FORM 10-K


                       SECURITIES AND EXCHANGE COMMISSION

                             Washington,WASHINGTON, D.C. 20549

                                    FORM 10-K

(Mark One)

[ ][x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934

For the fiscal year ended DECEMBERDecember 31, 19992002      Commission file number:File Number: 0-16084
                          - - --------------------------------------------------------------     -------------------------------


                         CITIZENS & NORTHERN CORPORATION
             (Exact name of Registrant as specified in its charter)


PENNSYLVANIA                                   23-2451943
- ------------                                   ----------
(State or other jurisdiction of                (I.R.S. Employer
incorporation or organization)                 Identification No.)

90-92 MAIN STREET, WELLSBORO, PA 16901
- --------------------------------------
(Address of principal executive offices) (Zip code)

                                  570-724-3411
                                  ------------
               (Registrant's telephone number including area code)

        Securities registered pursuant to Section 12(b) of the Act: None
                                                                    ----


           Securities registered pursuant to section 12(g) of the Act:

                          COMMON STOCK Par ValuePAR VALUE $1.00

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X   No
                                      ____---     ---

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

APPLICABLE ONLY TO CORPORATE REGISTRANTS)

        Indicate the number of shares  outstanding  of each of the  registrant's
classes of common stock, as of the latest practicable date.

Title                                             Outstanding
Common Stock $1.00 par value                      5,205,266 shares March 1, 2000

The Aggregate   Marketaggregate market value of the registrant's common stock held by
non-affiliates at March 1, 2000:          $131,432,967. (a date within 60 daysFebruary 27, 2003 was $167,270,245.

The number of the date hereof)
- - -------------           --------------------------------------------------------

shares of common stock outstanding at February 27, 2003 was
5,335,574.



                       DOCUMENTS INCORPORATED BY REFERENCE

Excerpts fromPortions of the Registrants  Annual report to shareholders  are  incorporated
herein by reference in response to Part II, hereof. The Registrant's  definitive
Proxyregistrant's proxy statement to be used in  connection  withfor the 1999  Annual  Meetingannual meeting of its
shareholders to be held April 18, 2000 is15, 2003 are incorporated  herein by reference in
partial response tointo Part
III.


