Citizens Financial Services - 10-Q quarterly report FY

                                        (Mark One)

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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes____ No __X__

The number of shares outstanding of the Registrant's Common Stock, as of November 6, 2006; 2,826,970 shares of Common Stock, par value $1.00.

 

 

 

Citizens Financial Services, Inc.

Form 10-Q

INDEX

 

 

 

 

Citizens Financial Service, Inc., (the “Company”) is a Pennsylvania corporation organized as the holding company of its wholly owned subsidiary, First Citizens National Bank (the “Bank”), and its subsidiary, First Citizens Insurance Agency, Inc. (sometimes collectively referred to herein as the “Company”). All material inter-company balances and transactions have been eliminated in consolidation.

The accompanying consolidated financial statements have been prepared pursuant to rules and regulations of the Securities and Exchange Commission (“SEC”) and in conformity with U.S. generally accepted accounting principles. Because this report is based on an interim period, certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted.

In the opinion of Management of the registrant, the accompanying interim financial statements for the quarters ended September 30, 2006 and 2005 include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the financial condition and the results of operations for the period. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. The financial performance reported for the Company for the nine-month period ended September 30, 2006 is not necessarily indicative of the results to be expected for the full year. This information should be read in conjunction with the Company’s Annual Report to Shareholders and Form 10-K for the period ended December 31, 2005.

The following table sets forth the computation of earnings per share. Earnings per share calculations give retroactive effect to stock dividends declared by the Company. The Company has no dilutive securities.

Income tax expense is less than the amount calculated using the statutory tax rate, primarily the result of tax-exempt income earned from state and municipal securities and loans, and investments in tax credits.

For a detailed disclosure on the Company's pension and employee benefits plans, please refer to Note 10 of the Company's Consolidated Financial Statements included in the 2005 Annual Report on Form 10-K.

 

The following sets forth the components of net periodic benefit costs of the noncontributory defined benefit plan for the nine months ended September 30, 2006 and 2005, respectively (dollars presented in thousands):

The Company expects to contribute $442,000 to its defined benefit pension plan in 2006. As of September 30, 2006, no contributions have been made.

The Company also sponsors a defined contribution, 401(k) plan covering substantially all of its employees. The Company contributes three percent of applicable salaries into the plan. Contributions totaled $141,000 and $145,000 for the nine months ended September 30, 2006 and 2005, respectively.

 

 

 

Forward-looking statements may prove inaccurate. We have made forward-looking statements in this document, and in documents that we incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of operations of Citizens Financial Services, Inc., First Citizens National Bank, First Citizens Insurance Agency, Inc. or the combined company. When we use such words as "believes," "expects,” "anticipates," or similar expressions, we are making forward-looking statements. For a variety of reasons, actual results could differ materially from those contained in or implied by forward-looking statements. The Company would like to caution readers that the following important factors, among others, may have affected and could in the future affect the Company’s actual results and could cause the Company’s actual results for subsequent periods to differ materially from those expressed in any forward looking statement:

 

The following is management's discussion and analysis of the significant changes in the results of operations, capital resources and liquidity presented in its accompanying consolidated financial statements for Citizens Financial Service, Inc., a bank holding company and its subsidiary (the Company). Our Company's consolidated financial condition and results of operations consist almost entirely of our wholly owned subsidiary’s (First Citizens National Bank) financial condition and results of operations. Management’s discussion and analysis should be read in conjunction with the preceding September 30, 2006 financial information. The results of operations for the nine months ended September 30, 2006 are not necessarily indicative of the results you may expect for the full year.

