Citizens Financial Services, Inc. — Q3 2011 Form 10-Q
Business context and reporting period
The filing covers the quarter and nine months ended September 30, 2011; financial statements are unaudited. Citizens Financial is a Pennsylvania bank holding company whose operations are primarily conducted through First Citizens National Bank. It serves north-central Pennsylvania and southern New York, with banking, lending, trust, brokerage, insurance, and oil-and-gas-related customer services.
Financial performance and position
Unless otherwise indicated, amounts are in millions of dollars.
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net interest income | $7.207 | $7.013 | $21.219 | $20.569 |
| Provision for loan losses | $0.150 | $0.300 | $0.525 | $0.840 |
| Non-interest income | $1.729 | $1.445 | $4.916 | $4.359 |
| Non-interest expense | $4.399 | $4.486 | $13.659 | $13.170 |
| Net income | $3.378 | $2.897 | $9.355 | $8.570 |
| Earnings per share | $1.16 | $0.99 | $3.21 | $2.93 |
- For the nine months, net income rose 9.2% and EPS rose 9.6%. Q3 net income increased $0.481 million year over year.
- Nine-month total interest income was $28.647 million, down from $29.267 million; lower interest expense ($7.428 million versus $8.698 million) supported net interest income growth. Nine-month non-interest income rose 12.8%, including $0.351 million of net securities gains versus $0.099 million a year earlier.
- Tax-equivalent net interest margin was 3.94% for the first nine months, down from 4.23%; Q3 margin was 3.90%, versus 4.17%. Falling asset yields were partly offset by lower funding costs and growth in earning assets.
- Nine-month annualized return on assets was 1.49% versus 1.51%; return on equity was 17.65% versus 18.31%. Q3 annualized ROA was 1.57% versus 1.49%, and ROE was 18.48% versus 17.98%.
| Balance-sheet item | September 30, 2011 | December 31, 2010 |
|---|---|---|
| Total assets | $859.2 | $812.5 |
| Net loans | $472.3 | $467.6 |
| Available-for-sale securities | $303.2 | $251.3 |
| Deposits | $719.5 | $680.7 |
| Borrowed funds | $52.8 | $56.0 |
| Stockholders’ equity | $78.9 | $68.7 |
| Cash and cash equivalents | $34.8 | $44.0 |
- Nine-month operating cash flow was $10.9 million, investing cash outflow $52.9 million, and financing cash inflow $32.8 million. Cash declined $9.2 million from year-end.
- Deposits increased 5.7%, led by NOW, savings, and money-market accounts; certificates of deposit declined $7.3 million. Management attributed deposit growth partly to local Marcellus Shale activity and customers’ preference for bank deposits amid volatile markets.
- The allowance for loan losses was $6.323 million, or 1.32% of loans, compared with $5.915 million, or 1.25%, at year-end. Nine-month net charge-offs were $0.117 million. Nonperforming loans were $9.687 million, down 22.8% from year-end; nonperforming assets were $10.635 million.
- Company total risk-based capital was 16.07% and Tier 1 risk-based capital 14.80%; the Bank’s respective ratios were 15.07% and 13.82%. The filing states both met the applicable “well capitalized” thresholds.
Material changes and notable items
- Investment securities increased $51.9 million, or 20.7%, since year-end. Management said the portfolio was funded by deposit growth and investment cash flows, with purchases concentrated in short-term agency securities and selected municipal bonds amid low rates.
- Total loans grew 1.1%. Commercial real estate loans rose $9.5 million and state and municipal loans rose $5.4 million; residential real estate loans fell $4.7 million. Management cited weak overall loan demand and continued competition.
- Nonperforming loans declined primarily because an agricultural borrower returned to accrual status. However, three customer relationships accounted for approximately 86.1% of nonperforming loans. A $5.6 million commercial relationship was restructured as a troubled debt restructuring; the loan remained current through October 2011. The filing also reports three TDRs that defaulted during the nine-month period, with recorded investment totaling $0.111 million.
- Flooding late in Q3 led management to increase collateral-value qualitative factors for residential and commercial real estate loans. Management reported no widespread decline in affected collateral values.
- Stockholders’ equity rose $10.2 million, including a $3.5 million increase in accumulated other comprehensive income, largely from unrealized gains on available-for-sale securities. The company repurchased 12,368 shares during Q3 at a reported average $35.19 per share.
Outlook, risks, and contingencies
- No earnings or revenue guidance is provided. Management said available cash, core deposits, maturing assets, FHLB financing, correspondent-bank federal funds lines, and other funding alternatives were expected to meet obligations and off-balance-sheet commitments.
- The Bank reported approximately $243.6 million of FHLB borrowing capacity, of which $35.0 million was outstanding; a $10.0 million federal funds line and a $14.3 million Federal Reserve borrower-in-custody line were unused. The balance sheet reports total borrowed funds of $52.8 million.
- Off-balance-sheet commitments included $88.171 million of commitments to extend credit and $3.847 million of standby letters of credit. Non-contractual overdraft exposure was $12.352 million.
- Management identified interest-rate changes, economic weakness and borrower repayment capacity, market disruption, competition, regulatory and legal changes, fraud and information theft, key-personnel losses, and Marcellus Shale-related regulatory and environmental changes as risks. Regional loan performance depends substantially on local economic conditions.
- Management considered the allowance adequate but cautioned that prolonged weakness, high unemployment, collateral-value changes, or delayed borrower financial information could increase problem assets, provisions, charge-offs, and reduce income. TDRs carry greater loss risk than new-originated loans.
- Management reported no litigation expected to have a material adverse effect and no material change in risk factors from the 2010 Form 10-K. Disclosure controls were deemed effective, with no material Q3 change in internal control over financial reporting.
- Management expected $1.7 million of aggregate tax credits over eleven years from a low-income housing project, including $1.4 million beginning in 2012 after completion; approximately $24,000 was expected in 2011. This is an expectation, not a guarantee.
Important facts for investors to verify
- Track whether the large commercial nonaccrual relationship and the other major criticized borrowers remain current, and whether TDR defaults or collateral shortfalls increase.
- Review subsequent credit quality, including nonperforming loans, charge-offs, allowance coverage, and the effects of Q3 flooding on collateral.
- Assess sustainability of earnings growth given the falling net interest margin, low-rate reinvestment environment, and contribution from securities gains.
- Confirm deposit mix and funding costs, and reconcile reported total borrowings with the disclosed FHLB advances and other borrowing components.
- Monitor regulatory or market changes affecting debit-card fees, regional Marcellus Shale activity, and the expected low-income housing tax credits.