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 September 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 11/01/04 | |
| Common Stock ($2 par value) | 623,928 |
This report contains 32 pages.
CITIZENS FINANCIAL CORP.
Quarter Ended September 30, 2004
INDEX
| Page No. | ||||||
| Part I. | Financial Information | |||||
| Item 1. Financial Statements | ||||||
| Condensed Consolidated Balance Sheets September 30, 2004 and December 31, 2003 |
3 | |||||
| 4 | ||||||
| 5 | ||||||
| 6 | ||||||
| 7 | ||||||
| 8-13 | ||||||
| Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations | 14-23 | |||||
| Item 3. Quantitative and Qualitative Disclosures About Market Risk | 23-24 | |||||
| Item 4. Controls and Procedures | 24 | |||||
| Part II. | Other Information and Index to Exhibits | |||||
| Items 1 through 6 | 25-26 | |||||
| Signatures | 27 | |||||
| Certification by Executive Officers Pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act of 2002 | 28-31 | |||||
2
PART I ITEM I – FINANCIAL INFORMATION
CITIZENS FINANCIAL CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands of dollars)
| Sept. 30, 2004 |
Dec. 31, 2003 |
|||||||
| (Unaudited) | * | |||||||
| ASSETS |
||||||||
| Cash and due from banks |
$ | 5,944 | $ | 5,952 | ||||
| Federal funds sold |
350 | 0 | ||||||
| Securities available for sale |
52,193 | 60,077 | ||||||
| Loans, less allowance for loan losses of $1,306 and $1,396, respectively |
144,788 | 134,311 | ||||||
| Premises and equipment |
4,251 | 3,607 | ||||||
| Accrued interest receivable |
1,032 | 1,097 | ||||||
| Other assets |
4,420 | 4,085 | ||||||
| Total Assets |
$ | 212,978 | $ | 209,129 | ||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY |
||||||||
| Deposits: |
||||||||
| Noninterest bearing |
$ | 23,668 | $ | 23,512 | ||||
| Interest bearing |
144,463 | 138,037 | ||||||
| Total deposits |
168,131 | 161,549 | ||||||
| Short-term borrowings |
17,948 | 22,066 | ||||||
| Long-term borrowings |
4,825 | 3,403 | ||||||
| Other liabilities |
1,728 | 1,632 | ||||||
| Total liabilities |
192,632 | 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 |
19,526 | 18,966 | ||||||
| Accumulated other comprehensive income |
304 | 675 | ||||||
| Treasury stock at cost, 126,072 and 118,622 shares, respectively |
(3,084 | ) | (2,762 | ) | ||||
| Total shareholders’ equity |
20,346 | 20,479 | ||||||
| Total Liabilities and Shareholders’ Equity |
$ | 212,978 | $ | 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 September 30, |
Nine Months Ended September 30, | |||||||||||
| 2004 |
2003 |
2004 |
2003 | |||||||||
| (Unaudited) | (Unaudited) | |||||||||||
| INTEREST INCOME |
||||||||||||
| Interest and fees on loans |
$ | 2,376 | $ | 2,268 | $ | 6,981 | $ | 6,755 | ||||
| Interest and dividends on securities: |
||||||||||||
| Taxable |
390 | 496 | 1,265 | 1,509 | ||||||||
| Tax-exempt |
76 | 88 | 241 | 259 | ||||||||
| Interest on federal funds sold |
9 | 6 | 15 | 15 | ||||||||
| Total interest income |
2,851 | 2,858 | 8,502 | 8,538 | ||||||||
| INTEREST EXPENSE |
||||||||||||
| Interest on deposits |
669 | 703 | 1,966 | 2,143 | ||||||||
| Interest on short-term borrowings |
87 | 65 | 218 | 185 | ||||||||
| Interest on long-term borrowings |
34 | 29 | 90 | 86 | ||||||||
| Total interest expense |
790 | 797 | 2,274 | 2,414 | ||||||||
| Net interest income |
2,061 | 2,061 | 6,228 | 6,124 | ||||||||
| Provision for loan losses |
150 | 81 | 835 | 243 | ||||||||
| Net interest income after provision for loan losses |
1,911 | 1,980 | 5,393 | 5,881 | ||||||||
| NONINTEREST INCOME |
||||||||||||
| Trust department income |
49 | 87 | 120 | 220 | ||||||||
| Brokerage fees |
15 | 3 | 45 | 12 | ||||||||
| Service fees |
184 | 171 | 535 | 498 | ||||||||
| Insurance commissions |
8 | 15 | 22 | 31 | ||||||||
| Security gains/(losses) |
4 | 0 | 23 | 0 | ||||||||
| Secondary market loan fees |
15 | 23 | 43 | 75 | ||||||||
| Other |
105 | 38 | 237 | 130 | ||||||||
| Total noninterest income |
380 | 337 | 1,025 | 966 | ||||||||
| NONINTEREST EXPENSE |
||||||||||||
| Salaries and employee benefits |
828 | 871 | 2,594 | 2,553 | ||||||||
| Net occupancy expense |
64 | 61 | 192 | 179 | ||||||||
| Equipment rentals, depreciation and maintenance |
139 | 102 | 363 | 307 | ||||||||
| Data processing |
142 | 111 | 412 | 350 | ||||||||
| Director fees |
54 | 57 | 167 | 167 | ||||||||
| Postage |
49 | 44 | 131 | 119 | ||||||||
| Professional service fees |
48 | 33 | 126 | 105 | ||||||||
| Stationery |
40 | 28 | 122 | 99 | ||||||||
| Other |
351 | 232 | 857 | 688 | ||||||||
| Total noninterest expense |
1,715 | 1,539 | 4,964 | 4,567 | ||||||||
| Income before income taxes |
576 | 778 | 1,454 | 2,280 | ||||||||
| Income tax expense |
136 | 239 | 327 | 738 | ||||||||
| Net income |
$ | 440 | $ | 539 | $ | 1,127 | $ | 1,542 | ||||
| Basic and fully diluted earnings per common share |
$ | .70 | $ | .84 | $ | 1.79 | $ | 2.39 | ||||
| Weighted average shares outstanding |
625,903 | 641,146 | 628,283 | 644,480 | ||||||||
| Dividends per common share |
$ | .30 | $ | .30 | $ | .90 | $ | .90 | ||||
The accompanying notes are an integral part of these financial statements.
