Citizens Financial Services - 10-Q quarterly report FY

 

 

 

 

Citizens Financial Service, Inc., (individually and collectively with its direct and indirect subsidiaries, 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. (“First Citizens Insurance”).  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 Company, the accompanying interim financial statements for the quarters ended September 30, 2007 and 2006 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, 2007 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 on Form 10-K for the period ended December 31, 2006.

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, bank owned life insurance, 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 2006 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 three months and nine months ended September 30, 2007 and 2006, respectively:

 The Company expects to contribute $370,029 to its noncontributory defined benefit pension plan in 2007.  As of September 30, 2007, the Company has contributed $198,433.

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 $149,000 and $141,000 for the nine months ended September 30, 2007 and 2006, respectively.

In June 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes. FIN 48 is an interpretation of FAS No. 109, Accounting for Income Taxes, and it seeks to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. In addition, FIN No. 48 requires expanded disclosure with respect to the uncertainty in income taxes and is effective for fiscal years beginning after December 15, 2006.  The adoption of this standard is not expected to have a material effect on the Company’s financial position.

In September 2006, the FASB reached consensus on the guidance provided by Emerging Issues Task Force Issue 06-5(“EITF 06-5”), Accounting for Purchases of Life Insurance—Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance.  EITF 06-5 states that a policyholder should consider any additional amounts included in the contractual terms of the insurance policy other than the cash surrender value in determining the amount that could be realized under the insurance contract.  EITF 06-5 also states that a policyholder should determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual-life policy (or certificate by certificate in a group policy). EITF 06-5 is effective for fiscal years beginning after December 15, 2006.  The Company is currently evaluating the impact the adoption of the EITF will have on the Company’s financial condition.

 

In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”), Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements, providing guidance on quantifying financial statement misstatement and implementation when first applying this guidance.  Under SAB No. 108, companies should evaluate a misstatement based on its impact on the current year income statement, as well as the cumulative effect of correcting such misstatements that existed in prior years existing in the current year's ending balance sheet.  SAB 108 is effective for fiscal years ending after November 15, 2006. The adoption of this standard is not expected to have a material effect on the Company’s financial position.

 

In March 2007, the FASB ratified Emerging Issues Task Force Issue No. 06-10 (“EITF 06-10”), Accounting for Collateral Assignment Split-Dollar Life Insurance Agreements. EITF 06-10 provides guidance for determining a liability for the postretirement benefit obligation as well as recognition and measurement of the associated asset on the basis of the terms of the collateral assignment agreement. EITF 06-10 is effective for fiscal years beginning after December 15, 2007. The Company is currently evaluating the impact the adoption of the EITF will have on the Company’s results of operations or financial condition.

In June 2007, the FASB ratified Emerging Issues Task Force Issue No. 06-11 (“EITF 06-11”), Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards. EITF 06-11 applies to share-based payment arrangements with dividend protection features that entitle employees to receive (a) dividends on equity-classified non-vested shares, (b) dividend equivalents on equity-classified non-vested share units, or (c) payments equal to the dividends paid on the underlying shares while an equity-classified share option is outstanding, when those dividends or dividend equivalents are charged to retained earnings under FAS No. 123R, Share-Based Payment, and result in an income tax deduction for the employer. A consensus was reached that a realized income tax benefit from dividends or dividend equivalents that are charged to retained earnings and are paid to employees for equity-classified non-vested equity shares, non-vested equity share units, and outstanding equity share options should be recognized as an increase in additional paid-in capital.  EITF 06-11 is effective for fiscal years beginning after December 15, 2007, and interim periods within those fiscal years. The Company is currently evaluating the impact the adoption of the EITF will have on the Company’s financial condition.

 

 

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 the Company, the Bank, First Citizens Insurance 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 the Company, a bank holding company and its direct and indirect subsidiaries.  Our Company's consolidated financial condition and results of operations consist almost entirely of our wholly owned subsidiary’s (the Bank) financial conditions and results of operations. Management’s discussion and analysis should be read in conjunction with the preceding September 30, 2007 financial information. The results of operations for the three months and nine months ended September 30, 2007 and 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 a branch office in Wellsville, Allegany County.

 

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 direct and indirect subsidiaries.  We cannot 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 on Form 10-K for the year ended December 31, 2006, 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.  The financial services industry continues to experience tremendous change to competitive barriers between bank and non-bank institutions. We must compete not only with traditional financial institutions, but in addition, with 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, 2007 and December 31, 2006, the Trust Department had $93.7 million and $82.6 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 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.

Net income for the three months ended September 30, 2007 totaled $1,754,000 compared with $1,548,000 for the comparable period last year, an increase of $206,000 or 13.3%.  Earnings per share for the three months ended September 30, 2007 and 2006 were $.62 and $.54 per share, an increase of 14.8%, respectively. Annualized return on assets and return on equity for the quarter ended September 30, 2007 was 1.20% and 14.85%, respectively, compared with 1.12% and 14.03%, respectively, for last year’s comparable period.

