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CZNC > SEC Filings for CZNC > Form 10-Q on 9-May-2013All Recent SEC Filings

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Form 10-Q for CITIZENS & NORTHERN CORP


9-May-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Certain statements in this section and elsewhere in this quarterly report on Form 10-Q are forward-looking statements. Citizens & Northern Corporation and its wholly-owned subsidiaries (collectively, the Corporation) intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995. Forward-looking statements, which are not historical facts, are based on certain assumptions and describe future plans, business objectives and expectations, and are generally identifiable by the use of words such as, "should", "likely", "expect", "plan", "anticipate", "target", "forecast", and "goal". These forward-looking statements are subject to risks and uncertainties that are difficult to predict, may be beyond management's control and could cause results to differ materially from those expressed or implied by such forward-looking statements. Factors which could have a material, adverse impact on the operations and future prospects of the Corporation include, but are not limited to, the following:

changes in monetary and fiscal policies of the Federal Reserve Board and the U. S. Government, particularly related to changes in interest rates

changes in general economic conditions

legislative or regulatory changes

downturn in demand for loan, deposit and other financial services in the Corporation's market area

increased competition from other banks and non-bank providers of financial services

technological changes and increased technology-related costs

changes in accounting principles, or the application of generally accepted accounting principles.

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.

EARNINGS OVERVIEW

Net income was $4,706,000, or $0.38 per basic and diluted share in the first quarter 2013, representing an annualized return on average assets of 1.50% and an annualized return on average equity of 10.31%. Net income in the first quarter 2013 was down from $5,939,000 ($0.48 per share) in the fourth quarter 2012 and $5,587,000 ($0.46 per share) in the first quarter 2012.

Some of the more significant fluctuations in the components of earnings between the first quarter 2013 and the first quarter 2012 are as follows:

In the first quarter 2013, the Corporation generated net realized gains from available-for-sale securities totaling $1,159,000, and also incurred a loss from prepayment of a borrowing of $1,023,000. Net realized losses from available-for-sale securities totaled $2,000, and there were no prepayments of borrowings, in the first quarter 2012. Security gains in the first quarter 2013 included a gain of $571,000 from sale of a pooled trust-preferred security that had been written off in 2009. Also in the first quarter 2013, net realized gains from bank stocks totaled $497,000 and net gains from sales of other securities totaled $91,000. In the most recent quarter, the Corporation prepaid principal of $7 million on a long-term borrowing (repurchase agreement), with an average rate of 3.595%, resulting in the loss on prepayment of $1,023,000. Management estimates the effect of prepaying the $7 million portion of the borrowing, as opposed to reinvesting in securities at a current market yield, will be an after-tax benefit of $75,000 over the next 12 months. After the effect of the prepayment, the remaining balance of long-term borrowings under repurchase agreements was $61 million at March 31, 2013.

First quarter 2013 net interest income was $1,227,000 (10.0%) lower than the first quarter 2012 total. The lower level of net interest income in 2013 includes the effects of margin compression due to reductions in long-term interest rates, as C&N's fully taxable equivalent net interest margin of 4.18% was 0.23% lower than the corresponding first quarter 2012 margin. Also, first quarter 2012 net interest income included accretion income of $457,000 related to the recovery of a previously written down security that matured (with payment in full received) in the second quarter 2012. Other factors that significantly affected first quarter 2013 net interest income in comparison to 2012 included a lower average balance of loans outstanding (down $27.4 million), as well as reductions in average total deposits (down $27.7 million) and borrowed funds (down $35.5 million).

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

Noninterest revenue, excluding net gains from available-for-sale securities, totaled $3,843,000 in the first quarter 2013, an increase of $188,000 (5.1%) over the first quarter 2012, as net gains from sales of mortgage loans increased $280,000.