4
STATEMENTS OF COMPREHENSIVE INCOME
(In thousands of dollars)
| Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||
| 2004 |
2003 |
2004 |
2003 |
|||||||||||||
| (Unaudited) | (Unaudited) | |||||||||||||||
| Net income |
$ | 440 | $ | 539 | $ | 1,127 | $ | 1,542 | ||||||||
| Other comprehensive income: |
||||||||||||||||
| Gross unrealized gains/(losses) arising during the period |
507 | (811 | ) | (621 | ) | (742 | ) | |||||||||
| Adjustment for income tax (expense)/benefit |
(192 | ) | 308 | 236 | 282 | |||||||||||
| 315 | (503 | ) | (385 | ) | (460 | ) | ||||||||||
| Less: Reclassification adjustment for (gains)/losses included in net income |
(4 | ) | 0 | (23 | ) | 0 | ||||||||||
| Adjustment for income tax expense/(benefit) |
2 | 0 | 9 | 0 | ||||||||||||
| (2 | ) | 0 | (14 | ) | 0 | |||||||||||
| Other comprehensive income, net of tax |
317 | (503 | ) | (371 | ) | (460 | ) | |||||||||
| Comprehensive income |
$ | 757 | $ | 36 | $ | 756 | $ | 1,082 | ||||||||
The accompanying notes are an integral part of these financial statements.
5
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(In thousands of dollars)
| Nine Months Ended September 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 |
1,542 | 1,542 | ||||||||||||||||||||||
| Net change in unrealized gain/loss on securities |
(460 | ) | (460 | ) | ||||||||||||||||||||
| Cash dividends declared ($.90 per share) |
(579 | ) | (579 | ) | ||||||||||||||||||||
| Purchase of 7,715 shares of treasury stock |
(303 | ) | (303 | ) | ||||||||||||||||||||
| Balance September 30, 2003 |
750,000 | $ | 1,500 | $ | 2,100 | $ | 18,875 | $ | 784 | $ | (2,454 | ) | $ | 20,805 | ||||||||||
| Balance, January 1, 2004 |
750,000 | $ | 1,500 | $ | 2,100 | $ | 18,966 | $ | 675 | $ | (2,762 | ) | $ | 20,479 | ||||||||||
| Net income |
1,127 | 1,127 | ||||||||||||||||||||||
| Net change in unrealized gain/loss on securities |
(371 | ) | (371 | ) | ||||||||||||||||||||
| Cash dividends declared ($.90 per share) |
(567 | ) | (567 | ) | ||||||||||||||||||||
| Purchase of 7,450 shares of treasury stock |
(322 | ) | (322 | ) | ||||||||||||||||||||
| Balance September 30, 2004 |
750,000 | $ | 1,500 | $ | 2,100 | $ | 19,526 | $ | 304 | $ | (3,084 | ) | $ | 20,346 | ||||||||||
The accompanying notes are an integral part of these financial statements.
