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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the six-month period ended June 30, 2002
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from ________ to ___________
Commission file number: 0-16084
CITIZENS & NORTHERN CORPORATION
(Exact name of Registrant as specified in its charter)
Pennsylvania 23-2451943
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
90-92 Main Street
Wellsboro, Pa. 16901
(Address of principal executive offices) (Zip code)
570-724-3411
(Registrant's telephone number including area code)
Not applicable
(Former name, former address, and former fiscal year, if changed since last
report)
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 reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes ____ No ____
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
Title Outstanding
Common Stock ($1.00 par value) 5,284,312 Shares Outstanding August 12, 2002
1
CITIZENS & NORTHERN CORPORATION
Index
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheet - June 30, 2002 and
December 31, 2001 Page 3
Consolidated Statement of Income - Three Months and Six
Months Ended June 30, 2002 and 2001 Page 4
Consolidated Statement of Cash Flows - Six Months
Ended June 30, 2002 and 2001 Page 5
Notes to Consolidated Financial Statements Pages 6 through 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations Pages 8 through 21
Item 3. Information About Market Risk Pages 22 and 23
Part II. Other Information Page 24
Signatures Page 25
Exhibit 99.1 Certification Pursuant to 18 U.S.C. Section 1350
as Adopted Pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002 Page 26
2
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEET JUNE 30, DECEMBER 31,
(In Thousands Except Share Data) 2002 2001
(UNAUDITED) (NOTE)
ASSETS Cash and due from banks:
Noninterest-bearing $ 13,757 $ 14,055
Interest-bearing 1,880 1,981
- ---------------------------------------------------------------------------------------------
Total cash and cash equivalents 15,637 16,036
Available-for-sale securities 477,788 433,969
Held-to-maturity securities 859 1,448
Loans, net 406,430 373,963
Bank-owned life insurance 16,340 15,905
Accrued interest receivable 5,661 4,871
Bank premises and equipment, net 10,218 9,967
Foreclosed assets held for sale 407 179
Other assets 14,095 10,661
- ---------------------------------------------------------------------------------------------
TOTAL ASSETS $ 947,435 $ 866,999
=============================================================================================
LIABILITIES
Deposits:
Noninterest-bearing $ 64,008 $ 63,858
Interest-bearing 547,838 512,416
- ---------------------------------------------------------------------------------------------
Total deposits 611,846 576,274
Dividends payable 1,480 1,466
Short-term borrowings 35,742 58,064
Long-term borrowings 180,726 125,584
Accrued interest and other liabilities 8,933 5,424
- ---------------------------------------------------------------------------------------------
TOTAL LIABILITIES 838,727 766,812
- ---------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
Common stock, par value $1.00 per share; authorized 10,000,000
shares; issued 5,431,021 in 2002 and 5,378,212 in 2001 5,432 5,378
Stock dividend distributable -- 1,369
Paid-in capital 21,141 19,758
Retained earnings 75,023 70,352
- ---------------------------------------------------------------------------------------------
Total 101,596 96,857
Accumulated other comprehensive income 9,288 5,284
Unamortized stock compensation (91) (17)
Treasury stock, at cost:
146,709 shares at June 30, 2002 (2,085)
143,412 shares at December 31, 2001 (1,937)
- ---------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 108,708 100,187
- ---------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 947,435 $ 866,999
=============================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
Note: The balance sheet at December 31, 2001 has been derived from the audited
financial statements at that date but does not include all the information and
notes required by generally accepted accounting principles for complete
financial statements.
3
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
CONSOLIDATED STATEMENT OF INCOME
3 MONTHS ENDED FISCAL YEAR TO DATE
(In thousands, except per share data) (Unaudited) JUNE 30, JUNE 30, 6 MONTHS ENDED JUNE 30,
2002 2001 2002 2001
INTEREST INCOME (CURRENT) (PRIOR YEAR) (CURRENT) (PRIOR YEAR)
Interest and fees on loans $ 7,542 $ 7,010 $ 14,799 $ 13,912
Interest on balances with depository institutions 5 11 13 30
Interest on loans to political subdivisions 142 177 292 348
Interest on federal funds sold 10 65 14 126
Income from available-for-sale and
held-to-maturity securities:
Taxable 5,124 5,276 9,788 10,009
Tax-exempt 1,457 1,016 2,768 1,960
Dividends 243 275 491 538
- ------------------------------------------------------------------------------------------------------------------------------
Total interest and dividend income 14,523 13,830 28,165 26,923
- ------------------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Interest on deposits 4,368 5,258 8,625 10,951
Interest on short-term borrowings 242 1,149 514 2,480
Interest on long-term borrowings 2,135 871 3,922 1,339
- ------------------------------------------------------------------------------------------------------------------------------
Total interest expense 6,745 7,278 13,061 14,770
- ------------------------------------------------------------------------------------------------------------------------------
Interest margin 7,778 6,552 15,104 12,153
Provision for loan losses 180 150 360 300
- ------------------------------------------------------------------------------------------------------------------------------
Interest margin after provision for possible loan losses 7,598 6,402 14,744 11,853
- ------------------------------------------------------------------------------------------------------------------------------
OTHER INCOME
Service charges on deposit accounts 423 330 807 626
Service charges and fees 68 59 133 127
Trust and financial management income 506 427 945 814
Insurance commissions, fees and premiums 125 115 340 253
Increase in cash surrender value of life insurance 211 229 435 451
Fees related to credit card operation 152 148 282 276
Other operating income 196 208 426 403
- ------------------------------------------------------------------------------------------------------------------------------
Total other income before realized gains on securities, net 1,681 1,516 3,368 2,950
Realized gains on securities, net 781 742 2,007 1,197
- ------------------------------------------------------------------------------------------------------------------------------
Total other income 2,462 2,258 5,375 4,147
- ------------------------------------------------------------------------------------------------------------------------------
OTHER EXPENSES
Salaries and wages 2,351 2,052 4,589 4,070
Pensions and other employee benefits 644 523 1,259 1,103
Occupancy expense, net 308 250 586 509
Furniture and equipment expense 394 352 841 698
Expenses related to credit card operation 65 61 136 138
Pennsylvania shares tax 183 198 366 394
Other operating expense 1,303 1,144 2,577 2,266
- ------------------------------------------------------------------------------------------------------------------------------
Total other expenses 5,248 4,580 10,354 9,178
- ------------------------------------------------------------------------------------------------------------------------------
Income before income tax provision 4,812 4,080 9,765 6,822
Income tax provision 992 891 2,107 1,368
- ------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 3,820 $ 3,189 $ 7,658 $ 5,454
==============================================================================================================================
PER SHARE DATA:
Net income - basic $ 0.72 $ 0.60 $ 1.45 $ 1.03
Net income - diluted $ 0.72 $ 0.60 $ 1.44 $ 1.03
- ------------------------------------------------------------------------------------------------------------------------------
Dividend per share $ 0.28 $ 0.26 $ 0.56 $ 0.52
- ------------------------------------------------------------------------------------------------------------------------------
Number shares used in computation - basic 5,286,000 5,301,482 5,288,279 5,305,003
Number shares used in computation - diluted 5,300,314 5,302,060 5,300,195 5,305,303
The accompanying notes are an integral part of these consolidated financial
statements.
