SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15 (D) FOR THE NINE MONTH PERIOD ENDED: SEPTEMBER 30, 1996 COMMISSION FILE NUMBER: 0-16084 CITIZENS AND NORTHERN CORPORATION STATE OF INCORPORATION: PENNSYLVANIA I.R.S. EMPLOYER IDENTIFICATION NUMBER: 23-2451943 REGISTRANT'S TELEPHONE NUMBER (INCLUDING AREA CODE) : 717-724-3411 ADDRESS OF PRINCIPAL EXECUTIVE OFFICE: THOMPSON STREET RALSTON, PA 17763 MAILING ADDRESS OF EXECUTIVE OFFICE: 90-92 MAIN STREET WELLSBORO, PA 16901 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15 (D) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such report), and (2) has been subject to such filing requirements for the past 90 days. Yes x No As of October 1, 1996 5,117,182 COMMON SHARES WERE OUTSTANDING 1
CITIZENS AND NORTHERN CORPORATION - FORM 10-Q Part I - Financial Information Item 1. - Financial Statements CONSOLIDATED BALANCE SHEET Unaudited Audited (In Thousands) September 30, December 31, 1996 1995 ASSETS Cash & Due From Banks 16,835 12,945 Interest Bearing Deposits 712 645 Available-for-Sale Securities: US Treasury Securities 2,465 2,500 Securities of Other US Government Agencies 36,104 12,214 Mortgage Backed Securities 187,868 206,396 Obligations of States and Municipal Subdivisions 52,993 43,582 Other Securities 29,302 34,899 Total Available-for-Sale Securities 308,732 299,591 Held-to-Maturity Securities: US Treasury Securities 699 599 Mortgage Backed Securities 100 908 Securities of Other US Government Agencies 789 Total Held-to-Maturity Securities 1,588 1,507 Loans: Loans to Political Subdivisions 6,735 6,597 Other Loans 269,402 257,611 Total Loans 276,137 264,208 Less - Allowance for Possible Loan Losses (4,826) (4,579) Unearned Income (39) (26) Loans, Net 271,272 259,603 Bank Premises and Equipment 6,538 6,791 Other Real Estate 698 455 Accrued Interest on Bonds and Loans 4,493 4,058 Other Assets 1,206 392 TOTAL ASSETS 612,074 585,987 LIABILITIES Deposits: Demand 46,884 41,167 Interest Checking 40,976 43,180 Money Market 99,031 95,679 Savings 46,619 46,051 Other Time 196,367 203,475 Total Deposits 429,877 429,552 Dividends Payable 852 843 Borrowed Funds 59,000 45,000 Securities Sold Under Agreement to Repurchase 47,650 40,000 Other Liabilities 6,856 3,615 TOTAL LIABILITIES 544,235 519,010 SHAREHOLDERS' EQUITY Common Stock, Par Value $ 1.00 per Share 5,117 5,067 Authorized 10,000,000; Issued 5,117,182 and 5,066,516 in 1996 and 1995, respectively Stock Dividend Distributable 1,013 Paid in Capital 12,538 11,575 Retained Earnings 47,846 43,370 Total 65,501 61,025 Unrealized Gains (Losses) on Available-for-Sale Securities 3,338 6,952 Less: Treasury Stock at Cost 105,100 shares at September 30, 1996 (1,000) 104,060 shares at September 30, 1995 (1,000) TOTAL SHAREHOLDERS' EQUITY 67,839 66,977 TOTAL LIABILITIES & SHAREHOLDERS' EQUITY 612,074 585,987 Contingent Liabilities Under Unused Letters of Credit 2,671 2,633 The accompanying notes are an integral part of the financial statements. 2
CITIZENS AND NORTHERN CORPORATION - FORM 10-Q Part I - Financial Information (continued) Item 1. - Financial Statements (continued) CONSOLIDATED STATEMENT OF INCOME (In Thousands Except Share Data) <TABLE> <CAPTION> Three Months Ended Fiscal Year To Date September 30, 9 Months Ended September 30, 1996 1995 1996 1995 (Current) (Prior Year) (Current) (Prior Year) <S> <C> <C> <C> <C> INTEREST INCOME Interest and Fees on Loans 6,986 6,739 20,516 19,338 Interest on Balances with Depository Institutions 10 15 27 38 Interest on Loans to Political Subdivisions 106 107 318 315 Interest on Federal Funds Sold 1 59 64 Income from Available-for-Sale and Held-to-Maturity Securities: Taxable 4,000 3,939 12,059 11,259 Tax Exempt 785 693 2,226 1,992 Dividends 206 165 613 519 Total Interest and Dividend Income 12,094 11,658 35,818 33,525 INTEREST EXPENSE Interest on Deposits 4,521 4,772 13,290 14,186 Interest on Other Borrowings 1,415 1,492 4,218 4,308 Total Interest Expense 5,936 6,264 17,508 18,494 Interest Margin 6,158 5,394 18,310 15,031 Provision for Possible Loan Losses 175 184 525 552 Interest Margin After Provision for Possible Loan Losses 5,983 5,210 17,785 14,479 OTHER INCOME Service Charges on Deposit Accounts 289 286 847 842 Service Charges and Fees 70 73 200 204 Trust Department Income 227 178 615 562 Insurance Commissions, Fees and Premiums 134 164 402 477 Other Operating Income 7 8 34 37 Realized Gains on Available-for-Sale and Held-to-Maturity Securities, Net 183 378 451 1,229 Total Other Income 910 1,087 2,549 3,351 OTHER EXPENSES Salaries and Wages 1,484 1,368 4,406 4,096 Pensions and Other Employee Benefits 415 382 1,300 1,260 Occupancy Expense, Net 174 168 541 524 Furniture and Equipment Expense 181 176 546 486 Other Operating Expense 1,398 1,294 4,070 4,331 Total Other Expenses 3,652 3,388 10,863 10,697 Income Before Income Tax Provision 3,241 2,909 9,471 7,133 Income Tax Provision 875 840 2,439 1,671 NET INCOME 2,366 2,069 7,032 5,462 PER SHARE DATA: NET INCOME 0.47 0.41 1.40 1.09 NUMBER SHARES USED IN COMPUTATION 5,012,082 5,012,082 5,012,082 5,012,082 NUMBER SHARES ISSUED 5,117,182 5,066,516 5,117,182 5,066,516 NUMBER SHARES AUTHORIZED 10,000,000 10,000,000 10,000,000 10,000,000 DIVIDEND PER SHARE 0.17 0.16 0.51 0.48 </TABLE> 3
