FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the three-month period ended March 31, 2002
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from ________ to ___________
Commission file number: 0-16084
CITIZENS & NORTHERN CORPORATION
(Exact name of Registrant as specified in its charter)
Pennsylvania 23-2451943
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
90-92 Main Street
Wellsboro, Pa. 16901
(Address of principal executive offices) (Zip code)
570-724-3411
(Registrant's telephone number including area code)
Not applicable
(Former name, former address, and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes ____ No ____
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
Title Outstanding
Common Stock ($1.00 par value) 5,283,312 Shares Outstanding May 10, 2002
1
CITIZENS & NORTHERN CORPORATION
Index
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheet - March 31, 2002 and
December 31, 2001 Page 3
Consolidated Statement of Income - Three Months
Ended March 31, 2002 and 2001 Page 4
Consolidated Statement of Cash Flows - Three Months
Ended March 31, 2002 and 2001 Page 5
Notes to Consolidated Financial Statements Pages 6 through 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations Pages 8 through 20
Item 3. Information About Market Risk Pages 20 and 21
Part II. Other Information Page 22
Signatures Page 23
2
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEET MARCH 31, DECEMBER 31,
(In Thousands Except Share Data) 2002 2001
(UNAUDITED) (NOTE)
ASSETS
Cash and due from banks:
Noninterest-bearing $ 10,434 $ 14,055
Interest-bearing 2,569 1,981
- -------------------------------------------------------------------------------------------------------
Total cash and cash equivalents 13,003 16,036
Available-for-sale securities 478,851 433,969
Held-to-maturity securities 1,178 1,448
Loans, net 385,422 373,963
Bank-owned life insurance 16,129 15,905
Accrued interest receivable 5,689 4,871
Bank premises and equipment, net 10,220 9,967
Foreclosed assets held for sale 318 179
Other assets 12,115 10,661
- -------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 922,925 $ 866,999
=======================================================================================================
LIABILITIES
Deposits:
Noninterest-bearing $ 63,235 $ 63,858
Interest-bearing 528,738 512,416
- -------------------------------------------------------------------------------------------------------
Total deposits 591,973 576,274
Dividends payable 1,466 1,466
Short-term borrowings 37,885 58,064
Long-term borrowings 185,731 125,584
Accrued interest and other liabilities 5,634 5,424
- -------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 822,689 766,812
- -------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
Common stock, par value $1.00 per share; authorized 10,000,000
shares; issued 5,431,021 in 2002 and 5,378,212 in 2001 5,432 5,378
Stock dividend distributable - 1,369
Paid-in capital 21,133 19,758
Retained earnings 72,698 70,352
- -------------------------------------------------------------------------------------------------------
Total 99,263 96,857
Accumulated other comprehensive income 2,985 5,284
Unamortized stock compensation (112) (17)
Treasury stock, at cost:
140,854 shares at March 31, 2002 (1,900)
143,412 shares at December 31, 2001 (1,937)
- -------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 100,236 100,187
- -------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 922,925 $ 866,999
=======================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
Note: The balance sheet at December 31, 2001 has been derived from the audited
financial statements at that date but does not include all the information and
notes required by generally accepted accounting principles for complete
financial statements.
3
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
CONSOLIDATED STATEMENT OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
3 MONTHS ENDED
MARCH 31, MARCH 31,
2002 2001
INTEREST INCOME
Interest and fees on loans $ 7,257 $ 6,902
Interest on balances with depository institutions 8 19
Interest on loans to political subdivisions 150 171
Interest on federal funds sold 4 61
Income from available-for-sale and
held-to-maturity securities:
Taxable 4,664 4,733
Tax-exempt 1,311 944
Dividends 248 263
- -----------------------------------------------------------------------------------------------------------
Total interest and dividend income 13,642 13,093
- -----------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Interest on deposits 4,257 5,693
Interest on short-term borrowings 272 1,331
Interest on long-term borrowings 1,787 468
- -----------------------------------------------------------------------------------------------------------
Total interest expense 6,316 7,492
- -----------------------------------------------------------------------------------------------------------
Interest margin 7,326 5,601
Provision for loan losses 180 150
- -----------------------------------------------------------------------------------------------------------
Interest margin after provision for loan losses 7,146 5,451
- -----------------------------------------------------------------------------------------------------------
OTHER INCOME
Service charges on deposit accounts 384 296
Service charges and fees 65 68
Trust and financial management revenue 439 387
Insurance commissions, fees and premiums 215 138
Increase in cash surrender value of life insurance 224 222
Fees related to credit card operation 130 128
Other operating income 230 195
- -----------------------------------------------------------------------------------------------------------
Total other income before realized gains on securities, net 1,687 1,434
Realized gains on securities, net 1,226 455
- -----------------------------------------------------------------------------------------------------------
Total other income 2,913 1,889
- -----------------------------------------------------------------------------------------------------------
OTHER EXPENSES
Salaries and wages 2,238 2,018
Pensions and other employee benefits 615 580
Occupancy expense, net 278 259
Furniture and equipment expense 447 346
Expenses related to credit card operation 71 77
Pennsylvania shares tax 183 196
Other operating expense 1,274 1,122
- -----------------------------------------------------------------------------------------------------------
Total other expenses 5,106 4,598
- -----------------------------------------------------------------------------------------------------------
Income before income tax provision 4,953 2,742
Income tax provision 1,115 477
- -----------------------------------------------------------------------------------------------------------
NET INCOME $ 3,838 $ 2,265
===========================================================================================================
PER SHARE DATA:
Net income - basic $ 0.73 $ 0.43
Net income - diluted $ 0.72 $ 0.43
- -----------------------------------------------------------------------------------------------------------
Dividend per share $ 0.28 $ 0.26
- -----------------------------------------------------------------------------------------------------------
Number of shares used in computation - basic 5,291,559 5,308,562
Number of shares used in computation - diluted 5,301,360 5,308,856
The accompanying notes are an integral part of these consolidated financial
statements.
4
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS) (UNAUDITED)
3 MONTHS ENDED
MARCH 31, MARCH 31,
2002 2001
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,838 $ 2,265
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 180 150
Realized gains on securities, net (1,226) (455)
Gain on sale of foreclosed assets, net (8) (25)
Depreciation expense 367 305
Accretion and amortization, net (101) (627)
Increase in cash surrender value of life insurance (224) (222)
Amortization of restricted stock 21 -
Increase in accrued interest receivable and other assets (1,334) (1,010)
Increase in accrued interest payable and other liabilities 1,167 2,204
- ---------------------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 2,680 2,585
- ---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturity of held-to-maturity securities 268 860
Purchase of held-to-maturity securities - (626)
Proceeds from sales of available-for-sale securities 4,393 576
Proceeds from maturities of available-for-sale securities 26,408 36,530
Purchase of available-for-sale securities (77,838) (89,187)
Purchase of restricted stock (710) -
Net increase in loans (11,829) (1,651)
Purchase of premises and equipment (620) (210)
Proceeds from sale of foreclosed assets 59 105
- ---------------------------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (59,869) (53,603)
- ---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 15,699 1,899
Net decrease in short-term borrowings (20,179) (7,306)
Proceeds from long-term borrowings 60,153 60,000
Repayments of long-term borrowings (6) (5)
Purchase of treasury stock (32) (130)
Sale of treasury stock 13 -
Dividends paid (1,492) (1,353)
- ---------------------------------------------------------------------------------------------------------
Net Cash Provided by Financing Activities 54,156 53,105
- ---------------------------------------------------------------------------------------------------------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (3,033) 2,087
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 16,036 13,824
- ---------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 13,003 $ 15,911
=========================================================================================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Assets acquired through foreclosure of real estate loans $ 191 $ 136
Interest paid $ 5,212 $ 5,437
Income taxes paid $ 520 $ 25
The accompanying notes are an integral part of these consolidated financial
statements.