Location in Form 10-K Incorporated Information - - --------------------- ------------------------ Part II Item 5. Market for Registrant's Common Page 45 of the Annual Report Stock and Related Stockholder Matters Item 6. Selected Financial Data Pages 46 and 47 of the Annual Report Item 7. Management's Discussion and Analysis Pages 29 through 48 of the Annual of Financial Condition and Results Report Of Operations Item 7A. Quantitative and Qualitative Pages 41 through 43 of the Annual Disclosures Report About Market Risk Item 8. Financial Statements and Pages 7 through 10 and 45 through Supplementary Data 48 of the Annual Report Part III Item 10. Directors and Executive Officers PagesIII of this report. 1 through 5 of the Proxy of the Registrant Statement Item 11. Executive Compensation Pages 6 through 9 of the Proxy Statement Item 12. Security Ownership of Certain Pages 2 through 6 of the Proxy Beneficial Owners and Management Statement Item 13. Certain Relationships and Related Page 24 of the Annual Report Transactions Page 12 of the Proxy Statement
2 PART I ITEM 1. BUSINESS Citizens & Northern Corporation ("Corporation") is a one-bank holding company whose principal subsidiary is Citizens & Northern Bank ("Bank"). The information appearingCorporation's principal office is located in Wellsboro, Pennsylvania. The Corporation's other wholly-owned subsidiaries are Citizens & Northern Investment Corporation and Bucktail Life Insurance Company ("Bucktail"). Citizens & Northern Investment Corporation was formed in 1999 to engage in investment activities. Bucktail reinsures credit and mortgage life and accident and health insurance on behalf of the Bank. The operations of Citizens & Northern Investment Corporation and Bucktail are insignificant in relation to the total business of the Corporation. The Bank is a Pennsylvania banking institution that was formed by the consolidation of Northern National Bank of Wellsboro and Citizens National Bank of Towanda on October 1, 1971. Subsequent mergers included: First National Bank of Ralston in May 1972; Sullivan County National Bank in October 1977; Farmers National Bank of Athens in January 1984; and First National Bank of East Smithfield in May 1990. The Bank has held its current name since May 6, 1975, at which time the Bank changed its charter from a National bank to a Pennsylvania bank. The Bank provides an extensive range of banking services, including deposit and loan products for personal and commercial customers. The Bank also maintains a trust division that provides a wide range of financial services, such as 401(k) Plans, retirement planning, estate planning, estate settlements and asset management. In January 2000, the Bank formed a subsidiary, C&N Financial Services Corporation ("C&NFSC"). C&NFSC is a licensed insurance agency that provides insurance products to individuals and businesses. In 2001, C&NFSC added a broker-dealer division, which offers mutual funds, annuities, educational savings accounts and other investment products through registered agents. C&NFSC's operations are not significant in relation to the total operations of the Bank. All phases of the Bank's business are competitive. The Bank primarily competes in Tioga, Bradford and Sullivan counties and portions of Lycoming County. The Bank competes with local commercial banks headquartered in our market area as well as other commercial banks with branches in our market area. Some of the banks that have branches in the Annual Report underBank's market area are larger in overall size than the caption "DescriptionBank. With respect to lending activities and attracting deposits, the Bank also competes with savings banks, savings and loan associations, insurance companies, regulated small loan companies and credit unions. Also, the Bank competes with mutual funds for deposits. The Bank competes with insurance companies, investment counseling firms, mutual funds and other business firms and individuals for trust, investment management, broker dealer and insurance services. The Bank is generally competitive with all financial institutions in its service area with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans. The Bank serves a diverse customer base, and is not economically dependent on any small group of Business"customers or on page 49 is herein incorporatedany individual industry. Although there have been no mergers or acquisitions within the last 5 years, the Bank has engaged in several ventures designed to improve customer service and generate financial growth. These ventures included the following major initiatives: - - expanded trust and financial services capabilities, including investment management, employee benefits and insurance services; - - installed 18 automated teller machines, beginning in 1997; - - created the "customer repurchase agreement" cash management service for commercial customers in 1998; - - established internet banking services in 1999; and - - constructed and opened new branches in Mansfield, PA (1998) and Muncy, PA (2000). At December 31, 2002, the Bank had total assets of $996,644,000, total deposits of $641,164,000 and net loans outstanding of $445,356,000. At December 31, 2002, the Bank had a total of 265 full-time equivalent employees. Most of the activities of the Corporation and its subsidiaries are regulated by reference. Regulation and Supervisionfederal or state agencies. The Corporationprimary regulatory relationships are described as follows: 2 - - The Corporation is a one-bank holding company formed under the provisions of Section 3 of the Federal Reserve Act. The Corporation is under the direct supervision of the Federal Reserve board and must comply with the reporting requirements of the Federal Bank Holding Company Act. The Bank- - The Bank is a state charteredstate-chartered, nonmember bank, supervised by and under the reporting requirements of the Pennsylvania Department of Banking and the Federal Deposit Insurance Corporation. Investment Corporation Citizens & Northern Investment Corporation is chartered in the state of Delaware and is under the direct supervision of the Federal Reserve Board. Bucktail Life Insurance Company The corporation is also the parent company of Bucktail Life Insurance Company. Bucktail Life Insurance Company- - C&NFSC is a credit lifePennsylvania corporation. The Pennsylvania Department of Insurance regulates C&NFSC's insurance activities. Through October 31, 2002, the broker dealer division offered brokerage products as an office of supervisory jurisdiction of Hackett Associates, Inc. Effective November 1, 2002, brokerage products are offered through a third party networking agreement between the Bank and accident and health insurance provider for credit facilities issued by Citizens & Northern Bank. The Insurance CompanyUVEST Financial Services, Inc. - - Bucktail is incorporated in the state of Arizona and is supervised by the Arizona Department of Insurance. ITEM 2. PROPERTIES Information relating toThe Bank owns each of its properties, except for the location of banking officesfacility located at 68 Main Street, Wellsboro, which is located on page 50 of the Annual Report. There are no encumbrances against anyleased. All of the properties are in good condition. In 2001, the Bank entered into a lease of the property at 68 Main Street, Wellsboro. This facility is used for C&NFSC's operations and for training. None of the owned by the Bank.properties are subject to encumbrance. A listing of properties is as follows: Main administrative office: 90-92 Main Street Wellsboro, PA 16901 Branch offices: 428 S. Main Street Main Street 41 Main Street Athens, PA 18810 Liberty, PA 16930 Tioga, PA 16946 111 Main Street 1085 S. Main Street 428 Main Street Dushore, PA 18614 Mansfield, PA 16933 Towanda, PA 18848 Main Street Route 220 Courthouse Square East Smithfield, PA 18817 Monroeton, PA 18832 Troy, PA 16947 104 Main Street 3461 Route 405 Highway 90-92 Main Street Elkland, PA 16920 Muncy, PA 17756 Wellsboro, PA 16901 102 E. Main Street Thompson Street Route 6 Knoxville, PA 16928 Ralston, PA 17763 Wysox, PA 18854 Main Street 503 N. Elmira Street Laporte, PA 18626 Sayre, PA 18840 Other offices: Bankcard Services Facilities Management RR7 Box 503 One Brewery Lane Wellsboro, PA 16901 Wellsboro, PA 16901 C&N Financial Services Corp. Audit and Compliance 64 Main Street Water Street Wellsboro, PA 16901 Wellsboro, PA 16901
3 ITEM 3. LEGAL PROCEEDINGS NoneThe Corporation and the Bank are involved in various legal proceedings incidental to their business. Management believes the aggregate liability, if any, resulting from such pending and threatened legal proceedings will not have a material, adverse effect on the Corporation's financial condition or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted duringDuring the fourth quarter of the fiscal year covered by this report2002, no matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise. PART II 3 ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS QUARTERLY SHARE DATA Trades of the Corporation's stock are executed through various brokers who maintain a market in the Corporation's stock. Information regarding sales prices of the Corporation's stock is available through the OTC Bulletin Board (www.otcbb.com). The Corporation's stock is not listed or traded on Nasdaq or a national securities exchange. As of December 31, 2002, there were 2,406 shareholders of record of the Corporation's common stock. The following table sets forth the approximate high and low sales prices of the common stock during 2002 and 2001:
2002 2001 Dividend Dividend Declared Declared per per High Low Quarter High Low Quarter - ---------------------------------------------------------------------------------------------- First quarter $ 28.50 $ 24.50 $ 0.28 $ 22.00 $ 20.00 $ 0.26 Second quarter 30.00 27.70 0.28 21.75 20.41 0.26 Third quarter 32.00 29.30 0.30 23.45 21.00 0.26 Fourth quarter 33.00 30.15 0.30 26.50 23.10 0.28 plus 1% plus 1% stock dividend stock dividend
Known "market makers" who handle Citizens & Northern Corporation stock transactions are: BAIRD PATRICK & CO. MONROE SECURITIES, INC. SANDLER O'NEILL & PARTNERS, LP 20 Exchange Place 47 State Street 919 Third Avenue New York, NY 10005 Rochester, NY 14614 New York, NY 10022 (212) 493-6619 (800) 766-5560 (800) 635-6851 F. J. MORRISSEY & CO. BOENNING & SCATTERGOOD, INC. RBC DAIN RAUSCHER RYAN, BECK & COMPANY 4 Tower Bridge - Suite 300 3 Times Square, 24th Floor 3 Parkway 200 Barr Harbor Drive New York, NY 10036 Philadelphia, PA 19102 West Conshohocken, PA 19428 (866) 835-1422 (800) 342-2325 (800) 842-8928 FERRIS, BAKER WATTS, INC. 6 Bird Cage Walk Holidaysburg, PA 16648 (800) 343-5149
4 INVESTOR INFORMATION ANNUAL MEETING OF STOCK TRANSFER AGENT INDEPENDENT AUDITORS SHAREHOLDERS The Annual Meeting of Shareholders AMERICAN STOCK TRANSFER & will be held at the Arcadia Theatre in TRUST CO. PARENTE RANDOLPH, PC Wellsboro, PA, at 2:00 p.m. on Tuesday, 59 Maiden Lane, Plaza Level 400 Market Street April 15, 2003. New York, NY 10038 Williamsport, PA 17701 (800) 278-4353
GENERAL SHAREHOLDER INQUIRIES SHOULD BE SENT TO: CITIZENS & NORTHERN CORPORATION 90-92 Main Street, P.O. Box 58 Wellsboro, PA 16901 COMMON STOCK AND RELATED SHAREHOLDERS MATTERSPER SHARE DATA
2002 2001 2000 1999 1998 Net income per share - basic $ 2.80 $ 2.25 $ 1.58 $ 2.14 $ 2.06 Net income per share - diluted 2.79 2.25 1.58 2.14 2.06 Cash dividends declared per share 1.16 1.04 0.95 0.87 0.78 Cash dividends declared per share - historical basis 1.16 1.06 0.98 0.90 0.82 Stock dividend 1% 1% 1% 1% 1% Stockholders' equity per share (a) 21.70 18.76 16.58 14.29 16.89 Stockholders' equity per share, excluding accumulated other comprehensive income (loss) (a) 19.42 17.77 16.57 15.94 14.67 Weighted average shares outstanding - basic 5,339,449 5,348,963 5,363,232 5,362,861 5,367,497 Weighted average shares outstanding - diluted 5,354,041 5,350,452 5,364,386 5,368,325 5,377,392 Number of shares outstanding at year-end 5,285,606 5,234,800 5,207,244 5,153,729 5,102,028 Number of shares authorized 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000
(a) For purposes of this computation, the number of outstanding shares has been increased for the effects of 1% stock dividends issued in January following each year-end. EQUITY COMPENSATION PLAN INFORMATION The following table sets forth information appearingconcerning the Stock Incentive Plan and Independent Directors Stock Incentive Plan, both of which have been approved by the Corporation's shareholders. The shareholders have approved all of the Corporation's equity compensation plans. The figures shown are as of December 31, 2002, and do not include awards made in January 2003. More details related to the Annual Report underCorporation's equity compensation plans are provided in Notes 1 and 12 to the caption "Quarterly Share Data" on page 45 and the "Summary of Quarterly Financial Data" on page 47 is herein incorporated by reference.consolidated financial statements.
NUMBER OF SECURITIES NUMBER OF SECURITIES REMAINING AVAILABLE TO BE ISSUED UPON WEIGHTED-AVERAGE FOR FUTURE ISSUANCE EXERCISE OF EXERCISE PRICE OF UNDER EQUITY OUTSTANDING OPTIONS OUTSTANDING OPTIONS COMPENSATION PLANS - --------------------------------------------------------------------------------------------------------- Equity compensation plans approved by shareholders 120,489 $27.17 96,829
5 ITEM 6. SELECTED FINANCIAL DATA The "Five-Year Summary of Operations"(IN THOUSANDS)
INCOME STATEMENT 2002 2001 2000 1999 1998 Interest income $ 57,285 $54,661 $51,643 $48,036 $45,183 Interest expense 26,315 28,356 30,145 24,571 22,693 - --------------------------------------------------------------------------------------------------------------- Interest margin 30,970 26,305 21,498 23,465 22,490 Provision for loan losses 940 600 676 760 763 - --------------------------------------------------------------------------------------------------------------- Interest margin after provision for loan losses 30,030 25,705 20,822 22,705 21,727 Other income 6,624 6,120 5,002 6,823 6,359 Securities gains 2,888 1,920 1,377 3,043 3,001 Other expenses 20,849 18,671 16,906 17,732 16,483 - --------------------------------------------------------------------------------------------------------------- Income before income tax provision 18,693 15,074 10,295 14,839 14,604 Income tax provision 3,734 3,022 1,819 3,354 3,527 - --------------------------------------------------------------------------------------------------------------- Net income $ 14,959 $12,052 $ 8,476 $11,485 $11,077 =============================================================================================================== BALANCE SHEET AT YEAR END Total securities (1) $513,597 $437,398 $343,596 $356,287 $327,309 Gross loans, excluding unearned discount 451,145 379,228 328,305 310,892 291,003 Total assets 1,018,768 866,999 719,335 705,898 646,298 Total deposits 640,304 576,274 528,967 500,474 476,518 Stockholders' equity, excluding accumulated other comprehensive income 103,691 94,903 88,887 85,507 78,645 Total stockholders' equity 115,837 100,187 88,969 76,623 90,567 AVERAGE BALANCE SHEET Total securities, at amortized cost (1) 470,764 412,654 371,360 349,133 300,692 Gross loans, excluding unearned discount 410,670 346,353 318,382 301,584 285,275 Earning assets 881,434 759,007 689,743 650,717 585,966 Total assets 943,001 805,229 704,221 680,864 626,102 Total assets, excluding unrealized gains/ Losses 930,539 798,590 717,052 672,999 606,163 Total deposits 613,392 544,579 503,848 483,858 448,601 Stockholders' equity, excluding accumulated other comprehensive income 99,361 91,703 87,258 81,767 74,810 Stockholders' equity 107,595 96,021 78,792 87,143 87,997 FINANCIAL RATIOS Return on stockholders' equity, excluding accumulated other comprehensive income (2) 15.06% 13.14% 9.71% 14.05% 14.81% Return on stockholders' equity (2) 13.90% 12.55% 10.76% 13.18% 12.59% Return on assets (2) 1.59% 1.50% 1.20% 1.69% 1.77% Stockholders' equity to assets, excluding accumulated other comprehensive income (2) 10.68% 11.48% 12.17% 12.15% 12.34% Stockholders' equity to assets (2) 11.41% 11.92% 11.19% 12.80% 14.05% Stockholders' equity to loans (2) 26.20% 27.72% 24.75% 28.90% 30.85% Net income to: Total interest income 26.11% 22.05% 16.41% 23.91% 24.52% Interest margin 48.30% 45.82% 39.43% 48.95% 49.25% Dividends as a % of net income 41.17% 46.08% 60.19% 40.39% 37.81%
(1) Includes available-for-sale and held-to-maturity securities, and interest-bearing cash and due from banks (2) Financial ratios calculated based on page 46 of the Annual Report is herein incorporated by reference.average balance sheet data 6 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information appearingCertain statements in this section and elsewhere in this Annual Report on Form 10-K are forward-looking statements. Citizens & Northern Corporation and its wholly-owned subsidiaries (collectively, the Corporation) intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Company's annual Report underPrivate Securities Reform Act of 1995. Forward-looking statements, which are not historical facts, are based on certain assumptions and describe future plans, business objectives and expectations, and are generally identifiable by the caption "Management'suse of words such as, "believe", "expect", "intend", "anticipate", "estimate", "project", and similar expressions. These forward-looking statements are subject to risks and uncertainties that are difficult to predict, may be beyond management's control and could cause results to differ materially from those currently anticipated. Factors which could have a material, adverse impact on the operations and future prospects of the Corporation include, but are not limited to, the following: - - changes in monetary and fiscal policies of the Federal Reserve Board and the U.S. Government, particularly related to changes in interest rates - - changes in general economic conditions - - legislative or regulatory changes - - downturn in demand for loan, deposit and other financial services in the Corporation's market area - - increased competition from other banks and non-bank providers of financial services - - technological changes and increased technology-related costs - - changes in accounting principles, or the application of generally accepted accounting principles (see "Critical Accounting Policies," later in Management's Discussion and Analysis). These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. EARNINGS OVERVIEW The Corporation has enjoyed 2 consecutive years with record-high levels of net income in 2002 and 2001. In 2002, net income was $14,959,000, or $2.80 per share - - basic and $2.79 per share - diluted. This represents a 24.1% increase over 2001 net income of $12,052,000 ($2.25 per share - basic and diluted). Net income for 2001 was 42.2% higher than in 2000. In 2000, net income amounted to $8,476,000 ($1.58 per share - basic and diluted). The most significant income statement changes between 2002 and 2001, and between 2001 and 2000, are as follows: - The interest margin (excess of interest income over interest expense) increased significantly in both 2002 and 2001. The interest margin increased to $30,970,000 in 2002 from $26,305,000 in 2001, an increase of $4,665,000 or 17.7%. Further, the interest margin in 2001 was $4,807,000, or 22.4%, higher in 2001 than in 2000. As discussed in more detail in the "Net Interest Margin" section of Management's Discussion and Analysis, growth in the net interest margin over the last 2 years has resulted from increases in volume of earning assets, and from falling interest rates paid on deposits and borrowed funds. For a variety of reasons, including market conditions, the opening of the Muncy, PA, branch in October 2000, and the hiring of additional commercial lending staff, the Corporation has achieved significant growth in loans and deposits in 2002 and 2001. Also, management has identified opportunities to borrow funds and invest the proceeds in securities at positive spreads. Changes in interest rates have also had a dramatic impact on operating results over the last 3 years. As widely publicized, the Federal Reserve Board lowered its targeted federal funds rate 11 times during 2001, from 6.5% to 1.75%. The federal funds target rate remained at 1.75% throughout most of 2002, until the Fed lowered it to its current level of 1.25% in November 2002. The ripple effects of the Fed's actions throughout the national and local economy have substantially lowered the Corporation's cost of funds. In contrast, in 2000, the Fed increased its target rate several times, which resulted in increases in the Corporation's cost of funds. - Other (noninterest) income (excluding securities gains) was $6,624,000 in 2002, an increase of $504,000 (8.2%) over 2001. As described in more detail later in Management's Discussion and Analysis, the major sources of increased noninterest revenue in 2002 were from Service Charges on Deposit Accounts and Trust and Financial ConditionManagement services. Noninterest income increased $1,118,000, or 22.4%, in 2001 over 2000. The major source of this revenue growth in 2001 was from recognition of an increase in cash surrender value of insurance of $905,000. In late December 2000, the Corporation purchased bank-owned life insurance (BOLI) at a cost of $15,000,000. The Corporation purchased BOLI to help fund future anticipated increases in employee benefits. Prior to December 2000, the Corporation had no BOLI holdings. 7 - Net realized securities gains amounted to $2,888,000 in 2002, $1,920,000 in 2001 and $1,377,000 in 2000. Most of the gains realized throughout the 3-year period ended December 31, 2002, were from sales of bank stocks. The amounts of such gains realized in any accounting period depend on management's evaluation of the specific stocks owned by the Corporation. - Other (noninterest) operating expenses increased $2,178,000, or 11.7%, in 2002 over 2001, and 10.4% in 2001 over 2000. Higher operating expenses reflect increases in payroll costs, professional fees, depreciation and maintenance expense associated with computer hardware and software. These types of costs have increased as a result of the need to add personnel and supplement existing systems to keep up with expansions of services and growth in lending activity over the last few years. Also, in 2001, the Corporation's operating expenses increased due to the opening of the Muncy branch. Noninterest expenses are discussed in more detail later in Management's Discussion and Analysis. - The income tax provision increased to $3,734,000 in 2002 from $3,022,000 in 2001 and $1,819,000 in 2000, primarily because pre-tax income was higher. The income tax provision, as a percentage of pre-tax income, was 19.98% in 2002, 20.05% in 2001 and 17.67% in 2000. More details related to the Corporation's income taxes are provided in Note 13 to the Consolidated Financial Statements (included in Item 8 of this Form 10-K). OUTLOOK FOR 2003 Looking into the future, management anticipates another year of good financial performance in 2003. However, management believes it will be difficult to continue the pace of earnings growth achieved in 2001 and 2002. With interest rates at historic lows, there is not much farther for them to fall. Most economists are predicting a rising interest rate environment as the U. S. economy recovers from the brief recession and when the uncertainty of war with Iraq is resolved. The Corporation's interest margin will be affected as higher yielding loans mature or are refinanced and as higher yielding investments mature or are called. The Corporation began seeing some reduction in the margin in the last quarter of 2002. If interest rates do begin to rise, the Corporation will experience some additional stress on the interest margin because its interest-bearing liabilities (deposits and borrowings) reprice faster than its earning assets (primarily, loans and investment securities). Management continues to look for opportunities to increase noninterest revenues, in an effort to reduce the Corporation's reliance upon interest rates. The Corporation's interest rate risk is discussed in more detail in Section 7A of this Annual Report on Form 10-K. CRITICAL ACCOUNTING POLICIES The presentation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect many of the reported amounts and disclosures. Actual results could differ from these estimates. A material estimate that is particularly susceptible to significant change is the determination of Operations"the allowance for loan losses. Management believes that the allowance for loan losses is adequate and reasonable. The Corporation's methodology for determining the allowance for loan losses is described in a separate section later in Management's Discussion and Analysis. Given the very subjective nature of identifying and valuing loan losses, it is likely that well-informed individuals could make materially different assumptions, and could, therefore calculate a materially different allowance value. While management uses available information to recognize losses on pages 29loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation's allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination. Further, in 2003, the American Institute of Certified Public Accountants is expected to issue an exposure draft of a statement of position that would establish detailed implementation guidance for calculating the allowance for loan losses. This statement of position is expected to call for implementation of its provisions beginning in 2004. Implementation of that detailed implementation guidance, if it is approved, could result in an adjustment to the Corporation's allowance. 8 Another material estimate is the calculation of fair values of the Corporation's debt securities. The Corporation receives estimated fair values of debt securities from an independent valuation service, or from brokers. In developing these fair values, the valuation service and the brokers use estimates of cash flows, based on historical performance of similar instruments in similar interest rate environments. Based on experience, management is aware that estimated fair values of debt securities tend to vary among brokers and other valuation services. Accordingly, when selling debt securities, management typically obtains price quotes from more than one source. As described in Notes 1 and 11 of the consolidated financial statements, the large majority of the Corporation's securities are classified as available-for-sale. Accordingly, these securities are carried at fair value on the consolidated balance sheet, with unrealized gains and losses excluded from earnings and reported separately through 48,accumulated other comprehensive income (included in stockholders' equity). NET INTEREST MARGIN 2003/2002/2001 The Corporation's primary source of operating income is herein incorporatedrepresented by reference.the net interest margin. The net interest margin is equal to the difference between the amounts of interest income and interest expense. Tables I, II and III include information regarding the Corporation's net interest margin in 2002, 2001 and 2000. In each of these tables, the amounts of interest income earned on tax-exempt securities and loans have been adjusted to a fully taxable-equivalent basis. Accordingly, the net interest margin amounts presented in these tables exceed the amounts presented in the consolidated financial statements. Also, dividends from the Corporation's investment in the Federal Home Loan Bank of Pittsburgh (FHLB - Pittsburgh), which were included in interest and dividend income in prior years, have been excluded from the amounts included in the Tables for 2002, 2001 and 2000 in this year's Annual Report on Form 10-K. Dividends from FHLB - Pittsburgh stock are now included in Other (Noninterest) Income in the consolidated statement of income. The discussion that follows is based on amounts in the Tables. The net interest margin (also referred to as net interest income), on a taxable-equivalent basis, was $33,963,000 in 2002, an increase of $5,413,000 or 19.0% over 2001. In turn, fully taxable-equivalent net interest income was $5,038,000, or 21.4% higher in 2001 than in 2000. As described in the "Earnings Overview" section of Management's Discussion and Analysis, these increases in net interest margin were caused mainly by increases in volume of earning assets, and from declining interest rates on the Corporation's deposits and borrowed funds. Table III shows the effect of volume and rate changes on the Corporation's major interest earning assets and interest-bearing liabilities. Table III shows that changes in volume of earning assets and interest-bearing liabilities resulted in an increase in net interest income of $4,264,000 in 2002, while changes in rates increased net interest income $1,149,000. In 2001, when (as discussed in the "Earnings Overview" section) short-term interest rates fell dramatically, rate changes had the effect of increasing net interest income $4,472,000, and volume changes increased net interest income $566,000. Table II, which shows average daily balances and rates, shows that the "Interest Rate Spread" (excess of average rate of return on interest-earning assets over average cost of funds on interest-bearing liabilities) widened substantially in 2001 over 2000, and widened a bit more in 2002 over 2001. The Interest Rate Spread was 3.38% in 2002, 3.17% in 2001 and 2.53% in 2000. INTEREST INCOME AND EARNING ASSETS The Corporation's major categories of interest-bearing assets are available-for-sale investment securities and loans. Total interest income increased $3,372,000, or 5.9%, in 2002 over 2001. Interest and dividends from available-for-sale securities increased $1,758,000, or 6.5%, and interest and fees from loans increased $1,864,000, or 6.3%. In Table III, the growth in interest income is broken down between the impact of volume changes and the impact of interest rate changes. Higher average balances of available-for-sale securities and loans in 2002 than in 2001 resulted in increases in interest income in 2001, despite lower average rates of return. Similarly, total interest income increased $3,249,000, or 6.1%, in 2001 over 2000, with the effects of increased average volume of earning assets more than offsetting the impact of lower average rates. Income from available-for-sale securities increased $1,544,000, or 6.1% in 2001 over 2000. Interest and fees from loans increased $1,644,000, or 5.9%, in 2001 over 2000. As shown in Table II, the average balance of the available-for-sale investment portfolio (at amortized cost) was $465,650,000 in 2002, $395,908,000 in 2001 and $359,265,000 in 2000. The major components of the portfolio are mortgage-backed securities, obligations of state and political subdivisions (municipal bonds), and U. S. Government Agency securities. Also, the Corporation holds other corporate debt securities and equity securities (primarily stocks of banks and bank holding companies). In total, available-for-sale securities grew because management was able to identify opportunities to borrow funds and invest the proceeds in securities at a positive spread. These opportunities were available because of the "steep yield curve" (longer-term interest rates much higher than shorter-term rates) that existed throughout most of 2002 and 2001. The average rate of return on available-for-sale securities was 6.16% for 2002, considerably lower than the 2001 (6.80%) and 2000 (6.92%). The average return on available-for-sale securities was 5.87% in the 4th quarter 2002. 9 Table II also shows that the composition of the available-for-sale securities portfolio has changed significantly. The average balance of U.S. Government agency securities fell to 16% of the average balance of the total portfolio in 2002 from 29% in 2001 and 37% in 2000. In contrast, the average balance of mortgage-backed securities increased to 45% of the total portfolio in 2002 from 38% in 2001 and 28% in 2000. In 2002 and in the latter part of 2001, as a result of declining interest rates, substantial amounts of U.S. Government agency securities were called. The Corporation reinvested much of the proceeds in mortgage-backed securities. Also, much of the leveraged security purchases described above consisted of mortgage-backed securities. The portfolio's increased weighting in mortgage-backed securities is designed to provide increased cash flow, in the form of monthly principal and interest payments. This increased level of cash inflows will be available to be reinvested at higher rates when interest rates rise. Obligations of state and political subdivisions (municipal bonds) also were a larger portion of the portfolio in 2002 than in 2001 and 2000. The average balance of municipal bonds grew to $113,540,000, or 24% of the portfolio, in 2002 from 20% of the portfolio in 2001 and 23% of the portfolio in 2000. On a taxable equivalent basis, municipal bonds are the highest yielding category of available-for-sale security. The Corporation determines the levels of its municipal bond holdings based on income tax planning and other considerations. Other securities consist of corporate obligations, mainly "Trust Preferred Securities" issued by financial institutions. Trust Preferred Securities are long-term obligations (usually 20-40 year maturities, often callable at the issuer's option after 5-10 years) which bear interest at fixed or variable rates. The average balance of other securities increased to $43,826,000 in 2002 from $29,577,000 in 2001 and $22,572,000, primarily as a result of purchases of Trust Preferred Securities. The loan portfolio makes up most of the balance of the earning asset base and is the largest contributor to total interest income. The Corporation's market area consists of small rural communities. Consequently, the loan portfolio is retail-oriented, consisting mostly of real estate secured mortgages on one-to-four family dwellings. Total average real estate secured mortgage loans made up approximately 80% of the loan portfolio during 2002, 2001 and 2000. In 2002 and 2001, there has been significant growth in lending activities. Average loans outstanding increased $64,317,000, or 18.6%, in 2002, and $27,971,000, or 8.8%, in 2001. Much of the growth in the loan portfolio in 2002 and 2001 has been in real estate secured loans, including commercial as well as residential real estate loans. Lower market interest rates, which have spurred significant levels of refinancing, and have resulted in many individuals' and businesses' willingness to take on more debt, have contributed to the Corporation's loan growth. Also, the Corporation's loan growth is attributable to the opening of the Muncy office, along with the hiring of several additional lending personnel in 2002 and 2001. The balance of the loan portfolio includes consumer installment loans and commercial loans. The Corporation also has a credit card operation, which is operated for the Corporation's customers and for other banks. The average return on the total loan portfolio for 2002 was 7.67%, down from 8.56% in 2001 and 8.79% in 2000. The lower return in 2002 was impacted by significant levels of mortgage refinancings, and by lower returns on commercial loans with variable rates. The average return on loans was 7.42% in the 4th quarter 2002. INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES Interest expense fell to $26,315,000 in 2002 from $28,356,000 in 2001 and $30,145,000 in 2000. As reflected in Table III, lower average interest rates had the effect of lowering expense $7,184,000 in 2002 and $5,994,000 in 2001. The impact of lower rates more than offset the effects on interest expense of higher average balances of interest-bearing liabilities. As shown in Table II. average balances of interest-bearing liabilities increased 18.1%, to $760,738,000 in 2002, and 13.8%, to $643,980,000 in 2001. As reflected in Table III, lower rates caused interest expense from money market accounts to fall $1,392,000 in 2002, and $2,518,000 in 2001. Money market accounts are repriced weekly, and thus are highly rate sensitive. As shown in Table II, the average cost of money market funds was 2.31% in 2002, 3.49% in 2001 and 5.39% in 2000. Table III also shows that interest expense from savings accounts declined in 2002 and 2001. Interest expense from savings accounts fell $508,000 in 2002 and $132,000 in 2001. In 2001, the Corporation's savings rate fell 2 times, from 2.5% to 2%, and then to its current level of 1%. As a result, the average interest rate incurred on savings accounts fell to 1.01% in 2002 from 2.16% in 2001 and 2.49% in 2000. 10 Interest expense from CDs decreased $1,532,000 in 2002 and increased $1,109,000 in 2001. Because CDs have terms that may range from 3 months to 5 years, they do not reprice as quickly as money market accounts or IRAs. The average rate incurred on CDs was 3.97% in 2002, 5.48% in 2001 and 5.64% in 2000. In contrast to the other major types of deposits, interest expense from Individual Retirement Accounts (IRAs) increased $455,000 in 2002. As shown in Table II, in 2002, the average balance of IRAs increased 14.3%, to $90,856,000. Throughout 2002, the Corporation offered the highest IRA rate in its marketplace, which was instrumental in this growth. For several years, the Corporation's IRA product was adjustable rate, repriced quarterly based on an index, with a floor of 5%. Effective September 1, 2002, the Corporation made changes to its IRA products, including: (1) for new IRAs, reduced the floor to 4%, and removed the tie to an external index, on the quarterly repricing IRA product, and (2) began to offer the Index Powered CD as an additional IRA product. (Index Powered CDs are described in detail in Note 10 to the consolidated financial statements.) In 2001, interest expense from IRAs fell $756,000, as falling interest rates gradually caused the Corporation's IRA rate to fall to the floor of 5%. The average rate incurred on IRAs was 4.98% in 2002, 5.12% in 2001 and 6.32% in 2000. As you can calculate from Table II, average total deposits (interest-bearing and noninterest-bearing) increased $68,813,000, or 12.6%, in 2002. In 2001, average total deposits increased $40,731,000, or 8.1%. In addition to IRAs, as described above, the other major types of deposits that increased in 2002 and 2001 were CDs, money market accounts and demand (checking) accounts. Management believes that deposit growth has resulted, in part, from declines in the U.S stock market, which has caused some investors to move funds to less volatile investments. Also, deposit growth has been enhanced by the expansion of the branch system in recent years, with relatively new offices opened in Mansfield (1998) and Muncy (2000). Interest expense on borrowed funds is presented in Table I in 2 categories - "Overnight borrowings" and "Other borrowed funds." Overnight borrowings include federal funds purchased from other banks and overnight repurchase agreements with FHLB - Pittsburgh. Other borrowed funds include overnight repurchase agreements with customers (the Corporation's "RepoSweep" accounts), borrowings from FHLB - Pittsburgh and other repurchase agreements. Interest expense on average other borrowed funds increased $1,278,000 in 2002 and $1,125,000 in 2001. Average other borrowed funds balances increased to $211,092,000 in 2002 from $151,615,000 in 2001 and $108,581,000 in 2000. As discussed in the "Interest Income - Earning Assets" section above, the Corporation borrowed funds in 2002 and 2001 to fund purchases of available-for-sale securities. Because of a favorable interest rate environment, the Corporation extended the terms of most of its borrowings from very short term (as of the end of 2000) to a "ladder" of staggered maturities extending out (primarily) over 5 years. Note 9 to the consolidated financial statements provides more details regarding the composition of borrowed funds as of December 31, 2002 and 2001. Average interest rates on other borrowed funds amounted to 4.29% in 2002, 5.13% in 2001 and 6.13% in 2000. Overall, Table III shows that lower rates had the effect of reducing interest expense associated with other borrowed funds in 2002 by $1,421,000, while higher average borrowing balances increased interest expense $2,699,000. In 2001, lower average rates decreased interest expense $1,208,000, while the increase in average borrowings increased interest expense by $2,333,000. 11 TABLE I - ANALYSIS OF INTEREST INCOME AND EXPENSE
YEARS ENDED DECEMBER 31, INCREASE(DECREASE) (IN THOUSANDS) 2002 2001 2000 02/01 01/00 INTEREST INCOME Available-for-sale securities: U.S. Treasury securities $ 75 $ 151 $ 154 $ (76) $ (3) Securities of other U.S. Government agencies and corporations 4,728 7,718 9,417 (2,990) (1,699) Mortgage-backed securities 11,097 9,487 6,874 1,610 2,613 Obligations of states and political subdivisions 8,641 6,216 6,342 2,425 (126) Equity securities 1,148 1,090 851 58 239 Other securities 2,975 2,244 1,724 731 520 - ---------------------------------------------------------------------------------------------------------------------------------- Total available-for-sale securities 28,664 26,906 25,362 1,758 1,544 - ---------------------------------------------------------------------------------------------------------------------------------- Held-to-maturity securities: U.S. Treasury securities 27 40 37 (13) 3 Securities of other U.S. Government agencies and corporations 20 43 68 (23) (25) Mortgage-backed securities 9 16 21 (7) (5) - ---------------------------------------------------------------------------------------------------------------------------------- Total held-to-maturity securities 56 99 126 (43) (27) - ---------------------------------------------------------------------------------------------------------------------------------- Interest-bearing due from banks 17 82 114 (65) (32) Federal funds sold 42 184 64 (142) 120 Loans: Real estate loans 25,454 23,431 21,895 2,023 1,536 Consumer 2,974 3,055 3,056 (81) (1) Agricultural 199 190 191 9 (1) Commercial/industrial 1,934 1,831 1,847 103 (16) Other 69 68 71 1 (3) Political subdivisions 858 1,043 909 (185) 134 Leases 11 17 22 (6) (5) - ---------------------------------------------------------------------------------------------------------------------------------- Total loans 31,499 29,635 27,991 1,864 1,644 - ---------------------------------------------------------------------------------------------------------------------------------- Total Interest Income 60,278 56,906 53,657 3,372 3,249 - ---------------------------------------------------------------------------------------------------------------------------------- INTEREST-BEARING LIABILITIES Interest checking 425 651 1,036 (226) (385) Money market 3,970 5,362 7,880 (1,392) (2,518) Savings 504 1,012 1,144 (508) (132) Certificates of deposit 7,752 9,284 8,175 (1,532) 1,109 Individual Retirement Accounts 4,528 4,073 4,829 455 (756) Other time deposits 36 35 44 1 (9) Overnight borrowings 44 161 384 (117) (223) Other borrowed funds 9,056 7,778 6,653 1,278 1,125 - ---------------------------------------------------------------------------------------------------------------------------------- Total Interest Expense 26,315 28,356 30,145 (2,041) (1,789) - ---------------------------------------------------------------------------------------------------------------------------------- Net Interest Income $33,963 $28,550 $23,512 $ 5,413 $ 5,038 ==================================================================================================================================
(1) Interest income from tax-exempt securities and loans has been adjusted to a fully taxable-equivalent basis, using the Corporation's marginal federal income tax rate of 34%. (2) Fees on loans are included with interest on loans and amounted to $1,286,000 in 2002, $1,054,000 in 2001 and $761,000 in 2000. 12 TABLE II - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES
2002 2001 2000 (DOLLARS IN THOUSANDS) RATE OF RATE OF RATE OF RETURN/ RETURN/ RETURN/ AVERAGE COST OF AVERAGE COST OF AVERAGE COST OF BALANCE FUNDS BALANCE FUNDS BALANCE FUNDS % % % EARNING ASSETS Available-for-sale securities, at amortized cost: U.S. Treasury securities $ 1,241 6.04 $ 2,506 6.03 $ 2,512 6.13 Securities of other U.S. Government agencies and corporations 75,646 6.25 113,186 6.82 133,063 7.08 Mortgage-backed securities 209,539 5.30 150,838 6.29 101,155 6.80 Obligations of states and political subdivisions 113,540 7.61 78,741 7.89 81,312 7.80 Equity securities 21,858 5.25 21,060 5.18 18,651 4.56 Other securities 43,826 6.79 29,577 7.59 22,572 7.64 - --------------------------------------------------------------------------------------------------------------------------------- Total available-for-sale securities 465,650 6.16 395,908 6.80 359,265 7.06 - --------------------------------------------------------------------------------------------------------------------------------- Held-to-maturity securities: U.S. Treasury securities 511 5.28 742 5.39 685 5.40 Securities of other U.S. Government agencies and corporations 331 6.04 680 6.32 1,019 6.67 Mortgage-backed securities 131 6.87 205 7.80 283 7.42 - --------------------------------------------------------------------------------------------------------------------------------- Total held-to-maturity securities 973 5.76 1,627 6.08 1,987 6.34 - --------------------------------------------------------------------------------------------------------------------------------- Interest-bearing due from banks 1,444 1.18 2,659 3.08 1,861 6.13 Federal funds sold 2,698 1.56 5,064 3.63 1,000 6.40 Loans: Real estate loans 338,133 7.53 279,828 8.37 254,225 8.61 Consumer 29,720 10.01 28,062 10.89 27,760 11.01 Agricultural 2,556 7.79 2,070 9.18 1,963 9.73 Commercial/industrial 28,182 6.86 22,212 8.24 21,336 8.66 Other 1,028 6.71 892 7.62 886 8.01 Political subdivisions 10,929 7.85 13,108 7.96 12,009 7.57 Leases 122 9.02 181 9.39 203 10.84 - --------------------------------------------------------------------------------------------------------------------------------- Total loans 410,670 7.67 346,353 8.56 318,382 8.79 - --------------------------------------------------------------------------------------------------------------------------------- Total Earning Assets 881,435 6.84 751,611 7.57 682,495 7.86 Cash 13,318 11,871 10,887 Unrealized gain/loss on securities 12,462 6,639 (12,831) Allowance for loan losses (5,453) (5,370) (5,233) Bank premises and equipment 10,246 9,602 8,712 Other assets 30,993 30,876 20,191 - --------------------------------------------------------------------------------------------------------------------------------- Total Assets $ 943,001 $ 805,229 $ 704,221 ================================================================================================================================= INTEREST-BEARING LIABILITIES Interest checking $ 37,984 1.12 $ 37,192 1.75 $ 36,086 2.87 Money market 171,767 2.31 153,738 3.49 146,209 5.39 Savings 49,779 1.01 46,750 2.16 45,963 2.49 Certificates of deposit 195,099 3.97 169,275 5.48 144,997 5.64 Individual Retirement Accounts 90,856 4.98 79,482 5.12 76,439 6.32 Other time deposits 1,814 1.98 1,916 1.83 1,717 2.56 Overnight borrowings 2,347 1.87 4,012 4.01 5,721 6.71 Other borrowed funds 211,092 4.29 151,615 5.13 108,581 6.13 - --------------------------------------------------------------------------------------------------------------------------------- Total Interest-bearing Liabilities 760,738 3.46 643,980 4.40 565,713 5.33 Demand deposits 66,093 56,226 52,437 Other liabilities 8,575 9,002 7,279 - -------------------------------------------------------------------------- --------------- -------------- Total Liabilities 835,406 709,208 625,429 - -------------------------------------------------------------------------- --------------- -------------- Stockholders' equity, excluding other comprehensive income/loss 99,361 91,703 87,258 Other comprehensive income/loss 8,234 4,318 (8,466) - -------------------------------------------------------------------------- --------------- -------------- Total Stockholders' Equity 107,595 96,021 78,792 - -------------------------------------------------------------------------- --------------- -------------- Total Liabilities and Stockholders' Equity $ 943,001 $ 805,229 $ 704,221 ========================================================================== =============== ============== Interest Rate Spread 3.38 3.17 2.53 Net Interest Income/Earning Assets 3.85 3.80 3.45
(1) Rates of return on tax-exempt securities and loans are calculated on a fully-taxable equivalent basis, using the Corporation's marginal federal income tax rate of 34%. (2) Nonaccrual loans are included in the loan balances above. 13 TABLE III - THE EFFECT OF VOLUME AND RATE CHANGES ON INTEREST INCOME AND INTEREST EXPENSE
YEARS ENDED 12/31/02 VS. 01 YEARS ENDED 12/31/01 VS. 00 (IN THOUSANDS) CHANGE IN CHANGE IN TOTAL CHANGE IN CHANGE IN TOTAL VOLUME RATE CHANGE VOLUME RATE CHANGE EARNING ASSETS Available-for-sale securities: U.S. Treasury securities $ (76) $ - $ (76) $ - $ (3) $ (3) Securities of other U.S. Government agencies and corporations (2,389) (601) (2,990) (1,364) (335) (1,699) Mortgage-backed securities 3,277 (1,667) 1,610 3,158 (545) 2,613 Obligations of states and political subdivisions 2,655 (230) 2,425 (202) 76 (126) Equity securities 42 16 58 117 122 239 Other securities 987 (256) 731 531 (11) 520 - ------------------------------------------------------------------------------------------------------------------------------------ Total available-for-sale securities 4,496 (2,738) 1,758 2,240 (696) 1,544 - ------------------------------------------------------------------------------------------------------------------------------------ Held-to-maturity securities: U.S. Treasury securities (12) (1) (13) 3 - 3 Securities of other U.S. Government agencies and corporations (21) (2) (23) (21) (4) (25) Mortgage-backed securities (5) (2) (7) (6) 1 (5) - ------------------------------------------------------------------------------------------------------------------------------------ Total held-to-maturity securities (38) (5) (43) (24) (3) (27) - ------------------------------------------------------------------------------------------------------------------------------------ Interest-bearing due from banks (27) (38) (65) 38 (70) (32) Federal funds sold (64) (78) (142) 159 (39) 120 Loans: Real estate loans 4,550 (2,527) 2,023 2,157 (621) 1,536 Consumer 174 (255) (81) 33 (34) (1) Agricultural 41 (32) 9 10 (11) (1) Commercial/industrial 442 (339) 103 74 (90) (16) Other 9 (8) 1 - (3) (3) Political subdivisions (171) (14) (185) 86 48 134 Leases (5) (1) (6) (2) (3) (5) - ------------------------------------------------------------------------------------------------------------------------------------ Total loans 5,040 (3,176) 1,864 2,358 (714) 1,644 - ------------------------------------------------------------------------------------------------------------------------------------ Total Interest Income 9,407 (6,035) 3,372 4,771 (1,522) 3,249 - ------------------------------------------------------------------------------------------------------------------------------------ INTEREST-BEARING LIABILITIES Interest checking 14 (240) (226) 31 (416) (385) Money market 574 (1,966) (1,392) 388 (2,906) (2,518) Savings 62 (570) (508) 20 (152) (132) Certificates of deposit 1,277 (2,809) (1,532) 1,337 (228) 1,109 Individual Retirement Accounts 570 (115) 455 186 (942) (756) Other time deposits (2) 3 1 5 (14) (9) Overnight borrowings (51) (66) (117) (95) (128) (223) Other borrowed funds 2,699 (1,421) 1,278 2,333 (1,208) 1,125 - ------------------------------------------------------------------------------------------------------------------------------------ Total Interest Expense 5,143 (7,184) (2,041) 4,205 (5,994) (1,789) - ------------------------------------------------------------------------------------------------------------------------------------ Net Interest Income $ 4,264 $ 1,149 $ 5,413 $ 566 $ 4,472 $ 5,038 ====================================================================================================================================