6
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of dollars)
| Nine Months Ended September 30, |
||||||||
| 2004 |
2003 |
|||||||
| (Unaudited) | ||||||||
| Cash flows from operating activities: |
||||||||
| Net Income |
$ | 1,127 | $ | 1,542 | ||||
| Adjustments to reconcile net income to cash provided by operating activities: |
||||||||
| Provision for loan losses |
835 | 243 | ||||||
| Depreciation and amortization |
314 | 266 | ||||||
| Amortization and accretion on securities |
219 | 213 | ||||||
| (Gain)/loss on sale on securities |
(23 | ) | 0 | |||||
| (Gain)/loss on disposal of equipment |
10 | 1 | ||||||
| (Gain)/loss on sale of OREO |
(44 | ) | (1 | ) | ||||
| (Increase)/decrease in accrued interest receivable |
65 | (19 | ) | |||||
| (Increase)/decrease in other assets |
(80 | ) | (74 | ) | ||||
| Increase/(decrease) in other liabilities |
323 | 223 | ||||||
| Cash provided by operating activities |
2,746 | 2,394 | ||||||
| Cash flows from investing activities: |
||||||||
| Proceeds from principal payments received on securities available for sale |
2,356 | 4,559 | ||||||
| Proceeds from maturities and calls of securities available for sale |
13,108 | 10,515 | ||||||
| Proceeds from sale of securities available for sale |
2,044 | 134 | ||||||
| Purchases of securities available for sale |
(10,418 | ) | (26,361 | ) | ||||
| Purchases of premises and equipment |
(959 | ) | (178 | ) | ||||
| Proceeds from sale of other real estate |
214 | 20 | ||||||
| Purchase of real estate |
(105 | ) | 0 | |||||
| (Increase)/decrease in loans |
(11,641 | ) | (10,625 | ) | ||||
| Cash used in investing activities |
(5,401 | ) | (21,936 | ) | ||||
| Cash flows from financing activities: |
||||||||
| Cash dividends paid |
(567 | ) | (579 | ) | ||||
| Acquisition of treasury stock |
(322 | ) | (303 | ) | ||||
| Increase/(decrease) in short-term borrowing |
(4,118 | ) | 3,296 | |||||
| Proceeds from long-term borrowing |
3,100 | 3,000 | ||||||
| Repayment of long-term borrowing |
(1,678 | ) | (1,062 | ) | ||||
| Increase/(decrease) in time deposits |
2,893 | 5,524 | ||||||
| Increase/(decrease) in other deposits |
3,689 | 9,893 | ||||||
| Cash provided by financing activities |
2,997 | 19,769 | ||||||
| Net increase in cash and cash equivalents |
342 | 227 | ||||||
| Cash and cash equivalents at beginning of period |
5,952 | 4,789 | ||||||
| Cash and cash equivalents at end of period |
$ | 6,294 | $ | 5,016 | ||||
| Supplemental disclosure of cash flow information: |
||||||||
| Cash payments for: |
||||||||
| Interest on deposits and other borrowings |
$ | 2,298 | $ | 2,491 | ||||
| Income taxes |
$ | 379 | $ | 684 | ||||
| Supplemental schedule of noncash investing and financing activities: |
||||||||
| Other real estate and other assets acquired in settlement of loans |
$ | 329 | $ | 18 | ||||
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” or “the company”) conform to accounting principles generally accepted in the United States of America and to general practices 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 nine months ended September 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 - SIGNIFICANT NEW ACCOUNTING POLICIES
Emerging Issues Task Force Issue No. 03-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF 03-1”) was issued and is effective March 31, 2004. The EITF 03-1 provides guidance for determining the meaning of “other-than-temporarily impaired” and its application to certain debt and equity securities within the scope of Statement of Financial Accounting Standards No. 115 “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS No. 115”) and investments accounted for under the cost method. The guidance requires that investments which have declined in value due to credit concerns or solely due to changes in interest rates must be recorded as other-than-temporarily impaired unless the Company can assert and demonstrate its intention to hold the security for a period of time sufficient to allow for a recovery of fair value up to or beyond the cost of the investment which might mean maturity. This issue also requires disclosures assessing the ability and intent to hold investments in instances in which an investor determines that an investment with a fair value less than cost is not other-than-temporarily impaired.
On September 30, 2004, the Financial Accounting Standards Board decided to delay the effective date for the measurement and recognition guidance contained in Issue 03-1. This delay does not suspend the requirement to recognize other-than-temporary impairments as required by existing authoritative literature. The disclosure guidance in Issue 03-1 was not delayed.
8
NOTE 3 - RECLASSIFICATIONS
Certain accounts in the condensed consolidated financial statements for 2003, as previously presented, have been reclassified to conform with current year classifications.
NOTE 4 - SECURITIES
The amortized cost, unrealized gains, unrealized losses and estimated fair values of securities at September 30, 2004 and December 31, 2003 are summarized as follows (in thousands):
| September 30, 2004 | ||||||||||||
| Amortized Cost |
Unrealized Gains |
Unrealized Losses |
Carrying Value (Estimated Fair Value) | |||||||||
| (Unaudited) | ||||||||||||
| Available for sale: |
||||||||||||
| U.S. Government agencies and corporations |
$ | 31,878 | $ | 332 | $ | 60 | $ | 32,150 | ||||
| Mortgage backed securities- U.S. Government agencies and corporations |
7,015 | 20 | 65 | 6,970 | ||||||||
| Corporate debt securities |
3,100 | 19 | 22 | 3,097 | ||||||||
| Tax exempt state and political subdivisions |
8,703 | 272 | 1 | 8,974 | ||||||||
| Federal Reserve Bank stock |
108 | 0 | 0 | 108 | ||||||||
| Federal Home Loan Bank stock |
894 | 0 | 0 | 894 | ||||||||
| Total securities available for sale |
$ | 51,698 | $ | 643 | $ | 148 | $ | 52,193 | ||||
| December 31, 2003* | ||||||||||||
| Amortized Cost |
Unrealized Gains |
Unrealized Losses |
Carrying 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 | ||||
| * | From audited financial statements. |
Provided below is an unaudited summary of securities available for sale which were in an unrealized loss position at September 30, 2004. These securities, which total $16,986,000, carry a total unrealized loss of $148,000, or .87%. Of these securities, $3,729,000 of mortgage backed securities issued by U.S. Government agencies and corporations with unrealized losses of $62,000 have been in a continuous loss position for the past twelve months. We believe these unrealized losses are the temporary result of changing interest rates and that the implied faith and credit of the U.S. Government which the issuers enjoy, along with our intent and ability to hold the investments to maturity, provide strong evidence that we will fully recover our investment.
