Citizens Financial Services, Inc. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing also reports fourth-quarter results. Citizens is a Pennsylvania bank holding company operating First Citizens Community Bank and an insurance agency, primarily in Pennsylvania and southern New York.
Financial performance and condition
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Net income | $18.0 million | $13.0 million | Up 38.5% |
| Basic and diluted EPS | $5.14 | $3.70 | Up from $3.70 |
| Net interest income | $47.2 million | $42.3 million | Up $4.9 million |
| Tax-equivalent net interest margin | 3.66% | 3.80% | Down 14 basis points |
| Provision for loan losses | $1.9 million | $2.5 million | Down $0.6 million |
| Non-interest income | $7.7 million | $8.7 million | Down $0.9 million |
| Non-interest expense | $31.6 million | $29.3 million | Up 7.7% |
- Fourth-quarter 2018 net income was $4.5 million, or $1.29 per diluted share, versus $2.6 million, or $0.74 per diluted share, in fourth-quarter 2017.
- Net interest income growth reflected higher loan balances and income; rising deposit and borrowing costs pressured margin. Interest expense increased to $9.6 million from $5.8 million.
- Lower non-interest income primarily reflected the absence of 2017’s $1.0 million net securities gain; 2018 recorded a $19,000 net securities loss. Higher compensation and professional/legal fees contributed to expense growth.
- Effective tax rate fell to 15.9% from 31.7%, principally reflecting the federal corporate tax rate reduction to 21%; 2017 also included a $1.5 million charge to revalue deferred tax assets.
- Year-end total assets were $1.43 billion, loans $1.08 billion, deposits $1.19 billion, borrowings $91.2 million, and stockholders’ equity $139.2 million. Loans grew 8.1%, deposits 7.3%, and borrowings fell 20.5% year over year.
- Operating cash flow was $21.5 million; investing activities used $72.4 million, mainly due to $81.1 million of net loan growth. Financing activities provided $49.1 million. Cash and cash equivalents ended at $16.8 million, down from $18.5 million.
- Capital ratios exceeded well-capitalized thresholds: total risk-based capital was 13.42% at the Company and 12.82% at the Bank; Tier 1 leverage was 9.15% and 8.70%, respectively. Return on assets was 1.29% and return on equity 13.00%.
Changes, outlook, and material risks
- Loan growth was concentrated in agricultural, commercial real estate, and construction lending. Agriculture represented 30.2% of loans; dairy-industry loans were 14.3%. Management identified weak milk prices and local agricultural conditions as credit concerns.
- Nonperforming loans rose to $13.8 million from $10.7 million, with two agricultural relationships among the principal drivers. Nonperforming assets were 1.33% of loans and allowance coverage of nonperforming loans was 93.4%, versus 104.3% a year earlier. Management considered the $12.9 million allowance adequate.
- Four borrower relationships represented 68.7% of nonperforming loans. Risks include depressed dairy prices, natural-gas-related economic exposure, municipal funding and deposit sensitivity, loan concentrations, and potential further credit deterioration.
- Management reported a flattening and partial inversion of the yield curve and anticipated possible additional margin pressure. Its interest-rate model projected net interest income declines of 3.05% under a +100-basis-point shock and 6.54% under +200 basis points; management said modeled scenarios remained within policy limits.
- Liquidity sources include deposits, cash, securities, FHLB capacity of approximately $518.4 million, and $34.0 million of federal-funds lines. The filing states management expected available sources to meet obligations and commitments; parent-company liquid assets were $5.6 million.
- No specific earnings or growth guidance was provided. Management expected comparable cash dividends to continue, subject to earnings, capital, legal and regulatory limits. The 2018 dividend was $1.74 per share; payout ratio was 34.1%.
- Expected accounting changes include approximately $1.5 million each in right-of-use assets and lease liabilities on adoption of the lease standard in 2019. The company could not estimate the impact of the expected-credit-loss standard, effective for it after December 15, 2019, and anticipated a one-time allowance adjustment.
- A bankruptcy-related lawsuit settlement was approved in March 2019; the Bank was to receive property titles in lieu of additional payments and was evaluating fair value and allowance implications. Management said pending proceedings were not expected to materially affect financial condition or results, while acknowledging unexpected outcomes could be material.
- The auditor issued unqualified opinions on the financial statements and internal controls. Management reported effective disclosure controls and no identified material weaknesses.
Investor verification priorities
- Track performance and collateral recovery for the nonperforming agricultural and commercial relationships, including the 2019 deed-in-lieu settlement and associated allowance estimates.
- Assess dairy and broader agricultural credit exposure, commercial real estate and construction concentrations, and the adequacy of the allowance as the portfolio grows.
- Monitor deposit pricing, funding mix, margin sensitivity to rate changes, and whether the yield curve or competition further raises funding costs.
- Verify the pace and quality of loan growth, deposit growth, and returns from newer central and south-central Pennsylvania markets.
- Review the eventual CECL transition estimate and the actual balance-sheet effect of lease-standard adoption; neither impact was fully quantified in the filing.
- Confirm dividend capacity and parent-company liquidity, given reliance on Bank dividends and regulatory restrictions.