UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2001
Or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
For the transition period from_____________________ to ___________________
Commission file number 0-13222
CITIZENS FINANCIAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2265045
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
15 South Main Street, Mansfield, Pennsylvania 16933
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (570) 662-2121
Indicate by checkmark whether the registrant (1) has filed all reports
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 reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes__X___ No_____
The number of shares outstanding of the Registrant's Common Stock, as of
August 1, 2001, 2,799,420 shares of Common Stock, par value $1.00.
Citizens Financial Services, Inc.
Form 10-Q
INDEX
Page
Part I FINANCIAL INFORMATION (UNAUDITED)
Item 1-Financial Statements
Consolidated Balance Sheet as of June 30, 2001, and
December 31, 2000 1
Consolidated Statement of Income for the
Three Months and Six Months Ended June 30, 2001 and 2000 2
Consolidated Statement of Comprehensive Income for the
Three Months and Six Months Ended June 30, 2001 and 2000 3
Consolidated Statement of Cash Flows for the Six Months Ended
June 30, 2001 and 2000 4
Notes to Consolidated Financial Statements 5
Item 2-Management's Discussion and Analysis of Financial Condition
and Results of Operations 6-19
Item 3-Quantitative and Qualitative Disclosure About Market Risk 20
Part II OTHER INFORMATION
Item 1-Legal Proceedings 21
Item 2-Changes in Securities and Use of Proceeds 21
Item 3-Defaults upon Senior Securities 21
Item 4-Submission of Matters to a Vote of Security Holders 21
Item 5-Other Information 21
Item 6-Exhibits and Reports on Form 8-K 22
SIGNATURES 23
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
June 30
December 31
(in thousands)
2001
2000
ASSETS:
Cash and due from banks:
Noninterest-bearing
$ 10,208
$ 15,622
Interest-bearing
17,409
11,996
Total cash and cash equivalents
27,617
27,618
Available-for-sale securities
106,447
99,891
Loans (net of allowance for loan losses $3,050 and $2,777)
264,440
260,209
Foreclosed assets held for sale
490
508
Premises and equipment
11,099
10,924
Accrued interest receivable
2,049
2,318
Intangible assets, net
9,282
9,790
Other assets
2,739
2,074
TOTAL ASSETS
$ 424,163
$ 413,332
LIABILITIES:
Deposits:
$ 36,515
$ 42,353
340,783
325,432
Total deposits
377,298
367,785
Borrowed funds
11,497
11,204
Accrued interest payable
2,025
2,620
Other liabilities
1,452
1,174
TOTAL LIABILITIES
392,272
382,783
STOCKHOLDERS' EQUITY:
Common Stock
$1.00 par value; authorized 10,000,000 shares;
issued 2,827,409 shares
2,827
Additional paid-in capital
8,670
Retained earnings
20,611
19,657
TOTAL
32,108
31,154
Accumulated other comprehensive income
732
344
Less: Treasury Stock, at cost
55,162 shares
(949)
TOTAL STOCKHOLDERS' EQUITY
31,891
30,549
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY
The accompanying notes are an integral part of these financial statements.
CONSOLIDATED STATEMENT OF INCOME
Three Months Ended
Six Months Ended
(in thousands, except per share data)
INTEREST INCOME:
Interest and fees on loans
$ 5,579
$ 5,013
$ 11,091
$ 9,892
Interest-bearing deposits with banks
196
3
343
13
Investment securities:
Taxable
1,200
979
2,338
1,991
Nontaxable
211
233
432
466
Dividends
130
145
276
255
TOTAL INTEREST INCOME
7,316
6,373
14,480
12,617
INTEREST EXPENSE:
Deposits
3,608
3,022
7,302
5,955
137
405
258
814
TOTAL INTEREST EXPENSE
3,745
3,427
7,560
6,769
NET INTEREST INCOME
3,571
2,946
6,920
5,848
Provision for loan losses
120
100
195
200
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES
3,451
2,846
6,725
5,648
OTHER OPERATING INCOME:
Service charges
575
446
1,138
852
Trust
123
280
217
Other
170
82
271
179
Realized securities gains, net
353
(14)
383
5
TOTAL OTHER OPERATING INCOME
1,221
614
2,072
1,253
OTHER OPERATING EXPENSES:
Salaries and employee benefits
1,571
1,105
3,051
2,186
Occupancy
243
141
481
282
Furniture and equipment
242
185
460
360
Professional fees
150
126
249
257
Amortization of intangible assets
254
27
109
956
774
1,863
1,423
TOTAL OTHER OPERATING EXPENSES
3,416
2,358
6,612
4,617
Income before provision for income taxes
1,256
1,102
2,185
2,284
Provision for income taxes
219
205
357
449
NET INCOME
$ 1,037
$ 897
$ 1,828
$ 1,835
OPERATING CASH EARNINGS**
$ 1,204
$ 915
$ 2,163
$ 1,907
Earnings Per Share
$ 0.37
$ 0.32
$ 0.66
Operating Cash Earnings Per Share**
$ 0.43
$ 0.33
$ 0.78
$ 0.69
Cash Dividend Declared
$ 0.160
$ 0.150
$ 0.315
$ 0.295
**Operating cash earnings are net income before amortization of intangible assets and merger and acquisition costs, net of tax.