9
Among the securities carrying unrealized losses for less than twelve months, the majority are U.S. Government agency securities backed by our nation’s full faith and credit while some corporate and municipal securities also carry unrealized losses. In each case, these corporate and municipal securities carry credit ratings of “A” or better. These features, along with our ability and intent to hold the securities to maturity, cause us to believe these unrealized losses are also the temporary result of changing interest rates.
| 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 |
$ | 8,704 | $ | 60 | $ | 0 | $ | 0 | $ | 8,704 | $ | 60 | ||||||
| Mortgage backed securities- U.S. Government agencies and corporations |
1,192 | 3 | 3,729 | 62 | 4,921 | 65 | ||||||||||||
| Corporate debt securities |
2,077 | 22 | 0 | 0 | 2,077 | 22 | ||||||||||||
| Tax exempt state and political subdivisions |
1,284 | 1 | 0 | 0 | 1,284 | 1 | ||||||||||||
| Total securities available for sale |
$ | 13,257 | $ | 86 | $ | 3,729 | $ | 62 | $ | 16,986 | $ | 148 | ||||||
The maturities, amortized cost and estimated fair values of the bank’s securities at September 30, 2004 are summarized as follows (in thousands, unaudited):
| Available for sale | ||||||
| Amortized Cost |
Estimated Fair Value | |||||
| Due within 1 year |
$ | 11,279 | $ | 11,407 | ||
| Due after 1 but within 5 years |
38,185 | 38,497 | ||||
| Due after 5 but within 10 years |
1,232 | 1,287 | ||||
| Due after 10 years |
0 | 0 | ||||
| Equity securities |
1,002 | 1,002 | ||||
| $ | 51,698 | $ | 52,193 | |||
Mortgage backed securities have remaining contractual maturities ranging from 1 to 12 years and are reflected in the maturity distribution schedule shown above based on their anticipated average life to maturity, which ranges from 1.13 to 4.52 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 nine month periods ended September 30, 2004 and 2003 are as follows (in thousands, unaudited):
| Proceeds From |
Gross Realized | ||||||||||||||
| Sales |
Calls and Maturities |
Principal Payments |
Gains |
Losses | |||||||||||
| September 30, 2004: |
|||||||||||||||
| Securities available for sale |
$ | 2,044 | $ | 13,108 | $ | 2,356 | $ | 37 | $ | 14 | |||||
| September 30, 2003: |
|||||||||||||||
| Securities available for sale |
$ | 134 | $ | 10,515 | $ | 4,559 | $ | 0 | $ | 0 | |||||
At September 30, 2004 and December 31, 2003 securities with an amortized cost of $26,583,000 and $27,063,000, respectively, having estimated fair values of $26,910,000 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 September 30, 2004, the company had a concentration within its corporate debt securities classification which included obligations of financial services
10
industry companies with global operations having an approximate amortized cost of $2,313,000 and an estimated fair value of $2,320,000. There were no concentrations with any one issuer.
NOTE 5 - LOANS
Total loans are summarized as follows (in thousands):
| September 30, 2004 |
December 31, 2003 |
|||||||
| (Unaudited) | * | |||||||
| Commercial, financial and agricultural |
$ | 25,726 | $ | 25,417 | ||||
| Real estate - construction |
8,051 | 5,963 | ||||||
| Real estate - mortgage |
97,993 | 89,111 | ||||||
| Installment loans |
11,531 | 12,396 | ||||||
| Other |
2,852 | 2,868 | ||||||
| Total loans |
146,153 | 135,755 | ||||||
| Net deferred loan origination costs |
(56 | ) | (48 | ) | ||||
| Less unearned income |
(3 | ) | 0 | |||||
| Total loans net of unearned income and net deferred loan origination costs |
146,094 | 135,707 | ||||||
| Less allowance for loan losses |
(1,306 | ) | (1,396 | ) | ||||
| Loans, net |
$ | 144,788 | $ | 134,311 | ||||
| * | From audited financial statements |
At September 30, 2004 our recorded investment in impaired loans was $146,000. The valuation allowance assigned to these loans totaled $36,000. Our average investment in the impaired loans was $195,000 during the quarter. The amount of interest income recorded on them in the third quarter was $4,000 while the amount of interest collected was $5,000.
No loans were identified as impaired at December 31, 2003.
Loans in a nonaccrual status were $0 and $16,000 at September 30, 2004 and December 31, 2003, respectively.
