Citizens & Northern Corporation — Q3 2022 Form 10-Q
Business context and reporting period
Citizens & Northern Corporation is a Pennsylvania bank holding company. This unaudited report covers the quarter and nine months ended September 30, 2022; balance-sheet comparisons are with December 31, 2021. Financial amounts below are in millions unless stated otherwise.
Financial performance and position
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Net interest income | $20.9 | $19.5 | $60.8 | $58.2 |
| Provision for loan losses | $3.8 | $1.5 | $5.0 | $2.5 |
| Noninterest income | $5.7 | $6.4 | $18.3 | $19.5 |
| Noninterest expense | $17.4 | $15.3 | $51.4 | $46.5 |
| Net income | $4.5 | $7.4 | $18.8 | $23.2 |
| Diluted earnings per share | $0.29 | $0.47 | $1.21 | $1.46 |
- Net interest margin was 3.69% in Q3, up from 3.59%; nine-month margin was 3.72%, up from 3.70%. The net interest rate spread was 3.46% for Q3 and 3.55% for the nine-month period, unchanged year over year in each comparison.
- Q3 net interest income rose 7.3% on a fully taxable-equivalent basis, while interest expense increased as deposit and borrowing rates rose. Excluding PPP loans, average loans grew 11.0% in Q3 and 6.6% year to date, year over year.
- At September 30, total assets were $2,400.2, gross loans $1,690.2, deposits $2,039.6, and stockholders’ equity $238.8. Loans grew $125.4 from year-end 2021; deposits grew $114.5.
- The allowance for loan losses was $16.2, or 0.96% of gross loans, versus $13.5, or 0.87%, at year-end. Nonperforming loans were $20.5 (1.21% of loans), down from $21.2 (1.36%).
- Cash and cash equivalents were $55.4 at September 30, down $40.4 since year-end. Nine-month operating cash flow was $26.5, investing cash outflow $180.2, and financing cash inflow $113.3.
- Borrowings totaled approximately $97.2 at September 30, comprising $55.5 of FHLB advances, $2.5 of short-term borrowings, $14.7 of senior notes, and $24.6 of subordinated debt. The FHLB facility had $754.7 of available capacity; total available credit facilities were $872.1.
- Available-for-sale securities had fair value of $488.0 against amortized cost of $559.8, an unrealized shortfall of $71.9 (12.8%). Nine-month after-tax other comprehensive loss was $61.5; accumulated other comprehensive loss was $56.5 at quarter-end, compared with income of $5.0 at year-end 2021. Management attributed the securities declines to higher market interest rates and said it found no credit-related impairment.
Material changes versus comparable periods
- Net income declined 39.8% in Q3 and 19.0% for the first nine months. Higher net interest income did not offset the larger loan-loss provision, lower noninterest income, and higher operating expenses.
- Q3 provision expense included $2.2 of net charge-offs and a $1.6 increase in the collectively determined allowance. A $2.16 partial charge-off related to a commercial real-estate participation loan to a healthcare borrower was a notable item.
- Noninterest income fell 11.1% in Q3, mainly because residential mortgage loan-sale gains declined $0.7. Nine-month noninterest income fell 5.9%, with loan-sale gains down $2.1, partly offset by higher brokerage, insurance, deposit-service, and servicing revenue.
- Noninterest expense rose 13.7% in Q3 and 10.6% year to date. Higher salaries and benefits, technology costs, and occupancy expenses contributed; Q3 occupancy expense included $0.2 of accelerated depreciation for two planned branch closures.
- Q3 included $0.29 of accrued refunds for certain consumer overdraft fees following updated regulatory guidance. The nine-month tax provision also benefited from a $0.30 reversal of tax penalties; the effective tax rate was 17.4%, compared with 19.0%.
Outlook, management commentary, risks and contingencies
- No specific earnings or revenue guidance is provided. Management said future loan growth will depend on further rate increases, economic conditions, and other factors. As of the filing, the Federal Reserve had raised rates during 2022 and indicated further increases were anticipated.
- The company describes itself as asset-sensitive. Its model projects one-year net interest income increasing 3.1% under an immediate +100-basis-point shock and 11.9% under +400 basis points, and decreasing 4.0% under -100 basis points and 9.3% under -200 basis points. Management said modeled results were within policy limits; actual outcomes may differ materially because of assumptions about deposit behavior, loan repayments, and securities prepayments.
- Key risks include interest-rate and inflation changes, economic deterioration, credit losses, competition, technology and information-security failures, regulation, and integration of acquired institutions. Lending is concentrated in the company’s Pennsylvania and New York market areas; commercial lending and participation loans create borrower and collateral exposure.
- The healthcare-related participation loan remained nonaccrual and impaired, with a recorded investment of $4.76 after the charge-off. Recovery depends principally on real-estate sale proceeds and, if needed, guarantor payments. Management cautioned that realized losses on monitored commercial relationships may differ materially from estimates.
- Liquidity sources include correspondent-bank lines, the Federal Reserve discount window, and FHLB borrowing capacity. Management said it was well-positioned to meet funding obligations and would be more likely to pledge securities than sell them in an emergency given the unrealized losses.
- Management expected adoption of the current expected credit loss standard (CECL) on January 1, 2023; estimates were preliminary and still being refined. It did not expect adoption of ASU 2022-02 to have a material financial-statement impact.
- Management stated pending and threatened litigation was not expected to materially affect financial condition or results. No material changes to previously disclosed risk factors were reported. Disclosure controls were deemed effective, with no significant change in internal control over financial reporting.
Important facts for investors to verify
- Whether the healthcare borrower’s collateral sales and guarantor support recover the remaining $4.76 loan investment, and whether further charge-offs or provisions are needed.
- How CECL implementation affects the allowance, retained earnings, and credit-loss estimates beginning in 2023.
- Whether rising deposit costs and borrowing costs keep pace with asset yields, and whether modeled asset sensitivity translates into realized net interest income.
- Whether the securities portfolio’s unrealized losses remain temporary and whether liquidity needs could require securities sales.
- Whether loan growth, asset quality, and noninterest expense trends support earnings recovery, including the effects of branch closures and overdraft-fee refunds.
- Capital, liquidity, and dividend capacity: the Bank reported a 14.74% total risk-based capital ratio and a 6.74% capital conservation buffer; the filing notes distributions remain subject to regulatory and financial-condition constraints.