(1) Changes in interest income on tax-exempt securities and loans are presented on a fully taxable-equivalent basis, using the Corporation's marginal federal income tax rate of 34%. (2) The change in interest due to both volume and rates has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. 14 NONINTEREST INCOME 2002/2001/2000 Total noninterest income increased $1,472,000, or 18.3%, in 2002 compared to 2001. The increase in net realized security gains is discussed in the "Earnings Overview" section of Management's Discussion and Analysis. Other items of significance are as follows: 2002 VS. 2001 - - Service charges on deposit accounts increased $349,000, or 25.4%. This increase resulted from growth in deposits, as well as fee increases implemented in the second half of 2001 on certain types of services. - - Trust and financial management revenue increased $179,000, or 11.4%. This increase resulted from fee increases implemented in the latter part of 2001, and from receipt of certain fees for services provided prior to 2002. Trust revenue is recorded on a cash basis, which does not vary materially from the accrual basis. 2001 VS. 2000 Total noninterest income increased $1,661,000, or 26.0%, in 2001 compared to 2000. The most significant changes - the increase in security gains and income from the (BOLI) life insurance contract - are discussed in the "Earnings Overview" section of Management's Discussion and Analysis. Other items of significance are as follows: - - Service charges on deposit accounts increased $226,000, or 19.7%. This increase resulted from increased numbers of accounts and higher average balances, as well as fee increases on certain types of services. - - Insurance revenue increased $210,000, or 56.5%. This increase is mainly attributable to revenue from the insurance agency division of C&N Financial Services Corporation (C&NFSC). C&NFSC began operations in 2000, with minimal revenues. C&NFSC generated insurance revenue of $216,000 in 2001 and $22,000 in 2000. - - Noninterest fees from the credit card operation decreased $347,000, or 38.7%. In late 1999, the Corporation sold its merchant processing program, which dramatically reduced the amount of interchange fees earned and costs incurred. In the first quarter 2000, the Corporation recorded final residual fees. - - Other operating income increased $146,000. In 2001, C&NFSC began operating a broker dealer division, which offers annuities, mutual funds and other non-bank investment products. The broker dealer division generated revenue of $84,000 in 2001. Another significant change within the items included in other operating income is interchange fees received from the Bank's VISA check card product. This product was introduced in late 1999, and has grown in numbers of accounts and usage. These fees increased to $87,000 in 2001 from $42,000 in 2000. Also within other operating income, gains from sales of other real estate properties increased to $135,000 in 2001 from $104,000 in 2000. TABLE IV - COMPARISON OF NONINTEREST INCOME
(IN THOUSANDS) 2002 % CHANGE 2001 % CHANGE 2000 Service charges on deposit accounts $ 1,725 25.4 $ 1,376 19.7 $ 1,150 Service charges and fees 258 4.5 247 6.5 232 Trust and financial management revenue 1,755 11.4 1,576 (2.3) 1,613 Insurance commissions, fees and premiums 577 (0.9) 582 56.5 372 Increase in cash surrender value of life insurance 853 (5.7) 905 N/A - Fees related to credit card operation 631 14.7 550 (38.7) 897 Other operating income 825 (6.7) 884 19.8 738 - ----------------------------------------------------------------------------------------------------------------- Total other income before realized gains on securities, net 6,624 8.2 6,120 22.4 5,002 Realized gains on securities, net 2,888 50.4 1,920 39.4 1,377 - ----------------------------------------------------------------------------------------------------------------- Total Other Income $ 9,512 18.3 $ 8,040 26.0 $ 6,379 =================================================================================================================
15 OTHER NONINTEREST EXPENSE 2002/2001/2000 Total noninterest expense increased 11.7% in 2002, to $20,849,000. In 2001, total noninterest expense was $18,671,000, a 10.4% increase over 2000. 2002 VS. 2001 Salaries and wages increased $925,000, or 10.9%, in 2002 compared to 2001. The increase is the result of annual merit raises ranging from 2%-5%, an increase in the number of employees and an increase in incentive bonus expense. Increases in staff during the last half of 2001 and throughout 2002 included the addition of new positions in branch and commercial lending, branch administration, compliance and marketing. The incentive bonus plan provides for compensation to be paid to certain key officers based on a combination of corporate and personal performance. Total incentive bonus expense increased $185,000 in 2002. Pensions and other employee benefits increased $438,000, or 19.8%, in 2002 over 2001. A portion of this increase is directly related to the increase in salaries and wages. Also, pension expense from the Corporation's defined benefit pension plan increased $245,000 in 2002 over 2001. A decline in the market value of plan assets was the main cause of the increase in expense in 2002. Note 12 to the consolidated financial statements provides more information related to the defined benefit pension plan. Other expense increased $704,000, or 15.9%, in 2002 over 2001. This category includes many different types of expenses. Some of the overall increase in this category was caused by increases in number of transactions processed and number of employees. The most significant changes within this category are as follows: - Expenses of Bucktail Life Insurance Company, increased $111,000, to $335,000. This increase resulted mainly from a larger amount of life insurance claims incurred. - Professional fees increased $101,000, to $276,000. This increase reflected costs associated with organizational and product profitability consultants, human resources consultants and other consultants related to various aspects of the Corporation's operations. - Office and other supplies increased $77,000, to $502,000, as a result of increased volumes of employees and customers. - Restricted stock amortization increased $58,000, to $80,000. This category of expense included amortization associated with 2 years of awards to Directors and certain employees in 2002, compared to only 1 year in 2001 (the first year for which there were restricted stock awards). Stock-based compensation plans are described in more detail in Note 12 to the financial statements. - In 2002, the Corporation wrote off asset-liability reporting software of $41,000, due to management's decision to change to an outsourcing provider of asset-liability reports. 2001 VS. 2000 Salaries and wages increased $896,000, or 11.8%, in 2001 compared to 2000. The increase is the result of annual merit raises ranging from 2%-5%, and an increase in the number of employees. Higher staffing levels were required for the Muncy branch, commercial and retail lending, trust and financial management and insurance sales and service. Pensions and other employee benefits increased $274,000, or 14.1%, in 2001. In addition to increased costs resulting from the higher number of employees, the Corporation experienced an increase in medical insurance premium rates. Occupancy expense increased $90,000, or 9.7%, in 2001. This increase is mainly due to additional facilities. In 2000, the Corporation constructed a new branch in Muncy, purchased a building for credit card operations, and purchased 2 buildings near the Wellsboro branch/administrative building for additional administrative space. 16 Furniture and equipment expense increased $237,000, or 19.8%, in 2001. The major categories of furniture and equipment expense that increased in 2001 compared to 2000 were maintenance costs associated with computer hardware and software, and depreciation. The increase in computer maintenance costs is mainly attributable to the timing of certain maintenance costs. Increased depreciation expense resulted primarily from the addition of the Muncy branch, which began operations in the 4th quarter 2000, and the opening of the new credit card operations facility in mid-2000. Credit card expenses decreased in 2001 because of lower interchange fees paid. This change resulted from the sale of the merchant banking program, as discussed in the "Noninterest Income" section of Management's Discussion and Analysis. Other expense increased $346,000, or 8.5%, in 2001. This category includes many different types of expenses. Some of the overall increase in this category was caused by increases in number of transactions processed and number of employees. The most significant fluctuations in individual types of expenses between years are as follows: - - Customer support and maintenance charges related to software products increased $74,000, to $144,000, in 2001. This reflects increased use of third-party software programs for specialized applications, which are used as a complement to the Corporation's core, in house programs. - - In 2001, the Corporation incurred consulting expense of $51,000 related to sales and service training. This training program is a substantial undertaking, aimed at improving the sales and service skills of virtually all employees. The amount of expense noted here does not include costs of miscellaneous training materials, nor more significantly, any allocation of internal payroll-related costs associated with sales and service training. - - Telephone expenses related to data lines increased $47,000, to $254,000, in 2001. These costs are mainly related to the Corporation's computer network that allows all branches and operating locations to access mainframe and PC applications. The Corporation's monthly data line costs increased to approximately the current level starting in the 2nd quarter 2000. - - Public relations expense increased $45,000, to $189,000, in 2001. This increase includes new sponsorships of several community-oriented programs located in the Corporation's market area, as well as costs related to promotion of the Muncy office. - - Expenses associated with maintaining other real estate properties increased $42,000, to $76,000, in 2001. - - In 2000, the Corporation incurred professional fees of $193,000 related to a proposed merger with Peoples, Ltd. of Wyalusing, PA. In November 2000, the vote by Peoples, Ltd.'s shareholders did not result in the 75% affirmative count required to approve the deal. TABLE V - COMPARISON OF NONINTEREST EXPENSE
(IN THOUSANDS) 2002 % CHANGE 2001 % CHANGE 2000 Salaries and wages $ 9,418 10.9 $ 8,493 11.8 $ 7,597 Pensions and other employee benefits 2,651 19.8 2,213 14.1 1,939 Occupancy expense, net 1,094 7.5 1,018 9.7 928 Furniture and equipment expense 1,532 7.1 1,431 19.8 1,194 Expenses related to credit card operation 285 (3.4) 295 (27.5) 407 Pennsylvania shares tax 734 (7.1) 790 4.5 756 Other operating expense 5,135 15.9 4,431 8.5 4,085 - ------------------------------------------------------------------------------------------------------------------ Total Other Expense $ 20,849 11.7 $ 18,671 10.4 $ 16,906 ==================================================================================================================
17 FINANCIAL CONDITION Significant changes in the average balances of the Corporation's earning assets and interest-bearing liabilities are described in the "NET INTEREST MARGIN" section of Management's Discussion and Analysis. In particular, the discussion of changes in available-for-sale securities, loans, deposits and borrowed funds in 2002 is sufficient to explain the overall change in the year-end balances in 2002 compared to 2001. Other significant balance sheet items - the allowance for loan losses and stockholders' equity - are discussed in separate sections of Management's Discussion and Analysis. Table VI shows the composition of the investment portfolio at December 31, 2002, 2001 and 2000. Premises and equipment, net of accumulated depreciation, increased to $10,333,000 at December 31, 2002 from $9,967,000 at December 31, 2001. The total cost of premises and equipment purchases was $1,712,000 in 2002, $1,935,000 in 2001 and $2,426,000 in 2000. In 2002, the most significant capital purchases included renovations of the Tioga and Athens offices, and completion of renovations to the leased facility on Main Street in Wellsboro. Other major categories of capital purchases in 2002 included purchases of computer hardware and software, and purchase and demolition of property adjacent to the Wysox office. In 2001, the most significant capital purchases were for new proof of deposit software, renovations to branches and a new telephone system. The most significant capital investment in 2000 was the addition of the Muncy branch, for which land, building construction and initial furniture and equipment cost slightly more than $1,000,000. Depreciation expense amounted to $1,346,000 in 2002, $1,300,000 in 2001 and $1,086,000 in 2000. The total cost of capital expenditures for 2003 is expected to be in the range of the amounts spent in 2000-2002. Capital expenditures will not have a detrimental effect on the Corporation's financial condition in 2003. TABLE VI - INVESTMENT SECURITIES
AS OF DECEMBER 31, 2002 2001 2000 (IN THOUSANDS) AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE COST VALUE AVAILABLE-FOR-SALE SECURITIES: Obligations of the U.S. Treasury $ - $ - $ 2,503 $ 2,557 $ 2,509 $ 2,533 Obligations of other U.S. Government agencies 71,657 72,348 75,295 75,172 132,713 128,883 Obligations of states and political subdivisions 127,690 130,879 95,835 95,261 68,236 69,065 Other securities 62,296 63,592 34,315 34,532 22,111 20,964 Mortgage-backed securities 207,244 212,276 198,269 198,975 91,708 91,240 - ---------------------------------------------------------------------------------------------------------------------------------- Total debt securities 468,887 479,095 406,217 406,497 317,277 312,685 Marketable equity securities 24,886 33,080 19,745 27,472 22,098 26,814 - ---------------------------------------------------------------------------------------------------------------------------------- Total $ 493,773 $512,175 $ 425,962 $433,969 $ 339,375 $339,499 ================================================================================================================================== HELD-TO-MATURITY SECURITIES: Obligations of the U.S. Treasury $ 321 $ 359 $ 726 $ 735 $ 707 $ 708 Obligations of other U.S. Government agencies 297 322 547 561 946 947 Mortgage-backed securities 89 93 175 181 258 259 - ---------------------------------------------------------------------------------------------------------------------------------- Total $ 707 $ 774 $ 1,448 $ 1,477 $ 1,911 $ 1,914 ==================================================================================================================================
18 PROVISION AND ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio. In evaluating collectibility, management considers a number of factors, including the status of specific impaired loans, trends in historical loss experience, delinquency trends, credit concentrations, comparison of historical loan loss data to that of other financial institutions and economic conditions within the Corporation's market area. Allowances for impaired loans are determined based on collateral values or the present value of estimated cash flows. The allowance is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. Each quarter, management performs a detailed assessment of the allowance and the provision for loan losses. The loan quality committee performs this assessment. This committee includes the Bank's President, Chief Financial Officer, Executive Vice Presidents in charge of loans and branch administration and additional commercial lending staff. The committee reviews the identified risk elements in the loan portfolio, including the "Watch List", past due reports and other information. The "Watch List" is a collection of loans that have a history of delinquency, collateral deficiency, cash flow problems, or other factors that have come to management's attention to create the need for special monitoring. The Bank also engages a consulting firm each year to perform an independent credit review. Their review is performed annually on credit relationships of $250,000 and higher as well as other selected credit relationships. The loan quality committee gives substantial consideration to the classifications and recommendations of the independent credit reviewer in determining the allowance for loan losses. The allowance for loan losses includes two components, allocated and unallocated. The allocated component of the allowance for loan losses reflects expected losses resulting from the analysis of individual loans and historical loss experience, as modified for identified trends and concerns, for each loan category. The historical loan loss experience element is determined based on the ratio of net charge-offs to average loan balances over a five-year period, for each significant type of loan, modified for risk adjustment factors identified by management for each type of loan. The charge-off ratio, as modified, is then applied to the current outstanding loan balance for each type of loan (net of Watch List and other loans that are individually evaluated). The unallocated portion of the allowance is determined based on management's assessment of general economic conditions as well as specific economic factors in the market area. This determination inherently involves a higher degree of uncertainty and considers current risk factors that may not have yet manifested themselves in the Bank's historical loss factors used to determine the allocated component of the allowance, and it recognizes that management's knowledge of specific losses within the portfolio may be incomplete. Table IX reflects an allowance of $1,877,000 for losses related to impaired loans as of December 31, 2002. This reflects management's evaluation of impairment associated with several commercial loan relationships. Management believes it has been conservative, but reasonable, in its commercial loan impairment calculations. However, the actual losses realized from these relationships could vary materially from the allowances calculated as of December 31, 2002. As you can see in Table IX, the allowance for loan losses related to impaired loans was much higher at December 31, 2002 than as of the ends of each of the previous 4 years. In years prior to 2002, amounts disclosed related to impaired loans were limited to commercial loans that had been classified as nonaccrual. Effective in the fourth quarter 2002, management changed its method of identifying impaired loans to include all individual loans for which an allowance was calculated. Management believes this method of determining disclosure information is more consistent with the applicable requirements of FASB Statements No. 114 and 118. This change affects disclosures related to impaired loans, and the allocation of the allowance for loan losses as presented in Table IX, but does not represent a change in management's method for calculating the allowance for loan losses. As noted in Table IX, the unallocated portion of the allowance for loan losses was $1,759,000 at December 31, 2002 and $2,187,000 at December 31, 2001. The unallocated balances ranged from $1,759,000 to $2,222,000 in 2002 and $1,983,000 to $2,364,000 during 2001. In evaluating the unallocated portion of the allowance, management considers several trends, including comparisons of loan loss data to other financial institutions and tracking of delinquency and charge-off trends. Loan delinquency data has been fairly consistent over the last 2 years. Total 90 day or more past due loans, plus nonaccrual loans, amounted to $3,570,000 (0.79% of total loans) at December 31, 2002, and $3,117,000 (0.82% of total loans) at December 31, 2001. Total 30-89 day past due loans amounted to $8,853,000 (1.96% of total loans) at December 31, 2002, and $7,066,000 (1.86% of total loans) at December 31, 2001. As reflected in Table VIII, gross and net charge-offs were slightly lower in 2002 than in any of the previous 4 years; however, in light of the increase in allowances on impaired loans, this may not be a sustainable trend. 19 The provision for loan losses amounted to $940,000 in 2002, $600,000 in 2001 and $676,000 in 2000. The higher provision in 2002 reflects increased estimates of allowances on impaired or Watch List loans, as described above. The amount of the provision in each year is determined based on the amount required to maintain an appropriate allowance in light of the factors described above. Tables VII, VIII, IX and X present an analysis of the loan portfolio, the allowance for loan losses, the allocation of the allowance and a five-year summary of loans by type. TABLE VII - FIVE-YEAR HISTORY OF LOAN LOSSES (IN THOUSANDS)
2002 2001 2000 1999 1998 AVERAGE Year-end gross loans, excluding unearned discount $451,145 $379,228 $328,305 $310,892 $291,003 $352,115 Year-end allowance for loan Losses 5,789 5,265 5,291 5,131 4,820 5,259 Year-end nonaccrual loans 1,252 1,050 1,608 1,956 1,135 1,400 Year-end loans 90 days or more past due and still accruing 2,318 2,067 1,221 1,797 1,628 1,806 Net charge-offs 416 626 516 449 856 573 Provision for loan losses 940 600 676 760 763 748 Earnings coverage of charge- Offs 36.0 19.3 16.4 25.6 12.9 20.3 Allowance coverage of charge- Offs 13.9 8.4 10.3 11.4 5.6 9.2 Net charge-offs as a % of provision for loan losses 44.3% 104.3% 76.3% 59.1% 112.2% 76.6%
TABLE VIII - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
(IN THOUSANDS) YEARS ENDED DECEMBER 31, 2002 2001 2000 1999 1998 Balance, beginning of year $ 5,265 $ 5,291 $ 5,131 $ 4,820 $ 4,913 - --------------------------------------------------------------------------------------------- Charge-offs: Real estate loans 123 144 272 81 257 Installment loans 116 138 77 138 144 Credit cards and related plans 190 200 214 192 264 Commercial and other loans 123 231 53 219 301 - --------------------------------------------------------------------------------------------- Total charge-offs 552 713 616 630 966 - --------------------------------------------------------------------------------------------- Recoveries: Real estate loans 30 6 26 81 12 Installment loans 30 27 23 60 43 Credit cards and related plans 18 20 28 30 40 Commercial and other loans 58 34 23 10 15 - --------------------------------------------------------------------------------------------- Total recoveries 136 87 100 181 110 - --------------------------------------------------------------------------------------------- Net charge-offs 416 626 516 449 856 Provision for loan losses 940 600 676 760 763 - --------------------------------------------------------------------------------------------- Balance, end of year $ 5,789 $ 5,265 $ 5,291 $ 5,131 $ 4,820 =============================================================================================
20 TABLE IX - ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES BY TYPE
(IN THOUSANDS) 2002 2001 2000 1999 1998 Commercial $ 1,315 $ 1,837 $ 1,612 $ 2,081 $ 650 Consumer mortgage 460 674 952 834 97 Impaired loans 1,877 73 273 609 290 Consumer 378 494 471 437 702 All other commitments - - - 150 202 Unallocated 1,759 2,187 1,983 1,020 2,879 - ------------------------------------------------------------------------------------- Total Allowance $ 5,789 $ 5,265 $ 5,291 $ 5,131 $ 4,820 =====================================================================================
The above allocation is based on estimates and subjective judgments and is not necessarily indicative of the specific amounts or loan categories in which losses may occur. The calculation for 1998 did not include specific amounts for "Watch List" loans. These loans were included in the total population of loans and historical loss ratios applied. TABLE X - FIVE-YEAR SUMMARY OF LOANS BY TYPE
(IN THOUSANDS) 2002 % 2001 % 2000 % 1999 % 1998 % Real estate - construction $ 103 0.02 $ 1,814 0.48 $ 452 0.14 $ 649 0.21 $ 1,004 0.34 Real estate - mortgage 370,453 82.12 306,264 80.76 263,325 80.21 247,604 79.64 230,815 79.31 Consumer 31,532 6.99 29,284 7.72 28,141 8.57 29,140 9.37 30,924 10.63 Agricultural 3,024 0.67 2,344 0.62 1,983 0.60 1,899 0.61 1,930 0.66 Commercial 30,874 6.84 24,696 6.51 20,776 6.33 18,050 5.81 17,630 6.06 Other 2,001 0.44 1,195 0.32 948 0.29 1,025 0.33 1,062 0.36 Political subdivisions 13,062 2.90 13,479 3.55 12,462 3.80 12,332 3.97 7,449 2.56 Lease receivables 96 0.02 152 0.04 218 0.07 222 0.07 218 0.07 - --------------------------------------------------------------------------------------------------------------------------------- Total 451,145 100.00 379,228 100.00 328,305 100.00 310,921 100.00 291,032 100.00 Less: unearned discount - - - (29) (29) - --------------------------------------------------------------------------------------------------------------------------------- 451,145 379,228 328,305 310,892 291,003 Less: allowance for loan losses (5,789) (5,265) (5,291) (5,131) (4,820) - --------------------------------------------------------------------------------------------------------------------------------- Loans, net $ 445,356 $ 373,963 $ 323,014 $ 305,761 $ 286,183 =================================================================================================================================
LIQUIDITY Liquidity is the ability to quickly raise cash at a reasonable cost. An adequate liquidity position permits the Corporation to pay creditors, compensate for unforeseen deposit fluctuations and fund unexpected loan demand. The Corporation maintains overnight borrowing facilities with several correspondent banks that provide a source of day-to-day liquidity. Also, the Corporation maintains borrowing facilities with FHLB - Pittsburgh, secured by various securities and mortgage loans. At December 31, 2002, the Corporation had unused borrowing availability with correspondent banks and FHLB - Pittsburgh totaling approximately $205,000,000. Additionally, the Corporation uses repurchase agreements placed with brokers to borrow short-term funds secured by investment assets, and uses "RepoSweep" arrangements to borrow funds from commercial banking customers on an overnight basis. On a longer-term basis, one of the tools used to measure liquidity is the loan to deposit ratio. As of December 31, 2002, this ratio was 70%, which (by banking industry standards) is a relatively low ratio (which indicates a relatively high level of liquidity). This low loan to deposit ratio permits the Corporation to utilize "excess" funds to purchase investment securities. If required to raise cash in an emergency situation, the Corporation could sell non-pledged investment securities to meet its obligations. Management believes the combination of its strong capital position (discussed in the next section), ample available borrowing facilities and low loan to deposit ratio have placed the Corporation in a position of minimal short-term and long-term liquidity risk. 21 STOCKHOLDERS' EQUITY AND CAPITAL ADEQUACY The Corporation and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. For many years, the Corporation and the Bank have maintained strong capital positions. Details concerning the Corporation's and the Bank's regulatory capital amounts and ratios are presented in Note 16 to the consolidated financial statements. As reflected in Note 16, at December 31, 2002 and 2001, the ratios of total capital to risk-weighted assets, tier 1 capital to risk-weighted assets and tier 1 capital to average total assets are well in excess of the amounts necessary to be classified as "well-capitalized" by the banking agencies. The Corporation's total stockholders' equity is affected by fluctuations in the fair values of available-for-sale securities. The difference between amortized cost and fair value of available-for-sale securities, net of deferred income tax, is classified as "Accumulated Other Comprehensive Income" within stockholders' equity. Changes in accumulated other comprehensive income are excluded from earnings and directly increase or decrease stockholders' equity. COMPREHENSIVE INCOME Comprehensive income is a measure of all changes in the equity of a corporation, excluding transactions with owners in their capacity as owners (such as proceeds from issuances of stock and dividends). The difference between net income and comprehensive income is termed "Other Comprehensive Income". For the Corporation, other comprehensive income consists of unrealized gains and losses on available-for-sale securities, net of deferred income tax. Comprehensive income should not be construed to be a measure of net income. The amount of unrealized gains or losses reflected in comprehensive income may vary widely from period-to-period, depending on the financial markets as a whole and how the portfolio of available-for-sale securities is affected by interest rate movements. Total comprehensive income (loss) was $21,821,000 in 2002, $17,254,000 in 2001 and $17,442,000 in 2000. Other comprehensive income amounted to $6,862,000 in 2002, $5,202,000 in 2001 and $8,966,000 in 2000. INFLATION Over the last several years, direct inflationary pressures on the Corporation's payroll-related and other noninterest costs have been modest. In fact, some economists have warned of the threat of deflationary pressures, similar to recent experiences in Japan. The Corporation is significantly affected by the Federal Reserve Board's efforts to control inflation through changes in interest rates. Management monitors the impact of economic trends, including any indicators of inflationary (or deflationary) pressure, in managing interest rate and other financial risks. RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, The Financial Accounting Standard Board ("FASB") issued Statement No. 143, "Accounting for Asset Retirement Obligations." This statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) the normal operation of a long-lived asset, except for certain obligations of lessees. As used in this Statement, a legal obligation is an obligation that a party is required to settle as a result of an existing or enacted law, statute, ordinance or written or oral contract or by legal construction of a contract under the doctrine of promissory estopple. This Statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. This Statement amends FASB Statement No. 19 "Financial Accounting and Reporting by Oil and Gas Producing Companies" and it applies to all entities. It is effective for financial statements issued for fiscal years beginning after June 15, 2002. The adoption of this Statement on January 1, 2003 is not expected to have an impact on the Corporation's earnings, financial condition or equity. 22 In August 2001, the FASB issued Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This Statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets, and supersedes FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." However, the Statement retains the fundamental provisions of Statement No. 121 for (a) recognition and measurement of the impairment of long-lived assets to be held and used and (b) measurement of long-lived assets to be disposed of by sale. This Statement supersedes the accounting and recording provisions of APB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of a segment of a business. However, this Statement retains the requirement of Opinion No. 30 to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that either has been disposed of (by sale, by abandonment or in the distribution to owners) or is classified as held for sale. This Statement also amends ARB No. 51, "Consolidated Financial Statements", to eliminate the exception to consolidation for a temporarily-controlled subsidiary. The provisions of this Statement were effective for financial statements issued for fiscal years beginning after December 15, 2001. The Adoption of this Statement on January 1, 2002 did not have an impact on the Corporation's earnings, financial condition or equity. In April 2002, the FASB issued Statement No. 145 "Rescission of FASB Statements No. 4, 44, and 64 Amendment of FASB Statement No. 13, and Technical Corrections." "This Statement rescinds FASB Statement No. 4, "Reporting Gains and Losses from Extinguishment of Debt, " and an amendment of that Statement, FASB Statement No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements," along with rescinding FASB Statement No. 44, "Accounting for Intangible Assets of Motor Carriers and amending FASB Statement No. 13, Accounting for Leases." This Statement (1) eliminates an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions, (2) eliminates the extraordinary item treatment of reporting gains and losses from extinguishments of debt, and (3) makes certain other technical corrections. The provisions of this Statement related to the rescission of Statement 4 shall be applied in fiscal years beginning after May 15, 2002. Any gain or loss on extinguishments of debt that was classified as an extraordinary item in prior periods presented that does not meet the criteria in Opinion 30 for classification as an extraordinary item shall be reclassified. The provisions of this Statement related to Statement 13 shall be effective for transactions occurring after May 15, 2002. All other provisions of this Statement shall be effective for financial statements issued on or after May 15, 2002. The adoption of the effective portions of this Statement did not have an impact on the Corporation's earnings, financial condition or equity, except that (as described in Note 9 to the consolidated financial statements) the Corporation incurred prepayment penalties from the early retirement of debt of $101,000 in 2002, and included these costs in interest expense (prior to this Statement, the prepayment penalties would have been presented as extraordinary items in the income statement). The adoption of the remaining portions of this Statement is not expected to have an impact on the Corporation's earnings, financial condition or equity. In June 2002, the FASB issued Statement No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002. The Corporation does not expect the adoption of this Statement to have an impact on its earnings, financial condition or equity. On October 1, 2002, the FASB issued Statement No. 147, "Acquisitions of Certain Financial Institutions," effective for all business combinations initiated after October 1, 2002. This Statement addresses the financial accounting and reporting for the acquisition of all or part of a financial institution except for a transaction between two or more mutual enterprises. This Statement removes acquisitions of financial institutions, other than transactions between two or more mutual enterprises, from the scope of Statement No 72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions," and FASB Interpretation No. 9, "Applying APB Opinions No. 16 and 17 When a Savings and Loan Association or a Similar Institution is Acquired in a Business Combination Accounted for by the Purchase Method." The acquisition of all or part of a financial institution that meets the definition of a business combination shall be accounted for by the purchase method in accordance with Statement No. 141, "Business Combinations," and Statement No. 142, "Goodwill and Other Intangible Assets." This Statement also provides guidance on the accounting for the impairment or disposal of acquired long-term customer-relationship intangible assets (such as depositor-and-borrower-relationship intangible assets and credit cardholder intangible assets), including those acquired in transactions between two or more mutual enterprises. The Adoption of this Statement has not had an impact on the Corporation's earnings, financial condition or equity. 23 In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirement for Guarantees, Including Indirect Guarantees of the Indebtedness of Others." This Interpretation clarifies the requirements for a guarantor's accounting for and disclosures of certain guarantees issued and outstanding. The Interpretation requires a guarantor to recognize a liability for the fair value of the obligation it assumes under that guarantee. The initial recognition and initial measurement provisions of the Interpretation are applied on a prospective basis to guarantees issued or modified after December 31, 2002. The guarantor's accounting for guarantees issued prior to the date of initial application should not be revised or restated to reflect the effect of the recognition and measurement provisions of the Interpretation. The Interpretation's disclosure requirements were implemented during the year ended December 31, 2002 (see Note 15 to the consolidated financial statements for expanded disclosures related to standby letters of credit). The adoption of the recognition and measurement provisions of this statement are not expected to have a significant impact on the Corporation's earnings, financial condition or equity. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information concerningMARKET RISK The Corporation's two major categories of market risk, appears on pages 41 through 43interest rate and equity securities risk, are discussed in the following sections. INTEREST RATE RISK Business risk arising from changes in interest rates is an inherent factor in operating a bank. The Corporation's assets are predominantly long-term, fixed rate loans and debt securities. Funding for these assets comes principally from shorter-term deposits and borrowed funds. Accordingly, there is an inherent risk of lower future earnings or decline in fair value of the Annual ReportCorporation's financial instruments when interest rates change. The Bank uses a simulation model to calculate the potential effects of interest rate fluctuations on net interest income and the market value of portfolio equity. Only assets and liabilities of the Bank are included in management's monthly simulation model calculations. Since the Bank makes up more than 90% of the Corporation's total assets and liabilities, and because the Bank is herein incorporatedthe source of the most volatile interest rate risk, management does not consider it necessary to run the model for the remaining entities within the consolidated group. For purposes of these calculations, the market value of portfolio equity includes the fair values of financial instruments, such as securities, loans, deposits and borrowed funds, and the book values of nonfinancial assets and liabilities, such as premises and equipment and accrued interest. The model measures and projects potential changes in net interest income, and calculates the discounted present value of anticipated cash flows of financial instruments, assuming an immediate increase or decrease in interest rates. Management ordinarily runs a variety of scenarios within a range of plus or minus 50-300 basis points of current rates. In the 3rd quarter 2002, the Bank changed to a different simulation (software) model, and also changed some of the key methodologies and assumptions. The new simulation model is run on an outsourcing basis, using data supplied by reference.the Bank. These changes were made in an effort to improve the accuracy and relevance of the Bank's interest rate risk measurements. The more significant changes are as follows: - The new model permits more precise measurements, in that the estimated impact of interest rate changes is calculated for each individual investment security and for each individual loan and deposit instrument. In contrast, the old model required management to make assumptions regarding contractual cash flows for fairly broad categories of investment securities, loans and deposits. - Using the new model, the average principal repayment term for callable investment securities has been substantially lengthened. This change has increased the calculated impact of interest rate changes on the fair value of investment securities under each interest rate scenario. - Prior to the model change, management assumed no difference between book value and fair value of nonmaturity deposits and borrowings, such as money market accounts, NOW accounts, savings, customer repurchase agreements and checking accounts. Using the new model, management has estimated the "run-off" of nonmaturity deposits and borrowings, and has calculated the fair value of these liabilities using market interest rates consistent with the estimated terms. The effect of this change was to increase the market value of portfolio equity in all interest rate scenarios. 24 - Also related to nonmaturity deposits and borrowings, management has changed its assumptions regarding the impact of rate changes on interest expense. In the past, management estimated the impact of a rate change based on 100% of the "shock" amount - e.g., the rate paid on savings accounts would be assumed to increase from 1% to 3% in a "+200 basis point" calculation. Using the new model, management has limited the estimated impact of rate changes on interest expense. For example, in a +200 basis point calculation, the rate paid on savings accounts would be assumed to increase 50% of 200 basis points, or 1%, resulting in an increase in rate from 1% to 2%. The effect of this change was to decrease the impact of rate changes on net interest income in all interest rate scenarios. - In the past, the Bank's interest rate shock calculations compared "Base Most Likely" values to amounts calculated assuming an immediate increase or decrease in rates. In developing the Base Most Likely calculations, management made assumptions regarding growth in loans and deposits, and other balance sheet changes. Also, management used an interest rate forecast to estimate changes in interest rates on a monthly basis throughout the period of net interest income calculations. Using the new model, management's baseline calculation assumes a "flat" balance sheet, and uses current interest rates with no forecasted changes in rates. Management believes this change in methodology provides a measurement of interest rate risk that is more consistent with the majority of the financial institutions industry. The Bank's Board of Directors has established policy guidelines for acceptable levels of interest rate risk, based on an immediate increase or decrease in interest rates of 200 basis points. The policy limit for fluctuation in net interest income is minus 20% from the baseline one-year scenario. The policy limit for market value variance is minus 30% from the baseline one-year scenario. The most sensitive scenario presented in Table XII below is the "+200 basis points" scenario. As the table below shows, as of December 31, 2002, the result of the Bank's net interest income calculation is well within the policy threshold. However, if interest rates were to immediately increase 200 basis points, the Bank's calculations based on the model show that the market value of portfolio equity would decrease 34.2%, which exceeds the policy threshold. Over the next several months, management will evaluate whether to make any changes to asset or liability holdings in an effort to reduce exposure to decline in market value in a rising interest rate environment. The table also shows that, if interest rates were to immediately rise 200 basis points, net interest income over the next 12 months would decline by 1.8%, which is well under the 20% policy mark. This estimated exposure level is also significantly less than the 18.9% decline calculated as of December 31, 2001. Changes in the model, particularly the assumptions referred to above concerning the impact of rate changes on nonmaturity deposits and borrowings, had a substantial impact on these revised results. Also, some of management's actions during 2002, including an increased concentration of the investment securities portfolio in mortgage-backed securities (as discussed in the "Net Interest Margin" section of Management's Discussion and Analysis), have helped to reduce the exposure of net interest income to rising rates in the near term. The table that follows was prepared using the simulation models described above. The models make estimates, at each level of interest rate change, regarding cash flows from principal repayments on loans and mortgage-backed securities and call activity on other investment securities. Actual results could vary significantly from these estimates, which could result in significant differences in the calculations of projected changes in net interest margin and market value of portfolio equity. Also, the models do not make estimates related to changes in the composition of the deposit portfolio that could occur due to rate competition and the table does not necessarily reflect changes that management would make to realign the portfolio as a result of changes in interest rates. THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES
PERIOD ENDING DECEMBER 31, 2003 (IN THOUSANDS) DECEMBER 31, 2002 DATA CURRENT PLUS 200 MINUS 200 INTEREST BASIS BASIS RATES POINTS POINTS SCENARIO AMOUNT % CHANGE AMOUNT % CHANGE Interest income $ 54,989 $ 59,608 $ 49,607 Interest expense 24,132 29,320 19,083 - ------------------------------------------------------------------------------------------------------------------- Net Interest Income $ 30,857 $ 30,288 -1.8% $ 30,524 -1.1% =================================================================================================================== Market Value of Portfolio Equity at Dec. 31, 2002 $ 108,144 $ 71,117 -34.2% $ 130,764 20.9% ===================================================================================================================
25
PERIOD ENDING DECEMBER 31, 2002 (IN THOUSANDS) DECEMBER 31, 2001 DATA CURRENT PLUS 200 MINUS 200 INTEREST BASIS BASIS RATES POINTS POINTS SCENARIO AMOUNT % CHANGE AMOUNT % CHANGE Interest income $ 56,943 $ 60,192 $ 52,767 Interest expense 26,652 35,633 17,827 - ------------------------------------------------------------------------------------------------------------------- Net Interest Income $ 30,291 $ 24,559 -18.9% $ 34,940 15.3% =================================================================================================================== Market Value of Portfolio Equity at Dec. 31, 2001 $ 97,585 $ 69,980 -28.3% $ 118,667 21.6% ===================================================================================================================
EQUITY SECURITIES RISK The Corporation's equity securities portfolio consists primarily of investments in stocks of banks and bank holding companies, mainly based in Pennsylvania. The Corporation also owns some other stocks and mutual funds. Investments in bank stocks are subject to the risk factors affecting the banking industry generally, including competition from non-bank entities, credit risk, interest rate risk and other factors that could result in a decline in market prices. Also, losses could occur in individual stocks held by the Corporation because of specific circumstances related to each bank. Further, because of the concentration of its holdings in Pennsylvania banks, these investments could decline in value if there were a downturn in the state's economy. The Corporation's management monitors its risk associated with its equity securities holdings by reviewing its holdings on a detailed, individual security basis, at least monthly, considering all of the factors described above. Equity securities held as of December 31, 2002 and 2001 are as follows:
(IN THOUSANDS) HYPOTHETICAL HYPOTHETICAL 10% 20% DECLINE IN DECLINE IN FAIR MARKET MARKET AT DECEMBER 31, 2002 COST VALUE VALUE VALUE Banks and bank holding companies $ 22,936 $ 31,508 $ (3,151) $ (6,302) Other equity securities 1,950 1,572 (157) (314) - ------------------------------------------------------------------------------------------------- Total $ 24,886 $ 33,080 $ (3,308) $ (6,616) =================================================================================================
(IN THOUSANDS) HYPOTHETICAL HYPOTHETICAL 10% 20% DECLINE IN DECLINE IN FAIR MARKET MARKET AT DECEMBER 31, 2001 COST VALUE VALUE VALUE Banks and bank holding companies $ 18,922 $ 26,636 $ (2,664) $ (5,327) Other equity securities 823 836 (84) (167) - ------------------------------------------------------------------------------------------------- Total $ 19,745 $ 27,472 $ (2,748) $ (5,494) =================================================================================================