Noninterest expense, excluding the loss on prepayment of borrowings described above, totaled $8,553,000 in the first quarter 2013, which was $140,000 (1.7%) higher than the first quarter 2012 total. Other operating expense, which includes many different types of expenses, increased $192,000 (10.2%) in the first quarter 2013 over the first quarter 2012, including a loss from other real estate properties of $3,000 in the first quarter 2013 as compared to net gains from sales of $104,000 in the first quarter 2012. Pensions and other employee benefits expense decreased $111,000 (8.1%) in the first quarter 2013 as compared to the first quarter 2012, including reductions in unemployment compensation, health insurance and postretirement health care expenses.

The first quarter 2013 income tax provision of $1,584,000 (25.2% of pre-tax income), was down from $2,109,000 (27.4% of pre-tax income) in the first quarter 2012, mainly as a result of lower pre-tax income.

More detailed information concerning fluctuations in the Corporation's earnings results are provided in other sections of Management's Discussion and Analysis.

TABLE I - QUARTERLY FINANCIAL DATA
(In Thousands)
                                                    Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31,
                                                      2013     2012     2012      2012     2012
Interest income                                      $12,647  $13,491   $13,836  $14,529  $14,776
Interest expense                                       1,600    1,900     2,228    2,401    2,502
Net interest income                                   11,047   11,591    11,608   12,128   12,274
Provision (credit) for loan losses                       183    (133)       236      367    (182)
Net Interest income after provision (credit)
 for loan losses                                      10,864   11,724    11,372   11,761   12,456
Other income                                           3,843    4,327     4,122    4,279    3,655
Net gains (losses) on available-for-sale securities    1,159       51     2,430      203      (2)
Loss on prepayment of debt                             1,023        0     2,190      143        0
Other expenses                                         8,553    7,954     8,226    8,321    8,413
Income before income tax provision                     6,290    8,148     7,508    7,779    7,696
Income tax provision                                   1,584    2,209     2,014    2,094    2,109
Net income                                            $4,706   $5,939    $5,494   $5,685   $5,587
Net income per share - basic                           $0.38    $0.48     $0.45    $0.46    $0.46
Net income per share - diluted                         $0.38    $0.48     $0.45    $0.46    $0.46

CRITICAL ACCOUNTING POLICIES

The presentation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect many of the reported amounts and disclosures. Actual results could differ from these estimates.

A material estimate that is particularly susceptible to significant change is the determination of the allowance for loan losses. Management believes the allowance for loan losses is adequate and reasonable. Analytical information related to the Corporation's aggregate loans and the related allowance for loan losses is summarized by loan segment and classes of loans in Note 7 to the consolidated financial statements. Additional discussion of the Corporation's allowance for loan losses is provided 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.

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

Another material estimate is the calculation of fair values of the Corporation's debt securities. For most 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 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.

As described in Note 6 to the consolidated financial statements, management evaluates securities for other-than-temporary impairment (OTTI). In making that evaluation, consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether the Corporation intends to sell the security or more likely than not will be required to sell the security before its anticipated recovery. Management's assessments of the likelihood and potential for recovery in value of securities are subjective and based on sensitive assumptions.

NET INTEREST INCOME

The Corporation's primary source of operating income is net interest income, which 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 income for the three-month periods ended March 31, 2013 and March 31, 2012. 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 income amounts reflected in these tables exceed the amounts presented in the consolidated financial statements. The discussion that follows is based on amounts in the related Tables.

For the three-month periods, fully taxable equivalent net interest income was $11,870,000 in 2013, $1,253,000 (9.5%) lower than in 2012. As shown in Table IV, net changes in volume had the effect of decreasing net interest income $62,000 in 2013 compared to 2012, and interest rate changes had the effect of decreasing net interest income $1,191,000. The most significant components of the volume change in net interest income in 2013 were a decrease in interest income of $450,000 attributable to a decline in the balance of loans receivable, a decrease in interest expense of $328,000 attributable to a reduction in the balance of borrowed funds, and a decrease in interest expense of $146,000 attributable to a reduction in the balance of interest-bearing deposits (primarily certificates of deposit and Individual Retirement Accounts). The most significant components of the rate change in net interest income in 2013 were a decrease in interest income of $911,000 attributable to lower rates earned on available-for-sale securities, a decrease in interest income of $713,000 attributable to lower rates earned on loans receivable, and a decrease in interest expense of $426,000 due to lower rates paid on interest-bearing deposits. As presented in Table III, the "Interest Rate Spread" (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) was 4.00% in 2013, as compared to 4.17% in 2012.

