Citizens Financial Services, Inc. — Q3 2017 Form 10-Q
Business context and reporting period. Unaudited consolidated results for the three and nine months ended September 30, 2017, compared with the same 2016 periods. The company is a Pennsylvania-based bank holding company; its banking operations account for nearly all consolidated results. Financial statement amounts below are in millions unless otherwise noted.
Key financial metrics
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Interest income | $12.120 | $10.948 | $35.198 | $31.836 |
| Noninterest income | $1.921 | $1.908 | $5.844 | $5.807 |
| Net interest income | $10.617 | $9.712 | $31.018 | $28.088 |
| Provision for loan losses | $0.500 | $0.500 | $1.740 | $0.770 |
| Net income | $3.650 | $3.153 | $10.421 | $9.467 |
| Diluted EPS | $1.05 | $0.90 | $2.99 | $2.69 |
- Net income rose 15.8% in Q3 and 10.1% year to date. Annualized ROA and ROE were 1.15% and 11.16% for Q3, and 1.12% and 10.81% for the nine-month period.
- Tax-equivalent net interest margin was 3.79% in Q3 versus 3.78%; year to date it was 3.78% versus 3.67%.
- Nine-month operating cash flow was $12.703 million; investing activities used $52.851 million and financing activities provided $36.209 million. Cash and cash equivalents decreased $3.939 million to $13.815 million.
- At September 30, total assets were $1.270 billion; net loans $896.7 million; deposits $1.052 billion; borrowed funds $73.6 million; and stockholders’ equity $129.9 million. Since year-end 2016, net loans increased $106.0 million, deposits increased $46.6 million, and borrowed funds decreased $6.0 million.
- The allowance for loan losses was $10.447 million, or 1.15% of loans. Nonperforming loans were $11.994 million (1.32% of loans); nonperforming assets were $13.564 million. Allowance coverage of nonperforming loans was 87.1%.
- The company and bank were classified as well capitalized. Company total risk-based capital, common equity Tier 1, and Tier 1 leverage ratios were 14.41%, 12.40%, and 9.57%, respectively.
Material changes versus comparable periods
- Loan growth, particularly commercial and agricultural real estate lending, drove higher interest income and net interest income. Average commercial and agricultural loans increased $143.9 million year over year for the first nine months.
- Management funded loan growth in part by allowing investment securities to mature or be called and by selling securities. The securities portfolio fell $50.4 million, or 16.1%, from year-end 2016.
- The nine-month loan-loss provision increased $970,000 year over year, primarily reflecting loan growth. The allowance rose from $8.886 million at year-end to $10.447 million.
- Nine-month noninterest expense increased 0.9%; higher salaries, occupancy, Pennsylvania shares tax, and foreclosed-asset expenses were partly offset by lower other expenses and FDIC insurance costs.
- Effective tax rates increased to 22.9% for the first nine months and 23.8% for Q3, from 19.2% and 19.6%, respectively. The filing attributes the increase to higher pretax income and the end of a tax-credit generation period for one affordable-housing investment.
Outlook, commentary, risks, and unusual items
- No earnings or revenue guidance is provided. Management said nine-month results are not necessarily indicative of full-year results and described continued loan growth initiatives and an investment strategy focused on funding lending while maintaining liquidity.
- On July 27, 2017, the company agreed to acquire S&T Bank’s State College, Pennsylvania office. Management reported regulatory approval in Q4 2017 and expected the transaction to close in Q4.
- Liquidity sources include core deposits, loan repayments, investment cash flows, FHLB advances, and available federal-funds and Federal Reserve lines. The bank reported approximately $432.5 million of FHLB borrowing capacity, with $49.5 million outstanding; its $10 million federal-funds line and approximately $4.5 million Federal Reserve line were undrawn.
- Interest-rate, credit, liquidity, regulatory, and reputational risks are discussed. The company’s model estimated prospective one-year net interest income declines of 2.30% under a +100-basis-point shock and 10.85% under +400 basis points; actual outcomes may differ because of model assumptions.
- Credit exposure is concentrated in the company’s regional markets and includes a $134.7 million dairy-industry concentration, equal to 15.0% of loans. Management highlighted three troubled customer relationships representing approximately 61.6% of nonperforming loans, including exposures affected by natural-gas activity, bankruptcy proceedings, and agricultural operating issues.
- Ten loans totaling $7.108 million were modified as troubled debt restructurings during the first nine months. The company also issued a 5% stock dividend, with a stated market value of $9.0 million, and continued share repurchases.
- Management stated that it believed the allowance was adequate. It cautioned that economic weakness, collateral-value declines, borrower information delays, fraud, changing interest rates, and agricultural or natural-gas market conditions could adversely affect results. Management reported no material pending litigation or material change in risk factors from the 2016 Form 10-K.
Important facts for investors to verify
- Whether rapid loan growth is being maintained without deterioration in underwriting quality, especially in commercial, agricultural, and dairy-related exposures.
- Developments in the three significant nonperforming relationships, foreclosure proceedings, and the adequacy of the allowance as credit conditions evolve.
- Whether deposit growth and available borrowing capacity continue to fund loan demand at acceptable costs, and how deposit pricing affects margins.
- Progress and final terms of the State College office acquisition, including closing and integration effects.
- Actual sensitivity of earnings and capital to interest-rate changes, securities valuations, and adoption of the expected-credit-loss accounting standard.