Citizens Financial Services, Inc. — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013; unaudited. Citizens is a Pennsylvania bank holding company whose operations are primarily conducted through First Citizens Community Bank. It serves North Central Pennsylvania and Southern New York.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Interest income | $8.948m | $9.613m | $17.947m | $19.250m |
| Net interest income | $7.351m | $7.665m | $14.664m | $15.223m |
| Provision for loan losses | $0.075m | $0.105m | $0.225m | $0.210m |
| Non-interest income | $1.743m | $1.929m | $3.595m | $3.745m |
| Non-interest expense | $4.832m | $4.565m | $9.654m | $9.393m |
| Net income | $3.280m | $3.753m | $6.567m | $7.202m |
| Basic EPS | $1.08 | $1.23 | $2.17 | $2.35 |
Q2 net income fell 12.6%; first-half net income declined 8.8%. For the six months, annualized return on assets was 1.50% versus 1.63%, and return on equity was 14.99% versus 18.25%. Tax-equivalent net interest margin was 3.85% for Q2 and 3.87% for the six-month period, versus 4.03% and 4.04%, respectively, in 2012.
Financial condition, cash flow and liquidity
- At June 30, total assets were $879.1m, down 0.4% from year-end 2012. Net loans were $508.7m, up 2.6%; deposits were $748.0m, up $10.9m; and borrowed funds were $34.0m, down $12.1m.
- Cash and cash equivalents declined $14.8m to $11.6m. First-half cash from operations was $8.6m, investing activities used $20.1m, and financing activities used $3.3m. Management said liquidity needs were supported by cash, core deposits, maturing assets and borrowing access. The Bank had $19.2m outstanding against approximately $232.2m of FHLB borrowing capacity; a $10m federal funds line and approximately $13.8m Federal Reserve line were undrawn.
- Stockholders’ equity was $88.9m versus $89.5m at year-end. The decline reflected, in large part, a $5.3m reduction in accumulated other comprehensive income from investment-market-value changes. First-half comprehensive income was $1.2m.
- The Company reported capital ratios above regulatory “well-capitalized” thresholds: holding-company total risk-based capital was 17.95% and Tier 1 leverage was 10.18%; Bank ratios were 17.35% and 9.82%, respectively.
- Annualized net charge-offs were 0.01% of average loans. Nonperforming loans were $8.5m, or 1.64% of loans, and nonperforming assets were $9.1m, or 1.77%. The allowance was $7.0m, or 1.36% of loans, compared with $6.8m, or 1.35%, at year-end.
Material changes and management commentary
- Lower yields were the principal pressure on net interest income: the average yield on earning assets declined, while the low-rate environment led to repricing of loans and securities. Lower deposit costs and reduced borrowing balances partly offset the decline.
- Commercial and agricultural loan balances grew; management cited a focus on commercial, agricultural and municipal lending. Total loans increased $13.3m in the first half. Management also retained $4.3m of qualifying 15-year residential mortgages rather than selling them.
- Non-interest income declined 4.0% in the first half, including lower service charges and loan-sale gains. Management attributed lower service-charge revenue partly to debit-card regulation and reduced Marcellus Shale-related activity. Non-interest expense rose 2.8%, with higher salaries and benefits tied to merit increases and increased staffing.
- Available-for-sale securities were $307.9m. Their net unrealized position shifted materially: the portfolio had $5.7m gross unrealized gains and $3.8m gross unrealized losses at June 30; management attributed declines to market-rate and other non-credit factors and concluded impairment was not other-than-temporary. A $5.3m after-tax first-half OCI loss principally reflected securities valuation changes.
- Management identified local unemployment and reduced Marcellus Shale exploration as factors in its allowance assessment. It also increased certain qualitative credit-risk factors because of participations purchased from other banks and differing underwriting standards.
- Four customer relationships represented approximately 82.7% of nonperforming loans. One $4.3m commercial relationship, current under a restructured payment agreement at June 30, filed for Chapter 11 bankruptcy in July 2013; the Bank was evaluating possible effects on collateral and payments. Management stated that the allowance was adequate, while noting future adjustments could be needed if assumptions or conditions change.
- The company paid $1.7m in first-half cash dividends and reported a five-percent stock dividend with a stated issuance-date market value of $7.2m. It had also accelerated a $1.1m first-quarter 2013 cash dividend into 2012, citing potential tax changes.
Outlook, risks and contingencies
The filing provides no specific earnings or revenue guidance. Management cautioned that first-half results are not necessarily indicative of full-year results. Principal risks cited include changing interest rates, economic conditions and borrower repayment capacity, securities-market disruption, loan delinquencies and credit losses, regulatory or legal changes, competition, and the local economy’s exposure to Marcellus Shale activity, natural-gas prices and related regulation. The company disclosed $92.7m of commitments to extend credit and $3.2m of standby letters of credit, in addition to $12.6m of noncontractual overdraft exposure. Management reported no litigation expected to have a material adverse effect and no material change in risk factors from its 2012 Form 10-K.
Key facts for investors to verify
- Developments in the July 2013 Chapter 11 filing involving the $4.3m commercial borrower, including payment performance, collateral values and any reserve implications.
- Whether the concentration of nonperforming loans in four customer relationships and the adequacy of the $7.0m allowance change as credit conditions evolve.
- Trends in net interest margin, loan and securities yields, deposit pricing, and the effect of further interest-rate changes on earnings and securities values.
- Whether local unemployment and reduced natural-gas exploration affect borrowers, loan growth, deposit flows and credit quality.
- Cash and liquidity trends, including the funding of loan growth, undrawn borrowing facilities and the effect of securities-market valuation changes on equity.