Our Company currently engages in the general business of banking throughout our service area of Potter, Tioga and Bradford counties in North Central Pennsylvania and Allegany, Steuben, Chemung and Tioga counties in Southern New York. We maintain our central office in Mansfield, Pennsylvania. Presently we operate 16 banking facilities. In Pennsylvania, these offices are located in Mansfield, Blossburg, Ulysses, Genesee, Wellsboro, Troy, Sayre, Canton, Gillett, Millerton, LeRaysville, Towanda, the Wellsboro Weis Market store and the Mansfield Wal-Mart Super Center. In New York, we have completed construction of our first de novo branch office in the town of Wellsville. We began doing business in the new facility on October 30, 2006. This marks the Company’s first office location in New York.

 

Risk identification and management are essential elements for the successful management of the Company. In the normal course of business, the Company is subject to various types of risk including interest rate, credit, liquidity and regulatory risk.

Interest rate risk is the sensitivity of net interest income and the market value of financial instruments to the direction and frequency of changes in interest rates. Interest rate risk results from various re-pricing frequencies and the maturity structure of the financial instruments owned by the Company. The Company uses its asset/liability and funds management policy to control and manage interest rate risk.

Credit risk represents the possibility that a customer may not perform in accordance with contractual terms. Credit risk results from loans with customers and the purchasing of securities. The Company’s primary credit risk is in the loan portfolio. The Company manages credit risk by adhering to an established credit policy and through a disciplined evaluation of the adequacy of the allowance for loan losses. Also, the investment policy limits the amount of credit risk that may be taken in the investment portfolio.

Liquidity risk represents the inability to generate or otherwise obtain funds at reasonable rates to satisfy commitments to borrowers and obligations to depositors. The Company has established guidelines within its asset/liability and funds management policy to manage liquidity risk. These guidelines include, among other things, contingent funding alternatives.

Regulatory risk represents the possibility that a change in law, regulations or regulatory policy may have a material effect on the business of the Company and its subsidiary. We can not predict what legislation might be enacted or what regulations might be adopted, or if adopted, the effect thereof on our operations.

Readers should carefully review the risk factors described in other documents our Company files from time to time with the Securities and Exchange Commission, including the Annual Report for the year ended December 31, 2005, filed by our Company and any current reports on Form 8-K filed by us.

We face strong competition in the communities that we serve from other commercial banks, savings banks, and savings and loan associations, some of which are substantially larger institutions than our subsidiary. In addition, insurance companies, investment-counseling firms, and other business firms and individuals offer personal and corporate trust services. We also compete with credit unions, issuers of money market funds, securities brokerage firms, consumer finance companies, mortgage brokers and insurance companies. These entities are strong competitors for virtually all types of financial services.

In recent years, the financial services industry has experienced tremendous change to competitive barriers between bank and non-bank institutions. We must compete with traditional financial institutions, other business corporations that have begun to deliver competing financial services, and banking services that are easily accessible through the internet. Competition for banking services is based on price, nature of product, quality of service, and in the case of certain activities, convenience of location.

Our Investment and Trust Services Department is committed to helping our customers meet their financial goals. The Trust Department offers professional trust administration, investment management services, estate planning and administration, and custody of securities. We also help the members of our communities prepare for retirement by providing retirement plans for local employers and by managing individual IRA accounts. Assets held by the Company in a fiduciary or agency capacity for its customers are not included in the consolidated financial statements since such items are not assets of the Company. As of September 30, 2006 and December 31, 2005, the Trust Department had $78.4 million and $75.2 million of assets under management, respectively.

Our Investment Representatives offer full service brokerage services throughout the Bank’s market area, and appointments can be made at any First Citizens National Bank branch. The Investment Representatives provide financial planning and help our customers achieve their financial goals with their choice of mutual funds, annuities, health and life insurance. These products are made available through our insurance subsidiary, First Citizens Insurance Agency, Inc.

 

The Company had net income of $4,310,000 for the first nine months of 2006 compared with earnings of $3,898,000 for last year’s comparable period, an increase of $412,000, or 10.6%. Earnings per share for the first nine months of 2006 were $1.51, compared to $1.35 last year. Annualized return on assets and return on equity for the nine months of 2006 was 1.06% and 13.18%, respectively, compared with 1.03% and 12.53% for last year’s comparable period. Details of the reasons for this change are discussed on the following pages.