CITIZENS AND NORTHERN CORPORATION - FORM 10-Q Part I - Financial Information (continued) Item 1. - Financial Statements (continued) Nine Months Ended September 30, (In Thousands) 1996 1995 CASH FLOWS FROM OPERATING ACTIVITIES: Net Income 7,032 5,462 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities Provision for Possible Loan Losses 525 552 Realized (Gain), Loss on Available-for-Sale and Held-to-Maturity Securities, Net (451) (1,229) Provision for Depreciation 572 550 Accretion and Amortization 869 583 Deferred Income Tax (67) (18) (Increase) in Accrued Interest Receivable and Other Assets (1,182) (265) Increase in Accrued Interest Payable and Other Liabilities 5,112 5,375 Net Cash Provided by Operating Activities 12,410 11,010 CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from the Maturity of Held-to-Maturity Securities 118 126 Purchase of Held-to-Maturity Securities (199) (198) Proceeds from Sales of Available-for-Sale Securities 11,573 4,822 Proceeds from Maturities of Available-for-Sale Securities 28,844 25,884 Purchase of Available-for-Sale Securities (55,452) (53,811) Net Increase in Loans (12,194) (4,336) Purchase of Premises and Equipment (319) (243) Sale of Foreclosed Assets 212 241 Purchase of Other Real Estate (455) (428) Net Cash Used in Investing Activities (27,872) (27,943) CASH FLOWS FROM FINANCING ACTIVITIES: Net Increase in Deposits 325 26,079 Increase in Short Term Borrowings 7,650 27,150 Proceeds from (Repayment of) Long Term Borrowings 14,000 (33,500) Dividends Declared (2,556) (2,382) Net Cash Provided by Financing Activities 19,419 17,347 INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 3,957 414 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 13,590 12,407 CASH AND CASH EQUIVALENTS, END OF YEAR 17,547 12,821 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Interest Paid 13,567 14,030 Income Taxes Paid 2,599 1,606 The accompanying notes are an integral part of the consolidated financial statements. 4
CITIZENS AND NORTHERN CORPORATION - FORM 10-Q Part I - Financial Information (continued) Item 1. Financial Statements (continued) Notes to Consolidated Financial Statements 1. Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to form 10 - Q and Article 10 of regulation S-X. Accordingly, they do not include all the information and footnotes necessary for a comprehensive presentation of financial position and results of operations. It is management's opinion, however, that all material adjustments have been made which are necessary for a fair financial statement presentation. The results for the interim period are not necessarily indicative of the results to be expected for the year. For further information, refer to the consolidated financial statements and footnotes which are incorporated by reference in the Company's annual Report on Form 10-K for the year ended December 31, 1995. This document has not been reviewed or confirmed for accuracy or relevance by the Federal Deposit Insurance Corporation. 5
CITIZENS AND NORTHERN CORPORATION - FORM 10-Q Part I - Financial Information (continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations EARNINGS OVERVIEW The Corporation reported net income for the nine months ended September 30, 1996 of $ 7,032,000, or $1.40 per common share. This surpasses income reported for the same nine months in 1995 of $5,462,000 by $1,562,000 or $.31 per common share. The increase can be attributed to an increase in the net interest margin of 56 basis points during the nine months ended September 30, 1996, when compared to the same nine month period in 1995. The reported income exceeded budgeted estimates by approximately 27 percent. The directors and management of the Corporation expect that profits for the remainder of 1996 should be in the range of those recorded for the first nine months provided interest rates remain at the current levels. NET INTEREST MARGIN Quarters Ended September 30, 1996/1995 The net spread between the rate of return on earning assets and the cost of interest-bearing liabilities increased from 2.93 percent for the nine month period ended September 30, 1995 to 3.52 percent for the nine month period ended September 30, 1996. The net spread for the year ended December 31, 1995 was 2.99 percent. The gross rate of return on earning assets for the nine months ended September 30, 1996, year ended December 31, 1995 and nine months ended September 30, 1995 was 8.31 percent, 8.22 percent and 8.23 percent, respectively. The average cost of interest-bearing liabilities for the nine month period ended September 30, 1996, year ended December 31, 1995 and nine months ended September 30, 1995 was 4.79 percent, 5.23 percent and 5.30 percent, respectively. The 59 basis point increase in the net interest margin between the comparable nine month periods caused net interest income to increase $2,173,000; an additional $1,103,000 can be attributed to volume increases. The average rate of return on Available-for-Sale investments remained relatively unchanged during the periods being compared. However, the average balance for the nine months ended September 30, 1996 amounted to $305,462,000, increasing $21,202,000 between the two periods; this increase generated $1,047,000 in additional investment income. The average investment in Available-for-Sale investments for the year ended December 31, 1995 amounted to $287,069,000 and has increased just over $18,393,000 during the first nine months of 1996. The