5
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF INTERIM PRESENTATION
The financial information included herein, with the exception of the
consolidated balance sheet dated December 31, 2001, is unaudited; however, such
information reflects all adjustments (consisting solely of normal recurring
adjustments) that are, in the opinion of management, necessary for a fair
presentation of the financial position, results of operations and cash flows for
the interim periods.
Results reported for the three months ended March 31, 2002 might not be
indicative of the results for the year ending December 31, 2002.
Certain 2001 amounts have been reclassified to conform to the 2002 presentation.
This document has not been reviewed or confirmed for accuracy or relevance by
the Federal Deposit Insurance Corporation or any other regulatory agency.
2. PER SHARE DATA
Net income per share is based on the weighted-average number of shares of common
stock outstanding. The number of shares used in calculating net income and cash
dividends per share reflect the retroactive effect of stock dividends for all
periods presented. The following data show the amounts used in computing net
income per share and the weighted average number of shares of dilutive stock
options. The dilutive effect of stock options is computed as the
weighted-average common shares available from the exercise of all dilutive stock
options, less the number of shares that could be repurchased with the proceeds
of stock option exercises based on the average share price of the Corporation's
common stock during the period.
WEIGHTED-
AVERAGE EARNINGS
NET COMMON PER
INCOME SHARES SHARE
QUARTER ENDED MARCH 31, 2002
Earnings per share - basic $3,838,000 5,291,559 $ 0.73
Dilutive effect of stock options 9,801
- --------------------------------------------------------------------------------------------------------------------
Earnings per share - diluted $3,838,000 5,301,360 $ 0.72
====================================================================================================================
QUARTER ENDED MARCH 31, 2001
Earnings per share - basic $2,265,000 5,308,562 $ 0.43
Dilutive effect of stock options 294
- --------------------------------------------------------------------------------------------------------------------
Earnings per share - diluted $2,265,000 5,308,856 $ 0.43
====================================================================================================================
3. COMPREHENSIVE INCOME
Accounting principles generally require that recognized revenue, expenses, gains
and losses be included in net income. Although certain changes in assets and
liabilities, such as unrealized gains and losses on available-for-sale
securities, are reported as a separate component of the equity section of the
balance sheet, such items, along with net income, are components of
comprehensive income.
6
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Comprehensive income is calculated as follows:
QUARTERS ENDED
MARCH 31,
(IN THOUSANDS) 2002 2001
Net income $ 3,838 $ 2,265
Unrealized holding (losses) gains on available-for-sale securities (2,257) 7,041
Less: Reclassification adjustment for gains realized in income (1,226) (455)
- ----------------------------------------------------------------------------------------------------
Other comprehensive (loss) income before income tax (3,483) 6,586
Income tax related to other comprehensive income/loss 1,184 (2,239)
- ----------------------------------------------------------------------------------------------------
Other comprehensive (loss) income (2,299) 4,347
- ----------------------------------------------------------------------------------------------------
Comprehensive income $ 1,539 $ 6,612
====================================================================================================
4. DERIVATIVE FINANCIAL INSTRUMENTS
In June 2001, the Corporation began to utilize derivative financial instruments
related to a new certificate of deposit product called the "Index Powered
Certificate of Deposit" (IPCD). IPCDs have a term of 5 years, with interest paid
at maturity based on 90% of the appreciation (as defined) in the S&P 500 index.
There is no guaranteed interest payable to a depositor of an IPCD - however,
assuming an IPCD is held to maturity, a depositor is guaranteed the return of
his or her principal, at a minimum.
Statement of Financial Accounting Standards No. 133 requires the Corporation to
separate the amount received from each IPCD issued into 2 components: (1) an
embedded derivative, and (2) the principal amount of each deposit. Embedded
derivatives are derived from the Corporation's obligation to pay each IPCD
depositor a return based on appreciation in the S&P 500 index. Embedded
derivatives are carried at fair value, and are included in other liabilities in
the consolidated balance sheet. Changes in fair value of the embedded derivative
are included in other expense in the consolidated income statement. The
difference between the contractual amount of each IPCD issued, and the amount of
the embedded derivative, is recorded as the initial deposit (included in
interest-bearing deposits in the consolidated balance sheet). Interest expense
is added to principal ratably over the term of each IPCD at an effective
interest rate that will increase the principal balance to equal the contractual
IPCD amount at maturity.
In connection with IPCD transactions, the Corporation has entered into Equity
Indexed Call Option (Swap) contracts with the Federal Home Loan Bank of
Pittsburgh (FHLB-Pittsburgh). Under the terms of the Swap contracts, the
Corporation must pay FHLB-Pittsburgh quarterly amounts calculated based on the
contractual amount of IPCDs issued times a negotiated rate. In return,
FHLB-Pittsburgh is obligated to pay the Corporation, at the time of maturity of
the IPCDs, an amount equal to 90% of the appreciation (as defined) in the S&P
500 index. If the S&P 500 index does not appreciate over the term of the related
IPCDs, the FHLB-Pittsburgh would make no payment to the Corporation. The effect
of the Swap contracts is to limit the Corporation's cost of IPCD funds to the
market rate of interest paid to FHLB-Pittsburgh. (In addition, the Corporation
pays a fee of 0.75% to a consulting firm at inception of each deposit. This fee
is amortized to interest expense over the term of the IPCDs.) Swap liabilities
are carried at fair value, and included in other liabilities in the consolidated
balance sheet. Changes in fair value of swap liabilities are included in other
expense in the consolidated income statement.
7
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Amounts recorded as of March 31, 2002 and December 31. 2001, and for the first
quarter 2002, related to IPCDs are as follows (in thousands):
MARCH 31, DEC. 31,
2002 2001
Contractual amount of IPCDs (equal
to notional amount of Swap contracts) $ 2,156 $ 1,410
Carrying value of IPCDs 1,780 1,154
Carrying value of embedded derivative liabilities
326 233
Carrying value of Swap contract liabilities
62 31
3 MONTHS ENDED
MARCH 31,
2002
Interest expense $ 16
Other expense 4
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
PART I - FINANCIAL INFORMATION (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Certain statements in this section and elsewhere in Form 10-Q are
forward-looking statements. Citizens & Northern Corporation and its wholly-owned
subsidiaries (collectively, the Corporation) intend such forward-looking
statements to be covered by the safe harbor provisions for forward-looking
statements contained in the Private Securities Reform Act of 1995.
Forward-looking statements, which are based on certain assumptions and describe
future plans, business objectives and expectations, are generally identifiable
by the use of words such as, "believe", "expect", "intend", "anticipate",
"estimate", "project", and similar expressions. The Corporation's ability to
predict results or the actual effect of future plans or occurrences is
inherently uncertain. Factors which could have a material adverse effect on the
operations and future prospects of the Corporation include, but are not limited
to, the following:
- - changes in monetary and fiscal policies of the U.S. Treasury and the
Federal Reserve Board, particularly related to changes in interest rates
- - changes in general economic conditions
- - legislative or regulatory changes
- - downturn in demand for loan, deposit and other financial services in the
Corporation's market area
- - increased competition from other banks and non-bank providers of financial
services
- - technological changes and increased technology-related costs
- - changes in accounting principles.