NOTE 6 - ALLOWANCE FOR LOAN LOSSES
Analyses of the allowance for loan losses are presented below (in thousands):
| Three Months Ended September 30, |
Nine Months Ended September 30, | |||||||||||
| 2004 |
2003 |
2004 |
2003 | |||||||||
| (Unaudited) | (Unaudited) | |||||||||||
| Balance at beginning of period |
$ | 1,170 | $ | 1,444 | $ | 1,396 | $ | 1,386 | ||||
| Loans charged off: |
||||||||||||
| Commercial and industrial |
96 | 124 | 1,031 | 129 | ||||||||
| Real estate - mortgage |
36 | 0 | 36 | 0 | ||||||||
| Installment and other |
37 | 27 | 66 | 150 | ||||||||
| Total |
169 | 151 | 1,133 | 279 | ||||||||
| Recoveries: |
||||||||||||
| Commercial and industrial |
147 | 1 | 191 | 21 | ||||||||
| Real estate - mortgage |
0 | 0 | 0 | 0 | ||||||||
| Installment and other |
8 | 2 | 17 | 6 | ||||||||
| Total recoveries |
155 | 3 | 208 | 27 | ||||||||
| Net losses |
14 | 148 | 925 | 252 | ||||||||
| Provision for loan losses |
150 | 81 | 835 | 243 | ||||||||
| Balance at end of period |
$ | 1,306 | $ | 1,377 | $ | 1,306 | $ | 1,377 | ||||
11
NOTE 7 - DEPOSITS
The following is a summary of interest bearing deposits by type (in thousands):
| September 30, 2004 |
December 31, 2003 | |||||
| (Unaudited) | * | |||||
| Interest bearing checking |
$ | 32,454 | $ | 27,355 | ||
| Money market accounts |
7,175 | 8,690 | ||||
| Savings accounts |
27,307 | 27,360 | ||||
| Certificates of deposit under $100,000 |
48,785 | 48,063 | ||||
| Certificates of deposit of $100,000 or more |
28,742 | 26,569 | ||||
| Total |
$ | 144,463 | $ | 138,037 | ||
| * | From audited financial statements |
NOTE 8 - 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 September 30, 2004 were $0 while $3,000,000 was outstanding at December 31, 2003.
Long-term borrowings are also obtained from the FHLB but are used to finance specific lending activities.
NOTE 9 - EMPLOYEE BENEFIT PLANS
The components of net periodic benefit cost of our pension and other benefit plans are presented below (in thousands):
| Nine Months Ended September 30, |
||||||||||||||||
| Pension Benefits |
Other Benefits |
|||||||||||||||
| 2004 |
2003 |
2004 |
2003 |
|||||||||||||
| (Unaudited) | (Unaudited) | |||||||||||||||
| Service cost |
$ | 61 | $ | 73 | $ | 21 | $ | 18 | ||||||||
| Interest cost |
156 | 207 | 25 | 25 | ||||||||||||
| Expected return on plan assets |
(219 | ) | (309 | ) | 0 | 0 | ||||||||||
| Amortization of prior service cost |
(11 | ) | (14 | ) | 16 | 16 | ||||||||||
| Amortization of net (gain) loss |
10 | 0 | (3 | ) | (3 | ) | ||||||||||
| Amortization of transition asset |
0 | (20 | ) | 0 | 0 | |||||||||||
| Net periodic (benefit) cost |
$ | (3 | ) | $ | (63 | ) | $ | 59 | $ | 56 | ||||||
We do not expect to make any contributions to our pension plan or other postretirement plans in 2004.
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NOTE 10 - 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 11 - 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) |
Sept. 30, 2004 (unaudited) |
December 31, 2003 * | ||||
| Commitments to extend credit |
$ | 28,538 | $ | 29,974 | ||
| Standby letters of credit |
488 | 239 | ||||
| Total |
$ | 29,026 | $ | 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. |
NOTE 12 - EARNINGS PER SHARE
Basic earnings per share is based on the weighted average number of shares outstanding during the period. For the nine months ended September 30, 2004 and 2003 the weighted average number of shares were 628,283 and 644,480, respectively. The weighted average number of shares outstanding during the three month periods then ended were 625,903 and 641,146. During the periods ended September 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. Citizens Financial Corp. conducts no business other than the ownership of its subsidiaries. Citizens Financial Services, LLC is inactive and has no assets or liabilities. Our primary business activities are conducted through the bank. Therefore, 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 $213 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 related to the general economic conditions in our nation and other broad based issues such as interest rates and regulations as well as to other factors which may be more specific to our own operations. Examples of such factors may include our ability to attract and retain key personnel, implementing new technological systems, providing new products to meet changing customer and competitive demands, our ability to successfully manage growth strategies, controlling costs, maintaining our net interest margin, maintaining good credit quality, and others. 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.
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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.
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 nine months 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-premises ATMs. In addition, work to establish internet banking continues to progress and we will be offering this service in November 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 nine months of 2004 was $1,127,000 compared to $1,542,000 in the same period of 2003. This decrease is the result of higher provisions for loan losses made necessary by the failure of a commercial lending relationship as well as increases in certain operating expenses. These same factors caused income for the third quarter to fall from $539,000 in 2003 to $440,000 in 2004.
The risk of loan losses, such as we experienced this year, is inherent in the banking industry. We do, however, take every prudent measure to protect against such losses and follow established procedures to protect against them. Additional details concerning this loss, our operating expenses, and other factors impacting our results of operations, are discussed in the following sections of this report.
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NET INTEREST INCOME
Net interest income represents 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.
