Citizens Financial Services, Inc. — Q3 2023 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2023. Unaudited consolidated results are for Citizens Financial Services, Inc. and its subsidiaries, principally First Citizens Community Bank. Unless otherwise noted, amounts are in millions; the filing presents financial statements in thousands.
Business context and material developments
- The company completed its acquisition of HV Bancorp, Inc. (HVBC) on June 16, 2023, expanding into southeastern Pennsylvania and Burlington County, New Jersey. Consideration was approximately $76.7 million, including 693,858 shares valued at $60.1 million and $16.5 million in cash. The acquisition added approximately $506.9 million of loans and $533.4 million of deposits at acquisition and generated $53.4 million of goodwill.
- Year-over-year comparisons reflect the acquisition, which contributed to higher average assets and shares outstanding. HVBC results are included only from the acquisition date; the filing also provides unaudited pro forma comparisons, which management cautions are not necessarily indicative of actual or future results.
- The company adopted CECL on January 1, 2023. Adoption increased retained earnings by $1.8 million net of tax; the change reduced the loan allowance by $3.3 million and increased the off-balance-sheet credit reserve by $1.1 million. Consequently, some credit-loss measures are not directly comparable with 2022.
Financial performance
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Net interest income | $22.4 | $18.8 | $58.4 | $52.8 |
| Provision for credit losses | $0.5 | $0.7 | $5.3 | $1.4 |
| Non-interest income | $3.7 | $2.7 | $8.1 | $7.4 |
| Non-interest expenses | $16.4 | $11.6 | $48.9 | $33.0 |
| Net income | $7.5 | $7.5 | $10.3 | $21.2 |
| Basic and diluted EPS | $1.61 | $1.88 | $2.40 | $5.28 |
- Q3 net income was essentially unchanged year over year, while EPS fell 14.4%, primarily reflecting shares issued in the acquisition. Nine-month net income fell 51.5%; management attributed the decline mainly to one-time HVBC acquisition costs.
- Nine-month net interest income rose 10.5%. On a tax-equivalent basis, net interest margin was 3.25%, down from 3.39% a year earlier; the filing attributes the margin pressure chiefly to higher funding costs. Average interest-bearing asset yield rose to 4.91% from 3.78%, while the average rate paid on interest-bearing liabilities rose to 2.11% from 0.51%.
- Nine-month non-interest income increased 9.3%, including higher gains on loans sold and bank-owned life insurance income. Non-interest expense increased 48.4%, including $9.3 million of merger and acquisition costs; salaries and benefits also rose with added employees, compensation increases and higher health-care claims.
- Nine-month provision includes $4.6 million of day-one provision for acquired non-PCD loans. Excluding that amount, management said provision was lower than the comparable prior-year period.
- Q3 annualized return on assets and return on equity were 1.02% and 10.10%, respectively, compared with 1.31% and 13.34% a year earlier. For the nine months, the respective figures were 0.53% and 5.21%, versus 1.27% and 12.77%.
Financial position, cash flow and credit
- At September 30, total assets were $2.96 billion, up $625.8 million from year-end 2022, mainly due to HVBC. Net loans were $2.225 billion, up $518.5 million; deposits were $2.335 billion, up $490.9 million; and borrowed funds were $316.2 million, up $58.9 million.
- Cash and cash equivalents were $43.3 million, compared with $26.2 million at year-end. For the first nine months, operating cash flow was $10.3 million, investing cash flow was positive $55.8 million and financing cash flow was negative $49.0 million. Cash increased $17.1 million.
- Available-for-sale securities were $417.8 million, down from $439.5 million at year-end. Gross unrealized losses were $52.3 million at quarter-end, and accumulated other comprehensive loss was $36.6 million. Management cited rising longer-term rates as a factor in securities valuation losses.
- The loan allowance was $21.5 million, or 0.96% of loans, compared with $18.6 million, or 1.08%, at year-end. Total allowance including off-balance-sheet exposures was $22.7 million. Nine-month net charge-offs were $0.8 million. Non-performing loans were $13.1 million, up from $6.9 million at year-end; non-performing assets totaled $13.6 million.
- Management reported that five customer relationships represented 54.7% of non-performing loans and required a $286,000 specific reserve. One construction-related relationship was identified as requiring that reserve. Management stated it believed the allowance was adequate, while noting that economic deterioration, collateral declines or other changes in assumptions could require additional provision.
- Stockholders’ equity was $262.7 million, up from $200.1 million at year-end, substantially reflecting $60.1 million of acquisition shares. The bank’s community bank leverage ratio was 8.64% at September 30; the filing says it must reach 9.0% by the end of Q1 2024 to be considered well-capitalized under that framework.
Liquidity, outlook, risks and unusual items
- Management said liquidity needs were being met through cash, core deposits, Federal Home Loan Bank (FHLB) financing, correspondent federal funds lines and maturing investments and loans. Reported capacity included approximately $1.10 billion of FHLB borrowing capacity, $34.0 million of undrawn federal funds lines and a $54.5 million undrawn Federal Reserve Bank Term Funding Program line. The company also had a $20.0 million credit line, of which $17.5 million was used.
- Deposits excluding HVBC declined $42.4 million from year-end. Estimated deposits above the FDIC insurance limit were $1.08 billion, or 46.4% of total deposits; the company noted that $491.6 million of deposits were covered through the Intrafi network or collateralized, primarily municipal deposits. Brokered deposits were $80.9 million at quarter-end.
- The filing gives no specific earnings, revenue or margin guidance. Management described its securities strategy as using portfolio cash flows to repay overnight borrowings and timing purchases with regard to interest-rate ranges. It stated that it expected identified funding sources to meet obligations and commitments.
- The company’s interest-rate simulation estimated prospective one-year net interest income of $87.9 million in the base case; a parallel +400-basis-point shock reduced the estimate by 9.51%, while a -400-basis-point shock increased it by 6.64%. Management cautioned that model assumptions mean actual results may differ materially.
- Key disclosed risks include changing interest rates, funding costs and access, uninsured deposit balances and depositor confidence, loan delinquencies and concentrations, economic and agricultural conditions, acquisition integration, fraud and information theft, regulatory changes, and potential effects of U.S. debt-ceiling or credit-rating disruption on securities values and funding costs. The company reported no material change to its previously disclosed risk factors and no material pending litigation known to management.
- Unusual items include $9.3 million of nine-month acquisition expenses, the $4.6 million acquisition-related non-PCD credit provision, and approximately $0.2 million of income associated with a life-insurance death benefit. The filing also states that the company received $1.1 million of life-insurance proceeds in Q3.
Important facts for investors to verify
- Track post-acquisition earnings, expense reductions or integration progress, and the extent to which results depend on HVBC versus organic growth.
- Monitor deposit retention, deposit pricing, uninsured and brokered deposit levels, borrowing utilization and funding costs.
- Review loan delinquencies, non-performing exposures and concentrations, acquired-loan performance, charge-offs, and the adequacy and assumptions of the CECL allowance.
- Assess the path to a 9.0% community bank leverage ratio by Q1 2024 and any implications for capital flexibility or distributions.
- Evaluate sensitivity to interest rates and the size and duration of unrealized securities losses, including potential liquidity or capital effects.
- Reconcile expense figures: the primary income statement reports Q3 and nine-month non-interest expense of $16.444 million and $48.902 million, while MD&A tables give $16.579 million and $49.037 million. The filing text does not explain this difference.