average rate of return for 1995 was 6.41 percent. Average gross loans for the periods ended September 30, 1996, December 31, 1995 and September 30, 1995 totaled $267,190,000, $259,143,000 and $256,455,000, respectively. The average rate of return on the loan portfolio posted a slight increase of 19 basis points since year-end 1995 and 18 basis points since September 30, 1995. The increase in interest income resulting from increased rates was $487,000. The increase in interest income caused by an increase in the volume of average outstanding loans amounted to $695,000. Loan growth has been relatively flat during the past year. Average total loans have increased $10,735,000, or 4.2 percent since September 30, 1995. The loan categories that did increase slightly were mortgage and commercial loans. The biggest single factor inhibiting loan growth is rate competition from other banks and non bank competitors. The competition will probably keep the average rate of return on the portfolio at its current level for the balance of 1996. On the liability side of the balance sheet, average total interest-bearing deposits increased 4.9 percent or $22,800,000 when comparing average balances for the periods ended September 30, 1996 and September 30, 1995. Average total interest-bearing deposits increased 4.5 percent or $21,007,000 between December 31, 1995 and September 30, 1996. All of the deposit growth has been in interest-bearing deposit categories as demand deposit liabilities have remained flat. Average balances carried in interest checking, passbook and statement savings accounts have declined slightly when comparing the nine month periods. The average balances in regular and statement savings accounts generally have been declining, although very slowly and not to an alarming extent, over the last few years. These accounts still carry substantial balances and are considered core deposits. Average interest checking account balances have declined $1,330,000 between September 30, 1995 and September 30, 1996. The reason for the decrease was a change in the rate schedule applied to these accounts. The rate paid on balances in these accounts prior to November 1, 1995 was 79 percent of the 91 day Treasury bill auction rate. After November 1, 1995 the rate was lowered to 50 percent of the auction rate; account balances of less than $2,500 will be paid 25 percent of the 91-day Treasury bill auction rate. The former rate was 39.5 percent of the auction rate. 6
Money market account average balances for the periods ended September 30, 1996, December 31, 1995 and September 30, 1995 amounted to $100,041,000, $91,773,000 and $90,410,000, respectively. The average rates paid on these balances for the respective periods were 4.52 percent, 4.93 percent and 5.11 percent. The rate paid on Money Market accounts is 90 percent of the 91-day Treasury bill auction rate and is one of the highest in our market area. The average balances carried in certificates of deposit increased significantly between the comparable periods. The respective average balance for the periods ended September 30, 1996, December 31, 1995 and September 30, 1995 amounted to $117,595,000, $112,493,000 and $110,244,000. The average rate paid on the certificates dropped 12 basis points between September 30, 1995 and September 30, 1996. Individual retirement accounts also posted a modest increase in average balances due to the posting of interest on December 31, 1995. The average balances at September 30, 1996, December 31, 1995 and September 30, 1995 were $80,069,000, $78,534,000 and $78,503,000, respectively. The ending balance of individual retirement accounts at year end 1996 will probably decline to about $75,000,000 as competition increases for these funds, even with the Corporation's own Trust Department. Average borrowed funds increased $11,830,000 between the periods ended September 30, 1996 and September 30, 1995 and the average rate paid on those borrowed funds decreased 59 basis points. Borrowed funds are invested in mortgage backed securities issued primarily by Fannie Mae. The primary source of borrowing is the Federal Home Loan Bank of Pittsburgh. Management is expecting interest rates to remain stable for the balance of 1996 and the net spread to remain in the 3.55 to 3.60 percent range. Tables I and II are provided to reflect average balances and rates paid for the nine month periods ended September 30, 1996, December 31, 1995 and September 30, 1995, respectively. 7
CITIZENS AND NORTHERN CORPORATION - FORM 10-Q Part I - Financial Information (continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) TABLE I - Analysis of the Effect of Volume and Rate Changes in Interest Income and Interest Expense <TABLE> <CAPTION> Periods Ended September 30, 1996/1995 Change Change In In Total (In Thousands) Volume Rate Change EARNING ASSETS <S> <C> <C> <C> Available-for-Sale Securities: U S Treasury Securities Securities of Other US Government Agencies and Corporations 949 40 989 Mortgage Backed Securities (267) (33) (300) Obligations of States and Political Subdivisions 286 (52) 234 Stock 114 (20) 94 Other Securities (35) 140 105 Total Available-for-Sale Securities 1,047 75 1,122 Held-to-Maturity Securities US Treasury Securities 18 18 Securities of Other US Government Agencies and Corporations Mortgage Backed Securities (10) (5) (15) Obligations of States and Political Subdivisions Stock Other Securities Total Held-to-Maturity Securities 8 (5) 3 Interest -bearing Due from Banks (45) 34 (11) Federal Funds Sold 2 (7) (5) Loans: Real Estate Loans 619 348 967 Consumer (105) 198 93 Agricultural (24) (7) (31) Commercial/Industrial 189 (44) 145 Other 3 3 Political Subdivisions 10 (7) 3 Leases 2 2 Total Loans 694 488 1,182 Total Interest Income 1,706 585 2,291 INTEREST BEARING LIABILITIES Interest Checking (42) (571) (613) Money Market 122 (105) 17 Savings (33) 3 (30) Certificates of Deposit 301 68 369 Individual Retirement Accounts 81 (701) (620) Other Time Deposits (3) (3) (6) Federal Funds Purchased (191) (19) (210) Other Borrowed Funds 367 (260) 107 Total Interest Expense 602 (1,588) (986) NET INTEREST INCOME 1,104 2,173 3,277 </TABLE> The change in interest due to both volume and rates has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amount of the change in each. 8
CITIZENS AND NORTHERN CORPORATION - FORM 10-Q Part I - Financial Information (continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) <TABLE> <CAPTION> Table II - Analysis of Average Daily Balances and Rates Rate of Rate of Rate of Return/ Return/ Return/ Cost of Cost of Cost of (In Thousands) Funds Funds Funds EARNING ASSETS 9/30/96 % 12/31/95 % 9/30/95 % <S> <C> <C> <C> <C> <C> <C> Available-for-Sale Securities: US Treasury Securities 2,507 5.12 2,510 5.10 2,510 5.14 Securities of Other US Government Agencies and Corporations 28,580 6.91 10,639 6.49 10,157 6.42 Mortgage Backed Securities 203,037 6.57 208,469 6.55 208,461 6.59 Obligations of States and Political Subdivisions 47,962 6.21 41,756 6.39 41,756 6.38 Stock 16,392 5.00 13,547 5.09 13,327 5.21 Other Securities 6,984 8.21 10,148 5.60 8,049 5.38 Total Available-for-Sale Securities 305,462 6.49 287,069 6.41 284,260 6.44 Held-to-Maturity Securities U. S. Treasury Securities 698 6.13 324 6.79 299 6.26 Securities of Other U S Government Agencies and Corporations 44 6.08 Mortgage Backed Securities 844 6.97 1,004 7.67 1,032 7.64 Obligations of States and Political Subdivisions Stock Other Securities Total Held-to-Maturity Securities 1,586 6.58 1,328 7.45 1,331 7.33 Interest -bearing Due from Banks 568 6.36 996 5.52 1,089 4.67 Federal Funds Sold 1,444 5.46 1,301 6.07 1,406 6.09 Loans: Real Estate Loans 205,520 9.34 198,936 9.15 196,579 9.10 Consumer 35,438 17.92 36,230 17.01 36,296 17.15 Agricultural 2,739 10.10 3,051 10.32 3,050 10.43 Commercial/Industrial 16,346 9.64 13,998 10.03 13,686 10.10 Other 268 7.98 238 7.98 223 7.79 Political Subdivisions 6,685 6.36 6,524 6.45 6,458 6.52 Leases 194 8.96 166 4.00 163 9.02 Total Loans 267,190 10.43 259,143 10.24 256,455 10.25 Net Loans & Leases 267,190 10.43 259,143 10.24 256,455 10.25 Total Earning Assets 576,250 8.31 549,837 8.22 544,541 8.23 Cash 13,962 11,834 11,773 Securities Valuation Reserve 5,776 (2,668) (5,280) Allowance for Possible Loan Losses (4,647) (4,484) (4,442) Other Assets 5,347 4,737 6,387 Bank Premises & Equipment 6,822 6,774 6,775 Total Assets 603,510 566,030 559,754 INTEREST-BEARING LIABILITIES Interest Checking 40,664 2.47 42,118 4.02 41,994 4.35 Money Market 100,041 4.55 91,773 4.93 90,410 5.01 Savings 47,225 2.49 48,261 2.48 49,015 2.48 Certificates of Deposit 117,595 5.50 112,493 5.50 110,244 5.42 Individual Retirement Accounts 80,069 5.63 78,534 6.58 78,503 6.80 Other Time Deposits 2,465 2.44 2,465 2.60 2,638 2.58 Federal Funds Purchased 1,220 5.92 4,774 6.37 5,505 6.41 Other Borrowed Funds 99,874 5.57 87,728 6.09 88,044 6.16 Total Interest-bearing Liabilities 489,153 4.79 468,146 5.23 466,353 5.30 Demand Deposits 42,786 39,313 39,399 Other Liabilities 6,467 4,844 3,842 TOTAL LIABILITIES 538,406 512,303 509,594 Stockholders' Equity 61,291 55,961 53,645 Securities Valuation Reserve 3,813 (2,234) (3,485) Total Liabilities and Stockholders' Equity 603,510 566,030 559,754 Interest Rate Spread 3.52 2.99 2.93 </TABLE> 9
CITIZENS AND NORTHERN CORPORATION - FORM 10-Q Part I - Financial Information (continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) ALLOWANCE FOR POSSIBLE LOAN LOSSES The Allowance for Possible Loan Losses is a reserve established by management, which it believes will be adequate to absorb future loan losses based on management's assessment of the quality of the total loan portfolio. The assessment is performed on an ongoing basis and reviewed by the Board of Directors quarterly. The assessment evaluates portfolio quality and reviews historical charge-offs using a six year average. Portfolio quality is determined by regulatory and independent loan reviews. The Corporation employs an independent loan review specialist who reviews loans based on criteria set by the Board of Directors. The review includes, but is not limited to, loan documentation, financial statements, tax returns and a cash flow analysis of each loan. The tool most utilized by management to determine portfolio quality is the "Watch List". The "Watch List" is a collection of loans that are now or have been classified as substandard by our loan review specialist or management. The list is distributed to Branch Managers monthly for their review and updated before going to the Board of Directors. The list also contains all nonperforming loans that for purposes of SFAS No. 114 are segregated for reserve purposes and valued at