Through the first nine months of 2004 net interest income totaled $6,228,000 compared to $6,124,000 in the same period of last year, a change of just 1.7%. For the third quarter alone, net interest income was actually unchanged at $2,061,000.
This consistency is due to our balance sheet growth being offset by lower interest rates. Average earning assets during the nine month period rose by $18.1 million but because the yield on these assets fell by 61 basis points to 5.86% total interest income has remained nearly steady at $8.5 million. Interest bearing liabilities have grown by approximately $16.9 million when compared to the first nine months of 2003. A decrease in the rate paid on these liabilities of 30 basis points to 1.82%, however, produced a savings in interest expense of $140,000.
The decreases in the interest rates applicable to both interest earning assets and interest bearing liabilities have resulted from changes occurring in the larger economic environment. For several years our economy lacked significant growth and short-term rates, which have a major impact on our pricing, were until recently trending downward. Because we already enjoyed a low cost of funds, the rates applicable to our interest bearing liabilities did not drop as much as those on our earning assets. For this reason our net interest margin, which has historically been very high, has fallen from 4.71% in the first nine months of 2003 to 4.32% in the first nine months of this year; a level which is still slightly in excess of peer group averages. This type of margin compression has been very common in the banking industry in recent years. The current trend toward higher interest rates may change this situation. A discussion of our interest rate risk and how changing interest rates may impact our income is presented later in this report under the section entitled “Quantitative and Qualitative Disclosures About Market Risk”.
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.
Provisions made during the third quarter of 2004 totaled $150,000 compared to $81,000 in the third quarter of last year. This brings the year-to-date 2004 provision to $835,000, an unusually large number due to the charge-offs related to a commercial loan relationship. By comparison the total provision through September, 2003 was $243,000. This higher provision is a major cause of our lower 2004 earnings.
Additional details concerning this particular loss, as well as the 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.
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NONINTEREST INCOME
Noninterest income, which includes all revenues other than those related to earning assets, increased from $337,000 in the third quarter of 2003 to $380,000 in the third quarter this year. For the full nine month period noninterest income is up $59,000 to $1,025,000.
Service fees are the largest component of our noninterest income. These fees increased by $13,000 to $184,000 in the third quarter and by $37,000 to $535,000 for the year-to-date. Both increases are largely the result of our growing deposit base which causes fees such as overdraft fees and minimum balance fees to increase. The most significant rise, however, was ATM fees which were up $7,000 for the quarter and $16,000 for the year-to-date largely as the result of the installation of two new ATMs this year.
Other noninterest income has also improved. For the third quarter, other noninterest income was up $67,000 while the full nine month total rose by $107,000. In both cases the increase is largely due to increases in the cash surrender value of insurance contracts used to fund certain retirement benefits and gains from the sale of foreclosed properties. The gains from foreclosure sales totaled $42,000 in the third quarter and $50,000 for the full nine months.
Trust income is another significant source of noninterest income. However, due to the lack of estate settlement fees, trust income was down by $38,000 in the third quarter and $100,000 year-to-date. With total trust income through September 30, 2004 of $120,000 we believe our full year total may still approach $180,000.
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 $12,000 to $45,000 this year as we were without a licensed broker in early 2003. Unfortunately, we again found ourselves without a broker for part of the third quarter this year. Our current broker, however, has close ties to the local community and we believe we will now be able to successfully expand our brokerage program throughout our branch network. While this should result in higher levels of brokerage income in the future, our mortgage income has fallen because higher interest rates and the recent refinancing boom have resulted in fewer mortgages being written. Total mortgage income of $43,000 for the year-to-date and $15,000 for the third quarter are down $32,000 and $8,000, respectively. Rising interest rates could cause this trend to continue.
The remaining components of noninterest income, insurance commissions and security gains/(losses), are relatively minor. Most insurance commission income is from the sale of title insurance while gains and losses on securities, although totaling $23,000 through September, are uncommon as we typically hold our investment securities until they mature.
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.
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NONINTEREST EXPENSE
Noninterest expense includes all items of expense other than interest expense, the provision for loan losses, and income taxes. Total noninterest expense for the third quarter was $1,715,000 compared to $1,539,000 in the third quarter of last year while year-to-date totals are $4,964,000 for 2004 and $4,567,000 in 2003. While these increases are significant they were not unexpected. Our budgeted levels of noninterest expense were $1,714,000 for the quarter and $5,069,000 for the full nine month period.
Most of the increase in noninterest expense has occurred in the category of other noninterest expense which rose $119,000 for the quarter and $169,000 year-to-date. This rather significant increase may be traced to several things including the purchase, installation and ongoing maintenance of several new off the shelf data processing programs, increased marketing and contribution costs, higher telecommunications costs, and expenses related to the foreclosure, upkeep and sale of foreclosed properties. Although some of these fees, particularly those related to software products and foreclosed properties, are nonrecurring, it is likely these costs will continue to exceed previous levels.
The expansion of our branch network has caused increases in occupancy and equipment costs with higher depreciation and maintenance expense. In addition, because we vacated our Foodland office when we opened our new Marlinton facility in September, we wrote off approximately $24,000 of leasehold improvements. This also contributed to higher equipment costs during the quarter. With this expansion we have also seen an increase in our customer base leading to higher postage and stationery costs. Data processing expense, meanwhile, increased by $31,000 for the quarter and $62,000 for the full nine months. This is the result of several upgrades to our third party processor’s products, some related to our upcoming internet banking service, as well as higher fees resulting from adding two new ATMs to our system.
While these costs increased, our largest noninterest expense, personnel costs, decreased during the quarter by $43,000 and shows a year-to-date increase of just $41,000, or 1.6%. In both cases this is primarily due to lower costs associated with our self-funded group medical plan. As a result of lower medical claims, this cost fell by $68,000 in the third quarter bringing the year-to-date savings to $87,000. The deferral of personnel costs involved in making loans has also helped to control personnel expense this year. Actual salary costs, however, have risen $127,000, or 6.4%, through September due to annual increases and the need to staff branch locations while pension costs have increased by $58,000 reflecting a rising pension obligation as well as lower returns on plan assets.
Changes in other components of noninterest expense, such as directors fees and professional fees, have not been material although professional fees have risen partly in response to the commercial loan charge-off noted earlier.
Future levels of noninterest expense may also rise due to continuing technological changes and the need to comply with Section 404 of the Sarbanes Oxley Act in 2005. That Act requires management to report on the effectiveness of our internal control over financial reporting. Issuing such a report will require significant study and testing of controls and will involve the use of third party experts.
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INCOME TAXES
Our provision for income tax expense includes both federal and state income taxes. Due to our higher level of loan charge offs, income tax expense has fallen significantly in 2004 to $136,000 for the quarter and $327,000 for the year-to-date. This compares with $239,000 and $738,000, respectively, last year.
FINANCIAL CONDITION
SUMMARY
Although total assets have grown by just $3,849,000 since year-end to $212,978,000, we have experienced over $10.3 million in loan growth and $6.5 million in deposit growth in 2004. Decreases in borrowed funds, including seasonal changes in repurchase agreements, have caused us to fund much of our loan growth with maturing investment securities. Capital has changed little standing at 9.6% of assets.
Net charge-offs for the year of $925,000 are unusually high and primarily reflect charge-offs related to one particular customer rather than wider problems within our loan portfolio or our local economy. We believe the risk inherent in our loan portfolio has been adequately identified through our allowance for loan losses. The following sections of this report provide a further discussion of our major balance sheet categories as well as liquidity and the impact of inflation.
LOAN PORTFOLIO
As of September 30, 2004, gross loans totaled $146,153,000 which is $10,398,000 more than at year-end 2003. This is an increase of 7.7%. We are pleased with this growth and with the level of loan demand we are experiencing. However, competitive forces remain strong. This is especially true in the case of residential mortgage lending where many banks and mortgage finance companies continue to offer long-term fixed rate loans at attractive rates, and in the area of consumer lending where auto financers offer a variety of terms, incentives and interest rates favored by borrowers.
Despite these competitive factors, our residential mortgage portfolio has increased by approximately $3.6 million since year-end to $54,582,000 and our consumer portfolio has fallen by just $865,000 to $11.5 million. We believe our success in these areas is due to our service philosophy and to the fact that borrowers know who we are and who to ask when they have questions about their loans. Further, in the event customers do want long-term, fixed rate mortgages, we do offer services to meet those needs. We have also found that established customers value home equity loans as a means of meeting a variety of financing needs. These loans have increased by $1.4 million this year to $8.1 million.
Our strongest loan demand, however, has come from commercial businesses. A great deal of our commercial loans are secured by real property. As of the report date these loans totaled $34.9 million compared to $30.9 million at December 31, 2003. In addition to this, commercial loans not secured by real property total $25.7 million, just slightly higher than at year-end.
We expect these trends to continue in the foreseeable future and, due to the increasing importance of commercial lending, we will be adding a
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credit analyst to our staff. This should not only improve operating efficiency but also improve our credit decision process and result in reduced credit risk.
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 on 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 may 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 of September 30, 2004, the total allowance of $1,306,000 included estimated losses associated with loans that were specifically analyzed of $89,000, a pooled loss estimate of $502,000 and losses attributable to other factors of $715,000 which includes $333,000 assigned to concentrations of credit in the auto, lumber, and hotel/motel industries.
Year-to-date charge-offs total $1,133,000, mostly due to the bankruptcy of one customer as discussed in earlier filings. Recoveries of $208,000 for the year were significantly boosted by the successful conclusion of litigation following a 1999 charge-off. This recovery, which occurred during the third quarter, totaled $114,000 bringing the matter to a close.
We believe the losses we incurred this year were unique to one particular customer relationship and in no way indicates that credit quality has lessened or that the risk inherent in the loan portfolio has increased and that our allowance for loan losses is fairly stated.
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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, balancing interest sensitivity concerns and satisfying pledging requirements. All securities are classified as available for sale. During the first nine months of 2004 the amortized cost of the securities portfolio decreased by $7,290,000 to $51,698,000 in order to fund loan growth. This decrease primarily resulted from maturities, calls and paydowns.
The portfolio continues to be comprised of U.S. Agency securities, bank qualified municipal debt, government agency backed mortgage securities and investment grade corporate debt. None of our securities are considered to be permanently impaired and, as of the report date, the fair value of the portfolio exceeded its amortized cost by $495,000. 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.
Although yields on investment securities have improved in recent months, they remain quite low by historical standards. As a result, we continue to keep the average life of the portfolio short at 2.31 years as a means of managing risk should rates continue to rise. The average yield on our investment portfolio for the nine months ended September 30, 2004 was 3.95%. We expect this yield to 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 September 30, 2004, we had $350,000 of overnight funds sold and no overnight borrowings. Throughout the first nine months of the year our average overnight funds sold totaled $1,779,000 while our average overnight borrowings were $802,000. These amounts change daily depending on our funding position and liquidity needs. 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
Through the first nine months of the year deposits rose by $6,582,000 to $168,131,000. Nearly all of this growth occurred in interest bearing deposits, especially interest bearing checking accounts and jumbo CDs which are up $5.1 million and $2.2 million, respectively. The growth in jumbo CDs, which now total $28,763,000, is a continuation of a trend we have observed for several years. Such large dollar deposits have become an important source of funds for many community banks in recent years. We do not, however, market these products in any way nor do we accept out of area deposits or brokered deposits. Our jumbo CDs are local deposits which have proven to be quite stable.
We believe the growth and stability of our jumbo CDs is due to 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 clearly adds to the stability of our deposit base as well as our customer relationships. We also allow our CD customers to “bump up” their rate once during the life of the instrument which also serves as a tool to attract and retain a stable deposit base. We expect our deposit base to continue to grow at a manageable rate in the future.
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While our deposit growth has been strong, we also utilize several types of borrowings to fund our assets. Repurchase agreements with local businesses and municipalities have been an important funding source recently. Some of our repos are awarded on a competitive bid system so it is possible that we may not be able to retain them indefinitely. However, due to the parameters typically included in the bid requirements, we are well positioned to maintain them. Overall, despite some seasonal fluctuations, we have found our repos to be a reliable source of funds.
When appropriate, we also use long-term borrowings to fund our activities, usually specific commercial loan projects. These borrowings are structured such that their cash flow patterns are similar to the corresponding loan and to maintain an acceptable net interest spread. At September 30, 2004, our long-term borrowings totaled $4.8 million. With commercial lending gaining in importance we expect to continue to utilize this type of funding in the future and have established adequate borrowing agreements with several correspondents.
CAPITAL RESOURCES
At $20,346,000, or 9.6% of total assets, our capital base has not changed significantly since year-end and remains strong. The statement of changes in shareholders equity provides a complete analysis of our capital for the year.
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 |
14.13 | % | 8.00 | % | ||
| Tier I capital to risk weighted assets |
13.26 | % | 4.00 | % | ||
| Tier I capital to adjusted total assets |
9.36 | % | 4.00 | % |
We are not aware of any items which are expected to materially impair or alter our capital in the future. Based on our most recent projections, we expect book capital to continue to exceed 9% while our regulatory capital ratios are expected to increase slightly.
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 periodically 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, we may seek some 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 September 30, 2004, our gap over the next twelve months was .01% of total assets meaning that the potential for both assets and liabilities to reprice is nearly equal and the bank is well positioned from an interest rate risk standpoint. With interest rates now beginning to rise from
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historically low levels our ability to control increases in the rates we pay on deposits, especially deposits such as savings accounts, will be crucial to maintaining or improving our net interest margin.
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 assumptions 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 a 3.03% impact on net interest income over the next twelve months.
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. As noted above, 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.
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As of September 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.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds:
c. Citizens maintains a policy under which it may purchase shares of its own stock for treasury, subject to certain limitations, when the Board of Directors determines it is in the best interest of the company to do so. Such shares are purchased on the open market through independent brokers. At September 30, 2004 and December 31, 2003 the number of treasury shares was 126,072 and 118,622, respectively. The purchase of these shares has not had a material impact on either capital or liquidity. No plans currently exist regarding their use and there are no plans regarding future purchases.
The following table provides information with respect to Citizens’ purchases of its own common stock during the third quarter of the fiscal year. All such purchases were made under the general policy noted earlier and not as part of any publicly announcement plan or program.
ISSURER PURCHASES OF EQUITY SECURITIES
| Period |
Total Number of shares purchased |
Average price paid per share |
Total Number of shares |
Maximum Number may yet be | |||||
| July 1-31, 2004 |
0 | N/A | N/A | N/A | |||||
| August 1-31, 2004 |
5,650 | $ | 43.00 | N/A | N/A | ||||
| September 1-30, 2004 |
1,800 | $ | 44.00 | N/A | N/A | ||||
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 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 | |
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| (b) | Reports on Form 8-K: On July 14, 2004 we reported our second quarter 2004 earnings and related financial data under Item 12 of Form 8-K. |
In addition, on August 12, 2004 we reported our second 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: | 11/10/04 |
/s/ Robert J. Schoonover | ||
| Robert J. Schoonover | ||||
| President | ||||
| Chief Executive Officer | ||||
| Date: | 11/10/04 |
/s/ Thomas K. Derbyshire | ||
| Thomas K. Derbyshire | ||||
| Vice President, Treasurer and | ||||
| Principal Financial Officer | ||||
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