4
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS) (UNAUDITED)
6 MONTHS ENDED
JUNE 30, JUNE 30,
2002 2001
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 7,658 $ 5,454
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 360 300
Realized gains on securities, net (2,007) (1,197)
Gain on sale of foreclosed assets, net (10) (5)
Depreciation expense 725 616
Accretion and amortization, net (358) (1,166)
Increase in cash surrender value of life insurance (435) (451)
Amortization of restricted stock 42 11
Increase in accrued interest receivable and other assets (1,082) (928)
Increase in accrued interest payable and other liabilities 1,484 3,122
- ---------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 6,377 5,756
- ---------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturity of held-to-maturity securities 586 894
Purchase of held-to-maturity securities -- (626)
Proceeds from sales of available-for-sale securities 11,481 2,559
Proceeds from maturities of available-for-sale securities 51,928 54,637
Purchase of available-for-sale securities (101,293) (124,951)
Purchase of restricted stock (680) --
Net increase in loans (33,192) (16,437)
Purchase of premises and equipment (976) (978)
Proceeds from sale of foreclosed assets 147 280
- ---------------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (71,999) (84,622)
- ---------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 35,572 20,237
Net decrease in short-term borrowings (22,322) (9,129)
Proceeds from long-term borrowings 75,153 70,000
Repayments of long-term borrowings (20,011) (10)
Purchase of treasury stock (238) (521)
Sale of treasury stock 42 --
Dividends paid (2,973) (2,719)
- ---------------------------------------------------------------------------------------------
Net Cash Provided by Financing Activities 65,223 77,858
- ---------------------------------------------------------------------------------------------
DECREASE IN CASH AND CASH EQUIVALENTS (399) (1,008)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 16,036 13,824
- ---------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 15,637 $ 12,816
=============================================================================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Assets acquired through foreclosure of real estate loans $ 365 $ 258
Interest paid $ 10,914 $ 11,915
Income taxes paid $ 2,750 $ 1,014
The accompanying notes are an integral part of these consolidated financial
statements.
5
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF INTERIM PRESENTATION
The financial information included herein, with the exception of the
consolidated balance sheet dated December 31, 2001, is unaudited; however, such
information reflects all adjustments (consisting solely of normal recurring
adjustments) that are, in the opinion of management, necessary for a fair
presentation of the financial position, results of operations and cash flows for
the interim periods.
Results reported for the three-month and six-month periods ended June 30, 2002
might not be indicative of the results for the year ending December 31, 2002.
Certain 2001 amounts have been reclassified to conform to the 2002 presentation.
This document has not been reviewed or confirmed for accuracy or relevance by
the Federal Deposit Insurance Corporation or any other regulatory agency.
2. PER SHARE DATA
Net income per share is based on the weighted-average number of shares of common
stock outstanding. The number of shares used in calculating net income and cash
dividends per share reflect the retroactive effect of stock dividends for all
periods presented. The following data show the amounts used in computing net
income per share and the weighted average number of shares of dilutive stock
options. The dilutive effect of stock options is computed as the
weighted-average common shares available from the exercise of all dilutive stock
options, less the number of shares that could be repurchased with the proceeds
of stock option exercises based on the average share price of the Corporation's
common stock during the period.
WEIGHTED-
AVERAGE EARNINGS
NET COMMON PER
INCOME SHARES SHARE
---------- --------- -----
SIX-MONTH PERIOD ENDED JUNE 30, 2002
Earnings per share - basic $7,658,000 5,288,279 $1.45
Dilutive effect of stock options 11,916
- -------------------------------------------------------------------------------
Earnings per share - diluted $7,658,000 5,300,195 $1.44
===============================================================================
SIX-MONTH PERIOD ENDED JUNE 30, 2001
Earnings per share - basic $5,454,000 5,305,003 $1.03
Dilutive effect of stock options 300
- -------------------------------------------------------------------------------
Earnings per share - diluted $5,454,000 5,305,303 $1.03
===============================================================================
QUARTER ENDED JUNE 30, 2002
Earnings per share - basic $3,820,000 5,286,000 $0.72
Dilutive effect of stock options 14,314
- -------------------------------------------------------------------------------
Earnings per share - diluted $3,820,000 5,300,314 $0.72
===============================================================================
QUARTER ENDED JUNE 30, 2001
Earnings per share - basic $3,189,000 5,301,482 $0.60
Dilutive effect of stock options 578
- -------------------------------------------------------------------------------
Earnings per share - diluted $3,189,000 5,302,060 $0.60
===============================================================================
6
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
3. COMPREHENSIVE INCOME
Accounting principles generally require that recognized revenue, expenses, gains
and losses be included in net income. Although certain changes in assets and
liabilities, such as unrealized gains and losses on available-for-sale
securities, are reported as a separate component of the equity section of the
balance sheet, such items, along with net income, are components of
comprehensive income.
Comprehensive income is calculated as follows:
3 MONTHS ENDED 6 MONTHS ENDED
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
(IN THOUSANDS) 2002 2001 2002 2001
Net income $ 3,820 $ 3,189 $ 7,658 $ 5,454
Other comprehensive income (loss):
Unrealized holding gains (losses) on available-for-sale securities:
Gains (losses) arising during the period 10,333 (289) 8,074 6,752
Reclassification adjustment for realized gains (781) (742) (2,007) (1,197)
- --------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) before income tax 9,552 (1,031) 6,067 5,555
Income tax related to other comprehensive income/loss (3,249) 350 (2,063) (1,889)
- --------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) 6,303 (681) 4,004 3,666
- --------------------------------------------------------------------------------------------------------------------------------
Comprehensive income $ 10,123 $ 2,508 $ 11,662 $ 9,120
================================================================================================================================
4. DERIVATIVE FINANCIAL INSTRUMENTS
In June 2001, the Corporation began to utilize derivative financial instruments
related to a new certificate of deposit product called the "Index Powered
Certificate of Deposit" (IPCD). IPCDs have a term of 5 years, with interest paid
at maturity based on 90% of the appreciation (as defined) in the S&P 500 index.
There is no guaranteed interest payable to a depositor of an IPCD - however,
assuming an IPCD is held to maturity, a depositor is guaranteed the return of
his or her principal, at a minimum.
Statement of Financial Accounting Standards No. 133 requires the Corporation to
separate the amount received from each IPCD issued into 2 components: (1) an
embedded derivative, and (2) the principal amount of each deposit. Embedded
derivatives are derived from the Corporation's obligation to pay each IPCD
depositor a return based on appreciation in the S&P 500 index. Embedded
derivatives are carried at fair value, and are included in other liabilities in
the consolidated balance sheet. Changes in fair value of the embedded derivative
are included in other expense in the consolidated income statement. The
difference between the contractual amount of each IPCD issued, and the amount of
the embedded derivative, is recorded as the initial deposit (included in
interest-bearing deposits in the consolidated balance sheet). Interest expense
is added to principal ratably over the term of each IPCD at an effective
interest rate that will increase the principal balance to equal the contractual
IPCD amount at maturity.
In connection with IPCD transactions, the Corporation has entered into Equity
Indexed Call Option (Swap) contracts with the Federal Home Loan Bank of
Pittsburgh (FHLB-Pittsburgh). Under the terms of the Swap contracts, the
Corporation must pay FHLB-Pittsburgh quarterly amounts calculated based on the
contractual amount of IPCDs issued times a negotiated rate. In return,
FHLB-Pittsburgh is obligated to pay the Corporation, at the time of maturity of
the IPCDs, an amount equal to 90% of the appreciation (as defined) in the S&P
500 index. If the S&P 500 index does not appreciate over the term of the related
IPCDs, the FHLB-Pittsburgh would make no payment to the Corporation. The effect
of the Swap contracts is to limit the Corporation's cost of IPCD funds to the
market rate of interest paid to FHLB-Pittsburgh. (In addition, the Corporation
pays a fee of 0.75% to a consulting firm at inception of each deposit. This fee
is amortized to interest expense over the term of the IPCDs.) Swap liabilities
are carried at fair value, and included in other liabilities in the consolidated
balance sheet. Changes in fair value of swap liabilities are included in other
expense in the consolidated income statement.
7
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Amounts recorded related to IPCDs are as follows (in thousands):
JUNE 30, DEC. 31,
2002 2001
Contractual amount of IPCDs (equal
to notional amount of Swap contracts) $2,485 $1,410
Carrying value of IPCDs 2,072 1,154
Carrying value of embedded derivative liabilities 179 233
Carrying value of Swap contract liabilities 244 31
3 MONTHS 6 MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
2002 2002
Interest expense $21 $37
Other expense
1 5
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
PART I - FINANCIAL INFORMATION (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Certain statements in this section and elsewhere in Form 10-Q are
forward-looking statements. Citizens & Northern Corporation and its wholly-owned
subsidiaries (collectively, the Corporation) intend such forward-looking
statements to be covered by the safe harbor provisions for forward-looking
statements contained in the Private Securities Reform Act of 1995.