their observable collateral value. The most recent loan review by the Corporation's independent loan appraiser was conducted at the close of business May 31, 1996. The review was submitted on July 26, 1996 and listed $10,145,000 in criticized loans, an increase of $1,102,000 over the review completed June 16, 1995. Loans classified as substandard, doubtful and loss were $6,873,000, $276,000 and $82,000, respectively. Using regulatory standards of 15% of substandard loans, 50% of doubtful and 100% of loss credits the portfolio would require a minimum reserve balance of $1,251,000, this would leave an unallocated portion of $3,475,000. An allocation of the reserve using historical data produces an allocation of $1,618,000 and an unallocated balance of $3,208,000. Management and the Board of Directors has therefore determined that the Reserve for Possible Loan Losses is adequate. Other factors used to evaluate the reserve level are loan growth, economic conditions of the market area and peer group comparisons. Tables IV and V present a five year history of the Allowance for Possible Loan Losses and projection for the current year. Table V projects estimated losses using the last five years as a base. Years having abnormally large or low charge-offs are eliminated to present a realistic estimation. Table III provides reserve activity for the year-to-date, the most probable at year end and a worst case scenario which uses an historical average including years which had larger than normal losses. TABLE III - Reconciliation of the Reserve for Possible Loan Losses <TABLE> <CAPTION> (In Thousands) Worst Case Probable Actual Actual Dec 31, 1996 Dec 31, 1996 June 30, 1996 Dec 31, 1995 <S> <C> <C> <C> <C> Beginning Balance January 1, 4,579,210 4,579,210 4,579,210 4,228,741 Provision Charged to Earnings 701,000 701,000 350,250 736,500 Year-to-Date Recoveries 140,000 140,000 94,441 187,473 Year-to-Date Charge-offs (882,000) (600,000) (320,016) (573,504) Ending Balance 4,558,210 4,840,210 4,703,885 4,579,210 <CAPTION> TABLE IV--Loan Loss History (In Thousands) 1996 Est 1995 1994 1993 1992 1991 AVERAGE <S> <C> <C> <C> <C> <C> <C> <S> Net Loans * 290,000 264,182 258,472 238,755 225,475 199,072 210,851 Net Charge-offs 460 387 326 247 518 3,142 726 Allowance for Possible Loan Losses Balance 4,840 4,579 4,229 3,817 3,356 2,548 3,338 Provision for Loan Losses Charged to Earnings 701 737 737 708 1,326 3,151 1,054 Earnings 7,203 7,866 7,494 8,127 7,290 5,643 6,232 Earnings Coverage of Net Charge-offs 15.7x 20.3x 23.0x 32.9x 14.1x 1.8x 8.6x Allowance Coverage of Net Charge-offs 10.5x 11.8x 13.0x 15.5x 6.5x 0.8x 4.6x Loans Ninety Days or More Past Due and Still Accruing 2,500 2,915 2,743 2,899 2,532 3,810 2,486 Net Charge-offs as a Percent of the Provision 63.8% 52.5% 44.2% 34.9% 39.1% 99.7% 68.8% Year-End Nonperforming Loans 250 279 624 843 1,351 417 538 Allowance as a Percentage of Gross Loans: * Bank (1) 1.75% 1.73% 1.64% 1.60% 1.49% 1.28% 1.36% Peer Group (2) 1.54% 1.61% 1.65% 1.82% 1.42% 1.44% 1.38% * Gross Loans less Unearned Discount (1) At September 30, 1996 (2) At June 30, 1995 </TABLE> 10
CITIZENS AND NORTHERN CORPORATION - FORM 10-Q Part I Financial Information (continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Table V - Allocation of the Reserve for Possible Loan Losses <TABLE> <CAPTION> (In Thousands) LOAN CLASSIFICATION 1996 Est 1995 1994 1993 1992 1991 <S> <C> <C> <C> <C> <C> <C> Commercial, Financial & Agricultural 35,000 31,522 22,649 26,376 22,712 23,541 Real Estate - Construction 1,500 1,284 2,593 2,224 993 982 Real Estate - Mortgage 210,000 192,350 193,095 170,532 162,434 136,716 Credit Card & Related Plans 10,000 9,934 9,896 9,212 9,991 6,694 All Other Loans to Individuals 33,340 28,955 30,094 30,282 29,182 31,762 Lease Financing 160 163 145 154 162 129 Total Loans 290,000 264,208 258,472 238,780 225,474 199,824 FASB 114 Allocation 240 228 N/A N/A N/A N/A Letter of Credit Commitments 2,750 2,633 4,415 5,046 4,670 N/A All Other Commitments Consumer 25,000 24,811 24,202 23,323 22,174 N/A Mortgage 7,500 7,276 9,566 9,466 9,117 N/A Commercial 10,500 10,201 9,901 9,790 5,670 N/A <CAPTION> LOAN CLASSIFICATION Average <S> <C> <C> <C> <C> Commercial, Financial & Agricultural 26,967 0.01955 X 35,000 = 684 Real Estate - Construction 1,596 0.00000 X 1,500 = Real Estate - Mortgage 177,521 0.00017 X 210,000 = 36 Credit Card & Related Plans 9,288 0.01303 X 10,000 = 130 All Other Loans to Individuals 30,603 0.00551 X 33,340 = 184 Lease Financing 152 0.00000 X 160 = 0 Total Loans 246,126 FASB 114 Allocation 181 1.00000 X 240 = 240 Letter of Credit Commitments 4,191 0.00000 X 2,750 = 0 All Other Commitments Consumer 23,628 0.00551 X 25,000 = 138 Mortgage 8,856 0.00017 X 7,500 = 1 Commercial 8,891 0.01955 X 10,500 = 205 Reserve Allocation 1,618 Unallocated Portion 3,222 Reserve Balance 4,840 </TABLE> 11