These risks and uncertainties should be considered in evaluating forward-looking
statements and undue reliance should not be placed on such statements.
8
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
EARNINGS OVERVIEW
Net income for the first quarter 2002 was $3,838,000, or $0.73 per share - basic
and $0.72 per share - diluted. This represents an increase of 67.4% in net
income per share - diluted over the first quarter 2001. Return on average
assets, excluding unrealized gains and losses on securities, increased 44.6%, to
1.75% in the first quarter 2002 compared to 1.21% in the first quarter 2001.
Including the effects of unrealized gains and losses on securities, return on
average assets increased to 1.74% in the first quarter 2002 from 1.21% in the
first quarter 2001. Return on average equity, excluding unrealized gains and
losses on securities, rose 58.4%, to 16.06% in the first quarter 2002 from
10.14% in the first quarter 2001. Including unrealized gains and losses on
securities, return on average equity increased 49.6%, to 15.09% in the first
quarter 2002 from 10.09% in the first quarter 2001.
The most significant income statement changes between the first quarter 2002 and
the first quarter 2001 were as follows:
- - The interest margin increased significantly ($1,725,000, or 30.8%), to
$7,326,000 in the first quarter 2002 from $5,601,000 in the first quarter
2001. The Corporation's net interest margin (excess of interest and
dividend income over interest expense) widened dramatically over the last
three quarters of 2001 and the first quarter 2002 compared to the previous
several quarters. This resulted primarily from reductions in interest rates
on deposits and borrowed funds. Also, the Corporation has experienced
significant growth in deposits and loans, and has identified opportunities
to borrow funds and invest the proceeds in securities at positive spreads.
Changes in the net interest margin are discussed in more detail later in
Management's Discussion and Analysis.
- - Net realized gains on securities were $1,226,000 in the first quarter 2002,
compared to $455,000 in the first quarter 2001. In the first quarter 2002,
the Corporation sold its holdings of 2 bank stocks for realized gains
totaling $1,109,000 (pre-tax). These sales resulted from circumstances
specific to each underlying company, and the proceeds have been reinvested
in other bank stocks.
- - Other (noninterest) expenses increased $508,000, or 11.0%, in the first
quarter 2002 compared to the first quarter 2001. The increase reflects
increases in payroll costs, depreciation and maintenance agreements
associated with computer hardware and software. These types of costs have
increased as a result of the need to add personnel and supplement existing
systems to keep up with expansion of services and growth in lending
activity over the last few years.
- - The income tax provision increased to $1,115,000 in the first quarter 2002
from $477,000 in the first quarter 2001, because pre-tax income is higher.
9
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE I - QUARTERLY FINANCIAL DATA
(IN THOUSANDS)
MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
2002 2001 2001 2001 2001
Interest income $ 13,642 $ 13,776 $ 13,962 $ 13,830 $ 13,093
Interest expense 6,316 6,549 7,037 7,278 7,492
- --------------------------------------------------------------------------------------------------------------------------
Interest margin 7,326 7,227 6,925 6,552 5,601
Provision for loan losses 180 150 150 150 150
- --------------------------------------------------------------------------------------------------------------------------
Interest margin after provision for loan losses 7,146 7,077 6,775 6,402 5,451
Other income 1,687 1,570 1,600 1,516 1,434
Securities gains 1,226 203 520 742 455
Other expenses 5,106 4,918 4,575 4,580 4,598
- --------------------------------------------------------------------------------------------------------------------------
Income before income tax provision 4,953 3,932 4,320 4,080 2,742
Income tax provision 1,115 740 914 891 477
- --------------------------------------------------------------------------------------------------------------------------
Net income $ 3,838 $ 3,192 $ 3,406 $ 3,189 $ 2,265
==========================================================================================================================
Net income per share - basic $ 0.73 $ 0.60 $ 0.64 $ 0.60 $ 0.43
==========================================================================================================================
Net income per share - diluted $ 0.72 $ 0.60 $ 0.64 $ 0.60 $ 0.43
==========================================================================================================================
The number of shares used in calculating net income per share for each quarter
of 2001 reflects the retroactive effect of a 1% stock dividend declared in
December 2001 and issued in January 2002.
PROSPECTS FOR THE REMAINDER OF 2002
Overall, prospects for the remainder of 2002 are very good. Despite a national
recession, loan demand has been outstanding over the last year (net loans are up
18.8% as of March 31, 2002 compared to one year earlier) and continues to be
strong. The Corporation's major concentration continues to be real estate
secured loans, with significant new loans generated recently, and "in the
pipeline," related to both residential and commercial activity.
Deposits and customer repurchase agreements have also grown substantially (up
11.3% as of March 31, 2002 compared to one year earlier), and there continues to
be significant customer demand in recent months. The largest category of deposit
growth in recent months has been certificates of deposit, in part because
investors have moved funds out of the U.S. stock market. Also, the Corporation
has developed some new, innovative CD products over the last year. In June 2001,
the Corporation began to offer Index Powered CDs, which are described in more
detail in Note 4 to the consolidated financial statements. Effective in May
2002, the Corporation began to offer "Roll-up" CDs. Roll-up CDs allow the
investor to increase the interest rate, to the Corporation's current CD rate for
the same term, once during the term of a 3-year, 4-year or 5-year term, subject
to limitations. This roll-up feature permits the investor an opportunity to
receive a higher rate of return, if rates increase, without risk of reduction in
rate over the term of the CD.
Management believes the Corporation is positioned to do well over the rest of
2002; however, it may be difficult to achieve net income in the remaining
quarters as high as in the first quarter. From an interest rate risk
perspective, the Corporation is liability sensitive. That means the
Corporation's interest expense associated with interest-bearing liabilities
(deposits and borrowed funds) changes more quickly and dramatically than does
its income from interest earning assets (primarily securities and loans). As
short-term market interest rates fell throughout 2001, the Corporation realized
lower interest expense in its financial statements. This pattern continued into
the first quarter 2002. However, as can be seen in Table I, the rate of growth
in the interest margin has slowed over the last four quarters. The interest
margin increased $951,000 in the second quarter 2001 over the prior quarter,
then increased $373,000 in the third quarter 2001, $302,000 in the fourth
quarter 2001, and $99,000 in the first quarter 2002. Currently, yields on
securities and loans are at relatively low historic levels, and if short-term
rates rise later this year, the Corporation's interest margin will probably
shrink. Most economic forecasts anticipate an increase in short-term interest
rates to occur later this year; however, the timing, magnitude and abruptness of
the expected change is uncertain.
Another major variable that may affect 2002 earnings is securities gains and
losses. As described earlier, net realized securities gains were unusually high
in the first quarter 2002. At this time, it is impossible to predict, with any
degree of precision, the amounts of securities gains and losses that may be
realized over the remainder of 2002.
10
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
CRITICAL ACCOUNTING POLICIES
The presentation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect many of the reported amounts and disclosures. Actual results could differ
from these estimates.