Weighted average number of shares outstanding
2,772,247
2,777,884
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
Net income
Other comprehensive income:
Unrealized (losses) gains on available for sale securities
(259)
38
970
(127)
Less: Reclassification adjustment for (gains) losses included in net income
(353)
(612)
14
52
(383)
587
(5)
(132)
Other comprehensive income before tax
Income tax expense related to other comprehensive income
208
(18)
(199)
45
Other comprehensive income, net of tax
(404)
34
388
(87)
Comprehensive income
$ 633
$ 931
$ 2,216
$ 1,748
The accompanying notes are an integral part of these financial statements
CONSOLIDATED STATEMENT OF CASH FLOWS
June 30,
CASH FLOWS FROM OPERATING ACTIVITIES:
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for depreciation and amortization
416
Amortization and accretion of investment securities
55
113
Deferred income taxes
(191)
(61)
Realized gains on securities
Realized gains on loans sold
(9)
(4)
Losses on sales or disposals of premises and equipment
7
Originations of loans held for sale
(708)
Proceeds from sales of loans held for sale
717
408
Gain on sale of foreclosed assets held for sale
(55)
(6)
Decrease (increase) in accrued interest receivable
269
(99)
Increase in other assets and intangibles
(7)
(22)
Decrease in accrued interest payable
(595)
(628)
Increase in other liabilities
278
191
Net cash provided by operating activities
2,380
1,937
CASH FLOWS FROM INVESTING ACTIVITIES:
Available-for-sale securities:
Proceeds from sales of available-for-sale securities
21,120
8,695
Proceeds from maturity and principal repayments of securities
4,392
1,974
Purchase of securities
(31,152)
(7,656)
Net increase in loans
(4,568)
(6,919)
Acquisition of premises and equipment
(1,337)
(538)
Proceeds from sale of premises and equipment
16
-
Proceeds from sale of foreclosed assets held for sale
214
115
Net cash used in investing activities
(11,315)
(4,329)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits
9,513
4,801
Proceeds from long-term borrowings
413
1,403
Repayments of long-term borrowings
(829)
(4,509)
Net increase in short-term borrowed funds
710
22
Acquisition of Treasury Stock
(489)
Dividends paid
(873)
(812)
Net cash provided by financing activities
8,934
Net decrease in cash and cash equivalents
(1)
(1,976)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
8,522
CASH AND CASH EQUIVALENTS AT END OF PERIOD
$ 27,617
$ 6,546
Supplemental Disclosures of Cash Flow Information:
Interest paid
$ 8,155
$ 7,398
Income taxes paid
$ 315
$ 510
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - Basis of Presentation
Citizens Financial Services, Inc., (individually and collectively, the "Company") is a Pennsylvania corporation organized as the holding company of its wholly owned subsidiary, First Citizens National Bank (the "Bank"). Our Company's consolidated financial condition and results of operations consist almost entirely of our wholly owned subsidiary's financial conditions and results of operations. All material inter-company balances and transactions have been eliminated in consolidation.
The accompanying interim financial statements have been prepared by the Company without audit and, in the opinion of management, reflect all adjustments (which include only normal recurring adjustments) necessary to present fairly the Company's financial position as of June 30, 2001, and the results of operations for the interim periods presented. 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. Actual results could differ significantly from those estimates. For further information refer to the consolidated financial statements and footnotes thereto incorporated by reference in the Company's Annual Report on Form 10-K for the year ended December 31, 2000.
Note 2 - Earnings per Share
Earnings per share calculations give retroactive effect to stock dividends declared by the Company. The number of shares used in the earnings per share and dividends per share calculation was 2,772,247 for 2001 and 2,777,884 for 2000.
Note 3 - Income Tax Expense
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 investment in tax credits.
Note 4 - Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards Nos. 141, Business Combinations, effective for all business combinations initiated after June 30, 2001, as well as all business combinations accounted for by the purchase method that are completed after June 30, 2001. The new statement requires that the purchase method of accounting be used for all business combinations and prohibits the use of the pooling-of-interests method. The adoption of Statement No. 141 is not expected to have a material effect on the Company's financial position or results of operations.
In July 2001, the FASB issued Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, effective for fiscal years beginning after December 15, 2001. The new statement changes the accounting for goodwill from an amortization method to an impairment-only approach. Thus, amortization of goodwill, including goodwill recorded in past business combinations, will cease upon adoption of this Statement. At June 30, 2001, the Company has approximately $9.3 million of intangibles resulting from the purchase of loans, deposits and banking facilities from other financial institutions. Currently management is evaluating what effect the adoption of Statement No. 142 will have on the Company's financial position or results of operations
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENT
This report contains "forward-looking statements" which may prove inaccurate. We have made forward-looking statements in this document, and in documents that we incorporate by reference, that are subject to assumptions, risks and uncertainties. Forward-looking statements include the information concerning possible or assumed future results of operations of Citizens Financial Services, Inc., First Citizens National Bank, or the combined company. When we use words like "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:
INTRODUCTION
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 Services, 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 conditions and results of operations. Management's discussion and analysis should be read in conjunction with the preceding June 30, 2001 financial information. The results of operations for the three months and six months ended June 30, 2001 and 2000 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. Our lending and deposit products and investment services are offered primarily within the vicinity of our service area.
