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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the three-month period ended March 31, 2005
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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [X] 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) 8,210,321 Shares Outstanding May 4, 2005
1
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
Index
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheet - March 31, 2005 and
December 31, 2004 Page 3
Consolidated Statement of Income - Three Months Ended
March 31, 2005 and 2004 Page 4
Consolidated Statement of Cash Flows - Three Months
Ended March 31, 2005 and 2004 Page 5
Notes to Consolidated Financial Statements Pages 6 through 10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations Pages 10 through 23
Item 3. Quantitative and Qualitative Disclosures About
Market Risk Pages 23 through 26
Item 4. Controls and Procedures Page 26
Part II. Other Information Page 27
Signatures Page 28
Exhibit 31.1. Rule 13a-14(a)/15d-14(a) Certification -
Chief Executive Officer Page 29
Exhibit 31.2. Rule 13a-14(a)/15d-14(a) Certification -
Chief Financial Officer Page 30
Exhibit 32. Section 1350 Certifications Page 31
2
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEET
(In Thousands Except Share Data)
MARCH 31, DECEMBER 31,
2005 2004
(UNAUDITED) (NOTE)
ASSETS
Cash and due from banks:
Noninterest-bearing $ 11,818 $ 14,845
Interest-bearing 1,467 4,108
----------- -----------
Total cash and cash equivalents 13,285 18,953
Available-for-sale securities 465,074 475,085
Held-to-maturity securities 429 433
Loans, net 592,118 572,826
Bank-owned life insurance 18,222 18,083
Accrued interest receivable 5,459 5,094
Bank premises and equipment, net 17,130 16,725
Foreclosed assets held for sale 653 497
Other assets 17,291 15,306
----------- -----------
TOTAL ASSETS $ 1,129,661 $ 1,123,002
=========== ===========
LIABILITIES
Deposits:
Noninterest-bearing $ 83,656 $ 80,378
Interest-bearing 600,963 596,167
----------- -----------
Total deposits 684,619 676,545
Dividends payable 1,888 1,864
Short-term borrowings 50,167 34,178
Long-term borrowings 257,394 270,827
Accrued interest and other liabilities 6,768 8,003
----------- -----------
TOTAL LIABILITIES 1,000,836 991,417
----------- -----------
STOCKHOLDERS' EQUITY
Common stock, par value $1.00 per share; authorized 20,000,000 shares;
issued 8,389,418 in 2005 and 8,307,305 in 2004 8,390 8,307
Stock dividend distributable - 2,188
Paid-in capital 24,755 22,456
Retained earnings 91,891 90,484
----------- -----------
Total 125,036 123,435
Accumulated other comprehensive income 5,950 10,535
Unamortized stock compensation (124) (46)
Treasury stock, at cost:
180,097 shares at March 31, 2005 (2,037)
204,659 shares at December 31, 2004 (2,339)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 128,825 131,585
----------- -----------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $ 1,129,661 $ 1,123,002
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
Note: The balance sheet at December 31, 2004 has been derived from the audited
financial statements at that date but does not include all the information and
notes required by U.S. generally accepted accounting principles for complete
financial statements.
3
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
CONSOLIDATED STATEMENT OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
3 MONTHS ENDED
MARCH 31, MARCH 31,
2005 2004
INTEREST INCOME
Interest and fees on loans $ 9,006 $ 8,235
Interest on balances with depository institutions 4 3
Interest on loans to political subdivisions 247 214
Interest on federal funds sold 8 1
Income from available-for-sale and
held-to-maturity securities:
Taxable 3,661 3,264
Tax-exempt 1,472 1,935
Dividends 295 363
---------- ----------
Total interest and dividend income 14,693 14,015
---------- ----------
INTEREST EXPENSE
Interest on deposits 3,426 3,343
Interest on short-term borrowings 225 123
Interest on long-term borrowings 2,306 2,237
---------- ----------
Total interest expense 5,957 5,703
---------- ----------
Interest margin 8,736 8,312
Provision for loan losses 375 350
Interest margin after provision for loan losses 8,361 7,962
---------- ----------
OTHER INCOME
Service charges on deposit accounts 342 421
Service charges and fees 87 76
Trust and financial management revenue 479 457
Insurance commissions, fees and premiums 98 109
Increase in cash surrender value of life insurance 139 159
Fees related to credit card operation 210 184
Other operating income 348 219
---------- ----------
Total other income before realized gains on securities, net 1,703 1,625
Realized gains on securities, net 1,066 964
---------- ----------
Total other income 2,769 2,589
---------- ----------
OTHER EXPENSES
Salaries and wages 2,875 2,671
Pensions and other employee benefits 1,032 984
Occupancy expense, net 464 377
Furniture and equipment expense 648 336
Pennsylvania shares tax 215 212
Other operating expense 1,894 1,648
---------- ----------
Total other expenses 7,128 6,228
---------- ----------
Income before income tax provision 4,002 4,323
Income tax provision 707 617
---------- ----------
NET INCOME $ 3,295 $ 3,706
========== ==========
PER SHARE DATA:
Net income - basic $ 0.40 $ 0.45
Net income - diluted $ 0.40 $ 0.45
---------- ----------
Dividend per share $ 0.23 $ 0.22
---------- ----------
Number of shares used in computation - basic 8,193,240 8,193,182
Number of shares used in computation - diluted 8,264,288 8,249,283
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, EXCEPT PER SHARE DATA)(UNAUDITED)
3 MONTHS ENDED
MARCH 31, MARCH 31,
2005 2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,295 $ 3,706
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 375 350
Realized gains on securities, net (1,066) (964)
(Gain) loss on sale of foreclosed assets, net (50) 6
Depreciation expense 548 322
Accretion and amortization, net 67 127
Increase in cash surrender value of life insurance (139) (159)
Amortization of restricted stock 21 24
Increase in accrued interest receivable and other assets (2,444) (1,270)
Increase in accrued interest payable and other liabilities 1,151 936
-------- --------
Net Cash Provided by Operating Activities 1,758 3,078
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturity of held-to-maturity securities 3 110
Proceeds from sales of available-for-sale securities 31,488 11,526
Proceeds from calls and maturities of available-for-sale securities 18,204 36,802
Purchase of available-for-sale securities (45,628) (65,445)
Purchase of Federal Home Loan Bank of Pittsburgh stock (1,832) (2,463)
Redemption of Federal Home Loan Bank of Pittsburgh stock 1,902 1,090
Net increase in loans (19,832) (7,111)
Purchase of premises and equipment (953) (2,237)
Proceeds from sale of foreclosed assets 59 42
-------- --------
Net Cash Used in Investing Activities (16,589) (27,686)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits 8,074 (7,145)
Net increase in short-term borrowings 15,989 10,119
Proceeds from long-term borrowings 13,000 41,767
Repayments of long-term borrowings (26,433) (19,773)
Sale of treasury stock 423 407
Dividends paid (1,890) (1,789)
-------- --------
Net Cash Provided by Financing Activities 9,163 23,586
-------- --------
DECREASE IN CASH AND CASH EQUIVALENTS (5,668) (1,022)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 18,953 15,171
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 13,285 $ 14,149
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Accrued purchase of available-for-sale securities $ - $ 22,096
Assets acquired through foreclosure of real estate loans $ 165 $ -
Interest paid $ 5,421 $ 4,274
Income taxes paid $ 420 $ 150
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, 2004, 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 months ended March 31, 2005 might not be
indicative of the results for the year ending December 31, 2005.
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. As shown in the table that follows, diluted earnings per share is
computed using weighted average common shares outstanding, plus 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
QUARTER ENDED MARCH 31, 2005
Earnings per share - basic $3,295,000 8,193,240 $0.40
Dilutive effect of potential common stock
arising from stock options:
Exercise of outstanding stock options 241,417
Hypothetical share repurchase at $29.99 (170,369)
---------- --------- -----
Earnings per share - diluted $3,295,000 8,264,288 $0.40
========== ========= =====
QUARTER ENDED MARCH 31, 2004
Earnings per share - basic $3,706,000 8,193,182 $0.45
Dilutive effect of potential common stock
arising from stock options:
Exercise of outstanding stock options 198,006
Hypothetical share repurchase at $26.24 (141,905)
---------- --------- -----
Earnings per share - diluted $3,706,000 8,249,283 $0.45
========== ========= =====
6
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
3. STOCK COMPENSATION PLANS
The Corporation uses the intrinsic value method of accounting for stock
compensation plans, under Accounting Principles Board Opinion No. 25 (APB
Opinion 25), and as permitted by Statement of Financial Accounting Standards
(SFAS) No. 123. Utilizing the intrinsic value method, compensation cost is
measured by the excess of the quoted market price of the stock as of the grant
date (or other measurement date) over the amount an employee or director must
pay to acquire the stock. Stock options issued under the Corporation's stock
option plans have no intrinsic value, and accordingly, no compensation cost is
recorded for them.
The Corporation has also made awards of restricted stock. Compensation cost
related to restricted stock is recognized based on the market price of the stock
at the grant date over the vesting period.
The following table illustrates the effect on net income and earnings per share
if the Corporation had applied the fair value provisions of SFAS No. 123 to
stock options.
(NET INCOME IN THOUSANDS)
3 MONTHS ENDED
MARCH 31, MARCH 31,
2005 2004
Net income, as reported $ 3,295 $ 3,706
Deduct: Total stock option compensation
expense determined under fair value
method for all awards, net of tax effects (35) (49)
--------- ---------
Pro forma net income $ 3,260 $ 3,657
========= =========
Earnings per share-basic
As reported $ 0.40 $ 0.45
Pro forma $ 0.40 $ 0.45
Earnings per share-diluted
As reported $ 0.40 $ 0.45
Pro forma $ 0.39 $ 0.44
In December 2004, the Financial Accounting Standards Board issued SFAS No. 123R,
which replaces SFAS No. 123 and supersedes APB Opinion 25. SFAS No. 123R will
require the Corporation to record stock option expense based on estimated fair
value calculated using an option valuation model. As issued, SFAS No. 123R would
have applied to new awards granted, and to modifications of existing awards, on
or after July 1, 2005. In April 2005, however, the Securities and Exchange
Commission extended the date for mandatory implementation of SFAS No. 123R,
effectively requiring the Corporation to apply SFAS No. 123R in the first
quarter 2006. The Corporation does not plan early implementation of the
provisions of SFAS No. 123R.
4. COMPREHENSIVE INCOME
U.S. generally accepted accounting principles generally require that recognized
revenue, expenses, gains and losses be included in net income. Although
unrealized gains and losses on available-for-sale securities are reported as a
separate component of the equity section of the balance sheet, changes in
unrealized gains and losses on available-for-sale securities, along with net
income, are components of comprehensive income.
7
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
The components of comprehensive income, and the related tax effects, are as
follows:
QUARTERS ENDED
MARCH 31,
(IN THOUSANDS) 2005 2004
Net income $ 3,295 $ 3,706
Unrealized holding (losses) gains on available-for-sale securities (5,881) 4,865
Less: Reclassification adjustment for gains realized in income (1,066) (964)
-------- --------
Other comprehensive (loss) income before income tax (6,947) 3,901
Income tax related to other comprehensive income/loss 2,362 (1,326)
-------- --------
Other comprehensive (loss) income (4,585) 2,575
-------- --------
Comprehensive (loss) income $ (1,290) $ 6,281
======== ========
5. SECURITIES
Amortized cost and fair value of securities at March 31, 2005 are summarized as
follows:
MARCH 31, 2005
GROSS GROSS
UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING FAIR
(IN THOUSANDS) COST GAINS LOSSES VALUE
AVAILABLE-FOR-SALE SECURITIES:
Obligations of the U.S. Treasury $ - $ - $ - $ -
Obligations of other U.S. Government agencies 46,014 24 (1,012) 45,026
Obligations of states and political subdivisions 120,804 3,105 (1,030) 122,879
Other securities 94,704 1,722 (679) 95,747
Mortgage-backed securities 172,754 534 (3,484) 169,804
--------- ---------- ---------- --------
Total debt securities 434,276 5,385 (6,205) 433,456
Marketable equity securities 21,783 10,175 (340) 31,618
--------- ---------- ---------- --------
Total $ 456,059 $ 15,560 $ (6,545) $465,074
========= ========== ========== ========
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury $ 315 $ 15 $ - $ 330
Obligations of other U.S. Government agencies 98 11 - 109
Mortgage-backed securities 16 1 - 17
--------- ---------- ---------- --------
Total $ 429 $ 27 $ - $ 456
========= ========== ========== ========
8
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
The following table presents gross unrealized losses and fair value of
investments aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position at March 31, 2005.
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
(IN THOUSANDS) VALUE LOSSES VALUE LOSSES VALUE LOSSES
AVAILABLE-FOR-SALE SECURITIES:
Obligations of the U.S. Treasury $ - $ - $ - $ - $ - $ -
Obligations of other U.S. Government agencies 33,574 (426) 9,403 (586) 42,977 (1,012)
Obligations of states and political subdivisions 27,987 (571) 11,268 (459) 39,255 (1,030)
Other securities 47,810 (644) 5,063 (35) 52,873 (679)
Mortgage-backed securities 118,043 (2,543) 28,842 (941) 146,885 (3,484)
--------- ---------- -------- ---------- --------- ----------
Total debt securities 227,414 (4,184) 54,576 (2,021) 281,990 (6,205)
Marketable equity securities 5,000 (202) 766 (138) 5,766 (340)
--------- ---------- -------- ---------- --------- ----------
Total temporarily impaired available-for-sale
securities $ 232,414 $ (4,386) $ 55,342 $ (2,159) $ 287,756 $ (6,545)
========= ========== ======== ========== ========= ==========
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury $ - $ - $ - $ - $ - $ -
Obligations of other U.S. Government agencies - - - - - -
Mortgage-backed securities - - - - - -
--------- ---------- -------- ---------- --------- ----------
Total temporarily impaired held-to-maturity
securities $ - $ - $ - $ - $ - $ -
========= ========== ======== ========== ========= ==========
The unrealized losses on debt securities are primarily the result of volatility
in interest rates. Based on the credit worthiness of the issuers, which are
almost exclusively U.S. Government agencies or state and political subdivisions,
management believes the Corporation's debt securities at March 31, 2005 were not
other-than-temporarily impaired. Management also believes, based on the
financial condition and near-term prospects of the issuers, the Corporation's
marketable equity securities were not other-than-temporarily impaired.
6. DEFINED BENEFIT PLANS
The Corporation has a noncontributory defined benefit pension plan for all
employees meeting certain age and length of service requirements. Benefits are
based primarily on years of service and the average annual compensation during
the highest five consecutive years.
In addition, the Corporation sponsors a defined benefit health care plan that
provides postretirement medical benefits and life insurance to employees who
meet certain age and length of service requirements. This plan contains a
cost-sharing feature, which causes participants to pay for all future increases
in costs related to benefit coverage. Accordingly, actuarial assumptions related
to health care cost trend rates do not affect the liability balance and will not
affect the Corporation's future expenses. Similarly, such feature will minimize
the impact, if any, of the Medicare Prescription Drug, Improvement and
Modernization Act (the "Act"), signed into law in December 2003. The Corporation
has not yet determined whether benefits provided under the postretirement plan
are actuarially equivalent to benefits that will be available under Medicare
Part D. Accordingly, the financial statement amounts and disclosures related to
the postretirement benefits plan do not reflect the effects of the Act.
The Corporation uses a December 31 measurement date for its plans.
9
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
The components of net periodic benefit costs from these defined benefit plans
are as follows:
PENSION BENEFITS POSTRETIREMENT BENEFITS
3 MONTHS ENDED 3 MONTHS ENDED
MARCH 31, MARCH 31,
(IN THOUSANDS) 2005 2004 2005 2004
Service cost $ 119 $ 119 $ 12 $ 11
Interest cost 155 155 17 16
Expected return on plan assets (198) (187) - -
Amortization of transition (asset) obligation (6) (6) 9 9
Recognized net actuarial loss (gain) 10 16 1 1
-------- -------- --------- ----------
Net periodic benefit cost (benefit) $ 80 $ 97 $ 39 $ 37
======== ======== ========= ==========
The Corporation fully funded its 2005 defined benefit pension contribution of
$178,000 in April 2005. In the first quarter of 2005, the Corporation funded
postretirement contributions totaling $13,000, with estimated annual
postretirement contributions of $60,000 expected in 2005 for the full year.
7. CONTINGENCIES
In the normal course of business, the Corporation may be subject to pending and
threatened lawsuits in which claims for monetary damages could be asserted. In
management's opinion, the Corporation's financial position and results of
operations would not be materially affected by the outcome of such pending legal
proceedings.
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 this quarterly report on
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 not historical facts, are based on
certain assumptions and describe future plans, business objectives and
expectations, and are generally identifiable by the use of words such as,
"should", "likely", "expect", "plan", "anticipate", "target", "forecast", and
"goal". These forward-looking statements are subject to risks and uncertainties
that are difficult to predict, may be beyond management's control and could
cause results to differ materially from those expressed or implied by such
forward-looking statements. Factors which could have a material, adverse impact
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 Federal Reserve Board and
the U. S. Government, 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, or the application of generally accepted
accounting principles.
These risks and uncertainties should be considered in evaluating forward-looking
statements and undue reliance should not be placed on such statements.
10
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
REFERENCES TO 2005 AND 2004
Unless otherwise noted, all references to "2005" in the following discussion of
operating results are intended to mean the three months ended March 31, 2005,
and similarly, references to "2004" are intended to mean the three months ended
March 31, 2004.
EARNINGS OVERVIEW
Net income in 2005 was $3,295,000, or $.40 per share - basic and diluted. This
represents a decrease of 11.1% in net income compared to 2004. Return on average
assets was 1.17% in 2005, as compared to 1.38% in 2004. Return on average equity
was 9.87% in 2005, as compared to 11.45% in 2004.
The most significant income statement changes between 2005 and 2004 were as
follows:
- The interest margin increased $424,000, or 5.1%, to $8,736,000 in
2005 from $8,312,000 in 2004, mainly as a result of growth in loans.
Changes in the net interest margin are discussed in more detail
later in Management's Discussion and Analysis.
- Net realized gains on securities were $1,066,000 in 2005, compared
to $964,000 in 2004. In 2005, net gains from sales of equity
securities amounted to $406,000. Also in 2005, the Corporation sold
a Trust Preferred security for a gain of $445,000, and had net gains
from sales of municipal bonds of $262,000. In 2004, gains from sales
of equity securities amounted to $926,000.
- Other (noninterest) expenses increased $900,000, or 14.5%, in 2005
compared to 2004. The increase reflects depreciation and maintenance
costs associated with the new core banking software system, which
was implemented in the fourth quarter 2004, as well as higher
payroll costs from additional employees, including several new
employees added due to the expansion into Williamsport and South
Williamsport in 2004, and increases in several other categories of
expenses. Increases in other expenses are described in more detail
in the "Noninterest Expense" section of Management's Discussion and
Analysis.
- The income tax provision increased to $707,000 in 2005 from $617,000
in 2004. The Corporation's effective tax rate rose to 17.7% in 2005
from 14.3% in 2004. This higher effective tax rate resulted mainly
from management's decision to decrease the weighting of tax-exempt
obligations of states and political subdivisions, as a percentage of
total assets, to avoid or reduce what would have otherwise been a
substantial alternative minimum tax liability.
TABLE I - QUARTERLY FINANCIAL DATA
(IN THOUSANDS)
MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
2005 2004 2004 2004 2004
Interest income $ 14,693 $ 14,991 $ 14,573 $ 14,343 $ 14,015
Interest expense 5,957 5,745 5,665 5,493 5,703
-------- -------- --------- -------- --------
Interest margin 8,736 9,246 8,908 8,850 8,312
Provision for loan losses 375 350 350 350 350
-------- -------- --------- -------- --------
Interest margin after provision for loan losses 8,361 8,896 8,558 8,500 7,962
Other income 1,703 1,815 1,627 1,855 1,625
Securities gains 1,066 1,133 459 321 964
Other expenses 7,128 6,746 6,738 6,289 6,228
-------- -------- --------- -------- --------
Income before income tax provision 4,002 5,098 3,906 4,387 4,323
Income tax provision 707 1,035 501 698 617
-------- -------- --------- -------- --------
Net income $ 3,295 $ 4,063 $ 3,405 $ 3,689 $ 3,706
======== ======== ========= ======== ========
Net income per share - basic $ 0.40 $ 0.50 $ 0.42 $ 0.45 $ 0.45
======== ======== ========= ======== ========
Net income per share - diluted $ 0.40 $ 0.49 $ 0.41 $ 0.45 $ 0.45
======== ======== ========= ======== ========
11
The number of shares used in calculating net income per share for each quarter
presented in Table I reflects the retroactive effect of stock dividends.
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
PROSPECTS FOR THE REMAINDER OF 2005
Management expects 2005 to be a year of expansion. Construction is currently
underway in Jersey Shore, with opening of our 20th branch location expected by
the third quarter of this year, and we anticipate construction of a branch in
Old Lycoming Township to begin at or near the time the Jersey Shore project is
completed. We have filed regulatory applications for the acquisition of Canisteo
Valley Corporation, the holding company for First State Bank of Canisteo, NY,
with total assets of approximately $43 million at March 31, 2005. We expect to
close the transaction by the 3rd quarter of this year. Finally, construction has
begun on a new administrative building in Wellsboro, within 2 blocks of the main
office.
Management expects the investments in new markets to provide future, continuing
opportunities for earnings growth. Expansion into Williamsport has contributed
to growth in commercial lending volume over the last half of 2004 and first
quarter 2005, and management expects continuing opportunities in the Lycoming
County market. However, as evidenced by our lower earnings performance in the
1st quarter, it will be difficult to achieve earnings for the year 2005
comparable to 2004's annual results. Short-term interest rates have been rising
faster than long-term rates, and further increases in short-term rates are
expected over the remainder of 2005. As reflected in Table I above, the net
interest margin in the first quarter 2005 of $8,736,000 was down from $9,246,000
in the fourth quarter 2004. Management expects rising short-term interest rates
to continue to have a negative effect on the Corporation's net interest margin
throughout much of 2005. The Corporation's exposure to interest rate risk is
discussed in more detail in Item 3. Consistent with the first quarter results
discussed above, noninterest expense in 2005 is expected to be up significantly,
mainly due to payroll and other start-up costs related to the new branches, as
well as costs from the planned administrative facility and a full year of
depreciation and maintenance from the core computer system that was placed in
service in October 2004.
Another major variable that affects the Corporation's earnings is securities
gains and losses. Management's decisions regarding sales of securities are based
on a variety of factors, with the overall goal of maximizing portfolio return
over a long-term horizon. It is difficult to predict, with much precision, the
amount of net securities gains and losses that will be realized in 2005.
CRITICAL ACCOUNTING POLICIES
The presentation of financial statements in conformity with U.S. 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.
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).
12
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
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 2005 and 2004.
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 $9,546,000 in 2005, an
increase of $225,000, or 2.4%, over 2004. As reflected in Table IV, the increase
in net interest margin was caused mainly by growth in volume of loans. Overall,
increased interest income from higher volumes of earning assets exceeded
increases in interest expense attributable to higher volumes of interest-bearing
liabilities by $246,000 in 2005 compared to 2004. Table IV also shows that
interest rate changes had the effect of decreasing net interest income $21,000
in 2005 as compared to 2004. 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) was 3.32% for the first
quarter 2005, compared to 3.43% for the year ended December 31, 2004 and 3.39%
for the first quarter 2004.
INTEREST INCOME AND EARNING ASSETS
Interest income increased 3.2%, to $15,503,000 in 2005 from $15,024,000 in 2004.
Interest and fees from loans increased $818,000, or 9.6%, while income from
available-for-sale securities decreased $346,000, or 5.4%. Overall, the majority
of the increase in interest income resulted from higher volumes of loans, which
more than offset the effect of lower average interest rates and a reduction in
available-for-sale securities.
As indicated in Table III, average available-for-sale securities in the first
quarter 2005 amounted to $454,517,000, a decrease of 2.9% from the first quarter
2004. Proceeds from sales and maturities of securities have been used, in part,
to help fund the substantial growth in loans. Also, because short-term interest
rates have been rising faster than long-term rates, there have been few
opportunities to purchase mortgage-backed securities or other bonds at spreads
sufficient to justify the applicable interest rate risk. The average rate of
return on available-for-sale securities was 5.46% for first quarter 2005, lower
than the 5.56% level in the first quarter 2004, but slightly higher than the
rate of return for the year ended December 31, 2004 of 5.41%.
Tax-exempt securities (municipal bonds) were a smaller portion of the
available-for-sale securities portfolio in the first quarter 2005 than in the
first quarter 2004. The average balance of municipal bonds shrunk to
$122,536,000, or 27% of the portfolio, in the first quarter 2005 from
$160,624,000, or 34% of the portfolio, in the first 3 months of 2004. On a
taxable equivalent basis, municipal bonds are the highest yielding category of
available-for-sale security. Management decided to reduce the Corporation's
investment in municipal bonds during the fourth quarter 2004, in order to reduce
or eliminate the alternative minimum tax liabilities incurred in 2004, and that
would otherwise have been expected for 2005.
The average balance of gross loans increased 12.7% in the first quarter 2005
over the first 3 months of 2004, to $596,513,000 from $529,155,000. The largest
growth was in commercial loans, due in part to new personnel and relationships
in Williamsport and throughout Lycoming County, as well as from growth in
staffing and an increased emphasis on commercial lending throughout the
Corporation's market area over the last few years. The average rate of return on
loans fell to 6.37% in the first quarter 2005 from 6.50% in the first 3 months
of 2004. The decrease in average rate was affected, in part, by substantial
competition for commercial loan relationships with high credit quality,
particularly in Lycoming County.
13
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES
Interest expense rose $254,000, or 4.5%, to $5,957,000 in 2005 from $5,703,000
in 2004. Table III reflects the current trend in interest rates incurred on
liabilities, as the overall cost of funds on interest-bearing liabilities rose
to 2.65% for the first quarter 2005, from 2.53% for the year ended December 31,
2004 and down slightly from 2.66% for the first quarter 2004. In Table III, you
can see the impact of rising short-term interest rates on some of the
Corporation's largest sources of funds: (1) money market accounts, which
increased to an average rate of 1.82% in 2005 from 1.24% in the first quarter
2004, (2) certificates of deposit, which increased to an average rate of 3.07%
from 2.80%, and (3) short-term borrowings, which rose to an average rate of
2.08% from 1.24%. Helping to offset some of the impact of rising short-term
market rates were IRAs, for which the average rate fell to 3.49% from 4.81%, and
long-term borrowings, for which the average rate fell to 3.44% from 3.67%. In
the first quarter 2004, the average rate paid on the majority of the
Corporation's IRAs was 5%, which was the "floor" on 18-month passbook IRAs that
existed prior to October 1, 2003. Effective April 1, 2004, the floor on those
IRAs fell to 3%, and the Corporation's passbook IRA rate has ranged from 3.25%
to 3.50% thereafter. The decrease in average rate incurred on long-term
borrowings resulted from repayment of borrowings originated in earlier interest
rate cycles at higher rates, with replacements in either short-term instruments
or long-term instruments at lower rates, mostly during the second and third
quarters of 2004.
As you can calculate from Table III, total average deposits (interest-bearing
and noninterest-bearing) increased to $671,165,000 in the first three months of
2005 from $652,398,000 in the first three months of 2004. This represents an
increase of 2.9%. Of the increase in average deposits, the largest growth
categories were money market deposits of $11,483,000, or 6.2% and IRA's of
$6,776,000, or 5.9%.
Average total short-term and long-term borrowed funds increased $30,656,000 to
$315,783,000 in the first quarter 2005 from $285,127,000 in the first quarter
2004. In 2004, the Corporation utilized borrowings to fund security purchases
and to help fund loan growth. In the first quarter 2005, this trend has changed,
as management has begun to use proceeds from the securities portfolio to help
fund loan growth, has allowed total borrowings to remain approximately stagnant,
and in an attempt to contain the amount of growth in interest expense, has
rolled over maturing long-term borrowings into overnight or short-term
borrowings. This change in trend is reflected in the consolidated balance sheet,
as total short-term borrowings increased to $50,167,000 at March 31, 2005 from
$34,178,000 at December 31, 2004, and total long-term borrowings decreased to
$257,394,000 at March 31, 2005 from $270,827,000 at December 31, 2004.
14
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE II - ANALYSIS OF INTEREST INCOME AND EXPENSE
THREE MONTHS ENDED
MARCH 31, INCREASE/
(IN THOUSANDS) 2005 2004 (DECREASE)
INTEREST INCOME
Available-for-sale securities:
Taxable $ 3,950 $ 3,620 $ 330
Tax-exempt 2,168 2,844 (676)
---------- ------- ----------
Total available-for-sale securities 6,118 6,464 (346)
---------- ------- ----------
Held-to-maturity securities,
Taxable 6 7 (1)
Interest-bearing due from banks 4 3 1
Federal funds sold 8 1 7
Loans:
Taxable 9,006 8,235 771
Tax-exempt 361 314 47
---------- ------- ----------
Total loans 9,367 8,549 818
---------- ------- ----------
Total Interest Income 15,503 15,024 479
---------- ------- ----------
INTEREST EXPENSE
Interest checking 58 57 1
Money market 887 575 312
Savings 70 68 2
Certificates of deposit 1,365 1,270 95
Individual Retirement Accounts 1,045 1,371 (326)
Other time deposits 1 2 (1)
Short-term borrowings 225 123 102
Long-term borrowings 2,306 2,237 69
---------- ------- ----------
Total Interest Expense 5,957 5,703 254
---------- ------- ----------
Net Interest Income $ 9,546 $ 9,321 $ 225
========== ======= ==========
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%.
15
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE III - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES
3 MONTHS YEAR 3 MONTHS
ENDED RATE OF ENDED RATE OF ENDED RATE OF
3/31/2005 RETURN/ 12/31/2004 RETURN/ 3/31/2004 RETURN/
AVERAGE COST OF AVERAGE COST OF AVERAGE COST OF
(DOLLARS IN THOUSANDS) BALANCE FUNDS % BALANCE FUNDS % BALANCE FUNDS %
EARNING ASSETS
Available-for-sale securities, at amortized cost:
Taxable $ 331,981 4.83% $ 331,447 4.65% $ 307,321 4.74%
Tax-exempt 122,536 7.18% 151,049 7.09% 160,624 7.12%
----------- ---- ---------- ---- ----------- ----
Total available-for-sale securities 454,517 5.46% 482,496 5.41% 467,945 5.56%
----------- ---- ---------- ---- ----------- ----
Held-to-maturity securities,
Taxable 431 5.65% 460 5.87% 504 5.59%
Interest-bearing due from banks 856 1.90% 1,449 0.76% 965 1.25%
Federal funds sold 1,514 2.14% 778 1.29% 357 1.13%
Loans:
Taxable 573,140 6.37% 530,045 6.46% 510,481 6.49%
Tax-exempt 23,373 6.26% 21,307 6.58% 18,674 6.76%
----------- ---- ---------- ---- ----------- ----
Total loans 596,513 6.37% 551,352 6.47% 529,155 6.50%
----------- ---- ---------- ---- ----------- ----
Total Earning Assets 1,053,831 5.97% 1,036,535 5.96% 998,926 6.05%
Cash 9,011 14,273 13,268
Unrealized gain/loss on securities 15,627 16,182 21,693
Allowance for loan losses (6,909) (6,523) (6,166)
Bank premises and equipment 17,036 14,953 12,805
Other assets 42,571 38,621 36,835
----------- ---------- -----------
Total Assets $ 1,131,167 $1,114,041 $ 1,077,361
=========== ========== ===========
INTEREST-BEARING LIABILITIES
Interest checking $ 37,276 0.63% $ 39,188 0.59% $ 37,934 0.60%
Money market 197,858 1.82% 192,450 1.31% 186,375 1.24%
Savings 56,976 0.50% 57,439 0.49% 54,997 0.50%
Certificates of deposit 180,510 3.07% 180,332 2.85% 182,735 2.80%
Individual Retirement Accounts 121,462 3.49% 116,622 3.75% 114,686 4.81%
Other time deposits 950 0.43% 1,275 0.39% 1,057 0.76%
Short-term borrowings 43,774 2.08% 39,458 1.37% 39,945 1.24%
Long-term borrowings 272,009 3.44% 268,211 3.55% 245,182 3.67%
----------- ---- ---------- ---- ----------- ----
Total Interest-bearing Liabilities 910,815 2.65% 894,975 2.53% 862,911 2.66%
Demand deposits 76,133 82,001 74,614
Other liabilities 10,725 8,691 10,396
----------- ---------- -----------
Total Liabilities 997,673 985,667 947,921
----------- ---------- -----------
Stockholders' equity, excluding other
comprehensive income/loss 123,180 117,695 115,123
Other comprehensive income/loss 10,314 10,679 14,317
----------- ---------- -----------
Total Stockholders' Equity 133,494 128,374 129,440
----------- ---------- -----------
Total Liabilities and Stockholders' Equity $ 1,131,167 $1,114,041 $ 1,077,361
=========== ========== ===========
Interest Rate Spread 3.32% 3.43% 3.39%
Net Interest Income/Earning Assets 3.67% 3.78% 3.75%
(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.
16
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE IV - ANALYSIS OF VOLUME AND RATE CHANGES
(IN THOUSANDS)
YTD ENDED 3/31/05 VS. 3/31/04
CHANGE IN CHANGE IN TOTAL
VOLUME RATE CHANGE
EARNING ASSETS
Available-for-sale securities:
Taxable $ 268 $ 62 $ 330
Tax-exempt (696) 20 (676)
--------- --------- -------
Total available-for-sale securities (428) 82 (346)
--------- --------- -------
Held-to-maturity securities,
Taxable (1) - (1)
Interest-bearing due from banks - 1 1
Federal funds sold 5 2 7
Loans:
Taxable 927 (156) 771
Tax-exempt 72 (25) 47
--------- --------- -------
Total loans 999 (181) 818
--------- --------- -------
Total Interest Income 575 (96) 479
--------- --------- -------
INTEREST-BEARING LIABILITIES
Interest checking (1) 2 1
Money market 36 276 312
Savings 2 - 2
Certificates of deposit (16) 111 95
Individual Retirement Accounts 74 (400) (326)
Other time deposits - (1) (1)
Short-term borrowings 13 89 102
Long-term borrowings 221 (152) 69
--------- --------- -------
Total Interest Expense 329 (75) 254
--------- --------- -------
Net Interest Income $ 246 $ (21) $ 225
========= ========= =======
(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.
17
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE V - COMPARISON OF NONINTEREST INCOME
(IN THOUSANDS)
3 MONTHS ENDED
MARCH 31, MARCH 31,
2005 2004
Service charges on deposit accounts $ 342 $ 421
Service charges and fees 87 76
Trust and financial management revenue 479 457
Insurance commissions, fees and premiums 98 109
Increase in cash surrender value of life insurance 139 159
Fees related to credit card operation 210 184
Other operating income 348 219
-------- --------
Total other operating income, before realized
gains on securities, net 1,703 1,625
Realized gains on securities, net 1,066 964
-------- --------
Total Other Income $ 2,769 $ 2,589
======== ========
Total noninterest income increased $180,000, or 7.0%, in 2005 compared to 2004,
including an increase in net realized gains on securities of $102,000.
Securities gains are discussed in the Earnings Overview section of Management's
Discussion and Analysis. Other items of significance are as follows:
- - Service charges on deposit accounts fell $79,000, or 18.8%, in 2005 as
compared to 2004. Changes in deposit account processing resulting from the
new core banking system have resulted in overdraft and other charges no
longer being assessed for some transactions that would have generated
charges with the former system. Management is currently working with the
core system vendor to reestablish as many of the former overdraft and
service charge routines as possible.
- - Other operating income increased $129,000, or 58.9%, in 2005 over 2004.
Included in this category were inceases in gains from sales of other real
estate properties, dividend income on Federal Home Loan Bank of Pittsburgh
stock and debit card fees.
TABLE VI- COMPARISON OF NONINTEREST EXPENSE
(IN THOUSANDS)
3 MONTHS ENDED
MARCH 31, MARCH 31,
2005 2004
Salaries and wages $ 2,875 $ 2,671
Pensions and other employee benefits 1,032 984
Occupancy expense, net 464 377
Furniture and equipment expense 648 336
Pennsylvania shares tax 215 212
Other operating expense 1,894 1,648
--------- ---------
Total Other Expense $ 7,128 $ 6,228
========= =========
Salaries and wages increased $204,000, or 7.6%, for 2005 compared to 2004. The
increase in salaries expense is primarily a reflection of a greater number of
employees, as the number of full-time equivalent employees increased 9.2%, to
320 as of March 31, 2005 from 293 as of March 31, 2004. The increased number of
employees resulted from expansion into new branches in Williamsport and South
Williamsport in 2004, as well as additional employees hired for support
functions, such as Finance, Training and Compliance.
18
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Occupancy Expense rose $87,000, or 23.1%, in 2005 compared to 2004. With the
addition of facilities in Williamsport and South Williamsport, depreciation,
real estate taxes, building maintenance and other building-related costs have
increased in 2005.
Other Operating Expense increased $246,000 or 14.9% in 2005 compared to 2004.
The increase in other expenses included an increase in attorney fees of
$121,000, mainly related to collection activities on a large commercial credit;
an increase of $88,000 in expenses associated with maintaining and preparing
other real estate properties for sale; costs associated with NASDAQ Small Cap
registration and annual fees totaling $51,000, and an increase in Directors'
compensation of $29,000. Within other expenses, professional fees dropped
$56,000, as 2004's results included payment of fees related to a system
conversion for the credit card operation.
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. Also included in the Net
Interest Margin section is a discussion of a change in trend regarding
short-term and long-term borrowings. The allowance for loan losses and
stockholders' equity are discussed in separate sections of Management's
Discussion and Analysis.
As discussed in the "Prospects for the Remainder of 2005" section of
Management's Discussion and Analysis, the Corporation is expected to complete
construction of a new branch in Jersey Shore in 2005, as well as a new
administrative building in Wellsboro, and begin (and perhaps, complete,
depending on how quickly construction activity proceeds) another branch in Old
Lycoming Township. In addition to the building projects, the Corporation will
need to purchase furniture, equipment and computer-related items on an ongoing
basis for its existing and new operations. In total, management expects 2005
capital purchases to range between $6 and $8.5 million. As discussed in the
Earnings Overview section of Management's Discussion and Analysis, management
expects the initial depreciation and start-up costs associated with the new
locations to have a negative impact on 2005 earnings; however, in light of the
Corporation's strong capital position, the overall impact of 2005 capital
purchases is not expected to be materially adverse to the Corporation's
financial condition.
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: (1) the analysis of estimated probable losses
from individual loans, and (2) historical loss experience, as modified for
identified trends and concerns, for each loan risk category. The historical loss
experience-based portion of the allowance is calculated by determining the ratio
of net charge-offs to average loan balances over a five-year period, for each
significant type of loan, modified for risk adjustment factors identified by
management for each type of loan. The charge-off ratio, as modified, 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 management's knowledge of
specific losses within the portfolio may be incomplete.
The allowance for loan losses was $6,925,000 at March 31, 2005, an increase of
$138,000 from the balance at December 31, 2004. As you can see in Table VII, net
charge-offs totaled $237,000 during the first quarter 2005. The provision for
loan losses was $375,000 in the first quarter 2005, up from $350,000 in the
first quarter 2004. 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.
Table VIII presents a summary of the allocated allowance by loan type, as well
as the unallocated portion of the allowance. The unallocated portion of the
allowance was $2,504,000 at March 31, 2005, down slightly from $2,578,000 at
December 31, 2004.
19
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
As indicated in Table IX, total impaired loans amounted to $8,663,000 at March
31, 2005, up from $8,261,000 at December 31 2004 and $4,621,000 at December 31,
2003. Table IX also shows that the amount of loans classified as nonaccrual
increased to $8,429,000 at March 31, 2005 from $7,796,000 at December 31, 2004
and $1,145,000 at December 31, 2003. The growth in 2004 in past due and
nonaccrual loans resulted mainly from certain large commercial loan
relationships, including one commercial loan relationship with total outstanding
loan balances of approximately $3.7 million as of March 31, 2005 and December
31, 2004. In 2004, management moved most of the loans outstanding related to
this large relationship, as well as certain other commercial loans, into
nonaccrual status, and most of these loans remained in nonaccrual status as of
March 31, 2005. Also, in the first quarter 2005, a large ($600,000) residential
mortgage loan to the principal owner of the $3.7 million relationship was moved
to nonaccrual. As of March 31, 2005 and December 31, 2004, the valuation
allowance related to this large relationship amounted to $173,000. In total, the
valuation allowance related to impaired loans amounted to $1,340,000 at March
31, 2005 and $1,378,000 at December 31, 2004. Management believes it has been
conservative in its decisions concerning identification of impaired loans,
estimates of loss and nonaccrual status. However, the actual losses realized
from these relationships could vary materially from the allowances calculated as
of March 31, 2005. Management continues to closely monitor these commercial loan
relationships, and will adjust its estimates of loss and decisions concerning
nonaccrual status, if appropriate.
Tables VII, VIII, IX and X present an analysis of the allowance for loan losses,
the allocation of the allowance, information concerning impaired and past due
loans and a five-year summary of loans by type.
TABLE VII- ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
(IN THOUSANDS)
QUARTER QUARTER
ENDED ENDED
MARCH 31, MARCH 31, YEARS ENDED DECEMBER 31,
2005 2004 2004 2003 2002 2001 2000
Balance, beginning of year $ 6,787 $ 6,097 $ 6,097 $ 5,789 $ 5,265 $ 5,291 $ 5,131
--------- --------- ------- ------- ------- ------- -------
Charge-offs:
Real estate loans 100 20 375 168 123 144 272
Installment loans 56 27 217 326 116 138 77
Credit cards and related plans 65 50 178 171 190 200 214
Commercial and other loans 61 - 16 303 123 231 53
--------- --------- ------- ------- ------- ------- -------
Total charge-offs 282 97 786 968 552 713 616
--------- --------- ------- ------- ------- ------- -------
Recoveries:
Real estate loans 12 2 3 75 30 6 26
Installment loans 24 7 32 52 30 27 23
Credit cards and related plans 4 7 23 17 18 20 28
Commercial and other loans 5 4 18 32 58 34 23
--------- --------- ------- ------- ------- ------- -------
Total recoveries 45 20 76 176 136 87 100
--------- --------- ------- ------- ------- ------- -------
Net charge-offs 237 77 710 792 416 626 516
Provision for loan losses 375 350 1,400 1,100 940 600 676
--------- --------- ------- ------- ------- ------- -------
Balance, end of year $ 6,925 $ 6,370 $ 6,787 $ 6,097 $ 5,789 $ 5,265 $ 5,291
========= ========= ======= ======= ======= ======= =======
TABLE VIII - ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES BY TYPE
(IN THOUSANDS)
AS OF
MARCH 31, AS OF DECEMBER 31,
2005 2004 2003 2002 2001 2000
Commercial $ 2,165 $ 1,909 $ 1,578 $ 1,315 $ 1,837 $ 1,612
Consumer mortgage 512 513 456 460 674 952
Impaired loans 1,340 1,378 1,542 1,877 73 273
Consumer 404 409 404 378 494 471
Unallocated 2,504 2,578 2,117 1,759 2,187 1,983
--------- ------- ------- ------- ------- -------
Total Allowance $ 6,925 $ 6,787 $ 6,097 $ 5,789 $ 5,265 $ 5,291
========= ======= ======= ======= ======= =======
20
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE IX - PAST DUE AND IMPAIRED LOANS
(IN THOUSANDS)
MAR. 31, DEC. 31, DEC. 31, DEC. 31,
2005 2004 2003 2002
Impaired loans without a valuation allowance $ 3,945 $ 3,552 $ 114 $ 675
Impaired loans with a valuation allowance 4,718 4,709 4,507 3,039
-------- -------- -------- --------
Total impaired loans $ 8,663 $ 8,261 $ 4,621 $ 3,714
======== ======== ======== ========
Valuation allowance related to impaired loans $ 1,340 $ 1,378 $ 1,542 $ 1,877
Total nonaccrual loans $ 8,429 $ 7,796 $ 1,145 $ 1,252
Total loans past due 90 days or more and
still accruing $ 2,021 $ 1,307 $ 2,546 $ 2,318
TABLE X - SUMMARY OF LOANS BY TYPE
(IN THOUSANDS)
MARCH 31, AS OF DECEMBER 31,
2005 2004 2003 2002 2001 2000
Real estate - construction $ 3,627 $ 4,178 $ 2,856 $ 103 $ 1,814 $ 452
Real estate - residential mortgage 341,959 347,705 330,807 292,136 245,997 207,100
Real estate - commercial mortgage 133,510 128,073 100,240 78,317 60,267 56,225
Consumer 32,305 31,702 33,977 31,532 29,284 28,141
Agricultural 2,688 2,872 2,948 3,024 2,344 1,983
Commercial 61,681 43,566 34,967 30,874 24,696 20,776
Other 1,951 1,804 1,183 2,001 1,195 948
Political subdivisions 21,322 19,713 17,854 13,062 13,479 12,462
Lease receivables - - 65 96 152 218
--------- ---------- ---------- --------- --------- ---------
Total 599,043 579,613 524,897 451,145 379,228 328,305
Less: allowance for loan losses (6,925) (6,787) (6,097) (5,789) (5,265) (5,291)
--------- ---------- ---------- --------- --------- ---------
Loans, net $ 592,118 $ 572,826 $ 518,800 $ 445,356 $ 373,963 $ 323,014
========= ========== ========== ========= ========= =========
DERIVATIVE FINANCIAL INSTRUMENTS
The Corporation has utilized derivative financial instruments related to a
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. In 2004, the Corporation stopped originating new IPCDs,
but continues to maintain and account for IPCDs and the related derivative
contracts entered into between 2001 and 2004.
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.
21
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
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
paid a fee of 0.75% to a consulting firm at inception of each deposit. These
fees are being 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.
Amounts recorded as of March 31, 2005 and December 31, 2004, and for the first
quarters of 2005 and 2004, related to IPCDs are as follows (in thousands):
MARCH 31, DEC. 31,
2005 2004
Contractual amount of IPCDs (equal
to notional amount of Swap contracts) $ 3,970 $ 4,045
Carrying value of IPCDs 3,641 3,695
Carrying value of embedded derivative liabilities 444 297
Carrying value of Swap contract (assets) liabilities (127) 42
3 MOS. ENDED 3 MOS. ENDED
MARCH 31, MARCH 31,
2005 2004
Interest expense $ 40 $ 34
Other expense - 1
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 FHLB - Pittsburgh, secured by mortgage loans and
various investment securities. At March 31, 2005, the Corporation had unused
borrowing availability with correspondent banks and the Federal Home Loan Bank
of Pittsburgh totaling approximately $137,939,000. Additionally, the Corporation
uses repurchase agreements placed with brokers to borrow funds secured by
investment assets, and uses "RepoSweep" arrangements to borrow funds from
commercial banking customers on an overnight basis. Further, if required to
raise cash in an emergency situation, the Corporation could sell non-pledged
investment securities to meet its obligations. At March 31, 2005, the carrying
value of non-pledged securities was $273,705,000.
Management believes the combination of its strong capital position (discussed in
the next section), ample available borrowing facilities and substantial
non-pledged securities portfolio have placed the Corporation in a position of
minimal short-term and long-term liquidity risk.
22
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
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
Corporation's consolidated capital ratios at March 31, 2005 are as follows:
Total capital to risk-weighted assets 18.73%
Tier 1 capital to risk-weighted assets 17.15%
Tier 1 capital to average total assets 10.86%
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
(discussed in the "Financial Position" section of Management's Discussion and
Analysis) during the next 12 months, though expected to be substantial, are not
expected to have a significantly detrimental effect on capital ratios.
As reflected in the consolidated balance sheet, Accumulated Other Comprehensive
Income fell to $5,950,000 at March 31, 2005 from $10,535,000 at December 31,
2004. The balance in Accumulated Other Comprehensive Income represents
unrealized gains and losses on available-for-sale securities, net of deferred
income tax. Rising interest rates, which reduced the market prices of debt
securities, were the major cause of the decline in Accumulated Other
Comprehensive Income at March 31, 2005 compared to December 31, 2004.
INFLATION
Over the last several years, direct inflationary pressures on the Corporation's
payroll-related and other noninterest costs have been modest. 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 or deflationary
pressure, in managing interest rate and other financial risks.
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 a significant 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 expenses. The model
measures and projects potential changes in net interest income, and calculates
the discounted present value of anticipated cash flows of financial instruments,
assuming an immediate increase or decrease in interest rates. Management
ordinarily runs a variety of scenarios within a range of plus or minus 50-300
basis points of current rates.
