Citizens Financial Services, Inc. — Q3 2013 Form 10-Q
Business context and period. Pennsylvania bank holding company, primarily through First Citizens Community Bank, serving North Central Pennsylvania and Southern New York. This unaudited report covers the quarter and nine months ended September 30, 2013; balance-sheet comparisons are with December 31, 2012. Amounts below are in millions unless stated otherwise.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Interest income | $9.307 | $9.474 | $27.254 | $28.724 |
| Net interest income | $7.745 | $7.615 | $22.409 | $22.838 |
| Provision for loan losses | $0.090 | $0.105 | $0.315 | $0.315 |
| Non-interest income | $1.806 | $1.946 | $5.401 | $5.691 |
| Non-interest expense | $4.920 | $4.959 | $14.574 | $14.352 |
| Net income | $3.512 | $3.464 | $10.079 | $10.666 |
| Basic earnings per share | $1.16 | $1.13 | $3.33 | $3.49 |
- Quarterly net income rose 1.4%; nine-month net income fell 5.5%. Nine-month annualized return on assets was 1.52% versus 1.62%, and return on equity was 15.13% versus 17.74%.
- Tax-equivalent net interest margin was 3.93% for Q3 versus 3.99%; for the nine months it was 3.89% versus 3.99%. The reported nine-month net interest income decline reflects lower asset yields, partly offset by lower funding costs.
- Total assets were $899.4, up 1.9% from year-end. Net loans increased 4.0% to $515.3; total deposits grew 2.9% to $758.7. Borrowed funds declined to $43.2 from $46.1. Stockholders’ equity was $90.4.
- For the first nine months, operating cash flow was $12.9, investing cash flow was negative $40.1, and financing cash flow was positive $14.6. Cash and cash equivalents fell $12.6 to $13.8.
- The company reported total capital of 18.10% of risk-weighted assets and Tier 1 leverage of 10.29%; the Bank reported 17.70% and 10.05%, respectively. Both were above the filing’s stated “well capitalized” thresholds.
Material changes and operating drivers
- Nine-month earnings pressure came mainly from lower interest income and non-interest income. Tax-equivalent interest income declined $1.578 year over year, while interest expense fell $1.041; non-interest income decreased $0.290 and expenses increased $0.222.
- Commercial and agricultural loan growth supported lending income, while loan yields and investment yields fell. Average commercial and agricultural loans rose $14.9 year over year for the nine-month period; average investment securities fell $20.3. The company attributed lower yields to the low-rate environment and competition.
- Quarterly net interest income included $0.304 of interest recognized when a non-accrual loan was paid off. This is an unusual item that benefited Q3.
- Non-interest income included net securities gains of $0.385 for the nine months, down from $0.561. Service charges declined, partly attributed to Durbin-related regulation and reduced Marcellus Shale activity; trust and brokerage income increased.
- Available-for-sale securities increased to $318.5, but the nine-month decline in their unrealized value contributed to a $5.447 after-tax other comprehensive loss and a reduction in accumulated other comprehensive income from $4.631 to negative $0.816. Management attributed market-value declines largely to higher interest rates and did not consider the reported unrealized losses other-than-temporary impairments.
Credit, liquidity, outlook and risks
- Non-performing loans rose 8.3% from year-end to $9.285, or 1.78% of loans; non-performing assets were $9.786. The allowance was $7.070, equal to 1.35% of loans and 76.14% of non-performing loans. Net charge-offs were $0.029 for the nine months.
- Management said the allowance was adequate, but noted heightened regional unemployment associated with slower Marcellus Shale exploration and raised certain qualitative reserve factors. About 72% of non-performing loans were concentrated in four customer relationships. One $4.2 relationship was current under a restructured agreement but its borrower filed Chapter 11 in July 2013; the company was evaluating the effect. Other troubled relationships faced timber-industry or natural-gas-related pressures.
- Management stated liquidity was adequate, citing core deposits, loan and investment cash flows, FHLB funding and unused correspondent-bank and Federal Reserve lines. FHLB borrowing capacity was approximately $246.3, with $28.1 outstanding; the $10.0 federal funds line and $13.7 Federal Reserve line were undrawn. The company also had $96.3 of commitments to extend credit and standby letters of credit.
- The company provided no quantified earnings or full-year guidance and cautioned that nine-month results are not necessarily indicative of full-year results. Its investment strategy sought acceptable yields while limiting exposure to rising rates and duration; management expected future reinvestment opportunities might improve over two to five years.
- Key stated risks include interest-rate and securities valuation changes, regional economic conditions and natural-gas activity, borrower delinquencies, competition, regulatory and compliance costs, and operational or reputational risks. New Basel III capital rules were scheduled to take effect beginning January 1, 2015, with the capital conservation buffer phased in from 2016; management had not assured that the changes would have no material impact.
- No material litigation was identified. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Investor verification priorities
- Review the four concentrated non-performing relationships, particularly the Chapter 11 borrower, collateral values, payment status and reserve assumptions.
- Assess the sustainability of earnings excluding the $0.304 Q3 non-accrual interest recovery and securities gains.
- Check sensitivity of net interest income and capital to rate changes, and the potential effect of unrealized securities losses and Basel III implementation.
- Monitor deposit mix and funding costs, liquidity and contingent credit commitments alongside loan growth.
- Verify whether the slowdown in Marcellus Shale activity affects regional employment, customer cash flows, credit quality and deposit growth.