A material estimate that is particularly susceptible to significant change is
the determination of the allowance for loan losses. Management believes that the
allowance for loan losses is adequate and reasonable. The Corporation's
methodology for determining the allowance for loan losses is described in a
separate section later in Management's Discussion and Analysis. Given the very
subjective nature of identifying and valuing loan losses, it is likely that
well-informed individuals could make materially different assumptions, and
could, therefore calculate a materially different allowance value. While
management uses available information to recognize losses on loans, changes in
economic conditions may necessitate revisions in future years. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Corporation's allowance for loan losses. Such agencies
may require the Corporation to recognize adjustments to the allowance based on
their judgments of information available to them at the time of their
examination. Further, a task force of the American Institute of Certified Public
Accountants is working on detailed implementation guidance for calculating the
allowance for loan losses. Implementation of that detailed implementation
guidance could result in an adjustment to the allowance; however, based on the
latest targeted effective date, that guidance would not affect the Corporation
until 2004.
Another material estimate is the calculation of fair values of the Corporation's
debt securities. The Corporation receives estimated fair values of debt
securities from an independent valuation service, or from brokers. In developing
these fair values, the valuation service and the brokers use estimates of cash
flows, based on historical performance of similar instruments in similar
interest rate environments. Based on experience, management is aware that
estimated fair values of debt securities tend to vary among brokers and other
valuation services. Accordingly, when selling debt securities, management
typically obtains price quotes from more than one source. The large majority of
the Corporation's securities are classified as available-for-sale. Accordingly,
these securities are carried at fair value on the consolidated balance sheet,
with unrealized gains and losses excluded from earnings and reported separately
through accumulated other comprehensive income (included in stockholders'
equity).
NET INTEREST MARGIN
The Corporation's primary source of operating income is represented by the net
interest margin. The net interest margin is equal to the difference between the
amounts of interest income and interest expense. Tables II, III and IV include
information regarding the Corporation's net interest margin for the first
quarter 2002 and 2001. In each of these tables, the amounts of interest income
earned on tax-exempt securities and loans have been adjusted to a fully
taxable-equivalent basis. Accordingly, the net interest margin amounts reflected
in these tables exceed the amounts presented in the consolidated financial
statements. The discussion that follows is based on amounts in the Tables.
The net interest margin, on a tax-equivalent basis, was $7,998,000 in the first
quarter 2002, an increase of $1,922,000, or 31.6%, over the first quarter 2001.
Table IV shows that interest rate changes had the effect of increasing net
interest income $1,156,000 in the first quarter 2002 over the same period in
2001. As presented in Table III, the "Interest Rate Spread" (excess of average
rate of return on interest-bearing assets over average cost of funds on
interest-bearing liabilities) widened to 3.46% for the first quarter 2002, from
3.17% for the year ended December 31, 2001 and 2.78% for the first quarter 2001.
Growth in volume also contributed to the higher net interest margin in the first
quarter 2002. Table IV shows that increased interest income from higher volumes
of earning assets exceeded increases in interest expense attributable to higher
volumes of interest-bearing liabilities by $766,000.
11
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
INTEREST INCOME AND EARNING ASSETS
Interest income increased 5.5% to $14,314,000 in the first quarter 2002 from
$13,568,000 in the first quarter 2001. Income from available-for-sale securities
increased $492,000, or 7.8%, and interest from loans increased $328,000 or 4.6%.
Overall, the increase in interest income resulted from higher volumes of
securities and loans, which more than offset the effect of lower interest rates.
As indicated in Table III, average available-for-sale securities in the first
quarter 2002 amounted to $438,651,000, an increase of 20.4% over the first
quarter 2001. In total, available-for-sale securities grew because management
was able to identify opportunities to borrow funds and invest the proceeds in
securities at a positive spread. These opportunities were available because of
the "steep yield curve" (longer-term interest rates much higher than
shorter-term rates) that existed throughout most of the last 9 months of 2001
and the first quarter 2002. The average rate of return on available-for-sale
securities was 6.29% for the first quarter 2002, considerably lower than the
7.03% level in the first quarter 2001.
Table III also shows that the composition of the available-for-sale securities
portfolio has changed significantly. The average balance of U.S. Government
agency securities fell to 18% of the average balance of the total portfolio in
the first quarter 2002 from 37% in the first quarter 2001. In contrast, the
average balance of mortgage-backed securities increased to 47% of the total
portfolio in the first quarter 2002 from 31% in the first quarter 2001. In the
third and fourth quarters of 2001, as a result of declining interest rates,
substantial amounts of U.S. Government agency securities were called. The
Corporation reinvested much of the proceeds in mortgage-backed securities. Also,
much of the leveraged security purchases described above consisted of
mortgage-backed securities. The portfolio's increased weighting in
mortgage-backed securities is designed to provide increased cash flow, in the
form of monthly principal and interest payments. This increased level of cash
inflows will be available to be reinvested at higher rates when interest rates
rise.
Obligations of state and political subdivisions (municipal bonds) also were a
larger portion of the portfolio in the first quarter 2002 than in 2001. The
average balance of municipal bonds grew to $98,853,000, or 23% of the portfolio,
in the first quarter 2002 from $69,005,000, or 19% of the portfolio, in the
first quarter 2001. On a taxable equivalent basis, municipal bonds are the
highest yielding category of available-for-sale security. The Corporation
determines the levels of its municipal bond holdings based on income tax
planning and other considerations.
The average balance of gross loans increased 15.8% in the first quarter 2002
over the first quarter 2001, to $380,925,000 from $328,838,000. The largest area
of growth was real estate secured loans, with substantial increases in both
residential and commercial mortgages. Among the factors that helped create the
growth in loans was the opening of the Muncy, PA office in October 2000. The
Corporation also increased its lending staff in Bradford and Tioga (PA) Counties
during the second half of 2001. The average rate of return on loans fell to
7.96% in the first quarter 2002 from 8.82% in the first quarter 2001, due to
lower market rates. The Corporation experienced a great deal of refinancing and
rate modification activity in 2001, which has impacted loan yields in the first
quarter 2002, and probably will continue to impact returns for the next few
years.
INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES
Interest expense fell $1,176,000, or 15.7%, to $6,316,000 in the first quarter
2002 from $7,492,000 in the first quarter 2001. Overall, the impact of lower
interest rates more than offset higher volumes of interest-bearing liabilities
in the first quarter 2002 compared to the first quarter 2001. In Table IV, you
can see the impact of lower interest rates on the Corporation's major categories
of interest-bearing deposits - principally, money market accounts, CDs and
savings accounts. Table IV also shows that interest expense from other borrowed
funds increased in the first quarter 2002 by $282,000 over the first quarter
2001. This increase was attributable to higher average balances, related to
borrowings used to purchase available-for-sale securities, as discussed earlier.
As you can calculate from Table III, total average deposits (interest-bearing
and noninterest-bearing) increased $52,622,000, or 10.0%, for the first quarter
2002 over the first quarter 2001. Of the increase in average deposits, nearly
half ($25,625,000) consisted of growth in CDs. Table III also reflects the
downward trend in interest rates incurred on liabilities, as the overall cost of
funds on interest-bearing liabilities fell to 3.59% for the first quarter 2002,
from 4.40% for the year ended December 31, 2001 and 5.07% for the first quarter
2001.
