Citizens Financial Services, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Unaudited consolidated results; amounts below are in U.S. dollars. The company is a community bank holding company whose primary subsidiary is First Citizens Community Bank. The MidCoast acquisition closed April 17, 2020, adding operations in Wilmington and Dover, Delaware.
Financial performance and position
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest income | $16.47m | $12.90m | $45.65m | $37.15m |
| Provision for loan losses | $0.55m | $0.40m | $1.50m | $1.15m |
| Noninterest income | $3.54m | $2.18m | $7.46m | $6.24m |
| Noninterest expense | $9.69m | $8.41m | $30.03m | $24.97m |
| Net income | $8.01m | $5.20m | $17.88m | $14.45m |
| Basic EPS | $2.04 | $1.46 | $4.74 | $4.06 |
- Net income increased 54.1% in Q3 and 23.7% for the first nine months. Management reported nine-month annualized return on assets of 1.43% and return on equity of 13.85%, versus 1.33% and 12.99%, respectively, in 2019.
- Tax-equivalent net interest margin was 3.88% in Q3 versus 3.82%; for nine months it was 3.96% versus 3.71%. Management attributed the improvement primarily to lower funding costs and higher average loans; lower asset yields partly offset these factors.
- At September 30, assets were $1.858bn, loans net of allowance were $1.351bn, deposits were $1.553bn, borrowed funds were $99.6m, and stockholders’ equity was $189.1m. Compared with December 31, 2019, assets increased $392.0m, deposits $341.6m, and net loans $249.0m, largely reflecting MidCoast, PPP lending, and pandemic-related deposit growth.
- Cash and cash equivalents were $75.3m, up from $18.5m at year-end. Nine-month operating cash flow was negative $2.4m versus positive $15.8m in 2019; investing cash outflow was $66.2m and financing cash inflow was $125.3m. Management cited available cash, core deposits, FHLB financing, correspondent lines, and maturing investments and loans as liquidity sources.
- The allowance for loan losses was $15.2m, or 1.11% of loans, compared with $13.8m, or 1.24%, at year-end. Nonperforming loans were $12.9m versus $12.0m; nonperforming assets were $15.6m versus $15.4m. Nine-month net charge-offs were 0.02% of average loans.
- The Bank reported an 8.66% community bank leverage ratio and stated it was well-capitalized under the applicable framework.
Material changes and notable items
- MidCoast added $223.2m of loans and approximately $208.8m of deposits at acquisition. The company issued 373,356 shares and paid approximately $7.6m cash; recorded goodwill was $8.1m. MidCoast contributed $5.4m net interest income and $3.0m net income from acquisition through September 30.
- Loan growth included $53.9m of PPP loans outstanding at quarter-end. The 591 PPP loans bear 1% interest, are SBA-guaranteed, and may be forgiven subject to program requirements. Approximately $2.1m of processing fees were deferred and are to be amortized over loan lives.
- Noninterest income growth included higher gains on residential mortgage loan sales and $302,000 of securities gains; service charges declined. Noninterest expense rose 20.2% for the nine-month period, including $2.18m of MidCoast merger and acquisition costs, higher staffing and occupancy costs, and a pension-plan settlement item.
- The company entered into interest-rate swaps during 2020 to convert floating-rate debt to fixed-rate debt; their reported fair value was a $448,000 liability at September 30.
- Available-for-sale securities were $287.8m, including $7.3m of net unrealized gains. Management said securities with unrealized losses were not considered other-than-temporarily impaired.
Outlook, risks, and contingencies
- The filing provides no specific earnings or financial guidance. Management cautioned that interim results are not necessarily indicative of full-year results.
- COVID-19 remains a significant uncertainty. The company had modified 534 loans totaling $205.1m; 12 loans totaling $20.2m remained under modified terms at September 30, with most scheduled to mature by year-end. Management cited heightened credit concerns, particularly for hospitality and agriculture, and increased its loan-loss provision in response to economic conditions and unemployment.
- Reported industry exposures included hotels and motels of $41.4m, restaurants of $27.7m, amusement/theme parks of $13.8m, and agricultural lending of $351.5m. Dairy loans totaled $143.0m, or 10.5% of loans. Four customer relationships represented 57.7% of nonperforming loans; specific reserves associated with those relationships totaled approximately $214,000.
- Other stated risks include borrower repayment and collateral deterioration, interest-rate and market volatility, acquisition integration, competition, operational and cybersecurity risks, and regional economic conditions. The Bank had $310.9m of commitments to extend credit and standby letters of credit at quarter-end.
- The company, which qualifies as a smaller reporting company, expects to adopt the current expected credit losses standard after its deferred effective date; it could not yet estimate the impact and noted adoption may increase the allowance.
- Management reported no material litigation, no material change in risk factors other than the added COVID-19 discussion, and effective disclosure controls. No material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether remaining COVID-19 loan modifications, delinquencies, nonaccruals, and the four concentrated problem relationships lead to additional credit losses or reserve needs.
- How much earnings growth is sustainable after separating MidCoast contributions, acquisition costs, PPP fee income, mortgage-sale gains, securities gains, and swap-related effects.
- Whether deposit growth and available funding capacity remain adequate as customer cash balances and credit commitments change.
- The adequacy of capital under changing regulatory thresholds and the effects of acquisition integration and future CECL adoption.
- Whether management’s stated liquidity and interest-rate risk assumptions remain valid; the filing’s rate-shock analysis estimates prospective one-year net interest income declines of 1.34% to 6.13% for rate increases of 100 to 400 basis points.