CITIZENS & NORTHERN CORP quarterly report, Q2 FY2011

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Citizens & Northern Corporation — Q2 2011 Form 10-Q

Business context and reporting period

Quarterly report for the three and six months ended June 30, 2011. Citizens & Northern is a bank holding company whose lending is concentrated in Pennsylvania and New York. Interim financial statements are unaudited.

Financial performance and condition

  • Profit: Q2 net income was $5.70 million, versus $4.87 million a year earlier; diluted EPS was $0.47 versus $0.37. Six-month net income was $11.24 million, up from $9.31 million; EPS rose to $0.92 from $0.71. Prior-period earnings available to common shareholders were reduced by preferred dividends; the preferred stock was redeemed in Q3 2010.
  • Interest income and margin: Reported net interest income was $11.82 million for Q2, up 14.2% year over year, and $23.10 million for six months, up 10.9%. Fully taxable-equivalent net interest income for six months was $24.71 million, up 10.6%; net interest margin was 4.12% versus 3.72%, and interest-rate spread was 3.84% versus 3.43%.
  • Other income and expenses: Six-month noninterest income before securities gains was $6.23 million versus $6.81 million; excluding a $0.95 million limited-partnership write-off in 2011, it was $7.18 million, up 5.4%. Securities gains were $2.00 million versus $0.38 million. Noninterest expense rose 2.3% to $16.06 million. Six-month effective tax rate increased to 27.2% from 22.6%.
  • Cash flow: For the first six months, operating activities provided $22.80 million, investing activities provided $6.10 million, and financing activities used $25.81 million. Cash and cash equivalents increased $3.09 million to $49.39 million.
  • Balance sheet and credit: At June 30, assets were $1.310 billion, deposits $995.36 million, loans net of allowance $705.67 million, and stockholders’ equity $153.69 million. Compared with year-end 2010, loans and deposits declined, while available-for-sale securities rose to $464.21 million. The allowance was $8.27 million, down from $9.11 million; nonaccrual loans fell to $7.59 million from $10.81 million. Troubled debt restructurings, however, increased to $4.30 million from $0.65 million, and foreclosed assets rose to $1.67 million from $0.54 million.
  • Debt, liquidity and capital: Short- and long-term borrowings totaled $153.53 million, down from $166.91 million at year-end. The company reported $341.13 million of available credit facilities and $55.84 million of non-pledged available-for-sale securities. Management said it was well positioned to meet obligations. Consolidated total capital to risk-weighted assets was 19.40%; the bank’s ratio was 18.06%. Management expected capital to remain above well-capitalized standards.

Material changes, outlook and risks

  • Profit improvement reflected lower funding costs and borrowings, higher net interest income, and securities gains. First-half securities gains included $1.51 million from sales of previously written-off pooled trust-preferred securities. The $0.95 million limited-partnership investment was fully written off; management estimated the related $1.04 million loan receivable would be repaid in full.
  • Management provided no earnings guidance. It expected capital to remain above regulatory well-capitalized levels and said planned capital spending was not expected to materially harm financial condition or capital ratios.
  • Management described the balance sheet as liability-sensitive: its May 2011 model projected a 14.9% decline in one-year net interest income under an immediate 300-basis-point rate increase, within policy limits. Results depend on assumptions about deposit behavior, loan repayments and security calls.
  • Key risks include local economic conditions and real estate values affecting a regionally concentrated loan portfolio; subjective estimates for loan-loss reserves; and Level 3 valuations of pooled trust-preferred securities that rely on sensitive cash-flow and discount-rate assumptions. Management reported no OTTI losses in the first half of 2011, but noted possible variation in actual credit losses and fair values.
  • Management warned that interchange revenue could be pressured by regulatory and market changes, despite the company not being directly subject to the new large-institution rate cap. It also cited interest-rate, economic, regulatory, competitive and technology risks. Management considered pending legal proceedings not material; the filing reported no material change in previously disclosed risk factors.

Important facts for investors to verify

  • Whether the rise in troubled debt restructurings and foreclosed assets signals renewed credit deterioration, despite lower nonaccrual loans and impaired loans.
  • The sustainability of net interest income growth as deposit costs, borrowing levels and market interest rates change.
  • The assumptions supporting pooled trust-preferred security fair values and the collectability of the limited-partnership loan.
  • Whether the $10.10 million net deferred tax asset is realizable, including AMT-credit assumptions and the status of the IRS review of the 2009 return.
  • The effect of interchange-market changes and the company’s $1 million share-repurchase authorization; $428,548 remained available at June 30, 2011.