12
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE II - ANALYSIS OF INTEREST INCOME AND EXPENSE
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31, INCREASE/
2002 2001 (DECREASE)
INTEREST INCOME
Available-for-sale securities:
U.S. Treasury securities $ 37 $ 37 $ -
Securities of other U.S. Government agencies
and corporations 1,270 2,339 (1,069)
Mortgage-backed securities 2,747 1,902 845
Obligations of states and political subdivisions 1,914 1,344 570
Equity securities 248 263 (15)
Other securities 589 428 161
- --------------------------------------------------------------------------------------------------------------------
Total available-for-sale securities 6,805 6,313 492
- --------------------------------------------------------------------------------------------------------------------
Held-to-maturity securities:
U.S. Treasury securities 11 11 -
Securities of other U.S. Government agencies
and corporations 7 11 (4)
Mortgage-backed securities 3 5 (2)
- --------------------------------------------------------------------------------------------------------------------
Total held-to-maturity securities 21 27 (6)
- --------------------------------------------------------------------------------------------------------------------
Interest-bearing due from banks 7 19 (12)
Federal funds sold 5 61 (56)
Loans:
Real estate loans 5,995 5,600 395
Consumer 736 778 (42)
Agricultural 47 46 1
Commercial/industrial 462 456 6
Other 14 17 (3)
Political subdivisions 219 246 (27)
Leases 3 5 (2)
- --------------------------------------------------------------------------------------------------------------------
Total loans 7,476 7,148 328
- --------------------------------------------------------------------------------------------------------------------
Total Interest Income 14,314 13,568 746
- --------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Interest checking 106 204 (98)
Money market 958 1,787 (829)
Savings 130 275 (145)
Certificates of deposit 1,998 2,333 (335)
Individual Retirement Accounts 1,057 1,082 (25)
Other time deposits 8 12 (4)
Overnight borrowings 14 36 (22)
Other borrowed funds 2,045 1,763 282
- --------------------------------------------------------------------------------------------------------------------
Total Interest Expense 6,316 7,492 (1,176)
- --------------------------------------------------------------------------------------------------------------------
Net Interest Income $ 7,998 $ 6,076 $ 1,922
====================================================================================================================
Note: Interest income from tax-exempt securities and loans has been adjusted to
a fully tax-equivalent basis, using the Corporation's marginal federal income
tax rate of 34%.
13
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE III - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES
3 MONTHS YEAR 3 MONTHS
(DOLLARS IN THOUSANDS) ENDED RATE OF ENDED RATE OF ENDED RATE OF
3/31/2002 RETURN/ 12/31/2001 RETURN/ 3/31/2001 RETURN/
AVERAGE COST OF AVERAGE COST OF AVERAGE COST OF
BALANCE FUNDS BALANCE FUNDS BALANCE FUNDS
EARNING ASSETS
Available-for-sale securities, at amortized cost:
U.S. Treasury securities $ 2,502 6.00% $ 2,506 6.03% $ 2,508 5.98%
Securities of other U.S. Government agencies
and corporations 78,239 6.58% 113,186 6.82% 136,018 6.97%
Mortgage-backed securities 205,440 5.42% 150,838 6.29% 113,031 6.82%
Obligations of states and political subdivisions 98,853 7.85% 78,741 7.89% 69,005 7.90%
Equity securities 20,182 4.98% 21,062 5.18% 21,855 4.88%
Other securities 33,435 7.14% 29,577 7.59% 22,030 7.88%
- ------------------------------------------------------------------------------------------------------------------------------------
Total available-for-sale securities 438,651 6.29% 395,910 6.80% 364,447 7.03%
- ------------------------------------------------------------------------------------------------------------------------------------
Held-to-maturity securities:
U.S. Treasury securities 730 6.11% 742 5.39% 740 6.03%
Securities of other U.S. Government agencies
and corporations 434 6.54% 680 6.32% 746 5.98%
Mortgage-backed securities 163 7.46% 205 7.80% 234 8.67%
- ------------------------------------------------------------------------------------------------------------------------------------
Total held-to-maturity securities 1,327 6.42% 1,627 6.08% 1,720 6.37%
- ------------------------------------------------------------------------------------------------------------------------------------
Interest-bearing due from banks 1,901 1.49% 2,659 3.08% 1,653 4.66%
Federal funds sold 1,069 1.90% 5,064 3.63% 4,358 5.68%
Loans:
Real estate loans 311,233 7.81% 279,828 8.37% 264,129 8.60%
Consumer 28,974 10.30% 28,062 10.89% 28,100 11.23%
Agricultural 2,356 8.09% 2,070 9.18% 1,934 9.65%
Commercial/industrial 26,188 7.15% 22,212 8.24% 20,996 8.81%
Other 864 6.57% 892 7.62% 848 8.13%
Political subdivisions 11,169 7.95% 13,108 7.96% 12,624 7.90%
Leases 141 8.63% 181 9.39% 207 9.80%
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans 380,925 7.96% 346,353 8.56% 328,838 8.82%
- ------------------------------------------------------------------------------------------------------------------------------------
Total Earning Assets 823,873 7.05% 751,613 7.57% 701,016 7.85%
Cash 12,769 11,871 10,458
Unrealized gain/loss on securities 9,290 6,639 570
Allowance for loan losses (5,326) (5,370) (5,366)
Bank premises and equipment 10,162 9,602 9,328
Other assets 31,082 30,874 32,087
- ------------------------------------------------------------------------------------------------------------------------------------
Total Assets $ 881,850 $ 805,229 $ 748,093
====================================================================================================================================
INTEREST-BEARING LIABILITIES
Interest checking $ 37,112 1.16% $ 37,192 1.75% $ 35,574 2.33%
Money market 163,196 2.38% 153,738 3.49% 156,171 4.64%
Savings 49,064 1.07% 46,750 2.16% 44,982 2.48%
Certificates of deposit 184,397 4.39% 169,275 5.48% 158,772 5.96%
Individual Retirement Accounts 86,061 4.98% 79,482 5.12% 79,279 5.54%
Other time deposits 1,534 2.12% 1,916 1.83% 2,023 2.41%
Overnight borrowings 2,746 2.07% 4,012 4.01% 2,369 6.16%
Other borrowed funds 188,669 4.40% 151,615 5.13% 120,454 5.94%
- ------------------------------------------------------------------------------------------------------------------------------------
Total Interest-bearing Liabilities 3.59% 4.40% 599,624 5.07%
712,779 643,980
Demand deposits 59,926 56,226 51,867
Other liabilities 7,399 9,002 6,848
- ------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities 780,104 709,208 658,339
- ------------------------------------------------------------------------------------------------------------------------------------
Stockholders' equity, excluding other comprehensive income/loss 95,617 91,703 89,378
Other comprehensive income/loss 6,129 4,318 376
- ------------------------------------------------------------------------------------------------------------------------------------
Total Stockholders' Equity 101,746 96,021 89,754
- ------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 881,850 $ 805,229 $ 748,093
====================================================================================================================================
Interest Rate Spread 3.46% 3.17% 2.78%
Net Interest Income/Earning Assets 3.94% 3.80% 3.52%
(1) Rates of return on tax-exempt securities and loans are presented on a fully
taxable-equivalent basis.
(2) Nonaccrual loans have been included with loans for the purpose of analyzing
net interest earnings.