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, and liquidity 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 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 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 policy to manage liquidity risk. These guidelines include contingent funding alternatives.
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, 2000, filed by our Company and any Current Reports on Form 8-K filed by our Company.
We face strong competition in the communities 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 not only must compete with traditional financial institutions, but also with other business corporations that have begun to deliver competing financial services. Competition for banking services is based on price, nature of product, quality of service, and in the case of certain activities, convenience of location.
TRUST AND INVESTMENT SERVICES
Investment Management and Trust Services:
Our Company offers a full range of Trust Department services from investment management to estate settlement. We can assist our clients in financial planning and help to determine if they would benefit from a Living Trust or if they need to plan for a trust under will. We have a variety of retirement plans available to suit an individual's needs including rollover IRA's. We manage money for a variety of different charitable and community organizations and we manage several foundations in which the income supports charitable organizations. For individual, family and community organizations we are able to tailor an account aimed at meeting financial goals.
We offer business, professional and government clients a full range of employee retirement plan services including 401k, 403b and other pension, retirement savings and welfare plans.
Insurance and Investment Services through INVEST Financial Corp:
Through an agreement with INVEST Financial Corporation, member NASD/SIPC, a registered broker dealer, not affiliated with First Citizens National Bank, insurance and brokerage services are provided at our 15 South Main Street, Mansfield; Lockhart Street, Sayre; 2 West Main Street, Troy and 99 Main street, Wellsboro offices. Securities and insurance products offered through INVEST are not insured by the FDIC; not a deposit or other obligation of, or guaranteed by any bank and subject to risks including the possible loss of principal amount invested.
FINANCIAL CONDITION
Total assets (shown in the Consolidated Balance Sheet) have grown 2.6% since year-end 2000 to $424.2 million. Total loans increased 1.6% to $264.4 million and investment securities increased 6.6% to $106.5 million since year-end 2000. Total deposits increased 2.6% to $377.3 million since year-end 2000. Explanations of variances will be described with in the following appropriate sections.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents totaled $27,617,000 at June 30, 2001 compared to $27,618,000 on December 31, 2000. Noninterest-bearing cash decreased $5,414,000 since year-end 2000, while interest-bearing cash increased $5,413,000 during that same period.
We believe the liquidity needs of the Company, are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources, and the portion of the investment and loan portfolios that mature within one year. These sources of funds will enable the Company to meet cash obligations and off-balance sheet commitments as they come due.
INVESTMENTS
Our investment portfolio increased by $6,556,000 or 6.6% from December 31, 2000 to June 30, 2001. We were able to increase our investments primarily as the result of excess funds acquired with the Acquisition. During the first six months, we sold approximately $2,000,000 of Municipal Bonds along with $8,132,000 of Corporate Bonds and re-invested the proceeds into lower risk-weighted investments. These investments were made in Agency Mortgage-backed securities to supplement the slow loan growth at the beginning of the year and improve the Company's risk-based capital position.
Management monitors the earnings performance and the effectiveness of the liquidity of the investment portfolio on a regular basis. Through active balance sheet management and analysis of the securities portfolio, the Company maintains sufficient liquidity to satisfy depositor requirements and various credit needs of its customers.
LOANS
The Company's loan demand increased slightly during the first six months of 2001. We anticipate loan demand will pickup during the remainder of 2001 as a result of re-financings that will be taking place due to the current lower interest rate environment and our continued efforts to grow the new offices that we acquired from the Acquisition. The Company's lending is focused in the north central Pennsylvania market and the southern tier of New York. The composition of our loan portfolio consists principally of retail lending, which includes single-family residential mortgages and other consumer lending, and commercial lending primarily to locally owned small businesses. New loans are generated primarily from direct loans to our existing customer base, with new customers generated by referrals from real estate brokers, building contractors, attorneys, accountants and existing customers.
As shown in the following tables (dollars in thousands), the change in net loans increased by $4,231,000 or 1.6% for the period compared to the December 31, 2000. Residential mortgage lending is a principal business activity and one our Company expects to continue by providing a full complement of competitively priced conforming, nonconforming and home equity mortgages.
December 31,
Amount
%
Real estate:
Residential
$ 160,781
60.1
$ 154,894
58.9
Commercial
41,457
15.5
40,044
15.2
Agricultural
10,692
4.0
12,075
4.6
Loans to individuals
For household, family and other purchases
14,804
5.5
15,055
5.7
Commercial and other loans
16,749
6.3
17,509
6.7
State & political subdivision loans
23,036
8.6
23,444
8.9
Total loans
267,519
100.0
263,021
Less: Unearned income
29
35
Allowance for loan losses
3,050
2,777
Net loans
$ 264,440
$ 260,209
June 30, 2001/
December 31, 2000
Change
$ 5,887
3.8
1,413
3.5
(1,383)
(11.5)
Loans to individuals for household,
family and other purchases
(251)
(1.7)
(760)
(4.3)
(408)
$ 4,498
1.7
During the current period Residential loans increased 3.8% or $5,887,000 when compared to December 31, 2000. The result of this increase is primarily due to our home equity loan promotion during the first six months of 2001 in an effort to grow loans, especially in the new offices.
The reduction in interest rates during 2001, have caused loan originations to pick-up during the first six months of 2001. We expect that loan growth will continue for the rest of the year.
Our focus on commercial lending continues to be expanded over the past several years with the establishment of a core group of commercial lenders to handle a higher volume of small business loans.
ALLOWANCE FOR LOAN LOSSES
As shown in the following table (dollars in thousands), the Allowance for Loan Losses as a percentage of loans increased from 1.06%, at December 31, 2000, to 1.14%, at June 30, 2001. The dollar amount of the reserve increased $273,000, since year-end 2000. The increase is a result of the provision of $195,000 expensed during the first six months less net charge-offs. Gross charge-offs for the first six months of 2001 were $85,000, while recoveries were $163,000. During the first six months of 2001, we recovered $150,000 from one borrower that was previously charged-off during the fourth quarter of 1999. We do not expect to receive any more additional funds from this customer.
1999
1998
1997
Balance, at beginning of period
$ 2,777
$ 2,270
$ 2,292
$ 2,138
$ 1,995
Provision charged to income
610
475
218
210
Recoveries on loans previously
charged against the allowance
163
54
48
3,135
2,935
2,821
2,404
2,221
Loans charged against the allowance
(85)
(158)
(551)
(112)
(83)
Balance, at end of year
$ 3,050
Allowance for loan losses as a percent
of total loans
1.14%
1.06%
0.98%
1.11%
The adequacy of the allowance for loan losses is subject to a formal analysis by management of the Company. Management deems the allowance to be adequate to absorb probable losses in the portfolio, as of June 30, 2001. The Company has disclosed in its annual report on Form 10-K the process and methodology supporting the loan loss provision.
DEPOSITS
Traditional deposits continue to be the most significant source of funds for the Company. As shown in the following tables (dollars in thousands), deposits increased $9,513,000 or 2.6%, since December 31, 2000. Non-interest-bearing deposits decreased $5,838,000, at June 30, 2001, as a result of abnormally high year-end balances of approximately $5,500,000, which subsequently were withdrawn shortly after year-end.
Non-interest-bearing deposits
9.7
11.5
NOW accounts
47,513
12.6
48,384
13.2
Savings deposits
33,064
8.8
31,456
Money market deposit accounts
56,021
14.8
50,555
13.7
Certificates of deposit
204,185
54.1
195,037
53.0
Total
$ 377,298
$ 367,785
$ (5,838)
(13.8)
(871)
(1.8)
1,608
5.1
5,466
10.8
9,148
4.7
$ 9,513
2.6
BORROWED FUNDS
Borrowed funds increased $293,000 during the first six months of 2001. The Company's daily cash requirements or short-term investments are met by using the financial instruments available through the Federal Home Loan Bank. On October 30, 2000, we paid down all of our borrowings (approximately $30 million) at the Federal Home Loan Bank with the funds obtained from the acquisition, discussed previously.
In November 2000, the holding company borrowed $2,000,000 to invest in the bank subsidiary. This increased the Bank's capital and improved the negative impact on the regulatory capital ratios as a result of the branch acquisition (approximately $9.7 million in goodwill).
We evaluate stockholders' equity in relation to total assets and the risk associated with those assets. The greater the capital resources, the more likely a corporation is to meet its cash obligations and absorb unforeseen losses. For these reasons, capital adequacy has been, and will continue to be, of paramount importance.
Total Stockholders' Equity was $31,891,000, at June 30, 2001 compared to $30,549,000, at December 31, 2000, an increase of $1,342,000 or 4.4%. In the first six months, the Company earned $1,828,000 and declared dividends of $873,000, a dividend payout ratio of 47.8% of net income.
All of the Company's investment securities are classified as available-for-sale making this portion of the Company's balance sheet more sensitive to the changing market value of investments. Short-term interest rates in the first six months of 2001 have dropped approximately 275 basis points. This situation has caused an increase of $388,000 since December 31, 2000 in the accumulated other comprehensive income which is included in stockholders' equity.
On July 30, 1999, our Company began a plan to purchase, in open market or privately negotiated transactions, up to 135,000 shares of its outstanding common stock. This stock repurchase program was suspended, in April 2000, because of the acquisition. However, a total of 55,162 shares were repurchased at a cost of approximately $1 million as of June 30, 2001.
The Company has also complied with standards of capital adequacy mandated by the banking regulators. The Company's primary regulators have established "risk-based" capital requirements designed to measure capital adequacy. Risk-based capital ratios reflect the relative risks associated with various assets, entities hold in their portfolios. A weight category of 0% (lowest risk assets), 20%, 50%, or 100% (highest risk assets), is assigned to each asset on the balance sheet. The Company's computed risk-based capital ratios are as follows (dollars in thousands):
Total capital (to risk-weighted assets)
Ratio
Company
$ 25,099
9.89%
$ 23,295
8.89%
For capital adequacy purposes
20,313
8.00%
20,972
To be well capitalized
25,391
10.00%
26,215
Tier I capital (to risk-weighted assets)
$ 21,874
8.61%
$ 20,411
7.79%
10,156
4.00%
10,486
15,235
6.00%
15,729
Tier I capital (to average assets)
5.34%
5.10%
16,392
15,997
20,491
5.00%
19,996
See the discussion of liquidity below for details regarding the expansion project and the impact on capital.
On April 4, 2001, our Company filed a Registration Statement on Form S-3 establishing a Dividend Re-Investment Plan (DRIP), which will be effective for the July 2001 dividend.
RESULTS OF OPERATIONS
OVERVIEW OF THE INCOME STATEMENT
The Company had net income of $1,037,000 and $1,828,000 for the second quarter and first six months of 2001, respectively. Earnings per share, for the respective periods were $0.37 and $0.66. Net income was $897,000 and $1,835,000 for the second quarter and first six months of 2000, which equates to earnings per share of $0.32 and $0.66, respectively. The return on assets and the return on equity, for the six months of 2001, were 0.89% and 11.97%. Details of the reasons for this change are discussed on the following pages.
Operating cash earnings (net income before amortization of intangible assets and merger and acquisition costs, net of tax) was $1,204,000 and $2,163,000 for the second quarter and first six months of 2001, respectively, an increase of $289,000 and $256,000, from the $915,000 and $1,907,000 for the 2000 related period. Operating cash earnings per share was $0.43 and $0.78, during the second quarter and first six months of 2001, compared with $0.33 and $0.69, during the comparable 2000 period.
Net interest income, the most significant component of earnings, is the amount by which interest generated from earning assets exceeds interest expense on interest-bearing liabilities.
Net interest income, after provision for loan losses, totaled $3,451,000 in the second quarter, an increase of $605,000 or 21.3%, over the second quarter of 2000 and totaled $6,725,000 for the six months of 2001, an increase of $1,077,000 or 19.1% over the prior year. The Bank experienced an increase in earning assets in the past six months of 12.4%, which came primarily through the Acquisition that occurred in 2000.
June 30, 2001
June 30, 2000
June 30, 1999
Average
Balance (1)
Interest
Rate
$
ASSETS
Short-term investments:
Interest-bearing deposits at banks
14,966
4.62%
488
5.36%
2,264
4.90%
Total short-term investments
80,384
2,671
6.65%
72,329
2,305
6.37%
67,391
1,992
5.91%
Tax-exempt (3)
19,091
654
6.85%
20,634
706
6.84%
20,277
704
6.94%
Total investment securities
99,475
3,325
6.69%
92,963
3,011
6.48%
87,668
2,696
6.15%
Loans:
Residential mortgage loans
157,652
6,618
8.47%
143,629
6,018
8.43%
133,782
5,685
8.57%
Commercial and farm loans
69,075
3,130
9.14%
57,783
2,644
9.20%
48,741
2,267
9.38%
Loans to state and political subdivisions
22,519
895
8.01%
19,391
800
8.30%
11,271
473
8.46%
Other loans
14,519
749
10.40%
15,452
687
8.94%
14,557
647
8.96%
Loans, net of discount (2)(3)(4)
263,765
11,392
8.71%
236,255
10,149
8.64%
208,351
9,072
8.78%
Total interest-earning assets
378,206
15,060
8.03%
329,706
13,173
298,283
11,823
7.99%
Cash and due from banks
10,410
6,829
7,319
Bank premises and equipment
10,940
6,023
5,838
12,622
1,707
2,152
Total non-interest bearing assets
33,972
14,559
15,309
Total assets
412,178
344,265
313,592
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
47,050
331
1.42%
36,612
338
1.86%
35,486
314
1.78%
Savings accounts
32,273
190
1.19%
26,954
1.62%
27,473
252
1.85%
Money market accounts
51,332
1,039
4.08%
36,702
927
5.08%
40,410
860
4.29%
Sub-total
130,655
1,560
2.41%
100,268
1,482
2.97%
103,369
1,426
2.78%
200,150
5,742
5.79%
160,965
4,473
5.59%
151,956
4,204
5.58%
Total interest-bearing deposits
330,805
4.45%
261,233
4.58%
255,325
5,630
Other borrowed funds
12,904
4.03%
26,712
6.13%
5,595
148
5.33%
Total interest-bearing liabilities
343,709
4.44%
287,945
4.73%
260,920
5,778
4.47%
Demand deposits
35,377
23,739
21,467
2,546
3,376
2,872
Total non-interest-bearing liabilities
37,923
27,115
24,339
Stockholders' equity
30,546
29,205
28,333
Total liabilities & stockholders' equity
Net interest income
7,500
6,404
6,045
Net interest spread (5)
3.59%
3.31%
3.53%
Net interest income as a percentage
of average interest-earning assets
3.91%
4.09%
Ratio of interest-earning assets
to interest-bearing liabilities
1.10
1.15
1.14
(1) Averages are based on daily averages.
(2) Includes loan origination and commitment fees.
(3) Tax exempt interest revenue is shown on a tax equivalent basis for proper comparison using
a statutory federal income tax rate of 34%.
(4) Income on non-accrual loans is accounted for on a cash basis, and the loan balances are included in interest-earning assets.
(5) Interest rate spread represents the difference between the average rate earned on interest-earning assets
and the average rate paid on interest-bearing liabilities.
We have experienced an increasing interest margin percentage during the first six months of 2001, compared to the narrowing margin that we have experienced in the last few years. When the yield curve became inverted in 2000, interest rates began to rise resulting in our higher volume of short-term liabilities re-pricing faster than our short-term assets. Currently the yield curve is reverting back to a more normal slope beyond 6 months. Most of the Company's investments, loans, deposits and borrowings are priced or re-priced along the three month to five-year portion of the yield curve and a more normal yield curve should continue to improve our net interest margin. We continue to review various pricing and investment strategies to enhance deposit growth while maintaining or expanding the current interest margin.
