Citizens Financial Services, Inc. — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. The company is a Pennsylvania bank holding company operating First Citizens Community Bank and an insurance agency. It completed the acquisition of The First National Bank of Fredericksburg (FNB) in December 2015; year-over-year results therefore reflect expanded operations and are not fully comparable.
Financial performance and condition
| Metric | 2016 | 2015 | Change or context |
|---|---|---|---|
| Net interest income | $38.0 million | $30.8 million | Up 23.1%; tax-equivalent net interest income rose 21.3% to $40.9 million. |
| Net interest margin | 3.68% | 3.76% | Down 8 basis points; management cited a flat yield curve and asset-yield pressure. |
| Net income | $12.6 million | $11.6 million | Up 8.7%; 2014 net income was $13.4 million. |
| EPS, basic and diluted | $3.78 | $3.79 | Essentially flat despite higher net income. |
| Provision for loan losses | $1.52 million | $0.48 million | Increase attributed to loan growth and higher classified/nonperforming loans. |
| Total assets | $1.223 billion | $1.163 billion | Up 5.2%. |
| Total loans | $799.6 million | $695.0 million | Up 15.0%; agricultural real estate loans grew substantially. |
| Total deposits | $1.006 billion | $988.0 million | Up 1.8%. |
| Borrowed funds | $79.7 million | $41.6 million | Up $38.0 million, principally short-term FHLB funding for loan growth. |
| Cash and cash equivalents | $17.8 million | $24.4 million | Down $6.6 million. |
| Stockholders’ equity | $123.3 million | $119.8 million | Up 2.9%; 2016 return on assets was 1.06% and return on equity 10.24%. |
Reported non-interest income was $7.9 million, including $255,000 of net securities gains; the selected-data presentation separates securities gains from non-interest income. Non-interest expense rose 22.4% to $28.7 million, mainly reflecting FNB operations, added lending staff and branches. The efficiency ratio increased to 57.97% from 54.50%.
Cash from operating activities was $16.2 million. Investing activities used $70.1 million, primarily reflecting $103.9 million of net loan growth, partly offset by securities cash flows. Financing activities provided $47.3 million, including $38.0 million of increased short-term borrowings and $17.5 million of deposit growth. These figures reflect a bank’s lending and funding flows, not conventional free cash flow.
At year-end, the allowance for loan losses was $8.9 million, or 1.11% of loans, compared with $7.1 million, or 1.02%, in 2015. Nonperforming loans increased to $11.9 million from $7.2 million; nonperforming assets were $12.9 million, or 1.61% of loans. Net recoveries were $260,000. Regulatory capital ratios remained above well-capitalized thresholds: company total risk-based capital was 14.93%, common equity Tier 1 was 12.89%, and Tier 1 leverage was 9.46%.
Fourth-quarter context: Unaudited Q4 2016 net income was $3.17 million versus $2.46 million in Q4 2015. Q4 net interest income was $9.88 million versus $8.04 million, while provision for loan losses rose to $750,000 from $120,000.
Material changes versus prior period
- FNB integration and expansion into south-central Pennsylvania, alongside new lending teams and branches, contributed to higher average balances, revenue and expenses. The acquisition was completed in December 2015.
- Loans increased $104.6 million in 2016; agricultural real estate loans rose $65.8 million. The investment portfolio declined $45.7 million as cash flows helped fund loan growth.
- Despite higher net interest income, margin narrowed. Average loan yield fell to 5.13% from 5.24%; average cost of interest-bearing liabilities fell to 0.55% from 0.66%.
- Credit quality weakened on selected measures: nonperforming loans rose 65.8%, driven substantially by a small number of relationships. The allowance coverage of nonperforming loans fell to 74.9% from 99.3%.
- Deposits grew modestly, while FHLB advances rose to $41.3 million from $1.6 million. Management said loan growth was the primary reason for the additional short-term funding.
Outlook, risks and notable items
- The filing provides no quantitative earnings or growth guidance. Management expected comparable cash dividends to continue, subject to earnings, capital, legal restrictions and other conditions.
- Management said liquidity sources—including cash, available-for-sale securities, deposits and borrowing capacity—were expected to meet obligations and commitments. The Bank reported approximately $343.2 million of maximum FHLB borrowing capacity, inclusive of outstanding advances.
- Management warned of potential further margin pressure if the yield curve remains flat or inverts. Its year-end rate-shock model projected one-year net interest income declines of 1.82% for a +100-basis-point shock and 9.23% for +400 basis points; these are model estimates, not guidance.
- Credit exposures include commercial real estate, agriculture, municipal lending and customer businesses tied to natural-gas activity. Dairy-related loans totaled $95.3 million, or 11.9% of loans. Management also cited agricultural price/feed-cost pressures and local economic concentration.
- Three customer relationships represented about 67.8% of nonperforming loans. Disclosed cases included a natural-gas-services borrower, a borrower in bankruptcy litigation, and an agricultural borrower; a $54,000 specific reserve was recorded for the agricultural relationship.
- Other risks include Pennsylvania budget impasses affecting municipal borrowers and deposits, interest-rate-driven securities valuation changes, competition, regulatory/compliance costs, cyber and fraud exposure, and execution of acquisition and market-expansion plans.
- Available-for-sale securities had $1.109 million of gross unrealized losses across 88 securities at year-end. Management concluded the declines were not other-than-temporary. The company recorded no goodwill impairment.
- Commitments to extend credit were $206.5 million and standby letters of credit were $15.0 million. The filing reported no off-balance-sheet transaction reasonably likely to have a material effect on financial condition, results or cash flows. Routine legal proceedings were considered immaterial.
- The company and Bank were categorized as well capitalized. The independent auditor gave an unqualified opinion on the financial statements and internal controls; management reported effective financial reporting controls and no identified material weaknesses.
Important facts for investors to verify
- Whether the increase in nonperforming loans and provision needs further reserves, particularly as the acquired and expanded agricultural and commercial portfolios season.
- How much future loan growth can be funded by core deposits versus short-term FHLB advances, and whether funding costs or deposit mix pressure margins.
- Whether FNB integration, new branches and lending teams produce sustainable revenue and cost efficiencies; expenses rose faster than net income in 2016.
- Exposure and collateral quality in the largest borrower relationships, dairy concentration, municipal lending and natural-gas-related local businesses.
- Dividend and repurchase sustainability relative to earnings, capital needs and regulatory limits; the company repurchased 66,110 shares during 2016 and paid $1.66 per share in dividends.
- Potential effects of interest-rate changes on net interest income, securities values and accumulated other comprehensive income, and the effect of upcoming accounting standards, including the expected-credit-loss standard.