26 ITEM 8. FINANCIAL STATEMENTS andAND SUPPLEMENTARY DATA The Consolidated Financial Statements ( and notes thereto) found on pages 7 through 26 and the Summary of Quarterly Financial Data presented on page 47 are herein incorporated by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (a) Identification of Directors. The information appearing under the caption "Election of Directors" on pages 1 through 4 of the Corporation's Proxy Statement dated March 20, 2000, is herein incorporated by reference. (b) Identification of Executive Officers. The information appearing under the caption "Corporation's and Bank's Executive Officers" on pages 5 and 6 of the Corporation's Proxy Statement dated March 20, 2000, is herein incorporated by reference. ITEM 11. EXECUTIVE COMPENSATION 4 Information appearing under the caption "Executive Compensation" on pages 7 through 9 of the Corporation's Proxy Statement dated March 20, 2000, is herein incorporated by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information appearing under the caption "Election of Directors" on pages 2 and 3 and under the caption "Corporation's and Bank's Executive Officers" on pages 5 through 7 of the Corporation's proxy statement dated March 20, 2000, is herein incorporated by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information appearing in note 13 to the Consolidated Financial Statements on page 24 in the Annual Report is herein incorporated by reference. Information appearing under the caption "Certain Transactions" on page 12 of the Corporation's Proxy statement dated March 20, 2000, is herein incorporated by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K (a)(1).The following consolidated financial statements and reports are set forth in Item 8. Page ---- Independent Auditors'Report 27 Financial Statements: Consolidated Balance Sheet - December 31, 1999 and 1998 7 Consolidated Statement of Income - Years Ended December 31, 1999, 1998, and 1997 8 Consolidated Statement of Changes in Stockholders' Equity - Years Ended December 31, 1999, 1998 and 1997 9 Consolidated Statement of Cash Flows - Years Ended December 31, 1999, 1998 and 1997 10 Notes to Consolidated Financial Statements 11-26 (2) Financial statement schedules are either omitted because inapplicable or included in the financial statements or related notes. Individual financial statements of Bucktail Life Insurance Company and Citizens & Northern Investment Corporation, consolidated subsidiaries, have been omitted, as neither the assets nor the income from continuing operations before tax exceeded ten percent of the consolidated totals. (3) Exhibits (numbered as in Item 601 of Regulation S-K) 2. Plan of Acquisition, Reorganization, Arrangement Liquidation or Succession. Not applicable 3. (i) Articles of Incorporation * 5 3. (ii) Bylaws of the Registrant * 4. Articles of Incorporation of the Registrant as Currently in effect * 9. Voting Trust Agreement Not applicable 10. Material Contracts Not applicable 11. Statement re Computation of Per share earnings Not applicable 12. Statements re Computation of Ratios Not applicable 13. Annual Report to Shareholders Page 11 16. Letter re Change in Certifying Accountant Not applicable 18. Letter re Change in Accounting Principles Not applicable 21. List of Subsidiaries Page 10 22. Published Report Regarding Matters Submitted to Vote of Security Holders Not Applicable 23. Consent of Independent Auditors Page 12 24. Power of Attorney Not applicable 27. Financial Data Schedules None 28. Information from Reports Furnished to State Insurance Regulatory Authorities Not applicable 99. Additional Exhibits * Omitted in the interest of brevity (b) No reports on form 8-K were filed during the quarter ended December 31, 1999. (c) Exhibits - The required exhibits are included under 14 (a) (3) of Form 10-K (d) Financial Statement schedules are omitted because the required information is not applicable or is included elsewhere herein. SIGNATURES 6 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CITIZENS & NORTHERN CORPORATION Mar 24, 2000 By: Craig G. Litchfield /s/ - - ------------- --------------------------- Date Craig G. Litchfield Chairman, President and Chief Executive Officer March 24, 2000 By: James W. Seipler /s/ - - -------------- ------------------------ Date Treasurer 7 BOARD OF DIRECTORS Dennis F Beardslee /s/ Craig G Litchfield /s/ - - -------------------------------- -------------------------------- Dennis F. Beardslee Craig G Litchfield J Robert Bower /s/ Lawrence F Mase /s/ - - -------------------------------- -------------------------------- J Robert Bower Lawrence F Mase R Robert DeCamp /s/ Robert J Murphy /s/ - - -------------------------------- -------------------------------- R Robert DeCamp Robert J Murphy Adelbert E Eldridge /s/ Edward H Owlett, III /s/ - - -------------------------------- -------------------------------- Adelbert E Eldridge Edward H Owlett, III R Bruce Haner /s/ F David Pennypacker /s/ - - -------------------------------- -------------------------------- R Bruce Haner F David Pennypacker Susan E Hartley /s/ Leonard Simpson /s/ - - -------------------------------- -------------------------------- Susan E Hartley Leonard Simpson Karl W. Kroeck /s/ Donald E Treat /s/ - - -------------------------------- -------------------------------- Karl W. Kroeck Donald E Treat Edward L. Learn /s/ - - -------------------------------- Edward L. Learn 8 EXHIBIT INDEX 3. (i) Articles of Incorporation of the Registrant as currently in effect are herein incorporated by reference to Exhibit D to Registrant's Form S-4, Registration Statement dated March 27, 1987. 3. (ii) Bylaws of the Registrant as currently in effect are herein incorporated by reference to Exhibit E to Registrant's Form S-4, Registration Statement dated March 27, 1987. 4. Articles of Incorporation of the Registrant as currently in effect are herein incorporated by Reference to Exhibit D to Registrant's Form S-4, Registration Statement dated March 27, 1987. 10. Page 29 of Registrant's Form S-4, Registration Statement dated March 27, 1987, is herein incorporated by reference. 13. Annual Report to Shareholders 21. List of Subsidiaries 23. Consent of Parente Randolph, PC, Independent Auditors. 1999 Annual Report CEO Letter to Shareholders To our shareholders: Thanks to the support of our customers, employees and shareholders, Citizens & Northern has completed another record year. While the primary purpose of this letter is to review the accomplishments and achievements of 1999, the management, employees and directors of Citizens & Northern are intently focused on the future. We are at the beginning of a significant evolutionary change in the financial services industry. With the enactment of the Federal Financial Modernization Act in November 1999, banks are now provided entry into other financial service sectors that have been denied for decades. We intend to use the new regulatory freedom to offer a full range of financial services to meet our local customers' needs. We have the respect and trust of our customers and communities because we earn it every day. We believe all banking is local and personal. As a community bank, Citizens & Northern Bank is committed to serving each of our customers as they wish to be served. For years, we have been the premier community bank in our market. In the future, we will be the premier financial service provider. Our vision for Citizens & Northern Bank is to be recognized by the people in our market area as the provider of all their financial services: banking, investment and asset management, retirement planning, estate planning, and insurance needs. We believe that our vision for the future is captured and projected in the following: "Professionals dedicated to meeting your lifetime financial needs, with a personal touch."(TM) 1999 Financial Highlights Net income for 1999 set a new record of nearly $11.5 million. Most of the increase in Net Income is due to income from general operating activities. Securities Gains are substantially identical from 1998 to 1999. The net interest margin increased by over 4.7% and other operating income before realized securities gains, increased 5.9%. Our operating expenses have increased by nearly 7.6%, over $1.2 million. The boost in operating expenses is due to our desire to expand our opportunities for future business. Since mid-1998 we have added our first 12 twelve ATMs, opened the Mansfield office, added three trust officers to the Trust and Financial Services Division, and established our Internet Banking site. Each of these new endeavors adds to our expenses and creates current and future income prospects. The Corporation's Assets increased by 9.22%. Investment Securities increased by nearly 9% and loans by 6.8%. Total Deposits and Repurchase Sweep balances increased by over 5.5%. Shareholder Equity before adjustment for Accumulated Other Comprehensive Income rose by over 8.5%. Accumulated Other Comprehensive Income expresses the net unrealized gain or loss of Investment Securities and is a reflection of the interest rate sensitivity of the investment portfolio. The substantial reduction in Accumulated Other Comprehensive Income from the end of 1998 to the end of 1999 occurred due to a significant rise in long-term interest rates. Shareholder dividends declared for the 1999 year increased 10.77% from 1998, representing a nearly 41% pay out of Net Income. Since 1998, the market value of our stock has suffered, as have other regional bank stock prices. The last trade in 1999 was at a price of $27.25, which is down over 23% from the last trade price in 1998. For a more detailed description of our financial performance, please read Management's Discussion and Analysis of Financial Condition and Results of Operations found later in this report. Trust and Financial Services With $320.4 million in Assets Under Management, our Trust and Financial Services Division continues to grow at a double-digit rate, 13.1% for 1999. Additionally, Trust Department Income also increased by13%. The excellent sales and business development efforts coupled with good investment returns are responsible for the increases. With the addition of three more experienced financial services professionals, we anticipate substantial additional growth in this area. Our goal is to be the foremost provider of asset management, retirement planning and estate planning services in our market. We invite our shareholders to contact our Trust and Financial Services Division for a free consultation to show what we can do for you. Call 1-800-4TRUST4 to speak with one of our financial service professionals. C&Now(R) Internet Banking - www.cnbankpa.com Our Internet Banking System has been online since June 28th. As of the end of 1999, we had nearly 1,300 consumer users and over 100 commercial user of this cutting-edge service. We believe that the Internet provides another customer-convenient method for us to deliver our financial services. We will be adding to and enhancing our Internet presence for the years to come. Visit our web site at the above address and try one of our Internet Banking Demos. C&Now(R) Visa Check Card In October, we began offering our customers the C&Now(R) Visa Check Card as an alternative to their ATM card. The advantages of the Visa Check Card are that the card can be used as an ATM card and it can be used as a point-of-sale debit card for purchase with any merchant that accepts Visa, Plus, NYCE, MAC or The Exchange cards. The check card is a very popular new product. Insurance Marketing and Sales In January 2000, we formed a new corporate subsidiary of the bank, Citizens & Northern Financial Services Corporation. This new subsidiary will be licensed as an insurance agency, and will permit us to begin marketing insurance products. We believe that the sales of insurance products is a natural fit with banking services; and moves us closer to our vision of being a complete financial services provider. You will be hearing more about our initiative in coming months. Technology We continue to upgrade our management information systems to improve our ability to serve our customers better. Our mainframe was upgraded during the fourth quarter of 1999 to a new system that is 4 to 5 times faster. Our branch network system is being upgraded to provide more bandwidth for faster access. It came as no surprise to us that our staff of dedicated computer professionals handled the Y2K preparations in a very expert way. We are all thankful to them for their hard work. New Branch Office Plans We have just received regulatory approval to establish an new branch office in Muncy Creek Township less than 1 mile east of Muncy borough. At this writing, we are in the process of obtaining the necessary local permits and authorizations to build our seventeenth full service office. Eastern Lycoming County is a rapidly growing area, and we have existing relationships with many business located in the area. We believe that the area presents a terrific opportunity for us to deliver banking, trust and financial services. The location we have selected is less than an eighth of a mile from I-180 and on heavily traveled State Route 405. We hope to begin building in the spring and open before the end of summer. Retirements At the end of 1999, seven long time employees retired. Their years of service ran from 21 to 40 years for combined total years of service of 210 years. We will miss their daily contributions, but we wish them many happy and fulfilling years of retirement. Retiring from our Athens office are Sylvia Fay, Shirley Matthew, Keith Ferguson, Rita Fisk and Beverly Hill. Retiring from our Knoxville and Towanda offices are Barbara Mullican and Charmaine Stempel, respectively. Our thanks go to each of them for their hard work and commitment toward making Citizens & Northern Bank what it is today. Commitment The employees, officers and directors of Citizens & Northern Bank and Citizens & Northern Corporation are dedicated to meeting the financial needs of our customers. It is that dedication, which will continue to build long term value for our shareholders. In the future, we will have many challenges and opportunities. We embrace the possibilities with open and willing arms. Thank you for your continuing support. 2 Consolidated Balance SheetCONSOLIDATED BALANCE SHEET
(In Thousands Except Per Share Data) December(IN THOUSANDS EXCEPT SHARE DATA) DECEMBER 31, DecemberDECEMBER 31, 1999 1998 ASSETS Cash & Due From Banks:2002 2001 Noninterest-Bearing $15,337 $15,428 Interest-Bearing 2,726 700 - - -------------------------------------------------------------------------------------------------------------------------------- TotalASSETS Cash and Cash Equivalents 18,063 16,128 Available-for-Sale Securities 358,929 329,275 Held-to-Maturity Securities (Estimated fair value of $1,830due from banks: Noninterest-bearing $ 14,185 $ 14,055 Interest-bearing 715 1,981 - ----------------------------------------------------------------------------------------------------- Total cash and $1,931 in 1999cash equivalents 14,900 16,036 Available-for-sale securities 512,175 433,969 Held-to-maturity securities 707 1,448 Loans, net 445,356 373,963 Bank-owned life insurance 16,758 15,905 Accrued interest receivable 5,960 4,871 Bank premises and 1998, Respectively) 1,880 1,908 Loans, Net 305,761 286,183 Bank Premises and Equipment, Net 7,992 7,416equipment, net 10,333 9,967 Foreclosed Assets Heldassets held for Sale 310 652 Accrued Interest Receivable 5,066 4,109sale 56 179 Other Assets 7,897 627assets 12,523 10,661 - - ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $705,898 $646,298 ================================================================================================================================$ 1,018,768 $ 866,999 ===================================================================================================== LIABILITIES Deposits: Noninterest-Bearing $67,200 $57,871 Interest-Bearing 433,274 418,647Noninterest-bearing $ 70,824 $ 63,858 Interest-bearing 569,480 512,416 - ----------------------------------------------------------------------------------------------------- Total deposits 640,304 576,274 Dividends payable 1,586 1,466 Short-term borrowings 43,635 58,064 Long-term borrowings 208,214 125,584 Accrued interest and other liabilities 9,192 5,424 - -------------------------------------------------------------------------------------------------------------------------------- Total Deposits 500,474 476,518 Dividends Payable 1,237 1,123 Short-Term Borrowings 89,036 12,080 Long-Term Borrowings 35,025 60,044 Accrued Interest and Other Liabilities 3,503 5,966 - - ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES 629,275 555,731902,931 766,812 - ----------------------------------------------------------------------------------------------------- STOCKHOLDERS' EQUITY Common stock, par value $1.00 per share; authorized 10,000,000 shares; issued 5,431,021 in 2002 and 5,378,212 in 2001 5,431 5,378 Stock Par Value $ 1.00 per Share 5,272 5,220 Authorized 10,000,000; Issued 5,272,239 and 5,220,038 in 1999 and 1998, Respectively Stock Dividend Distributable 1,437 1,931 Paid in Capital 17,355 15,468dividend distributable 1,639 1,369 Paid-in capital 21,153 19,758 Retained Earnings 62,886 57,477earnings 77,584 70,352 - - ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Total 86,950 80,096105,807 96,857 Accumulated Other Comprehensive Income (8,884) 11,922 Less:other comprehensive income 12,146 5,284 Unamortized stock compensation (49) (17) Treasury Stockstock, at Cost 118,510cost: 145,415 shares at December 31, 1999 (1,443) 118,0102002 (2,067) 143,412 shares at December 31, 1998 (1,451)2001 (1,937) - - ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- TOTAL STOCKHOLDERS' EQUITY 76,623 90,567115,837 100,187 - - ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $705,898 $646,298 ================================================================================================================================$ 1,018,768 $ 866,999 =====================================================================================================
The accompanying notes are an integral part of the consolidated financial statements. 327 Consolidated Statement of Income (In Thousands Except Per Share Data)CONSOLIDATED STATEMENT OF INCOME
Years Ended DecemberYEARS ENDED DECEMBER 31, 1999 1998 1997 INTEREST INCOME(IN THOUSANDS EXCEPT PER SHARE DATA) 2002 2001 2000 INTEREST INCOME Interest and Feesfees on Loansloans $ 25,64230,641 $ 25,81928,592 $ 26,03327,082 Interest on Balancesbalances with Depository Institutions 30 37 54depository institutions 17 82 114 Interest on Loansloans to Political Subdivisions 541 380 391political subdivisions 587 719 644 Interest on Federal Funds Soldfederal funds sold 42 229 334184 64 Income from Available-for-Saleavailable-for-sale and Held-to-Maturity Securities:held-to-maturity securities: Taxable 16,421 14,062 14,361 Tax Exempt 4,534 3,982 3,59519,051 19,752 18,296 Tax-exempt 5,799 4,242 4,483 Dividends 1,205 950 8741,148 1,090 960 - --------------------------------------------------------------------------------------------------------------- Total interest and dividend income 57,285 54,661 51,643 - ---------------------------------------------------------------------------------------------------------------------------------- Total Interest and Dividend Income 48,415 45,459 45,642 - - ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- INTEREST EXPENSE Interest on Deposits 19,053 18,252 18,292deposits 17,215 20,417 23,108 Interest on Short-Term Borrowings 2,454 824 755short-term borrowings 916 3,944 6,102 Interest on Long-Term Borrowings 3,064 3,617 4,265long-term borrowings 8,184 3,995 935 - --------------------------------------------------------------------------------------------------------------- Total interest expense 26,315 28,356 30,145 - ---------------------------------------------------------------------------------------------------------------------------------- Total--------------------------------------------------------------------------------------------------------------- Interest Expense 24,571 22,693 23,312 - - ---------------------------------------------------------------------------------------------------------------------------------- Interest Margin 23,844 22,766 22,330margin 30,970 26,305 21,498 Provision for Possible Loan Losses 760 763 797loan losses 940 600 676 - --------------------------------------------------------------------------------------------------------------- Interest margin after provision for loan losses 30,030 25,705 20,822 - ---------------------------------------------------------------------------------------------------------------------------------- Interest Margin After Provision for Possible Loan Losses 23,084 22,003 21,533 - - ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- OTHER INCOME Service Chargescharges on Deposit Accounts 1,113 1,039 1,076deposit accounts 1,725 1,376 1,150 Service Chargescharges and fees 258 247 232 Trust and financial management revenue 1,755 1,576 1,613 Insurance commissions, fees and premiums 577 582 372 Increase in cash surrender value of life insurance 853 905 - Fees 274 288 281 Trust Department Income 1,456 1,288 1,004 Insurance Commissions, Fees and Premiums 438 405 462 Fees Relatedrelated to Credit Card Operation 3,064 2,969 2,627credit card operation 631 550 897 Other Operating Income 99 94 384operating income 825 884 738 - --------------------------------------------------------------------------------------------------------------- Total other income before realized gains on securities, net 6,624 6,120 5,002 Realized gains on securities, net 2,888 1,920 1,377 - ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Total Other Income Before Realized Gains on Securities, Net 6,444 6,083 5,834 Realized Gains on Securities, Net 3,043 3,001 1,001other income 9,512 8,040 6,379 - - ---------------------------------------------------------------------------------------------------------------------------------- Total Other Income 9,487 9,084 6,835 - - ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- OTHER EXPENSES Salaries and Wages 6,926 6,621 5,975wages 9,418 8,493 7,597 Pensions and Other Employee Benefits 1,831 1,760 1,691other employee benefits 2,651 2,213 1,939 Occupancy Expense, Net 896 827 726expense, net 1,094 1,018 928 Furniture and Equipment Expense 1,078 792 723equipment expense 1,532 1,431 1,194 Expenses related to Credit Card Operation 2,597 2,732 2,395credit card operation 285 295 407 Pennsylvania Shares Tax 723 656 596shares tax 734 790 756 Other Operating Expense 3,681 3,095 2,989operating expense 5,135 4,431 4,085 - --------------------------------------------------------------------------------------------------------------- Total other expenses 20,849 18,671 16,906 - ---------------------------------------------------------------------------------------------------------------------------------- Total Other Expenses 17,732 16,483 15,095--------------------------------------------------------------------------------------------------------------- Income before income tax provision 18,693 15,074 10,295 Income tax provision 3,734 3,022 1,819 - - ---------------------------------------------------------------------------------------------------------------------------------- Income Before Income Tax Provision 14,839 14,604 13,273 Income Tax Provision 3,354 3,527 3,166 - - ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- NET INCOME 11,485 11,077 10,107 ==================================================================================================================================$ 14,959 $ 12,052 $ 8,476 =============================================================================================================== NET INCOME PER SHARE - BASIC $ 2.212.80 $ 2.132.25 $ 1.94 ==================================================================================================================================1.58 =============================================================================================================== NET INCOME PER SHARE - DILUTED 2.20 2.12 1.94 ==================================================================================================================================$ 2.79 $ 2.25 $ 1.58 ===============================================================================================================
The accompanying notes are an integral part of the consolidated financial statements. 428 Consolidated Statement of Changes in Stockholders' Equity (In Thousands Except Per Share Data)CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (IN THOUSANDS EXCEPT PER SHARE DATA)
Consolidated Statement of Changes in Stockholders' Accumulated Equity Common Stock Other (In Thousands Except Per Share Data) Stock Dividend Paid In Retained Comprehensive Treasury Shares Amount Distributable Capital Earnings Income Stock Total ------ ------ ------------- ------- -------- ------ ----- -----STOCK COMMON DIVIDEND PAID-IN RETAINED STOCK DISTRIBUTABLE CAPITAL EARNINGS - ------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1999 $ 5,272 $ 1,437 $ 17,355 $ 62,886 Comprehensive income: Net income 8,476 Unrealized gain on securities, net of reclassification adjustment and tax effects - ------------------------------------------------------------------------------------- Total comprehensive income - ------------------------------------------------------------------------------------- Cash dividends declared, $.94 per share (5,102) Shares issued from treasury related to exercise of stock options 3 Stock dividend issued 53 (1,437) 1,384 Stock dividend declared, 1% 1,054 (1,054) Restricted stock granted 14 - ------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 2000 5,325 1,054 18,756 65,206 Comprehensive income: Net income 12,052 Unrealized gain on securities, net of reclassification adjustment and tax effects - ------------------------------------------------------------------------------------- Total comprehensive income - ------------------------------------------------------------------------------------- Cash dividends declared, $1.02 per share (5,554) Treasury stock purchased Amortization of restricted stock Tax benefit from employee benefit plan 17 Stock dividend issued 53 (1,054) 1,001 Stock dividend declared, 1% 1,369 (1,369) Restricted stock granted 1 - ------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 2001 5,378 1,369 19,758 70,352 Comprehensive income: Net income 14,959 Unrealized gain on securities, net of reclassification adjustment and tax effects - ------------------------------------------------------------------------------------- Total comprehensive income - ------------------------------------------------------------------------------------- Cash dividends declared, $1.16 per share (6,158) Treasury stock purchased Amortization of restricted stock Shares issued from treasury related to exercise of stock options 26 Tax benefit from employee benefit plan 70 Stock dividend issued 53 (1,369) 1,316 Stock dividend declared, 1% 1,639 (1,639) Restricted stock granted 55 Forfeiture of restricted stock (2) - ------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 2002 $ 5,431 $ 1,639 $ 21,153 $ 77,584 =====================================================================================
ACCUMULATED OTHER UNAMORTIZED COMPREHENSIVE STOCK TREASURY INCOME COMPENSATION STOCK TOTAL - ------------------------------------------------------------------------------------------- Balance DecemberBALANCE, DECEMBER 31, 1996 5,117 5,117 1,305 12,539 47,862 5,767 (997) 71,5931999 $ (8,884) $ - $ (1,443) $ 76,623 Comprehensive Income:income: Net Income 10,107 10,107income 8,476 Unrealized Gaingain on Securities, Netsecurities, net of Reclassification Adjustmentreclassification adjustment and Tax 7,568 7,568 Effectstax effects 8,966 8,966 - ------------------------------------------------------------------------------------------- Total comprehensive income 17,442 - ------------------------------------------------------------------------------------------- Cash dividends declared, $.94 per share (5,102) Shares issued from treasury related to exercise of stock options 3 6 Stock dividend issued - Stock dividend declared, 1% - Restricted stock granted (35) 21 - - ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 2000 82 (35) (1,419) 88,969 Comprehensive income: Net income 12,052 Unrealized gain on securities, net of reclassification adjustment and tax effects 5,202 5,202 - ------------------------------------------------------------------------------------------- Total Comprehensive Income 17,675comprehensive income 17,254 - ------------------------------------------------------------------------------------------- Cash dividends declared, $1.02 per share (5,554) Treasury stock purchased (521) (521) Amortization of restricted stock 22 22 Tax benefit from employee benefit plan 17 Stock dividend issued - Stock dividend declared, 1% - Restricted stock granted (4) 3 - - ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 2001 5,284 (17) (1,937) 100,187 Comprehensive income: Net income 14,959 Unrealized gain on securities, net of reclassification adjustment and tax effects 6,862 6,862 - ------------------------------------------------------------------------------------------- Total comprehensive income 21,821 - ------------------------------------------------------------------------------------------- Cash dividends declared, $1.16 per share (6,158) Treasury stock purchased (239) (239) Amortization of restricted stock 80 80 Shares issued from treasury related to exercise of stock options 50 76 Tax benefit from employee benefit plan 70 Stock Dividend Issued 51 51 (1,305) 1,254 Cash Dividends Declared $.72 Per Share (3,744) (3,744)dividend issued - Stock Dividend Declared,dividend declared, 1% 1,706 (1,706) Shares Issued from Treasury Related to Exercise- Restricted stock granted (116) 61 - Forfeiture of Stock Options 6 5 11restricted stock 4 (2) - - ------------------------------------------------------------------------------------------------------------------------------------ Balance December------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1997 5,168 5,168 1,706 13,799 52,519 13,335 (992) 85,535 - - ------------------------------------------------------------------------------------------------------------------------------------ Comprehensive Income: Net Income 11,077 11,077 Unrealized Loss on Securities, Net of Reclassification Adjustment and Tax (1,413) (1,413) Effects - - ------------------------------------------------------------------------------------------------------------------------------------ Total Comprehensive Income 9,664 - - ------------------------------------------------------------------------------------------------------------------------------------ Stock Dividend Issued 52 52 (1,706) 1,654 Cash Dividends Declared $.80 Per Share (4,188) (4,188) Stock Dividend Declared, 1% 1,931 (1,931) Shares Issued from Treasury Related to Exercise of Stock Options 15 9 24 Shares Purchased for Treasury (468) (468) - - ------------------------------------------------------------------------------------------------------------------------------------ Balance December 31, 1998 5,220 $5,220 $1,931 $15,468 $57,477 $11,922 ($1,451) $90,567 - - ------------------------------------------------------------------------------------------------------------------------------------ Comprehensive Income: Net Income 11,485 11,485 Unrealized Loss on Securities, Net of Reclassification Adjustment and Tax (20,806) (20,806) Effects - - ------------------------------------------------------------------------------------------------------------------------------------ Total Comprehensive Income (9,321) - - ------------------------------------------------------------------------------------------------------------------------------------ Stock Dividend Issued 52 52 (1,931) 1,879 Cash Dividends Declared $.89 Per Share (4,639) (4,639) Stock Dividend Declared, 1% 1,437 (1,437) Shares Issued from Treasury Related to Exercise of Stock Options 8 8 16 - - ------------------------------------------------------------------------------------------------------------------------------------ Balance December 31, 1999 5,272 5,272 1,437 17,355 62,886 (8,884) (1,443) $76,623 ====================================================================================================================================2002 $ 12,146 $ (49) $ (2,067) $ 115,837 ===========================================================================================
The accompanying notes are an integral part of the consolidated financial statements. 529 Consolidated Statement of Cash Flows (In Thousands)
Years Ended DecemberCONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS) YEARS ENDED DECEMBER 31, 1999 1998 19972002 2001 2000 CASH FLOWS FROM OPERATING ACTIVITIES: Net Incomeincome $ 11,48514,959 $ 11,07712,052 $ 10,1078,476 Adjustments to Reconcile Net Incomereconcile net income to Net Cash Providednet cash provided by Operating Activities:operating activities: Provision for Possible Loan Losses 760 763 797loan losses 940 600 676 Realized gains on securities, net (2,888) (1,920) (1,377) Gain on Securities, Net (3,043) (3,001) (1,001) (Gain) Loss on Salesale of Foreclosed Assets, Net 44 (26) 97 Provision forforeclosed assets, net (39) (88) (59) Depreciation 971 806 723expense 1,346 1,300 1,086 Accretion and Amortization (1,837) (455) 773 Deferred Income Tax 423 63 10 Decrease (Increase) in Accrued Interest Receivable and Other Assets (2,282) 717 163 ( Decrease)amortization, net (376) (1,869) (2,491) Increase in Accrued Interest Payablecash surrender value of life insurance (853) (905) - Amortization of restricted stock 80 22 - Deferred income taxes (284) (349) (63) Increase in accrued interest receivable and Other Liabilities 2,003 653 (848)other assets (958) (126) (88) Increase in accrued interest payable and other liabilities 669 579 1,247 - - ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 8,524 10,597 10,82112,596 9,296 7,407 - - ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from the Maturitymaturity of Held-to-Maturity Securities 372 178 755held-to-maturity securities 731 1,083 156 Purchase of Held-to-Maturity Securities (354) (498) (781)held-to-maturity securities - (626) (196) Proceeds from Salessales of Available-for-Sale Securities 30,027 83,888 134,157available-for-sale securities 29,345 25,788 32,173 Proceeds from Maturitiescalls and maturities of Available-for-Sale Securities 33,436 127,670 64,768available-for-sale securities 155,811 152,568 15,337 Purchase of Available-for-Sale Securities (119,753) (232,922) (186,798) Net Increase in Loans (20,503) (7,231) (7,652)available-for-sale securities (249,693) (261,148) (17,865) Purchase of PremisesFederal Home Loan Bank of Pittsburgh stock (3,943) (1,750) - Redemption of Federal Home Loan Bank of Pittsburgh stock 1,870 869 - Net increase in loans (72,819) (51,984) (18,374) Purchase of bank-owned life insurance - - (15,000) Purchase of interest in low-income housing partnerships - (306) (697) Purchase of premises and Equipment (1,547) (1,502) (834)equipment (1,712) (1,935) (2,426) Proceeds from sale of foreclosed assets 648 660 498 - -------------------------------------------------------------------------------------------------------------------------- Net Cash Used in Investing Activities (139,762) (136,781) (6,394) - -------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposits 64,030 47,307 28,493 Net (decrease) increase in short-term borrowings (14,429) (36,627) 5,655 Proceeds from long-term borrowings 117,653 125,000 - Repayments of long-term borrowings (35,023) (21) (34,420) Purchase of treasury stock (239) (521) - Sale of Foreclosed Assets 463 402 419treasury stock 76 - 6 Dividends paid (6,038) (5,441) (4,986) - ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by (Used in) Investing Activities (77,859) (30,015) 4,034 - - -------------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net Increase in Deposits 23,956 34,262 11,945 Net Increase (Decrease) in Short-Term Borrowings 76,956 (2,920) (13,850) Proceeds from Long-Term Borrowings - 34,400 10,074 Repayments of Long-Term Borrowings (25,019) (39,817) (20,013) Proceeds from the Sale of Treasury Stock 16 24 11 Purchase of Treasury Stock - (468) - Dividends Declared (4,639) (4,188) (3,744) - - -------------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by (Used In) Financing Activities 71,270 21,293 (15,577)126,030 129,697 (5,252) - - ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- (DECREASE) INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,935 1,875 (722)(1,136) 2,212 (4,239) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 16,128 14,253 14,97516,036 13,824 18,063 - - --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, END OF YEAR $18,063 $16,128 $ 14,253 ================================================================================================================================14,900 $ 16,036 $ 13,824 ========================================================================================================================== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATIONINFORMATION: Assets acquired through foreclosure of real estate loans $ 486 $ 435 $ 445 Interest Paid $24,006 $22,615 $22,380 ================================================================================================================================paid $ 26,424 $ 28,665 $ 29,446 Income Taxes Paid $2,973taxes paid $ 3,172 $3,512 ================================================================================================================================4,509 $ 2,961 $ 1,801
The accompanying notes are an integral part of the consolidated financial statements. 630 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF CONSOLIDATION - The consolidated financial statements include the accounts of Citizens and& Northern Corporation ("Corporation"), and its subsidiaries, Citizens & Northern Bank ("Bank"), Bucktail Life Insurance Company and Citizens & Northern Investment Corporation. The consolidated financial statements also include the accounts of the Bank's wholly-owned subsidiary, C&N Financial Services Corporation, which began operations in 2000. All material intercompany balances and transactions have been eliminated in consolidation. NATURE OF OPERATIONS - The Corporation is primarily engaged in providing a full range of banking and mortgage services to individual and corporate customers in Northcentral Pennsylvania. Lending activity includesproducts include mortgage loans, commercial loans, mortgageconsumer loans consumer installment loans,and credit cards, lease financing as well as specialized instruments such as commercial letters-of-credit. Deposit services providedproducts include various types of checking accounts, passbook and statement savings, money market accounts, interest checking accounts, internet banking, individual retirement accounts and certificates of deposit. The Corporation also offers non-insured Repo Sweep accounts and originates secondary market consumer mortgages."Repo Sweep" accounts. The Corporation provides Trust Departmentand Financial Management services, including the administration of trusts and estates, retirement plans, and other employee benefit plans.plans, and investment management services. In 2000, the Corporation began offering a variety of personal and commercial insurance products through C&N Financial Services Corporation. In 2001, C&N Financial Services Corporation added a broker-dealer division, which offers mutual funds, annuities, educational savings accounts and other investment products through registered agents. The Corporation is subject to competition from other financial institutions. It is also subject to regulation by certain federal and state agencies and undergoes periodic examination by those regulatory authorities. USE OF ESTIMATES - The presentation of financial statements in conformity with generally accepted accounting principles 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 reporting period.disclosures. Actual results could differ from these estimates. Material estimatesA material estimate that areis particularly susceptible to significant change relate tois the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowance for loan losses and the valuation of foreclosed assets held for sale, management relies on appraisals of its internal certified appraiser.losses. Management believes that the allowance for loan losses on loansis adequate and the valuation of foreclosed assets held for sale are adequate.reasonable. While management uses available information to recognize losses on loans, and foreclosed assets held for sale, changes in economic conditions may necessitate revisions of these estimates in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation's allowance for losses on loans and valuation of foreclosed assets held for sale.loan losses. Such agencies may require the Corporation to recognize adjustments to allowancesthe allowance based on their judgments of information available to them at the time of their examination. INVESTMENT SECURITIES - Investment securities are accounted for as follows: HELD-TO-MATURITY SECURITIES - includes debt securities that the Corporation has the positive intent and ability to hold to maturity. These securities are reported at cost adjusted for amortization of premiums and accretion of discounts, computed using a method approximating the level-yield basis.method. AVAILABLE-FOR-SALE SECURITIES - includes debt securities not classified as held-to-maturity and both restricted and unrestricted equity securities. Such securities, except for restricted equity securities are reported at fair value, with unrealized gains and losses excluded from earnings and reported separately through accumulated other comprehensive income, net of tax. The restricted equity securities consist primarily of Federal Home Loan Bank stock, which are carried at cost and evaluated for impairment. Amortization of premiums and accretion of discounts on available-for-sale securities are recorded using the level yield method over the remaining contractual life of the securities, adjusted for actual prepayments. Realized gains and losses on the salesales of available-for-sale securities are computed on the basis of specific identification of the adjusted cost of each security. 7 The fair valuesRESTRICTED EQUITY SECURITIES - Restricted equity securities consist primarily of the majorityFederal Home Loan Bank of the Corporation's investmentsPittsburgh stock, and are estimated based on bid prices published in financial newspapers or bid quotations received from securities dealers. The fair value of certain statecarried at cost and municipal securities is not readily available through market sources other than dealer quotations, so fair value estimates are based on quoted market prices of similar instruments, adjustedevaluated for differences between the quoted instruments and the instruments being valued. The carrying valuesimpairment. Holdings of restricted equity securities approximate fair values.are included in Other Assets in the Consolidated Balance Sheet, and dividends received on restricted securities are included in Other Income in the Consolidated Statement of Income. 31 LOANS AND LEASE FINANCE RECEIVABLES ("LOANS") - Loans are stated at unpaid principal balances, less the allowance for loan losses and net deferred loan fees and unearned discounts.fees. Loan origination and commitment fees, as well as certain direct origination costs, are deferred and amortized as a yield adjustment over the lives of the related loans using the interest method. Amortization of deferred loan fees is discontinued when a loan is placed on nonaccrual status. Loans are placed on nonaccrual status when, in the opinion of management, collection of interest is doubtful. Any unpaid interest previously accrued on those loans is reversed from income. Interest income is generally not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction of the loan principal balance. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received. The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio,based on factors such as credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. The allowance is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. BANK PREMISES AND EQUIPMENT - Bank premises and equipment are stated at cost less accumulated depreciation. Repair and maintenance expenditures which extend the useful lifelives of an asset,assets are capitalized, and other repair and maintenance expenditures are expensed as incurred. When premises or equipment are retired or sold the remaining cost and accumulated depreciation are removed from the account and any gain or loss is credited or charged to income. Depreciation expense is computed using the straight-line method. FORECLOSED ASSETS HELD FOR SALE - Foreclosed assets held for sale consist of real estate acquired by foreclosure and are carried at the lower ofestimated fair value, minus estimated cost to sell orless selling cost. The book value of foreclosed assets held for sale at December 31, 1999 and December 31, 1998 was $310,000 and $652,000, respectively. Foreclosed assets held for sale amounting to $165,000, $798,000 and $163,000 were acquired from the foreclosure of real estate loans during 1999, 1998 and 1997, respectively. INCOME TAXES - Provisions for deferred income taxes are made as a result of temporary differences in financial and income tax methods of accounting. These differences relate principally to provisions for possible loan losses, securities gains or losses, depreciation, pension and other postretirement benefits and amortization of loan origination fees and costs, pension expense, depreciationcosts. STOCK COMPENSATION PLANS - As permitted by Accounting Principles Board Opinion No. 25, the Corporation uses the intrinsic value method of bank premisesaccounting for stock compensation plans. Utilizing the intrinsic value method, compensation cost is measured by the excess of the quoted market price of the stock as of the grant date (or other measurement date) over the amount an employee or director must pay to acquire the stock. Stock options issued under the Corporation's stock option plans have no intrinsic value, and equipment,accordingly, no compensation cost is recorded for them. The Corporation has also made awards of restricted stock. Compensation cost related to restricted stock is recognized based on the market price of the stock at the grant date over the vesting period. 32 The following table illustrates the effect on net income and postretirement benefits.earnings per share if the Corporation had applied the fair value provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-based Compensation," to stock options. (NET INCOME IN THOUSANDS)
2002 2001 2000 Net income, as reported $ 14,959 $ 12,052 $ 8,476 Deduct: Total stock option compensation expense determined under fair value method for all awards, net of tax effects (191) (63) (77) - ---------------------------------------------------------------------------------------- Pro forma net income $ 14,768 $ 11,989 $ 8,399 ======================================================================================== Earnings per share-basic: As reported $2.80 $2.25 $1.58 Pro forma $2.77 $2.24 $1.57 Earnings per share-diluted: As reported $2.79 $2.25 $1.58 Pro forma $2.76 $2.24 $1.57
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS - In the ordinary course of business, the Corporation has entered into off-balance sheet financial instruments consisting of commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they become payable. CASH FLOWS - The Corporation utilizes the net reporting of cash receipts and cash payments for certain deposit and lending activities. The Corporation considers all cash and amounts due from depository institutions, interest-bearing deposits in other banks, and federal funds sold to be cash equivalents for purposes of the statement of cash flows.equivalents. TRUST ASSETS AND INCOME - Assets held by the Corporation in a fiduciary or agency capacity for its customers are not included in the financial statements since such items are not assets of the Corporation. Trust income is recorded on a cash basis, which is not materially different from the accrual basis. RECLASSIFICATION - Certain 19982001 and 19972000 amounts have been reclassified to conform to the 19992002 presentation. 8 2. COMPREHENSIVE INCOME Effective January 1, 1998, the Corporation adopted SFAS No. 130, "Reporting Comprehensive Income." Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income. The adoption of SFAS No. 130 had no effect on the Corporation's net income or stockholders' equity. As required by SFAS No. 130, the consolidated financial statements for 1997 have been reclassified to reflect application of this pronouncement. The components of other comprehensive income and the related tax effects are as follows:
Years Ended DecemberYEARS ENDED DECEMBER 31, (In Thousands) 1999 1998 1997 Unrealized holding gains (losses) on(IN THOUSANDS) 2002 2001 2000 Unrealized holding gains on available-for-sale securities $ (28,481) $860 $12,46813,283 $ 9,802 $ 14,963 Less: Reclassification adjustment for gains realized in income (3,043) (3,001) (1,001) -----------------------------------------------(2,888) (1,920) (1,377) - ----------------------------------------------------------------------------------------------------------- Net unrealized gains (losses) (31,524) (2,141) 11,46710,395 7,882 13,586 Tax effect 10,718 728 (3,899) -----------------------------------------------(3,533) (2,680) (4,620) - ----------------------------------------------------------------------------------------------------------- Net-of-tax amount $(20,806) $ (1,413)6,862 $ 7,568 ===============================================5,202 $ 8,966 ===========================================================================================================
33 3. PER SHARE DATA Net income per share is based on the weighted-average number of shares of common stock outstanding. The number of shares used in calculating net income and cash dividends per share reflect the retroactive effect of stock dividends declared in the fourth quarter of each year presented, payable in the first quarter of the following year. The following data show the amounts used in computing basic and diluted net income per share and the weighted average number of shares of dilutive stock options.share. The dilutive effect of stock options is computed as the weighted-average common shares available from the exercise of all dilutive stock options, less the number of shares that could be repurchased with the proceeds of stock option exercises based on the average share price of the Corporation's common stock during the period.
Weighted- Average Earnings Net Common Per Income Shares Share 1999 Earnings per share - basic $11,485,000 5,205,140 $2.21 Dilutive effect of stock options 5,809 - - ------------------------------------------------------------------------------------------ Earnings per share - diluted $11,485,000 5,210,949 $2.20 - - ------------------------------------------------------------------------------------------ 1998 Earnings per share - basic $11,077,000 5,209,640 $2.13 Dilutive effect of stock options 9,604 - - ------------------------------------------------------------------------------------------ Earnings per share - diluted $11,077,000 5,219,244 $2.12 - - ------------------------------------------------------------------------------------------ 1997 Earnings per share - basic $10,107,000 5,215,775 $1.94 Dilutive effect of stock options 4,850 - - ------------------------------------------------------------------------------------------ Earnings per share - diluted $10,107,000 5,220,625 $1.94 - - ------------------------------------------------------------------------------------------
9 WEIGHTED- AVERAGE EARNINGS NET COMMON PER INCOME SHARES SHARE 2002 Earnings per share - basic $ 14,959,000 5,339,449 $2.80 Dilutive effect of stock options 14,592 - ------------------------------------------------------------------------------ Earnings per share - diluted $ 14,959,000 5,354,041 $2.79 ============================================================================== 2001 Earnings per share - basic $ 12,052,000 5,348,963 $2.25 Dilutive effect of stock options 1,489 - ------------------------------------------------------------------------------ Earnings per share - diluted $ 12,052,000 5,350,452 $2.25 ============================================================================== 2000 Earnings per share - basic $ 8,476,000 5,363,232 $1.58 Dilutive effect of stock options 1,154 - ------------------------------------------------------------------------------ Earnings per share - diluted $ 8,476,000 5,364,386 $1.58 ============================================================================== 4. CASH AND DUE FROM BANKS Banks are required to maintain reserves consisting of vault cash and deposit balances with the Federal Reserve Bank in their district. The reserves are based on deposit levels during the year and account activity and other services provided by the Federal Reserve Bank. Average daily currency, coin, and cash balances with the Federal Reserve Bank needed to cover reserves against deposits for 19992002 ranged from $1,078,000$2,161,000 to $6,546,000.$6,458,000. For 1998,2001, these balances ranged from $4,467,000$1,489,000 to $5,679,000.$5,923,000. Average daily cash balances with the Federal Reserve Bank required to coverfor services provided to the Bank ranged from $25,000$1,500,000 to $425,000 during 1999$2,500,000 in 2002 and amounted to $425,000$1,500,000 throughout 1998.2001. Total balances restricted amounted to $6,332,000 at December 31, 19992002 and $4,735,000 at December 31, 1998 were $1,695,000 and $5,744,000, respectively.2001. Deposits with one financial institution are insured up to $100,000. The Corporation maintains cash and cash equivalents with certain financial institutions in excess of the insured amount. 34 5. SECURITIES Amortized cost and the fair value of securities at December 31, 1999, 19982002 and 19972001 are summarized as follows:
DecemberDECEMBER 31, 1999 Gross Gross Unrealized Unrealized Amortized Holding Holding Fair (In Thousands) Cost Gains Losses Value AVAILABLE-FOR-SALE SECURITES:2002 GROSS GROSS UNREALIZED UNREALIZED AMORTIZED HOLDING HOLDING FAIR (IN THOUSANDS) COST GAINS LOSSES VALUE AVAILABLE-FOR-SALE SECURITIES: Obligations of the U.S. Treasury $ 2,514- $ - $ (16)- $ 2,498- Obligations of Otherother U.S. Government Agencies 128,494 - (11,803) 116,691agencies 71,657 1,624 (933) 72,348 Obligations of Statesstates and Political 81,219 571 (5,042) 76,748 Subdivisionspolitical subdivisions 127,690 3,482 (293) 130,879 Other Securities 22,829 140 (1,262) 21,707securities 62,296 1,398 (102) 63,592 Mortgage-backed Securities 111,605 396 (4,185) 107,816securities 207,244 5,188 (156) 212,276 - ------------------------------------------------------------------------------------------------------------------------ Total debt securities 468,887 11,692 (1,484) 479,095 Marketable equity securities 24,886 8,959 (765) 33,080 - --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Total Debt Securities 346,661 1,107 (22,308) 325,460 Marketable Equity Securities 25,730 8,921 (1,182) 33,469 - - --------------------------------------------------------------------------------------------------------------- Total $372,391 $10,028 $(23,490) $358,929 ===============================================================================================================$ 493,773 $ 20,651 $ (2,249) $ 512,175 ======================================================================================================================== HELD-TO-MATURITY SECURITIES: Obligations of the U.S. Treasury $ 617321 $ 38 $ - $ (8) $ 609359 Obligations of Otherother U.S. Government Agencies 949agencies 297 25 - (39) 910322 Mortgage-backed Securities 314securities 89 4 (7) 311 - 93 - --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Total $ 1,880707 $ 467 $ (54)- $ 1,830 ===============================================================================================================774 ========================================================================================================================
DecemberDECEMBER 31, 1998 (In Thousands) Gross Gross Unrealized Unrealized Amortized Holding Holding Fair Cost Gains Losses Value2001 GROSS GROSS UNREALIZED UNREALIZED AMORTIZED HOLDING HOLDING FAIR (IN THOUSANDS) COST GAINS LOSSES VALUE AVAILABLE-FOR-SALE SECURITIES: Obligations of the U.S. Treasury $ 2,5122,503 $ 4454 $ - $ 2,5562,557 Obligations of Otherother U.S. Government Agencies 61,998 237 (394) 61,841agencies 75,295 698 (821) 75,172 Obligations of Statesstates and Political 78,434 3,167political subdivisions 95,835 1,422 (1,996) 95,261 Other securities 34,315 395 (178) 81,423 Subdivisions Other Securities 16,713 92 (338) 16,46734,532 Mortgage-backed Securities 130,189 1,043 (186) 131,046securities 198,269 1,045 (339) 198,975 - ------------------------------------------------------------------------------------------------------------------------ Total debt securities 406,217 3,614 (3,334) 406,497 Marketable equity securities 19,745 7,993 (266) 27,472 - --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Total Debt Securities 289,846 4,583 (1,096) 293,333 Marketable Equity Securities 21,365 14,788 (211) 35,942 - - --------------------------------------------------------------------------------------------------------------- Total $311,211 $19,371 $ (1,307) $329,275 ===============================================================================================================425,962 $ 11,607 $ (3,600) $ 433,969 ======================================================================================================================== HELD-TO-MATURITY SECURITIES: Obligations of the U.S. Treasury $ 630726 $ 4 $ 634 $ - Obligations of Other U.S. Government Agencies 849 4 (1) 852 Mortgage-backed Securities 429 19 (3) 445 - - --------------------------------------------------------------------------------------------------------------- Total $1,908 $27 $ (4) $ 1,931 ===============================================================================================================
10
December 31, 1997 (In Thousands) Gross Gross Unrealized Unrealized Amortized Holding Holding Fair Cost Gains Losses Value AVAILABLE-FOR-SALE SECURITIES: Obligations of the U.S. Treasury $ 2,520 $ 18 $ 2,538 $ - Obligations of Other U.S. Government Agencies 74,188 312 (51) 74,449 Obligations of States and Political 62,009 2,606 (1) 64,614 Subdivisions Other Securities 3,851 29 (107) 3,773 Mortgage-backed Securities 127,664 1,585 (59) 129,190 - - --------------------------------------------------------------------------------------------------------------- Total Debt Securities 270,232 4,550 (218) 274,564 Marketable Equity Securities 16,149 15,875 (1) 32,023 - - --------------------------------------------------------------------------------------------------------------- Total $286,381 $ 20,425 $ (219) $306,587 =============================================================================================================== HELD-TO-MATURITY SECURITIES: Obligations of the U.S. Treasury $ 6329 $ - $ (2) $ 630735 Obligations of Otherother U.S. Government Agencies 350 8agencies 547 14 - 358561 Mortgage-backed Securities 615 28 (8) 635securities 175 6 - 181 - --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Total $1,597 $ 361,448 $ (10)29 $ 1,623 ===============================================================================================================- $ 1,477 ========================================================================================================================