In 2012, the Corporation recognized interest income on a trust preferred security issued by Carolina First Mortgage Loan Trust, a subsidiary of The South Financial Group, Inc., which had been written down as OTTI in 2009 and early 2010. The security resumed payment after The South Financial Group, Inc. was acquired by The Toronto-Dominion Bank in late 2010. The security had a face amount of $2,000,000 and matured in May 2012. The yield to maturity recognized by the Corporation was 147.03%. Excluding interest income (including accretion) and the average balance of this security from the calculations used to determine Tables II, III and IV, the interest rate spread and interest margin (fully taxable equivalent net interest income divided by average total earning assets) would be as follows:

                                    3 Months Ended
                                  March 31, March 31,
                                    2013      2012
Interest rate spread:
Actual from Table III                 4.00%     4.17%
Excluding Carolina First security     4.00%     4.02%

Interest margin:
Actual from Table III                 4.18%     4.41%
Excluding Carolina First security     4.18%     4.26%

INTEREST INCOME AND EARNING ASSETS

Interest income totaled $13,470,000 in 2013, a decrease of 13.8% from 2012. Interest and fees on loans receivable decreased $1,163,000, or 10.6%. As indicated in Table III, average available-for-sale securities (at amortized cost) totaled $445,735,000 in 2013, a decrease of $13,001,000 (2.8%) from 2012. Net contraction in the Corporation's available-for-sale securities portfolio was primarily made up of U.S. Government agency mortgage-backed securities and trust preferred securities. This contraction was partially offset by increases in the balances of U.S. Government agency collateralized mortgage obligations, municipal securities, and U.S. Government agency bonds. The Corporation's yield on securities fell in 2012 and 2013 because of low market interest rates, the maturity of the Carolina First security noted above, and rapid prepayments on mortgage-backed securities and collateralized mortgage obligations. The average rate of return on available-for-sale securities was 3.32% for 2013 and 4.08% in 2012.

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

The average balance of gross loans receivable decreased 3.9% to $674,769,000 in 2013 from $702,154,000 in 2012. The Corporation experienced contraction in the balance of loans receivable due to borrowers prepaying or refinancing existing loans combined with modest demand for new loans. The decline in the balance of the residential mortgage portfolio was also affected by management's decision to sell a significant portion of newly originated residential mortgages on the secondary market. The Corporation's average rate of return on loans receivable declined to 5.88% in 2013 from 6.27% in 2012 as rates on new loans as well as existing, variable-rate loans have decreased.

The average balance of interest-bearing due from banks decreased to $29,638,000 in 2013 from $34,334,000 in 2012. This has consisted primarily of balances held by the Federal Reserve. Although the rate of return on balances with the Federal Reserve is low, the Corporation has maintained relatively high levels of liquid assets in 2012 and 2013 (as opposed to increasing long-term, available-for-sale securities at higher yields) in order to maximize flexibility for dealing with possible fluctuations in cash requirements, and due to management's concern about the possibility of substantial increases in interest rates in the future.

INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES

Interest expense fell $902,000, or 36.1%, to $1,600,000 in 2013 from $2,502,000 in 2012. Table III shows that the overall cost of funds on interest-bearing liabilities fell to 0.74% in 2013 from 1.08% in 2012.