CITIZENS AND NORTHERN CORPORATION - FORM 10-Q Part I - Financial Information (continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Periods Ended Table VI - Major Categories of Noninterest Income September 30, (In Thousands) $ % 1996 1995 Change Change Service Charges on Deposit Accounts 847 842 5 0.59 Service Charges and Fees 200 204 (4) (1.96) Trust Department Income 615 562 53 9.43 Insurance Commissions, Fees and Premiums 402 477 (75) (15.72) Other Operating Income 34 37 (3) (8.11) Realized Gains (Losses) on Securities, Net 451 1,229 (778) (63.30) Total Other Income 2,549 3,351 (802) (23.93) Only two items of other income reflect significant change: insurance premiums generated by the Corporation's captive life and accident and health insurance subsidiary which provides insurance for the consumer loan portfolio and realized gains from the sale of available-for-sale securities. The decline in insurance premiums is the general lack of loan demand during the comparable periods as evidenced by the small increase in average outstanding loan balances. Realized gains from the sale of available-for-sale securities are the result of the sale of stock. The Bank and Corporation both have substantial holdings of Pennsylvania banks and Pennsylvania bank holding companies. The stocks are evaluated continuously and frequently and when the holdings become too large or overvalued due to mergers or other reasons, all or portions of the holdings are sold. Some of the issues sold during the two comparable nine month periods were mandated by an FDIC ruling that banks may not hold stock that is traded over-the-counter and not listed on a recognized stock exchange. 12
CITIZENS AND NORTHERN CORPORATION - FORM 10-Q Part I - Financial Information (continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) The following table compares the various categories of other expense for the periods ended June 30, 1996 and June 30, 1995. Table VII - Major Categories of Noninterest Expense Periods Ended September 30, $ % 1996 1995 Change Change Salaries and Wages 4,406 4,096 310 7.57 Pensions and Other Employee Benefits 1,300 1,260 40 3.17 Occupancy Expense, Net 541 524 17 3.24 Furniture and Equipment Expense 546 486 60 12.35 Other Operating Expense 4,070 4,331 (261) (6.03) Total Other Expense 10,863 10,697 166 1.55 Salaries and wages increased 7.11 percent. The increase can be attributed to an increase in the number of full time equivalent employees and merit raises. The number of full time equivalent employees at September 30, 1996 was 204, compared to 199 at September 30, 1995. Merit raises effective January 1, 1996 were in the 5 to 6 percent range. Furniture and equipment expense increased $60,000 or just over 12 percent. The change is due to the increase in equipment maintenance costs on the new check imaging equipment. The new equipment was maintenance free for the first year of operation. The increase included depreciation expense which also increased $16,000 over the same nine month period last year. Other operating expense decreased $261,000 over the same period in 1995. The largest single factor contributing to the decrease was FDIC insurance. FDIC premiums dropped from $463,000 for the period ended September 30, 1995 to $2,000 for the period ended September 30, 1996. Several other expense items varied only slightly, however credit card processing costs increased $207,000 over the same period last year. It should also be noted that interest and fees associated with the credit card function included in interest and fees on loans increased $221,000 during the nine months ended September 30, 1996 when compared to the same period last year. 13
CITIZENS AND NORTHERN CORPORATION - FORM 10-Q Part I - Financial Information (continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) STATEMENT OF CONDITION Average total assets of the Corporation for the nine month period ended September 30, 1996 increased $43,756,000 or 7.8 percent when compared to the average balance for the period ended September 30, 1995. Average total assets increased $37,480,000 or 6.6 percent when compared to year-end 1995. The increase in average assets between September 30, 1995 and September 30, 1996 can be attributed to an increase in average deposits totaling $26,187,000 and an increase in average borrowed funds totaling $11,830,000. Deposit growth centered around certificates of deposit and money market accounts. The Corporation has traditionally used these accounts as its largest and most important source of funds. To maintain and grow the balances in these accounts the Corporation has always paid competitive or slightly higher than market rates, however, competitive pressures from nonbank sources has slowed deposit growth. Loan demand for 1995 was relatively flat. Total loans for 1995 increased only $5,713,000 or 2.2 percent. During the nine months ended September 30, 1996 loan growth was slow, increasing only 2.4 percent, with nearly all of the growth being in the third quarter. Annualized loan growth during the third quarter would be slightly less than 10 percent. The Corporation's leveraged borrowing level increased nearly $12,000,000 between September 30, 1995 and September 30, 1996. Given the current interest rate structure, management and the Corporation's Board of Directors feel that the current borrowing level of just over $100,000,000 is adequate. The maturity schedule of the borrowed funds ranges from three to eighteen months. Overnight borrowing normally averages $8,000,000 to $15,000,000 depending on deposit levels. The primary source of borrowing is the Federal Home Loan Bank of Pittsburgh repurchase agreements. Interest rate fluctuations have caused wide variations in the required market value adjustment due to the large holdings of Available-for-Sale securities. The net after tax adjustment