The following table shows the effect of changes in volume and rate on interest income and expense. Tax-exempt interest revenue is shown on a tax-equivalent basis for proper comparison using a statutory federal income tax rate of 34%, for the six month period ended June 30 (dollars in thousands):
2001 vs. 2000 (1)
2000 vs. 1999 (1)
Change in
Volume
In Rate
Interest Income:
$ 332
$ (2)
$ 330
$ (48)
$ 6
$ (42)
332
(2)
330
(48)
6
(42)
262
104
366
313
Tax-exempt
(52)
11
2
161
154
315
589
600
410
(77)
333
512
(26)
486
412
(35)
377
(28)
95
334
327
(37)
99
62
40
Total loans, net of discount
1,187
56
1,243
1,196
(119)
1,077
Total Interest Income
1,729
158
1,887
1,309
41
1,350
Interest Expense:
Interest-bearing deposits:
96
(103)
10
24
74
(101)
(27)
(30)
Money Market accounts
224
112
(65)
132
67
1,120
149
1,269
250
19
1,514
(167)
1,347
135
325
(334)
(222)
(556)
638
28
666
Total interest expense
1,180
(389)
791
828
991
$ 549
$ 547
$ 1,096
$ 481
$ (122)
$ 359
(1) The change in interest due to both rate and volume has been allocated to the volume and rate in
proportion to the absolute dollar amounts of each change.
As can be seen from the preceding tables, tax equivalent net interest income rose from $6,045,000, in 1999, to $6,404,000, in 2000, and increased to $7,500,000, in 2001. In the period ending June 30, 2001, net interest income increased $1,096,000, while overall spread increased from 3.31% to 3.59%. The increased volume of interest-earning assets generated an increase in interest income of $1,729,000 while increased volume of interest-bearing liabilities produced $1,180,000 of interest expense. The change in volume resulted in an increase of $549,000 in net interest income. The net change in rate was a positive $547,000, resulting in a total positive net change of $1,096,000, when combined with change in volume. The yield on interest-earning assets remained constant at 8.03% and the average interest rate on interest-bearing liabilities decreased 29 basis points, from 4.73% to 4.44%, because of the previously described changes to the yield curve.
Provision For Loan Losses
The Company recorded a provision for loan losses in the second quarter of $120,000 compared to the second quarter of 2000 at $100,000 and $195,000 for the six months of 2001 compared to $200,000 in 2000.
This provision was appropriate given management's quarterly review of the allowance for loan losses that 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 adjustments and peer comparisons.
OTHER OPERATING INCOME
Other operating income, as detailed below, increased $607,000 or 98.9% and $819,000 or 65.4% in the second quarter and the first six months of 2001,respectively, when compared to the same periods in 2000. Service charge income continues to be the primary source of growth in other operating income. For the first six months, account service charges totaled $1,138,000 up $286,000 or 33.6% over last year. These increases in fee income were mainly the result of growth in the number of customers and related deposit accounts as a result of the acquisition.
The following table shows the breakdown of other operating income for the three months ended June 30, 2001 and 2000(dollars in thousands):
Three months ended
$ 575
$ 446
$ 129
28.9
23
23.0
88
107.3
367
2,621.4
$ 1,221
$ 614
$ 607
98.9
The following table shows the breakdown of other operating income for the six months ended June 30, 2001 and 2000(dollars in thousands):
Six months ended
$ 1,138
$ 852
$ 286
33.6
63
29.0
92
51.4
378
7,560.0
$ 2,072
$ 1,253
$ 819
65.4
Trust income increased $23,000 and $63,000 in the second quarter and the first six months of 2001, respectively, when compared to the same periods in 2000. The increase is due primarily to estate fees recognized in the current period.
Other operating income increased $88,000 and $92,000 in the second quarter and the first six months of 2001, respectively, when compared to the same periods in 2000. The increase is largely attributable to gains recognized on foreclosed property sales and master card/VISA income.
In an effort to accelerate the improvement of our capital ratios and take advantage of current market conditions, we elected to sell and reinvest approximately $20,737,000 of investment securities in the first six months of 2001, which resulted in $383,000 of security gains.
We continue to evaluate means of increasing other operating income to offset the loss of net interest margin described above. Our approach is to apply service charges on business transaction accounts by charging fees on transaction activity (reduced by earnings credit based on customers' balances) to more equitably recover costs. We expect to continue this analysis for our other products.
OTHER OPERATING EXPENSES
Total other operating expense, as detailed below, increased $1,058,000 or 44.9% during the second quarter of 2001 and $1,995,000 or 43.2% in the first six months of 2001 when compared to the same period in 2000. This increased level of other operating expense is attributable to the acquisition that occurred during 2000, which increased our number of locations by four (after the consolidation of two banking offices, in February 2001). The increase in salaries and employee benefits a result of the acquisition; increased staff for our new branch in Wal-Mart, which opened in August 2000, and the filling of some corporate positions related to the growth strategies that we have implemented. The increase in occupancy and furniture and equipment expenses is also a direct result of the recent acquisition, along with the completion of the two new facilities. The increase in other expense is primarily the result of increased amortization expense associated with the acquisition along with normal operating expense s associated with additional locations.
