CITIZENS FINANCIAL SERVICES INC quarterly report, Q1 FY2017

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Citizens Financial Services, Inc. — Q1 2017 Form 10-Q

Business context and reporting period. Pennsylvania-based bank holding company operating through First Citizens Community Bank and First Citizens Insurance Agency. The unaudited quarter ended March 31, 2017; income and cash-flow comparisons are against Q1 2016, while balance-sheet changes are generally against December 31, 2016. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.

Financial performance and condition

  • Earnings: Net income was $3.303 million, up $20,000 (0.6%) year over year. Diluted EPS was $1.00 versus $0.98. Annualized ROA was 1.08% versus 1.11%; ROE was 10.45% versus 10.81%.
  • Interest income and margins: Net interest income rose 8.6% to $9.997 million. On a tax-equivalent basis, net interest income was $10.662 million versus $9.977 million, and net interest margin was 3.78% versus 3.64%. Growth in average loans—particularly commercial and agricultural lending—supported interest income, partly offset by lower average loan yields.
  • Credit costs: Provision for loan losses increased to $615,000 from $135,000, which management attributed primarily to loan growth. The allowance was $9.405 million, or 1.11% of loans, at quarter-end.
  • Other income and expenses: Noninterest income rose 6.2% to $2.035 million, including $172,000 in securities gains versus $27,000 a year earlier. Noninterest expense increased 4.0% to $7.191 million, led by higher salaries and benefits and occupancy costs.
  • Assets and lending: Total assets were $1.225 billion, up $1.5 million from year-end. Gross loans reached $845.3 million, up $45.7 million (5.7%); net loans were $835.9 million. Commercial real estate loans rose $14.5 million and agricultural real estate loans rose $32.7 million.
  • Funding and liquidity: Deposits increased $32.1 million to $1.038 billion; borrowed funds fell $32.8 million to $46.8 million. Cash and equivalents declined $3.0 million to $14.8 million. Management said available cash, core deposits, FHLB funding, correspondent-bank lines, and portfolio cash flows were sufficient to meet liquidity needs. FHLB borrowing capacity was approximately $377.3 million, with $23.4 million outstanding; a $10 million federal funds line and an approximately $4.5 million Federal Reserve line were undrawn.
  • Cash flow: Operating activities provided $6.3 million versus $2.4 million in Q1 2016; investing activities used $7.0 million versus $15.3 million; financing activities used $2.3 million versus providing $25.9 million. Cash and equivalents ended at $14.8 million.
  • Capital and shareholder returns: Stockholders’ equity was $125.0 million, up 1.4% from year-end. The Company and Bank were categorized as well capitalized; the Company’s total risk-based capital ratio was 14.57% and Tier 1 leverage ratio was 9.52%. The quarterly dividend was $0.425 per share; $1.198 million of dividends were paid.

Material changes versus comparable periods

  • Loan growth drove higher interest income and net interest income, while average loan yield declined 25 basis points to 4.92% on a tax-equivalent presentation.
  • Investment securities decreased $32.2 million from year-end as cash flows and maturities helped fund loan growth. The portfolio’s tax-equivalent yield was 2.51%, versus 2.43% in Q1 2016.
  • Net nonperforming loans declined $362,000 from year-end to $11.497 million; nonaccrual loans were $10.482 million. Nonperforming assets were $12.745 million.
  • Net charge-offs were $96,000 in Q1 2017, compared with net recoveries of $260,000 for full-year 2016 (not a quarter-to-quarter comparison).

Outlook, risks, contingencies, and unusual items

  • No specific earnings or growth guidance was provided. Management cautioned that Q1 results are not necessarily indicative of full-year results.
  • Management’s investment strategy directs portfolio cash flows toward loan growth and emphasizes shorter fixed maturities and repricing periods. Its modeled one-year net interest income declined 1.85% under a +100-basis-point shock and 9.00% under +400 basis points; actual outcomes may differ because of model assumptions.
  • Credit and concentration risks include a $106.9 million dairy-industry loan concentration (12.6% of loans) and exposure to regional agricultural conditions and natural-gas-related businesses. Management cited three customer relationships as approximately 68% of nonperforming loans. One commercial borrower’s natural-gas support activity was affected by slower exploration; another relationship involved bankruptcy proceedings; an agricultural borrower was marketing collateral for sale.
  • Two commercial real estate loan modifications totaling $703,000 were classified as troubled debt restructurings in Q1; no TDR modifications occurred in Q1 2016. Management reported no material legal proceedings expected to adversely affect the Company, while noting the borrower bankruptcy litigation described in the credit discussion.
  • Other disclosed risks include interest-rate changes, local and national economic conditions, competition, fraud and information security, regulatory or legal changes, acquisition integration, and volatility in agricultural and natural-gas-related markets. Management reported no material change in risk factors from the 2016 Form 10-K.
  • Management stated that controls and procedures were effective and that no material change in internal control over financial reporting occurred during the quarter.

Important facts for investors to verify

  • Whether rapid loan growth continues and whether the increased provision and allowance remain adequate as the loan portfolio expands.
  • Credit performance in the dairy and agricultural portfolios, the concentrated nonperforming borrower relationships, and the resolution of the bankruptcy-related matter.
  • Deposit growth, use of borrowed funding, available liquidity, and sensitivity of earnings to interest-rate changes.
  • How much of Q1 noninterest income came from securities gains, and whether elevated compensation and branch costs persist.
  • Regulatory capital ratios and any future effects from new accounting standards, particularly the expected-credit-loss standard; the filing says the eventual impact could not yet be determined.