Forward-looking statements, which are based on certain assumptions and describe
future plans, business objectives and expectations, are generally identifiable
by the use of words such as, "believe", "expect", "intend", "anticipate",
"estimate", "project", and similar expressions. The Corporation's ability to
predict results or the actual effect of future plans or occurrences is
inherently uncertain. Factors which could have a material adverse effect on the
operations and future prospects of the Corporation include, but are not limited
to, the following:
- - changes in monetary and fiscal policies of the U.S. Treasury and the
Federal Reserve Board, particularly related to changes in interest rates
- - changes in general economic conditions
- - legislative or regulatory changes
- - downturn in demand for loan, deposit and other financial services in the
Corporation's market area
- - increased competition from other banks and non-bank providers of financial
services
- - technological changes and increased technology-related costs
- - changes in accounting principles.
These risks and uncertainties should be considered in evaluating forward-looking
statements and undue reliance should not be placed on such statements.
8
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
REFERENCES TO 2002 AND 2001
Unless otherwise noted, all references to "2002" in the following discussion of
operating results are intended to mean the six months ended June 30, 2002, and
similarly, references to "2001" are intended to mean the six months ended June
30, 2001.
EARNINGS OVERVIEW
Net income for 2002 was $7,658,000, or $1.45 per share - basic and $1.44 per
share - diluted. This represents an increase of 39.9% in net income per share -
diluted over 2001. Return on average assets, excluding unrealized gains and
losses on securities, increased 19.9%, to 1.69% in 2002 compared to 1.41% in
2001. Including the effects of unrealized gains and losses on securities, return
on average assets increased to 1.68% in 2002 from 1.41% in 2001. Return on
average equity, excluding unrealized gains and losses on securities, rose 30.4%,
to 15.80% in 2002 from 12.12% in 2001. Including unrealized gains and losses on
securities, return on average equity increased 26.0%, to 14.93% in 2002 from
11.85% in 2001.
The most significant income statement changes between 2002 and 2001 were as
follows:
- - The interest margin increased significantly ($2,951,000, or 24.3%), to
$15,104,000 in 2002 from $12,153,000 in 2001. The Corporation has
experienced significant growth in deposits and loans, and has identified
opportunities to borrow funds and invest the proceeds in securities at
positive spreads. Also, average interest rates on deposits and borrowed
funds have been lower in 2002, as the Corporation's average rates were more
fully impacted by the Federal Reserve Board's lowering of the federal funds
target rate several times throughout 2001. Changes in the net interest
margin are discussed in more detail later in Management's Discussion and
Analysis.
- - Net realized gains on securities were $2,007,000 in 2002, compared to
$1,197,000 in 2001. In both years, the gains were mainly from sales of bank
stocks. These sales resulted from circumstances specific to each underlying
company, and the proceeds have been reinvested in other bank stocks.
- - Service charges on deposit accounts increased $181,000, or 28.9%. This
increase resulted from increased numbers of accounts and higher average
balances, as well as fee increases implemented in the second half of 2001
on certain types of services.
- - Other (noninterest) expenses increased $1,176,000, or 12.8%, in 2002
compared to 2001. The increase reflects increases in payroll costs,
depreciation and maintenance agreements associated with computer hardware
and software. These types of costs have increased as a result of the need
to add personnel and supplement existing systems to keep up with expansion
of services and growth in lending activity over the last few years.
- - The income tax provision increased to $2,107,000 in 2002 from $1,368,000 in
2001, because pre-tax income is higher.
SECOND QUARTER 2002
Net income for the second quarter 2002 was $3,820,000, or 19.8% higher than net
income for the second quarter 2001 of $3,189,000. The interest margin increased
$1,226,000 for the second quarter 2002 compared to the second quarter 2001,
while noninterest expenses increased $668,000 between the periods. The major
reasons for these changes are the same as described in the comparison of the six
months ended June 30, 2002 and 2001 operating results above.
Net income for the second quarter 2002 is slightly less than the $3,838,000
reported in the first quarter 2002. As you can see in Table I, the interest
margin increased $452,000 in the second quarter over the first quarter. However,
net securities gains were $445,000 lower in the second quarter compared to the
first quarter, and noninterest expenses increased $142,000.
9
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE I - QUARTERLY FINANCIAL DATA
(IN THOUSANDS)
JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
2002 2002 2001 2001 2001 2001
Interest income $14,523 $13,642 $13,776 $13,962 $13,830 $13,093
Interest expense 6,745 6,316 6,549 7,037 7,278 7,492
- -----------------------------------------------------------------------------------------------------------------------------
Interest margin 7,778 7,326 7,227 6,925 6,552 5,601
Provision for loan losses 180 180 150 150 150 150
- -----------------------------------------------------------------------------------------------------------------------------
Interest margin after provision for loan losses 7,598 7,146 7,077 6,775 6,402 5,451
Other income 1,681 1,687 1,570 1,600 1,516 1,434
Securities gains 781 1,226 203 520 742 455
Other expenses 5,248 5,106 4,918 4,575 4,580 4,598
- -----------------------------------------------------------------------------------------------------------------------------
Income before income tax provision 4,812 4,953 3,932 4,320 4,080 2,742
Income tax provision 992 1,115 740 914 891 477
- -----------------------------------------------------------------------------------------------------------------------------
Net income $ 3,820 $ 3,838 $ 3,192 $ 3,406 $ 3,189 $ 2,265
=============================================================================================================================
Net income per share - basic $ 0.72 $ 0.73 $ 0.60 $ 0.64 $ 0.60 $ 0.43
=============================================================================================================================
Net income per share - diluted $ 0.72 $ 0.72 $ 0.60 $ 0.64 $ 0.60 $ 0.43
=============================================================================================================================
The number of shares used in calculating net income per share for each quarter
of 2001 reflects the retroactive effect of a 1% stock dividend declared in
December 2001 and issued in January 2002.
PROSPECTS FOR THE REMAINDER OF 2002
Prospects for the remainder of 2002 continue to be very good. Net loans are up
19.9% as of June 30, 2002 compared to one year earlier. The Corporation's major
concentration continues to be real estate secured loans, with significant new
loans generated recently, and "in the pipeline," related to both residential and
commercial activity.
Deposits and customer repurchase agreements have also grown substantially (up
11.1% as of June 30, 2002 compared to one year earlier), and there continues to
be significant customer demand in recent months. The largest category of deposit
growth in recent months has been certificates of deposit. It appears that
investors have moved funds out of, or are not investing new dollars in, the U.S.
stock market. Also, the Corporation has developed some new, innovative CD
products over the last year. In June 2001, the Corporation began to offer Index
Powered CDs, which are described in more detail in Note 4 to the consolidated
financial statements. Effective in May 2002, the Corporation began to offer
"Roll-up" CDs. Roll-up CDs allow the investor to increase the interest rate, to
the Corporation's current CD rate for the same term, once during the term of a
3-year, 4-year or 5-year term, subject to limitations. This roll-up feature
permits the investor an opportunity to receive a higher rate of return, if rates
increase, without risk of reduction in rate over the term of the CD.
Management believes the Corporation is positioned to do well over the rest of
2002; however, it may be difficult to achieve net income in the last half of
2002 as high as in the first six months. From an interest rate risk perspective,
the Corporation is liability sensitive. That means the Corporation's interest
expense associated with interest-bearing liabilities (deposits and borrowed
funds) changes more quickly and dramatically than does its income from interest
earning assets (primarily securities and loans). Until recently, virtually all
economic forecasts anticipated an increase in short-term interest rates to occur
later this year. Recently, due to "mixed signals" regarding the status of the
national economic recovery, some economists have deferred the anticipated rate
increases until sometime in 2003.
