Citizens Financial Services, Inc. — Q1 2018 Form 10-Q
Business context and reporting period
Unaudited results cover the three months ended March 31, 2018, compared with Q1 2017 for income and cash flow, and with December 31, 2017 for balance-sheet changes. The company is a Pennsylvania bank holding company operating through First Citizens Community Bank and an insurance agency, serving central and eastern Pennsylvania and southern New York. Its business is predominantly community banking. The December 2017 acquisition of a State College branch contributed to loan, deposit, and staffing growth.
Key financial metrics
| Metric | Q1 2018 / March 31, 2018 | Comparable period / prior year-end |
|---|---|---|
| Net income | $4.247 million | $3.303 million in Q1 2017; up 28.6% |
| Diluted EPS | $1.22 | $0.94 in Q1 2017 |
| Net interest income | $11.420 million | $9.997 million in Q1 2017; up 14.2% |
| Net interest margin, tax-equivalent | 3.68% | 3.78% in Q1 2017 |
| Net interest spread | 3.54% | 3.68% in Q1 2017 |
| Provision for loan losses | $0.500 million | $0.615 million in Q1 2017 |
| Total assets | $1.382 billion | $1.362 billion at December 31, 2017 |
| Total loans / net loans | $1.032 billion / $1.020 billion | Total loans up $31.2 million from year-end |
| Total deposits | $1.115 billion | $1.105 billion at December 31, 2017 |
| Borrowed funds | $124.1 million | $114.7 million at December 31, 2017 |
| Cash and cash equivalents | $12.5 million | $18.5 million at December 31, 2017 |
| Operating cash flow | $6.3 million provided | $6.3 million provided in Q1 2017 |
| Investing / financing cash flow | $30.2 million used / $17.8 million provided | $7.0 million used / $2.3 million used in Q1 2017 |
| Stockholders’ equity | $129.9 million | $129.0 million at December 31, 2017 |
Noninterest income was $1.906 million, down 6.3%, while noninterest expense rose 8.9% to $7.832 million. The effective tax rate fell to 15.0% from 21.8%, primarily reflecting the reduction in the federal statutory corporate rate from 34% to 21%. Annualized return on assets and return on equity were 1.24% and 12.62%, respectively, versus 1.08% and 10.45% a year earlier. The quarterly dividend was $0.435 per share, compared with $0.405.
Material changes versus comparable periods
- Average loans grew substantially year over year, especially commercial and agricultural lending; management attributed growth to lending teams in central and south-central Pennsylvania and the State College branch acquisition.
- Interest income increased, but funding costs also rose: interest expense increased to $1.963 million from $1.303 million. Management cited higher deposit and borrowing rates and higher average borrowed balances.
- Noninterest income declined mainly because Q1 2017 included $172,000 of available-for-sale securities gains; no such securities were sold in Q1 2018. Service-charge and trust income increased.
- Noninterest expense increased by $641,000, led by salaries and benefits (up $469,000), reflecting merit increases, added employees and profit-sharing/retirement costs. Occupancy and other real estate owned expenses also increased.
- Nonperforming loans rose to $11.862 million from $10.726 million at year-end; nonperforming assets were $12.814 million. The allowance was $11.587 million, or 1.12% of loans, versus 1.12% at year-end.
- Accumulated other comprehensive loss widened by $1.579 million to $4.977 million, primarily from unrealized losses on available-for-sale securities as interest rates changed. The company reported 138 securities in unrealized loss positions and concluded the losses were not other-than-temporary.
Outlook, commentary, risks and unusual items
The filing provides no specific earnings or revenue guidance. Management says liquidity is supported by deposits, loan repayments, investment cash flows, FHLB funding, correspondent-bank lines and other available sources. FHLB borrowing capacity was approximately $472.1 million, with $101.9 million outstanding; the $10 million federal funds line and approximately $4.2 million Federal Reserve borrower-in-custody line were undrawn. Management described its investment strategy as focused on shorter fixed maturities and maintaining liquidity while managing exposure to rising rates.
Management’s rate-shock model projected one-year net interest income declines of 2.7% under a +100-basis-point shock, 5.9% under +200 basis points, and 12.3% under +400 basis points; actual results may differ from model estimates. The company and bank were categorized as well capitalized; at March 31, company total risk-based capital was 13.09% and Tier 1 leverage was 8.87%.
Credit risks include regional economic conditions, agricultural and dairy-sector volatility, loan concentrations, and exposure to businesses serving natural-gas exploration and drilling activity. Dairy-industry loans totaled $138.4 million, or 13.4% of loans. Two customer relationships accounted for 50.5% of nonperforming loans, including a natural-gas-related service business and a borrower involved in bankruptcy litigation; management reported no specific reserve for either relationship. The filing also cites risks from changing interest rates, competition, fraud, regulatory changes, and potential economic weakness. Management stated that no pending or threatened litigation was known to have a material adverse effect; routine proceedings remain possible.
Accounting changes included adoption of ASU 2016-01, with a $1.0 million reclassification between accumulated other comprehensive income and retained earnings at adoption, and ASU 2017-07, which changed pension-cost presentation. Adoption of revenue-recognition guidance had no material impact. The company expected the forthcoming credit-loss standard to require a one-time allowance adjustment but could not estimate its size. It estimated lease-standard adoption would increase assets and liabilities by less than 1%.
Important facts for investors to verify
- Whether loan growth, particularly in commercial, agricultural, and dairy-related exposures, is being matched by stable credit quality and adequate loss reserves.
- Developments in the two large nonperforming borrower relationships, associated collateral values, and the bankruptcy litigation.
- Whether rising deposit and borrowing costs continue to pressure net interest margin and earnings.
- The sensitivity of securities values, accumulated other comprehensive income, liquidity, and net interest income to interest-rate changes.
- Whether deposit growth and available funding capacity remain adequate as loans expand, and how the State College acquisition contributes to results.
- The eventual allowance impact and implementation status of the expected credit-loss accounting standard.