at September 30, 1996, December 31, 1995 and September 30, 1995 was $3,338,000, $6,952,000, and $2,706,000, respectively. The capital base of the Corporation remains strong. The ratio of capital to deposits excluding the market value adjustment for Available-for-Sale securities at September 30, 1996, December 31, 1995 and September 30, 1995 was 15.0 percent, 14.2 percent and 13.7 percent, respectively. The risk based capital ratio for the same periods, respectively, was 22.37 percent, 18.72 percent and 18.36 percent. The dividend as a percentage of net income for the nine months ended September 30, 1996 and September 30, 1995 was 36.3 percent and 43.6 percent, respectively. The dividend for the year ended December 31, 1995 was 41.2 percent. The Corporation does not expect that there will be any significant change in the mix of assets and liabilities for the remainder of 1996. This expectation is based on the assumption that interest rates will remain stable through the balance of the year. There are no planned capital expenditures which would have a detrimental effect on the capital ratios or the results of operations. LIQUIDITY AND INTEREST RATE SENSITIVITY The Corporation's ability to absorb short term deposit fluctuations or unusually heavy loan demand, should they occur, are met by using a Flexline of credit and the Open RepoPlus program available through the Federal Home Loan Bank of Pittsburgh. The Flexline of credit provides the Corporation with a credit line of approximately $28,000,000. The Open RepoPlus line is $50,000,000. The maturities of the repurchase agreements generally range from 30 days to 2 years. The Corporation also has credit lines with correspondent banks totaling approximately $15,000,000. At September 30, 1996 total corporate borrowing amounted to $106,650,000, consisting of repurchase agreements amounting to $47,650,000 and long term borrowings totaling $59,000,000. This relatively short term borrowing created a large negative gap which had a detrimental effect on earnings during the three quarters of 1995, however interest rates have declined and the net interest margin has shown steady improvement through the last half of 1995 and nine months ended September 30, 1996. The Corporation uses a computer model to measure the theoretical effect of interest rate swings on the market value and the net interest margin using a rate shock. The model shocks interest 300 basis points upward and downward. The Asset and Liability Policy set by the Board of Directors imposes limits on the change in net interest income and market value of portfolio equity at a 200 basis point increase in interest rates. Net interest income may not decline more than 20 percent and the change in market value of portfolio equity may not decline more than 25 percent. The Board of Directors feels that the parameters are reasonable based on the capital strength of the Corporation. The interest rate sensitivity table presented on page 15 uses static gap methodology to measure the difference between rate sensitive assets and liabilities at September 30, 1996. The analysis shows that the Corporation has a negative gap; i.e. liabilities reprice faster than assets. The Corporation has the ability to increase or decrease the gap by selling assets and repaying borrowed funds. It should be noted that the Corporation relies more heavily on its computer model to monitor interest rate risk than the static gap. The reader should refer to pages 16 and 17 for a fuller understanding of the effect of interest rate movements. 14
CITIZENS AND NORTHERN CORPORATION - FORM 10-Q Part I - Financial Information (continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Table VIII - Rate Sensitive Assets and Rate Sensitive Liabilities <TABLE> <CAPTION> (In Thousands) 1 YEAR 1 - 5 YEARS 5 - 10 YEARS 10 YEARS TOTAL <S> <C> <C> <C> <C> <C> ASSETS Interest-bearing Deposits 712 712 Available-for-Sale Securities: US Treasury Securities 2,465 2,465 Securities of Other Government Agencies 8,902 16,999 10,203 36,104 Mortgage Backed Securities 29,022 123,711 35,135 187,868 Municipals 1,684 4,479 4,220 42,610 52,993 Other Bonds 899 2,400 1,000 1,340 5,639 Stocks 23,663 23,663 Total Available-for-Sale Securities 31,605 141,957 57,354 77,816 308,732 Held-to-Maturity Securities: US Treasury Securities 699 699 Securities of Other Government Agencies 100 100 Mortgage Backed Securities 789 789 Total Held-to-Maturity Securities 0 799 0 789 1,588 Loans and Lease Financing: Real Estate-Construction 1,284 1,284 Real Estate-Mortgage 87,463 49,440 44,901 26,499 208,303 Consumer 10,943 14,211 1,593 9,007 35,754 Agricultural 1,230 1,199 226 22 2,677 Commercial 12,437 3,329 502 168 16,436 Other 4,687 0 4,687 Political Subdivisions 1,504 2,479 1,465 1,287 6,735 Leases 58 163 1 222 Total Loans 119,606 70,821 48,688 36,983 276,098 Allowance for Possible Loan Losses (4,826) (4,826) Net Loans and Leases 119,606 70,821 48,688 32,157 271,272 Federal Funds Sold 0 Cash and Due From Banks 16,835 16,835 Other Assets 12,935 12,935 TOTAL ASSETS 151,923 213,577 106,042 140,532 612,074 LIABILITIES AND EQUITY Interest-bearing Deposits: Money Market 99,031 99,031 NOW and SNOW 40,976 40,976 Christmas/Fund Clubs 2,432 2,432 CDs 74,945 40,607 88 115,640 Reg/Key Savings 46,619 46,619 GPS 744 744 IRAs 77,551 77,551 Total Interest-bearing Deposits 294,935 40,607 88 47,363 382,993 Demand Deposits 46,884 46,884 Repurchase Agreements 47,650 47,650 Borrowed Funds: Variable Fixed 39,000 20,000 59,000 Total Borrowed Funds 39,000 20,000 59,000 Other Liabilities 852 6,856 7,708 Stockholders' Equity 67,839 67,839 TOTAL LIABILITIES AND EQUITY 382,437 60,607 88 168,942 612,074 INTEREST RATE SENSITIVITY GAP (230,514) 152,970 105,954 (28,410) </TABLE> 15
