UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
Commission file number 2-96144
CITIZENS FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
| Delaware | 55-0666598 | |
| (State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
| 213 Third Street, Elkins, West Virginia | 26241 | |
| (Address of principal executive offices) | (Zip Code) |
(304) 636-4095
(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 Sections 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 Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
| Class |
Outstanding at July 10, 2004 | |
| Common Stock ($2 par value) |
631,378 |
This report contains 25 pages.
CITIZENS FINANCIAL CORP.
Quarter Ended June 30, 2004
INDEX
| Page No. | ||||||
| Part I. |
||||||
| Item 1. Financial Statements |
||||||
| Condensed Consolidated Balance Sheets June 30, 2004 and December 31, 2003 |
3 | |||||
| 4 | ||||||
| 5 | ||||||
| 6 | ||||||
| Condensed Consolidated Statements of Cash Flows Six Months Ended June 30, 2004 and June 30, 2003 |
7 | |||||
| 8-13 | ||||||
| Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations |
14-22 | |||||
| Item 3. Quantitative and Qualitative Disclosures About Market Risk |
22-23 | |||||
| Item 4. Controls and Procedures |
23 | |||||
| Part II. |
||||||
| 23-24 | ||||||
| 25 | ||||||
| Certification by Executive Officers Pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act of 2002 |
||||||
2
PART I ITEM I - FINANCIAL INFORMATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands of dollars)
| June 30, 2004 |
Dec. 31, 2003 |
|||||||
| (Unaudited) | * | |||||||
| ASSETS |
||||||||
| Cash and due from banks |
$ | 5,351 | $ | 5,952 | ||||
| Securities available for sale |
54,682 | 60,077 | ||||||
| Loans, less allowance for loan losses of $1,170 and $1,396, respectively |
141,115 | 134,311 | ||||||
| Premises and equipment |
4,235 | 3,607 | ||||||
| Accrued interest receivable |
1,070 | 1,097 | ||||||
| Other assets |
4,401 | 4,085 | ||||||
| Total Assets |
$ | 210,854 | $ | 209,129 | ||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY |
||||||||
| Deposits: |
||||||||
| Noninterest bearing |
$ | 22,321 | $ | 23,512 | ||||
| Interest bearing |
143,964 | 138,037 | ||||||
| Total deposits |
166,285 | 161,549 | ||||||
| Short-term borrowings |
17,412 | 22,066 | ||||||
| Long-term borrowings |
5,499 | 3,403 | ||||||
| Other liabilities |
1,559 | 1,632 | ||||||
| Total liabilities |
190,755 | 188,650 | ||||||
| Commitments and contingencies |
||||||||
| SHAREHOLDERS’ EQUITY |
||||||||
| Common stock, $2.00 par value, authorized 2,250,000 shares, issued 750,000 shares |
1,500 | 1,500 | ||||||
| Additional paid in capital |
2,100 | 2,100 | ||||||
| Retained earnings |
19,274 | 18,966 | ||||||
| Accumulated other comprehensive income/loss |
(13 | ) | 675 | |||||
| Treasury stock at cost, 118,622 shares shares |
(2,762 | ) | (2,762 | ) | ||||
| Total shareholders’ equity |
20,099 | 20,479 | ||||||
| Total Liabilities and Shareholders’ Equity |
$ | 210,854 | $ | 209,129 | ||||
| * | From audited financial statements. |
The accompanying notes are an integral part of these financial statements.
3
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands of dollars, except per share data)
| Three Months Ended June 30, |
Six Months Ended June 30, | |||||||||||
| 2004 |
2003 |
2004 |
2003 | |||||||||
| (Unaudited) | (Unaudited) | |||||||||||
| INTEREST INCOME |
||||||||||||
| Interest and fees on loans |
$ | 2,311 | $ | 2,276 | $ | 4,605 | $ | 4,487 | ||||
| Interest and dividends on securities: |
||||||||||||
| Taxable |
415 | 499 | 875 | 1,013 | ||||||||
| Tax-exempt |
83 | 88 | 165 | 171 | ||||||||
| Interest on federal funds sold |
1 | 5 | 6 | 9 | ||||||||
| Total interest income |
2,810 | 2,868 | 5,651 | 5,680 | ||||||||
| INTEREST EXPENSE |
||||||||||||
| Interest on deposits |
650 | 717 | 1,297 | 1,440 | ||||||||
| Interest on short-term borrowings |
70 | 62 | 131 | 120 | ||||||||
| Interest on long-term borrowings |
33 | 33 | 56 | 57 | ||||||||
| Total interest expense |
753 | 812 | 1,484 | 1,617 | ||||||||
| Net interest income |
2,057 | 2,056 | 4,167 | 4,063 | ||||||||
| Provision for loan losses |
595 | 81 | 685 | 162 | ||||||||
| Net interest income after provision for loan losses |
1,462 | 1,975 | 3,482 | 3,901 | ||||||||
| NONINTEREST INCOME |
||||||||||||
| Trust department income |
38 | 43 | 71 | 133 | ||||||||
| Brokerage fees |
16 | 2 | 30 | 9 | ||||||||
| Service fees |
186 | 169 | 351 | 327 | ||||||||
| Insurance commissions |
9 | 11 | 14 | 16 | ||||||||
| Security gains/(losses) |
0 | 0 | 19 | 0 | ||||||||
| Secondary market loan fees |
19 | 29 | 28 | 52 | ||||||||
| Other |
70 | 46 | 132 | 92 | ||||||||
| Total noninterest income |
338 | 300 | 645 | 629 | ||||||||
| NONINTEREST EXPENSE |
||||||||||||
| Salaries and employee benefits |
895 | 845 | 1,766 | 1,682 | ||||||||
| Net occupancy expense |
63 | 56 | 128 | 118 | ||||||||
| Equipment rentals, depreciation and maintenance |
111 | 106 | 224 | 205 | ||||||||
| Data processing |
135 | 121 | 270 | 239 | ||||||||
| Director fees |
56 | 55 | 113 | 110 | ||||||||
| Postage |
31 | 39 | 82 | 75 | ||||||||
| Professional service fees |
33 | 31 | 78 | 72 | ||||||||
| Stationery |
45 | 37 | 82 | 71 | ||||||||
| Other |
256 | 255 | 506 | 456 | ||||||||
| Total noninterest expense |
1,625 | 1,545 | 3,249 | 3,028 | ||||||||
| Income before income taxes |
175 | 730 | 878 | 1,502 | ||||||||
| Income tax expense |
22 | 238 | 191 | 499 | ||||||||
| Net income |
$ | 153 | $ | 492 | $ | 687 | $ | 1,003 | ||||
| Basic and fully diluted earnings per common share |
$ | .24 | $ | .76 | $ | 1.09 | $ | 1.55 | ||||
| Weighted average shares outstanding |
631,378 | 645,831 | 631,378 | 646,085 | ||||||||
| Dividends per common share |
$ | .30 | $ | .30 | $ | .60 | $ | .60 | ||||
The accompanying notes are an integral part of these financial statements.