Another major variable that may affect 2002 earnings is securities gains and
losses. By the Corporation's historical standards, net realized securities gains
were high in the first six months of 2002, especially in the first quarter. At
this time, it is impossible to predict, with any degree of precision, the
amounts of securities gains and losses that may be realized over the remainder
of 2002.
10
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
CRITICAL ACCOUNTING POLICIES
The presentation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect many of the reported amounts and disclosures. Actual results could differ
from these estimates.
A material estimate that is particularly susceptible to significant change is
the determination of the allowance for loan losses. Management believes that the
allowance for loan losses is adequate and reasonable. The Corporation's
methodology for determining the allowance for loan losses is described in a
separate section later in Management's Discussion and Analysis. Given the very
subjective nature of identifying and valuing loan losses, it is likely that
well-informed individuals could make materially different assumptions, and
could, therefore, calculate a materially different allowance value. While
management uses available information to recognize losses on loans, changes in
economic conditions may necessitate revisions in future years. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Corporation's allowance for loan losses. Such agencies
may require the Corporation to recognize adjustments to the allowance based on
their judgments of information available to them at the time of their
examination. Further, a task force of the American Institute of Certified Public
Accountants is working on detailed implementation guidance for calculating the
allowance for loan losses. Implementation of that detailed implementation
guidance could result in an adjustment to the allowance; however, based on the
latest targeted effective date, that guidance would not affect the Corporation
until 2004.
Another material estimate is the calculation of fair values of the Corporation's
debt securities. The Corporation receives estimated fair values of debt
securities from an independent valuation service, or from brokers. In developing
these fair values, the valuation service and the brokers use estimates of cash
flows, based on historical performance of similar instruments in similar
interest rate environments. Based on experience, management is aware that
estimated fair values of debt securities tend to vary among brokers and other
valuation services. Accordingly, when selling debt securities, management
typically obtains price quotes from more than one source. The large majority of
the Corporation's securities are classified as available-for-sale. Accordingly,
these securities are carried at fair value on the consolidated balance sheet,
with unrealized gains and losses excluded from earnings and reported separately
through accumulated other comprehensive income (included in stockholders'
equity).
NET INTEREST MARGIN
The Corporation's primary source of operating income is represented by the net
interest margin. The net interest margin is equal to the difference between the
amounts of interest income and interest expense. Tables II, III and IV include
information regarding the Corporation's net interest margin for 2002 and 2001.
In each of these tables, the amounts of interest income earned on tax-exempt
securities and loans have been adjusted to a fully taxable-equivalent basis.
Accordingly, the net interest margin amounts reflected in these tables exceed
the amounts presented in the consolidated financial statements. The discussion
that follows is based on amounts in the Tables.
The net interest margin, on a tax-equivalent basis, was $16,507,000 in 2002, an
increase of $3,328,000, or 25.3%, over 2001. The Corporation's net interest
margin has increased in each of the last 5 quarters (including the second
quarter 2002). In the last 3 quarters of 2001 and the first quarter 2002, the
increase in net interest margin was mainly caused by lower average interest
rates on deposits and borrowed funds. As reflected in Table IV, however, growth
in volume has surpassed the impact of interest rate changes as a cause of the
increase in the net interest margin for 2002 over 2001. Increased interest
income from higher volumes of earning assets exceeded increases in interest
expense attributable to higher volumes of interest-bearing liabilities by
$1,822,000 in 2002. Table IV also shows that interest rate changes had the
effect of increasing net interest income $1,506,000 in 2002 over 2001. As
presented in Table III, the "Interest Rate Spread" (excess of average rate of
return on interest-bearing assets over average cost of funds on interest-bearing
liabilities) widened to 3.43% for the first 6 months of 2002. The Interest Rate
Spread was 3.17% for the year ended December 31, 2001, and 2.99% for the first
six months of 2001.
11
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
INTEREST INCOME AND EARNING ASSETS
Interest income increased 5.8% to $29,568,000 in 2002 from $27,949,000 in 2001.
Income from available-for-sale securities increased $956,000, or 7.2%, and
interest from loans increased $812,000 or 5.6%. Overall, the increase in
interest income resulted from higher volumes of securities and loans, which more
than offset the effect of lower interest rates.
As indicated in Table III, average available-for-sale securities in 2002
amounted to $456,786,000, an increase of 18.8% over the first 6 months of 2001.
In total, available-for-sale securities grew because management was able to
identify opportunities to borrow funds and invest the proceeds in securities at
a positive spread. These opportunities were available because of the "steep
yield curve" (longer-term interest rates much higher than shorter-term rates)
that existed throughout most of 2001 and the first 6 months of 2002. The average
rate of return on available-for-sale securities was 6.31% for 2002, considerably
lower than the 6.99% level in the first half of 2001.
Table III also shows that the composition of the available-for-sale securities
portfolio has changed significantly. The average balance of U.S. Government
agency securities fell to 17% of the average balance of the total portfolio in
2002 from 33% in the first 6 months of 2001. In contrast, the average balance of
mortgage-backed securities increased to 47% of the total portfolio in 2002 from
34% in the first 6 months of 2001. In the third and fourth quarters of 2001, as
a result of declining interest rates, substantial amounts of U.S. Government
agency securities were called. The Corporation reinvested much of the proceeds
in mortgage-backed securities. Also, much of the leveraged security purchases
described above consisted of mortgage-backed securities. The portfolio's
increased weighting in mortgage-backed securities is designed to provide
increased cash flow, in the form of monthly principal and interest payments.
This increased level of cash inflows will be available to be reinvested at
higher rates when interest rates rise.
Obligations of state and political subdivisions (municipal bonds) also were a
larger portion of the portfolio in 2002 than in 2001. The average balance of
municipal bonds grew to $106,094,000, or 23% of the portfolio, in 2002 from
$71,006,000, or 18% of the portfolio, in the first 6 months of 2001. On a
taxable equivalent basis, municipal bonds are the highest yielding category of
available-for-sale security. The Corporation determines the levels of its
municipal bond holdings based on income tax planning and other considerations.
The average balance of gross loans increased 17.9% in 2002 over the first 6
months of 2001, to $391,012,000 from $331,666,000. The largest area of growth
was real estate secured loans, with substantial increases in both residential
and commercial mortgages. Among the factors that helped create the growth in
loans was the opening of the Muncy, PA office in October 2000. The Corporation
also increased its lending staff in Bradford and Tioga (PA) Counties during the
second half of 2001. The average rate of return on loans fell to 7.87% in 2002
from 8.76% in the first 6 months of 2001, due to lower market rates. The
Corporation experienced a great deal of refinancing and rate modification
activity in 2001, which has impacted loan yields in 2002, and probably will
continue to impact returns for the next few years.
INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES
Interest expense fell $1,709,000, or 11.6%, to $13,061,000 in 2002 from
$14,770,000 in 2001. Overall, the impact of lower interest rates more than
offset higher volumes of interest-bearing liabilities in 2002 compared to 2001.
In Table IV, you can see the impact of lower interest rates on the Corporation's
major categories of interest-bearing deposits - principally, CDs, money market
accounts and savings accounts. Table IV also shows that interest expense from
other borrowed funds increased in 2002 by $666,000 over 2001. This increase was
attributable to higher average balances, related to borrowings used to purchase
available-for-sale securities, as discussed earlier.
As you can calculate from Table III, total average deposits (interest-bearing
and noninterest-bearing) increased to $593,387,000 in 2002 from $535,744,000 in
the first 6 months of 2001. This represents an increase of 10.8%. Of the
increase in average deposits, the largest growth categories were CDs (growth in
average balance of $22,959,000, or 13.8%), money market accounts ($12,388,000,
or 8.1%), IRAs ($8,456,000, or 10.7%) and demand deposits ($8,145,000, or
15.2%). Table III also reflects the downward trend in interest rates incurred on
liabilities, as the overall cost of funds on interest-bearing liabilities fell
to 3.56% for 2002, from 4.40% for the year ended December 31, 2001 and 4.79% for
the first 6 months of 2001.
12
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE II - ANALYSIS OF INTEREST INCOME AND EXPENSE
SIX MONTHS ENDED
JUNE 30, INCREASE/
(IN THOUSANDS) 2002 2001 (DECREASE)
INTEREST INCOME
Available-for-sale securities:
U.S. Treasury securities $ 75 $ 76 $ (1)
Securities of other U.S. Government agencies 2,567 4,505 (1,938)
and corporations
Mortgage-backed securities 5,885 4,354 1,531
Obligations of states and political subdivisions 4,036 2,832 1,204
Equity securities 491 538 (47)
Other securities 1,229 1,022 207
- --------------------------------------------------------------------------------------------
Total available-for-sale securities 14,283 13,327 956
- --------------------------------------------------------------------------------------------
Held-to-maturity securities:
U.S. Treasury securities 17 20 (3)
Securities of other U.S. Government agencies
and corporations 11 23 (12)
Mortgage-backed securities 4 9 (5)
- --------------------------------------------------------------------------------------------
Total held-to-maturity securities 32 52 (20)
- --------------------------------------------------------------------------------------------
Interest-bearing due from banks 13 30 (17)
Federal funds sold 14 126 (112)
Loans:
Real estate loans 12,270 11,296 974
Consumer 1,449 1,543 (94)
Agricultural 96 94 2
Commercial/industrial 947 936 11
Other 31 34 (3)
Political subdivisions 427 502 (75)
Leases 6 9 (3)
- --------------------------------------------------------------------------------------------
Total loans 15,226 14,414 812
- --------------------------------------------------------------------------------------------
Total Interest Income 29,568 27,949 1,619
- --------------------------------------------------------------------------------------------
INTEREST EXPENSE
Interest checking 222 367 (145)
Money market 1,986 3,092 (1,106)
Savings 256 545 (289)
Certificates of deposit 3,979 4,856 (877)
Individual Retirement Accounts 2,167 2,067 100
Other time deposits 15 24 (9)
Federal funds purchased 20 69 (49)
Other borrowed funds 4,416 3,750 666
- --------------------------------------------------------------------------------------------
Total Interest Expense 13,061 14,770 (1,709)
- --------------------------------------------------------------------------------------------
Net Interest Income $16,507 $13,179 $ 3,328
============================================================================================
Note: Interest income from tax-exempt securities and loans has been adjusted to
a fully tax-equivalent basis, using the Corporation's marginal federal income
tax rate of 34%.
13
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE III - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES
(DOLLARS IN THOUSANDS) 6 MONTHS YEAR 6 MONTHS
ENDED RATE OF ENDED RATE OF ENDED RATE OF
6/30/2002 RETURN/ 12/31/2001 RETURN/ 6/30/2001 RETURN/
AVERAGE COST OF AVERAGE COST OF AVERAGE COST OF
BALANCE FUNDS % BALANCE FUNDS % BALANCE FUNDS %
EARNING ASSETS
Available-for-sale securities, at amortized cost:
U.S. Treasury securities $ 2,502 6.04% $ 2,506 6.03% $ 2,507 6.11%
Securities of other U.S. Government agencies and
corporations 79,268 6.53% 113,186 6.82% 128,709 7.06%
Mortgage-backed securities 214,415 5.53% 150,838 6.29% 132,339 6.63%
Obligations of states and political subdivisions 106,094 7.67% 78,741 7.89% 71,006 8.04%
Equity securities 20,827 4.75% 21,062 5.18% 21,764 4.98%
Other securities 33,680 7.36% 29,577 7.59% 28,200 7.31%
- ------------------------------------------------------------------------------------------------------------------------------
Total available-for-sale securities 456,786 6.31% 395,910 6.80% 384,525 6.99%
- ------------------------------------------------------------------------------------------------------------------------------
Held-to-maturity securities:
U.S. Treasury securities 639 5.36% 742 5.39% 742 5.44%
Securities of other U.S. Government agencies and
corporations 365 6.08% 680 6.32% 721 6.43%
Mortgage-backed securities 155 5.20% 205 7.80% 231 7.86%
- ------------------------------------------------------------------------------------------------------------------------------
Total held-to-maturity securities 1,159 5.57% 1,627 6.08% 1,694 6.19%
- ------------------------------------------------------------------------------------------------------------------------------
Interest-bearing due from banks 1,702 1.54% 2,659 3.08% 1,539 3.93%
Federal funds sold 1,767 1.60% 5,064 3.63% 5,224 4.86%
Loans:
Real estate loans 320,649 7.73% 279,828 8.37% 266,502 8.55%
Consumer 28,842 10.22% 28,062 10.89% 27,755 11.21%
Agricultural 2,441 7.93% 2,070 9.18% 1,992 9.52%
Commercial/industrial 27,176 7.03% 22,212 8.24% 21,596 8.74%
Other 938 6.66% 892 7.62% 862 7.95%
Political subdivisions 10,831 7.95% 13,108 7.96% 12,762 7.93%
Leases 135 8.96% 181 9.39% 197 9.21%
- ------------------------------------------------------------------------------------------------------------------------------
Total loans 391,012 7.87% 346,353 8.56% 331,666 8.76%
- ------------------------------------------------------------------------------------------------------------------------------
Total Earning Assets 852,426 6.99% 751,613 7.57% 724,648 7.78%
Cash 13,294 11,871 11,096
Unrealized gain/loss on securities 8,573 6,639 3,200
Allowance for loan losses (5,361) (5,370) (5,374)
Bank premises and equipment 10,211 9,602 9,399
Other assets 32,428 30,874 31,795
- ------------------------------------------------------------------------------------------------------------------------------
Total Assets $911,571 $ 805,229 $ 774,764
==============================================================================================================================
INTEREST-BEARING LIABILITIES
Interest checking $ 37,834 1.18% $ 37,192 1.75% $ 35,980 2.06%
Money market 165,214 2.42% 153,738 3.49% 152,826 4.08%
Savings 49,869 1.04% 46,750 2.16% 45,788 2.40%
Certificates of deposit 189,267 4.24% 169,275 5.48% 166,308 5.89%
Individual Retirement Accounts 87,708 4.98% 79,482 5.12% 79,252 5.26%
Other time deposits 1,771 1.71% 1,916 1.83% 2,011 2.41%
Federal funds purchased 2,052 1.97% 4,012 4.01% 2,915 4.77%
Other borrowed funds 205,789 4.33% 151,615 5.13% 136,425 5.54%
- ------------------------------------------------------------------------------------------------------------------------------
Total Interest-bearing Liabilities 739,504 3.56% 643,980 4.40% 621,505 4.79%
Demand deposits 61,724 56,226 53,579
Other liabilities 7,731 9,002 7,600
- ------------------------------------------------------------------------------------------------------------------------------
Total Liabilities 808,959 709,208 682,684
- ------------------------------------------------------------------------------------------------------------------------------
Stockholders' equity, excluding other
comprehensive income/loss 96,955 91,703 89,968
Other comprehensive income/loss 5,657 4,318 2,112
- ------------------------------------------------------------------------------------------------------------------------------
Total Stockholders' Equity 102,612 96,021 92,080
- ------------------------------------------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 911,571 $ 805,229 $ 774,764
==============================================================================================================================
Interest Rate Spread 3.43% 3.17% 2.99%
Net Interest Income/Earning Assets 3.91% 3.80% 3.67%
(1) Rates of return on tax-exempt securities and loans are presented on a fully
taxable-equivalent basis.
(2) Nonaccrual loans have been included with loans for the purpose of analyzing
net interest earnings.
14
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE IV - ANALYSIS OF VOLUME AND RATE CHANGES
(IN THOUSANDS) SIX MONTHS ENDED 6/30/02 VS. 6/30/01
CHANGE IN CHANGE IN TOTAL
VOLUME RATE CHANGE
EARNING ASSETS
Available-for-sale securities:
U.S. Treasury securities $ - $ (1) $ (1)
Securities of other U.S. Government agencies
and corporations (1,622) (316) (1,938)
Mortgage-backed securities 2,347 (816) 1,531
Obligations of states and political subdivisions 1,340 (136) 1,204
Equity securities (23) (24) (47)
Other securities 200 7 207
- ----------------------------------------------------------------------------------------------
Total available-for-sale securities 2,242 (1,286) 956
- ----------------------------------------------------------------------------------------------
Held-to-maturity securities:
U.S. Treasury securities (3) -- (3)
Securities of other U.S. Government agencies
and corporations (11) (1) (12)
Mortgage-backed securities (2) (3) (5)
- ----------------------------------------------------------------------------------------------
Total held-to-maturity securities (16) (4) (20)
- ----------------------------------------------------------------------------------------------
Interest-bearing due from banks 3 (20) (17)
Federal funds sold (55) (57) (112)
Loans:
Real estate loans 2,144 (1,170) 974
Consumer 59 (153) (94)
Agricultural 19 (17) 2
Commercial/industrial 215 (204) 11
Other 3 (6) (3)
Political subdivisions (76) 1 (75)
Leases (3) -- (3)
- ----------------------------------------------------------------------------------------------
Total loans 2,361 (1,549) 812
- ----------------------------------------------------------------------------------------------
Total Interest Income 4,535 (2,916) 1,619
- ----------------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES
Interest checking 18 (163) (145)
Money market 234 (1,340) (1,106)
Savings 45 (334) (289)
Certificates of deposit 608 (1,485) (877)
Individual Retirement Accounts 213 (113) 100
Other time deposits (3) (6) (9)
Federal funds purchased (16) (33) (49)
Other borrowed funds 1,614 (948) 666
- ----------------------------------------------------------------------------------------------
Total Interest Expense 2,713 (4,422) (1,709)
- ----------------------------------------------------------------------------------------------
Net Interest Income $ 1,822 $ 1,506 $ 3,328
==============================================================================================
(1) Changes in income on tax-exempt securities and loans is presented on a fully
taxable-equivalent basis, using the Corporation's marginal federal income tax
rate of 34%.
(2) 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.
15
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE V - COMPARISON OF NONINTEREST INCOME
(IN THOUSANDS) 6 MONTHS ENDED
JUNE 30, JUNE, 30
2002 2001
Service charges on deposit accounts $ 807 $ 626
Service charges and fees 133 127
Trust and financial management revenue 945 814
Insurance commissions, fees and premiums 340 253
Increase in cash surrender value of life insurance 435 451
Fees related to credit card operation 282 276
Other operating income 426 403
- --------------------------------------------------------------------------
Total other operating income, before realized
gains on securities, net 3,368 2,950
Realized gains on securities, net 2,007 1,197
- --------------------------------------------------------------------------
Total Other Income $5,375 $4,147
==========================================================================
Total noninterest income increased $1,228,000, or 29.6%, in 2002 compared to
2001. The most significant changes - the increases in security gains and service
charges on deposit accounts- are discussed in the "Earnings Overview" section of
Management's Discussion and Analysis. Other items of significance are as
follows:
- - Trust and financial management revenue increased $131,000, or 16.1%. This
increase resulted from fee increases implemented in the latter part of
2001, and from receipt of certain fees for services provided prior to 2002.
Trust revenue is recorded on a cash basis, which does not vary materially
from the accrual basis.
- - Insurance revenue increased $87,000, or 34.4%. Revenue from accident and
health, mortgage group life, and individual life insurance, sold to lending
customers through Bucktail Life Insurance Company, increased to $228,000 in
2002 from $170,000 in 2001. Also, revenue from the insurance agency
division of C&N Financial Services Corporation increased to $112,000 in the
2002 from $83,000 in 2001.
16
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE VI- COMPARISON OF NONINTEREST EXPENSE
(IN THOUSANDS) 6 MONTHS ENDED
JUNE 30, JUNE 30,
2002 2001
Salaries and wages $ 4,589 $ 4,070
Pensions and other employee benefits 1,259 1,103
Occupancy expense, net 586 509
Furniture and equipment expense 841 698
Pennsylvania shares tax 366 394
Expenses related to credit card operation 136 138
Other operating expense 2,577 2,266
- -------------------------------------------------------------------
Total Other Expense $10,354 $ 9,178
===================================================================
Salaries and wages increased $519,000, or 12.8%, in 2002 compared to 2001. The
increase is the result of annual merit raises ranging from 2%-5%, an increase in
the number of employees and an increase in incentive bonus expense. Increases in
staff during the last half of 2001 and first six months of 2002 included the
addition of new positions in branch and commercial lending, branch
administration, compliance and marketing, as well as several college
students/interns hired for the summer of 2002. The number of full-time
equivalent employees has increased 10.3%, to 267 as of June 30, 2002 compared to
242 as of June 30, 2001. The incentive bonus plan provides for compensation to
be paid to certain key officers early in the following year, with the payment
amounts based on a combination of personal and corporate performance in the
current year. The estimate of such expense for 2002 increased $136,000 over the
accrual recorded in 2001.
Pensions and other employee benefits increased $156,000, or 14.1%, in 2002 over
2001. A portion of this increase is directly related to the increase in salaries
and wages. Also, pension expense from the Corporation's defined benefit pension
plan increased $75,000 in 2002 over 2001. Although the defined benefit pension
plan remains adequately funded, a decline in the market value of plan assets was
the main cause of the increase in expense in 2002.
Occupancy expense increased $77,000, or 15.1%, in 2002 over 2001. Rent and
depreciation expenses increased a total of $35,000, primarily from a newly
rented facility in Wellsboro. The new facility is being used for C&N Financial
Services Corporation's operations (insurance and broker dealer) and as a
training facility for all employees. Also, insurance expense increased $26,000,
due to rate increases and an increased number of facilities.
Furniture and equipment expense increased $143,000, or 20.5%, in 2002 compared
to 2001. The largest increase within this category was in depreciation expense,
which increased $96,000. There were several substantial capital expenditures
over the last half of 2001 and first half of 2002 that produced higher
depreciation expense in 2002. The most significant items were new proof of
deposit software, a new phone system and ongoing purchases of PCs and software
required to maintain and upgrade the computer network. Repairs and maintenance
expense increased $39,000, primarily from maintenance contracts associated with
computer hardware and software.
Other expense increased $311,000, or 13.7%, in 2002 over 2001. This category
includes many different types of expenses. Some of the overall increase in this
category was caused by increases in number of transactions processed and number
of employees. The most significant individual change within this category was an
increase of $99,000 in expenses from Bucktail Life Insurance Company, which
resulted mainly from a larger amount of life insurance claims incurred.
17
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
FINANCIAL CONDITION
Significant changes in the average balances of the Corporation's earning assets
and interest-bearing liabilities are described in the "Net Interest Margin"
section of Management's Discussion and Analysis. There are no significant
changes in the Corporation's consolidated balance sheet as of June 30, 2002
compared to December 31, 2001, other than the items addressed in that
discussion. Table VII provides a summary of investment securities held at June
30, 2002 and December 31, 2001. The allowance for loan losses and stockholders'
equity are discussed in separate sections of Management's Discussion and
Analysis.
TABLE VII - INVESTMENT SECURITIES
(In Thousands)
JUNE 30, 2002 DECEMBER 31, 2001
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
AVAILABLE-FOR-SALE SECURITIES:
Obligations of the U.S. Treasury $ -- $ -- $ 2,503 $ 2,557
Obligations of other U.S. Government agencies 71,965 72,618 75,295 75,172
Obligations of states and political subdivisions 112,892 113,830 95,835 95,261
Other securities 41,242 41,660 34,315 34,532
Mortgage-backed securities 215,716 219,604 198,269 198,975
- --------------------------------------------------------------------------------------------------------
Total debt securities 441,815 447,712 406,217 406,497
Marketable equity securities 21,901 30,076 19,745 27,472
- --------------------------------------------------------------------------------------------------------
Total $463,716 $477,788 $425,962 $433,969
========================================================================================================
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury $ 423 $ 437 $ 726 $ 735
Obligations of other U.S. Government agencies 297 314 547 561
Mortgage-backed securities 139 145 175 181
- --------------------------------------------------------------------------------------------------------
Total $ 859 $ 896 $ 1,448 $ 1,477
========================================================================================================
18
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses includes two components, allocated and
unallocated. The allocated component of the allowance for loan losses reflects
probable losses resulting from the analysis of individual loans, specific
allowances for loans in certain industries and historical loss experience for
each loan category. The historical loan loss experience element is determined
based on the ratio of net charge-offs to average loan balances over a five-year
period, for each significant type of loan. The charge-off ratio is then applied
to the current outstanding loan balance for each type of loan (net of other
loans that are individually evaluated).
The unallocated portion of the allowance is determined based on management's
assessment of general economic conditions as well as specific economic factors
in the market area. This determination inherently involves a higher degree of
uncertainty and considers current risk factors that may not have yet manifested
themselves in the Bank's historical loss factors used to determine the allocated
component of the allowance, and it recognizes that knowledge of the portfolio
credit risk may be incomplete.
In total, the allowance for loan losses increased $89,000, to $5,354,000 at June
30, 2002 from $5,265,000 at December 31, 2001. As noted in Table IX, the
unallocated portion of the allowance for loan losses was $1,790,000 at June 30,
2002, down from $2,187,000 at December 31, 2001. The unallocated allowance
balance reflects management's concern related to possible adverse changes in the
local economy, including concerns related to several local plant lay-offs. The
decline in the unallocated allowance is offset by increases in allocated
allowances on consumer mortgages and impaired loans. Despite the increase in
allocated allowances, overall delinquency data showed significant improvement in
the second quarter 2002. Total 90 day or more past due loans, plus nonaccrual
loans, decreased 11.1%, to $3,106,000 at June 30, 2002 from $3,492,000 at March
31, 2002. The total amount of 90 day or more past due loans, plus nonaccrual
loans, was $3,117,000 at December 31, 2001.
The provision for loan losses increased to $360,000 in 2002 from $300,000 in
2001. The amount of the provision in each period is determined based on the
amount required to maintain an appropriate allowance in light of the factors
described above.
Tables VIII, IX and X present an analysis of the allowance for loan losses, the
allocation of the allowance and a five-year summary of loans by type.
TABLE VIII- ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
(IN THOUSANDS) 6 MONTHS 6 MONTHS
ENDED ENDED
JUNE 30, JUNE 30, YEARS ENDED DECEMBER 31,
2002 2001 2001 2000 1999 1998 1997
Balance, beginning of year $5,265 $5,291 $5,291 $5,131 $4,820 $4,913 $4,776
- --------------------------------------------------------------------------------------------------------------------
Charge-offs:
Real estate loans 87 123 144 272 81 257 246
Installment loans 85 44 138 77 138 144 230
Credit cards and related plans 114 103 200 214 192 264 305
Commercial and other loans 12 -- 231 53 219 301 3
- --------------------------------------------------------------------------------------------------------------------
Total charge-offs 298 270 713 616 630 966 784
- --------------------------------------------------------------------------------------------------------------------
Recoveries:
Real estate loans 3 5 6 26 81 12 21
Installment loans 14 13 27 23 60 43 64
Credit cards and related plans 8 15 20 28 30 40 30
Commercial and other loans 2 32 34 23 10 15 9
- --------------------------------------------------------------------------------------------------------------------
Total recoveries 27 65 87 100 181 110 124
- --------------------------------------------------------------------------------------------------------------------
Net charge-offs 271 205 626 516 449 856 660
Provision for loan losses 360 300 600 676 760 763 797
- --------------------------------------------------------------------------------------------------------------------
Balance, end of year $5,354 $5,386 $5,265 $5,291 $5,131 $4,820 $4,913
====================================================================================================================
19
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE IX - ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES BY TYPE
(IN THOUSANDS)
AT
JUNE 30, AT DECEMBER 31:
2002 2001 2000 1999 1998 1997
Commercial $1,861 $1,837 $1,612 $2,081 $ 650 $ 625
Consumer mortgage 1,053 674 952 834 97 350
Impaired loans 205 73 273 609 290 274
Consumer 445 494 471 437 702 375
All other commitments -- -- -- 150 202 343
Unallocated 1,790 2,187 1,983 1,020 2,879 2,946
- ---------------------------------------------------------------------------------------------
Total Allowance $5,354 $5,265 $5,291 $5,131 $4,820 $4,913
=============================================================================================
TABLE X - FIVE-YEAR SUMMARY OF LOANS BY TYPE
(IN THOUSANDS)
JUNE 30, DEC. 31, DEC. 31, DEC. 31, DEC. 31, DEC. 31,
2002 2001 2000 1999 1998 1997
Real estate - construction $ 1,660 $ 1,814 $ 452 $ 649 $ 1,004 $ 406
Real estate - mortgage 338,136 306,264 263,325 247,604 230,815 219,952
Consumer 29,477 29,284 28,141 29,140 30,924 33,094
Agricultural 2,519 2,344 1,983 1,899 1,930 2,424
Commercial 27,558 24,696 20,776 18,050 17,630 17,176
Other 2,053 1,195 948 1,025 1,062 6,260
Political subdivisions 10,258 13,479 12,462 12,332 7,449 5,895
Lease receivables 123 152 218 222 218 256
- ------------------------------------------------------------------------------------------------------------------------------
Total 411,784 379,228 328,305 310,921 291,032 285,463
Less: unearned discount -- -- -- (29) (29) (37)
- ------------------------------------------------------------------------------------------------------------------------------
411,784 379,228 328,305 310,892 291,003 285,426
Less: allowance for loan losses (5,354) (5,265) (5,291) (5,131) (4,820) (4,913)
- ------------------------------------------------------------------------------------------------------------------------------
Loans, net $ 406,430 $ 373,963 $ 323,014 $ 305,761 $ 286,183 $ 280,513
==============================================================================================================================
20
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
LIQUIDITY
Liquidity is the ability to quickly raise cash at a reasonable cost. An adequate
liquidity position permits the Corporation to pay creditors, compensate for
unforeseen deposit fluctuations and fund unexpected loan demand. The Corporation
maintains overnight borrowing facilities with several correspondent banks that
provide a source of day-to-day liquidity. Also, the Corporation maintains
borrowing facilities with the Federal Home Loan Bank of Pittsburgh, secured by
mortgage loans and mortgage-backed securities. At June 30, 2002, the Corporation
had unused borrowing availability with correspondent banks and the Federal Home
Loan Bank of Pittsburgh totaling approximately $223,608,000. Additionally, the
Corporation uses repurchase agreements placed with brokers to borrow short-term
funds secured by investment assets, and uses "RepoSweep" arrangements to borrow
funds from commercial banking customers on an overnight basis.
STOCKHOLDERS' EQUITY AND CAPITAL ADEQUACY
The Corporation and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. For many years, the
Corporation and the Bank have maintained strong capital positions. The following
table presents consolidated capital ratios at June 30, 2002:
TABLE XI - CAPITAL RATIOS 6/30/2002
CITIZENS & REGULATORY STANDARDS:
NORTHERN
CORPORATION WELL MINIMUM
(ACTUAL) CAPITALIZED STANDARD
- -----------------------------------------------------------------------------------------------
Total capital to risk-weighted assets 21.46% 10% 8%
Tier 1 capital to risk-weighted assets 19.67% 6% 4%
Tier 1 capital to average total assets 10.57% 5% 4%
Management expects the Corporation and the Bank to maintain capital levels that
exceed the regulatory standards for well-capitalized institutions for the next
12 months and for the foreseeable future. Planned capital expenditures during
the next 12 months are not expected to have a detrimental effect on capital
ratios or results of operations.