The amortized cost and fair value of investment debt securities at December 31, 19992002 follow. Maturities of debt securities (including mortgage-backed securities) are presented based on contractual maturities. Expected maturities will differ from contractual maturities because monthly principal payments are received from mortgage-backed securities, and because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Maturities of mortgage-backed securities have been estimated based on the contractual maturity.35
DecemberDECEMBER 31, 1999 (In Thousands) Amortized Fair Cost Value AVAILABLE-FOR-SALE SECURITIES:2002 AMORTIZED FAIR (IN THOUSANDS) COST VALUE AVAILABLE-FOR-SALE SECURITIES: Due in one year or less $ 7505,008 $ 7575,012 Due after one year through five years 11,525 11,65329,314 30,626 Due after five years through ten years 20,892 20,62359,744 60,762 Due after ten years 313,494 292,427374,821 382,695 - - --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Total $346,661 $325,460 =========================================================================================================$ 468,887 $ 479,095 ========================================================================================== HELD-TO-MATURITY SECURITIES: Due in one year or less $ -321 $ -359 Due after one year through five years 1,023 1,006122 123 Due after five years through ten years 767 737234 261 Due after ten years 90 8730 31 - - --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Total $1,880 $1,830 =========================================================================================================$ 707 $ 774 ==========================================================================================
The following table shows the amortized cost and maturity distribution of the debt securities portfolio at December 31, 1999:2002:
Within One(IN THOUSANDS, EXCEPT FOR PERCENTAGES) WITHIN ONE - Five FiveFIVE FIVE - Ten After Ten One Year Yield Years Yield Years Yield Years Yield Total Yield AVAILABLE-FOR-SALE SECURITIES:TEN AFTER TEN ONE YEAR YIELD YEARS YIELD YEARS YIELD YEARS YIELD TOTAL YIELD AVAILABLE-FOR-SALE SECURITIES: Obligations of other U.S. Government agencies $ - - $ 26,104 5.05% $ 22,031 5.74% $ 23,522 5.66% $ 71,657 5.46% Obligations of states and political subdivisions - - 2,137 6.69% 4,154 5.81% 121,399 5.14% 127,690 5.19% Other securities 5,008 4.39% 1,000 9.25% 11,000 5.74% 45,288 6.24% 62,296 6.05% Mortgage-backed securities - - 73 7.92% 22,559 4.34% 184,612 5.11% 207,244 5.03% - ----------------------------------------------------------------------------------------------------------------------------------- Total $ 5,008 0.00% $ 29,314 5.32% $ 59,744 5.22% $ 374,821 5.29% $ 468,887 5.27% =================================================================================================================================== HELD-TO-MATURITY SECURITIES: Obligations of the U.S. Treasury $ 321 5.30% $ - - $ 2,514 5.760.00% $ - - $ - - $ 2,514 5.76321 5.30% Obligations of Otherother U.S. Government agencies - - 100 5.63% 197 6.76% - - 297 6.38% Mortgage-backed securities - - - - - - Government Agencies - - - - 16,984 7.61 111,510 6.94 128,494 7.03 Obligations of States and - - - - - - - - - Political Subdivisions $750 7.04 3,436 6.29 2,926 6.45 74,107 5.42 81,219 5.51 Other Securities - - 1,000 9.25 550 8.75 21,279 7.36 22,829 7.47 Mortgage-backed Securities - - 4,575 7.45 432 7.48 106,598 6.81 111,605 6.84 - - ----------------------------------------------------------------------------------------------------------------------------------- Total $750 7.04 $11,525 6.89 $20,892 7.48 $313,494 6.56 $346,661 6.63 =================================================================================================================================== HELD-TO-MATURITY SECURITIES Obligations of the U.S. Treasury $ 617 5.60 $ - - $ - - $ 617 5.60 Obligations of Other U.S. $ - - - - - - - - - - Government Agencies 400 6.32 549 6.59 - 0.00 949 6.48 Mortgage-backed Securities - - 6 9.20 218 7.31 90 6.41 314 7.09 -22 8.22% 37 5.73% 30 3.48% 89 5.59% - ----------------------------------------------------------------------------------------------------------------------------------- Total $ - - $1,023 5.90321 5.30% $ 767 6.80122 6.10% $ 90 6.41 $1,880 6.29234 6.60% $ 30 3.48% $ 707 5.79% ===================================================================================================================================
Investment securities carried at approximately $50,755,000 and $57,424,000$90,655,000 at December 31, 19992002 and 1998, respectively,$69,962,000 at December 31, 2001, were pledged as collateral for public deposits, trusts and certain other deposits as provided by law. In 1999, grossAlso, see Note 9 for information concerning securities pledged to secure borrowing arrangements. Gross realized gains and losses from the salesales of available-for-sale securities, were $3,186,000 and gross realized losses were $143,000. Gross realized gains from the sale of available-for-sale securities in 1998 were $3,423,000, while gross realized losses for that year were $422,000. In 1997, gross realized gains from the sale of available-for-sale securities amounted to $2,883,000 and gross realized losses were $1,882,000. The income tax provision applicablerelated to net realized gains, amounted to $1,035,000, $1,020,000for 2002, 2001 and $340,000, for 1999, 1998 and 1997, respectively. 112000 were as follows:
(IN THOUSANDS) 2002 2001 2000 Gross realized gains $ 2,926 $ 2,408 $ 2,163 Gross realized losses (38) (488) (786) - ------------------------------------------------------------------------------------------------------ Net realized gains $ 2,888 $ 1,920 $ 1,377 ====================================================================================================== Income tax provision related to net realized gains $ 982 $ 653 $ 468 ======================================================================================================
36 6. NET LOANS AND LEASE FINANCE RECEIVABLES Major categories of loans and leases included in the loan portfolio are summarized as follows:
At December(IN THOUSANDS) DECEMBER 31, (In Thousands) % ofOF DECEMBER 31, % of 1999 Total 1998 TotalOF 2002 TOTAL 2001 TOTAL Real Estateestate - Constructionconstruction $ 649 0.21%103 0.02% $ 1,004 0.35%1,814 0.48% Real Estateestate - Mortgage 247,604 79.64% 230,815 79.30%mortgage 370,453 82.12% 306,264 80.76% Consumer 29,140 9.37% 30,924 10.63% Agriculture 1,899 0.61% 1,930 0.66%31,532 6.99% 29,284 7.72% Agricultural 3,024 0.67% 2,344 0.62% Commercial 18,050 5.80% 17,630 6.06%30,874 6.84% 24,696 6.51% Other 1,025 0.33% 1,062 0.37%2,001 0.44% 1,195 0.32% Political Subdivisions 12,332 3.97% 7,449 2.56%subdivisions 13,062 2.90% 13,479 3.55% Lease Receivables 222 0.07% 218 0.07%receivables 96 0.02% 152 0.04% - ------------------------------------------------------------------------------------------------- Total 451,145 100.00% 379,228 100.00% Less: allowance for loan losses (5,789) (5,265) - ----------------------------------------------------------------------------------------------------------------------------- Total 310,921 100.00% 291,032 100.00% Less Unearned Discount (29) (29) - - ----------------------------------------------------------------------------------------------------------------------------- 310,892 291,003 Less Allowance for Possible Loan Losses (5,131) (4,820) - - ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------- ----------------- Loans, net $ 445,356 $ 373,963 ================================================ =================
Net Loans and Lease Finance Receivables $305,761 $286,183 ============================================================================================================================= At December 31, 1999 and 1998, net unamortized loan fees and costs of $1,761,000$1,564,000 at December 31, 2002 and $1,875,000, respectively,$1,512,000 at December 31, 2001 have been offset against the carrying value of loans. There is no concentration of loans to borrowers engaged in similar businesses or activities that exceedsexceed 10% of total loans at December 31, 1999.2002. The Corporation grants commercial, residential and personal loans to customers primarily in Tioga, Bradford, Sullivan and Lycoming counties.Counties. Although the Corporation has a diversified loan portfolio, a significant portion of its debtors' ability to honor their contracts is dependent on the local economic conditions within the region. Loan Maturity DistributionLOAN MATURITY DISTRIBUTION
December 31, 1999 Over One Year but After (In Thousands) One Year Less than Five Or Less Five Years Years Total(IN THOUSANDS) FIXED RATE LOANS: VARIABLE OR ADJUSTABLE RATE LOANS: GREATER THAN GREATER THAN 1 YEAR OR 1-5 YEARS 5 YEARS TOTAL 1 YEAR OR 1-5 YEARS 5 YEARS TOTAL LESS LESS Real Estateestate - Constructionconstruction $ 649103 $ - $ - $ 649103 $ - $ - $ - $ - Real Estateestate - Mortgage 64,704 65,504 117,396 247,604mortgage 22,281 64,577 135,153 222,011 19,323 27,579 101,540 148,442 Consumer 10,731 13,244 5,165 29,140 Agriculture 724 1,069 106 1,8997,189 12,609 2,277 22,075 9,014 244 199 9,457 Agricultural 779 1,021 55 1,855 436 646 87 1,169 Commercial 9,241 6,101 2,708 18,0503,767 8,383 3,746 15,896 11,066 2,849 1,063 14,978 Other 243 283 499 1,025 Political Subdivisions 692 2,919 8,721 12,332 Lease Receivables 21 83 118 2221,066 375 362 1,803 198 - - ------------------------------------------------------------------------------------------------------------------------------198 Political subdivisions 798 3,253 9,010 13,061 - - 1 1 Lease receivables 31 65 - 96 - - - - - ---------------------------------------------------------------------------------------------------------------------------------- Total $87,005 $89,203 $134,713 $310,921 ==============================================================================================================================$36,014 $90,283 $ 150,603 $ 276,900 $40,037 $31,318 $ 102,890 $ 174,245 ==================================================================================================================================
Loans in the preceding table with maturities over one year but less than five years and over five yearsthat are all fixed rate loans. All loans due on demand or at a variable rate are shown as one year or less. Loans on which the accrual of interest has been discontinued or reduced amounted to $1,956,000$1,252,000 at December 31, 19992002 and $1,135,000$1,050,000 at December 31, 1998.2001. Interest income on such loans is recorded only as received. 1237 Loans on which the original terms have been restructured totaled $143,000 and $156,000$66,000 at December 31, 19992002 and $75,000 at December 31, 1998, respectively.2001. None of the loans on which the original terms were changed were past due at December 31, 19992002 and 2001. Loans which were more than 90 days past due and still accruing interest totaled $2,318,000 at December 31, 19992002 and $2,067,000 at December 31, 1998 totaled $1,797,000 and $1,628,000, respectively.2001. Transactions in the allowance for possible loan losses were as follows:
Years Ended December 31, (In Thousands) 1999 1998 1997 Balance at Beginning of Year $4,820 $4,913 $4,776 Provision Charged to Operations 760 763 797 Loans Charged Off (630) (966) (784) Recoveries 181 110 124 - - ------------------------------------------------------------------------------------------------------------------------------ Balance at End of Year $5,131 $4,820 $4,913 ==============================================================================================================================
(IN THOUSANDS) 2002 2001 2000 Balance at beginning of year $ 5,265 $ 5,291 $ 5,131 Provision charged to operations 940 600 676 Loans charged off (552) (713) (616) Recoveries 136 87 100 - ------------------------------------------------------------------------- Balance at end of year $ 5,789 $ 5,265 $ 5,291 ========================================================================= Information related to impaired loans as of December 31, 19992002 and 19982001 is as follows: (In Thousands) 1999 1998(IN THOUSANDS) 2002 2001 Balance of impaired loans $1,956 $1,135 ===============================$ 3,714 $ 582 Specific allowance related to impaired $956 $290 Loansloans $ 1,877 $ 73 The average balance of impaired loans amounted to $1,582,000, $1,397,000$3,838,000 in 2002, $781,000 in 2001 and $1,208,000 for 1999, 1998 and 1997, respectively.$1,079,000 in 2000. The following is a summary of cash receipts on impaired loans and how they were applied.
(In Thousands) 1999 1998 1997 Cash receipts applied to reduce principal balance $233 $154 $ 79 Cash receipts recognized as interest income 35 67 86 - - --------------------------------------------------------------------------------------------------------------- Total cash receipts $268 $221 $165 ===============================================================================================================
13 (IN THOUSANDS) 2002 2001 2000 Cash receipts applied to principal $ 497 $ 35 $ 503 Cash receipts recognized as interest income 247 14 87 - ---------------------------------------------------------------------------- Total cash receipts $ 744 $ 49 $ 590 ============================================================================ 7. BANK PREMISES AND EQUIPMENT Bank premises and equipment are summarized as follows:
December 31, (In Thousands) 1999 1998 Land $ 559 $ 497 Buildings and Improvements 9,562 9,300 Furniture and Equipment 6,623 5,430 - - ------------------------------------------------------------------------------------------------------------------- Total 16,744 15,227 Less Accumulated Depreciation 8,752 7,811 - - ------------------------------------------------------------------------------------------------------------------- Net $ 7,992 $ 7,416 ===================================================================================================================
(IN THOUSANDS) DECEMBER 31, 2002 2001 Land $ 1,275 $ 1,126 Buildings and improvements 12,295 11,313 Furniture and equipment 9,022 8,565 - ------------------------------------------------------------------------ Total 22,592 21,004 Less: accumulated depreciation (12,259) (11,037) - ------------------------------------------------------------------------ Net $ 10,333 $ 9,967 ======================================================================== 38 Depreciation expense included in occupancy expense and furniture and equipment expense was comprisedas follows: (IN THOUSANDS) 2002 2001 2000 Occupancy expense $ 432 $ 401 $ 370 Furniture and equipment expense 914 899 716 - ---------------------------------------------------------------------------- Total $ 1,346 $ 1,300 $ 1,086 ============================================================================ 8. DEPOSITS Balances and maturities of the following:time deposits are as follows:
Years Ended December(IN THOUSANDS) DECEMBER 31, (In Thousands) 1999 1998 1997 Building and Improvements $362 $340 $296 Furniture and Equipment 609 466 427 - - -------------------------------------------------------------------------------------------------------------------------------- Total $971 $806 $723 ================================================================================================================================
8. DEPOSITS The following table reflects time deposits included in total deposits and their remaining maturities.
December, 31, 1999 (In Thousands) 2000 2001 2002 2003 2004 Thereafter Total2005 2006 2007 THEREAFTER TOTAL Certificates of Deposit $127,796 $20,369 $14,648 $10,878 $19,743 $ 90,867 $33,564 $9,058 $6,815 $2,765251 $ 63 $143,132193,685 Yield 5.20% 5.54% 5.71% 5.53% 5.26% 5.60% 5.33%3.18% 3.75% 4.38% 4.84% 4.83% 4.47% 3.59% Individual Retirement Accounts 47,218 30,41676,875 22,690 - - 169 - 99,734 Yield 5.00% 5.00% - - 77,6344.62% - 5.00% - ------------------------------------------------------------------------------------------------------------------------------- Total Time Deposits $204,671 $43,059 $14,648 $10,878 $19,912 $ 251 $ 293,419 - ------------------------------------------------------------------------------------------------------------------------------- Yield 6.03% 6.03% - - - - 6.03% - - ----------------------------------------------------------------------------------------------------------------------------------- Total time deposits $138,085 $63,980 $9,058 $6,815 $2,765 $ 63 $220,766 - - ----------------------------------------------------------------------------------------------------------------------------------- Yield 5.46% 5.74% 5.71% 5.53% 5.26% 5.60% 5.55% ===================================================================================================================================3.86% 4.41% 4.38% 4.84% 4.83% 4.47% 4.07% ===============================================================================================================================
DecemberDECEMBER 31, 1998 (In Thousands) 1999 2000 2001 2002 2003 Thereafter Total2004 2005 2006 THEREAFTER TOTAL Certificates of Deposit $136,845 $25,406 $ 80,445 $33,422 $12,240 $6,369 $4,983 $16 $137,4757,004 $ 3,808 $ 6,289 $ 169 $ 179,521 Yield 5.17% 5.76% 5.82% 5.88% 5.67% 4.90% 5.42%4.59% 4.53% 4.99% 5.32% 5.01% 5.00% 4.63% Individual Retirement Accounts 51,000 25,97754,607 29,533 - - - - 76,97784,140 Yield 5.00% 5.00% - - - - 5.00% - ------------------------------------------------------------------------------------------------------------------------------- Total Time Deposits $191,452 $54,939 $ 7,004 $ 3,808 $ 6,289 $ 169 $ 263,661 - ----------------------------------------------------------------------------------------------------------------------------------- Total time deposits $131,445 $59,399 $12,240 $6,369 $4,983 $16 $214,452 - - ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ Yield 5.10% 5.43% 5.82% 5.88% 5.67% 4.90% 5.27% ===================================================================================================================================4.71% 4.78% 4.99% 5.32% 5.01% 5.00% 4.75% ===============================================================================================================================
Included in interest-bearing deposits are time deposits issued in the amount of $100,000 or more. These certificates and theirAs of December 31, 2002, the remaining maturities or repricing frequency of time deposits of $100,000 or more are as follows: 14
At December 31, 1999 (In Thousands) 2000 2001 2002 2003 2004 Total Certificates of Deposit $23,244 $4,265 $1,316 $1,101 $100 $30,026 Yield 5.47% 5.64% 6.02% 5.61% 5.25% 5.52% Individual Retirement Accounts 6,819 2,820 - - - 9,639 Yield 6.03% 6.03% - - - 6.03% - - --------------------------------------------------------------------------------------------------------------- Total time deposits $30,063 $7,085 $1,316 $1,101 $100 $39,665 - - --------------------------------------------------------------------------------------------------------------- Yield 5.60% 5.80% 6.02% 5.61% 5.25% 5.65% ===============================================================================================================
At December 31, 1998 (In Thousands) 1999 2000 2001 2002 2003 Total Certificates of Deposit $13,141 $11,390 $1,228 $1,066 $852 $27,677 Yield 5.32% 5.70% 5.96% 6.13% 5.75% 5.55% Individual Retirement Accounts 5,634 3,902 - - - 9,536 Yield 5.00% 5.00% - - - 5.00% - - --------------------------------------------------------------------------------------------------------------- Total $18,775 $15,292 $1,228 $1,066 $852 $37,213 - - --------------------------------------------------------------------------------------------------------------- Yield 5.22% 5.52% 5.96% 6.13% 5.75% 5.41% ===============================================================================================================
The interest paid on(IN THOUSANDS) Three months or less $28,973 Over 3 months through 12 months 33,212 Over 1year through 3 years 4,919 Over 3 years 5,859 - --------------------------------------------------- Total $72,963 =================================================== Interest expense from deposits of $100,000 or more amounted to $1,760,000, $1,047,000$3,238,000 in 2002, $3,220,000 in 2001 and $898,000 for the years ended December 31, 1999, 1998 and 1997, respectively.$1,925,000 in 2000. 39 9. BORROWED FUNDS SHORT-TERM BORROWINGS Short-term borrowings include the following:
(In Thousands) At December 31, 1999 1998 Federal Funds Purchased (a) $ - $ - Flexline(b) - - Federal Home Loan Bank Borrowings (c) 58,000 10,000 Customer Repurchase Agreements (d) 4,705 2,080 Repurchase Agreements (e) 26,331 - - - -------------------------------------------------------------------------------------------------------- Total Short-Term Borrowings $89,036 $12,080 ========================================================================================================
(IN THOUSANDS) AT DECEMBER 31, 2002 2001 Overnight borrowings (a) $ 14,350 $ 6,300 Federal Funds Purchased generally represent overnightHome Loan Bank of Pittsburgh borrowings (b) 2,500 22,000 Customer repurchase agreements (c) 20,218 19,764 Other repurchase agreements (d) 6,567 10,000 - -------------------------------------------------------------------------------- Total short-term borrowings $ 43,635 $ 58,064 ================================================================================ The weighted average interest rate on total short-term borrowings outstanding was 1.77% at December 31, 2002 and 3.44% at December 31, 2001. The maximum amount of total short-term borrowings outstanding at any month-end was $43,635,000 in 2002 and $96,167,000 in 2001. (a) Overnight borrowings include federal funds purchased overnight from correspondent banks and overnight borrowings from correspondent banks.the Federal Home Loan Bank of Pittsburgh (FHLB-Pittsburgh) on the "Open Repo Plus" facility. The maximum month-end amount of such borrowingborrowings was $14,350,000 in 1999, 19982002, $20,000,000 in 2001 and 1997 was $14,500,000, $2,000,000 and $10,000,000, respectively.$16,500,000 in 2000. The average amount of such borrowings was $6,085,000, $2,801,000$2,347,000 in 2002, $4,012,000 in 2001 and $663,000$5,721,000 in 1999, 1998 and 1997, respectively, and the weighted2000. Weighted average interest rates were 4.91%1.86% in 1999, 4.75%2002, 4.58% in 19982001 and 4.98%6.70% in 1997.2000. (b) Flexline is a line of credit with the Federal Home Loan Bank ofShort-term FHLB - Pittsburgh used overnight. The line was discontinued on December 31, 1998. The weighted average interest rate for 1998 and 1997 was 4.75% and 4.98%, respectively. The maximum outstanding balance was $16,500,000 in 1998 and $20,000,000 in 1997. (c) Federal Home Loan Bank loans included in Short-Term Borrowings are as follows: At DecemberAT DECEMBER 31, (In Thousands) 1999 1998(IN THOUSANDS) 2002 2001 Fixed Rate 5.75%5.25% matured January 24, 2002 $ - $ 5,000 Fixed Rate 5.20% matured February 19, 2002 - 7,000 Fixed Rate 2.38% matured October 30, 2002 - 10,000 Fixed Rate 1.51% maturing February 14, 2000 $10,000 $19, 2003 1,000 - Fixed Rate 5.72%1.68% maturing February 26, 2000 5,000 - Fixed Rate 6.14% maturing March 20, 2000 10,000 - Fixed Rate 6.12% maturing April 21, 2000 10,000 - Fixed Rate 6.08% maturing June 7, 2000 10,000 - Fixed Rate 5.91% maturing August 26, 2000 5,000 - Variable Rate 5.825% maturing December 22, 2004, callable 5,000 - In 2000 Variable rate Open Repo Plus maturing overnight 3,000 10,000November 19, 2003 1,500 - - -------------------------------------------------------------------------------- Total Short-Term Federal Home Loan Bank Borrowings $58,000 $10,000short-term FHLB - Pittsburgh borrowings $ 2,500 $ 22,000 ================================================================================ 15 Collateral for Federal Home Loan BankFHLB - Pittsburgh loans is described below under long-term borrowings. d)the "Long-term Borrowings" section of this note. (c) Customer repurchase agreements included in Short-Term Borrowings amounted to $4,705,000 as of December 31, 1999 and $2,080,000 at December 31, 1998. These repurchase agreements mature overnight, and are collateralized by securities with a carrying value of $4,705,000$23,305,000 at December 31, 19992002 and $2,080,000$32,431,000 at December 31, 1998. (e) Repurchase Agreements2001. (d) Other repurchase agreements included in Short-Termshort-term borrowings are as follows: At DecemberAT DECEMBER 31, (In Thousands) 1999 1998(IN THOUSANDS) 2002 2001 Fixed Rate 5.18%5.72% matured January 3, 2002 $ - $ 10,000 Fixed Rate 2.91% maturing March 31, 2000 $16,881 $ - Fixed Rate 5.50% maturing June 19, 2000 9,45025, 2003 6,567 - - - --------------------------------------------------------------------------------------------------------------------------------------------------------- Total Repurchase Agreements $26,331short-term other repurchase agreements $ - =========================================================================6,567 $ 10,000 ================================================================================ The terms and collateral related to repurchase agreements are described under the "Long-term Borrowings" section of this note. 40 LONG-TERM BORROWINGS Long-term borrowings are as follows: (In Thousands) At December 31, 1999 1998 Federal Home Loan Bank Borrowings (f) $25,625 $35,644 Repurchase Agreements (g) 9,400 24,400
(IN THOUSANDS) AT DECEMBER 31, 2002 2001 Federal Home Loan Bank of Pittsburgh borrowings (e) $ 170,061 $ 125,584 Repurchase agreements (f) 38,153 - - ------------------------------------------------------------------------------------------- Total long-term borrowings $ 208,214 $ 125,584 ===========================================================================================
(e) Long-term borrowings from FHLB - - ------------------------------------------------------------------------------- Total Long Term Borrowings $35,025 $60,044 =============================================================================== (f) Federal Home Loan Bank Loans included in Long-Term BorrowingsPittsburgh are as follows:
(In Thousands) At December(IN THOUSANDS) AT DECEMBER 31, 1999 19982002 2001 VariableFixed rate at 4.74%5.095%, matured May 1, 2002 $ - $ 15,000 Fixed rate at 5.38%, matured July 24, 2002 - 5,000 Fixed rate at 5.37%, maturing October 26, 2000 $ 5,000 $ 5,000 VariableJanuary 12, 2003 (*) - 10,000 Fixed rate at 5.60%5.48%, maturing January 24, 2003 (*) - 5,000 Fixed rate at 4.79%, maturing April 26, 2003 10,000 10,000 Fixed rate at 4.82%, maturing May 14, 2003 10,000 10,000 Fixed rate at 4.63%, maturing July 11, 20022003 10,000 10,000 VariableFixed rate at 5.19%4.65%, maturing July 22, 2003 -August 30, 2004 10,000 Variable10,000 Fixed rate at 4.32%3.84%, maturing October 20, 200322, 2004 10,000 10,000 Fixed rate at 2.34%, maturing November 19, 2004 3,000 - Fixed rate at 2.16%, maturing December 20, 2004 5,000 - Fixed rate at 4.19%, maturing January 24, 2005 5,000 - Fixed rate at 4.04%, maturing February 22, 2005 7,000 - Fixed rate at 5.05%, maturing August 29, 2005 5,000 5,000 Fixed rate at 4.145%, maturing October 31, 2005 5,000 5,000 Fixed rate at 2.84%, maturing November 21, 2005 2,500 - Fixed rate at 2.68%, maturing December 20, 2005 5,000 - Fixed rate at 4.83%, maturing February 21, 2006 20,000 20,000 Fixed rate at 4.455%, maturing October 30, 2006 5,000 5,000 Fixed rate at 3.28%, maturing November 20, 2006 2,000 - Fixed rate at 3.09%, maturing December 20, 2006 5,000 - Fixed rate at 4.58%, maturing May 1, 2007 15,000 - Fixed rate at 3.66%, maturing October 15, 2007 10,000 - Fixed rate at 3.45%, maturing December 24, 2007 10,000 - Fixed rate at 4.98%, maturing March 23, 2011 5,000 5,000 Fixed rate at 4.54%, maturing January 4, 2012 10,000 - Fixed rate at 6.86%, maturing December 30, 2016 555 571498 518 Fixed rate at 6.83%, maturing June 5, 2017 70 7363 66 - ------------------------------------------------------------------------------------------ Total long-term FHLB - ----------------------------------------------------------------------------------------------- Total Federal Home Loan Bank Borrowings $25,625 $35,644 ===============================================================================================Pittsburgh borrowings $ 170,061 $ 125,584 ==========================================================================================
All Federal Home Loan Bank(*) In November 2002, the Corporation paid off these loans, and incurred prepayment penalties totaling $101,000. The prepayment penalties are included in interest expense in the Consolidated Statement of Income. The FHLB - Pittsburgh loan facilities are collateralized by Federal Home Loan Bank Stock, mortgage-backedqualifying securities and first mortgage loans with a book value totaling $292,759,000$387,091,000 at December 31, 1999. (g)2002. Also, the FHLB - Pittsburgh loan facilities require the Corporation to invest in established amounts of FHLB - Pittsburgh stock. The carrying values of the Corporation's holdings of FHLB - Pittsburgh stock were $10,202,000 at December 31, 2002 and $8,129,000 at December 31, 2001. 41 (f) Repurchase Agreementsagreements included in Long-Term Borrowingslong-term borrowings are as follows:
(In Thousands) At December 31, 1999 1998 Morgan Stanley fixed rate at 5.68% maturing January 30, 2000 $9,400 $ 9,400 Morgan Stanley fixed rate at 5.57% maturing December 18, 2001 - 15,000 - - ------------------------------------------------------------------------------------------------------------ Total Repurchase Agreements $9,400 $24,400 ============================================================================================================
AT DECEMBER 31, (IN THOUSANDS) 2002 2001 Fixed Rate 2.53% maturing February 25, 2003 $ 7,500 $ - Fixed Rate 3.45% maturing February 25, 2004 7,500 - Fixed Rate 3.96% maturing March 25, 2004 6,567 - Fixed Rate 4.15% maturing February 25, 2005 5,000 - Fixed Rate 4.63% maturing March 25, 2005 6,766 - Fixed Rate 4.63% maturing February 25, 2006 4,820 - - ----------------------------------------------------------------------------- Total long-term repurchase agreements $ 38,153 $ - ============================================================================= Securities sold under repurchase agreements were delivered to the broker-dealers who arrangearranged the transactions. The broker-dealers may have sold, loaned or otherwise disposed of such securities to other parties in the normal course of their operations, and have agreed to resell to the Corporation substantially identical securities at the maturities of the agreements. The respective carrying value of the underlying securities was $54,763,000 at December 31, 19992002 and 1998 was $32,512,000 and $25,967,000.$9,975,000 at December 31, 2001. Average daily repurchase agreement borrowings for the years ended December 31, 1999, 1998, and 1997 amounted to $46,059,000, $28,967,000$36,482,000 in 2002, $14,217,000 in 2001 and $37,481,000, respectively.$14,372,000 in 2000. During 2002, 2001 and 2000, the maximum amounts of outstanding borrowings under repurchase agreements with broker-dealers were $44,720,000, $19,450,000 and $35,731,000. The weighted average interest rate on repurchase agreements was 3.72%, 6.20% in 2001 and 5.68% in 2000. 10. DERIVATIVE FINANCIAL INSTRUMENTS In June 2001, the Corporation began to utilize derivative financial instruments related to a new certificate of deposit product called the "Index Powered Certificate of Deposit" (IPCD). IPCDs have a term of 5 years, with interest paid at maturity based on 90% of the appreciation (as defined) in the S&P 500 index. There is no guaranteed interest payable to a depositor of an IPCD - however, assuming an IPCD is held to maturity, a depositor is guaranteed the return of his or her principal, at a minimum. Statement of Financial Accounting Standards No. 133 requires the Corporation to separate the amount received from each IPCD issued into 2 components: (1) an embedded derivative, and (2) the principal amount of each deposit. Embedded derivatives are derived from the Corporation's obligation to pay each IPCD depositor a return based on appreciation in the S&P 500 index. Embedded derivatives are carried at fair value, and are included in other liabilities in the consolidated balance sheet. Changes in fair value of the embedded derivative are included in other expense in the consolidated income statement. The difference between the contractual amount of each IPCD issued, and the amount of the embedded derivative, is recorded as the initial deposit (included in interest-bearing deposits in the consolidated balance sheet). Interest expense is added to principal ratably over the term of each IPCD at an effective interest rate that will increase the principal balance to equal the contractual IPCD amount at maturity. In connection with IPCD transactions, the Corporation has entered into Equity Indexed Call Option (Swap) contracts with FHLB-Pittsburgh. Under the terms of the Swap contracts, the Corporation must pay FHLB-Pittsburgh quarterly amounts calculated based on the contractual amount of IPCDs issued times a negotiated rate. In return, FHLB-Pittsburgh is obligated to pay the Corporation, at the time of maturity of the IPCDs, an amount equal to 90% of the appreciation (as defined) in the S&P 500 index. If the S&P 500 index does not appreciate over the term of the related IPCDs, the FHLB-Pittsburgh would make no payment to the Corporation. The effect of the Swap contracts is to limit the Corporation's cost of IPCD funds to the market rate of interest paid to FHLB-Pittsburgh. (In addition, the Corporation pays a fee of 0.75% to a consulting firm at inception of each deposit. This fee is amortized to interest expense over the term of the IPCDs.) Swap liabilities are carried at fair value, and included in other liabilities in the consolidated balance sheet. Changes in fair value of swap liabilities are included in other expense in the consolidated income statement. 42 Amounts recorded as of and for 1999, 1998the years ended December 31, 2002 and 1997 was 5.70%, 5.40% and 5.77%, respectively. During 1999, 1998 and 1997 the maximum outstanding borrowings were $53,731,000, $39,200,000 and $44,650,000. 16 10. ESTIMATED2001 related to IPCDs are as follows (in thousands): AT DECEMBER 31, 2002 2001 Contractual amount of IPCDs (equal to notional amount of Swap contracts) $ 3,028 $ 1,410 Carrying value of IPCDs 2,572 1,154 Carrying value of embedded derivative liabilities 156 233 Carrying value of Swap contract liabilities 309 31 FOR THE YEARS ENDED DECEMBER 31, 2002 2001 Interest expense 88 17 Other expense 8 7 11. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value estimatesis best determined based upon quoted market prices. However, in many instances, there are made at a specific point in time, based on relevantno quoted market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offeringprices for sale at one time the Corporation's entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Corporation's financial instruments,instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristicsmay not be realized in an immediate settlement of variousthe instrument. Statement of Financial Accounting Standards No. 107 excludes certain financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions can significantly affectall nonfinancial instruments from its disclosure requirements. Therefore, the estimates. Estimatedaggregate fair values have been determined byvalue amounts presented may not represent the Corporation using historical data, and an estimation methodology suitable for each category of financial instruments. The method for determining the estimatedunderlying fair value of the Corporation's investment securities is described in Note 1.Corporation. The Corporation's fair value estimates,Corporation used the following methods and assumptions are set forth belowin estimating fair value disclosures for the Corporation's other financial instruments.instruments: CASH AND DUE FROM BANKSCASH EQUIVALENTS - The carrying amounts forof cash and due from banks reported in the consolidated balance sheetshort-term instruments approximate fair values. SECURITIES - Fair values for securities, excluding restricted equity securities, are based on quoted market prices. The carrying value of restricted equity securities approximates these assets' fair values.value based on applicable redemption provisions. LOANS - Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, commercial real estate, residential mortgage, credit card and other consumer. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories. The fair value of performing loans, except residential mortgage and credit card loans, is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loans. The estimate of maturity is based on the Corporation's historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. For performing residential mortgage loans, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates based on historical experience. For credit card loans, cash flows and maturities are estimated based on contractual interest rates and historical experience. Fair value of nonperforming loans is based on recent appraisals or estimates prepared by the Corporation's lending officers. The following tables present information on loans.
December 31, 1999 (In Thousands) Book Current Discount Fair Value Yield Rate (1) Value Real Estate: Real Estate Fixed $201,246 8.71 8.75 $201,229 Real Estate Variable 45,444 8.42 7.50 45,808 - - --------------------------------------------------------------------------------------------------------------------- Total Real Estate 246,690 247,037 - - --------------------------------------------------------------------------------------------------------------------- Consumer: Consumer Fixed 20,632 10.06 10.50 20,648 Consumer Variable 369 8.91 9.00 369 Credit Cards 7,524 14.90 14.90 7,524 Key Loans 582 18.00 18.00 582 - - --------------------------------------------------------------------------------------------------------------------- Total Consumer 29,107 29,123 - - --------------------------------------------------------------------------------------------------------------------- Agriculture 1,899 9.43 9.50 1,880 - - --------------------------------------------------------------------------------------------------------------------- Commercial: Commercial Fixed 11,648 9.41 9.50 11,627 Commercial Variable 6,013 9.24 9.50 6,012 - - --------------------------------------------------------------------------------------------------------------------- Total Commercial 17,661 17,639 - - --------------------------------------------------------------------------------------------------------------------- Other Loans 1,025 7.70 8.00 1,026 Political Subdivisions 12,332 5.70 6.00 12,331 Leases 222 6.31 8.00 201 Nonperforming 1,956 1,956 - - --------------------------------------------------------------------------------------------------------------------- Total Loans 310,921 311,193 Allowance for Possible Loan Losses (5,131) (5,131) Net Loans $305,761 $306,062
1743
December 31, 1998 Book Current Discount Fair Value Yield Rate(1) Value Real Estate: Real Estate Fixed $176,206 8.58 7.69 $179,542 Real Estate Variable 48,539 8.01 7.18 48,558 - - ---------------------------------------------------------------------------------------------------------------------- Total Real Estate 224,745 228,100 - - ---------------------------------------------------------------------------------------------------------------------- Consumer: Consumer Fixed 21,824 9.14 8.77 21,930 Consumer Variable 548 8.50 8.27 548 Credit Cards 7,863 14.90 14.90 7,863 Key Loans 660 18.00 18.00 660 - - ---------------------------------------------------------------------------------------------------------------------- Total Consumer 30,895 31,001 - - ---------------------------------------------------------------------------------------------------------------------- Agriculture 1,903 10.00 8.75 1,928 - - ---------------------------------------------------------------------------------------------------------------------- Commercial: Commercial Fixed 10,106 9.06 8.75 10,150 Commercial Variable 7,524 8.59 8.75 7,505 - - ---------------------------------------------------------------------------------------------------------------------- Total Commercial 17,630 17,655 - - ---------------------------------------------------------------------------------------------------------------------- Other Loans 7,028 7.81 7.75 7,047 Political Subdivisions 7,449 6.05 5.00 7,616 Leases 218 7.93 8.00 207 Nonperforming 1,135 1,135 - - ---------------------------------------------------------------------------------------------------------------------- Total Loans 286,183 294,689 Allowance for Possible Loan Losses (4,820) (4,820) - - ---------------------------------------------------------------------------------------------------------------------- Total Loans $281,363 $ 289,869
(1) Management has made estimates of fair value discount rates that it believes to be reasonable. However, because there is no market for many of these financial instruments, management has no basis to determine whether the fair value presented above would be indicative of the value negotiated in an actual sale. DEPOSITS - The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, money market and interest checking accounts, is (by definition) equal to the amount payable on demand at December 31, 19992002 and 1998.2001. The fair value of all other deposit categories is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.
December 31, 1999 Book Market (In Thousands) Value Value - - ------------------------------------------------------------------------------------------------------ Noninterest-bearing Demand Deposits $ 67,200 $ 67,200 - - ------------------------------------------------------------------------------------------------------ Interest-bearing Deposits: Money Market 126,994 126,994 Interest Checking 39,077 39,077 Savings 45,420 45,420 Certificates of Deposit 143,132 142,581 Other Time 78,651 77,257 - - ------------------------------------------------------------------------------------------------------ Total Interest-bearing Deposits 433,274 431,329 - - ------------------------------------------------------------------------------------------------------ Total Deposits $500,474 $498,529 ======================================================================================================
18
December 31, 1998 Book Market (In Thousands) Value Value - - ------------------------------------------------------------------------------------------------------ Noninterest-bearing Demand Deposits $ 57,871 $ 57,871 - - ------------------------------------------------------------------------------------------------------ Interest-bearing Deposits: Money Market 121,082 121,082 Interest Checking 36,751 36,751 Savings 45,301 45,301 Certificates of Deposit 137,475 142,673 Other Time 78,038 78,040 - - ------------------------------------------------------------------------------------------------------ Total Interest-bearing Deposits 418,647 423,847 - - ------------------------------------------------------------------------------------------------------ Total Deposits $476,518 $481,718 ======================================================================================================
The fair value estimates aboveof deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market, commonly referred to as the core deposit intangible. BORROWED FUNDS - RatesThe fair value of borrowings is estimated using discounted cash flow analyses based on rates currently available to the Corporation for borrowed funds with similar termstypes of borrowing arrangements. ACCRUED INTEREST - The carrying amounts of accrued interest receivable and remaining maturitiespayable approximate fair values. EMBEDDED DERIVATIVE LIABILITIES - IPCDS - The fair values of embedded derivatives are used to estimatecalculated by a third party. Factors that affect the fair value of existing borrowed funds.
December 31, 1999 (In Thousands) Book Market Value Value Borrowings: Short-Term $ 89,036 $ 88,933 Long-Term 35,025 34,934 - - ------------------------------------------------------------------------------------------------------ Total Borrowings $124,061 $123,867 ====================================================================================================== December 31, 1998 (In Thousands) Book Fair Value Value Borrowings: Short -Term $12,080 $12,071 Long -Term 60,044 59,999 - - ------------------------------------------------------------------------------------------------------ Total Borrowings $72,124 $72,070 ======================================================================================================
COMMITMENTS TO EXTEND CREDIT AND STANDBY LETTERS OF CREDITembedded derivatives include term to maturity, market interest rates and other market factors that affect the present value of the Corporation's obligation to pay each IPCD depositor a return based on appreciation in the S&P 500 index. EMBEDDED DERIVATIVE LIABILITIES - There is no material difference between the notional amount andEQUITY OPTION SWAP CONTRACTS - The fair values of equity option Swap contracts are calculated by a third party. Factors that affect the fair value of off-balance sheet items which totaled $65,272,000 at Decemberequity option Swap contracts include: (1) the negotiated rate associated with the Corporation's obligation to make quarterly payments to the FHLB-Pittsburgh over the term of each IPCD; and (2) term to maturity, market interest rates and other market factors that affect the present value of the FHLB-Pittsburgh's obligation to pay the Corporation a return based on appreciation in the S&P 500 index. The estimated fair values, and related carrying amounts, of the Corporation's financial instruments are as follows:
(IN THOUSANDS) AT DECEMBER 31, 2002 2001 CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE Financial assets: Cash and cash equivalents $ 14,900 $14,900 $ 16,036 $ 16,036 Available-for-sale securities 512,175 512,175 433,969 433,969 Held-to-maturity securities 707 774 1,448 1,477 Restricted equity securities 10,202 10,202 8,129 8,129 Loans, net 445,356 447,382 373,963 377,124 Accrued interest receivable 5,960 5,960 4,871 4,871 Financial liabilities: Deposits 640,304 643,305 576,274 578,319 Short-term borrowings 43,635 43,662 58,064 58,148 Long-term borrowings 208,214 215,875 125,584 128,977 Accrued interest payable 1,307 1,307 1,420 1,420 Embedded derivative liabilities - IPCDs 156 156 233 233 Equity option Swap contracts - IPCDs 309 309 31 31 1999 and $54,010,000 at December 31, 1998 and are primarily comprised of unfunded loan commitments which are generally priced at market at the time of funding. 11.
44 12. EMPLOYEE AND POSTRETIREMENT BENEFIT PLANS DEFINED BENEFIT PLANS The Corporation has a noncontributory defined benefit pension plan for all employees meeting certain age and length of service requirements. Benefits are based primarily on years of service and the average annual compensation during the highest five consecutive years within the final ten years of employment. Also, the Corporation sponsors a defined benefit health care plan that provides postretirement medical benefits and life insurance to employees who meet certain age and length of service requirements. This plan contains a cost-sharing feature, which causes participants to pay for all future increases in costs related to benefit coverage. Accordingly, actuarial assumptions related to health care cost trend rates do not affect the liability balance at December 31, 19992002 and 2001, and will not affect the Corporation's future expenses. The following tables show the funded status and components of net periodic benefit cost from these defined benefit plans: 19
Postretirement Pension Benefits Benefits (In Thousands) 1999 1998 1999 1998 CHANGE IN BENEFIT OBLIGATION:(IN THOUSANDS) PENSION POSTRETIREMENT BENEFITS BENEFITS 2002 2001 2002 2001 CHANGE IN BENEFIT OBLIGATION: Benefit obligation at beginning of year $6,870 $6,059 $ 732 $7157,679 $ 7,646 $ 888 $ 790 Service cost 302 267 28 25349 271 24 19 Interest cost 460 424 50 42553 497 57 58 Plan participants' contributions 44 54- - 115 80 Actuarial loss (gain) loss (199) 384 15 -617 (338) (25) 79 Benefits paid (292) (264) (98) (104)(429) (397) (173) (138) - - --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Benefit obligation at end of year $7,141 $6,870 $ 771 $732 =============================================================================================================================8,769 $ 7,679 $ 886 $ 888 ==============================================================================================
Postretirement (In Thousands) Pension Benefits Benefits 1999 1998 1999 19982002 2001 2002 2001 CHANGE IN PLAN ASSETS: Fair value of plan assets at Beginningbeginning of year $8,378 $7,628$ 8,423 $ 9,317 $ - $ - Actual return on plan assets 1,151 1,014(326) (497) - - Employer contribution 54 50- - 58 58 Plan participants' contributions 44 54- - 115 80 Benefits paid (292) (264) (98) (104) -----------------------------------------------------------(429) (397) (173) (138) - ---------------------------------------------------------------------------------------------- Fair value of plan assets at end of year $9,237 $8,378 $ 7,668 $ 8,423 $ - $ - ========================================================================================================================================================= Funded status $(1,101) $ 2,096 $1,508 $(771) $(732)744 $ (886) $ (888) Unrecognized net actuarial loss (gain) loss (1,391) (790) (96) (111)1,726 90 (43) (17) Unrecognized transition obligation (251) (274) 475 511(182) (205) 365 401 - ---------------------------------------------------------------------------------------------- Prepaid (accrued) benefit cost $ 454443 $ 444 $(392) $(332) ============================================================629 $ (564) $ (504) ==============================================================================================
Pension Benefits Postretirement Benefits 1999 1998 1999 1998 WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31:2002 2001 2002 2001 WEIGHTED-AVERAGE ASSUMPTIONS: Discount rate 6.75% 7.00% 6.75% 7.00% 6.75% Expected return on plan assets 8.50% 8.50% N/A N/A Rate of compensation increase 4.75% 5.00% 5.00% N/A N/A N/A
45
Pension Benefits Postretirement Benefits (In Thousands) 1999 1998 1997 1999 1998 1997PENSION BENEFITS POSTRETIREMENT BENEFITS COMPONENTS OF NET PERIODIC BENEFIT COST: 2002 2001 2000 2002 2001 2000 Service cost $302 $ 267349 $ 234271 $ 28308 $ 25 $1924 $ 19 $ 27 Interest cost 460 424 400 50 42 48553 497 491 57 58 52 Expected return on plan assets (749) (640) (550)(702) (787) (815) - - - Amortization of transition obligation (23) (23) (23) 36 36 36 Amortization of prior service cost - - - - - -37 37 Recognized net actuarial loss (gain) loss8 (30) (64) 1 1 (2) - - - - (2) (7) - - ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ Net periodic benefit cost (benefit) $(10) $ 28185 $ 61 $114 $101 $96 ====================================================================================================================================(72) $ (103) $ 118 $ 115 $ 114 ============================================================================================================