4
STATEMENTS OF COMPREHENSIVE INCOME/LOSS
(In thousands of dollars)
| Three Months Ended June 30 |
Six Months Ended June 30 |
|||||||||||||||
| 2004 |
2003 |
2004 |
2003 |
|||||||||||||
| (Unaudited) | (Unaudited) | |||||||||||||||
| Net income |
$ | 153 | $ | 492 | $ | 687 | $ | 1,003 | ||||||||
| Other comprehensive income: |
||||||||||||||||
| Gross unrealized gains/(losses) arising during the period |
(1,354 | ) | 304 | (1,128 | ) | 69 | ||||||||||
| Adjustment for income tax (expense)/benefit |
538 | (115 | ) | 428 | (26 | ) | ||||||||||
| (816 | ) | 189 | (700 | ) | 43 | |||||||||||
| Less: Reclassification adjustment for (gains)/losses included in net income |
0 | 0 | (19 | ) | 0 | |||||||||||
| Adjustment for income tax expense/(benefit) |
0 | 0 | 7 | 0 | ||||||||||||
| 0 | 0 | (12 | ) | 0 | ||||||||||||
| Other comprehensive income, net of tax |
(816 | ) | 189 | (688 | ) | 43 | ||||||||||
| Comprehensive income |
$ | (663 | ) | $ | 681 | $ | (1 | ) | $ | 1,046 | ||||||
The accompanying notes are an integral part of these financial statements.
5
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(In thousands of dollars)
| Six Months Ended June 30, 2004 and 2003 |
||||||||||||||||||||||||
| (unaudited) | ||||||||||||||||||||||||
| Common Stock |
Additional Paid-in Capital |
Retained Earnings |
Accumulated Other Comprehensive Income |
Treasury Stock |
Total Share - holders’ Equity |
|||||||||||||||||||
| Shares |
Amount |
|||||||||||||||||||||||
| Balance, January 1, 2003 |
750,000 | $ | 1,500 | $ | 2,100 | $ | 17,912 | $ | 1,244 | $ | (2,151 | ) | $ | 20,605 | ||||||||||
| Net income |
1,003 | 1,003 | ||||||||||||||||||||||
| Net change in unrealized gain on securities |
43 | 43 | ||||||||||||||||||||||
| Cash dividends declared ($.60 per share) |
(387 | ) | (387 | ) | ||||||||||||||||||||
| Purchase of 1,000 shares of treasury stock |
(37 | ) | (37 | ) | ||||||||||||||||||||
| Balance June 30, 2003 |
750,000 | $ | 1,500 | $ | 2,100 | $ | 18,528 | $ | 1,287 | $ | (2,188 | ) | $ | 21,227 | ||||||||||
| Balance, January 1, 2004 |
750,000 | $ | 1,500 | $ | 2,100 | $ | 18,966 | $ | 675 | $ | (2,762 | ) | $ | 20,479 | ||||||||||
| Net income |
687 | 687 | ||||||||||||||||||||||
| Net change in unrealized gain/loss on securities |
(688 | ) | (688 | ) | ||||||||||||||||||||
| Cash dividends declared ($.60 per share) |
(379 | ) | (379 | ) | ||||||||||||||||||||
| Balance June 30, 2004 |
750,000 | $ | 1,500 | $ | 2,100 | $ | 19,274 | $ | (13 | ) | $ | (2,762 | ) | $ | 20,099 | |||||||||
The accompanying notes are an integral part of these financial statements.
6
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of dollars)
| Six Months Ended June 30, |
||||||||
| 2004 |
2003 |
|||||||
| (Unaudited) | ||||||||
| Cash flows from operating activities: |
||||||||
| Net Income |
$ | 687 | $ | 1,003 | ||||
| Adjustments to reconcile net income to cash provided by operating activities: |
||||||||
| Provision for loan losses |
685 | 162 | ||||||
| Depreciation and amortization |
188 | 177 | ||||||
| Amortization and (accretion) on securities |
151 | 117 | ||||||
| (Gain)/loss on disposal of equipment |
3 | 1 | ||||||
| (Gain)/loss on sale of securities |
(19 | ) | 0 | |||||
| (Gain)/loss on sale of OREO |
(4 | ) | (1 | ) | ||||
| (Increase)/decrease in accrued interest receivable |
27 | 36 | ||||||
| (Increase)/decrease in other assets |
(289 | ) | (6 | ) | ||||
| Increase/(decrease) in other liabilities |
347 | 235 | ||||||
| Cash provided by operating activities |
1,776 | 1,724 | ||||||
| Cash flows from investing activities: |
||||||||
| Principal payments, available for sale securities |
1,705 | 2,607 | ||||||
| Proceeds from sales of available for sale securities |
1,041 | 134 | ||||||
| Proceeds from maturities and calls, available for sale securities |
7,810 | 6,015 | ||||||
| Purchases of available for sale securities |
(6,403 | ) | (11,854 | ) | ||||
| Purchases of premises and equipment |
(812 | ) | (89 | ) | ||||
| (Increase)/decrease in loans |
(7,488 | ) | (7,455 | ) | ||||
| Purchase of real estate |
(105 | ) | 0 | |||||
| Proceeds from sale of other real estate owned |
75 | 20 | ||||||
| Cash used in investing activities |
(4,177 | ) | (10,622 | ) | ||||
| Cash flows from financing activities: |
||||||||
| Cash dividends paid |
(379 | ) | (387 | ) | ||||
| Acquisition of treasury stock |
0 | (37 | ) | |||||
| Increase/(decrease) in short-term borrowing |
(4,654 | ) | 116 | |||||
| Acquisition of long-term borrowing |
3,100 | 3,000 | ||||||
| Repayment of long-term borrowing |
(1,003 | ) | (651 | ) | ||||
| Increase/(decrease) in time deposits |
1,069 | 3,248 | ||||||
| Increase/(decrease) in other deposits |
3,667 | 7,390 | ||||||
| Cash provided by financing activities |
1,800 | 12,679 | ||||||
| Net increase/(decrease) in cash and cash equivalents |
(601 | ) | 3,781 | |||||
| Cash and cash equivalents at beginning of period |
5,952 | 4,789 | ||||||
| Cash and cash equivalents at end of period |
$ | 5,351 | $ | 8,570 | ||||
| Supplemental disclosure of cash flow information: |
||||||||
| Cash paid during the period for: |
||||||||
| Interest |
$ | 1,504 | $ | 1,681 | ||||
| Income taxes |
$ | 314 | $ | 498 | ||||
| Supplemental Schedule of Noncash Investing and Financing Activities: |
||||||||
| Other real estate and other assets acquired in settlement of loans |
$ | 83 | $ | 19 | ||||
The accompanying notes are an integral part of these financial statements.
7
CITIZENS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The accounting and reporting policies of Citizens Financial Corp. and Subsidiaries (“Citizens”, “the company” or “we”) conform to accounting principles generally accepted in the United States of America and to general policies within the financial services industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates.
The condensed consolidated statements contained herein include the accounts of Citizens Financial Corp. and its wholly-owned subsidiaries Citizens National Bank (“the bank”) and Citizens Financial Services, LLC. All significant intercompany balances and transactions have been eliminated. The information contained in the financial statements is unaudited except where indicated. In the opinion of management, all adjustments for a fair presentation of the results of the interim periods have been made. All such adjustments were of a normal, recurring nature. The results of operations for the six months ended June 30, 2004 are not necessarily indicative of the results to be expected for the full year. The financial statements and notes included herein should be read in conjunction with those included in Citizens’ 2003 Annual Report to Shareholders and Form 10-K.
NOTE 2 - RECLASSIFICATIONS
Certain accounts in the condensed consolidated financial statements for 2003, as previously presented, have been reclassified to conform with current year classifications.
NOTE 3 - SECURITIES
The amortized cost, unrealized gains, unrealized losses and estimated fair values of securities at June 30, 2004 and December 31, 2003 are summarized as follows (in thousands):
| June 30, 2004 | ||||||||||||
| Amortized Cost |
Unrealized Gains |
Unrealized Losses |
Carrying Value (Estimated Fair Value) | |||||||||
| (Unaudited) | ||||||||||||
| Available for sale: |
||||||||||||
| U.S. Government agencies and corporations |
$ | 33,700 | $ | 311 | $ | 271 | $ | 33,740 | ||||
| Mortgage backed securities - U.S. Government agencies and corporations |
7,690 | 5 | 160 | 7,535 | ||||||||
| Corporate debt securities |
3,612 | 49 | 45 | 3,616 | ||||||||
| Tax exempt state and political subdivisions |
8,700 | 143 | 54 | 8,789 | ||||||||
| Federal Reserve Bank stock |
108 | 0 | 0 | 108 | ||||||||
| Federal Home Loan Bank stock |
894 | 0 | 0 | 894 | ||||||||
| Total securities available for sale |
$ | 54,704 | $ | 508 | $ | 530 | $ | 54,682 | ||||
8
| December 31, 2003* | ||||||||||||
| Amortized Cost |
Unrealized Gains |
Unrealized Losses |
Carrying Value (Estimated Fair Value) | |||||||||
| * | ||||||||||||
| Available for sale: |
||||||||||||
| U.S. Government agencies and corporations |
$ | 32,743 | $ | 732 | $ | 43 | $ | 33,432 | ||||
| Mortgage-backed securities - U.S. Government agencies and corporations |
9,454 | 29 | 64 | 9,419 | ||||||||
| Corporate debt securities |
6,840 | 136 | 18 | 6,958 | ||||||||
| Tax exempt state and political subdivisions |
8,990 | 320 | 3 | 9,307 | ||||||||
| Federal Reserve Bank stock |
108 | 0 | 0 | 108 | ||||||||
| Federal Home Loan Bank stock |
853 | 0 | 0 | 853 | ||||||||
| Total securities available for sale |
$ | 58,988 | $ | 1,217 | $ | 128 | $ | 60,077 | ||||
Provided below is a summary of securities available for sale which were in an unrealized loss position at June 30, 2004. None of these securities has been in a continuous loss position for twelve months or more. We believe the deterioration in value is attributable to changes in market interest rates and not the credit quality of the issuer. Management intends, and has the ability, to hold these securities until maturity at which time the full value is expected to be recovered.
| Securities Available for Sale | ||||||||||||||||||
| Less Than 12 Months |
12 Months or More |
Total | ||||||||||||||||
| Fair Value |
Unrealized Losses |
Fair Value |
Unrealized Losses |
Fair Value |
Unrealized Losses | |||||||||||||
| U.S. Government agencies and corporations |
$ | 13,257 | $ | 271 | $ | 0 | $ | 0 | $ | 13,257 | $ | 271 | ||||||
| Mortgage backed securities - U.S. Government agencies and corporations |
6,819 | 160 | 0 | 0 | 6,819 | 160 | ||||||||||||
| Federal Reserve Bank stock |
0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||
| Federal Home Loan Bank stock |
0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||
| Corporate debt securities |
2,068 | 45 | 0 | 0 | 2,068 | 45 | ||||||||||||
| Tax exempt state and political subdivisions |
2,379 | 54 | 0 | 0 | 2,379 | 54 | ||||||||||||
| Total securities available for sale |
$ | 24,523 | $ | 530 | $ | 0 | $ | 0 | $ | 24,523 | $ | 530 | ||||||
The maturities, amortized cost and estimated fair values of the bank’s securities at June 30, 2004 are summarized as follows (in thousands):
| Available for sale | ||||||
| Amortized Cost |
Estimated Fair Value | |||||
| Due within 1 year |
$ | 12,164 | $ | 12,268 | ||
| Due after 1 but within 5 years |
40,305 | 40,175 | ||||
| Due after 5 but within 10 years |
1,233 | 1,237 | ||||
| Due after 10 years |
0 | 0 | ||||
| Equity securities |
1,002 | 1,002 | ||||
| $ | 54,704 | $ | 54,682 | |||
9
Mortgage backed securities have remaining contractual maturities ranging from 2.5 years to 12 years and are reflected in the maturity distribution schedule shown above based on their anticipated average life to maturity, which ranges from 1.05 to 4.75 years. The company’s equity securities are required to be held for membership in the Federal Reserve and Federal Home Loan Bank and are shown at cost since they may only be sold to the respective issuer or another member at par.