Details of the reasons for these changes 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.

For the three months ended September 30, 2007, net interest income was $4,885,000, which was $418,000 or 9.4% higher than the comparable period last year.  The provision for loan losses was $60,000 for the three months ended September 30, 2007 compared with $105,000 for the same period last year.  As such, net interest income after the provision for loan losses was $4,825,000 compared with $4,362,000 for the quarters ended September 30, 2007 and 2006, respectively.

Net interest income, for the nine months of 2007, was $13,998,000 compared to $13,312,000 for the same period in 2006.  For the first nine months of 2007, the provision for loan losses totaled $225,000, the same as the first nine months of 2006.  Consequently, net interest income after the provision for loan losses was $13,773,000 for the first nine months of 2007 compared to $13,087,000 for the first nine months of 2006, an increase of $686,000.

The following tables set forth the average balances of, and the interest earned or incurred on, each principal category of assets, liabilities and stockholders’ equity, the related rates, net interest income and rate “spread” created for the three months and the nine months ended September 30, 2007 and 2006:

 

 

 

 

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 income on a fully taxable equivalent basis for the three and nine months ended September 30, 2007 and 2006:

 

The following table shows the tax-equivalent effect of changes in volume and rate on interest income and expense for the three months and nine months ended September 30, 2007.

 

 

As can be seen from the preceding tables, our net interest spread improved from 3.34% for the three months ended September 30, 2006 to 3.44% for the same time period in 2007.  For the first nine months of 2007, our net interest spread was 3.36% compared with 3.44% for the first nine months of 2006, a decrease of 8 basis points.  From June 2004 to June 2006, the Federal Reserve increased the Federal Funds rate 425 basis points.  Since that period, we have experienced a flat to inverted interest rate yield curve.  This resulted in an increase in the rates paid on our shorter-term cost of funds.  We did not however see the same level of increase in longer-term rates on our interest earning assets.  As such, we experienced a compression in our net interest margin.

 

In August 2007, the Federal Reserve lowered the discount rate 50 basis points due primarily to a decrease in overall liquidity related to the sub-prime housing market.  On September 18, 2007, due to various economic factors, the Federal Reserve reduced the Federal Funds rate by 50 basis points.  For the quarter ended September 30, 2007, these events resulted in a slightly positive affect on the Company by decreasing our short-term cost of funds more than the decrease in interest income earned on shorter term interest earning assets.  As such, our net interest spread has improved compared to the same period last year. If the yield curve becomes more normal, we expect our interest margin to continue to improve. Management continues to review various pricing and investment strategies in an attempt to maintain or improve upon our current interest margin.  Low cost deposits continue to be our focus and are essential in improving the interest margin going forward.

 

For the three months ended September 30, 2007, tax equivalent net interest income increased from $4,805,000 in 2006 to $5,243,000.  The yield on interest-earning assets was 6.99% compared to 6.75% and the rate on interest-bearing liabilities was 3.56% compared to 3.42%.

 

Tax equivalent net interest income improved from $14,319,000 for the nine months ended September 30, 2006 to $15,040,000 for the same period in 2007.  This represents an increase of $721,000 on a tax equivalent basis.  The increase in interest-earning assets of $30.1 million generated an increase in interest income of $2,708,000, with $1,644,000 due to volume, and $1,064,000 of the increase attributable to a change in rate.  The yield on interest earning assets has increased 30 basis points going from 6.66% to 6.96%.  Interest-bearing liabilities increased $27.0 million resulting in an increase of $1,988,000 of interest expense predominately attributable to a change in rate.  Comparing the first nine months of 2007 with 2006, the average interest rate on interest-bearing liabilities increased 38 basis points, from 3.22% to 3.60%.

 

Non-interest income for the three months ended September 30, 2007, as detailed below, totaled $1,178,000, a decrease of $35,000 over the comparable period last year.  The main decrease is in brokerage and insurance revenues which decreased by $40,000 when compared to last year.  We continue the transition to a new broker-dealer.  As a result, our focus has moved from annuity products to fee based managed accounts that will allow us to further develop our relationship with our customers.  During the three months ended September 30, 2007, we recorded a $24,000 net gain on the sale of investment securities.  This compares to a net gain of $5,000 recorded during the third quarter of 2006.

 

The following tables show the breakdown of non-interest income for the three months and nine months ended September 30, 2007 and 2006:

Non-interest expenses, as detailed below, totaled $3,788,000 for the three months ended September 30, 2007 compared with $3,698,000 for the comparable period last year.  This is an increase of $90,000, or 2.4%.  Salaries and employee benefits have increased by $75,000, or 3.6%, primarily due to an increase in employee incentive accruals.  Professional fees increased $24,000 due to various consulting arrangements consistent with our strategic initiatives.

 

The following tables reflect the breakdown of non-interest expense and professional fees for the three months and nine months ended September 30, 2007 and 2006: