Citizens & Northern Corporation — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Unaudited consolidated results; dollar amounts below are in millions unless stated otherwise.
Business context and reporting period
The Pennsylvania-based community banking company completed its acquisition of Covenant Financial, Inc. on July 1, 2020, expanding into Bucks and Chester Counties. Covenant’s results are included from that date. The acquisition and the prior-year Monument acquisition affect period comparisons.
Key financial metrics
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest income | $19.3 | $14.3 | $47.8 | $40.2 |
| Provision for loan losses | $1.9 | $1.2 | $3.3 | $0.2 |
| Noninterest income | $7.0 | $5.0 | $17.8 | $14.2 |
| Noninterest expense | $21.1 | $11.7 | $47.4 | $37.4 |
| Net income | $2.8 | $5.3 | $12.5 | $14.0 |
| Diluted earnings per share | $0.18 | $0.39 | $0.86 | $1.06 |
- Margins: Net interest margin was 3.57% in Q3, versus 3.81% a year earlier; nine-month margin was 3.67%, versus 3.90%. Lower interest rates and low-yield PPP lending pressured margins, while acquisition-related growth lifted net interest income.
- Unusual earnings items: Merger expenses were $6.4 million in Q3 and $7.5 million year to date. Excluding merger expenses and net securities gains, management reported non-GAAP diluted EPS of $0.50 versus $0.40 in Q3 2019, and $1.27 versus $1.31 year to date. These adjusted figures are not GAAP measures.
- Balance sheet at September 30: Total assets were $2,352.8 million, up from $1,654.1 million at December 31, 2019. Net loans were $1,680.6 million, deposits $1,871.5 million, and stockholders’ equity $296.3 million. Loan growth includes Covenant-acquired loans and $163.1 million of PPP loans.
- Credit quality: Allowance for loan losses was $10.8 million, or 0.64% of loans, versus $9.8 million, or 0.83%, at year-end. Nonperforming loans were 1.48% of loans, up from 0.88%; nonperforming assets were $27.5 million, up from $13.3 million. The filing attributes much of the increase to newly identified impaired loans and credit-impaired loans acquired from Covenant.
- Cash flow and liquidity: Nine-month operating cash flow was $14.6 million, investing cash flow $53.9 million, and financing cash flow $68.5 million. Cash and cash equivalents ended the period at $168.1 million, versus $31.1 million at year-end; the company cites $76.0 million of net cash received in the Covenant transaction that had not yet been fully deployed. Available credit facilities totaled $842.1 million, including $701.4 million available.
- Borrowings and capital: At September 30, short-term borrowings were $40.9 million, long-term borrowings $102.8 million, and subordinated debt $16.6 million. C&N Bank’s total capital to risk-weighted assets ratio was 15.65%, and its leverage ratio was 9.74%; management said capital exceeded well-capitalized requirements.
- Dividends: The company declared $0.81 per share for the first nine months of 2020, compared with $0.91 for the comparable 2019 period.
Material changes versus the prior comparable period
- GAAP net income and diluted EPS declined year over year in Q3 and year to date, while reported net interest income increased 35% in Q3 and 19% year to date. Acquisitions contributed to both revenue growth and higher operating costs.
- Q3 noninterest expense included the $6.4 million Covenant merger charge. Excluding merger costs, Q3 noninterest expense still rose $3.2 million, reflecting acquired staff and operations, data processing, benefits and other expenses.
- Loan-sale gains rose to $2.1 million in Q3 and $3.9 million year to date, primarily from higher mortgage refinancing and sale volumes. Deposit service charges fell, which management linked to reduced overdraft activity.
- The loan-loss provision increased substantially year to date, including a $2.2 million charge-off on a $3.5 million commercial loan and higher estimated loss factors and qualitative reserves.
- Net income was partly offset in comprehensive income by changes in securities values: nine-month other comprehensive income was $7.9 million, primarily reflecting unrealized gains on available-for-sale securities.
Outlook, commentary, risks and contingencies
- No numerical earnings or financial guidance is provided. Management said additional Covenant merger-related expenses were expected to be insignificant and did not expect capital expenditures to materially harm 2020 financial condition.
- Management cautioned that the duration and economic effects of COVID-19 are uncertain and that the pandemic’s total effect on the loan portfolio cannot be determined. At September 30, 44 loans totaling $41.6 million remained under COVID-related deferrals; 28 were commercial loans totaling $39.9 million. Most previously deferred loans had returned to full payment status.
- The company reported $163.1 million of PPP loans. These are SBA-guaranteed subject to program compliance; forgiveness depends on borrowers meeting program requirements.
- Loan concentrations in the company’s regional markets make credit performance sensitive to local economic conditions. Acquired Covenant loans and estimates of acquired asset fair values remain subject to refinement, and the allowance for loan losses relies on subjective estimates.
- Management performed a quantitative goodwill impairment test amid pandemic-related market concerns and reported no impairment at September 30. The estimated reporting-unit fair value was $352.7 million, 19% above book value; management noted the assumptions are subjective.
- The filing discusses potential risks from interest-rate changes, economic conditions, credit deterioration, competition, technology costs, regulation and the integration of acquired institutions. Legal proceedings were described as not expected to materially affect financial position or results.
- Disclosure controls were judged effective. However, integration of Covenant’s processes and internal controls over financial reporting was still in progress at September 30, despite completion of the core-system conversion in August.
Important facts for investors to verify
- Whether acquired-loan credit quality, COVID-related deferrals and local economic conditions lead to further increases in nonperforming loans, charge-offs or the allowance.
- How much of earnings growth is sustainable after excluding merger costs, acquisition accounting effects, PPP fees and elevated mortgage loan-sale gains.
- Whether margin compression continues as low market rates and PPP lending affect asset yields, and how deposit and funding costs respond.
- Whether Covenant integration is completed as planned, remaining costs are limited, and internal-control changes are effective.
- Whether liquidity, capital ratios and dividend capacity remain strong as acquired assets are deployed and credit conditions evolve.