The proceeds from sales, calls and maturities of securities, including principal payments received on mortgage backed securities, and the related gross gains and losses realized for the six month periods ended June 30, 2004 and 2003 are as follows (in thousands):
| Proceeds From |
Gross Realized | ||||||||||||||
| Sales |
Calls and Maturities |
Principal Payments |
Gains |
Losses | |||||||||||
| June 30, 2004: |
|||||||||||||||
| Securities available for sale |
$ | 1,041 | $ | 7,810 | $ | 1,705 | $ | 19 | $ | 0 | |||||
| June 30, 2003: |
|||||||||||||||
| Securities available for sale |
$ | 134 | $ | 6,015 | $ | 2,607 | $ | 0 | $ | 0 | |||||
At June 30, 2004 and December 31, 2003 securities with an amortized cost of $26,625,000 and $27,063,000, respectively, with estimated fair values of $26,772,000 and $27,920,000, respectively, were pledged to secure public deposits, securities sold under agreements to repurchase, and for other purposes required or permitted by law.
At June 30, 2004, the company had a concentration within its corporate debt securities classification which included obligations of financial services industry companies with global operations having an approximate amortized cost of $2,322,000 and an estimated fair value of $2,329,000. There were no concentrations with any one issuer.
| * | From audited financial statements. |
NOTE 4 - LOANS
Total loans are summarized as follows (in thousands):
| June 30, 2004 |
December 31, 2003 |
|||||||
| (Unaudited) | * | |||||||
| Commercial, financial and agricultural |
$ | 25,672 | $ | 25,417 | ||||
| Real estate - construction |
7,427 | 5,963 | ||||||
| Real estate - mortgage |
94,181 | 89,111 | ||||||
| Installment loans |
12,131 | 12,396 | ||||||
| Other |
2,918 | 2,868 | ||||||
| Total loans |
142,329 | 135,755 | ||||||
| Net deferred loan origination costs fees and costs |
(44 | ) | (48 | ) | ||||
| Total loans net of unearned income and net deferred loan origination fee and costs |
142,285 | 135,707 | ||||||
| Less allowance for loan losses |
1,170 | 1,396 | ||||||
| Loans, net |
$ | 141,115 | $ | 134,311 | ||||
| * | From audited financial statements |
At June 30, 2004 our recorded investment in impaired loans was $377,000. The valuation allowance assigned to these loans totaled $130,000. Our average investment in the impaired loans was $452,000 during the quarter. The amount of interest income recorded on them in the second quarter was $3,000 while the amount of interest collected was $5,000.
10
No loans were identified as impaired at December 31, 2003.
Loans in a nonaccrual status were $259,000 and $16,000 at June 30, 2004 and December 31, 2003, respectively.
NOTE 5 - ALLOWANCE FOR LOAN LOSSES
Analyses of the allowance for loan losses are presented below (in thousands):
| Three Months Ended June 30, |
Six Months Ended June 30, | |||||||||||
| 2004 |
2003 |
2004 |
2003 | |||||||||
| Balance at beginning of period |
$ | 1,474 | $ | 1,449 | $ | 1,396 | $ | 1,386 | ||||
| Loans charged off: |
||||||||||||
| Commercial and industrial |
935 | 5 | 935 | 5 | ||||||||
| Real estate - mortgage |
0 | 0 | 0 | 0 | ||||||||
| Consumer and other |
9 | 84 | 29 | 123 | ||||||||
| Total |
944 | 89 | 964 | 128 | ||||||||
| Recoveries: |
||||||||||||
| Commercial and industrial |
42 | 0 | 44 | 20 | ||||||||
| Real estate - mortgage |
0 | 0 | 0 | 0 | ||||||||
| Consumer and other |
3 | 3 | 9 | 4 | ||||||||
| Total recoveries |
45 | 3 | 53 | 24 | ||||||||
| Net losses |
899 | 86 | 911 | 104 | ||||||||
| Provision for loan losses |
595 | 81 | 685 | 162 | ||||||||
| Balance at end of period |
$ | 1,170 | $ | 1,444 | $ | 1,170 | $ | 1,444 | ||||
NOTE 6 - DEPOSITS
The following is a summary of interest bearing deposits by type (in thousands):
| June 30, 2004 |
December 31, 2003 | |||||
| (Unaudited) | * | |||||
| Interest bearing checking |
$ | 32,724 | $ | 27,355 | ||
| Money market accounts |
7,123 | 8,690 | ||||
| Savings accounts |
28,416 | 27,360 | ||||
| Certificates of deposit under $100,000 |
48,538 | 48,063 | ||||
| Certificates of deposit of $100,000 or more |
27,163 | 26,569 | ||||
| Total |
$ | 143,964 | $ | 138,037 | ||
| * | From audited financial statements |
NOTE 7 - BORROWINGS
Short-term borrowings consist of securities sold under agreements to repurchase (repurchase agreements) and, when required, overnight advances under a line of credit with the Federal Home Loan Bank of Pittsburgh (FHLB). Overnight advances outstanding at June 30, 2004 were $3,092,000 while $3,000,000 was outstanding at December 31, 2003.
11
Long-term borrowings are also obtained from the FHLB but are used to finance specific lending activities.
NOTE 8 - EMPLOYEE BENEFIT PLANS
The components of net periodic benefit cost of our pension and other benefit plans are presented below (in thousands):
| Six Months Ended June 30, |
||||||||||||||||
| Pension Benefits |
Other Benefits |
|||||||||||||||
| 2004 |
2003 |
2004 |
2003 |
|||||||||||||
| Service cost |
$ | 32 | $ | 58 | $ | 14 | $ | 12 | ||||||||
| Interest cost |
83 | 162 | 16 | 17 | ||||||||||||
| Expected return on plan assets |
(116 | ) | (243 | ) | 0 | 0 | ||||||||||
| Amortization of prior service cost |
(6 | ) | (27 | ) | 10 | 10 | ||||||||||
| Amortization of net (gain) loss |
5 | 0 | (1 | ) | (2 | ) | ||||||||||
| Net periodic (benefit) cost |
$ | (2 | ) | $ | (50 | ) | $ | 39 | $ | 37 | ||||||
We do not expect to make any contributions to our pension plan or other postretirement plans in 2004.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
The company is not aware of any commitments or contingencies which may reasonably be expected to have a material impact on operating results, liquidity or capital resources. Known commitments and contingencies include the maintenance of reserve balances with the Federal Reserve, various legal actions arising in the normal course of business and commitments to extend credit.