PROFIT SHARING AND DEFERRED COMPENSATION PLANS The Corporation has a profit sharing plan that incorporates the deferred salary savings provisions of Section 401(k) of the Internal Revenue Code. The Corporation's matching contributions to the planPlan depend upon the tax deferred contributions of employees. The Corporation's total basic and matching contributions were $667,000 in 2002, $588,000 in 2001 and $511,000 in 2000. Effective December 31, 2001, the Corporation amended the 401(k) Plan to convert the "Basic Stock Fund" component of the Plan to an Employee Stock Ownership Plan (ESOP). A portion of the Corporation's basic contributions to the Plan are made to the ESOP, and the Plan uses these funds to purchase Corporation stock for 1999, 1998the accounts of Plan participants. These purchases are made on the market (not directly from the Corporation), and 1997employees are not permitted to purchase Corporation stock under the Plan. The Plan includes a diversification feature which permits Plan participants, upon reaching age 55 and 10 years of service (as defined), to sell up to 50% of their Corporation shares back to the Plan over a period of 6 years. This diversification feature will become effective in 2003, and accordingly, as of December 31, 2002, there were $513,000, $477,000no shares allocated for repurchase by the Plan. Dividends paid on shares held by the ESOP are charged to retained earnings. All Corporation shares owned through the ESOP are included in the calculation of weighted-average shares outstanding for purposes of calculating earnings per share - basic and $436,000, respectively.diluted. As of December 31, 2002, the ESOP held 189,263 shares of Corporation stock, all of which had been allocated to Plan participants. The Corporation's contributions to the ESOP portion of the Plan for 2002 (included in total contributions reported above) totaled $343,000. The Corporation also has a nonqualified supplemental deferred compensation arrangement with its key officers. Charges to expense for officers' supplemental deferred compensation for 1999, 1998were $44,000 in 2002, $38,000 in 2001 and 1997 amounted to $54,000, $42,000 and $35,000, respectively. STOCK OPTION$70,000 in 2000. STOCK-BASED COMPENSATION PLANS The Corporation establishedhas a Stock Incentive Plan for a selected group of senior officers. ApproximatelyA total of 180,000 shares of common stock may be issued under the Stock Incentive Plan. The recipients'Awards may be made under the Stock Incentive Plan in the form of qualified options ("Incentive Stock Options," as defined in the Internal Revenue Code), nonqualified options, stock appreciation rights or restricted stock. Through 1999, all awards under the Stock Incentive Plan were Incentive Stock Options, with exercise prices equal to exercise these options vest ratablythe market price of the stock at the date of grant, ratable vesting over a 5-year period5 years and each option has a contractual expiration of 10 years. In 2000 and 2002, there were awards of Incentive Stock Options and restricted stock. The Incentive Stock Options granted in 2000 and 2002 have an exercise price equal to the market value of the stock at the date of grant, vest after 6 months and expire after 10 years. The restricted stock awards vest ratably over 3 years. Also, the Corporation establishedhas an Independent Directors Stock Incentive Plan (formerly called the Independent Directors Stock Option Plan which allows the issuancePlan). In 2001, this plan was amended to permit awards of approximately 25,000nonqualified stock options and/or restricted stock to non-employee directors. As amended, a total of 50,000 shares of common stock to non-employee directors.may be issued under the Independent Directors Stock Incentive Plan. The recipients' rights to exercise thesestock options under this plan expire 10 years from the date of grant. The exercise prices of all stock options awarded under the plansIndependent Directors Stock Incentive Plan are equal to fair market value as of the dates of grant. The restricted stock awards vest ratably over 3 years. Effective January 2, 2003, the Corporation granted options to purchase a total of 30,942 shares of common stock through the Stock Incentive and Independent Directors Stock Incentive Plans. The exercise price for these options is $31.10 per share, which was the market price at the date of grant. Also, effective January 2, 2003, the grant 20Corporation awarded a total of 3,444 shares of restricted stock under the Stock Incentive and Independent Directors Stock Incentive Plans. The stock options and restricted stock awards that were awarded in January 2003 are not included in the tables that follow. 46 TheAs described in Note 1, the Corporation applies Accounting Principles Board Opinion 25 and related interpretations in accounting for stock options. Accordingly, no compensation expense has been recognized for the stock options. Had compensation cost for the stock options been determined based on the fair value at the grant dates for awards consistent with the method of SFAS No. 123, the effect on the Corporation's net income and earnings per share for 1999, 1998 and 1997 would have been adjusted to the pro forma amounts indicated below. (Net Income in Thousands) 1999 1998 1997the following table. (NET INCOME IN THOUSANDS) 2002 2001 2000 Net income As reported $11,485 $11,077 $10,107$14,959 $12,052 $8,476 Pro forma $11,428 $11,048 $10,096$14,768 $11,989 $8,399 Earnings per share-basic As reported $2.21 $2.13 $1.94$2.80 $2.25 $1.58 Pro forma $2.20 $2.12 $1.94$2.77 $2.24 $1.57 Earnings per share-diluted As reported $2.79 $2.25 $1.58 Pro forma $2.76 $2.24 $1.57 For purposes of the calculations of SFAS No. 123, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions. 1999 1998 1997assumptions: 2002 2001 2000 Volatility 17% 17% 18% 18% 19% Expected option lives 6 Years 6 Years 6 Years Risk-free interest rate 6.46% 5.05% 5.78%5.00% 5.08% 5.00% Dividend yield 3.76% 3.78% 4.05%4.16% 3.57% 3.96% A summary of the status of the Corporation's stock option plans as of December 31, 1999, 1998, and 1997, and changes during the years then ended, is presented below:
1999 1998 19972002 2001 2000 - - ----------------------------------------------------------------------------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE Outstanding, beginning of year 58,850 $30.38 39,360 $27.09 22,850 $22.6583,236 $ 27.73 100,810 $ 28.04 82,420 $ 29.63 Granted 25,550 $27.67 20,500 $36.40 17,800 $32.2740,815 $ 25.50 1,976 $ 21.25 18,615 $ 20.91 Exercised (680) $24.06 (1,010) $24.03 (590) $20.00(3,562) $ 20.97 - $ - (225) $ 20.00 Forfeited (1,300) $27.89- $ - (19,550) $ 28.72 - - (700) $20.00 - - ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Outstanding, end of year 82,420 $29.63 58,850 $30.38 39,360 $27.09 ===================================================================================================================================120,489 $ 27.17 83,236 $ 27.73 100,810 $ 28.04 ============================================================================================================================= Options exercisable at year-end 30,700 $28.69 17,990 $26.99 8,720 $23.65110,549 $ 26.95 64,906 $ 26.94 48,215 $ 28.69 Fair value of options granted $ 5.273.67 $ 5.853.48 $ 5.883.14
2147 The following table summarizes information about stock options outstanding as of December 31, 1999:
Outstanding Exercisable At Remaining At December 31, Contractual December 31, 1999 Life in Years 1999 Exercise Prices $20.00 9,220 6 7,080 $25.50 - $27.84 13,100 7 8,980 $33.25 - $36.50 16,850 8 8,300 $33.13 - $36.38 20,500 9 6,340 $27.00 22,750 10 - - - ------------------------------------------------------------------------------------------------------------------- 82,420 30,700 ===================================================================================================================
12.2002: OUTSTANDING EXERCISABLE AT REMAINING AT DECEMBER 31, CONTRACTUAL DECEMBER 31, EXERCISE PRICES 2002 LIFE IN YEARS 2002 $20.00 2,995 3 2,995 $25.50 - $27.84 9,700 4 9,700 $33.25-$36.50 12,850 5 12,850 $33.13-$36.38 16,500 6 13,760 $25.00-$27.00 20,400 7 13,200 $20.25-$21.25 17,587 8 17,587 $25.50 40,457 9 40,457 - ------------------------------------------------------------------------------- 120,489 110,549 =============================================================================== The following table summarizes restricted stock awards through December 31, 2002: 2002 2001 2000 Number of shares awarded 4,431 221 1,752 Market price of stock at date of grant $ 25.50 $ 21.25 $ 20.25 Compensation expense related to restricted stock was $80,000 in 2002 and $22,000 in 2001. There was no compensation expense related to restricted stock awards in 2000. 13. INCOME TAXES The following temporary differences gave rise to the net deferred tax asset at December 31, 1999 and liability at December 31, 1998: (In Thousands) 1999 19982002 and 2001: (IN THOUSANDS) 2002 2001 Deferred tax liabilities: Depreciation $ 275 $ 240 Prepaid pension 155 220 Accretion on securities 6 2 Investments in limited partnerships 21 24 Unrealized holding gains on securities 6,257 2,722 - --------------------------------------------------------------------- Total 6,714 3,208 - --------------------------------------------------------------------- Deferred tax assets: Allowance for loan losses (2,026) (1,843) Postretirement and sick benefits (216) (194) Loan fees and costs (76) (60) Supplemental executive retirement plan (175) (168) Restricted stock compensation (27) - - --------------------------------------------------------------------- Total (2,520) (2,265) - --------------------------------------------------------------------- Deferred tax liability, net $ 4,194 $ 943 ===================================================================== Tax Liabilities: Bond Accretion $15 $ 23 Depreciation 241 148 Realized Gains on Equity Investments ( Per EITF 91-5) 432 - Pension Expense 156 153 Unrealized Holding Gains on Available-for Sale Securities 6,142 - - ---------------------------------------------------------------------------------------------------------- Total 844 6,466 Deferred Tax Assets: Loan Fees and Costs (134) (199) SERP Plan (111) (92) Postretirement and Sick Benefits (163) (129) Unrealized Holding Gains on Available-for Sale Securities (4,577) Allowance for Loan Losses (1,796) (1,687) Write down of Other Real Estate Owned (7) (7) - - ---------------------------------------------------------------------------------------------------------- Total (6,788) (2,114) - - ---------------------------------------------------------------------------------------------------------- Deferred Tax (Asset) Liability, Net $(5,944) $4,352 ==========================================================================================================
provision: 2002 2001 2000 Currently payable $ 4,018 $ 3,371 $ 1,882 Deferred (284) (349) (63) - -------------------------------------------------------------------------------- Total provision $ 3,734 $ 3,022 $ 1,819 ================================================================================ 48 Reconciliation of tax provision:
The federal income tax provision is comprised of the following components: (IN THOUSANDS) 1999 1998 1997 Currently Payable $2,931 $3,464 $3,156 Deferred Provision 423 63 10 - - ------------------------------------------------------------------------------------------------------------------------ Total Provision $3,354 $3,527 $3,166 ======================================================================================================================== The following tabulation is a reconciliation of the expected provision for federal income taxes determined by application of the statutory rates at which income is expected to be taxed and the actual income tax provision.
Years Ended December 31, 1999 1998 1997 (IN THOUSANDS) Amount2002 2001 2000 AMOUNT % AmountAMOUNT % AmountAMOUNT % Expected Provisionprovision $ 5,194 35.006,543 35.00% $ 5,111 35.005,276 35.00% $ 4,646 35.00 Nontaxable Bond Interest (1,538) (10.36) (1,375) (9.40) (1,249) (9.40) Nontaxable Loan Interest (189) (1.28) (133) (0.90) (137) (1.00)3,603 35.00% Tax-exempt interest income (2,223) (11.89) (1,730) (11.48) (1,738) (16.88) Nondeductible Interest Expense 232 1.56 192 1.30 167 1.30interest expense 239 1.28 226 1.50 280 2.72 Dividends Received Deduction (203) (1.37) (165) (1.10) (161) (1.20) Surtax (102) (0.69) (108) (0.70) (112) (0.80) Exemption Other, Net (40) (0.26) 5 - 12received deduction (280) (1.50) (267) (1.77) (235) (2.28) Increase in cash surrender value of life insurance (299) (1.60) (317) (2.10) - - Surtax exemption (176) (0.94) (151) (1.00) (103) (1.00) Other, net (70) (0.37) (15) (0.10) 12 0.11 - -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Effective Income Tax and Rates $3,354 22.60 $3,527 24.20 $3,166 23.90 =============================================================================================================================income tax provision $ 3,734 19.98% $ 3,022 20.05% $ 1,819 17.67% =====================================================================================================================
22 13.14. RELATED PARTY TRANSACTIONS Loans to executive officers, directors of the Corporation and its subsidiarysubsidiaries and any associates of the foregoing persons are as follows: (In Thousands)(IN THOUSANDS)
Beginning New Other Ending Name of Borrower Balance Loans Repayments Changes Balance BEGINNING NEW OTHER ENDING BALANCE LOANS REPAYMENTS CHANGES BALANCE 15 Directors, 14 directors, 6 Executive Officers 1999 $4,709 $2,551executive officers 2002 $ (1,056)6,535 $ 169 $6,373 15 Directors, 5 Executive Officers 1998 5,578 1,487 (1,647) (709) 4,709 15 Directors, 2 Executive Officers 1997 5,441 736 (2,096) 1,497 5,5782,464 $ (2,722) $ 346 $ 6,623 14 directors, 6 executive officers 2001 5,730 658 (1,833) 1,980 6,535 14 directors, 6 executive officers 2000 6,640 724 (1,450) (184) 5,730
The above transactions were made in the ordinary course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and do not involve more than normal risks of collectibility. Other changes represent net increases in existing lines of credit and transfers in and out of the related party category. 14.15. OFF-BALANCE SHEET RISK The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and financial standby letters of credit. These instruments involve, to varying degrees, elements of credit, interest rate or liquidity risk in excess of the amount recognized in the consolidated balance sheet. The contract amounts of these instruments express the extent of involvement the Corporation has in particular classes of financial instruments. The Corporation's exposure to credit loss from nonperformance by the other party to the financial instruments for commitments to extend credit and financial standby letters of credit is represented by the contractual amount of these instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Financial instruments whose contract amounts represent credit risk at December 31, 19992002 and 19982001 are as follows: (In Thousands) 1999 1998(IN THOUSANDS) 2002 2001 Commitments to extend credit $59,215 $48,610 Standby$ 103,138 $ 86,498 Financial standby letters of credit $ 6,057 $ 5,40010,753 5,508 Commitments to extend credit are legally binding agreements to lend to customers. Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future liquidity requirements. The Corporation evaluates each customer's creditworthiness on a case-by-case basis. The amount of 49 collateral obtained, if deemed necessary by the Corporation, for extensions of credit is based on management's credit assessment of the counterparty. StandbyFinancial standby letters of credit are conditional commitments issued by the Corporation guaranteeing performance by a customer to a third party. Those guarantees are issued primarily to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. 15.Some of the financial standby letters of credit are collateralized by real estate or other assets, while others are unsecured. The extent to which proceeds from liquidation of collateral would be expected to cover the maximum potential amount of future payments related to financial standby letters of credit is not estimable. The Corporation has recorded no liability associated with financial standby letters of credit as of December 31, 2002 and 2001. Financial standby letters of credit as of December 31, 2002 expire as follows: (IN THOUSANDS) YEAR OF EXPIRATION AMOUNT - ---------------------------------------- 2003 $ 5,462 2004 2,605 2005 1,165 2006 593 2007 928 - ---------------------------------------- Total $ 10,753 ======================================== 16. CONTINGENCIES In the normal course of business, the Corporation may be subject to pending and threatened lawsuits in which claims for monetary damages could be asserted. In management's opinion, the Corporation's financial position and results of operations would not be materially affected by the outcome of such legal proceedings. 17. REGULATORY MATTERS The Corporation (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken could have a direct material effect on the Bank'sCorporation's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Bank must meet specific capital guidelines that involve quantitative measures of the Bank'stheir assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amountamounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets ( as(as defined), and of Tier I capital (as defined), to average assets (as defined). Management believes, as of December 31, 1999,2002 and 2001, that the Corporation and the Bank meetsmeet all capital adequacy requirements to which it isthey are subject. 23 To be categorized as well capitalized, a bankan institution must maintain minimum total risk based, Tier I risk based and Tier I leverage ratios as set forth in the following table. The Corporation's and the Bank's actual capital amounts and ratios are also presented in the following table. At December 31, 1999 1998 Tier I Capital $85,507 $78,645 Tier II Supplemental Capital (1) 8,763 11,096 - - --------------------------------------------------------------------------- Total Capital 94,270 89,741 =========================================================================== Average Assets (2) $588,071 $614,598 Risk Weighted Assets: Balance Sheet 362,410 333,783 Off-Balance Sheet 37,111 29,054 - - --------------------------------------------------------------------------- Total Risk Weighted Assets $399,521 $362,837 ===========================================================================50
Minimum Well Actual Requirements Capitalized - - --------------------------------------------------------------------------------------------------------------------- As of December 31, 1999(DOLLARS IN THOUSANDS) MINIMUM TO BE WELL MINIMUM CAPITALIZED UNDER CAPITAL PROMPT CORRECTIVE ACTUAL REQUIREMENT ACTION PROVISIONS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ------------------------------------------------------------------------------- DECEMBER 31, 2002: Total Capitalcapital to Risk Weighted Assets 23.60% >=risk- weighted assets: Consolidated $113,168 20.09% $ 45,055 greater than $ 56,319 greater than or equal to 8% >=or equal to 10% Bank 94,044 17.17% 43,825 greater than 54,782 greater than or equal to 8% or equal to 10% Tier I Capital1 capital to Risk Weighted Assets 21.40% >=risk- weighted assets: Consolidated 103,691 18.41% 22,528 greater than 33,792 greater than or equal to 4% >=or equal to 6% Bank 86,140 15.72% 21,913 greater than 32,869 greater than or equal to 4% or equal to 6% Tier I1 capital to Average Assets 14.54% >=average assets: Consolidated 103,691 10.53% 39,372 greater than 49,215 greater than or equal to 4% >=or equal to 5% As of DecemberBank 86,140 8.94% 38,520 greater than 48,150 greater than or equal to 4% or equal to 5% DECEMBER 31, 19982001: Total Capitalcapital to Risk Weighted Assets 24.73% >=risk- weighted assets: Consolidated $103,645 22.94% $ 36,144 greater than $ 45,180 greater than or equal to 8% >=or equal to 10% Bank 87,070 19.69% 35,372 greater than 44,215 greater than or equal to 8% or equal to 10% Tier I Capital1 capital to Risk Weighted Assets 21.68% >=risk- weighted assets: Consolidated 94,903 21.01% 18,072 greater than 27,108 greater than or equal to 4% >=or equal to 6% Bank 79,855 18.06% 17,686 greater than 26,529 greater than or equal to 4% or equal to 6% Tier I1 capital to Average Assets 12.80% >=average assets: Consolidated 94,903 11.18% 33,960 greater than 42,450 greater than or equal to 4% >=or equal to 5% Bank 79,855 9.63% 33,164 greater than 41,455 greater than or equal to 4% or equal to 5%
(1) Inclusion of the allowance for possible loan losses is allowed up to 1.25% of "Risk Adjusted Assets" and 45 percent of the unrealized gain on unrestricted equity securities is allowed. (2) Includes 45 percent of the unrealized gain or loss on equity securities. Otherwise, unrealized gains or (losses) on available-for-sale securities are excluded. Restrictions imposed by Federal Reserve Regulation H limit dividend payments in any year to the current year's net income plus the retained net income of the prior two years without approval of the Federal Reserve Board. Accordingly, Companythe Corporation's dividends in 20002003 may not exceed $13,735,000,$15,299,000, plus Companyconsolidated net income for 1999.2003. Additionally, banking regulators limit the amount of dividends that may be paid by the Bank to the Corporation. Retained earnings against which dividends may be paid without prior approval of the banking regulators amounted to approximately $61,996,000$76,113,000 at December 31, 1999,2002, subject to the minimum capital ratio requirements noted above. Restrictions imposed by federal law prohibit the Corporation from borrowing from the Bank unless the loans are secured in specific amounts. Such secured loans to the Corporation are generally limited to 10% of the Bank's stockholder's equity (excluding unrealized gains on available-for-sale-securities)accumulated other comprehensive income) or $7,202,000$8,614,000 at December 31, 1999. 242002. 51 16.18. PARENT COMPANY ONLY The following is condensed financial information for Citizens & Northern Corporation. CONDENSED BALANCE SHEET
December 31, (In Thousands) 1999 1998 ASSETS Cash $1,381 $ 89 Available-for-Sale Securities 9,270 Subsidiary Investments Citizens and Northern Bank 60,981 81,000 Citizens & Northern Investment Corporation 13,585 Bucktail Life Insurance Company 1,913 1,796 - - ----------------------------------------------------------------------------------------------------------------------- Total Subsidiary Investments 76,479 82,796 Dividend Receivable 1,300 - - ----------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $77,860 $93,455 ======================================================================================================================= LIABILITIES AND STOCKHOLDERS' EQUITY Borrowed Funds and Other Liabilities $ - $1,765 Dividend Payable 1,237 1,123 Stockholders' Equity 76,623 90,567 - - ----------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $77,860 $93,455 ======================================================================================================================= DECEMBER 31, (IN THOUSANDS) 2002 2001 ASSETS Cash $ 592 $ 333 Investment in subsidiaries: Citizens & Northern Bank 95,879 82,914 Citizens & Northern Investment Corporation 18,929 16,383 Bucktail Life Insurance company 2,006 2,010 Other assets 45 13 - --------------------------------------------------------------------------- TOTAL ASSETS $117,451 $101,653 =========================================================================== LIABILITIES AND STOCKHOLDERS' EQUITY Dividends payable $ 1,586 $ 1,466 Other liabilities 28 - Stockholders' equity 115,837 100,187 - --------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $117,451 $101,653 =========================================================================== CONDENSED INCOME STATEMENT (In Thousands) Years Ended December
YEARS ENDED DECEMBER 31, 1999 1998 1997(IN THOUSANDS) 2002 2001 2000 DividendDividends from Subsidiary $7,000 $5,500 $3,980Citizens & Northern Bank $ 7,063 $ 6,286 $ 4,077 Other Dividend Income 224 218 186 Available-for-Saledividend income 174 250 - Securities Gains 159 822 74 Expenses (184) (356) (77)gains - - ------------------------------------------------------------------------------------------------------------------------ Expenses (140) (74) (179) - ------------------------------------------------------------------------------------ Income Beforebefore equity in undistributed income of subsidiaries 7,097 6,462 3,898 Equity in Undistributed Earningsundistributed income of Subsidiaries 7,199 6,184 4,163 Equity in Undistributed Earnings of Subsidiaries 4,286 4,893 5,944subsidiaries 7,862 5,590 4,578 - - ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- NET INCOME $11,485 $11,077 $10,107 ======================================================================================================================= $14,959 $12,052 $ 8,476 ====================================================================================
52 CONDENSED STATEMENT OF CASH FLOWS Years Ended December
YEARS ENDED DECEMBER 31, (In Thousands) 1999 1998 1997(IN THOUSANDS) 2002 2001 2000 CASH FLOWS FROM OPERATING ACTIVITIES ACTIVITIES: Net Income $11,485 $11,077 $10,107income $ 14,959 $ 12,052 $ 8,476 Adjustments to Reconcile Net Incomereconcile net income to Net Cash Providednet cash provided by Operating Activities: Equity Securities Gains (159) (822) (74)operating activities: Equity in Undistributed Net Incomeundistributed net income of Subsidiaries (4,285) (4,893) (5,944)subsidiaries (7,862) (5,590) (4,578) Amortization of restricted stock 80 22 - (Increase) Decreasedecrease in Other Assets 1,300 (200) (150)other assets (32) 14 (28) Increase (Decrease) in Other Liabilities (145) 372 111other liabilities 98 - 17 - --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 8,196 5,534 4,0507,243 6,498 3,887 - - --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES, Cash Investment in (1,888) -- -- Subsidiarysubsidiary (783) (266) (225) - ------------------------------------------------------------------------------------------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from sale of treasury stock 76 - 6 Purchase of Available-for-Sale Securities (753) (2,257) (602) Proceeds from Sale of Available-for-Sale Securities 360 1,441 187treasury stock (239) (521) - Dividends paid (6,038) (5,441) (4,986) - --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Net Cash Used in Investing Activities (2,281) (816) (415)(6,201) (5,962) (4,980) - - --------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Sale of Treasury Stock 16 24 11 Purchase of Treasury Stock (468) Dividends Declared (4,639) (4,188) (3,744) - - --------------------------------------------------------------------------------------------------------------------- Net Cash Used in Financing Activities (4,623) (4,632) (3,733) - - --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,292 86 (98)259 270 (1,318) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 89 3 101333 63 1,381 - - --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 1,381592 $ 89333 $ 3 =====================================================================================================================63 ================================================================================================
2519. SUMMARY OF QUARTERLY CONSOLIDATED FINANCIAL DATA (UNAUDITED) The following table presents summarized quarterly financial data for 2002 and 2001:
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 QUARTER ENDED Mar. 31, June 30, Sept. 30, Dec. 31, Interest income $ 13,642 $ 14,523 $ 14,675 $ 14,445 Interest expense 6,316 6,745 6,675 6,579 - ----------------------------------------------------------------------------------------------------------------- Interest margin 7,326 7,778 8,000 7,866 Provision for loan losses 180 180 280 300 - ----------------------------------------------------------------------------------------------------------------- Interest margin after provision for loan losses 7,146 7,598 7,720 7,566 Other income 1,687 1,681 1,642 1,614 Securities gains 1,226 781 489 392 Other expenses 5,106 5,248 5,310 5,185 - ----------------------------------------------------------------------------------------------------------------- Income before income tax provision 4,953 4,812 4,541 4,387 Income tax provision 1,115 992 831 796 - ----------------------------------------------------------------------------------------------------------------- Net income $ 3,838 $ 3,820 $ 3,710 $ 3,591 ================================================================================================================= Net income per share - basic $ 0.72 $ 0.72 $ 0.70 $ 0.67 ================================================================================================================= Net income per share - diluted $ 0.72 $ 0.71 $ 0.69 $ 0.67 =================================================================================================================
53
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2001 QUARTER ENDED Mar. 31, June 30, Sept. 30, Dec. 31, Interest income $ 13,093 $ 13,830 $ 13,962 $ 13,776 Interest expense 7,492 7,278 7,037 6,549 - ---------------------------------------------------------------------------------------------------------------- Interest margin 5,601 6,552 6,925 7,227 Provision for loan losses 150 150 150 150 - ---------------------------------------------------------------------------------------------------------------- Interest margin after provision for loan losses 5,451 6,402 6,775 7,077 Other income 1,434 1,516 1,600 1,570 Securities gains 455 742 520 203 Other expenses 4,598 4,580 4,575 4,918 - ---------------------------------------------------------------------------------------------------------------- Income before income tax provision 2,742 4,080 4,320 3,932 Income tax provision 477 891 914 740 - ---------------------------------------------------------------------------------------------------------------- Net income $ 2,265 $ 3,189 $ 3,406 $ 3,192 ================================================================================================================ Net income per share - basic $ 0.42 $ 0.60 $ 0.64 $ 0.60 ================================================================================================================ Net income per share - diluted $ 0.42 $ 0.60 $ 0.64 $ 0.60 ================================================================================================================
54 INDEPENDENT AUDITORS' REPORT To the Stockholders and Board of Directors of Citizens & Northern Corporation: We have audited the accompanying consolidated balance sheetssheet of Citizens & Northern Corporation and subsidiaries ("Corporation") as of December 31, 19992002 and 1998,2001, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1999.2002. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted auditing standards.in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Citizens & Northern Corporation and subsidiaries as of December 31, 19992002 and 1998,2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999,2002, in conformity with accounting principles generally accepted accounting principles.in the United States of America. Parente Randolph, PC /s/ Williamsport, Pennsylvania February 10, 2000 26 MANAGEMENT'S RESPONSIBILITY FOR7, 2003 55 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL REPORTING February 3, 2000 ToDISCLOSURE None PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information concerning Directors and Executive Officers is incorporated herein by reference to disclosure under the Stockholderscaptions "Proposal 1 - Election of Directors," "Corporation's and BoardBank's Executive Officers," and "Section 16(a) Beneficial Ownership Reporting Compliance" of the Corporation's proxy statement dated March 18, 2003 for the annual meeting of stockholders to be held on April 15, 2003. ITEM 11. EXECUTIVE COMPENSATION Information concerning executive compensation information is incorporated herein by reference to disclosure under the caption "Executive Compensation" of the Corporation's proxy statement dated March 18, 2003 for the annual meeting of stockholders to be held on April 15, 2003. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference to disclosure under the caption "Security Ownership of Management" of the Corporation's proxy statement dated March 18, 2003 for the annual meeting of stockholders to be held on April 15, 2003. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information concerning loans to Directors and Executive Officers is provided in Note 14 to the Consolidated Financial Statements, which is included in Part II, Item 8 of this Annual Report on Form 10-K. Additional information is incorporated herein by reference to disclosure appearing under the caption "Certain Transactions" of the Corporation's proxy statement dated March 18, 2003 for the annual meeting of stockholders to be held on April 15, 2003. ITEM 14. CONTROLS AND PROCEDURES Within 90 days prior to the filing date of this report, the Corporation's Chief Executive Officer and Chief Financial Officer carried out an evaluation of the design and effectiveness of the Corporation's disclosure controls and procedures pursuant to Rule 13a-14(c) and Rule 15d-14(c) of the Securities Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Corporation's disclosure controls and procedures are effective to ensure that information required to be disclosed in reports the Corporation files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. There have been no significant changes in the Corporation's internal controls or in other factors that could significantly affect these controls subsequent to the date of the Chief Executive Officer's and Chief Financial Officer's most recent evaluation. There were no significant deficiencies or material weaknesses noted in the evaluation, and therefore there were no corrective actions taken. 56 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (1). The following consolidated financial statements are set forth in Part II, Item 8:
Page ---- Independent Auditors' Report 55 Financial Statements: Consolidated Balance Sheet - December 31, 2002 and 2001 27 Consolidated Statement of Income - Years Ended December 31, 2002, 2001 and 2000 28 Consolidated Statement of Changes in Stockholders' Equity - Years Ended December 31, 2002, 2001 and 2000 29 Consolidated Statement of Cash Flows - Years Ended December 31, 2002, 2001 and 2000 30 Notes to Consolidated Financial Statements 31- 54
(a)(2) Financial statement schedules are not applicable or included in the financial statements or related notes.
(a)(3) Exhibits (numbered as in Item 601 of Regulation S-K): 2. Plan of acquisition, reorganization, arrangement, liquidation or succession Not applicable 3. (i) Articles of Incorporation Incorporated by reference to the exhibits filed with the Corporation's registration statement on Form S-4 on March 27, 1987. 3. (ii) By-laws Incorporated by reference to the exhibits filed with the Corporation's registration statement on Form S-4 on March 27, 1987. 4. Instruments defining the rights of security holders, including indentures Not applicable 9. Voting trust agreement Not applicable 10. Material contracts: Citizens & Northern Corporation Independent Directors Incorporated by reference to the exhibits Stock Incentive Plan filed with the Corporation's proxy statement dated March 19, 2001 for the annual meeting of stockholders held on April 17, 2001. First Amendment to Citizens & Northern Corporation Incorporated by reference to the exhibits Stock Incentive Plan filed with the Corporation's proxy statement dated March 22, 1999 for the annual meeting of stockholders held on April 20, 1999.
57 Citizens & Northern Corporation Stock Incentive plan Incorporated by reference to the exhibits filed with the Corporation's proxy statement dated March 20, 1995 for the annual meeting of stockholders held on April 18, 1995. 11. Statement re: computation of per share earnings Information concerning the computation of earnings per share is provided in Note 3 to the Consolidated Financial Statements, which is included in Part II, Item 8 of Form 10-K. 12. Statements re: computation of ratios Not applicable 13. Annual report to security holders, Form 10-Q or quarterly report to security holders Not applicable 16. Letter re: change in certifying accountant Not applicable 18. Letter re: change in accounting principles Not applicable 21. Subsidiaries of the registrant Filed herewith 22. Published report regarding matters submitted to vote of security holders Not applicable 23. Consents of experts and counsel Not applicable 24. Power of attorney Not applicable 99. Additional exhibits: 99.1 Certifications pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002 Filed herewith 99.2 Additional information mailed to stockholders with proxy statement and Form 10-K on March 19, 2002 Filed herewith
(b) On October 11, 2002, a Current Report on Form 8-K was filed to report the Corporation's consolidated earnings results for the three-month and nine-month periods ended September 30, 2002. (c) Exhibits - The required exhibits are listed under Part IV, Item 14(a)(3) of Form 10-K. (d) Financial statement schedules are omitted because the required information is not applicable or is included elsewhere in Form 10-K. 58 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Citizens & Northern Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized: CITIZENS & NORTHERN CORPORATION By: Craig G. Litchfield /s/ - --------------------------- Craig G. Litchfield Chairman, President and Chief Executive Officer Date: March 18, 2003 By: Mark A. Hughes /s/ - --------------------------- Treasurer and Principal Accounting Officer Date: March 18, 2003 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. BOARD OF DIRECTORS /s/ Dennis F. Beardslee /s/ Edward L. Learn Dennis F. Beardslee Edward L. Learn Date: March 18, 2003 Date: March 18, 2003 /s/ R. Robert DeCamp /s/ Craig G. Litchfield R. Robert DeCamp Craig G. Litchfield Date: March 18, 2003 Date: March 18, 2003 /s/ Jan E. Fisher /s/ Lawrence F. Mase Jan E. Fisher Lawrence F. Mase Date: March 18, 2003 Date: March 18, 2003 /s/ R. Bruce Haner /s/ Leonard Simpson R. Bruce Haner Leonard Simpson Date: March 18, 2003 Date: March 18, 2003 /s/ Susan E. Hartley /s/ James E. Towner Susan E. Hartley James E. Towner Date: March 18, 2003 Date: March 18, 2003 /s/ Karl W. Kroeck /s/ Ann M. Tyler Karl W. Kroeck Ann M. Tyler Date: March 18, 2003 Date: March 18, 2003 /s/ Leo F. Lambert Leo F. Lambert Date: March 18, 2003 59 CERTIFICATIONS I, Craig G. Litchfield, Chairman, Chief Executive Officer and President of Citizens & Northern Corporation, Managementcertify that: 1. I have reviewed this annual report on Form 10-K of Citizens & Northern Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. March 18, 2003 By: Craig G. Litchfield /s/ - -------------- ----------------------- Date Chairman, President and Chief Executive Officer 60 I, Mark A. Hughes, Treasurer and Chief Financial Officer of Citizens & Northern Corporation, and its subsidiaries has preparedcertify that: 1. I have reviewed this annual report on Form 10-K of Citizens & Northern Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the consolidatedstatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the "Annual Reportfinancial condition, results of operations and Form 10-K"cash flows of the registrant as of, and for, the periods presented in accordance with generally accepted accounting principlesthis annual report; 4. The registrant's other certifying officers and isI are responsible for its contentestablishing and accuracy. In meeting its responsibility, management relies on internal accounting and related control systems, which include selection and training of qualified personnel, establishment and communication of accounting and administrative policiesmaintaining disclosure controls and procedures appropriate segregation of responsibilities(as defined in Exchange Act Rules 13a-14 and programs of internal audit. These systems are15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to provide reasonable assuranceensure that financial records are reliable for preparing financial statements and maintaining accountability for assets and that assets are safeguarded against unauthorized use or disposition. Such assurance cannot be absolute because of inherent limitations in any internal control system. Management also recognizesmaterial information relating to the registrant, including its responsibilityconsolidated subsidiaries, is made known to foster a climateus by others within those entities, particularly during the period in which Company affairs are conducted withthis annual report is being prepared; b) evaluated the highest ethical standards. The Company's Code of Conduct, furnished to each employee and director, addresses the importance of open internal communications, potential conflicts of interest, compliance with applicable laws, including those related to financial disclosure, the confidentiality of proprietary information and other items. There is an ongoing program to assess compliance with these policies. The Audit Committeeeffectiveness of the Company's Board of Directors consists solely of outside directors. The Audit Committee meets periodically with managementregistrant's disclosure controls and the independent accountants to discuss audit, financial reporting and related matters. Parente Randolph, PC, and the Company's internal auditors have direct access to the Audit Committee. Craig G. Litchfield James W. Seipler President & CEO Treasurer CAUTIONARY STATEMENT - - -------------------------------------------------------------------------------- This Report contains certain "forward-looking statements" including statements concerning plans, objectives, future events or performance and assumptions and other statements which are other than statements of historical fact. Citizens & Northern Corporation and its subsidiaries wish to caution readers that the following important factors, among others, may have affected and could in the future affect the Corporation's actual results and could cause the Corporation's actual results for subsequent periods to differ materially from those expressed in any forward-looking statement made by or on behalf of the Corporation herein: the effect of changes in laws and regulations, including federal and state banking laws and regulations, with which the Corporation must comply, and the associated cost of compliance with such laws and regulations either currently or in the future as applicable; the effects of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as the Financial Accounting Standards Board; changes in the Corporation's organization, compensation and benefit plans; the effect of increasing consolidation within the banking and financial services industries, including the increased competition from the larger regional banking organizations as well as nonbank providers of various financial services; the effect of changes in interest rates; and the effect of changes in the business cycle and downturns in the local, regional or national economies. - - -------------------------------------------------------------------------------- 27 GLOSSARY OF FREQUENTLY USED TERMS AVAILABLE-FOR-SALE SECURITIES - Debt and equity securities that are reported at fair value, with unrealized gains and losses excluded from earnings and reported separately through accumulated other comprehensive income, net of tax. ALLOWANCE FOR POSSIBLE LOAN LOSSES - A reserve created by a periodic charge to earnings that represents an estimate of the potential credit loss inherent in the loan portfolioprocedures as of a pointdate within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in time. AMORTIZATION -this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The systematic chargeregistrant's other certifying officers and I have disclosed, based on our most recent evaluation, to earnings to reduce the premium paid for an investment security. CAPITAL RATIOSregistrant's auditors and COMPONENTS: 1. Capital Ratios a. Leverage ratio - The ratiothe audit committee of total equity to total liabilities. b. Return on equity - Net income divided by equity. c. Risk-based capital ratio - Ratioregistrant's board of equity to risk weighted assets. 2. Components of Capital a. Capital Stock - Investor ownership of common stockdirectors (or persons performing the equivalent function): a) all significant deficiencies in the Corporation stated as par value. b. Paid-in-Capital - Valuedesign or operation of common stock in excess of the par value. c. Retained Earnings - Accumulated earnings less dividends paid to common shareholders. d. Stock Dividend Distributable - Non-cash dividend payable in common stock of the Corporation. e. Tier I Capital or Equity - Sum of common stock, paid-in-capital and retained earnings. f. Tier II Capital - Sum of subordinated debt, preferred stock, convertible debt securities, a calculated portion of the allowance for loan losses and 45 percent of unrealized gains on unrestricted equity securities. g. Total Capital - Sum of Tier I and Tier II Capital COMPREHENSIVE INCOME - The change in equity during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. For the Corporation it means net income and unrealized gains and losses on available-for-sale securities. CORE DEPOSITS - A subjective dollar value of deposits that management feels will be unaffected by interest rates. DEMAND DEPOSIT - A noninterest-bearing deposit with no stated maturity and requires no notice of withdrawal. EARNING ASSETS - Interest-bearing assets owned by the Corporation consisting predominantly of investments and loans. HELD-TO-MATURITY SECURITIES - Securities purchased with the intent and ability to be held to maturity; carried on the books at cost. INTEREST-BEARING LIABILITIES - All interest-bearing deposits and borrowings of the Corporation. INTEREST RATE RISK - The risk that changes in interest ratesinternal controls which could adversely affect the value ofregistrant's ability to record, process, summarize and report financial data and have identified for the Corporationregistrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or its future earnings. MORTGAGE-BACKED SECURITIES - A pool of mortgages sold on the secondary market. The interest rate paid is the weighted average coupon rate of the underlying mortgages. MVPE- MARKET VALUE OF PORTFOLIO EQUITY - The market value of assets less the market value of liabilities. The market value of assets and liabilities are the present value of all future cash flows at current market rates. This amount does not include assets and liabilitiesmaterial, that are not financial instruments, such as premises and equipment, accrued interest receivableinvolves management or payable, deferred taxes, etc. NIM - Net Interest Margin - Total interest income less total interest expense. NONPERFORMING LOANS - Impaired loans classified as nonaccrual due to nonperformance of borrowers. OTHER REAL ESTATE - Real estate acquired throughother employees who have a deed in lieu of foreclosure or foreclosure proceedings against a debtor. RISK ADJUSTED ASSETS - The sum of the Corporation's assets deemed to be at risk. Calculation of risk assets is performed using percentages supplied by the regulators. SENDERO MODEL - A PC based simulation model purchased from the Sendero Corporation which simulates interest income and market value ehavior under various interest rate scenarios using a variety of asset and liability mixes. WATCH LIST - A list of loanssignificant role in the portfolio thatregistrant's internal controls; and 6. The registrant's other certifying officers and I have been isolated for a variety of reasons: delinquency, collateral, cash flow, documentation, etc. 28 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 1999 PERFORMANCE REVIEW Citizens and Northern Corporation ("Corporation") and its major subsidiary, Citizens and Northern Bank ("Bank"), recorded basic per share earnings of $2.21, $2.13 and $1.94, respectively, for the years ended December 31, 1999, 1998 and 1997. Diluted earnings per share amounted to $2.20, $2.12 and $1.94 for the years ended December 31, 1999, 1998 and 1997, respectively. Return on the Corporation's average equity, excluding the net unrealized gainindicated in this annual report whether or loss on available-for-sale securities, for the years ended 1999, 1998 and 1997 amounted to 14.05 percent, 14.81 percent and 14.56 percent, respectively. Net income for the years ended 1999, 1998 and 1997 amounted to $11,485,00, $11,077,000 and $10,107,000, respectively. Net securities gains included in income for the same periods, respectively, amounted to $3,043,000, $3,001,000 and $1,001,000. During 1998 the Corporation recorded an unusual security gain. Stock that had been acquired as the result of a defaulted loan in 1919 and carried on the Corporation books at $1.00 was sold for an approximate gain of $1,766,000. Net income exclusive of securities gains net of tax for the years ended December 31, 1999, 1998 and 1997 amounted to $9,477,000, $9,097,000 and $9,446,000, respectively. During 1999, the Corporation added fully transactional internet banking to the menu of services provided. The new product has been well accepted by the Corporation's customer base. Also Citizens & Northern Investment Corporation, a Delaware corporation, was formed to hold equity investments. The new corporation will offer tax advantages that are not available in Pennsylvania. A great deal of 1999 was spent getting ready for Y2K and because of the efforts of the data processing department, the audit department and the compliance department, 1999 rolled into 2000 without a glitch. The Corporation did install a new gas generator at its Wellsboro location, just in case. The new generator should prove quite useful during times of power outages. The mainframe computer system was also upgraded to enhance processing speed. OUTLOOK FOR 2000 The Corporation's Board of Directors and management team look ahead to 2000 with optimism and with good reason: your Corporation has an excellent earning asset base, capable personnel, a well established and managed branch network, an increasingly large deposit base and a package of services that continues to grow. A new branch will be opened in Muncy, Pennsylvania during the third or fourth quarter of 2000, and beginning January 2000 the Corporation will be offering a wide range of insurance products through its new insurance subsidiary. The goal of your Corporation is to provide its customers with a complete line of financial services. The year 2000 will be a year of challenge for the Corporation. The challenge will be to continue to provide excellent earnings in an increasingly volatile interest rate environment. Interest rates have risen steadily during the past year and are expected to continue rising well into 2000 before pulling back. When interest rates increase net interest margins narrow and erode earnings. However, at this time your Corporation remains optimistic about the coming year and continues to position the Corporation to provide the highest possible return to its shareholders and remain a strong independent community bank serving the people, the businesses and the communities of its market area. NET INTEREST MARGIN 1999/1998/1997 The primary source of operating income for the Corporation is the net interest margin. The net interest margin is the difference between total interest income generated by interest-bearing assets and the interest expense incurred on interest-bearing liabilities. INTEREST INCOME Interest income generated by the Corporation comes primarily from two earning asset sources: investments and loans. The investment portfolio has traditionally comprised about half of the base of earning assets. Nearly all of the Corporation's investments are classified as available-for-sale, excluding approximately $1,800,000 held by the Corporation's insurance subsidiary, Bucktail Life Insurance Company. The investment portfolio is funded primarily by deposits and borrowed funds. The average balance of the available-for-sale investment portfolio during 1999, 1998 and 1997, on a cost basis amounted to $345,823,000, $294,121,000 and $287,553,000, respectively. The portfolio consists of U. S. Treasury securities, U. S. Agency securities, municipal bonds, pools of mortgage-backed instruments and equity investments of banks and bank holding companies located primarily in Pennsylvania. 