The following tables reflect the breakdown of other operating expense and professional fees for the three months ended June 30, 2001 and 2000(dollars in thousands):
$ 1,571
$ 1,105
$ 466
42.2
102
72.3
57
30.8
19.0
Amortization
227
840.7
182
23.5
$ 3,416
$ 2,358
$ 1,058
44.9
Other professional fees
$ 113
$ 108
$ 5
Legal fees
9
180.0
Examinations and audits
76.9
$ 150
$ 126
$ 24
The following tables reflect the breakdown of other operating expense and professional fees for the six months ended June 30, 2001 and 2000(dollars in thousands):
$ 3,051
$ 2,186
$ 865
39.6
199
70.6
27.8
(8)
(3.1)
399
366.1
440
30.9
$ 6,612
$ 4,617
43.2
$ 185
$ 221
$ (36)
(16.3)
12
109.1
25
64.0
$ 249
$ 257
$ (8)
PROVISION FOR INCOME TAXES
The provision for income taxes was $219,000 for the second quarter of 2001 compared to $205,000 in the second quarter of 2000. For the six-month period comparisons, the provision for income taxes was $357,000 in 2001 and $449,000 in 2000. The decrease was primarily a result of increased levels of tax-exempt income and recognition of tax credits as described below.
We have entered into two limited partnership agreements, to establish low-income housing projects in our market area. As a result of these agreements, we expect to receive approximately $1,290,000 of tax credits over a ten-year period when the projects are completed.
LIQUIDITY
Liquidity is a measure of our Company's ability to efficiently meet normal cash flow requirements of both borrowers and depositors. To maintain proper liquidity, we use funds management policies along with our investment policies to assure we can meet our financial obligations to depositors, credit customers and stockholders. Liquidity is needed to meet depositors' withdrawal demands, extend credit to meet borrowers' needs, provide funds for normal operating expenses and cash dividends, and to fund other capital expenditures.
Our Company's historical activity in this area can be seen in the Consolidated Statement of Cash Flows from investing and financing activities.
Cash generated by operating activities, investing activities and financing activities influences liquidity management. The most important source of funds is the deposits that are primarily core deposits (deposits from customers with other relationships). Short-term debt from the Federal Home Loan Bank supplements our Company's availability of funds.
Our Company's use of funds is shown in the investing activity section of the Consolidated Statement of Cash Flows, where the net loan activity is presented. Other significant uses of funds include capital expenditures. Surplus funds are then invested in investment securities.
Capital expenditures during the first six months of 2001 were $1.3 million, $.8 million more than the same period in 2000. The large increase is primarily the result of the building projects in process (described below):
Major capital expenditures for 2001 were:
Some major capital expenditures for 2000 were:
We believe our Company has sufficient resources to complete these projects from our normal operations and that they will have a long-term positive effect on revenues, efficiency and the capacity for future growth.
Our Company achieves additional liquidity primarily from temporary or short-term investments in the Federal Home Loan Bank of Pittsburgh, PA, and investments that mature in less than one year. The Company also has a maximum borrowing capacity at the Federal Home Loan Bank of approximately $129 million as an additional source of liquidity.
Apart from those matters described above, management does not currently believe that there are any current trends, events or uncertainties that would have a material impact on capital.
CREDIT QUALITY RISK
The following table identifies amounts of loan losses and non-performing loans. Past due loans are those that were contractually past due 90 days or more as to interest or principal payments (dollars in thousands).
Non-performing loans:
Non-accruing loans
$ 488
$ 421
$ 1,495
$ 1,169
Impaired loans
1,522
1,334
382
Accrual loans - 90 days or
more past due
39
78
15
Total non-performing loans
2,157
726
1,833
1,892
1,721
573
529
238
Total non-performing assets
$ 2,647
$ 1,234
$ 2,406
$ 2,421
$ 1,959
Non-performing loans as a percent of loans
net of unearned income
0.81%
0.28%
0.79%
0.92%
0.90%
Non-performing assets as a percent of loans
0.99%
0.47%
1.04%
1.18%
1.02%
Interest does not accrue on non-accrual loans. Subsequent cash payments received are applied to the outstanding principal balance or recorded as interest income, depending upon management's assessment of its ultimate ability to collect principal and interest.
INTEREST RATE AND MARKET RISK MANAGEMENT
The objective of interest rate sensitivity management is to maintain an appropriate balance between the stable growth of income and the risks associated with maximizing income through interest sensitivity imbalances and the market value risk of assets and liabilities.
Because of the nature of our operations, we are not subject to foreign currency exchange or commodity price risk and, since our Company has no trading portfolio, it is not subject to trading risk.
Currently, our Company has equity securities that represent only 4% of our investment portfolio and, therefore, equity risk is not significant.
The primary components of interest-sensitive assets include adjustable-rate loans and investments, loan repayments, investment maturities and money market investments. The primary components of interest-sensitive liabilities include maturing certificates of deposit, IRA certificates of deposit and short-term borrowings. Savings deposits, NOW accounts and money market investor accounts are considered core deposits and are not short-term interest sensitive (except for the top-tier money market investor accounts which are paid current market interest rates).