INFLATION
Over the last several years, direct inflationary pressures on the Corporation's
payroll-related and other noninterest costs have been modest. However, the
Corporation is significantly affected by the Federal Reserve Board's efforts to
control inflation through changes in interest rates. Management monitors the
impact of economic trends, including any indicators of inflationary pressure, in
managing interest rate and other financial risks.
21
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
PART I - FINANCIAL INFORMATION (CONTINUED)
ITEM 3. INTEREST RATE RISK AND MARKET RISK
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------------------------------------------------------------------
MARKET RISK
The Corporation's two major categories of market risk, interest rate and equity
securities risk, are discussed in the following sections.
INTEREST RATE RISK
Business risk arising from changes in interest rates is an inherent factor in
operating a bank. The Corporation's assets are predominantly long-term, fixed
rate loans and debt securities. Funding for these assets comes principally from
short-term deposits and borrowed funds. Accordingly, there is an inherent risk
of lower future earnings or decline in fair value of the Corporation's financial
instruments when interest rates change.
The Bank uses a simulation model to calculate the potential effects of interest
rate fluctuations on net interest income and the market value of portfolio
equity. Only assets and liabilities of the Bank are included in management's
monthly simulation model calculations. Since the Bank makes up more than 90% of
the Corporation's total assets and liabilities, and because the Bank is the
source of the most volatile interest rate risk, management does not consider it
necessary to run the model for the remaining entities within the consolidated
group. For purposes of these calculations, the market value of portfolio equity
includes the fair values of financial instruments, such as securities, loans,
deposits and borrowed funds, and the book values of nonfinancial assets and
liabilities, such as premises and equipment and accrued interest. The model
measures and projects potential changes in net interest income, and calculates
the discounted present value of anticipated cash flows of financial instruments,
under the "base most likely" and "what if" scenarios. Typically, management runs
these calculations using the base most likely scenario, and assuming increases
and decreases of 100 basis points (1%), 200 basis points and 300 basis points
from the base most likely scenario.
The Bank's Board of Directors has established policy guidelines for acceptable
levels of interest rate risk, based on an immediate increase or decrease in
interest rates of 200 basis points. The policy limit for fluctuation in net
interest income is minus 20% from the base most likely one-year scenario. The
policy limit for market value variance is minus 30% from the base most likely
one-year scenario. As Table XII shows, as of June 30, 2002, the Bank's interest
rate risk calculations were within the policy thresholds. The most sensitive
scenario presented is the "+200 basis points" scenario. If interest rates were
to immediately increase 200 basis points, the Bank's calculations based on the
model show that net interest income would decrease 13.93% over the next 12
months, and the market value of portfolio equity would decrease 23.80%.
The table that follows was prepared using the simulation model described above.
The model makes estimates, at each level of interest rate change, regarding cash
flows from principal repayments on loans and mortgage-backed securities and call
activity on other investment securities. Management believes its assumptions,
which determine the model's estimates, are conservative and reasonable. However,
actual results could vary significantly from these estimates, which could result
in significant differences in the calculations of projected changes in net
interest margin and market value of portfolio equity. Also, the model does not
make estimates related to changes in the composition of the deposit portfolio
that could occur due to rate competition and the table does not necessarily
reflect changes that management would make to realign the portfolio as a result
of changes in interest rates.
22
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE XII - THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES
Period Ending June 30, 2003
(In Thousands)
June 30, 2002 Data
PLUS 200 MINUS 200
MOST LIKELY BASIS BASIS
FORECAST POINTS POINTS
AMOUNT AMOUNT % CHANGE AMOUNT % CHANGE
Interest income:
Securities $ 26,890 $ 28,857 7.31 $ 24,839 (7.63)
Interest-bearing due from banks
and federal funds sold 142 190 33.80 33 (76.76)
Loans 31,768 33,440 5.26 28,965 (8.82)
- ------------------------------------------------------------------------------------------------------------------
Total interest income 58,800 62,487 6.27 53,837 (8.44)
- ------------------------------------------------------------------------------------------------------------------
Interest expense:
Interest on deposits 17,742 25,141 41.70 12,302 (30.66)
Interest on borrowed funds 8,964 9,723 8.47 8,219 (8.31)
- ------------------------------------------------------------------------------------------------------------------
Total interest expense 26,706 34,864 30.55 20,521 (23.16)
- ------------------------------------------------------------------------------------------------------------------
Net Interest Income $ 32,094 $ 27,623 (13.93) $ 33,316 3.81
==================================================================================================================
Market Value of Portfolio Equity at June 30, 2002 $ 93,970 $ 71,609 (23.80) $105,365 12.13
==================================================================================================================
EQUITY SECURITIES RISK
The Corporation's equity securities portfolio consists primarily of investments
in stock of banks and bank holding companies located mainly in Pennsylvania. The
Corporation also owns some other stocks and mutual funds.
Investments in bank stocks are subject to the risk factors that affect the
banking industry in general, including competition from nonbank entities, credit
risk, interest rate risk and other factors, which could result in a decline in
market prices. Also, losses could occur in individual stocks held by the
Corporation because of specific circumstances related to each bank. Further,
because of the concentration of bank and bank holding companies located in
Pennsylvania, these investments could decline in market value if there is a
downturn in the state's economy.
Equity securities held as of June 30, 2002 and December 31, 2001 are presented
in Table XIII.
TABLE XIII - EQUITY SECURITIES
(IN THOUSANDS) HYPOTHETICAL HYPOTHETICAL
10% 20%
DECLINE IN DECLINE IN
FAIR MARKET MARKET
AT JUNE 30, 2002 COST VALUE VALUE VALUE
Banks and bank holding companies $ 20,043 $ 28,366 $ (2,837) $ (5,673)
Other equity securities 1,858 1,710 (171) (342)
- ------------------------------------------------------------------------------------------
Total $ 21,901 $ 30,076 $ 3,008) $ (6,015)
==========================================================================================
HYPOTHETICAL HYPOTHETICAL
10% 20%
DECLINE IN DECLINE IN
FAIR MARKET MARKET
AT DECEMBER 31, 2001 COST VALUE VALUE VALUE
Banks and bank holding companies $18,922 $26,636 $(2,664) $(5,327)
Other equity securities 823 836 (84) (167)
- -------------------------------------------------------------------------------------
Total $19,745 $27,472 $(2,748) $(5,494)
=====================================================================================
23
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Neither the Corporation nor any of its subsidiaries is a party to any
material pending legal proceedings.
Item 2. Not Applicable
Item 3. Not Applicable
Item 4. Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders:
The Annual Meeting of Shareholders of Citizens & Northern Corporation
was held on Tuesday, April 16, 2002. The Board of Directors fixed the
close of business on March 1, 2002 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 5,291,140 shares of Common
Stock.
The total number of votes cast was 3,936,051. 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:
Dennis F. Beardslee Craig G. Litchfield
Jan E. Fisher Ann M. Tyler
Karl W. Kroeck
The total votes in favor of any one of the above-listed Directors
was not less than 3,813,785.
2. The ratification of the action of the Board of Directors in the
appointment of the firm of Parente Randolph, PC as independent
auditors of the Corporation.
Total Votes in Favor 3,850,036
Total Votes Against 50,973
Total Votes Abstained 35,042
Item 5. Other Information
a. None
Item 6. Exhibits and Reports on Form 8 - K
a. Exhibits:
Page
----
99.1 Certification Pursuant to U.S.C. Section 1350 as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 26
b. On April 11, 2002, a Current Report on Form 8-K was filed to report
the Corporation's consolidated earnings results for the first quarter
2002.
24
CITIZENS AND NORTHERN CORPORATION - FORM 10 - Q
Signature Page
SIGNATURES
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.
CITIZENS & NORTHERN CORPORATION
August 13, 2002 By: Craig G. Litchfield /s/
- --------------- -----------------------
Date Chairman, President and Chief Executive Officer
August 13, 2002 By: Mark A. Hughes /s/
- --------------- ------------------
Date Treasurer and Principal Accounting Officer
25