14
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE IV - ANALYSIS OF VOLUME AND RATE CHANGES
(IN THOUSANDS) QUARTERS ENDED 3/31/02 VS. 01
CHANGE IN CHANGE IN TOTAL
VOLUME RATE CHANGE
EARNING ASSETS
Available-for-sale securities:
U.S. Treasury securities $ - $ - $ -
Securities of other U.S. Government agencies
And corporations (945) (124) (1,069)
Mortgage-backed securities 1,300 (455) 845
Obligations of states and political subdivisions 578 (8) 570
Equity securities (21) 6 (15)
Other securities 204 (43) 161
- --------------------------------------------------------------------------------------------------------------------
Total available-for-sale securities 1,116 (624) 492
- --------------------------------------------------------------------------------------------------------------------
Held-to-maturity securities:
U.S. Treasury securities - - -
Securities of other U.S. Government agencies
and corporations (5) 1 (4)
Mortgage-backed securities (1) (1) (2)
- --------------------------------------------------------------------------------------------------------------------
Total held-to-maturity securities (6) - (6)
- --------------------------------------------------------------------------------------------------------------------
Interest-bearing due from banks 3 (15) (12)
Federal funds sold (30) (26) (56)
Loans:
Real estate loans 938 (543) 395
Consumer 23 (65) (42)
Agricultural 9 (8) 1
Commercial/industrial 101 (95) 6
Other - (3) (3)
Political subdivisions (29) 2 (27)
Leases (1) (1) (2)
- --------------------------------------------------------------------------------------------------------------------
Total loans 1,041 (713) 328
- --------------------------------------------------------------------------------------------------------------------
Total Interest Income 2,124 (1,378) 746
- --------------------------------------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES
Interest checking 9 (107) (98)
Money market 77 (906) (829)
Savings 23 (168) (145)
Certificates of deposit 339 (674) (335)
Individual Retirement Accounts 88 (113) (25)
Other time deposits (3) (1) (4)
Overnight borrowings 5 (27) (22)
Other borrowed funds 820 (538) 282
- --------------------------------------------------------------------------------------------------------------------
Total Interest Expense 1,358 (2,534) (1,176)
- --------------------------------------------------------------------------------------------------------------------
Net Interest Income $ 766 $ 1,156 $ 1,922
====================================================================================================================
(1) Changes in income on tax-exempt securities and loans is presented on a fully
taxable-equivalent basis, using the Corporation's marginal federal income tax
rate of 34%.
(2) The change in interest due to both volume and rates has been allocated to
volume and rate changes in proportion to the relationship of the absolute dollar
amount of the change in each.
15
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE V - COMPARISON OF NONINTEREST INCOME
(IN THOUSANDS) 3 MONTHS ENDED
MARCH 31, MARCH 31,
2002 2001
Service charges on deposit accounts $ 384 $ 296
Service charges and fees 65 68
Trust and financial management revenue 439 387
Insurance commissions, fees and premiums 215 138
Increase in cash surrender value of life insurance 224 222
Fees related to credit card operation 130 128
Other operating income 230 195
- --------------------------------------------------------------------------------------------------
Total other operating income, before realized
gains on securities, net 1,687 1,434
Realized gains on securities, net 1,226 455
- --------------------------------------------------------------------------------------------------
Total Other Income $ 2,913 $ 1,889
==================================================================================================
Total noninterest income increased $1,024,000, or 54.2%, in the first quarter
2002 compared to the first quarter 2001. The most significant change - the
increase in security gains - is 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 $88,000, or 29.7%. This
increase resulted from increased numbers of accounts and higher average
balances, as well as fee increases implemented in the second half of 2001
on certain types of services.
- - Trust and financial management revenue increased $52,000, or 13.4%. 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.
- - Insurance revenue increased $77,000, or 55.8%. Revenue from the insurance
agency division of C&N Financial Services Corporation increased to $79,000
in the first quarter 2002 from $40,000 in the first quarter 2001. Also,
revenue from accident and health, mortgage group life, and individual life
insurance, sold to lending customers through Bucktail Life Insurance
Company, increased to $136,000 in the first quarter 2002 from $98,000 in
the first quarter 2001.
TABLE VI- COMPARISON OF NONINTEREST EXPENSE
(IN THOUSANDS) 3 MONTHS ENDED
MARCH 31, MARCH 31,
2002 2001
Salaries and wages $ 2,238 $ 2,018
Pensions and other employee benefits 615 580
Occupancy expense, net 278 259
Furniture and equipment expense 447 346
Pennsylvania shares tax 183 196
Expenses related to credit card operation 71 77
Other operating expense 1,274 1,122
- -------------------------------------------------------------------------------
Total Other Expense $ 5,106 $ 4,598
===============================================================================
Salaries and wages increased $220,000, or 10.9%, in the first quarter 2002
compared to the first quarter 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 3
quarters of 2001 and first quarter 2002 included the addition of new positions
in branch and commercial lending, branch administration, compliance and
marketing. The number of full-time equivalent employees has increased 7.1%, to
256 as of March 31, 2002 compared to 239 as of March 31, 2001. The incentive
bonus plan provides for compensation to be paid to certain key officers early in
the following year, with the payment amounts based on a combination of personal
and corporate performance in the current year. The estimate of such expense for
the first quarter 2002 increased $42,000 over the accrual recorded in the first
quarter 2001.
16
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Pensions and other employee benefits increased $35,000, or 6.0%, in the first
quarter 2002 over the first quarter 2001. This increase is directly related to
the increase in salaries and wages.
Furniture and equipment expense increased $101,000, or 29.2%, in the first
quarter 2002 compared to the first quarter 2001. The largest increase within
this category was in depreciation expense, which increased $56,000. There were
several substantial capital expenditures over the last 3 quarters of 2001 and
first quarter 2002 that produced higher depreciation expense in the first
quarter 2002. The most significant items were new proof of deposit software, a
new phone system and ongoing purchases of PCs and software required to maintain
and upgrade the computer network. Repairs and maintenance expense increased
$36,000, primarily from maintenance contracts associated with computer hardware
and software.
Other expense increased $152,000, or 13.5%, in the first quarter 2002 over the
first quarter 2001. This category includes many different types of expenses.
Some of the overall increase in this category was caused by increases in number
of transactions processed and number of employees. The most significant
individual change within this category was an increase of $76,000 in expenses
from Bucktail Life Insurance Company, which resulted mainly from a larger amount
of life insurance claims incurred.
FINANCIAL CONDITION
Significant changes in the average balances of the Corporation's earning assets
and interest-bearing liabilities are described in the "Net Interest Margin"
section of Management's Discussion and Analysis. There are no significant
changes in the Corporation's consolidated balance sheet as of March 31, 2002
compared to December 31, 2001, other than the items addressed in that
discussion. Table VII provides a summary of investment securities held at March
31, 2002 and December 31, 2001. The allowance for loan losses and stockholders'
equity are discussed in separate sections of Management's Discussion and
Analysis.