29 The rate of return on the investment portfolio declined slightly during 1999 when compared to the prior two years. The return for the years ended December 31, 1999, 1998 and 1997, respectively was 6.37 percent, 6.42 percent and 6.51 percent, respectively. The decline during the current year can be attributed to the prepayments associated with the mortgage-backed investments in 1998 and the call of several U. S. Agency Securities during that year. The large cash flow generated was invested in lower rate investments available at that time. The portfolio is primarily a long-term investment vehicle and does not have a great deal of turnover with the exception of mortgage-backed securities that provide a monthly flow of payments. The portfolio is, however, monitored continuously for long-term profit maximization, especially during periods of interest rate volatility, and at such times the Corporation may sell selected securities from the available-for-sale category. During 1998 and 1999there were significant changes in interest rates caused the mix of portfolio assets to change. Low interest rates during 1998 increased the amount of monthly payments received on mortgage-backed instruments as consumers exercised their option to refinance mortgages. Alsointernal controls or in 1998 government agencies refinanced debt held by the Corporation amounting to about $74,000,000. The increased cash flow of debt refinancing was reinvested in U. S. Agency issues; primarily Federal National Mortgage Association and Federal Home Loan Bank zero coupon bonds. During 1999 the trend in interest rates reversed and prepayments of mortgage-backed instruments slowed dramatically. Average balances carried in mortgage-backed pools during 1999 amounted to $117,902,000 and $121,466,000 during 1998. The average balance of mortgage-backed pools during 1997 was $163,942,000. The average balance of U. S. Agencies for the respective three-year periods was $101,205,000, $68,512,000 and $41,968,000. Also during 1999 and 1998 municipal bonds, because of their nontaxable income and the Corporation's tax position, provided respectable yields. The average balance of municipal securities in 1999 increased to $80,970,000; this compares to $68,942,000 for 1998 and $59,554,000 for 1997. At their current level they provide the Corporation a significant tax benefit without incurring an Alternative Minimum Tax liability. Additional equity securities purchased during 1999 increased the average balances carried to $22,288,000. Average balances carried during 1998 and 1997 were $18,725,000 and $15,039,000, respectively. Several equity investments were sold for a before tax profit of $2,476,000. Included in realized gains were two stocks that were party to mergers during 1999. Accounting rules require that the stock received from the acquiring company be recorded at market value on the date of the merger with the difference between our cost basis in the acquired company's stock and the market value of the acquiring company stock received be realized as a gain or loss in the income statement. The pre-tax amount of gains realized as a result of these mergers was $1,271,000. The equity portfolio is monitored continuously for stocks that management feels are fully valued. It is the practice of the Corporation to sell certain stocks each year and realize gains, which comprise a substantial portion of the overall yield of equity investments. Traditionally equity securities average an annual return of between 2 to 4 percent. Approximately 21 percent of the historical cost basis of the equity portfolio consists of Federal Home Loan Bank stock which carries a substantially higher return than the rest of the equity portfolio. During the last 3 years the Federal Home Loan Bank stock has posted an annual return of about 6.60 percent. Membership in The Federal Home Loan Bank requires stock ownership and the amount of stock varies according to the amount of outstanding loans made to the Corporation. The average balance of other securities was $20,948,000, $13,960,000 and $4,536,000 during 1999, 1998 and 1997, respectively. Other securities consist of corporate bonds or notes normally of other large financial service providers. The loan portfolio makes up most of the balance of the earning asset base and is the largest contributor to total interest income. The Corporation's market area consists of several small rural communities, which surround three or four more heavily populated towns. Consequently, the loan portfolio is retail oriented, consisting mostly of real estate secured mortgages on one to four family dwellings. Total average real estate secured mortgage loans to customers in our market area made up approximately 80 percent of the loan portfolio during 1999, 1998 and 1997 and contributed approximately 78 percent of the total interest income derived from the loan portfolio. The balance of the loan portfolio includes consumer installment loans and commercial loans. The Corporation also has an extensive credit card operation, which provides credit cards to the Corporation's customer base and 48 other agent banks in Pennsylvania. The return on the Corporation's total loan portfolio for the years ended December 31,1999, 1998 and 1997 amounted to 8.68 percent, 9.18 percent and 9.25 percent, respectively. Other interest income producing assets included federal funds sold and interest-bearing deposits held with correspondent banks. The balances held and income produced were considered insignificant for discussion purposes. 30 INTEREST EXPENSE The liability and equity side of the balance sheet is made up of stockholders' equity, interest-bearing liabilities and noninterest-bearing demand deposits and other liabilities. The return on the Corporation's assets and equity are dependent on the spread between rates paid on earning assets and the rate of interest paid on interest-bearing liabilities. Interest-bearing liabilities are made up of deposits and borrowed funds. Average total deposits, including demand deposits, increased 7.9 percent during 1999. This compares to growth rates of 3.2 percent and 1.4 percent for 1998 and 1997, respectively. Deposit growth during 1999 can be attributed to the introduction of new deposit products, the success of a new office and extensive marketing efforts. The Corporation introduced internet banking during the second quarter of 1999 and to date over 1,300 customers have taken advantage of the service. Also very popular is the municipal Money Market Account that was introduced late in 1998. The interest rate paid on the account is tied to the overnight federal funds rate. The account is very popular with local school districts and municipalities. During the fourth quarter of 1998 the Corporation introduced a new type of account called the "RepoSweep". Although linked to deposit activity, "RepoSweep" balances are classified as Short-term Borrowings on the Corporation's balance sheet. The accounts are monitored each day and excess funds above a predetermined level are swept to an interest-bearing account. The rate paid is indexed to the 91-day Treasury Bill rate. Though the FDIC does not insure the accounts, they are secured by investment securities pledged specifically for them and held at a correspondent bank. Balances in the accounts during 1998 ranged from $1.5 million to $3 million and during 1999 average balances exceeded $4 million on a daily basis. Certificates of Deposit and Individual Retirement Accounts are considered core deposits and are the largest single source of deposits. The maturity schedule of certificates ranges from one month to five years. Average balances carried in certificates of deposit for the years ended December 31, 1999, 1998 and 1997 were $139,916,000, $126,902,000 and $119,226,000, respectively. The average rate paid for those deposits for the same periods, respectively, was 5.24 percent, 5.50 percent and 5.49 percent. At year-end 1999 total Certificates of Deposit amounted to approximately $143,132,000. Individual Retirement Accounts are the other source of long term funding. These accounts carry an eighteen-month maturity schedule and the rate changes quarterly. The Corporation had in the past been successful in growing the balances in these accounts by paying higher than market rates. However, due to mutual fund competition and competition from the Corporation's Trust Department for the balances carried in Individual Retirement Accounts we have witnessed a small decline during the past three years. Average balances and rates paid on Individual Retirement Accounts during the years ended December 31, 1999, 1998 and 1997 were, respectively, $75,882,000 at 5.21 percent, $76,557,000 at 5.42 percent and $78,662,000 at 5.99 percent. Short term deposits (deposits that reprice more frequently) consist of Money Market accounts, Interest Checking accounts and Savings accounts. Money Market accounts are the Corporation's second largest source of deposits. The Corporation has paid higher than the market rate for these deposits and has been successful in attracting and maintaining large average balances. Average balances carried for the years ended December 31, 1999, 1998 and 1997, respectively, were $131,741,000, $115,143,000 and $107,287,000. Average rates paid for those same periods were, respectively, 4.34 percent, 4.42 percent and 4.55 percent. The Interest Checking accounts allow normal checking activity but earn a lesser rate of interest. Average balances and rates paid on these accounts for the years ended December 31, 1999, 1998 and 1997 were, respectively, $37,248,000 at 2.27 percent, $36,556,000 at 2.33 percent and $38,334,000 at 2.47 percent. Finally, the last short term interest-bearing accounts carried by the Corporation are the Regular Savings accounts. Regular Savings come in two forms, passbook and statement, and both pay the same rate of interest. Regular Savings have traditionally been the backbone of the Corporation's core deposit base. Average balances for the years ended December 31, 1999, 1998 and 1997 were $46,643,000, $45,207,000 and $46,338,000, respectively. The rate paid for each of the three years was approximately 2.50 percent. The Corporation also carries noninterest-bearing Demand Deposits; average balances for the past three years, respectively, were $50,787,000, $46,336,000 and $42,780,000. The increase in average balances during 1999 is due to internet banking, municipal accounts, the growth of a new branch opened late in 1998 and other factors. The final type of interest-bearing liability found on the Corporation balance sheet is borrowed funds, both short and long-term. The Corporation normally uses short term borrowing for liquidity purposes, i.e., deposit fluctuations, loan demand etc. This may be in the form of overnight Federal Funds borrowed from a correspondent bank or a repurchase agreement arranged through the Federal Home Loan Bank of Pittsburgh or a broker. Long-term borrowing is used to leverage the Corporation's strong capital base to enhance earnings. Long-term borrowings may be in the form of repurchase agreements or secured borrowing, also through the Federal Home Loan Bank of Pittsburgh or a broker. Short-term borrowing is defined as having an original maturity of overnight to one year. Long-term borrowed funds have a maturity of one year or more. Average balances carried as short and long-term borrowing and RepoSweep accounts for the years ended December 31, 1999, 1998 and 1997 amounted to $97,585,000, $76,040,000 and $88,548,000, respectively. Average rates for the same periods, respectively, were 5.35 percent, 5.67 percent and 5.63 percent. Average balances carried in overnight federal funds for the years ended December 31, 1999. 1998, and 1997 were $6,085,000, $2,801,000 and $663,000, respectively. The average rate paid for the same periods respectively, was 4.91 percent, 4.75 percent and 4.98 percent. 31 TABLE I - ANALYSIS OF INTEREST INCOME AND EXPENSE
(In Thousands) Years Ended December 31, Increase (Decrease) 1999 1998 1997 99/98 98/97 INTEREST INCOME Available-for-Sale Securities: U. S. Treasury Securities $ 148 $ 151 $ 139 $ (3) $ 12 Securities of Other U. S. Government Agencies and Corporations 7,007 4,842 3,002 2,165 1,840 Mortgage Backed Securities 7,791 7,992 11,060 (201) (3,068) Obligations of States and Political Subdivisions 4,533 3,982 3,595 551 387 Stock 1,207 950 874 257 76 Other Securities 1,355 961 52 394 909 - - ---------------------------------------------------------------------------------------------------------------------------------- Total Available-for-Sale Securities 22,041 18,878 18,722 3,163 156 - - ---------------------------------------------------------------------------------------------------------------------------------- Held-to-Maturity Securities: U. S. Treasury Securities 34 37 34 (3) 3 Securities of Other U. S. Government Agencies and Corporations 58 41 22 17 19 Mortgage backed Securities 27 38 52 (11) (14) - - ---------------------------------------------------------------------------------------------------------------------------------- Total Held-to-Maturity Securities 119 116 108 3 8 - - ---------------------------------------------------------------------------------------------------------------------------------- Interest -bearing Due from Banks 30 37 54 (7) (17) Federal Funds Sold 42 229 334 (187) (105) Loans: Real Estate Loans 20,620 20,371 20,218 249 153 Consumer 3,170 3,529 3,857 (359) (328) Agricultural 194 223 272 (29) (49) Commercial/Industrial 1,590 1,621 1,606 (31) 15 Other 55 55 62 - (7) Political Subdivisions 541 380 391 161 (11) Leases 13 20 18 (7) 2 - - ---------------------------------------------------------------------------------------------------------------------------------- Total Loan Income 26,183 26,199 26,424 (16) (225) - - ---------------------------------------------------------------------------------------------------------------------------------- Total Interest Income 48,415 45,459 45,642 2,956 (183) ================================================================================================================================== INTEREST-BEARING LIABILITIES Interest Checking 844 853 945 (9) (92) Money Market 5,723 5,093 4,879 630 214 Savings 1,157 1,121 1,150 36 (29) Certificates of Deposit 7,328 6,984 6,549 344 435 Individual Retirement Accounts 3,956 4,152 4,713 (196) (561) Other Time Deposits 44 49 56 (5) (7) Federal Funds Purchased 299 133 33 166 100 Other Borrowed Funds 5,220 4,308 4,987 912 (679) - - ---------------------------------------------------------------------------------------------------------------------------------- Total Interest Expense 24,571 22,693 23,312 1,878 (619) ================================================================================================================================== Net Interest Income $23,844 $22,766 $22,330 $1,078 $ 436 ==================================================================================================================================
(1) Net interest income, if reflected on a fully tax equivalent basis, would have amounted to $26,026,000, $27,621,000, and $26,773,000 for 1999, 1998, and 1997, respectively. (2) Fees on loans are included with interest on loans and amounted to $720,000, $710,000 and $612,000 for the years ended 1999, 1998 and 1997, respectively. 32 Table I I - Analysis of Average Daily Balances and Rates
Rate of Rate of Rate of (In Thousands) Return/ Return/ Return/ Cost of Cost of Cost of Funds Funds Funds EARNING ASSETS 12/31/99 % % 12/31/98 % 12/31/97 Available-for-Sale Securities *: U. S. Treasury Securities $ 2,510 5.90 $ 2,516 6.00 $ 2,514 5.53 Securities of Other U.S. Government Agencies and Corporations 101,205 6.92 68,512 7.07 41,968 7.15 Mortgage Backed Securities 117,902 6.61 121,466 6.58 163,942 6.75 Obligations of States and Political Subdivisions 80,970 5.58 68,942 5.78 59,554 6.04 Stock 22,288 5.42 18,725 5.07 15,039 5.81 Other Securities 20,948 6.47 13,960 6.88 4,536 1.15 - - ------------------------------------------------------------------------------------------------------------------------- Total Available-for-Sale Securities 345,823 6.37 294,121 6.42 287,553 6.51 - - ------------------------------------------------------------------------------------------------------------------------- Held-to-Maturity Securities: U. S. Treasury Securities 615 5.53 626 5.91 601 5.66 Securities of Other U. S. Government Agencies and 895 6.48 629 6.52 297 7.41 Corporations Mortgage backed Securities 368 7.34 507 7.50 689 7.55 - - ------------------------------------------------------------------------------------------------------------------------- Total Held-to-Maturity Securities 1,878 6.34 1,762 6.58 1,587 6.81 - - ------------------------------------------------------------------------------------------------------------------------- Interest -bearing Due from Banks 566 5.30 671 5.66 795 6.79 Federal Funds Sold 866 4.85 4,139 5.53 6,132 5.45 Loans **: Real Estate Loans 240,951 8.56 227,845 8.94 223,510 9.05 Consumer 28,982 10.94 30,366 11.62 32,293 11.94 Agricultural 1,961 9.89 2,219 10.05 2,689 10.12 Commercial/Industrial 19,271 8.25 17,698 9.16 16,743 9.59 Other 714 7.70 707 7.78 754 8.22 Political Subdivisions 9,499 5.70 6,227 6.10 6,355 6.15 Leases 206 6.31 214 9.35 236 7.63 - - ------------------------------------------------------------------------------------------------------------------------- Total Loans 301,584 8.68 285,276 9.18 282,580 9.35 - - ------------------------------------------------------------------------------------------------------------------------- Total Earning Assets 650,717 7.44 585,969 7.76 578,647 7.89 Cash 14,028 12,694 12,228 Securities Valuation Reserve 7,865 19,939 9,907 Allowance for Possible Loan Losses (5,083) (4,822) (4,844) Other Assets 5,509 5,337 5,745 Bank Premises & Equipment 7,828 6,985 6,594 - - ------------------------------------------------------------------------------------------------------------------------- Total Assets $680,864 $626,102 $608,277 ========================================================================================================================= INTEREST-BEARING LIABILITIES Interest Checking $ 37,248 2.27 $36,556 2.33 $38,334 2.47 Money Market 131,741 4.34 115,143 4.42 107,287 4.55 Savings 46,643 2.48 45,207 2.48 46,338 2.48 Certificates of Deposit 139,916 5.24 126,902 5.50 119,226 5.49 Individual Retirement Accounts 75,882 5.21 76,557 5.42 78,662 5.99 Other Time Deposits 1,641 2.68 1,900 2.58 2,223 2.52 Federal Funds Purchased 6,085 4.91 2,801 4.75 663 4.98 Other Borrowed Funds 97,585 5.35 76,040 5.67 88,548 5.63 - - ------------------------------------------------------------------------------------------------------------------------- Total Interest-bearing Liabilities 536,741 4.58 481,106 4.72 481,281 4.84 Demand Deposits 50,787 46,336 42,780 Other Liabilities 6,193 10,663 8,211 - - ------------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES 593,721 538,105 532,272 Stockholders' Equity 81,767 74,810 69,440 - - ------------------------------------------------------------------------------------------------------------------------- Securities Valuation Reserve 5,376 13,187 6,565 - - ------------------------------------------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $680,864 $626,102 $608,277 ========================================================================================================================= Interest Rate Spread 2.86 3.04 3.05
(*) Average balances do not include unrealized gains and losses on Available-for-Sale Securities. (**) Nonaccrual loans have been included with loans for the purpose of analyzing net interest earnings. 33 TABLE III - ANALYSIS OF THE EFFECT OF VOLUME AND RATE CHANGES ON INTEREST INCOME AND INTEREST EXPENSE
Years Ended December 31, 1999/1998 (In Thousands) Change in Change in Total Volume Rate Change EARNING ASSETS Available-for-Sale Securities: U. S. Treasury Securities $ - $ (3) $ (3) Securities of Other U.S. Government Agencies and Corporations 2,261 (96) 2,165 Mortgage Backed Securities (238) 37 (201) Obligations of States and Political Subdivisions 669 (118) 551 Stock 192 65 257 Other Securities 448 (54) 394 - - -------------------------------------------------------------------------------------------------------------------- Total Available-for-Sale Securities 3,332 (169) 3,163 Held-to-Maturity Securities U. S. Treasury Securities (1) (2) (3) Securities of Other U.S. Government Agencies and Corporations 17 - 17 Mortgage Backed Securities (10) (1) (11) - - -------------------------------------------------------------------------------------------------------------------- Total Held-to-Maturity Securities 6 (3) 3 Interest -bearing Due from Banks (4) (3) (7) Federal Funds Sold (162) (25) (187) Loans: Real Estate Loans 975 (726) 249 Consumer (157) (202) (359) Agricultural (26) (3) (29) Commercial/Industrial 267 (298) (31) Other - - - Political Subdivisions 184 (23) 161 Leases (1) (6) (7) - - -------------------------------------------------------------------------------------------------------------------- - - -------------------------------------------------------------------------------------------------------------------- Total Loans 1,242 (1,258) (16) - - -------------------------------------------------------------------------------------------------------------------- Total Interest Income 4,414 (1,458) 2,956 - - -------------------------------------------------------------------------------------------------------------------- INTEREST BEARING LIABILITIES Interest Checking 17 (26) (9) Money Market 719 (89) 630 Savings 36 - 36 Certificates of Deposit 651 (307) 344 Individual Retirement Accounts (36) (160) (196) Other Time Deposits (7) 2 (5) Federal Funds Purchased 161 5 166 Other Borrowed Funds 1,136 (224) 912 - - -------------------------------------------------------------------------------------------------------------------- Total Interest Expense 2,677 (799) 1,878 - - -------------------------------------------------------------------------------------------------------------------- NET INTEREST INCOME $1,737 $ (659) $1,078 ==================================================================================================================== Years Ended December 31, 1998/1997 (In Thousands) Change in Change in Total Volume Rate Change EARNING ASSETS Available-for-Sale Securities: U. S. Treasury Securities $ - $ 12 $ 12 Securities of Other U.S. Government Agencies and Corporations 1,876 (36) 1,840 Mortgage Backed Securities (2,800) (268) (3,068) Obligations of States and Political Subdivisions 533 (146) 387 Stock 158 (82) 76 Other Securities 267 642 909 - - -------------------------------------------------------------------------------------------------------------------- Total Available-for-Sale Securities 34 122 156 - - -------------------------------------------------------------------------------------------------------------------- Held-to-Maturity Securities: U. S. Treasury Securities 1 2 3 Securities of Other U.S. Government Agencies and Corporations 19 - 19 Mortgage backed Securities (14) - (14) - - -------------------------------------------------------------------------------------------------------------------- Total Held-to-Maturity Securities 6 2 8 - - -------------------------------------------------------------------------------------------------------------------- Interest -bearing Due from Banks (9) (8) (17) Federal Funds Sold (110) 5 (105) Loans: Real Estate Loans 383 (230) 153 Consumer (227) (101) (328) Agricultural (47) (2) (49) Commercial/Industrial 72 (57) 15 Other (4) (3) (7) Political Subdivisions (8) (3) (11) Leases (1) 3 2 - - -------------------------------------------------------------------------------------------------------------------- Total Loans 168 (393) (225) - - -------------------------------------------------------------------------------------------------------------------- Total Interest Income 89 (272) (183) - - -------------------------------------------------------------------------------------------------------------------- INTEREST BEARING LIABILITIES Interest Checking (43) (49) (92) Money Market 342 (128) 214 Savings (28) (1) (29) Certificates of Deposit 422 13 435 Individual Retirement Accounts (123) (438) (561) Other Time Deposits (8) 1 (7) Federal Funds Purchased 101 (1) 100 Other Borrowed Funds (709) 30 (679) - - -------------------------------------------------------------------------------------------------------------------- Total Interest Expense (46) (573) (619) - - -------------------------------------------------------------------------------------------------------------------- NET INTEREST INCOME $ 135 $ 301 $ 436 ====================================================================================================================
The change in interest due to both volume and rates has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. 35 NONINTEREST INCOME 1999/1998/1997 Noninterest income is composed of seven major components: Service Charges on Deposit Accounts, Service Charges and Fees, Trust Department Income, Insurance Commissions, Fees and Premiums, Fees Related to the Credit Card Operations Other Operating Income and Realized Net Gains on Available-for-Sale Securities. The percentages cited below in the discussion of the components of Noninterest Income are derived using Noninterest Income Before Gains on Securities, Net. Overall, Noninterest Income increased $361,000, or 5.9 percent, in 1999 compared to 1998 and $610,000 or 10.5 percent when compared to 1997. A comparison of 1998 to 1997reflects an increase of 4.3 percent; however, noninterest income for 1997 includes a gain of $301,000 from the sale of a copyrighted logo. Exclusive of this gain, other noninterest income would have increased 7.2 percent during 1998 when compared to 1997. Income generated from Service Charges on Deposit Accounts is from fees assessed on checking accounts for monthly service charges, per-check charges for checks drawn and checks deposited and for charges assessed for checking account overdrafts. For each of the three years presented service charges amounted to 55 percent of the total and the remainder, overdraft fees. Service Charges on Deposit Accounts for the years ended December 31, 1999, 1998 and 1997 accounted for 17 percent of total Noninterest Income. Because of increased account activity and the introduction of internet banking service charge income has increased during 1999 when compared to 1998 and 1997. The Corporation does offer free deposit accounts to a large number of its account holders including senior citizens and accounts using direct deposit of payroll. Other Service Charges and Fees are derived from debit card fees, credit card annual fees, fees for bank customer data processing services and a variety of other services such as check cashing for noncustomers, bank money orders, cashier checks, traveler's checks, etc. Annually, Other Service Charges and Fees contributed approximately 4 percent of the total Noninterest Income in each of the three years presented. Trust Department Income has become the large source of noninterest income. For the years ended December 31, 1999, 1998 and 1997, respectively, Trust Department Income amounted to 23 percent, 21 percent and 17 percent of total noninterest income. Trust Department Income has increased approximately 13 percent when comparing the years ended December 31, 1999 and 1998 and 28 percent when comparing 1998 to 1997. The increase can be attributed to an increase in the number of trust accounts and the amount of trust assets. Assets under management as of December 31, 1999, 1998 and 1997, respectively, were $320,385,000, $283,262,000 and $230,149,000. The increase in trust assets can be attributed to the highly qualified and technical staff employed by the Trust Department and the record levels posted on various stock markets. Insurance Commissions, Fees and Premiums generated by the Corporation's subsidiary, Bucktail Life Insurance Company, accounted for about 7 percent of Noninterest Income for the years ended December 31, 1999,1998 and 1997. Insurance Commissions, Fees and Premiums did decline slightly when comparing 1998 to 1997. The fees did increase slightly during 1999, however, they were still below levels attained during 1997. The Corporation will be adding a new insurance subsidiary in 2000 that will offer a wide range of insurance products to its customers. Bucktail Life Insurance Company only offers insurance products that are tied to credit arrangements. Fees related to the Credit Card Operation are derived from merchant fees and agent bank fees. Merchant fees are the charge to merchants for processing sales and agent bank fees are generated from processing the credit card program for agent banks. The Corporation currently processes for 48 agent banks. The fees earned during 1999 increased 3.2 percent compared to 1998. The fees earned during 1998 when compared to 1997 were up 13.2 percent. The 1998/1997 increase was because of an increase in activity in some of the agent banks' programs. During 1999 the increase was not as large because of the loss of two large agent banks due to mergers. 35 Net realized gains on Available-for-Sale Securities in 1999 amounted to $3,043,000, gross gains were $3,186,000 and gross losses amounted to $143,000. Included in net realized gains were two stocks owned by the Corporation that were party to mergers. Accounting rules require that the difference between the original cost of the acquired company's stock and the market value of the acquiring company's stock be recognized as current income. The amount of recognized gain attributable to those stocks amounted to $1,271,000. Prior to the merger the difference between the original cost and the current market value was recorded as Other Accumulated Comprehensive Income. Gross gains on Available-for-Sale-Securities for 1998 amounted to $3,422,000, while gross losses recognized amounted to $421,000 for a net gain of $3,001,000. Included in 1998 gains was the sale of a stock that had been acquired in 1919 as collateral on a defaulted loan. The stock had been carried on the Corporation books at $1.00. The company represented by the stock was sold in 1998 and the Corporation recognized a gain of $1,766,000. Net realized gains on available-for-sale securities for the year ended December 31, 1997 amounted to $1,001,000. Gross gains and gross losses realized during 1997, respectively, amounted to $2,883,000 and $1,882,000, resulting in a net gain of $1,001,000. During recent years it has been the practice of the Corporation's management and Board of Directors to sell certain equity investments that it feels are overpriced and use the realized gains to increase the return on the equity investment portion of the portfolio to a level consistent with the remainder of the portfolio.
Years Ended December 31, TABLE IV - COMPARISON OF NONINTEREST INCOME % % (In Thousands) 1999 Change 1998 Change 1997 Service Charges on Deposit Accounts $1,113 7.12 $1,039 (3.44) 1,076 Service Charges and Fees 274 (4.86) 288 2.49 281 Trust Department Income 1,456 13.04 1,288 28.29 1,004 Insurance Commissions, Fees and Premiums 438 8.15 405 (12.34) 462 Fees Related to Credit Card Operation 3,064 3.20 2,969 13.02 2,627 Other Operating Income 99 5.32 94 (75.52) 385 - - ----------------------------------------------------------------------------------------------------------------------------------- Total Other Operating Income before Realized Securities Gains, Net 6,444 5.93 6,083 4.27 5,834 Realized Gains on Securities, Net 3,043 1.40 3,001 199.80 1,001 - - ----------------------------------------------------------------------------------------------------------------------------------- Total Other Income $9,487 4.44 $9,084 32.90 $6,835 ===================================================================================================================================
OTHER NONINTEREST EXPENSE 1999/1998/1997 Other Noninterest Expense is made up of Salaries and Wages, Pension and Other Employee Benefit Expenses, Occupancy Expense, Furniture and Equipment Expense, Expenses Related to Credit Card Operations, Pennsylvania Shares Tax and Other Operating Expense. Other Noninterest Expense for the year ended December 31, 1999 increased 8 percent when compared to the year ended December 31, 1998 and 9 percent when comparing 1998 to the year 1997. Salaries and Wages for the year ended December 31, 1999 when compared to 1998 increased $305,000. The increase is attributable to an increase in the number of full time equivalent employees from 209 at year-end 1998 to 213 at year-end 1999. The increase in the number of employees can be attributed to the addition of internet banking. Merit raises of about 4.5 percent also contributed to the increase. A comparison of salary expense for the years ended December 31, 1998 and 1997 reflects an increase of $646,000 or 11 percent. The 1998 increase reflects the addition of a new branch and a marketing department , as well as merit increases. Pension and Other Employee Benefits for the year ended December 31, 1999 increased about 4 percent when compared to 1998. A large portion of the increase can be attributed to the expense of funding the Corporation's 401 (k) Plan due to an increase in employee contributions that were matched by the Corporation. The Corporation matches dollar for dollar employee contributions up to 3 percent of an employee's salary, and $.50 per dollar of contribution up to 5 percent of salary. There was also a substantial increase in the cost of group hospitalization insurance in 1999. A comparison of 1998 and 1997 pension and benefit costs also reflects an increase of 4 percent or $69,000. Again the increase is primarily an increase in the cost of funding the Corporations 401 (k) Plan and an increase in group hospitalization costs. Occupancy Expense increased 8 percent or $69,000 during 1999 when compared to 1998 and 14 percent or $101,000 when comparing 1998 to 1997. Nearly all of the increase in 1999 can be attributed to depreciation and increased insurance costs related to the new office opened in late 1998. The increase that occurred in 1998 can be attributed in part to the expenses associated with the opening of the new office. Also, the janitors in two of the larger offices were replaced with cleaning services which had the effect of lowering salaries and wages and increasing occupancy expense. 36 A comparison of Furniture and Equipment Expense for the years 1999 and 1998 reflects an increase of 36 percent or $286,000. The increase can be attributed to depreciation and maintenance costs associated with the ATM system and internet banking. The approximate depreciation basis of the ATM network and the internet banking systems , respectively, was $450,000 and $250,000, maintenance costs for the systems is also very high, however, both systems are an essential part of the service provided by the Corporation. A comparison of Furniture and Fixtures cost between 1998 and 1997 reflects an increase of $69,000. This increase is related to the installation and maintenance of the ATM system in 1998. During 1998 and 1999 the Corporation also upgraded by replacement a substantial portion of the personal computers in use to be Y2K compliant and thin clients (personal computers connected to a server) installed in branches that were introduced into the branch system to complement internet banking. Expenses Related to Credit Card Operations declined 5 percent or $135,000 during 1999. The decrease can be attributed to the loss of 2 merchant banks and the related expense due to conversions. A comparison of 1998 and 1997 costs reflects an increase during 1998 of 14 percent or $337,000 over 1997. Nearly all of the increase is related to an increase in interchange transaction fees (those are fees paid to networks of which we are not a member) and the growing number of credit card transactions. The Corporation is a major credit card processor for 48 banks in Pennsylvania. Pennsylvania Shares Tax is also a substantial Noninterest Expense amounting to $723,000, $656,000 and $596,000 for the years ended December 31, 1999, 1998 and 1997, respectively. The tax is based on the Bank's six-year average capital excluding U. S. Treasury and qualifying U. S. Government agency securities, at a rate of 1.25 percent. Other Operating Expense, whose major components are educational expense, supplies, directors' fees, advertising, examination charges and legal fees, increased 19 percent or $586,000 in 1999 over 1998 and increased 4 percent in 1998 when compared to 1997. The increase in 1999 was substantial, but was essential as internet banking was implemented and Y2K was at the forefront. A substantial part of the increased expense was related to Y2K as software had to be replaced, also the internet banking system made it essential that thin clients (and the related servers) be placed in the branch system, which entailed software and educational costs. Also included in Other Operating Expense during 1999 were the costs of introducing a new Visa debit card. Other Operating Expense did not increase substantially between 1998 and 1997.
Years Ended December 31, TABLE V- COMPARISON OF NONINTEREST EXPENSE % % (In Thousands) 1999 Change 1998 Change 1997 Salaries and Wages $ 6,926 4.61 $ 6,621 10.81 $ 5,975 Pensions and Other Employee Benefits 1,831 4.03 1,760 4.08 1,691 Occupancy Expense, Net 896 8.34 13.91 827 726 Furniture and Equipment Expense 1,078 36.11 9.54 792 723 Expenses Related to Credit Card Operation 2,597 (4.94) 2,732 14.07 2,395 Pennsylvania Shares Tax 723 10.21 656 10.07 596 Other Operating Expense 3,681 18.93 3,095 3.55 2,989 - - ------------------------------------------------------------------------------------------------------------------------------ Total Other Expense $ 17,732 7.58 $ 16,483 9.20 $ 15,095 ==============================================================================================================================
INCOME TAXES The Corporation's Income Tax Provision reflected as a per share cost to stockholders amounted to $.64, $.68 and $.61, respectively, for 1999, 1998 and 1997. The amount of income tax payable per common share for those years was $.56, $.61 and $.61, respectively. The per share tax payable for 1999 is a reasonable estimate as the return has not been prepared as of the date of this analysis. The difference between the amount of income tax currently payable and the amount reflected in the Corporation's income statement is caused by temporary differences. Generally, temporary differences occur when an item of income or expense is included in taxable income during different accounting periods for financial statement and tax return purposes. The most significant items creating temporary differences are accretion on bonds, depreciation, realized gains on investments, loan loss expense, loan fees and expense and employee benefit plans. There are items included in the income statement that are not fully taxable, including dividends received from certain domestic corporations and a portion of interest received on municipal bonds and loans. 37 The reader should refer to Note 12 of the "Notes to the Consolidated Financial Statements" for a more complete analysis of income tax expense. ALLOWANCE FOR POSSIBLE LOAN LOSSES Credit risk is the risk to earnings or capital arising from an obligor's failure to meet the terms of a contract with the Corporation. Management's responsibility for maintaining an adequate allowance for loan losses is clearly identified by the banking regulatory agencies in the Interagency Policy Statement on the Allowance for Loan and Lease Losses (The Interagency Policy) and in generally accepted accounting principles (GAAP). The Interagency Policy states: "Federally insured depository institutions must maintain an Allowance for Loan Losses at a level that is adequate to absorb estimated credit losses associated with the loan and lease portfolio, including all binding commitments to lend." An assessment of the allowance is performed quarterly. The purpose of the quarterly assessment is to determine the adequacy of the reserve and to estimate the allocated and unallocated components that make up the reserve. The assessment of the allowance balance is performed by management and reviewed by The Board of Directors each quarter. The Board of Directors also reviews the Corporation's "Watch List" monthly. The "Watch List" is a collection of loans that have a history of delinquency, collateral deficiency, cash flow problems, etc. Total "Watch List" loans at December 31, 1999 were approximately $13,453,000. All of the watch list loans have the potential of becoming significant credit risks; however, a substantial portion of the loans are current as to principal and interest. The assessment is performed by a loan quality committee which consists of the President, Treasurer, Executive Vice-presidents in charge of loans and branch administration and in a review capacity, the Corporation's internal auditor. The committee reviews all of the risk elements in the loan portfolio; namely, the "Watch List", past due reports, nonperforming loans, Other Real Estate and historical information related to charge-offs and recoveries by loan categories. In the event that a loan becomes 90 to 120 days or more past due, the loan is reviewed by the loan quality committee and if necessary is classified as an impaired or nonperforming loan. At the time the loan is classified as impaired, all accrued interest is written off against earnings or the allowance for loan losses, whichever is applicable. The collateral value is compared to the carrying value and any deficiency becomes a specific allocation of the Allowance for Possible Loan Losses as required by SFAS No. 114, " Accounting by a Creditor for Impairment of a Loan". Specific allocations for impaired loans at December 31, 1999 and 1998 amounted to $609,000 and $290,000, respectively. The allowance for loan losses is evaluated based on an assessment of the losses inherent in the portfolio. This assessment results in an allowance consisting of two components, allocated and unallocated. The allocated component of the allowance for loan losses reflects expected losses resulting from the analysis of individual loans, developed through specific credit allocations for individual loans and historical loss experience for each loan category. The specific credit allocations are based on a regular analysis of all loans and commitments on the Corporation's "Watch List". Also, the historical loan loss element is determined based on the ratio of net charge-offs to average loan balances over a five-year period, for each significant type of loan. The charge-off ratio is then applied to the current outstanding loan balance for each type of loan (net of "Watch List" loans that are individually evaluated). The Corporation also engages a consulting firm to perform an independent credit review. Their review is performed annually on loans of $175,000 and higher. The most recent review was at the close of business June 11, 1999. The loan quality committee gives substantial consideration to the classifications and recommendations of the independent credit reviewer in determining the allowance for loan losses. The unallocated portion of the allowance is determined based on management's assessment of general economic conditions as well as specific economic factors in the Corporation's market area. This determination inherently involves a higher degree of uncertainty and considers current risk factors that may not have yet manifested themselves in the Corporation's historical loss factors used to determine the allocated component of the allowance, and it recognizes that knowledge of the portfolio may be incomplete. The Corporation was examined by the State Department of Banking as of December 31, 1998. The Corporation charges off loans that are recommended by the examiners unless there are underlying circumstances that management feel will make the debt collectible. The Corporation also has a policy of charging off loans, based on management's analysis and The Board of Directors' approval, at the end of each quarter. 38 Tables VI, VII, VIII and IX present an analysis of the loan portfolio, the allowance for loan losses, the allocation of the allowance and a five-year summary of loans by type.
TABLE VI - SIX YEAR HISTORY OF LOAN LOSSES (In Thousands) 1999 1998 1997 1996 1995 1994 AVERAGE Net Loans * 310,892 291,003 285,426 278,639 264,182 258,472 281,436 Net Charge offs 449 856 660 504 387 326 530 Allowance for Possible Loan Losses Balance 5,131 4,820 4,913 4,776 4,579 4,229 4,741 Provision for Loan Losses Charged to Earnings 760 763 797 701 737 737 749 Earnings 11,485 11,077 10,107 9,255 7,866 7,494 9,547 Earnings Coverage of Net Charge offs 25.6 X 12.9 X 15.3 X 18.4 x 20.3 X 23.0 x 18.0 x x Allowance Coverage of Net Charge offs 11.4 X 5.6 X 7.4 X 9.5 x 11.8 X 13.0 x 8.9 x Loans Ninety Days or More Past Due and Still Accruing 1,797 1,628 1,986 2,994 2,915 2,743 2,344 Net Charge offs as a Percent of the Provision 59.1 % 112.2% % 82.8 % 71.9 % 52.5 % 44.2 % 70.8% Year-End Nonperforming Loans** 1,956 1,135 1,412 864 279 624 1,045 Allowance as a Percentage of Gross Loans: * Bank (1) 1.65 % 1.66 % 1.72 % 1.71 % 1.73 % 1.64 % 1.69% Peer Group (2) 1.42 % 1.65 % 1.43 % 1.50 % 1.61 % 1.65 % 1.54%
* Gross Loans less Unearned Discount (1) December 31, (2) At September 30, TABLE VII - ANALYSIS OF THE ALLOWANCE FOR POSSIBLE LOAN LOSSES
Years Ended December 31, 1999 1998 1997 1996 1995 Balance at Beginning of Year $ 4,820 $ 4,913 $ 4,776 $ 4,579 $ 4,229 Charge-offs Real Estate Loans 81 257 246 157 38 Installment Loans 138 144 230 240 236 Credit cards and Related Plans 192 264 305 201 184 Commercial and Other Loans 219 301 3 74 116 - - --------------------------------------------------------------------------------------------------------------------------------- Total Charge-offs 630 966 784 672 574 - - --------------------------------------------------------------------------------------------------------------------------------- Recoveries Real Estate Loans 81 12 21 22 - Installment Loans 60 43 64 53 60 Credit Card and Related Plans 30 40 30 38 41 Commercial and Other Loans 10 15 9 55 86 - - -------------------------------------------------------------------------------------------------------------------------------- Total Recoveries 181 110 124 168 187 - - -------------------------------------------------------------------------------------------------------------------------------- Net Charge-offs 449 856 660 504 387 Additions Charged to Operations 760 763 797 701 737 - - -------------------------------------------------------------------------------------------------------------------------------- Balance at End of Year $ 5,131 $ 4,820 $ 4,913 $ 4,776 $ 4,579 ================================================================================================================================ TABLE VIII - ALLOCATION OF THE ALLOWANCE FOR POSSIBLE LOAN LOSSES BY TYPE (In Thousands) 1999 1998 1997 1996 1995 1994 Mortgage 834 97 350 58 38 35 Consumer 437 702 375 303 286 241 Commercial 2,081 650 625 630 604 443 Impaired Loans 609 290 274 113 228 -- All Other Commitments 150 202 343 369 374 386 Unallocated 1,020 2,879 2,946 3,303 3,049 3,124 - - -------------------------------------------------------------------------------------------------------------- Total Allowance 5,131 4,820 4,913 4,776 4,579 4,229 ==============================================================================================================
The above allocation is based on estimates and subjective judgments and is not necessarily indicative of the specific amounts or loan categories in which losses may occur. The lower unallocated portion of the allowance in 1999 is the result of a change in the method used to calculate the allocation. The calculation for years prior to 1999 did not include specific amounts for "Watch List" and impaired loans. These loans were included in the total population of loans and historical loss ratios applied. These loans are now segregated from total loans prior to applying the historical loss ratios. TABLE IX - Six Year Summary of Loans by Type
1999 % 1998 % 1997 % 1996 % 1995 % 1994 % (In Thousands) Real Estate-Construction 649 0.21 1,004 0.34 406 0.14 1,166 0.42 1,284 0.49 2,539 0.98 Real Estate-Mortgage 247,604 79.64 230,815 79.30 219,952 77.05 213,957 76.79 200,066 75.72 193,095 74.72 Consumer 29,140 9.37 30,924 10.63 33,094 11.59 33,420 11.99 36,351 13.76 37,531 14.52 Agricultural 1,899 0.61 1,930 0.66 2,424 0.85 2,603 0.93 2,815 1.07 3,154 1.22 Commercial 18,050 5.81 17,630 6.06 17,176 6.02 15,751 5.65 14,445 5.47 13,625 5.27 Other 1,025 0.33 1,062 0.37 6,260 2.19 5,014 1.80 2,512 0.95 2,459 0.95 Political Subdivisions 12,332 3.97 7,449 2.56 5,895 2.07 6,464 2.32 6,546 2.48 5,870 2.27 Lease Receivables 222 0.07 218 0.07 256 0.09 264 0.09 189 0.07 168 0.07 - - ---------------------------------------------------------------------------------------------------------------------------- Total 310,921 100.00 291,032 100.00 285,463 100.00 278,639 100.00 264,208 100.00 258,441 100.00 Less Unearned Discount (29) (29) (37) (42) (26) (23) - - ---------------------------------------------------------------------------------------------------------------------------- 310,892 291,003 285,426 278,597 264,182 258,418 Less Allowance for Possible (5,131) (4,820) (4,913) (4,776) (4,579) (4,229) for Possible Loan Losses - - ---------------------------------------------------------------------------------------------------------------------------- Net Loans and Lease 305,761 286,183 280,513 273,821 259,603 254,189 Financing Receivables ============================================================================================================================
Certain loans classified as "Other" for the years 1997, 1996, 1995 and 1994 were reclassified as "Real Estate - Mortgage" in 1999 and 1998. The loans were home improvement loans that did not have a correct collateral classification prior to 1998. BALANCE SHEET Average Total Assets of the Corporation for the year ended December 31, 1999 were $680,864,000. This compares to average total assets for the years ended December 31, 1998 and December 31, 1997 of $626,102,000 and $608,277,000, respectively. Assets of the Corporation consist of earning and nonearning assets. Earning assets include investments, loans and certain interest-bearing deposits held at the Federal Home Loan Bank of Pittsburgh and other correspondent banks. The average balance of the investment portfolio (excluding unrealized gains or losses) during 1999 amounted to $347,701,000, or about 53 percent of average earning assets. This compares to average investment s during 1998 and 1997 of $295,883,000 and $289,140,000, respectively. The investment portfolio amounted to 50.5 percent of earning assets in 1998 and 50.0 percent in 1997. Investments are purchased when the Corporation has deposits in excess of its loan demand, or when leverage opportunities exist and funds are borrowed. Investing borrowed funds allows the Corporation to leverage its strong capital position. Normally the leveraged borrowing will produce a spread of about 150 basis points (1.5 percent). During the last two years interest rate spreads have narrowed to ranges that allow relatively few leveraging opportunities. The average portfolio balance did increase nearly 18 percent during 1999. The increase was funded by deposit growth and an increase in average borrowed funds of about $25,000,000. The investment portfolio consists of U. S. Treasury securities, U. S. agency securities, municipal bonds, other bonds and equity securities. U. S. Treasury issues normally make up a small percentage of the total portfolio and traditionally carry a lower after tax return than the other investments. The issues that are carried are required as collateral for U. S. Government and state deposits. Mortgage-backed securities make up the largest part of the portfolio averaging 34.0 percent, 41.2 percent and 56.9 percent for 1999, 1998, 1997, respectively. The decline in balances during 1999 and 1998 clearly underscores the prepayment risk associated with the investments. Mortgage-backed investments are issued by the Federal National Mortgage Association, the Government National Mortgage Association and the Federal Home Loan Mortgage Corporation. The investments represent a share of a pool of mortgages or a bond secured by a pool of mortgages. The rate of return on the pool depends on the weighted average coupon or mortgage rate of the individual mortgages in the pool and whether the pool was purchased at a discount or premium. The pools are used for liquidity purposes as they normally provide a monthly cash flow of $2,000,000 to $3,000,000; however, at times during 1998 and 1997 monthly payments amounted to $4,000,000. During 1999 the portfolio mix changed somewhat, as U. S. Agency investments became a larger part of the overall portfolio. Investments in U. S. Agency securities averaged 29.4 percent of the total portfolio in 1999, average U. S. Agency securities in 1998 and 1997 amounted to 23.4 percent and 14.6 percent of the portfolio, respectively. The increase began in late 1997 and carried well into 1998 when interest rates declined and a significant portion of the investment in mortgage-backed securities began to prepay. The cash flow from the mortgage-backed investments was reinvested in U. S. Agency securities, primarily Federal Home Loan Bank zero coupon bonds. 40 A significant portion of the funds provided by the growth in deposits was invested in municipal securities. Average municipal holdings during 1999 amounted to $80,970,000. Average municipal holdings during the years ended December 31, 1998 and 1997 were $68,942,000 and $59,554,000, respectively. The municipal bonds carry a lower rate of interest; however, a large portion of the interest is tax exempt, which effectively increases the rate of return. A portion of the interest paid on deposits used to purchase these bonds, however, is nondeductible. Tax-exempt interest income from municipal bonds and loans totaled $4,393,000 in 1999, $4,362,000 in 1998 and $3,986,000 in 1997 while the amount of nondeductible interest during each of the last three years was $665,000 in 1999, $549,000 in 1998 and $477,000 in 1997. During 1999, 1998 and 1997 average balances carried in municipal bonds made up 23.3 percent, 23.3 percent and 20.6 percent of the investment portfolio, respectively. Average balances carried during 1999 increased because of attractive rates and the tax position of the Corporation. The remainder of the portfolio consists of other bonds and equity investments. Other bonds are normally bonds or notes issued by large financial institutions that carry a slightly higher interest rate because of lower or no rating. Average Other Securities as a percentage of the total portfolio for years ended December 31, 1999, 1998 and 1997, respectively, were 6.0 percent, 4.7 percent and 1.6 percent. The balance of the portfolio is made up of equity investments. These are equities of banks or bank holding companies. Most of the institutions are located in Pennsylvania or neighboring states. Average balances carried in equity investments as a percentage of the investment portfolio form for the years ended December 31, 1999, 1998 and 1997 were, respectively, 6.4 percent, 6.3 percent and 5.2 percent. The available-for-sale investment portfolio must be reported at market value, as such, at the end of each quarterly reporting period the entire portfolio is repriced to the current market value. The difference between cost and market value represents unrealized gain or loss and is recorded, net of tax as an increase or decrease in capital of the Corporation. The net adjustment to capital as of December 31, 1999, 1998 and 1997 was ($8,884,000), $11,922,000 and 13,335,000,respectively. The sharp decline in appreciation between the years ended December 31, 1998 and December 31, 1999 is due to an increase in long interest rates of about 150 plus basis points during 1999. At December 31, 1998 the yield on the 30 Year Treasury was at about 5 percent at December 31, 1999 the yield had risen to 6.7 percent. The effect of such rate increases is to undermine the underlying market value of the total portfolio, as a substantial portion of the investments were purchased at less than current market rates. Average total loans for the years ended December 31, 1999, 1998 and 1997 amounted to $301,584,000, $285,276,000 and $282,580,000, respectively. As a percentage of average earning assets for those years they were 46.3 percent, 48.7 percent and 48.8 percent, respectively. Historically, real estate secured loans have made up 70 to 80 percent of the dollars in the loan portfolio. The mortgages are primarily 1-4 family dwellings and commercial loans secured by real estate. The commercial side of the portfolio is weighted heavily in forest and wood product loans because of the abundance of hard woods natural to our geographic area. The mortgage portfolio carries with it the same risk of prepayment as the mortgage-backed investments in a falling interest rate environment. The structure and nature of the loan portfolio is not expected to change significantly in the coming years and loan growth for 2000 will probably be about 5 percent.. The Corporation introduced a new home equity line of credit during 1997 that has enjoyed a certain amount of success because of the price, ease and speed with which it is set up. Approximately 4.0 percent of the Corporation's average assets for 1999, 1998 and 1997 were invested in land, buildings, furniture and fixtures, noninterest-bearing cash and other assets. The Corporation has 16 banking offices in Tioga, Bradford, Sullivan and Lycoming counties and is planning the construction of a new branch in Muncy, Pennsylvania. All of the offices are modern banking facilities. In February of 2000 the Corporation also purchased an additional facility in Wellsboro, Pennsylvania to house the credit card operation. The Corporation has also installed 12 automated teller machines throughout its market area. The liability side of the balance sheet is made up of three basic components: deposits, borrowed funds and capital. The deposit base is primarily interest-bearing and posted significant growth during 1999, particularly Certificates of Deposit and Money Market accounts. Interest-bearing deposit categories include Interest Checking accounts, Money Market accounts, Regular Savings (passbook and statement), Certificates of Deposit, Individual Retirement Accounts and other time deposits (Christmas clubs, Vacation clubs). Certificates of Deposit provide the major portion of the deposit base for the Corporation. Average balances, respectively, for the years ended December 31, 1999, 1998 and 1997 amounted to $139,916,000, $126,902,000 and $119,226,000, making up nearly a third of the deposit base in each of the three years. At December 31, 1999 the Corporation had approximately 10,283 accounts with a weighted average interest rate of 5.33 percent. 41 The Corporation's Super Money Fund (Money Market) accounts provide the second largest source of deposits, providing about 25 percent of deposit funds and numbered 3,538 accounts at December 31, 1999. The accounts are required to carry a higher minimum balance and are paid a higher rate of interest than Interest Checking and Savings accounts. The interest rate is determined utilizing the 91-day treasury bill rate as an index. Monthly activity is restricted by regulation. The Corporation has been successful in recent years in attracting Super Money Fund accounts by paying a slightly higher rate than other institutions in our market area. During 1998 a new Money Market Municipal account was introduced. The account is paid a rate approximating the overnight Federal Funds rate and is available to all municipal customers. The account has been very popular and has had the effect of keeping municipal funds in the market area. The rate paid is tiered depending on the balance. Interest Checking accounts make up slightly more than 7 percent of the deposit base and numbered about 2,227 accounts at December 31, 1999. This type of account allows unlimited transaction activity and earns a rate of interest slightly higher than Regular Savings, provided the balance is $2,500 or higher; when the balance falls below $2,500 the rate paid is less than Regular Savings. The indicator used to price this account is the 91-day treasury bill auction rate. The Corporation also offers the still very popular Regular Savings account. The account comes in two forms: passbook and statement. The account pays a rate of 2.50 percent, which is very competitive for our market area. The average balance for this type of account has experienced some erosion during the past three years, however average balances stabilized at about $45,000,000 during 1998 and has held at that level during 1999. It is expected that average balances will decline modestly in 2000 as funds are moved to higher rate instruments and alternative investments, especially mutual funds. At December 31, 1999, the Corporation had approximately 19,300 Regular Savings and Statement Savings accounts. Demand deposit average balances have remained stable during the past three years, averaging about 10 percent of the deposit base. The Corporation offers a variety of checking account types to meet the needs of our market area. The total number of checking accounts being serviced at December 31, 1999 was approximately 21,250. Individual Retirement Accounts are the third largest source of deposit funds for the Corporation and during the past three years have made up more than 15 percent of the deposit base. The Corporation has aggressively marketed Individual Retirement Accounts by paying a rate slightly higher than that of the competition in our market area. During the past three years increased competition from mutual funds and the Corporation's Trust department have slowed deposit growth. The number of accounts was about 3,782 at December 31, 1999. The remaining component of interest-bearing liabilities is borrowed funds. Borrowed funds may be in the form of unsecured overnight Federal Funds purchased, fixed term borrowings secured by a blanket floating-lien agreement and repurchase agreements secured by individual securities through brokers. The borrowings are classified as either short-term or long-term depending on the original maturity. Borrowings with an original maturity of one year or less are classified short-term. Borrowings whose original maturity exceeds one year are classified long-term. Average borrowed funds for the years ended December 31, 1999, 1998 and 1997 (excluding Federal funds Purchased) amounted to $97,585,000, $76,040,000 and $88,548,000, Borrowed funds are normally used for liquidity purposes or to leverage the capital of the Corporation. During 1998 average borrowed funds declined when compared to 1999 and 1997 as leveraging opportunities were nonexistent or hard to find because of a flat yield curve. To successfully leverage Corporation capital there must be a spread of at least 150 basis points between long-term and short-term rates. Average borrowed funds increased just over $20,000,000 as two leveraging opportunities totaling $22,000,000 arose during 1999. The spread between the funds borrowed and the underlying asset acquired was 2.11 percent. The terms for fixed rate borrowings and Repurchase Agreements range from 3 months to 5 years. The floating-lien agreement loans are with the Federal Home Loan Bank of Pittsburgh, a major source of funding for the Corporation. The loans secured by repurchase agreements are placed with either the Federal Home Loan Bank of Pittsburgh, Solomon Brothers or Morgan Stanley. The Capital accounts of the Corporation will be discussed later in Management's Discussion in the Capital section. LIQUIDITY Bank liquidity is the ability to quickly raise cash at a reasonable cost in order to serve customer needs and to operate efficiently by meeting short-term obligations on a timely basis. An adequate liquidity position permits the Corporation to pay creditors, to allow for unforeseen deposit runoffs, to fund unexpected increases in loan demand and to fund loan growth without making costly balance sheet adjustments. Normally, day to day deposit decreases do not vary more than $4,000,000 to $6,000,000 and new loan advances, net of loan repayments, average less than $100,000 daily. To accommodate fluctuations in deposits and the funding needed to support loan growth, the Corporation has several cash sources. Beyond the regular and on-going liquidity generated by loan repayments, amortization of mortgage-backed securities, the maturing of bonds and the routine growth in deposits, the Corporation has several additional sources for meeting its liquidity needs: the sale of assets (primarily investment securities), short-term or long-term borrowing (e.g., federal funds purchased and Federal Home Loan Bank borrowings) and attracting short-term deposits (principally certificates of deposit). When deposits decline for short periods or when loan demand increases unexpectedly, the Corporation relies on several credit lines. The Corporation maintains an "Open-Repo Plus" program with the Federal Home Loan Bank of Pittsburgh, and overnight borrowing agreements with several of its correspondent banks, principally Mellon Bank and the Atlantic Central Bankers Bank. The Federal Home Loan Bank borrowing is secured by the Corporation's mortgage loans and mortgage-backed securities. Additionally, the Corporation uses repurchase agreements placed with Solomon Brothers and Morgan Stanley to borrow short-term funds secured by investment assets. 42 During the fourth quarter of 1998 the Corporation introduced a new interest-bearing noninsured account called the "Repo Sweep" secured by investments deposited with a correspondent bank. The account is paid a rate that is tiered and indexed to the Federal Funds rate. The account looks at checking account balances during daily processing and transfers balances above a predetermined level to the "Repo Sweep" account and during processing for the next business day the balances are transferred back. Average balances carried in "Repo Sweep" accounts during 1999 exceeded $4,000,000. The Corporation also has a similar product available to business customers with credit lines. Credit lines are accessed or paid down automatically depending on predetermined deposit balances. MARKET RISK The Corporation's two major categories of market risk, interest rate and equity securities risk, are discussed in the following sections. INTEREST RATE RISK Business risk that exists and arises from changes in interest rates is an inherent factor in operating a bank. The Corporation's assets are predominantly composed of long-term bonds, term loans with amortizations over periods up to 20 years and other long-term assets. Funding for these assets comes principally from short-term deposits: demand deposits (checking accounts), money market accounts, certificates of deposit with maturities of 1 to 60 months and regular savings accounts. When short-term funding sources, with interest rates that can change frequently, are used to fund long-term assets, with rates that change much less frequently, there is an inherent interest rate and market value risk. Interest rate fluctuations impact the market values of the Corporation's investments, which are carried as available-for-sale securities and marked to the current market values at the end of each quarter. Rising interest rates can cause significant depreciation in the portfolio. Conversely, falling interest rates can dramatically increase the value of the portfolio. Interest rate fluctuations can also affect the loan portfolio and the Corporation's deposit base. However, those assets and liabilities are considered long-term and not available for sale, therefore, market value fluctuations are not recorded. Two important measurements of Interest Rate Risk are the impact on net interest income and the impact on the market value of the Corporation's portfolio equity. Quantifying interest rate risk can be achieved using several methods. Many experts and regulators agree that sophisticated income simulation models provide the best way to measure and predict the effects of Interest Rate Risk. The Corporation uses such a model to calculate the Interest Rate Risk and its potential effect on net interest income and market value of portfolio equity. The simulation model is used monthly by the Corporation. Applying interest rate increases and decreases of 100, 200 and 300 basis points to earning assets and interest-bearing liabilities the model measures and projects potential changes in net interest income and calculates the discounted present value of anticipated cash flows of the assets and liabilities to arrive at a net market value under the base "most likely" and "what if" scenarios. The simulation is performed using a number of different asset and liability mix scenarios that allows management to measure on a "what if" basis. The Corporation's Board of Directors has established parameters within which the Interest Rate Risk effects on income and market value may fall when interest rates are simulated to increase or decrease 200 basis points. The acceptable range for fluctuations in net interest income is minus 20 percent from the base most likely one-year scenario. The acceptable range for market value variance is minus 30 percent from the base most likely one-year scenario. During the months of November and December 1999 the 30 percent parameter associated with market value variance of the securities portfolio was exceeded by about 4 percent and 8 percent, respectively. The board of Directors and management in conjunction with the ALCO committee decided to not take any action at this time to reduce the variance to acceptable levels. The plan decided upon was to wait and see if long interest rates would begin to decline between now and mid-year. Had the Board and management decided to take corrective action there would only be two viable options available. The first would be to sell, at a significant loss, a portion of the portfolio. This option was discounted because the instruments in the portfolio causing the greatest market value loss provide a return and a spread to the cost of the underlying liabilitiies that is 43 acceptable. The second option would be to put in place a hedge transaction that would prevent a further deterioration of market value. This option is currently being investigated. The model used by the Corporation, Sendero, has the capability of applying the embedded options inherent in any balance sheet such as prepayments during a period of declining interest rates or runoffs of certain deposits during periods of rising rates. The model is flexible enough to allow several rates to be applied to several different balance sheet assumptions. Table X was prepared using the Sendero model described above. The estimated change in the net interest margin was calculated based on the difference between the Corporation's estimated interest margin for the year 2000 amounting to $23,061,000 based on current interest rates as of December 31, 1999, and the hypothetical interest margin that would result from an increase or decrease in interest rates of 200 basis points. The market value of portfolio equity represents the difference between incoming and outgoing cash flows, discounted to present value, from assets, liabilities and off-balance sheet contracts. The results presented in Table X indicate that the Corporation exceeded at December 31, 1999 the Board established guideline. In 1999, updated prepayment tables were used which resulted in a greater negative impact on net interest income in the rising rate scenario and a less favorable impact on net interest income in the declining rate scenario. The model utilized to create Table X makes estimates, at each level of interest rate change, regarding cash flows from principal repayments on loans and mortgage-backed securities and call activity on other investment securities. Actual results could vary significantly from these estimates which could result in significant differences in the calculations of projected changes in net interest margin and market value of portfolio equity. Also, the model does not make estimates related to changes in the composition of the deposit portfolio that could occur due to rate competition and the table does not necessarily reflect changes that management would make to realign the portfolio as a result of changes in interest rates. TABLE X - THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES
(In Thousands) Period Ending December 31, 2000 December 31, 1999 Data Plus 200 Basis Points Minus 200 Basis Points Most Likely Forecast Amount Amount % Change Amount % Change Interest Income: Investments $24,529 $25,289 3.10 $23,694 -3.40 Interest Bearing Due 457 612 33.92 303 -33.70 Loans 27,607 28,791 4.29 25,461 -7.77 Federal Funds Sold 5 4 -20.00 23 360.00 - - ---------------------------------------------------------------------------------------------------------------------- Total Interest Income 52,598 54,696 3.99 49,481 -5.93 Interest Expense: Interest on Deposits 22,014 27,653 25.62 16,374 -25.62 Interest on Borrowed Funds 7,523 9,594 27.53 5,557 -26.13 - - ---------------------------------------------------------------------------------------------------------------------- Total Interest Expense 29,537 37,247 26.10 21,931 -25.75 - - ---------------------------------------------------------------------------------------------------------------------- Net Interest Income 23,061 17,449 -24.34 27,550 19.47 ====================================================================================================================== Market Value of Portfolio Equity at December 31, 1999 $67,619 $41,817 -38.16 $83,250 23.12 ======================================================================================================================
(In Thousands) Period Ending December 31, 1999 December 31, 1998 Data Plus 200 Basis Points Minus 200 Basis Points Most Likely Forecast Amount Amount % Change Amount % Change Interest Income: Investments $18,753 $20,317 8.34 $18,520 -1.24 Interest Bearing Due 395 279 -29.37 114 -71.14 Loans 26,822 27,311 1.82 23,483 -12.45 Federal Funds Sold 54 44 -18.52 19 -64.81 - - ------------------------------------------------------------------------------------------------------------------------------- Total Interest Income 46,024 47,951 4.19 42,136 -8.45 Interest Expense: Interest on Deposits 18,415 22,197 20.54 13,693 -25.64 Interest on Borrowed Funds 3,591 4,508 25.54 3,177 -11.53 - - ------------------------------------------------------------------------------------------------------------------------------- Total Interest Expense 22,006 26,705 21.35 16,870 -23.34 - - ------------------------------------------------------------------------------------------------------------------------------- Net Interest Income $24,018 $21,246 -11.54 $25,266 5.20 =============================================================================================================================== Market Value of Portfolio Equity at December 31, 1998 $88,235 $66,909 -24.17 $110,814 25.59 ===============================================================================================================================
EQUITY SECURITIES RISK The Corporation's equity securities portfolio consists of restricted stock, primarily of the Federal Home Loan Bank of Pittsburgh ("FHLB"), and investments in stocks of other banks and bank holding companies, mainly based in Pennsylvania. FHLB stock can only be sold back to the FHLB or to another member institution at par value. Accordingly, the Corporation's investment in FHLB stock is carried at cost, which equals par value, and is evaluated for impairment. Factors that might cause FHLB stock to become impaired (decline in value on an other than temporary basis) are primarily regulatory in nature and are related to potential problems in the residential lending market; for example, the FHLB may be required to make dividend or other payments to the Financing Corporation, the Resolution Funding Corporation, or other entities, in amounts that could exceed the FHLB's total equity. Investments in bank stocks are subject to the risk factors affecting the banking industry generally, including competition from non-bank entities, credit risk, interest rate risk and other factors that could result in a decline in market prices. Also, losses could occur in individual stocks held by the Corporation because of specific circumstances related to each bank. Further, because of the concentration of its holdings in Pennsylvania banks, these investments could decline in value if there were a downturn in the state's economy. The Corporation's management monitors its risk associated with its equity securities holdings by reviewing its holdings on a detailed, individual security basis, at least monthly, considering all of the factors described above. Equity securities held as of December 31, 1999, 1998, and 1997 are as follows: (In Thousands)
Hypothetical Hypothetical 10% 20% Decline Decline Fair In Market In Market At December 31, 1999 Cost Value Value Value - - ----------------------------------------------------------------------------------------------------------------------------- Bank & Bank Holding Companies $18,482 $26,221 $(2,622) $(5,244) Federal Home Loan Bank and Other Restricted Stocks 7,248 7,248 (725) (1,450) - - ----------------------------------------------------------------------------------------------------------------------------- Total $25,730 $33,469 $(3,347) $(6,694) ============================================================================================================================= Hypothetical Hypothetical 10 % 20 % Decline Decline In Market In Market At December 31, 1998 Cost Fair Value Value Value - - ----------------------------------------------------------------------------------------------------------------------------- Banks & Bank Holding Companies $16,791 $31,368 $(3,137) $(6,274) Federal Home Loan Bank and Other Restricted Stocks 4,574 4,574 (457) (915) - - ----------------------------------------------------------------------------------------------------------------------------- $21,365 $35,942 $(3,594) $(7,189) =============================================================================================================================
Hypothetical Hypothetical 10 % 20 % Decline Decline In Market In Market At December 31, 1997 Cost Fair Value Value Value - - ----------------------------------------------------------------------------------------------------------------------------- Banks & Bank Holding Companies $12,035 $27,909 $(2,791) $(5,582) Federal Home Loan Bank and Other Restricted Stocks 4,114 4,114 (411) (823) - - ----------------------------------------------------------------------------------------------------------------------------- Total $16,149 $32,023 $(3,202) $(6,405) =============================================================================================================================
46 CAPITAL ADEQUACY Under regulations published by the Federal Deposit Insurance Corporation and other bank regulators, a bank's capital must be divided into two tiers. The first tier consists primarily of common stock, retained earnings, surplus and noncumulative perpetual preferred stock, if any. The second tier includes the allowance for possible loan losses (limited to 1.25 percent of risk-weighted assets), cumulative preferred stock and subordinated debt and 45 percent of unrealized gains on equity investments. Risk-based capital guidelines published in 1990 require banks to maintain a risk-based capital ratio of 8 percent, 4 percent of which must be tier I; the remainder may be tier II. The total (tier I and tier II) risk-based capital ratios at December 31, 1999 and 1998 were 24.73 percent and 24.60 percent, respectively. The primary source of capital growth for Citizens and Northern Corporation is earnings. The growth of capital, excluding unrealized gains or losses on available-for-sale securities, attributable to earnings, (net of dividends), for the years ended December 31, 1999, 1998 and 1997 was 9.1 percent, 9.5 percent and 9.7 percent, respectively. Return on average assets ( net of unrealized gains or losses on available-for-sales securities)for the periods ended December 31, 1999, 1998 and 1997, respectively was 1.71 percent, 1.77 percent and 1.66 percent. Return on average equity (excluding unrealized gains or losses on available-for-sales securities) for the same respective periods was 14.05 percent, 14.81 percent and 14.56 percent The total capital of the Corporation at December 31, 1999, excluding net unrealized gains or losses on Available-for-Sale Securities, amounted to $85,807,000. This compares to total capital of $78,645,000 and $72,200,000 at December 31, 1998 and 1997, respectively. Total capital of the Corporation at December 31, 1999, 1998, and 1997, respectively, including the adjustment for unrealized gains and losses on Available-for-Sale Securities, amounted to $76,623,000, $90,567,000 and $85,535,000. The adjustment is caused by the required implementation of Statement of Financial Accounting Standards (SFAS) No. 115. This pronouncement requires that investment securities held as available-for-sale be marked-to-market on the last day of each accounting period and the adjustment, net of taxes, be included in shareholders' equity. The leverage ratio (capital divided by total liabilities), excluding the adjustment for unrealized gains and losses on available-for-sale securities, at December 31, 1999 and 1998 was 13.6 percent and 14.2 percent, respectively. The capital to deposits ratio at the same dates was 17.1 percent and 16.5 percent, respectively. Capital expenditures for 2000 are expected to be between $750,000 and $1,250,000. These expenditures include a satellite location to house the credit card operation and the construction of a branch in Muncy, Pennsylvania. These capital expenditures will not have a detrimental effect on the capital ratios or the results of operations. COMPREHENSIVE INCOME Comprehensive Income is a measure of all changes in the equity of a corporation, excluding transactions with owners in their capacity as owners (such as proceeds from issuances of stock and dividends). The difference between Net Income and Comprehensive Income is termed "Other Comprehensive Income". For the Corporation, Other Comprehensive Income consists of unrealized gains and losses on available-for-sale securities, net of deferred income tax. Comprehensive Income should not be construed to be a measure of net income. The effect of Other Comprehensive Income would only be reflected in the income statement if the entire portfolio of available-for-sale securities were sold on the statement date. The amount of unrealized gains or losses reflected in Comprehensive Income may vary widely at statement dates depending on the markets as a whole and how the portfolio of available-for-sale securities is affected by interest rate movements. Other Comprehensive Income (Loss) for the periods ended December 31, 1999, 1998, and 1997 were respectively, ($20,806,000), ($1,413,000) and $7,568,000. The substantial decrease in comprehensive income that occurred during 1999 when compared to 1998 and 1997 is the result of an increase in long-term interest rates. When long-term securities currently carried in the Corporation's portfolio are priced in a rising rate economy they will normally be discounted substantially. This is because they were purchased from accelerated cash flow generated during periods of lower or declining long-term rates. 47 YEAR 2000 The Year 2000 and the associated problems that could have occurred, came and went without any discernable problems. The MIS, Audit, and Compliance departments did a commendable job in readying the Corporation for this event. The estimated costsignificantly affect internal controls subsequent to the Corporationdate of our most recent evaluation, including any corrective actions with regard to become Y2K compliant was approximately $750,000. The costs were primarily hardwaresignificant deficiencies and software related and were incurred over a four-year period. Most of these costs have been capitalized and are being depreciated over 3-5 years. Determining internal programming costs would be difficult to estimate since programming efforts were spread over a four year period from 1996 through 1999. To the best of management's knowledge there are no computer applications critical to the operation of the Corporation that have not been used successfully and been found to be compliant after January 1, 2000. INFLATION Inflation is the increase in the price of goods or services from one period to the next and is normally measured by the change in the CPI or Consumer Price Index. Other measures include the PPI or Producer Price Index and GDP, the Gross Domestic Product. Inflation affects nearly every aspect of banking, primarily interest rates, which have been discussed in detail earlier under Interest Rate Risk. The effect of inflation impacts the purchase of goods, such as supplies, services and labor used to provide banking products to our customers. The Federal Reserve Open Market Committee raised rates three times during 1999 in an effort to maintain a noninflationary economy. At the present time the inflation rate is about 2 percent. QUARTERLY SHARE DATA The Corporation's stock is not traded on an established stock exchange. However, stock transactions are effected through various brokers who maintain a market in the Corporation's stock or trades are made on a person to person basis. The following table sets forth the approximate high and low sales prices of the common stock during 1999, 1997 and 1996 as furnished by brokers and other sources considered by the Corporation to be reliable.
1999 1998 1997 Dividend Dividend Dividend Declared Declared Declared per per per High Low Quarter High Low Quarter High Low Quarter - - ------------------------------------------------------------------------------------------------------------ First Quarter 35.50 33.25 0.22 36.75 33.65 0.20 26.50 24.00 0.18 Second Quarter 33.25 31.25 0.22 37.95 36.50 0.20 29.25 27.25 0.18 Third Quarter 32.50 31.00 0.22 38.50 37.00 0.20 32.25 29.50 0.18 Fourth Quarter 30.25 27.00 0.24 36.80 35.35 0.22 33.50 30.75 0.20 plus plus plus 1 % stock 1 % stock 1 % stock
COMMON STOCK AND PER SHARE DATA - - -------------------------------------------------------------------------------------------------------------------------- 1999 1998 1997 1996 1995 Net Income - Basic $2.21 $2.13 $1.94 $1.77 $1.51 Net Income - Diluted $2.20 $2.12 $1.94 $1.76 $1.51 Cash Dividends Declared $0.89 $0.80 $0.72 $0.66 $0.62 Cash Dividends Declared on an Historical Basis $0.90 $0.82 $0.74 $0.69 $0.65 Stock Dividend 1 % 1 % 1 % 1 % 1 % Number of Shares Outstanding(excluding shares held in 5,153,729 5,102,028 5,063,043 5,012,332 4,962,456 treasury) Number of Shares Used for Computation - Basic 5,205,140 5,209,640 5,215,775 5,215,740 5,215,636 Number of Shares Issued 5,272,239 5,220,038 5,168,354 5,117,182 5,066,516 Number of Shares Authorized 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000 Stockholders' Equity Per Share 14.72 17.38 16.40 13.59 12.84 Stockholders' Equity Per Share (*) 16.43 15.10 13.84 12.50 11.51 Number of stockholders at Year End 2,321 2,300 2,182 2,119 2,027
48 (*) Does not include unrealized holding gains or losses on available-for-sale securities. (a) For purposes of this computation, the number of shares outstanding, excluding shares held in treasury has been increased for the effects of the 1% stock dividend issued in January following each year-end. Known "market makers" who handle Citizens & Northern Corporation stock transactions are:
F. J. MORRISSEY & CO., INC. HOPPER SOLIDAY & COMPANY RYAN, BECK & COMPANY 1700 Market Street, Suite 1420 1703 Oregon Pike 3 Parkway Philadelphia, PA 19103-3913 Lancaster, PA 17601-6401 Philadelphia, PA 19102 (215) 563-8500 (800) 526-6371 (800) 342-2325 FERRIS, BAKER WATTS, INC. MERRILL LYNCH, PIERCE, SANDLER O'NEILL & PARTNERS, LP 6 Bird Cage Walk FENNER & SMITH, INC. Two World Trade Center, 104th Floor Holidaysburg, PA 16648 One West Third Street New York, NY 10048 (800) 343-5149 Williamsport, PA 17701 (800) 635-6851 (800) 937-0769 INVESTOR INFORMATION INDEPENDENT AUDITORS ANNUAL MEETING OF General shareholder inquiries PARENTE, RANDOLPH, ORLANDO SHAREHOLDERS Should be sent to: CAREY & ASSOCIATES 400 Market Street The Annual Meeting of Shareholders CITIZENS & NORTHERN Williamsport, PA 17701 will be held at the Arcadia Theatre in CORPORATION Wellsboro, PA, at 2:00 p.m. Tuesday, April 20, 2000. 90-92 Main Street, P.O. Box 58 Wellsboro, PA 16901 STOCK TRANSFER AGENT Citizens & Northern Bank 90-92 Main Street, P.O. Box 58 Wellsboro, PA 16901 (800) 487-8784
49 FIVE YEAR SUMMARY OF OPERATIONS (In Thousands Except Per Share Data)
INCOME STATEMENT 1999 1998 1997 1996 1995 Interest Income $48,415 $45,459 $45,642 $45,589 $43,114 Interest Expense 24,571 22,693 23,312 23,451 24,477 - - -------------------------------------------------------------------------------------------------------------------------- Interest Margin 23,844 25,766 22,330 22,138 18,637 Provision for Possible Loan Losses 760 763 797 701 737 - - -------------------------------------------------------------------------------------------------------------------------- Interest Margin After Provision for Possible Loan Losses 23,084 22,003 21,533 21,437 17,900 Other Income 6,444 6,083 5,834 5,180 4,863 Securities Gains 3,043 3,001 1,001 475 1,675 Other Expenses 17,732 16,483 15,095 14,686 14,079 - - -------------------------------------------------------------------------------------------------------------------------- Income Before Income Tax Provision 14,839 14,604 13,273 12,406 10,359 Income Tax Provision 3,354 3,527 3,166 3,151 2,493 - - -------------------------------------------------------------------------------------------------------------------------- Net Income $11,485 $11,077 $10,107 $9,255 $7,866 ==========================================================================================================================
BALANCE SHEET AT YEAR END Total Securities (1) 363,535 331,883 $308,988 $310,077 $301,743 Loans (Excluding Unearned Discount) 310,892 291,003 285,426 278,597 264,182 Total Assets 705,898 646,298 615,353 610,172 585,987 Total Deposits 500,474 476,518 442,256 430,311 429,552 Stockholders' Equity Before Adjustment for Unrealized Gain or Loss on Available-for-Sale Securities 85,507 78,645 72,200 65,826 60,025 Stockholders' Equity 76,623 90,567 85,535 71,593 66,977 AVERAGE BALANCE SHEET Total Securities (Amortized Cost) (1) 349,133 300,692 296,067 306,680 290,695 Loans (Excluding Unearned Discount) 301,584 285,275 282,580 271,618 259,142 Earning Assets 650,717 585,966 578,647 578,298 549,837 Total Assets 680,864 626,102 608,277 604,408 566,030 Total Assets Excluding Market Value Adjustment for Unrealized Gain or Loss on Available-for-Sale Securities 672,999 606,163 598,370 598,813 568,700 Total Deposits 483,858 448,601 435,190 429,036 414,958 Stockholders' Equity Before Adjustment for Unrealized Gain or Loss on Available-for-Sale Securities 81,767 74,810 69,440 62,797 55,961 Stockholders' Equity 87,143 87,997 76,005 66,490 53,727 FINANCIAL RATIOS Return on Stockholders' Equity (4) 14.05% 14.81% 14.56% 14.74% 14.06% Return on Stockholders' Equity (3) 13.18% 12.59% 13.30% 13.92% 14.51% Return on Assets (3) 1.69% 1.77% 1.66% 1.53% 1.39% Stockholders' Equity to Assets (4) 12.15% 12.34% 11.60% 10.49% 9.84% Stockholders' Equity to Assets (3) 12.80% 14.05% 12.50% 11.00% 9.58% Stockholders' Equity to Loans (3) 28.90% 30.85% 26.90% 24.48% 20.91% Net Income to: Total Interest Income 23.72% 24.37% 22.14% 20.30% 18.24% Interest Margin 48.17% 48.66% 45.26% 41.81% 42.21% Dividend as a % of Net Income 40.39% 37.81% 37.04% 37.36% 41.01%
(1) Includes Interest-Bearing Due from Banks and Fed Funds Sold (2) Balance Sheet at Year End (3) Average Balance Sheet, Including Valuation Reserve (4) Average Balance Sheet, Excluding Valuation Reserve 50 SUMMARY OF QUARTERLY FINANCIAL DATA (Unaudited) The following table presents summarized quarterly financial data for 1999 and 1998 (In Thousands, Except Per Share Data).
1999 Quarter Ended Mar. 31, June 30, Sept. 30, Dec. 31, Interest Income $11,315 $11,851 $12,536 $12,713 Interest Expense 5,397 5,908 6,420 6,846 - - --------------------------------------------------------------------------------------------------------------------------------- Interest Margin 5,918 5,943 6,116 5,867 Provision for Loan Losses 225 225 120 190 - - --------------------------------------------------------------------------------------------------------------------------------- Interest Margin After Provision for Possible Loan Losses 5,693 5,718 5,996 5,677 Other Income 1,535 1,654 1,657 1,598 Securities Gains (Losses) 490 568 789 1,196 Other Expense 4,253 4,401 4,564 4,514 - - --------------------------------------------------------------------------------------------------------------------------------- Income Before Income Taxes 3,465 3,539 3,878 3,957 Income Tax Provision 789 751 954 860 - - --------------------------------------------------------------------------------------------------------------------------------- Net Income $2,676 $2,788 $2,924 $3,097 ================================================================================================================================= Net Income Per Share - Basic $0.51 $0.54 $0.56 $0.59 ================================================================================================================================= Net Income Per Share - Diluted $0.51 $0.54 $0.56 $0.59 =================================================================================================================================
1998 Quarter Ended Mar. 31, June 30, Sept. 30, Dec. 31, Interest Income $11,288 $11,293 $11,561 $11,377 Interest Expense 5,724 5,701 5,769 5,499 - - --------------------------------------------------------------------------------------------------------------------------------- Interest Margin 5,504 5,592 5,792 5,878 Provision for Loan Losses 191 191 191 190 - - --------------------------------------------------------------------------------------------------------------------------------- Interest Margin After Provision for Possible Loan Losses 5,313 5,401 5,601 5,688 Other Income 1,411 1,517 1,617 1,538 Securities Gains (Losses) 754 1,860 235 152 Other Expense 3,937 4,089 4,154 4,303 - - --------------------------------------------------------------------------------------------------------------------------------- Income Before Income Taxes 3,541 4,689 3,299 3,075 Income Tax Provision 860 1,227 785 655 - - --------------------------------------------------------------------------------------------------------------------------------- Net Income $2,681 $3,462 $2,514 $2,420 ================================================================================================================================= Net Income Per Share - Basic $0.51 $0.66 $0.48 $0.46 ================================================================================================================================= Net Income Per Share - Diluted $0.51 $0.66 $0.48 $0.46 =================================================================================================================================
51 TRUST DEPARTMENT
(In Thousands) 1999 1998 1997 1996 1995 1994 Assets $320,385 $283,262 $230,149 $222,541 $181,351 $146,178 Earnings $1,456 $1,288 $1,004 $852 $726 $582
The composition of trust assets and liabilities as of December 31, 1999, 1998 and 1997 are shown in the following table: (In Thousands) 1999 1998 1997 INVESTMENTS Bonds $ 85,615 $ 78,442 $70,413 Stock 108,279 100,479 77,356 Savings and Money Market Funds 18,411 19,150 14,835 Mutual Funds 102,635 80,361 65,331 Mortgages 1,003 1,066 425 Real Estate 3,430 3,061 1,156 Miscellaneous 1,012 703 633material weaknesses. March 18, 2003 By: Mark A. Hughes /s/ - - ------------------------------------------------------------------------------- Total $320,385 $283,262 $230,149 =============================================================================== ACCOUNTS Estates $ 2,256 $ 2,370 $ 3,537 Trusts 106,279 86,079 62,280 Guardianships 2,642 1,972 1,893 Pension/Profit Sharing 127,769 113,110 86,506 Investment Management 81,439 79,731 75,933 - - ------------------------------------------------------------------------------- Total $320,385 $283,262 $230,149 =============================================================================== STOCKHOLDER INQUIRIES A copy of the Corporation's Annual Report for the year ended December 31, 1999, on Form 10-K as required to be filed with the Securities and Exchange Commission, will be furnished to a stockholder without charge upon written request to the Corporation's-------------- ----------------------- Date Treasurer at the principal office at P O Box 58, Wellsboro, PA 16901. The information is also available at the website of the Securities and Exchange Commission at www.sec.gov. This statement has not been reviewed or confirmed for accuracy or relevance by the Federal Deposit Insurance Corporation. 52 DESCRIPTION OF BUSINESS Citizens & Northern Corporation ("Corporation") is a one-bank holding company whose principal subsidiary is Citizens & Northern Bank ("Bank"). The Bank is a Pennsylvania banking institution that was formed pursuant to the consolidation of Northern National Bank of Wellsboro and Citizens National Bank of Towanda on October 1, 1971. In May of 1972, the Bank merged with the First National Bank of Ralston and on October 1, 1977, merged with the Sullivan County National Bank. Then on January 1, 1984 the Bank merged with the Farmers National Bank of Athens. On May 1, 1990, The First National Bank of East Smithfield merged with the Bank. The Bank has held its current name since May 6, 1975, at which time the Bank changed its charter from a National bank to a Pennsylvania bank. The Bank's principal office is located in Wellsboro, Pennsylvania. On December 31, 1999 the Bank had total assets of $688,978,000, total deposits of $500,474,000 and total loans outstanding of $310,921,000. The Bank provides an extensive range of banking services, including interactive internet banking, checking accounts, savings accounts, certificates of deposit, money market accounts, personal, commercial and installment loans and such types of deposits and other loans that are common to a full service bank of its size and structure. The Bank also maintains a trust division that provides full range of financial fiduciary services. The Corporation also owns two subsidiaries, Bucktail Life Insurance Company, which provides credit life and accident and health insurance on behalf of the Bank and Citizens & Northern Investment Corporation whose primary function is to hold equity investments. The total assets and income generated by Bucktail Life Insurance Company and Citizens & Northern Investment Corporation is insignificant in relation to the total business of the Corporation. The main office of the Bank is located at 90-92 Main Street, Wellsboro, Pennsylvania. The Bank has a total of sixteen (16) banking offices; all located in the Pennsylvania counties of Bradford, Lycoming, Sullivan and Tioga. The Bank owns all such properties. There are no encumbrances against any of the Bank's properties. As of December 31, 1999, the Bank had a total of 213 full-time equivalent employees. The Bank provides a variety of employee benefits and considers its relationship with its employees to be good. All phases of the Bank's business are competitive. The Bank primarily competes in the market area composed of Tioga and Bradford counties and portions of Lycoming and Sullivan counties. The Bank competes with approximately 15 commercial banks, including local commercial banks headquartered in our market area as well as other commercial banks with branches in the Bank's market area. Some of the banks that have branches in the Bank's market area are larger in overall size than the Bank. The Bank, along with other commercial banks, competes with respect to its lending activities as well as in attracting demand and savings deposits with savings banks, savings and loan associations, insurance companies, regulated small loan companies and credit unions. The Bank also competes with insurance companies, investment counseling firms, mutual funds and other business firms and individuals in corporate trust and investment management services. The Bank is generally competitive with all financial institutions in its service area with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans. 2 CITIZENS & NORTHERN CORPORATION And CITIZENS & NORTHERN BANK
BOARD OF DIRECTORS DIRECTORS EMERITI Dennis F. Beardslee Susan E. Hartley Robert J. Murphy R. James Dunham Owner, Terrace Lanes Attorney at Law Retired, formerly Attorney President, Bowling Center In law firm of Davis, Murphy, R. J. Dunham, Inc. Karl W. Kroeck Niemiec & Smith Department Store J. Robert Bower Farmer Pharmacist Edward H. Owlett, III William K. Francis Edward L. Learn Attorney in law firm of Retired, formerly R. Robert DeCamp Owner of Learn Hardware & Owlett & Lewis , P.C. Chairman of the Board President of Building Supply Patterson Lumber Co., Inc. F. David Pennypacker John H. Macafee Craig G. Litchfield Certified Public Accountant, Retired, formerly operator of Adelbert E. Eldridge Chairman of the Board, Formerly in firm of Mapoval Farms, Inc. Retired Regional Director of President and Chief Executive Pennypacker & Gooch, P.C. Susquehanna Region of Officer Pennsylvania Electric Co. Leonard Simpson Lawrence F. Mase Attorney at Law R. Bruce Haner Retired, formerly Inventory Control Manager, President of Mase's Inc. Donald E. Treat Williams Auto Group, Retired, formerly owner Formerly owner of Haner's Of Treat Hardware Auto Sales 54 ADVISORY BOARDS ATHENS & SAYRE ELKLAND MANSFIELD TROY Terry R. Depew Scott A. Keck Robin K. Carleton Mark C. Griffis Stephan W. Bowen Eric L. Beard Gary Ray Butters Dennis F. Beardslee Warren J. Croft John C. Kenyon David Kurzejewski Roy W. Cummings, Jr. Max P. Gannon Edward L. Learn John F. Wise, Jr. J. Robert Garrison R. Bruce Haner Gregory W. Powers Susan E. Hartley KNOXVILLE RALSTON George D. Howell Mary Rose Sacks Daniel P. Clark WELLSBORO Wayne E. Lowery Gerald L. Bliss George E. Bittner Richard L. Wilkinson John H. Macafee Grant Gehman William W. Brooks, III Donald R. Abplanalp Laurance A. Reagan, Jr. Karl W. Kroeck Richard T. Demitras J. Robert Bower David Rosenbloom William W. Roosa R. Robert DeCamp TIOGA R. James Dunham DUSHORE LAPORTE Lois C. Wood Jan E. Fisher Helen W. Ferris Randy R. Meckes John E. Brackley Edward H. Owlett, III Ronald A. Gutosky Kenneth F. Fry C. Frederick LaVancher F. David Pennypacker Robert P. Henderson, Jr. Marvin L. Higley Leisa L. LaVancher Leo F. Lambert Walter B. Neidig Donald E. Treat WYSOX Dennis K. McCarty Leonard Simpson Debra S. Kithcart Kerry A. Meehan TOWANDA & MONROETON Lucille P. Donovan LIBERTY James E. Parks Robert L. Fulmer EAST SMITHFIELD Ann L. Yuscavage Jeffery E. Aeppli Mark W. Smith Peggy A. Brown Lyle R. Brion James A. Bowen Walter E. Warburton, Jr. Roy L. Beardslee Gary Dinnison Adelbert E. Eldridge Laurence R. Kingsley Lawrence F. Mase Robert J. Murphy Liston D. Pepper Ray E. Wheeland Jeffrey A. Smith Bennett R. Young James E. Towner Deborah J. Weisbrod
55
OPERATIONS C & N FINANCIAL SERVICES 90-92 MAIN STREET CORPORATION WELLSBORO, PA 16901 INSURANCE MARKETING 570-724-3411 DIVISION 90-92 MAIN STREET Craig G. Litchfield Chairman, President and WELLSBORO, PA 16901 Chief Executive Officer 570-724-3411 Brian L. Canfield Senior Executive Vice President and Branch System Administrator Thomas L. Rudy, Jr Vice President Matthew P. Prosseda Executive Vice President and Commercial Loan Coordinator MANAGEMENT INFORMATION SYSTEMS Kathleen M. Osgood Corporate Secretary 90-92 MAIN STREET Robert E. Bolt Assistant Vice President WELLSBORO, PA 16901 Jeffrey B. Osgood Assistant Vice President and 570-724-3411 Personnel Officer Sandra G. Andrews Assistant Cashier Robert W. Anderson Executive Vice President Sandra A. Parulas Training Officer Management Information System James H. Shelmire Senior Systems Analyst Rick J. Cisco Senior Systems Analyst 428 MAIN STREET TOWANDA, PA 18848 AUDIT and COMPLIANCE 570-265-6171 90-92 MAIN STREET WELLSBORO, PA 16901 James W. Seipler Executive Vice President and 570-724-3411 Treasurer Klas G. Anderson Assistant Vice President Russell H. Bauman Vice President and Auditor Joseph A. Snell Assistant Controller Shawn M. Schreck Assistant Vice President, Compliance Joan L. Grenell Assistant Vice President Officer and Security Officer Harold F. Hoose, III Assistant Vice President Glenda R. Marzo Assistant Auditor TRUST & FINANCIAL SERVICES DIVISION 90-92 MAIN STREET BANKCARD SERVICES WELLSBORO, PA 16901 90-92 MAIN STREET 1-800-487-8784 WELLSBORO, PA 16901 428 MAIN STREET 1-800-676-6639 TOWANDA, PA 18848 1-888-987-8784 Eileen K. Ranck Bankcard Manager Carl M. Chambers Assistant Vice President Thomas L. Briggs Executive Vice President and Nathan L. Davis Assistant Cashier, Bankcard Manager Senior Trust Officer Sales Deborah E. Scott Executive Vice President and Senior Trust Officer BOOKKEEPING DEPARTMENT Nicholas Helf, Jr Vice President and Employee 90-92 MAIN STREET Benefit Officer WELLSBORO, PA 16901 Linda L. Kriner Vice President and Trust 1-800-726-2265 Officer Larry D. Alderson Trust Officer Darla G. Krotzer Employee Benefit Sales Officer Karen L. Keck Bookkeeping Manager Rhonda J. Litchfield Trust Investment Officer Philip A. Prough Trust Officer INTERNET BANKING Mary J. Wood Trust Officer 90-92 MAIN STREET James D. Butters Assistant Trust Officer WELLSBORO, PA 16901 570-724-3411 MARKETING DEPARTMENT 90-92 MAIN STREET Shelly L. D'Haene Internet Banking Coordinator WELLSBORO, PA 16901 570-724-3411 Michelle M. Karas Assistant Vice President and Marketing Coordinator 56 BRANCH OFFICES 428 S MAIN STREET ROUTE 220 ATHENS, PA 18810 MONROETON, PA 18832 570-888-2291 570-265-2157 Terry R. Depew Vice President THOMPSON STREET Kathy L. Griffis Assistant Cashier RALSTON, PA 17763 Virginia L. Reap Assistant Cashier 570-995-5421 111 MAIN STREET Daniel P. Clark Assistant Vice President DUSHORE, PA 18614 William C. Holmes Assistant Cashier 570-928-8124 503 N ELMIRA STREET Helen W. Ferris Assistant Vice President SAYRE, PA 18840 Brenda B. Whiteley Assistant Cashier 570-888-2220 MAIN STREET Stephan W. Bowen Assistant Vice President EAST SMITHFIELD, PA 18817 Marcella J. Chaykosky Assistant Cashier 570-596-3131 41 MAIN STREET Peggy A. Brown Assistant Vice President TIOGA, PA 16946 Sandra J. McNeal Assistant Cashier 570-835-5236 104 MAIN STREET Lois C. Wood Assistant Vice President ELKLAND, PA 16920 Joan F. Johnson Assistant Cashier 814-258-5111 428 MAIN STREET Scott A. Keck Vice President TOWANDA, PA 18848 Roberta C. Heck Assistant Cashier 570-265-6171 102 E MAIN STREET James E. Parks Vice President KNOXVILLE, PA 16928 Valerie W. Kinney Assistant Vice President 814-326-4151 COURTHOUSE SQUARE Mary Rose Sacks Assistant Vice President TROY, PA 16947 Lynette M. Burrous Assistant Cashier 570-297-2159 MAIN STREET Mark C. Griffis Vice President LAPORTE, PA 18626 David S. Schucker Assistant Vice President 570-946-4011 Janet R. Ordway Assistant Cashier Randy R. Meckes Vice President 90-92 MAIN STREET Linda M. Etzel Assistant Cashier WELLSBORO, PA 16901 570-724-3411 MAIN STREET LIBERTY, PA 16930 Richard L. Wilkinson Vice President 570-324-2331 Kim L. Miller Vice President Jan L. Southworth Assistant Vice President Ann L. Yuscavage Vice President Leonard Mitchell, Iii Assistant Cashier Joan M. Blackwell Assistant Cashier Donna J. Emmick Assistant Cashier 1085 S MAIN STREET ROUTE 6 MANSFIELD, PA 16933 WYSOX, PA 18854 570-662-1111 570-265-5016 Robin K. Carleton Assistant Vice President Debra S. Kithcart Assistant Vice President Jeffery E. Aeppli Assistant Vice President
57 CITIZENS & NORTHERN CORPORATION OFFICERS Craig G. Litchfield James W. Seipler Kathleen M. Osgood Chairman of the Board, Treasurer Corporate Secretary President and Chief ExecutiveFinancial Officer CITIZENS & CORPORATION Athens/Dushore/East Smithfield/Elkland/Knoxville Laporte/Liberty/Mansfield/Monroeton/Ralston/Sayre/Tioga Towanda/Troy/Wellsboro/Wysox/Member FDIC 58 961