23
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
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. The Bank's policy provides limits at +/- 100, 200 and 300 basis
points from current rates for fluctuations in net interest income from the
baseline (flat rates) one-year scenario. The policy also limits acceptable
market value variances from the baseline values based on current rates. The most
sensitive scenario presented in Table XI presented below is the "+300 basis
points" scenario. As the table shows, as of March 31, 2005, if interest rates
were to immediately rise 300 basis points, the Bank's calculations based on the
model show that although the change in net interest income is within the policy
threshold, the market value of portfolio equity would decrease 51.1%, which
exceeds the policy limit of 45%. Similarly, at December 31, 2004, the change in
net interest income was within the policy threshold, but the market value of
portfolio equity decrease of 49.2% exceeded the policy threshold. Management
will continue to evaluate whether to make any changes to asset or liability
holdings in an effort to reduce exposure to decline in market value or net
interest income in a rising interest rate environment.
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. 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.
TABLE XI - THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES
MARCH 31, 2005 DATA
(IN THOUSANDS)
12 MOS. ENDING MAR. 31, 2006
INTEREST INTEREST NET INTEREST NII NII
BASIS POINT CHANGE IN RATES INCOME EXPENSE INCOME (NII) % CHANGE RISK LIMIT
+300 64,048 36,494 27,554 -17.2% 20.0%
+200 62,351 32,796 29,555 -11.2% 15.0%
+100 60,588 29,098 31,490 -5.4% 10.0%
0 58,691 25,400 33,291 0.0% 0.0%
-100 56,011 22,113 33,898 1.8% 10.0%
-200 53,179 19,398 33,781 1.5% 15.0%
-300 50,565 17,784 32,781 -1.5% 20.0%
MARKET VALUE OF PORTFOLIO EQUITY
AT MARCH 31, 2005
PRESENT PRESENT PRESENT
VALUE VALUE VALUE
BASIS POINT CHANGE IN RATES EQUITY % CHANGE RISK LIMIT
+300 65,884 -51.1% 45.0%
+200 88,280 -34.5% 35.0%
+100 111,664 -17.1% 25.0%
0 134,696 0.0% 0.0%
-100 148,133 10.0% 25.0%
-200 155,056 15.1% 35.0%
-300 165,510 22.9% 45.0%
24
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
DECEMBER 31, 2004 DATA
(IN THOUSANDS)
12 MOS. ENDING DEC. 31, 2005
INTEREST INTEREST NET INTEREST NII NII
BASIS POINT CHANGE IN RATES INCOME EXPENSE INCOME (NII) % CHANGE RISK LIMIT
+300 62,724 34,583 28,141 -16.8% 20.0%
+200 61,066 30,840 30,226 -10.7% 15.0%
+100 59,327 27,098 32,229 -4.7% 10.0%
0 57,343 23,510 33,833 0.0% 0.0%
-100 54,581 20,676 33,905 0.2% 10.0%
-200 51,800 17,924 33,876 0.1% 15.0%
-300 49,090 16,850 32,240 -4.7% 20.0%
MARKET VALUE OF PORTFOLIO EQUITY
AT DECEMBER 31, 2004
PRESENT PRESENT PRESENT
VALUE VALUE VALUE
BASIS POINT CHANGE IN RATES EQUITY % CHANGE RISK LIMIT
+300 71,244 -49.2% 45.0%
+200 94,088 -32.9% 35.0%
+100 117,491 -16.2% 25.0%
0 140,168 0.0% 0.0%
-100 153,026 9.2% 25.0%
-200 162,400 15.9% 35.0%
-300 171,463 22.3% 45.0%
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. Included in "Other
Equity Securities" in the table that follows are preferred stocks issued by U.S.
Government agencies with a fair value of $1,988,000 at March 31, 2005 and
$6,130,000 at December 31, 2004.
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.
25
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Equity securities held as of March 31, 2005 and December 31, 2004 are presented
in Table XII.
TABLE XII - EQUITY SECURITIES
(IN THOUSANDS)
HYPOTHETICAL HYPOTHETICAL
10% 20%
DECLINE IN DECLINE IN
FAIR MARKET MARKET
AT MARCH 31, 2005 COST VALUE VALUE VALUE
Banks and bank holding companies $ 17,798 $ 27,385 $ (2,739) $ (5,477)
Other equity securities 3,985 4,233 (423) (847)
-------- -------- ------------ ------------
Total $ 21,783 $ 31,618 $ (3,162) $ (6,324)
======== ======== ============ ============
HYPOTHETICAL HYPOTHETICAL
10% 20%
DECLINE IN DECLINE IN
FAIR MARKET MARKET
AT DECEMBER 31, 2004 COST VALUE VALUE VALUE
Banks and bank holding companies $ 17,426 $ 29,880 $ (2,988) $ (5,976)
Other equity securities 8,962 8,383 (838) (1,677)
-------- -------- ------------ ------------
Total $ 26,388 $ 38,263 $ (3,826) $ (7,653)
======== ======== ============ ============
PART I - FINANCIAL INFORMATION (CONTINUED)
ITEM 4. CONTROLS AND PROCEDURES
The Corporation's management, under the supervision of and with the
participation of the Corporation's Chief Executive Officer and Chief Financial
Officer, has carried out an evaluation of the design and effectiveness of the
Corporation's disclosure controls and procedures as defined in Rule 13a-15(e)
and Rule 15d-15(e) of the Securities Exchange Act of 1934 as of the end of
period covered by this report. Based upon that evaluation, the Chief Executive
Officer and Chief Financial Officer have concluded that, as of the end of such
period, the Corporation's disclosure controls and procedures are effective to
ensure that all material information required to be disclosed in reports the
Corporation files or submits under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported, within the time periods specified
in the Securities and Exchange Commission's rules and forms.
There were no significant changes in the Corporation's internal control over
financial reporting that occurred during the period covered by this report that
has materially affected, or that is reasonably likely to affect, our internal
control over financial reporting.
26
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Corporation and the Bank are involved in various legal proceedings
incidental to their business. Management believes the aggregate
liability, if any, resulting from such pending and threatened legal
proceedings will not have a material, adverse effect on the
Corporation's financial condition or results of operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits
3. (i) Articles of Incorporated by reference to the
Incorporation exhibits filed with the Corporation's
registration statement on Form S-4 on
March 27, 1987.
3. (ii) By-laws Incorporated by reference to Exhibit
3.1 of the Corporation's Form 8-K
filed August 25, 2004
11. Statement re: computation Information concerning the computation
of per share earnings of earnings per share is provided in
Note 2 to the Consolidated Financial
Statements, which is included in Part
I, Item 1 of Form 10-Q
31. Rule 13a-14(a)/15d-14(a)
certifications:
31.1 Certification of Chief
Executive Officer Filed herewith
31.2 Certification of Chief
Financial Officer Filed herewith
32. Section 1350 certifications Filed herewith
27
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
May 10, 2005 By: /s/ Craig G. Litchfield
- ------------ -----------------------------------------------
Date Chairman, President and Chief Executive Officer
May 10, 2005 By: /s/ Mark A. Hughes
- ------------ -------------------------------------
Date Treasurer and Chief Financial Officer
28