Citizens Financial Services, Inc. — Q1 2019 Form 10-Q
Business context and reporting period. The Pennsylvania bank holding company reported unaudited consolidated results for the three months ended March 31, 2019, compared with Q1 2018 for operating results and December 31, 2018 for balance-sheet changes. Its business is primarily community banking across central and south-central Pennsylvania and southern New York. The quarter’s results are not necessarily indicative of full-year performance.
Financial performance and position
| Metric | Q1 2019 / March 31, 2019 | Comparison |
|---|---|---|
| Net income | $4.405 million; $1.26 per basic and diluted share | Up 3.7% from $4.247 million; EPS was $1.21 |
| Net interest income | $11.915 million | Up 4.3% from $11.420 million |
| Net interest margin, tax-equivalent | 3.62% | Down from 3.68% |
| Provision for loan losses | $0.400 million | Down from $0.500 million |
| Noninterest income / expense | $2.033 million / $8.322 million | Income up 6.7%; expense up 6.3% |
| Return on assets / equity, annualized | 1.22% / 12.12% | 1.24% / 12.62% in Q1 2018 |
| Total assets | $1.448 billion | Up $17.3 million from year-end |
| Loans / deposits | Gross loans $1.091 billion; deposits $1.182 billion | Loans up $9.0 million; deposits down $3.5 million from year-end |
| Borrowed funds | $108.3 million | Up $17.1 million from year-end |
| Cash and cash equivalents | $17.8 million | Up $1.0 million from year-end |
| Operating cash flow | $4.757 million | $6.325 million in Q1 2018 |
Material changes and management commentary
- Net interest income growth reflected higher average earning-asset balances and yields, including loan growth. However, funding costs rose: interest expense increased $1.139 million, and the average rate on interest-bearing liabilities rose to 1.14% from 0.75%. Management attributed the lower net interest margin primarily to higher funding costs.
- Loan growth was concentrated in commercial and agricultural real estate. Agricultural loans were $295.5 million; the company reported a dairy-industry concentration of $156.9 million, or 14.4% of total loans.
- Nonperforming loans fell $2.0 million, or 14.7%, from year-end to $11.8 million. Nonperforming assets nevertheless rose to $16.1 million from $14.4 million, mainly because foreclosed assets increased to $4.3 million from $0.6 million. A bankruptcy settlement transferred approximately $3.1 million of loans into foreclosed property.
- The allowance for loan losses was $13.1 million, or 1.20% of loans, versus $12.9 million, or 1.19%, at year-end. Net charge-offs were $0.2 million, primarily related to one customer. Management considers the allowance adequate but notes estimates could require revision.
- Noninterest expense growth included higher salaries and benefits, OREO costs, and pension-related expense. Other expense included an increase in periodic pension costs associated with the decision to terminate the acquired FNB pension plan.
- Stockholders’ equity was $142.8 million, up 2.6% from year-end. The company paid $0.445 per share in dividends and repurchased 5,762 shares for approximately $0.330 million. The company and bank were categorized as well capitalized; the company’s total risk-based capital ratio was 13.59% and Tier 1 leverage ratio was 9.22%.
Outlook, liquidity, risks, and unusual items
- No specific earnings or financial guidance was provided. Management stated that Q1 results should not be viewed as indicative of full-year results.
- Management said liquidity needs were being met through cash, core deposits, FHLB financing, correspondent-bank federal funds lines, brokered CDs, and portfolio maturities. At quarter-end, FHLB borrowing capacity was approximately $515.9 million, with $128.9 million outstanding via loans and letters of credit; $34.0 million of federal funds lines and a $10.7 million Federal Reserve borrower-in-custody line were undrawn.
- Interest-rate sensitivity modeling estimated prospective one-year net interest income would decline 6.00% under a +200-basis-point shock and 12.44% under a +400-basis-point shock. Management cautioned that actual results could differ materially because the model depends on assumptions.
- Key risks include interest-rate changes, regional economic weakness, credit deterioration, agricultural-sector volatility and depressed milk prices, and exposure to customers affected by natural-gas support activity. Three customer relationships represented about 62% of nonperforming loans; two were agricultural borrowers affected by depressed milk prices.
- The company adopted lease accounting on January 1, 2019, recording right-of-use assets and lease liabilities of $1.454 million at adoption. Operating lease liability was $1.383 million at March 31.
- The company expects adoption of the expected-credit-loss standard to create a one-time adjustment to the allowance, but could not estimate its size or overall financial-statement effect.
- A lawsuit involving the Bank and a bankrupt customer was settled in Q1 2019; the Bank received residential properties recorded as foreclosed assets. Management stated that legal reserves were adequate and that the proceedings were not expected to have a material adverse effect, while noting unexpected developments could be material.
- Available-for-sale securities had $1.294 million of gross unrealized losses at quarter-end; management attributed these to market and rating changes and concluded they were not other-than-temporary impairments.
Important facts for investors to verify
- Whether loan growth can continue to offset rising deposit and borrowing costs, and how net interest margin develops.
- Credit quality in the dairy and commercial portfolios, including the status and collateral recovery of the large nonperforming relationships and the recently acquired foreclosed properties.
- Whether the $13.1 million allowance remains adequate as credit-loss standards change and economic conditions evolve.
- Deposit trends, reliance on FHLB and other borrowings, and the company’s liquidity and capital position.
- The eventual cost and earnings effect of the FNB pension-plan termination and the adoption of the expected-credit-loss standard.
- Potential outcomes of legal matters and the value and sale timing of foreclosed assets.