Citizens & Northern Corporation — Q2 2018 Form 10-Q
Business context and period. Regional bank holding company serving markets in Pennsylvania and New York. This unaudited filing covers the quarter and six months ended June 30, 2018; balance-sheet comparisons are with December 31, 2017. Dollar amounts below are in millions unless noted.
Financial results and position
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income | $11.255 | $10.362 | $22.152 | $20.521 |
| Net interest margin, fully taxable-equivalent | 3.87% | 3.83% | 3.86% | 3.81% |
| Noninterest income | $6.157 | $4.213 | $10.563 | $8.222 |
| Noninterest expense | $9.684 | $9.076 | $19.579 | $18.374 |
| Net income | $6.371 | $4.121 | $10.746 | $7.555 |
| Diluted earnings per share | $0.52 | $0.34 | $0.87 | $0.62 |
| Provision (credit) for loan losses | ($0.020) | $0.004 | $0.272 | $0.456 |
Q2 net income increased 54.6% year over year; six-month net income increased 42.2%. Excluding the Visa Class B gain and net available-for-sale securities losses or gains, management reported adjusted net income growth of 28.7% for Q2 and 29.7% year to date. These adjusted figures are management-presented non-GAAP comparisons.
- Balance sheet at June 30: Total assets were $1,284.0; loans, net, $809.8; deposits, $1,040.9; and stockholders’ equity, $189.2. Gross loans were $818.6, up 0.4% from year-end; deposits were up 3.2%.
- Cash flow and liquidity: Operating cash flow was $12.2 for the first half, compared with $7.6 in 2017. Cash and cash equivalents ended at $48.7, an increase of $11.7 from the start of the year. Available credit facilities totaled $424.0, of which $385.0 was available; management said it was well-positioned to meet obligations.
- Borrowings: Short- and long-term borrowings totaled $44.2, down from $71.0 at year-end. Short-term borrowings fell to $17.2 from $61.8, while long-term borrowings rose to $27.1 from $9.2, including new FHLB advances.
- Credit quality: Allowance for loan losses was $8.8, or 1.08% of loans. Nonperforming loans were $14.4 (1.76% of loans), and nonperforming assets were $17.3 (1.35% of assets). Impaired loans declined to $8.0 from $9.5 at year-end, while foreclosed assets rose to $2.9 from $1.6.
- Capital: Consolidated total capital to risk-weighted assets was 23.82%; common equity tier 1 was 22.70%. Management stated both the company and bank exceeded regulatory requirements and expected to remain above applicable standards.
Material changes and unusual items
- Higher loan balances and yields drove interest income and net interest income growth. Average loans increased 7.3% year to date, while average available-for-sale securities declined 7.1%. Deposit costs rose, partly offset by lower borrowing costs after repayment of higher-cost debt.
- Noninterest income excluding securities and Visa items rose 14.1% for the first half, led by deposit service charges, trust revenue, debit-card interchange and brokerage revenue. Noninterest expense increased 6.6%, including higher compensation, employee health costs, technology, professional fees and telecommunications.
- A $1.75 million pre-tax gain was recorded on Visa Class B shares after the company agreed to sell 10,000 shares at $88.43 each; settlement occurred in July. The gain included an unrealized valuation component for the remaining shares. The company also recorded a $282,000 securities impairment loss on securities sold in July. Management said $17.8 million of sale proceeds were reinvested in mortgage-backed securities, with an estimated yield of 3.36% versus 1.73% on the securities sold.
- The company donated its Towanda banking property in June, recording $250,000 of expense, and entered into a temporary lease to continue operations. Related state tax credits partly offset the impact.
- Other comprehensive loss was $4.6 million for the first half, primarily from unrealized available-for-sale securities losses; accumulated other comprehensive loss increased to $6.3 million. Comprehensive income was $6.2 million, versus $9.0 million in the first half of 2017.
Outlook, risks and contingencies
The filing provides no earnings or revenue guidance and cautions that interim results may not indicate full-year results. Management expects capital levels to remain above regulatory standards. Interest-rate sensitivity modeling showed projected net interest income declines of 1.9% to 13.1% across +100 to +400 basis-point scenarios and 3.6% to 13.1% across -100 to -400 basis-point scenarios; modeled results were within internal limits. Actual results could differ because of assumptions about prepayments, deposits and customer behavior.
- Key stated risks include interest-rate and securities-market changes, local economic conditions, credit performance, regulatory or accounting changes, competition, technology costs and demand for banking services.
- Loans and participation loans are concentrated in the company’s regional markets; management noted that local economic conditions affect borrowers’ ability to repay. Leveraged participation loans totaled $13.9 million.
- Mortgage-sale representation-and-warranty exposure had no recorded allowance. The MPF Original program’s maximum credit-enhancement obligation was $3.6 million, with a $0.3 million allowance.
- Management said pending legal proceedings were not expected to materially affect financial condition or results. No material changes to previously disclosed risk factors were reported.
- The company adopted several accounting updates in 2018. The expected-credit-loss standard is scheduled for adoption in 2020; management was assessing its impact and data needs.
Important facts for investors to verify
- How much future earnings growth depends on core banking operations versus the one-time Visa valuation gain, securities loss and Towanda-related items.
- Whether loan growth, deposit pricing and net interest margin can be sustained as rates and funding costs change.
- Credit trends in commercial, participation and leveraged loans, and the recoverability and disposition timing of foreclosed properties.
- The valuation sensitivity of the securities portfolio and the effect of unrealized losses on equity and future earnings.
- FHLB borrowing maturities, availability of contingent funding, and the continuing adequacy of capital and liquidity buffers.