million | $9.467 million | $2.857 million / $9.166 million |
| Basic and diluted EPS | $0.94 | $2.83 | $0.94 / $3.00 |
| Non-interest income | $1.908 million | $5.807 million | $1.865 million / $5.548 million |
| Non-interest expense | $7.200 million | $21.413 million | $5.852 million / $16.615 million |
Year-to-date net interest income rose 23.2% and net income rose 3.3%; basic EPS fell 5.7%, with weighted-average shares increasing to 3.35 million from 3.05 million. Q3 net income increased 10.4%, while EPS was unchanged. Tax-equivalent net interest margin was 3.78% for Q3 (3.73% in Q3 2015) and 3.67% year to date (3.78% in 2015). Year-to-date annualized return on assets and equity were 1.06% and 10.28%, respectively, versus 1.31% and 11.93%.
At September 30, 2016, total assets were $1.198 billion, up 3.0% from year-end 2015. Net loans were $743.1 million, up $55.2 million; deposits were $1.009 billion, up $20.7 million; and borrowed funds were $51.9 million, up $10.2 million. Cash and cash equivalents were $16.4 million, down $8.0 million. Stockholders’ equity was $125.6 million. The allowance for loan losses was $8.2 million, or 1.09% of loans. The filing reports nine-month operating cash flow of $10.8 million, investing cash outflow of $44.1 million, financing cash inflow of $25.3 million, and an $8.0 million net decrease in cash.
Regulatory capital ratios remained above “well capitalized” thresholds: at the company, total risk-based capital was 15.72%, Tier 1 risk-based capital 14.62%, common equity Tier 1 13.64%, and Tier 1 leverage 9.55%. Management stated the company and bank met applicable capital requirements.
Material changes and notable items
- Loan growth, largely in commercial and agricultural lending and supported by FNB and expanded central and south-central Pennsylvania teams, drove higher interest income. Management said it expected further loan growth in Q4 2016.
- Year-to-date non-interest expense rose 28.9%, primarily reflecting FNB-related staffing and operating costs, additional lenders and support staff, and $0.3 million of customer fraud-related charges. Intangible amortization also began in 2016. No merger and acquisition expense was recorded in 2016, compared with $0.4 million in 2015.
- Credit indicators weakened: non-performing loans rose $3.4 million, or 47.8%, from year-end to $10.6 million; non-performing assets were $11.8 million. The increase was mainly associated with one $3.7 million commercial relationship placed on non-accrual. Management cited increased delinquencies and criticized loans as reasons for the higher loan-loss provision, but considered the allowance adequate.
- A $0.463 million recovery on a loan partially charged off in 2014 contributed to net loan recoveries of $0.318 million for the first nine months. Management also increased certain allowance assumptions, citing local unemployment, agricultural pressures and portfolio growth.
- The company reported $181.1 million of commitments to extend credit and $14.1 million of standby letters of credit. Available liquidity sources include deposits, securities and loan cash flows, and FHLB borrowing capacity of approximately $321.6 million; $29.3 million was outstanding at the FHLB at quarter-end.
- Management’s interest-rate simulation estimated prospective one-year net interest income would decline 1.64% under a +100-basis-point shock and 7.24% under +400 basis points. These are model estimates subject to assumptions, not forecasts.
Outlook, risks and other disclosures
No numerical earnings or margin guidance was provided. Management anticipated further loan growth in Q4 and said liquidity was sufficient to meet obligations and commitments. Key risks cited include changing interest rates, economic and borrower conditions, agricultural commodity and input-cost volatility, natural-gas activity and pricing in the region, competition, fraud and information theft, regulatory or legal changes, and acquisition integration. The company said it had no material change in its reported risk factors and no litigation known to management that would materially adversely affect its financial position. Disclosure controls were considered effective, with no material quarterly change in internal control over financial reporting.
Most important facts for investors to verify
- Whether the increase in non-performing loans—especially the three significant customer relationships described in the filing—leads to additional reserves, charge-offs or collateral losses.
- Whether loan growth and expected Q4 agricultural and commercial demand continue, and how growth affects funding costs, margins and credit quality.
- How much of higher operating costs is ongoing after FNB integration, including staffing, fraud-related costs and new intangible amortization.
- Whether liquidity and capital remain adequate as loan growth uses cash and borrowed funds increase; review the full regulatory capital and funding disclosures.
- Whether the modeled exposure to higher interest rates, available-for-sale securities valuation changes, and regional agricultural and natural-gas conditions affect future earnings.