Citizens Financial Services, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019; unaudited. The company is a Pennsylvania-based bank holding company operating primarily through First Citizens Community Bank, serving communities in Pennsylvania and southern New York.
Financial performance and condition
Amounts are in millions, except per-share data and percentages.
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net interest income | $12.34 | $11.75 | $24.25 | $23.17 |
| Provision for loan losses | $0.35 | $0.33 | $0.75 | $0.83 |
| Noninterest income | $2.03 | $1.84 | $4.06 | $3.75 |
| Noninterest expense | $8.24 | $7.70 | $16.56 | $15.53 |
| Net income | $4.85 | $4.69 | $9.25 | $8.94 |
| Diluted EPS | $1.38 | $1.32 | $2.62 | $2.52 |
- Q2 net income increased 3.3%; first-half net income increased 3.5%. First-half annualized ROA was 1.28% versus 1.29% and ROE was 12.61% versus 13.15% in 2018.
- Tax-equivalent net interest margin was 3.74% in Q2 versus 3.70%; for the first half it was 3.66% versus 3.67%. Management attributed first-half margin pressure primarily to higher funding costs. Interest expense rose 47.8% for the first half, as the average rate paid on interest-bearing liabilities rose from 0.80% to 1.14%.
- At June 30, assets were $1,447.2, up $16.5 from year-end 2018. Gross loans were $1,099.6, up 1.6%; net loans were $1,086.3. Available-for-sale securities totaled $236.7, down from $241.0.
- Deposits were $1,183.7, down $1.5 from year-end; borrowed funds rose $9.8 to $101.0. Stockholders’ equity was $148.0, up 6.3%. The company declared first-half cash dividends of $0.881 per share, totaling $3.1.
- Six-month operating cash flow was $10.3, compared with $9.6 in 2018. Investing used $14.6 versus $41.3; financing provided $3.9 versus $28.7. Cash and cash equivalents declined $0.3 to $16.5.
- Regulatory capital ratios remained above “well-capitalized” thresholds: company total risk-based capital was 13.73% and Tier 1 leverage was 9.37% at June 30. Management said the company and bank met applicable capital requirements.
Changes, outlook, and risks
- Loan growth, particularly in commercial and agricultural real estate, and higher asset yields supported net interest income. Higher deposit and borrowing costs offset some of that benefit. First-half tax-equivalent NII rose 4.4% while margin edged down.
- Noninterest income increased 8.3% year over year in the first half, led by brokerage and insurance revenue, up 58.7%, and trust revenue, up 10.0%. Noninterest expense increased 6.6%; management cited compensation, computer replacements, higher OREO costs, pension costs related to the planned termination of the acquired FNB pension plan, and increased fraudulent charges on customer deposit accounts.
- Credit indicators were mixed: nonperforming loans fell 7.9% from year-end to $12.7, while nonperforming assets rose to $16.6 from $14.4, mainly reflecting foreclosed property. The allowance for loan losses was $13.3, or 1.21% of loans; first-half net charge-offs were $0.33.
- A first-quarter bankruptcy settlement transferred approximately $3.1 of loans and more than 80 properties to foreclosed assets; foreclosed assets totaled $3.9 at June 30 versus $0.6 at year-end. The filing also reports $3.7 of loans transferred to foreclosed property during the first half.
- Credit risk is concentrated geographically and in agriculture: dairy-industry loans were $154.4, or 14.0% of total loans. Four borrower relationships represented 63.5% of nonperforming loans. Management described depressed milk prices and weaker natural-gas exploration activity as pressures on certain borrowers; updated collateral appraisals for one relationship were planned for Q3.
- Management reported adequate liquidity, supported by cash, core deposits, investment and loan cash flows, and borrowing capacity. FHLB capacity was approximately $526.4, with $122.7 outstanding via loans and letters of credit; additional federal funds lines of $34.0 and a Federal Reserve line of approximately $9.9 were undrawn.
- Interest-rate sensitivity modeling estimated prospective one-year NII would decline 5.84% under an instantaneous +200 basis-point shock and 12.08% under +400 basis points. Management cautioned that modeled outcomes depend on assumptions and actual results may differ.
- No earnings guidance is provided; management cautioned that interim results are not necessarily indicative of full-year results. The filing identifies interest-rate changes, economic and agricultural conditions, borrower credit quality, industry concentrations, fraud, competition, regulatory changes, and execution of strategic initiatives as risks. Risk factors were reported as not materially changed from the 2018 Form 10-K. Management reported no known litigation expected to have a material adverse effect.
- The company adopted lease accounting on January 1, 2019, recording right-of-use assets and lease liabilities of $1.454 each at adoption. It expects the forthcoming credit-loss standard (CECL) to require a cumulative allowance adjustment, but could not yet estimate the amount or overall financial impact.
Important facts for investors to verify
- Track the dairy and other criticized loan relationships, their updated collateral values, borrower repayment prospects, and any resulting reserve needs or charge-offs.
- Monitor the increase in foreclosed assets, costs to sell, and the timing and proceeds from disposition of the properties received in the bankruptcy settlement.
- Assess whether deposit and borrowing costs continue to rise faster than loan yields, and the resulting effect on net interest margin and earnings.
- Review the eventual CECL adoption estimate and its effect on the allowance, retained earnings, and capital ratios.
- Confirm that liquidity and capital remain adequate as loan commitments, deposit flows, and reliance on borrowed funds evolve.