NOTE 10 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The subsidiary bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement the bank has in particular classes of financial instruments.
| Financial instruments whose contract amounts represent credit risk (in thousands) |
June 30, 2004 |
December 31, 2003 | ||||
| (unaudited) | * | |||||
| Commitments to extend credit |
$ | 25,458 | $ | 29,974 | ||
| Standby letters of credit |
540 | 239 | ||||
| Total |
$ | 25,998 | $ | 30,213 | ||
The bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
| * | From audited financial statements. |
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NOTE 11 - EARNINGS PER SHARE
Basic earnings per share is based on the weighted average number of shares outstanding during the period. For the six months ended June 30, 2004 and 2003 the weighted average number of shares were 631,378 and 646,085, respectively. The weighted average number of shares outstanding during the three month periods then ended were 631,378 and 645,831. During the periods ended June 30, 2004 and 2003 the company did not have any dilutive securities.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The following discussion and analysis presents the significant changes in financial condition and the results of operations of Citizens Financial Corp. and its subsidiaries, Citizens National Bank of Elkins, and Citizens Financial Services, LLC, for the periods indicated and should be read in conjunction with our 2003 audited financial statements and Annual Report on Form 10-K. Because our primary business activities are conducted through the bank, this discussion focuses primarily on the financial condition and operations of the bank. Amounts and percentages used in this discussion have been rounded.
DESCRIPTION OF BUSINESS
We are a $211 million, one-bank holding company which provides loan, deposit, trust, brokerage and other banking and banking related services to customers in northcentral and eastern West Virginia and nearby areas through the six branch offices of our wholly-owned subsidiary bank.
FORWARD LOOKING STATEMENTS
This report contains forward looking statements which reflect our current expectations based on information available to us. These forward looking statements involve uncertainties including those associated with interest rates, the general economic environment, regulations, competitive changes, and other risks. Forward looking statements can be identified by words such as “may”, “will”, “expect”, “anticipated”, “believe”, “estimate”, “plans”, “intends”, or similar words. We do not attempt to update any forward looking statements. When provided, we intend forward looking information to assist readers in understanding anticipated future operations and we include them pursuant to applicable safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices within the financial services industry. Application of these principles requires us to make estimates, assumptions, and judgments that affect the amounts reported in our financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements and could change as new information becomes available. Consequently, later financial statements could reflect different estimates, assumptions, and judgments.
Some policies rely more heavily on the use of estimates, assumptions, and judgments than others and, therefore, have a greater possibility of producing results that could be materially different than originally reported. Our most significant accounting policies, including an explanation of how assets and liabilities are valued, may be found in Note 1 to the consolidated financial statements in our 2003 Annual Report on Form 10-K.
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The allowance for loan losses represents our estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, the estimated amount of losses in pools of homogeneous loans and the effect of various economic and business factors, all of which may be subject to significant change. Due to these uncertainties, as well as the sensitivity of our financial statements to the assumptions and estimates needed to determine the allowance, we have identified the determination of the allowance for loan losses as a critical accounting estimate. As such, it could be subject to revision as new information becomes available. Should this occur, changes to the provision for loan losses, which may increase or decrease future earnings, may be necessary. A discussion of the methods we use to determine our allowance for loan losses is presented later in this report.
OVERVIEW
Our business emphasis throughout the first half of 2004 was focused on making our products and services more accessible to customers in our market area. We successfully opened a new, full service branch facility in Marlinton, West Virginia; expanded our existing Petersburg facility; and installed two off-premise ATMs. In addition, work to establish internet banking continues to progress and we hope to begin offering this service in September or October of this year. We continue to believe that initiatives such as these, together with our wide selection of products and services and our commitment to superior customer service, will allow us to develop more complete customer relationships and improve our market share.
RESULTS OF OPERATIONS
EARNINGS SUMMARY
Net income for the first half of 2004 was $687,000 while income for the second quarter totaled $153,000. These figures are down considerably from $1,003,000 and $492,000 in the same periods last year due to unusually high net charge offs following the failure of a commercial lending relationship. The effects of this charge off can also be seen in lower earnings per share of $1.09 for the six months compared to $1.55 at June of 2003 and return on average assets of .66% verses 1.09%.
Although we take every prudent measure to protect against such occurrences, the risk of loan losses is inherent in the banking industry and we believe our performance for the remainder of 2004 will return to more typical levels. Additional details concerning this loan loss, as well as other factors impacting our results of operations, are discussed in the following sections of this report.
NET INTEREST INCOME
Net interest income is the primary component of our earnings. It is the difference between interest and fee income generated by interest earning assets and interest expense incurred to carry interest bearing liabilities. Net interest income is affected by changes in balance sheet composition and interest rates. We attempt to maximize net interest income by determining the optimal product mix in light of current and expected yields on assets, cost of funds and economic conditions while maintaining an acceptable degree of risk.
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Through the first six months of 2004 net interest income totaled $4,167,000 compared to $4,063,000 in the same period of last year. On a tax-equivalent basis these totals were $4,284,000 and $4,201,000, respectively. For the second quarter net interest income of $2,057,000 was nearly unchanged from last year.
These results are driven by rising levels of interest earning assets and interest bearing liabilities being largely offset by lower yields. Average earning assets for the first half of 2004 were $196,555,000 compared to $175,046,000 in the first half of 2003. The yield on these assets, however, fell 78 basis points to 5.89% with the result that total interest income decreased by $29,000 to $5,651,000. Similarly, average interest bearing liabilities also increased by approximately $20,000,000 but because the rate paid on them was just 1.80% total interest expense fell from $1,617,000 to $1,484,000. Thus net interest income for the six months increased $104,000 to $4,167,000.
Net interest income is often expressed as a percentage of average earning assets and referred to as net interest margin. Because of the rise in earning assets our net interest margin for the six months of 2004 was 4.37%, down from 4.84% in the first half of 2003. Such margin compression has been common in the banking industry. The latest peer group data available for March 31, 2004, indicates the peer average margin was 4.26%.
Recently, interest rates have begun to rise which may impact future levels of net interest income. A discussion about this and other elements of interest rate risk is presented later in this report.
PROVISION FOR LOAN LOSSES
The provision for loan losses is management’s estimate of the amount which must be charged against current earnings in order to maintain the allowance for loan losses at a level considered adequate to provide for losses which are inherent in the loan portfolio. This amount is determined through quarterly evaluations of the loan portfolio.
During the second quarter of this year we experienced one large charge-off. As a result, the provision made during the quarter was unusually large at $595,000 bringing the total provision for the year to $685,000. This compares with $81,000 in the second quarter and $162,000 for the first half of 2003. This large provision was the primary cause of our lower 2004 earnings.