Net interest income, the most significant component of earnings, is the amount by which interest income generated from interest-earning assets exceeds interest expense on interest-bearing liabilities.

Net interest income, through the third quarter of 2006, after provision for loan losses, was $13,087,000 a decrease of $81,000, compared to the same period in 2005. For the first nine months of 2006, the provision for losses totaled $225,000. For the first nine months of 2005, the provision was $30,000.

 

 

 

 

 

 

Tax exempt revenue is shown on a tax-equivalent basis for proper comparison using a statutory, federal income tax rate of 34%. For purposes of the comparison, as well as the discussion that follows, this presentation facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Company’s 34% Federal statutory rate. The following table represents the adjustment to convert net interest income to net interest on a fully tax equivalent basis for the periods ending September 30, 2006, 2005 and 2004:

 

 

The following table shows the tax-equivalent effect of changes in volume and rate on interest income and expense.

 

 

 

As can be seen from the preceding tables, we continue to experience a compression of our net interest margin. During 2006, the Federal Reserve has continued its policy of monetary tightening by raising short-term interest rates. Although the Federal Reserve has not increased rates in the third quarter, they have increased short-term interest rates 425 basis points since June of 2004. Accordingly, our cost of funds (interest paid on deposits and borrowings) has increased significantly. During this same period, long-term rates have remained relatively stable, resulting in a flattening of the yield curve. The rates earned on interest bearing assets have also increased during this period, but have not increased by the same magnitude. As such, our net interest spread has decreased from 3.72% for the first nine months of 2005 to 3.44% for the first nine months of 2006. We would anticipate our interest margin improving as the yield curve returns to a more normal slope. We continue to review various pricing and investment strategies to enhance our current deposit growth while maintaining or improving the current interest margin.

 

 

Tax equivalent net interest income rose from $13,642,000 in 2004 to $14,004,000 in 2005, and increased to $14,319,000 in 2006. In the period ending September 30, 2006, net interest income increased $315,000 on a tax equivalent basis over the same period in 2005. The increased volume of interest-earning assets of $38.0 million generated an increase in interest income of $2,112,000 while the increased volume of interest-bearing liabilities of $34.3 million produced an additional $1,281,000 of interest expense. Combined, this resulted in an increase due to volume of $831,000 in net interest income.

 

 

Comparing the first nine months of 2006 with 2005, the yield on interest-earning assets increased 36 basis points from 6.30% to 6.66% and the average interest rate on interest-bearing liabilities increased 64 basis points, from 2.58% to 3.22%. As such, the net change in rate resulted in a negative $516,000 of net interest income primarily due to the flattened yield curve referred to above.

 

    For the nine-month period ending September 30, 2006, we charged $225,000 to the provision as a result of our quarterly review of the allowance for loan losses, which compares to $30,000 for the same period last year. The increase is primarily attributable to continued loan growth. Management's quarterly review of the allowance for loan losses is based on the following information: migration analysis of delinquent and non-accrual loans, estimated future losses on loans, recent review of large problem credits, local and national economic conditions, historical loss experience, OCC qualitative factors and peer comparisons.

 

 

 

 

The tables below reflect the breakdown of non-interest expense and professional fees for the three months ended and the nine months ended September 30, 2006 (dollars in thousands). For the three months ended September 30, 2006 compared to last year, expenses decreased $123,000. Most of this decrease is attributable to a decrease in the amortization of intangibles, as the core deposit intangible related to the Sovereign acquisition in 2000 was fully amortized as of the end of March, 2006. Salaries and benefits increased by $62,000 for the three months ended September 30, 2006 compared to 2005 mainly due to increases in insurance, pension expense, and merit increases. Professional fees modestly decreased by $7,000 compared to 2005.