CZNC

Citizens & Northern Corp. 10-Q Summary (Period Ended Sept 30, 2009)

Business Context and Reporting Period

Citizens & Northern Corporation (C&N) is a Pennsylvania-based bank holding company operating community banking subsidiaries. This Form 10-Q covers the quarterly period ended September 30, 2009, and the nine-month period ended on that date. The company is classified as an accelerated filer. As of November 2, 2009, there were 9,235,611 shares of common stock outstanding.

Key Financial Metrics

• Revenue (Interest Income): $16.8 million for Q3 2009; $51.7 million for the nine months ended Sept 30, 2009.
• Net Loss: $28.2 million for Q3 2009; $44.0 million for the nine months ended Sept 30, 2009.
• Net Loss Available to Common Shareholders: $28.6 million for Q3 2009; $45.0 million for the nine months ended Sept 30, 2009.
• Earnings Per Share (Diluted): Loss of $3.17 for Q3 2009; Loss of $5.01 for the nine months ended Sept 30, 2009.
• Net Interest Margin: $10.8 million for Q3 2009; $32.9 million for the nine months ended Sept 30, 2009.
• Total Assets: $1.283 billion as of Sept 30, 2009.
• Total Deposits: $896.9 million as of Sept 30, 2009.
• Stockholders' Equity: $126.1 million as of Sept 30, 2009.
• Cash and Cash Equivalents: $48.0 million as of Sept 30, 2009.
• Long-term Borrowings: $216.5 million as of Sept 30, 2009.

Material Changes vs. Prior Period

The financial results for the nine months ended September 30, 2009, represent a significant deterioration compared to the same period in 2008, primarily driven by non-recurring impairment charges.

• OTTI Charges: The company recognized net impairment losses on available-for-sale securities of $84.4 million for the nine months ended Sept 30, 2009, compared to $6.2 million in the prior year period. This included $72.8 million related to pooled trust-preferred securities (mezzanine tranches) and $6.3 million related to bank stocks.
• Net Income to Loss: The company reported a net loss of $44.0 million for the nine months of 2009, a reversal from net income of $7.9 million in the same period of 2008.
• Interest Margin: Net interest income increased by $1.1 million (3.6%) for the nine-month period, aided by lower interest rates on deposits and borrowings, despite a decrease in average loan balances.
• Non-Interest Expense: Increased by $0.6 million (2.4%) year-over-year, largely due to a $1.5 million increase in FDIC insurance costs (including a special assessment), partially offset by lower salaries and wages due to prior personnel reductions.
• Capital Structure: In January 2009, the company issued $26.4 million of Series A Preferred Stock and a warrant to the U.S. Treasury under the TARP Capital Purchase Program.

Guidance, Outlook, and Risks

Management Commentary: Management attributes the net loss primarily to other-than-temporary impairment (OTTI) charges on securities. Excluding these charges, "Core Earnings" were positive at $11.4 million for the nine months ended Sept 30, 2009. Management believes the vast majority of losses on pooled trust-preferred securities have been realized, given the small remaining cost basis ($1.6 million).

Outlook: Management expects Q4 2009 results to reflect positive operational changes, including expense reductions and enhanced non-interest revenue. Capital expenditures for 2009 are estimated at $1.5 million to $2.0 million.

Risks and Contingencies:

• Deferred Tax Assets: A significant risk factor is the realization of a $31.1 million net deferred tax asset, largely stemming from securities losses not currently deductible for tax purposes. A valuation allowance of $0.9 million was recorded, with realization dependent on future capital gains.
• Securities Portfolio: Continued exposure to potential losses in bank stocks, private label CMOs, and trust-preferred securities due to economic conditions.
• Loan Portfolio: While nonperforming loans remain relatively low (0.77% of assets), management notes that credit issues with larger commercial borrowers could significantly impact future provisions for loan losses.
• Interest Rate Risk: The company is liability-sensitive; rising interest rates could decrease net interest income and market value of portfolio equity.

Investor Verification Checklist

• Verify the composition and remaining fair value of the pooled trust-preferred securities portfolio to assess residual OTTI risk.
• Review the specific commercial loan relationships identified as impaired to understand the adequacy of the $1.1 million allowance on impaired loans.
• Confirm the assumptions used for the valuation allowance on deferred tax assets and the likelihood of generating future capital gains to realize these benefits.
• Monitor the impact of TARP preferred stock dividends ($1.1 million for the nine months) on net income available to common shareholders.
• Assess the sustainability of "Core Earnings" by reviewing non-interest income trends, specifically trust revenue and service charges, excluding one-time gains.