CZNC

Citizens & Northern Corp. Q2 2009 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2009, for Citizens & Northern Corporation, a Pennsylvania-based bank holding company. The filing includes unaudited consolidated financial statements and management discussion regarding the impact of the 2008-2009 financial crisis, specifically regarding securities impairments and the adoption of new accounting standards (FSP FAS 115-2).

Key Financial Metrics

Material Changes vs. Prior Period

• Significant Losses: The company reported a net loss of $15.76 million for the six months ended June 30, 2009, compared to net income of $6.87 million in the same period in 2008. This reversal is primarily due to Other-Than-Temporary Impairment (OTTI) losses on available-for-sale securities totaling $36.46 million (pre-tax) for the six-month period.
• Securities Write-downs: Impairment charges included $30.28 million on pooled trust-preferred securities and $6.18 million on bank stocks. Management noted that trading volume for trust-preferred securities was virtually nonexistent, forcing the use of Level 3 valuation models (discounted cash flows).
• Interest Margin: Net interest income increased by $1.45 million (7.0%) year-over-year, driven by lower interest rates paid on deposits and borrowings, which reduced total interest expense by $3.61 million.
• Expense Increases: Noninterest expenses rose $1.08 million (6.4%), largely due to a $1.21 million increase in FDIC assessments (including a $589,000 special assessment). Excluding FDIC costs, operating expenses were slightly lower.
• Capital Injection: In January 2009, the company issued $26.44 million of Series A Preferred Stock and a warrant to the U.S. Treasury under the TARP Capital Purchase Program. This increased stockholders' equity significantly.

Guidance, Outlook, and Risks

• Core Earnings: Management utilizes a non-GAAP "Core Earnings" measure to exclude OTTI losses. For the six months ended June 30, 2009, Core Earnings available to common shareholders were $7.63 million ($0.85 per share), compared to $7.81 million in 2008. Management remains optimistic about annual 2009 Core Earnings despite the securities losses.
• Loan Portfolio: The provision for loan losses was a credit of $80,000 for the six months ended June 30, 2009. Nonperforming loans and other real estate owned were 0.84% of assets. Management has not originated subprime mortgages but warns that further economic deterioration could necessitate higher provisions.
• Outlook: Management expects total noninterest operating expenses to increase slightly in 2009 due to higher FDIC premiums. Noninterest revenue may be lower than 2008 due to the absence of a one-time Visa gain and discontinued dividends from the Federal Home Loan Bank of Pittsburgh.
• Risks: Key risks include the valuation of pooled trust-preferred securities (subject to sensitive assumptions regarding defaults and discount rates), potential further deterioration in the commercial loan portfolio, and the impact of rising interest rates on the company's liability-sensitive position.

Investor Verification Checklist

• OTTI Methodology: Verify the assumptions used in the Level 3 valuation of pooled trust-preferred securities, specifically the discount rates and estimated default levels.
• Core Earnings Sustainability: Assess whether "Core Earnings" (excluding securities losses) accurately reflect the bank's underlying operational health given the magnitude of the unrealized losses in the portfolio.
• FDIC Assessment Impact: Confirm the projected FDIC expense for the remainder of 2009, as this is a significant driver of noninterest expenses.
• Commercial Loan Quality: Monitor the "Watch List" and specific large commercial relationships that drove the increase in impaired loans to $7.04 million.
• TARP Restrictions: Note the restrictions on common stock repurchases and dividend increases imposed by the TARP participation until January 2012 or redemption of preferred stock.