Additional details concerning this loss, as well as factors we consider in analyzing the allowance for loan losses and establishing the provision for loan losses, are discussed in the Allowance for Loan Losses section of this report.
NONINTEREST INCOME
Noninterest income, which includes all revenues other than those related to earning assets, increased from $300,000 in the second quarter of 2003 to $338,000 in the second quarter this year. For the full six month period noninterest income increased from $629,000 last year to $645,000 this year.
Service fees, which make up over half of our noninterest income, improved in both the first and second quarters of 2004 due to the addition
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of two ATMs and the continuing growth of our deposit base which has resulted in higher fees for overdrafts, minimum balance requirements and checkbook charges.
Trust income is another significant source of noninterest income. It can, however, fluctuate due to the settlement of estates or lack thereof. Because of a large estate that was settled in early 2003, trust income year to date is down significantly from $133,000 to $71,000. However, second quarter income was comparable to last year and we expect the full year income to approximate $200,000.
In recent years we have attempted to improve noninterest income by offering two nontraditional banking products; brokerage services and fixed rate secondary market mortgages. Our brokerage income has improved from $9,000 to $30,000 this year as we were without a licensed broker in early 2003. Mortgage income, however, has fallen from $52,000 to $28,000 as higher mortgage rates and the refinancing boom of recent years have resulted in fewer mortgages being written. Higher interest rates could cause this trend to continue.
Other noninterest income has improved due to increases in the cash surrender value of insurance contracts used to fund certain retirement benefits and a one time gain on the sale of real estate of $8,000. We also benefited in 2004 from another one time occurrence; $19,000 from gains on the sale of securities.
In general, our level of noninterest income will continue to be primarily determined by our rate of deposit growth and the success of our trust, brokerage and mortgage operations.
NONINTEREST EXPENSE
Noninterest expense includes all items of expense other than interest expense, the provision for loan losses, and income taxes. Noninterest expense for the second quarter of the year increased $80,000 to $1,625,000 while the year-to-date increase of $221,000 brings total noninterest expense to $3,249,000. These increases were expected as total noninterest expense for the first half of the year was budgeted at $3,355,000.
Personnel costs account for the majority of our noninterest expense and have risen by $50,000 for the quarter and $84,000 for the year to date. These increases reflect higher salary levels as well as higher pension and retirement plan costs. Salaries have risen $103,000 year to date and $47,000 for the quarter due to annual increases and the addition of staff needed for branch operations and information technology positions. While our pension plan remains overfunded and actually generates a benefit rather than a cost each year, a rising pension obligation and lower return on plan assets have reduced the amount of this benefit significantly in 2004. Through June 30 this has had the effect of increasing expense by approximately $47,000. To some extent these costs have been offset by lower group medical costs and an increase in the deferral of certain loan origination costs. Together these total $113,000 so far this year. However, our group medical program is self funded and our ultimate cost is largely dependent on the health claims we experience during the year.
As expected, the expansion of our branch network has caused our occupancy and equipment expense to increase. Data processing expense has risen $14,000 for the quarter and $31,000 for the year due to upgrades in several of our third party processors’ services as well as the installation
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of two new ATMs. And other noninterest expense, although stable during the second quarter, is up $50,000 for the year due to the purchase of various items related to our branch expansion, higher costs for off the shelf software products and costs of approximately $26,000 related to holding and selling foreclosed properties. Other components of noninterest expense, such as directors’ fees and professional services have not changed materially.
INCOME TAXES
Our provision for income tax expense includes both state and federal taxes. Due to our higher level of loan charge offs, income tax expense has fallen significantly in 2004 to $22,000 for the quarter and $191,000 for the year to date. This compares with $238,000 and $499,000, respectively, last year.
FINANCIAL CONDITION
SUMMARY
We have continued to experience balance sheet growth, and in particular loan growth, throughout the first half of 2004. Gross loans have increased by $6,574,000 during that time. This was funded by maturities, calls and paydowns of investment securities while certain larger loans were funded through longer term borrowings. Deposit growth also continues to provide funding although this year’s growth of $4,736,000 was offset by a decrease in short-term repurchase agreements. However, our repurchase agreements have clear seasonal patterns and are expected to increase again next winter.
Despite net loan charge-offs of $899,000 during the quarter, our asset quality remains strong. The charge-offs incurred were due to the specific business practices of one customer and do not reflect wider problems with our local economy or the loan portfolio. We believe the risk inherent in our loan portfolio has been adequately identified and our capital remains well in excess of regulatory requirements. A further discussion of our major balance sheet categories, as well as liquidity and the impact of inflation, follows.
LOAN PORTFOLIO
At $142,329,000, total loans have grown by $6,574,000, or 4.8%, since year-end. Although competition from fixed mortgage lenders remains strong, our residential mortgage portfolio, which is a variable rate portfolio, increased by nearly $3.4 million during the last six months to $61.1 million. Our commercial real estate loans, which have done very well over the last several years, also increased by $1.7 million to approximately $32.6 million. Other forms of commercial lending have remained relatively stable at $25.7 million.
Consumer lending, which faces strong competition from auto manufacturers and credit card companies, has been relatively strong dropping just $265,000 since year-end. By contrast, consumer loans fell almost $1.3 million in 2003.
Looking forward, we expect to continue to face strong competition for residential mortgage and consumer loans while commercial lending opportunities are expected to continue increasing due to the improving economy and our own geographic expansion.
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ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses represents our estimate of the loss which is inherent in our loan portfolio. We maintain the allowance at a level we consider adequate to cover this loss by performing a detailed analysis of the portfolio each quarter. This analysis considers the potential loss in specifically identified loans and homogeneous pools of loans as well as other factors such as delinquency levels, historical loss experience, current and anticipated economic conditions, concentrations of credit, changes in lending policies or staff, and other factors. As noted previously, this analysis ultimately determines the amount which is expensed as provision for loan losses.
Loans which are specifically analyzed include all loans with balances in excess of $250,000, all loans past due 90 or more days and those placed in our internally generated watch list. Management develops this list from various sources including past due loan reports, previous internal and external loan evaluations and knowledge of each borrower’s financial situation. This list contains loans with possible weaknesses regarding collectibility, performance or the adequacy of collateral.
Loans that management places on the watch list are given a classification based on their perceived risk using a method similar to that of the bank’s primary regulatory agency. After management determines the watch list to be complete, detailed reviews of each loan are made. Based on the results of these reviews, specific reserves for potential losses are determined.
Potential losses for loans not specifically analyzed are quantified by applying historical loss factors to pools of loans. Separate pools, and separate loss factors, are used for each of our major loan portfolios. We may assign additional loss exposure for changes in economic conditions, trends in past due loans, changes in lending policies or staff, concentrations of credit, unused lines or letters of credit and other factors. Finally, because these methods carry inherent imprecision and subjectivity, we establish an additional reserve for losses that are likely to exist at the evaluation date but may not have been quantified by the specific, pooled, or other analyses. These estimated losses are then aggregated and the allowance for loan losses is adjusted as necessary through a provision for loan losses.
As discussed in our last quarterly filing, we encountered significant credit problems with one customer who ultimately declared bankruptcy during the second quarter. As a result, quarterly net charge-offs were an unusually high $899,000. Although this loss was partially identified in our previous analysis, we nonetheless made quarterly provisions for loan losses of $595,000 to raise the allowance for loan losses to $1,170,000, which we believe is adequate to cover losses which may be reasonably anticipated based on our analysis. We believe that this loss was unique to this particular customer relationship and that it in no way indicates that credit quality has lessoned or that the risk inherent in the loan portfolio has increased. Efforts to recover the loss and protect our collateral rights are ongoing. Aside from raising the loss factor we apply to our commercial loan portfolio when assessing the adequacy of the allowance, the loss is not expected to impact future earnings and we expect income to return to more typical levels for the remainder of the year.
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SECURITIES PORTFOLIO AND FEDERAL FUNDS SOLD
The bank’s securities portfolio uses funds not needed to satisfy loan demand to improve earnings while at the same time providing liquidity and balancing interest sensitivity concerns. All securities are classified as available for sale. During the first six months of 2004 the amortized cost of the securities portfolio decreased by $4,284,000 to $54,704,000 in order to fund loan growth. This decrease primarily resulted from maturities, calls and paydowns although one security was sold to improve credit quality.
Interest rates rose significantly during the first half of the year which resulted in a decrease in the fair value of our portfolio. At June 30, 2004, the estimated fair value of the portfolio was $54,682,000, $22,000 less than its amortized cost. In contrast, the fair value exceeded the amortized cost by $1,089,000 at year end. This reflects the sensitivity of fixed rate securities to changes in interest rates and not the credit quality of the securities themselves. The portfolio continues to be comprised of U.S. Agency securities, bank qualified municipal debt, government agency backed securities and investment grade corporate debt. None of our securities are considered to be permanently impaired and, since it is typically our practice to hold our securities to their maturity date, no losses are anticipated. We expect to continue our philosophy of maintaining a short-term, laddered portfolio of high quality bonds in the future and anticipate the yield on our securities will improve as interest rates rise.
While we attempt to stay fully invested in loans or securities, some involvement in overnight federal funds is expected. As of June 30, 2004, we had $3,092,000 in overnight borrowings and no overnight funds sold. Throughout the first six months of the year our average overnight borrowings were $1,019,000 while our average overnight funds sold totaled $1,416,000. These amounts change daily depending on our funding position. As these are overnight instruments, they carry relatively low interest rates and they are not considered to be either a long-term use of funds nor a long-term source of funds.
DEPOSITS AND OTHER FUNDING SOURCES
Deposits increased by $4,739,000 during the first half of 2004 to $166,285,000. This increase was centered in interest bearing products and specifically in interest bearing checking accounts which increased by more than $5.3 million. Smaller increases were observed in savings accounts and time deposits while money market accounts decreased. We believe our deposit growth is stable in nature although some variation in savings sweep accounts, which now total $9.8 million, is normal. Other large dollar deposits include jumbo CDs of $27,163,000 which have increased $594,000 this year. These deposits have become a more important source of funds in recent years and they continue to grow despite the fact that we do not market them at all. We believe this growth reflects 3 factors; customers desire for safety and preservation of principal, our expanding geographic market, and a product design that allows customers to add funds to their CDs. This last factor has been well received by our customers and, we believe, only adds to the stability of our deposit base as well as our customer relationship. We also allow our CD customers to “bump up” their rate one time during the life of the instrument which also serves as a tool to attract and retain a stable deposit base. Overall, we expect our deposit base to continue to exhibit manageable growth.
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In addition to deposits, we use several types of borrowings to fund our assets. The largest of these is repurchase agreements which we maintain with several local businesses and governmental units. Total repurchase agreements were $14.3 million at June 30 compared to $19.1 million at year-end. This decrease reflects the seasonal operating nature of one of our repurchase customers. Aside from this seasonality, repurchase agreements have been a stable source of funds in recent years. We are pleased to offer this service to customers in our area and expect repurchase agreements to continue to play an important role in our funding program.
Our long-term borrowings increased by $2,096,000 in the first half of 2004 as we acquired an additional $3 million in order to fund a commercial loan. These borrowings, which are entirely used to fund specific larger loans, carry repayment terms such that the cash flow is similar to that of the corresponding loan. With commercial lending gaining in importance, we expect to continue to utilize this type of funding in the future. For this reason, we have established adequate borrowing agreements with several correspondents.
CAPITAL RESOURCES
At $20,099,000, or 9.5% of total assets, our capital base remains strong despite decreasing by $380,000 since year-end. The reasons for this decrease, which are illustrated in the statement of changes in shareholders equity, include our lower than usual earnings, the change in the fair value of our available for sale securities portfolio, and the planned payment of dividends.
As a banking company, we are held to several minimum capital ratios established by bank regulatory authorities. As shown in the table below, we continue to exceed all of these requirements:
Minimum Capital Standard Ratios
| Citizens Financial Corp. |
Regulatory Requirements |
|||||
| Total capital to risk weighted assets |
14.31 | % | 8.00 | % | ||
| Tier I capital to risk weighted assets |
13.52 | % | 4.00 | % | ||
| Tier I capital to adjusted total assets |
9.47 | % | 4.00 | % |
We are not aware of any items which are expected to materially impair or alter our capital in the future. Projections for the next twelve months indicate book capital is expected to continue to approximate 9.5% of total assets while our regulatory capital ratios are all expected to show small increases.
LIQUIDITY
The objective of our liquidity management program is to ensure the continuous availability of funds to meet the withdrawal demands of customers, the credit needs of borrowers, and to provide for other operational needs. Liquidity is provided by various sources including unpledged investment securities, federal funds sold, loan repayments, a stable and growing deposit base and, when necessary, external borrowings.
We monitor liquidity on a continuous basis and prepare formal liquidity forecasts quarterly utilizing projected balance sheet levels over the next twelve months. Loans, and other uses of funds, are segregated into those that are expected to provide liquidity and those that aren’t. Deposits and other sources of funds are segregated into those which are reliable, and not likely to reduce liquidity, and those which are volatile and may cause a reduction in liquidity.
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Based on these analyses it is likely we will seek additional external funding over the next twelve months primarily to fund commercial loan growth. Ample funding sources, including the Federal Home Loan Bank and other correspondent banks, are available to meet this need. We find that this is becoming a common situation in banks like Citizens and do not believe funding larger loans in this manner presents any undue risk to earnings, capital, shareholders or others.
IMPACT OF INFLATION
The consolidated financial statements and related data included in this report were prepared in accordance with accounting principles generally accepted in the United States of America, which require our financial position and results of operations to be measured in terms of historical dollars except for the available for sale securities portfolio. Consequently, the relative value of money generally is not considered. Nearly all of our assets and liabilities are monetary in nature and, as a result, interest rates and competition in the market area tend to have a more significant impact on our performance than the effect of inflation.
However, inflation does affect noninterest expenses such as personnel costs and the cost of services and supplies we use. We attempt to offset increasing costs by controlling the level of noninterest expenditures and increasing levels of noninterest income. Because inflation rates have generally been low during the time covered by the accompanying consolidated financial statements, the impact of inflation on our earnings has not been significant.
Quantitative and Qualitative Disclosures About Market Risk
Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates and equity prices. Our primary market risk is interest rate risk which results from timing differences in the repricing of assets, liabilities and off-balance-sheet instruments. Some amount of interest rate risk is inherent and appropriate in banking.
We control interest rate risk through our interest rate sensitivity management program, also known as asset/liability management. The objective of this program is to maximize net interest income while minimizing the risk of adverse effects from changing interest rates. This is done by controlling the mix and maturities of interest sensitive assets and liabilities. The bank has established an asset/liability committee for this purpose.
The bank uses several techniques to monitor and control interest rate risk. Gap analysis measures the amount of interest earning assets and interest bearing liabilities that could reprice in a given time period. When more assets could reprice the gap is said to be positive. This is normally beneficial when interest rates rise. When more liabilities can reprice, the gap is negative which is usually good as interest rates fall. Normally, the size of the gap is expressed as a percent of total assets.
At June 30, 2004, our gap over the next twelve months was 2.34% of total assets. This is well below our +/- 10% guideline and indicates the bank is well positioned from an interest rate risk standpoint particularly with interest rates now beginning to rise from historically low levels.
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Gap theory, however, requires that a number of assumptions be made, including the assumption that interest rates on all of our products change at the same time and by the same amount. Because this is not usually true, we also employ rate shock analysis and simulation modeling to monitor and control interest rate risk.
Rate shock tests project net interest income given an immediate and sustained change applied to all interest sensitive assets and liabilities. Although this implies some of the same weaknesses as gap, rate shock tests do help define boundaries of interest rate risk. Typically, we conduct rate shock tests on a quarterly basis assuming rates change by +/- 100, 200 and 300 basis points. Some of our products now have rates that cannot decrease by as much as 100, 200 or 300 basis points. However, the rising rate shocks, which seem more realistic in this environment, all indicate our exposure to interest rate risk is quite low. For example, an immediate increase in rates of 300 basis points is projected to have just a 4.4%, or $367,000, impact on net interest income.
Under simulation modeling we attempt to measure interest rate risk under several scenarios including those we feel are most likely to occur. Currently, most forecasters believe interest rates may be increased several times over the next twelve months. Should this occur, our models indicate the impact on our net interest income should be minimal. Ultimately, our ability to control interest rates on those deposit products which can reprice at any time, such as savings accounts, is the most significant factor in managing our interest rate risk.
Controls and Procedures
As of the end of the period covered by this Quarterly Report on Form 10-Q, the company, under the supervision and with the participation of management, including the chief executive officer and principal financial officer, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the chief executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to the company which is required to be included in our periodic SEC filings. Subsequent to the date of that evaluation, there have been no significant changes in our internal controls or in other factors that could significantly offset internal controls, nor were any corrective actions required with regard to significant deficiencies or material weaknesses.
As of June 30, 2004 Citizens Financial Corp. was not involved in any material legal proceedings. We are, however, involved in various legal proceedings which occur in the normal course of business. After consultation with legal counsel, management believes that all such litigation will be resolved without materially affecting our financial position or results of operations. In addition, there are no material proceedings known to be threatened or contemplated against Citizens Financial Corp. or any of its subsidiaries.
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Item 2. Changes in Securities: None.
Item 3. Defaults upon Senior Securities: None.
Item 4. Submission of Matters to a Vote of Security Holders:
The annual meeting of shareholders of Citizens Financial Corp. was held on April 17, 2004. The shareholders determined that the maximum number of directors would be fixed at ten and that directors Brown, Campbell and Schoonover will serve three year terms ending in April, 2007. Each of these directors was unopposed.
In addition to the foregoing nominees, the following six (6) persons presently are serving as members of the Board of Directors, for terms to expire in the year indicated for each member: Robert N. Alday (2006); Max L. Armentrout (2005); John F. Harris (2005); Cyrus K. Kump (2006); L. T. Williams (2005); and John A. Yeager (2006). Director Raymond L. Fair, whose term was to expire in 2005, passed away on June 17, 2004. A successor to Mr. Fair has not yet been named.
Item 5. Other Information: None.
Item 6. Exhibits and Reports on Form 8-K:
| (a) | Exhibits: The following exhibits are filed with this report: |
| Exhibit No. |
Description of Exhibit | |
| 31.1 | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350 | |
| 31.2 | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350 | |
| 32.1 | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350 | |
| 32.2 | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350 | |
| (b) | Reports on Form 8-K: On April 14, 2004 we reported our first quarter 2004 earnings and related financial data under Item 12 of Form 8-K. |
In addition, on April 19, 2004, we reported under Item 4 of Form 8-K that we were replacing our certifying accountants, Arnett & Foster, with the firm of Yount, Hyde and Barbour. Arnett and Foster’s response to this was similarly filed on April 20, 2004.
On May 13, 2004 we reported our first quarter 2004 results of operations and financial condition, quarterly report to shareholders, under Item 12 of Form 8-K.
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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 FINANCIAL CORP. | ||
| Date: 8/12/04 |
/s/ Robert J. Schoonover | |
| Robert J. Schoonover | ||
| President | ||
| Chief Executive Officer | ||
| Date: 8/12/04 |
/s/ Thomas K. Derbyshire | |
| Thomas K. Derbyshire | ||
| Vice President, Treasurer and | ||
| Principal Financial Officer | ||
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