Citizens Financial Services, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. The Pennsylvania-based company operates through First Citizens Community Bank and related subsidiaries, serving Pennsylvania and southern New York. Financial statements are unaudited; amounts below are in millions unless noted.
Financial performance and condition
| Metric | Q2 2017 / June 30 | Comparable period / prior year-end |
|---|---|---|
| Net income | $3.47; diluted EPS $1.00 | Q2 2016: $3.03; diluted EPS $0.86 |
| Six-month net income | $6.77; diluted EPS $1.95 | Six months 2016: $6.31; diluted EPS $1.80 |
| Net interest income | Q2: $10.40; six months: $20.40 | Q2 2016: $9.17; six months 2016: $18.38 |
| Net interest margin, tax-equivalent | Q2: 3.82%; six months: 3.79% | Q2 and six months 2016: 3.62% |
| Total assets | $1,264.9 | $1,223.0 at December 31, 2016 |
| Loans, gross / net | $888.0 / $878.1 | $799.6 / $790.7 at December 31, 2016 |
| Deposits | $1,051.2 | $1,005.5 at December 31, 2016 |
| Borrowed funds | $70.0 | $79.7 at December 31, 2016 |
| Stockholders’ equity | $127.8 | $123.3 at December 31, 2016 |
- Profitability: Q2 net income rose 14.4% year over year; six-month net income increased 7.2%. Annualized Q2 ROA and ROE were 1.12% and 10.80%; six-month figures were 1.10% and 10.63%.
- Credit costs: Provision for loan losses was $0.63 in Q2 versus $0.14 a year earlier, and $1.24 for the first half versus $0.27. The allowance was $9.98, or 1.12% of gross loans, at June 30.
- Cash flow and liquidity: First-half operating cash flow was $9.79; investing activities used $41.29, principally reflecting $88.47 of net loan growth; financing activities provided $33.10. Cash and cash equivalents ended at $19.36, up $1.61 from year-end.
- Capital: Company total risk-based capital was 14.32%, Tier 1 risk-based capital 13.17%, common equity Tier 1 12.33%, and Tier 1 leverage 9.55%. The company and bank were categorized as well capitalized.
Material changes versus comparable periods
- Growth in commercial and agricultural lending drove much of the earnings and balance-sheet expansion. Gross loans rose 11.1% from year-end, including agricultural real estate loans up 52.5% and commercial real estate loans up 7.4%. Management attributed loan growth in part to lending teams hired for central and south-central Pennsylvania markets.
- Net interest income increased as higher loan volumes more than offset lower average loan yields. Tax-equivalent net interest margin improved 17 basis points for the first half. The securities portfolio declined $38.8, as portfolio cash flows were used to support loan growth.
- Noninterest income was nearly flat for the first half, up 0.6% to $3.92; Q2 declined 4.8% to $1.89. First-half noninterest expense rose 1.0% to $14.36, including an 11.1% increase in salaries and benefits, partly offset by lower other and foreclosed-property expenses.
- Nonperforming loans increased $0.46, or 3.9%, from year-end to $12.32; nonperforming assets were $13.52. The allowance increased from $8.89 to $9.98, reflecting a $1.24 provision and $0.15 in net charge-offs.
Outlook, risks, contingencies, and unusual items
- No specific earnings or revenue guidance is provided. Management cautions that first-half performance is not necessarily indicative of full-year results, and says liquidity needs are expected to be met through cash, core deposits, FHLB funding, correspondent lines, and portfolio cash flows and maturities.
- On July 27, 2017, after quarter-end, the company agreed to acquire S&T Bank’s State College, Pennsylvania office, subject to regulatory approval.
- Credit risk warrants attention: one dairy-industry loan concentration totaled $130.0, or 14.6% of loans. Management reported that 61.9% of nonperforming loans were associated with three customer relationships, including borrowers affected by weak natural-gas-related activity, bankruptcy litigation, and agricultural operating issues. One of these relationships had a $0.10 specific reserve; the other two had none at June 30. Management considered the allowance adequate but noted estimates could change with economic conditions, collateral values, or examination findings.
- Other disclosed risks include interest-rate changes, local and regional economic weakness, agricultural volatility, competition, fraud and information theft, regulatory change, and exposure of some customers to natural-gas activity. The company’s interest-rate model estimated one-year net interest income declines of 2.41% under a +100-basis-point shock and 8.07% under +300 basis points; modeled outcomes depend on assumptions and may differ from actual results.
- Off-balance-sheet commitments to extend credit were $198.7 and standby letters of credit $15.5. Management reported no pending or threatened litigation expected to materially adversely affect the company, while separately disclosing ongoing bankruptcy-court proceedings involving a nonperforming borrower.
- The company issued a 5% stock dividend during the first half, reported at a market value of $9.0, and paid $2.9 in declared cash dividends. It repurchased 1,995 shares during Q2 under its existing buyback authorization.
Most important facts for investors to verify
- Whether rapid commercial and agricultural loan growth can be sustained without further deterioration in credit quality or materially higher loan-loss provisions.
- Performance, collateral coverage, and resolution progress for the three borrower relationships that comprise most nonperforming loans, plus exposure to the dairy and natural-gas-related sectors.
- Whether deposit growth and funding costs continue to support lending growth, and how securities runoff and borrowing levels affect liquidity and net interest margin.
- Regulatory approval and expected terms or financial effect of the proposed State College office acquisition.
- Capital, dividend capacity, and the eventual effects of new accounting standards, particularly the expected-credit-loss standard; the filing says its impact cannot yet be quantified.