Gap analysis, one of the methods used by us to analyze interest rate risk, does not necessarily show the precise impact of specific interest rate movements on our Company's net interest income because the re-pricing of certain assets and liabilities is discretionary and is subject to competitive and other pressures. In addition, assets and liabilities within the same period may, in fact, be repaid at different times and at different rate levels. We have not experienced the kind of earnings volatility that might be indicated from gap analysis.
Our Company currently uses a computer simulation model to better measure the impact of interest rate changes on net interest income. We use the model as part of our risk management process that will effectively identify, measure, and monitor our Company's risk exposure.
We use numerous interest rate simulations employing a variety of assumptions to evaluate our interest rate risk exposure. A shock analysis at June 30, 2001, indicated that a 200 basis point movement in interest rates in either direction would have a minor impact on our Company's anticipated net interest income over the next twenty-four months.
GENERAL
The majority of assets and liabilities of a financial institution are monetary in nature and, therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. However, inflation does have an important impact on the growth of total assets and on non-interest expenses, which tend to rise during periods of general inflation. The recent action by the Federal Reserve of increasing short-term interest rates will help ensure that the level of inflation remains at a relatively low level.
Various congressional bills have been passed and other proposals have been made for significant changes to the banking system, including provisions for: limitation on deposit insurance coverage; changing the timing and method financial institutions use to pay for deposit insurance; and tightening the regulation of bank derivatives' activities.
On November 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley Act of 1999, which is also known as the Financial Services Modernization Act. The act repeals some depression-era banking laws and will permit banks, insurance companies and securities firms to engage in each other's business after complying with certain conditions and regulations that are yet to be finalized. The act grants to community banks the power to enter new financial markets as a matter of right that larger institutions have managed to do on an ad hoc basis.
Our Company does not believe that the Financial Services Modernization Act will have an immediate positive or negative material impact on our operations. However, the act may have the result of increasing the amount of competition that our Company faces from larger financial service companies, many of whom have substantially more financial resources than our Company, which may now offer banking services in addition to insurance and brokerage products.
Aside from those matters described above, we do not believe that there are any trends, events or uncertainties, which would have a material adverse impact on future operating results, liquidity or capital resources. We are not aware of any current recommendations by the regulatory authorities (except as described herein) which, if they were to be implemented, would have such an effect, although the general cost of compliance with numerous and multiple federal and state laws and regulations does have, and in the future may have, a negative impact on our Company's results of operations.
Item 3- Quantitative and Qualitative Disclosure About Market Risk
In the normal course of conducting business activities, the Company is exposed to market risk, principally interest rate risk, through the operations of its banking subsidiary. Interest rate risk arises from market driven fluctuations in interest rates that affect cash flows, income, expense and values of financial instruments and was discussed previously in this Form 10-Q. Management and a committee of the board of directors manage interest rate risk.
No material changes in market risk strategy occurred during the current period. A detailed discussion of market risk is provided in the SEC Form 10-K for the period ended December 31, 2000.
PART II - OTHER INFORMATION AND SIGNATURES
Item 1 - Legal Proceedings
Management is not aware of any litigation that would have a material adverse effect on the consolidated financial position of the Company. Any pending proceedings are ordinary, routine litigation incidental to the business of the Company and its subsidiary. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Company and its subsidiary by government authorities.
Item 2 - Changes in Securities and use of Proceeds - Note applicable.
Item 3 - Defaults Upon Senior Securities - Not applicable.
Item 4 - Submission of Matters to a Vote of Security Holders
Citizens Financial Services held its Annual Meeting of Shareholders on April 17, 2001, for the purpose of electing three directors and to transact such other business as would properly come before the meeting. Results of shareholder voting on these individuals were as follows:
For Withhold Authority
John E. Novak 2,609,835 56,172
Rudolph J. van der Hiel, Esquire 2,611,770 54,237
Mark L. Dalton 2,612,779 53,228
The total shares voted at the annual meeting were 2,666,007.
Item 5 - Other Information - None.
Item 6 -Exhibits and Reports on Form 8-K.
(a) Exhibits.
(3)(i) - Articles of Incorporation of the Corporation, as amended. (Incorporated by Reference to Exhibit (3)(ii) to the Quarterly Report of Form 10-Q for the period ended March 31, 2000, as filed with the Commission on May 11,2000.)
(3)(ii)- By-laws of the Corporation, as amended. (Incorporated by Reference to Exhibit (3)(ii) to the Annual Report of Form 10-K for the fiscal year ended December 31, 1995, as filed with the Commission on March 26, 1996.)
(4) - Instruments Defining the Rights of Stockholders. (Incorporated by reference to the Registrant's Registration Statement No.2-89103 on Form S-14, as filed with the Commission on February 17, 1984.)
(10) - Material Contracts. Employment Agreement between our Company and Richard E. Wilber. (Incorporated by Reference to Exhibit (10) to the Annual Report of Form 10-K for the fiscal year ended December 31, 1998, as filed with the Commission on March 17, 1998.)
(99) - Independent accountant's review of financial statements for the period ended June 30, 2001.
(b) Reports on Form 8-K - Nothing to report.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the undersigned Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
(Registrant)
August 9, 2001 /s/ Richard E. Wilber
By: Richard E. Wilber
President
(Principal Executive Officer)
August 9, 2001 /s/ Randall E Black
By: Randall E. Black
Assistant Treasurer
(Principal Financial Officer &
Principal Accounting Officer)
EXHIBITS INDEX