TABLE VII - INVESTMENT SECURITIES
(In Thousands)
MARCH 31, 2002 DECEMBER 31, 2001
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
AVAILABLE-FOR-SALE SECURITIES:
Obligations of the U.S. Treasury $ 2,501 $ 2,528 $ 2,503 $ 2,557
Obligations of other U.S. Government agencies 81,402 79,411 75,295 75,172
Obligations of states and political subdivisions 105,311 104,145 95,835 95,261
Other securities 32,376 32,547 34,315 34,532
Mortgage-backed securities 231,800 231,302 198,269 198,975
- -------------------------------------------------------------------------------------------------------
Total debt securities 453,390 449,933 406,217 406,497
Marketable equity securities 20,937 28,918 19,745 27,472
- -------------------------------------------------------------------------------------------------------
Total $474,327 $478,851 $425,962 $433,969
=======================================================================================================
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury $ 724 $ 730 $ 726 $ 735
Obligations of other U.S. Government agencies 297 305 547 561
Mortgage-backed securities 157 163 175 181
- -------------------------------------------------------------------------------------------------------
Total $ 1,178 $ 1,198 $ 1,448 $ 1,477
=======================================================================================================
17
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses includes two components, allocated and
unallocated. The allocated component of the allowance for loan losses reflects
probable losses resulting from the analysis of individual loans, specific
allowances for loans in certain industries and historical loss experience for
each loan category. The historical loan loss experience element is determined
based on the ratio of net charge-offs to average loan balances over a five-year
period, for each significant type of loan. The charge-off ratio is then applied
to the current outstanding loan balance for each type of loan (net of other
loans that are individually evaluated).
The unallocated portion of the allowance is determined based on management's
assessment of general economic conditions as well as specific economic factors
in the market area. This determination inherently involves a higher degree of
uncertainty and considers current risk factors that may not have yet manifested
themselves in the Bank's historical loss factors used to determine the allocated
component of the allowance, and it recognizes that knowledge of the portfolio
credit risk may be incomplete.
As noted in Table IX, the unallocated portion of the allowance for loan losses
was $2,222,000 at March 31, 2002, which is relatively consistent with the
unallocated allowance of $2,187,000 at December 31, 2001. These unallocated
allowance balances reflect management's concern related to possible adverse
changes in the local economy, including concerns related to several local plant
lay-offs. In recent months, there has been some deterioration in loan
delinquency data. Total 90 day or more past due loans, plus nonaccrual loans,
increased 12.0% to $3,492,000 at March 31, 2002 from $3,117,000 at December 31,
2001. As reflected in Table IX, there was little change in the total allocated
portion of the allowance at March 31, 2002 ($3,115,000) as compared to December
31, 2001 ($3,078,000).
The provision for loan losses increased to $180,000 in the first quarter 2002
from $150,000 in the first quarter 2001. The amount of the provision in each
period is determined based on the amount required to maintain an appropriate
allowance in light of the factors described above.
Tables VIII, IX and X present an analysis of the allowance for loan losses, the
allocation of the allowance and a five-year summary of loans by type.
TABLE VIII- ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
(IN THOUSANDS) QUARTER
ENDED
MARCH 31, YEARS ENDED DECEMBER 31,
2002 2001 2000 1999 1998 1997
Balance, beginning of year $ 5,265 $ 5,291 $ 5,131 $ 4,820 $ 4,913 $ 4,776
- --------------------------------------------------------------------------------------------------------------------
Charge-offs:
Real estate loans 13 144 272 81 257 246
Installment loans 42 138 77 138 144 230
Credit cards and related plans 63 200 214 192 264 305
Commercial and other loans - 231 53 219 301 3
- --------------------------------------------------------------------------------------------------------------------
Total charge-offs 118 713 616 630 966 784
- --------------------------------------------------------------------------------------------------------------------
Recoveries:
Real estate loans - 6 26 81 12 21
Installment loans 7 27 23 60 43 64
Credit cards and related plans 2 20 28 30 40 30
Commercial and other loans 1 34 23 10 15 9
- --------------------------------------------------------------------------------------------------------------------
Total recoveries 10 87 100 181 110 124
- --------------------------------------------------------------------------------------------------------------------
Net charge-offs 108 626 516 449 856 660
Provision for loan losses 180 600 676 760 763 797
- --------------------------------------------------------------------------------------------------------------------
Balance, end of year $ 5,337 $ 5,265 $ 5,291 $ 5,131 $ 4,820 $ 4,913
====================================================================================================================
18
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE IX - ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES BY TYPE
(IN THOUSANDS)
AT
MARCH 31, AT DECEMBER 31:
2002 2001 2000 1999 1998 1997
Commercial $ 1,632 $ 1,837 $ 1,612 $ 2,081 $ 650 $ 625
Consumer mortgage 844 674 952 834 97 350
Impaired loans 204 73 273 609 290 274
Consumer 435 494 471 437 702 375
All other commitments - - - 150 202 343
Unallocated 2,222 2,187 1,983 1,020 2,879 2,946
- -------------------------------------------------------------------------------------------------------------------
Total Allowance $ 5,337 $ 5,265 $ 5,291 $ 5,131 $ 4,820 $ 4,913
===================================================================================================================
TABLE X - LOANS BY TYPE
(IN THOUSANDS)
MAR. 31, DEC. 31, DEC. 31, DEC. 31, DEC. 31, DEC. 31,
2002 2001 2000 1999 1998 1997
Real estate - construction $ 1,850 $ 1,814 $ 452 $ 649 $ 1,004 $ 406
Real estate - mortgage 316,412 306,264 263,325 247,604 230,815 219,952
Consumer 28,881 29,284 28,141 29,140 30,924 33,094
Agricultural 2,424 2,344 1,983 1,899 1,930 2,424
Commercial 28,575 24,696 20,776 18,050 17,630 17,176
Other 1,914 1,195 948 1,025 1,062 6,260
Political subdivisions 10,568 13,479 12,462 12,332 7,449 5,895
Lease receivables 135 152 218 222 218 256
- -----------------------------------------------------------------------------------------------------------------
Total 390,759 379,228 328,305 310,921 291,032 285,463
Less: unearned discount - - - (29) (29) (37)
- -----------------------------------------------------------------------------------------------------------------
390,759 379,228 328,305 310,892 291,003 285,426
Less: allowance for loan losses (5,337) (5,265) (5,291) (5,131) (4,820) (4,913)
- -----------------------------------------------------------------------------------------------------------------
Loans, net $385,422 $373,963 $323,014 $305,761 $286,183 $280,513
=================================================================================================================
LIQUIDITY
Liquidity is the ability to quickly raise cash at a reasonable cost. An adequate
liquidity position permits the Corporation to pay creditors, compensate for
unforeseen deposit fluctuations and fund unexpected loan demand. The Corporation
maintains overnight borrowing facilities with several correspondent banks that
provide a source of day-to-day liquidity. Also, the Corporation maintains
borrowing facilities with the Federal Home Loan Bank of Pittsburgh, secured by
mortgage loans and mortgage-backed securities. At March 31, 2002, the
Corporation had unused borrowing availability with correspondent banks and the
Federal Home Loan Bank of Pittsburgh totaling approximately $228,207,000.
Additionally, the Corporation uses repurchase agreements placed with brokers to
borrow short-term funds secured by investment assets, and uses "RepoSweep"
arrangements to borrow funds from commercial banking customers on an overnight
basis.