CITIZENS AND NORTHERN CORPORATION - FORM 10-Q Part I - Financial Information (continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Table IX - Rate Shock Analysis and the Resulting Hypothetical Effect on Income for the Year Ended September 30, 1997 <TABLE> <CAPTION> (In Thousands) CHANGE IN RATE -3.00 -2.00 -1.00 FLAT +1.00 +2.00 +3.00 INCOME STATEMENT <S> <C> <C> <C> <C> <C> <C> <C> Interest Income Loans 26,394 27,541 28,688 29,753 30,983 32,131 33,278 Investments 18,994 19,395 19,795 20,182 21,000 21,831 22,953 Total Interest Income 45,388 46,936 48,483 49,935 51,983 53,962 56,231 Interest Expense Deposits 12,464 14,711 17,086 19,381 21,838 24,213 26,589 Borrowings 5,079 5,256 5,433 5,590 5,787 5,964 6,142 Fed Fds Purchased 30 51 82 118 156 197 233 Total Int Expense 17,573 20,018 22,601 25,089 27,781 30,374 32,964 Net Interest Income 27,815 26,918 25,882 24,846 24,202 23,588 23,267 Loan Loss Provision 701 701 701 701 701 701 701 Net Int Inc After Prov 27,114 26,217 25,181 24,145 23,501 22,887 22,566 Other Operating Income 2,280 2,280 2,280 2,280 2,280 2,280 2,280 Other Operating Exp 14,456 14,456 14,456 14,456 14,456 14,456 14,456 Income Before Inc Tax 14,938 14,041 13,005 11,969 11,325 10,711 10,390 Income Tax Provision 3,821 3,508 3,148 2,787 2,559 2,342 2,224 Net Income 11,117 10,533 9,857 9,182 8,766 8,369 8,166 Dividends 3,458 3,458 3,458 3,458 3,458 3,458 3,458 </TABLE> 16
CITIZENS AND NORTHERN CORPORATION - FORM 10-Q Part I - Financial Information (continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Table X - Rate Shock Analysis and the Theoretical Effect on Equity Market Values for the Period Ended September 30, 1996 <TABLE> <CAPTION> (In Thousands) -3.00 -2.00 -1.00 FLAT 1.00 2.00 3.00 <S> <C> <C> <C> <C> <C> <C> <C> ASSETS Book Value 600,407 600,407 600,407 600,407 600,407 600,407 600,407 Market Value 647,169 630,361 614,764 602,015 592,885 576,121 561,218 Change 46,762 29,954 14,357 1,608 (7,522) (24,286) (39,189) LIABILITIES Book Value 539,872 539,872 539,872 539,872 540,822 540,822 540,822 Market Value 557,940 551,954 546,155 541,153 533,860 527,449 521,068 Change (18,068) (12,082) (6,283) (1,281) 6,962 13,373 19,754 EQUITY Beginning Balance 60,535 60,535 60,535 60,535 60,535 60,535 60,535 Asset Change 46,762 29,954 14,357 1,608 (7,522) (24,286) (39,189) Liability Change (18,068) (12,082) (6,283) (1,281) 6,962 13,373 19,754 Market Value 89,229 78,407 68,609 60,862 59,975 49,622 41,100 </TABLE> Table XI - Current Exposure to Hypothetical Change in Interest Rates for the Period Ended September 30, 1997 Net Interest Income MV of Portfolio Equity Change in Rates Projected Projected Basis Points Change (%) Change (%) +300 -6.4 -30.6 +200 -5.1 -23.0 +100 -2.6 -13.1 FLAT 0.0 0.0 -100 4.2 12.7 -200 8.3 28.8 -300 12.0 46.6 17
CITIZENS AND NORTHERN CORPORATION - FORM 10-Q Part II - Other Information Item 1. Legal Proceedings Citizens and Northern Corporation is not a litigant in any pending material lawsuits. It is the opinion of the counsel of Citizens and Northern Corporation that minor lawsuits which are pending will not have a significant or materially detrimental effect on the capital of the Corporation or in any way effect the results of operations. Item 4. A submission of matters to a Vote by Security Holders The Annual Meeting of Shareholders of Citizens & Northern Corporation was held on Tuesday, April 16, 1996. The Board of Directors fixed the close of business on March 1, 1996 as the record date for the determination of stockholders entitled to notice of and to vote at the Annual Meeting and at any adjournment thereof. On this record date, there were outstanding and entitled to vote 5,012,082 shares of Common Stock. The total number of votes cast was 3,763,557. All were voted by proxy for the following purposes and with the following results. 1. The election of the following as Class III Directors to serve for a term of three years: J. Robert Bower Craig G. Litchfield William K. Francis Lawrence F. Mase Karl W. Kroeck The total votes in favor of any one of the above-listed Directors were not less than 3,699,695. 2. The ratification of the action of the Board of Directors in the appointment of the firm of Parente, Randolph, Orlando, Carey & Associates as independent auditors of the Corporation: Total Votes in Favor 3,737,010 Total Votes Against 6,672 Total Votes Abstained 18,875 Item 5. Other Events a. Exhibit 2 -- Appointment of New President of Citizens and Northern Corporation Item 6. Exhibits and Reports on Form 8-K a. Exhibits filed as part of this report - None b. No reports on Form 8-K were filed during the period ended June 30, 1996 18
CITIZENS AND NORTHERN CORPORATION - FORM 10-Q SIGNATURE PAGE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date November 6, 1996 WILLIAM K FRANCIS /S/ William K. Francis Chairman of the Board and Chief Executive Officer Date November 6, 1996 JAMES W SEIPLER /S/ James W. Seipler Treasurer (Chief Financial Officer) 19