Citizens Financial Services, Inc. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011; unaudited consolidated results. Citizens Financial is a Pennsylvania bank holding company whose business is primarily conducted through First Citizens National Bank, serving North Central Pennsylvania and Southern New York.
Financial results and position
| Metric | Q2 2011 | Six months 2011 | Comparison |
|---|---|---|---|
| Net income | $3.147 million | $5.977 million | Up 7.5% and 5.4%, respectively, from 2010 |
| Earnings per share | $1.09 | $2.07 | 2010: $1.01 and $1.96 |
| Net interest income | $7.076 million | $14.012 million | Up 3.9% and 3.4% |
| Provision for loan losses | $150,000 | $375,000 | 2010: $235,000 and $540,000 |
| Non-interest income | $1.672 million | $3.187 million | Up 9.7% for Q2 and 9.4% for six months |
| Non-interest expense | $4.584 million | $9.260 million | Up 5.2% and 6.6% |
- Margins: Fully tax-equivalent net interest margin was 3.93% for Q2 versus 4.17% in 2010, and 3.96% for the first half versus 4.26%. The six-month net interest spread was 3.76%, down from 4.04%.
- Balance sheet at June 30: Total assets were $853.0 million, up 5.0% from year-end 2010; deposits were $713.1 million, up 4.8%; net loans were $470.7 million, up 0.7%; available-for-sale securities were $288.6 million, up 14.8%.
- Liquidity and funding: Cash and cash equivalents were $44.4 million. Borrowed funds were $55.4 million, down $588,000 since year-end. The Bank reported $38.0 million outstanding against approximately $238.9 million of FHLB borrowing capacity; a $10 million federal funds line and approximately $14.5 million Federal Reserve line were undrawn.
- Cash flow, first half: Operating activities provided $6.8 million; investing activities used $36.5 million, primarily reflecting securities purchases; financing activities provided $30.1 million, including $32.4 million of deposit growth. Cash increased $437,000 to $44.4 million.
- Capital: Stockholders’ equity was $75.3 million, up 9.6% from year-end. The Bank’s total risk-based capital ratio was 14.62% and Tier 1 risk-based ratio was 13.36%; both exceeded the filing’s 10% and 6% “well capitalized” thresholds.
Changes versus comparable periods
- Net interest income rose despite lower asset yields: the six-month yield on interest-earning assets declined to 5.25% from 5.98%, while the average cost of interest-bearing liabilities fell to 1.49% from 1.94%. Growth in average interest-earning assets and lower funding costs supported earnings, but margin narrowed.
- Loan interest income declined for the first half, reflecting lower residential mortgage balances and lower yields; commercial and farm lending grew. Management cited weak general loan demand and more customers using conforming mortgages sold into the secondary market.
- Net non-performing loans fell 20.6% from December 31, 2010 to $9.956 million, largely because an agricultural borrower returned to accrual status. Non-performing assets were $10.724 million, down from $13.238 million.
- Non-interest expense increased, including higher salaries, occupancy and FDIC insurance costs. Non-interest income growth included $234,000 in net securities gains for the first half, compared with $99,000 a year earlier.
Outlook, risks and unusual items
- The filing provides no formal earnings or revenue guidance and cautions that first-half results are not necessarily indicative of full-year results. Management said rate simulations from a 100-basis-point decline to a 500-basis-point increase would have a minor effect on anticipated net interest income over the next 12–24 months.
- Management attributed deposit growth partly to local Marcellus Shale activity and customer preference for local bank deposits amid volatile financial markets. The company noted that regional economic conditions and changes in laws governing natural gas exploration could affect customers, loan demand, deposits and credit quality.
- Credit risks include regional economic weakness, borrower repayment capacity, collateral values and concentrations in commercial real estate and business relationships. Approximately 88.7% of non-performing loans related to four customer relationships. The allowance was $6.163 million, or 1.29% of total loans, versus $5.915 million, or 1.25%, at year-end.
- A first-half restructuring covered five loans for one commercial customer. The loans totaled about $5.845 million and were non-accrual at June 30, although current through July 2011; the Bank recorded a $128,000 specific allowance. Management also described several other material non-accrual commercial relationships.
- Available-for-sale securities had $6.989 million of gross unrealized gains and $435,000 of gross unrealized losses at June 30. Management concluded the losses were not other-than-temporary. Securities gains and unrealized valuation changes contributed to reported income and comprehensive income, respectively.
- The company invested $545,000 in land for potential future expansion. It expects to contribute $505,000 to its pension plan in 2011. Management reported no material litigation, effective disclosure controls, and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether the decline in net interest margin persists as low asset yields and deposit repricing affect earnings.
- The status, collateral support, repayment performance and reserve adequacy for the large non-accrual commercial relationships and the restructured $5.845 million customer exposure.
- Whether deposit growth and liquidity sources remain stable, and the impact of continued investment portfolio growth and interest-rate changes.
- How local Marcellus Shale activity, regional economic conditions and evolving regulatory requirements affect loan demand, credit quality and fee income.
- The sustainability of earnings growth given higher operating expenses and the contribution from securities gains.