STOCKHOLDERS' EQUITY AND CAPITAL ADEQUACY
The Corporation and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. For many years, the
Corporation and the Bank have maintained strong capital positions. The following
table presents consolidated capital ratios at March 31, 2002:
TABLE XI - CAPITAL RATIOS
CITIZENS & NORTHERN REGULATORY STANDARDS
CORPORATION WELL MINIMUM
(ACTUAL) CAPITALIZED STANDARD
- -------------------------------------------------------------------------------------------------------
Total capital to risk-weighted assets 22.61% 10% 8%
Tier 1 capital to risk-weighted assets 20.71% 6% 4%
Tier 1 capital to average total assets 11.03% 5% 4%
Management expects the Corporation and the Bank to maintain capital levels that
exceed the regulatory standards for well-capitalized institutions for the next
12 months and for the foreseeable future. Planned capital expenditures during
the next 12 months are not expected to have a detrimental effect on capital
ratios or results of operations.
19
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
INFLATION
Over the last several years, direct inflationary pressures on the Corporation's
payroll-related and other noninterest costs have been modest. However, the
Corporation is significantly affected by the Federal Reserve Board's efforts to
control inflation through changes in interest rates. Management monitors the
impact of economic trends, including any indicators of inflationary pressure, in
managing interest rate and other financial risks.
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
PART I - FINANCIAL INFORMATION (CONTINUED)
ITEM 3. INTEREST RATE RISK AND MARKET RISK
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
The Corporation's two major categories of market risk, interest rate and equity
securities risk, are discussed in the following sections.
INTEREST RATE RISK
Business risk arising from changes in interest rates is an inherent factor in
operating a bank. The Corporation's assets are predominantly long-term, fixed
rate loans and debt securities. Funding for these assets comes principally from
short-term deposits and borrowed funds. Accordingly, there is an inherent risk
of lower future earnings or decline in fair value of the Corporation's financial
instruments when interest rates change.
The Bank uses a simulation model to calculate the potential effects of interest
rate fluctuations on net interest income and the market value of portfolio
equity. Only assets and liabilities of the Bank are included in management's
monthly simulation model calculations. Since the Bank makes up more than 90% of
the Corporation's total assets and liabilities, and because the Bank is the
source of the most volatile interest rate risk, management does not consider it
necessary to run the model for the remaining entities within the consolidated
group. For purposes of these calculations, the market value of portfolio equity
includes the fair values of financial instruments, such as securities, loans,
deposits and borrowed funds, and the book values of nonfinancial assets and
liabilities, such as premises and equipment and accrued interest. The model
measures and projects potential changes in net interest income, and calculates
the discounted present value of anticipated cash flows of financial instruments,
under the "base most likely" and "what if" scenarios. Typically, management runs
these calculations using the base most likely scenario, and assuming increases
and decreases of 100 basis points (1%), 200 basis points and 300 basis points
from the base most likely scenario.
The Bank's Board of Directors has established policy guidelines for acceptable
levels of interest rate risk, based on an immediate increase or decrease in
interest rates of 200 basis points. The policy limit for fluctuation in net
interest income is minus 20% from the base most likely one-year scenario. The
policy limit for market value variance is minus 30% from the base most likely
one-year scenario. As Table XII shows, as of March 31, 2002, the Bank's interest
rate risk calculations were within the policy thresholds. The most sensitive
scenario presented is the "+200 basis points" scenario. If interest rates were
to immediately increase 200 basis points, the Bank's calculations based on the
model show that net interest income would decrease 13.39% over the next 12
months, and the market value of portfolio equity would decrease 26.14%.
The table that follows was prepared using the simulation model described above.
The model makes estimates, at each level of interest rate change, regarding cash
flows from principal repayments on loans and mortgage-backed securities and call
activity on other investment securities. Actual results could vary significantly
from these estimates, which could result in significant differences in the
calculations of projected changes in net interest margin and market value of
portfolio equity. Also, the model does not make estimates related to changes in
the composition of the deposit portfolio that could occur due to rate
competition and the table does not necessarily reflect changes that management
would make to realign the portfolio as a result of changes in interest rates.
20
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
TABLE XII - THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES
Period Ending March 31, 2003
(In Thousands)
March 31, 2002 Data
PLUS 200 MINUS 200
MOST LIKELY BASIS BASIS
FORECAST POINTS POINTS
AMOUNT AMOUNT % CHANGE AMOUNT % CHANGE
Interest income:
Securities $26,784 $29,020 8.35 $ 24,488 (8.57)
Interest-bearing due from banks
and federal funds sold 76 134 76.32 9 (88.16)
Loans 31,796 33,477 5.29 28,976 (8.87)
- ---------------------------------------------------------------------------------------------------------------------
Total interest income 58,656 62,631 6.78 53,473 (8.84)
- ---------------------------------------------------------------------------------------------------------------------
Interest expense:
Interest on deposits 18,137 25,505 40.62 10,813 (40.38)
Interest on borrowed funds 9,084 9,901 8.99 8,317 (8.44)
- ---------------------------------------------------------------------------------------------------------------------
Total interest expense 27,221 35,406 30.07 19,130 (29.72)
- ---------------------------------------------------------------------------------------------------------------------
Net Interest Income $31,435 $27,225 (13.39) $ 34,343 9.25
=====================================================================================================================
Market Value of Portfolio Equity at
March 31, 2002 $90,526 $66,863 (26.14) $104,454 15.39
=====================================================================================================================
EQUITY SECURITIES RISK
The Corporation's equity securities portfolio consists primarily of investments
in stock of banks and bank holding companies located mainly in Pennsylvania. The
Corporation also owns some other stocks and mutual funds.
Investments in bank stocks are subject to the risk factors that affect the
banking industry in general, including competition from nonbank entities, credit
risk, interest rate risk and other factors, which could result in a decline in
market prices. Also, losses could occur in individual stocks held by the
Corporation because of specific circumstances related to each bank. Further,
because of the concentration of bank and bank holding companies located in
Pennsylvania, these investments could decline in market value if there is a
downturn in the state's economy.
Equity securities held as of March 31, 2002 and December 31, 2001 are presented
in Table XII.
TABLE XIII - EQUITY SECURITIES
(IN THOUSANDS) HYPOTHETICAL HYPOTHETICAL
10% 20%
DECLINE IN DECLINE IN
FAIR MARKET MARKET
AT MARCH 31, 2002 COST VALUE VALUE VALUE
- ----------------------------------------------------------------------------------------------------
Banks and bank holding companies $ 19,397 $ 27,309 $ (2,731) $ (5,462)
Other equity securities 1,540 1,609 (161) (322)
- ----------------------------------------------------------------------------------------------------
Total $ 20,937 $ 28,918 $ (2,892) $ (5,784)
====================================================================================================
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)
====================================================================================================
21
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Neither the Corporation nor any of its subsidiaries is a party to any
material pending legal proceedings.
Item 2. Not Applicable
Item 3. Not Applicable
Item 4. Not Applicable
Item 5. Other Information
a. None
Item 6. Exhibits and Reports on Form 8 - K
a. Exhibits have been omitted either because not applicable or because the
required information is included elsewhere in Form 10-Q.
b. On January 10, 2002, a Current Report on Form 8-K was filed to report
the Corporation's consolidated earnings results for the year ended December
31, 2001.
22
CITIZENS AND NORTHERN CORPORATION - FORM 10 - Q
Signature Page
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CITIZENS & NORTHERN CORPORATION
May 13, 2002 By: Craig G. Litchfield /S/
- ------------ -----------------------
Date Chairman, President and Chief Executive Officer
May 13, 2002 By: Mark A. Hughes /S/
- ------------ ------------------
Date Treasurer and Principal Accounting Officer
23