Total average deposits (interest-bearing and noninterest-bearing) decreased 2.8%, to $972,638,000 in 2013 from $1,000,304,000 in 2012. Decreases in the average balances of certificates of deposit, Individual Retirement Accounts, demand deposits, and money market accounts were partially offset by increases in average balances of interest checking and savings accounts. Consistent with continuing low short-term market interest rates, the average rates incurred on certificates of deposit and Individual Retirement Accounts have decreased significantly in 2013 as compared to 2012.

Total average borrowed funds decreased $35,468,000 to $87,561,000 in 2013 from $123,029,000 in 2012. During 2012 and 2013, the Corporation has paid off long-term borrowings as they matured using the cash flow received from loans and investment securities. In May and September 2012, the Corporation prepaid principal totaling $17,000,000 on long-term borrowings (repurchase agreements); the Corporation incurred losses from the prepayments totaling $2,333,000. In March 2013, the Corporation prepaid principal of $7,000,000 on a long-term borrowing (repurchase agreement) with a rate of 3.60%; the Corporation incurred a loss from the prepayment totaling $1,023,000, which is reported in Other Expenses in the Consolidated Statements of Income. Management expects that the prepayments will have a favorable effect on the net interest margin in the future. After the effect of the prepayments, the remaining balance of long-term borrowings under repurchase agreements was $61,000,000 at March 31, 2013. The average rate on borrowed funds was 3.81% in 2013, compared to 3.77% in 2012.

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

TABLE II - ANALYSIS OF INTEREST INCOME AND EXPENSE



                                    Three Months Ended
                                         March 31,       Increase/
(In Thousands)                        2013      2012     (Decrease)

INTEREST INCOME
Available-for-sale securities:
Taxable                                $1,799    $2,733      ($934)
Tax-exempt                              1,846     1,916        (70)
Total available-for-sale securities     3,645     4,649     (1,004)
Interest-bearing due from banks            28        28           0
Loans held for sale                        21         9          12
Loans receivable:
Taxable                                 9,225    10,366     (1,141)
Tax-exempt                                551       573        (22)
Total loans receivable                  9,776    10,939     (1,163)
Total Interest Income                  13,470    15,625     (2,155)

INTEREST EXPENSE
Interest-bearing deposits:
Interest checking                          52        51           1
Money market                               72        97        (25)
Savings                                    29        26           3
Certificates of deposit                   461       826       (365)
Individual Retirement Accounts            164       350       (186)
Total interest-bearing deposits           778     1,350       (572)
Borrowed funds:
Short-term                                  1         3         (2)
Long-term                                 821     1,149       (328)
Total borrowed funds                      822     1,152       (330)
Total Interest Expense                  1,600     2,502       (902)

Net Interest Income                   $11,870   $13,123    ($1,253)

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 35%.

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

TABLE III - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES

(Dollars in Thousands)



                                                                  3 Months           3 Months
                                                                   Ended    Rate of   Ended    Rate of
                                                                 3/31/2013  Return/ 3/31/2012  Return/
                                                                  Average   Cost of  Average   Cost of
                                                                  Balance   Funds %  Balance   Funds %
EARNING ASSETS
Available-for-sale securities, at amortized cost:
Taxable                                                            $315,612   2.31%   $331,007   3.32%
Tax-exempt                                                          130,123   5.75%    127,729   6.03%
Total available-for-sale securities                                 445,735   3.32%    458,736   4.08%
Interest-bearing due from banks                                      29,638   0.38%     34,334   0.33%
Federal funds sold                                                       15   0.00%          0   0.00%
Loans held for sale                                                   2,193   3.88%      1,057   3.42%
Loans receivable:
Taxable                                                             636,278   5.88%    665,936   6.26%
Tax-exempt                                                           38,491   5.81%     36,218   6.36%
Total loans receivable                                              674,769   5.88%    702,154   6.27%
Total Earning Assets                                              1,152,350   4.74%  1,196,281   5.25%
Cash                                                                 16,080             16,891
Unrealized gain/loss on securities                                   16,270             17,923
Allowance for loan losses                                           (7,126)            (7,739)
Bank premises and equipment                                          18,655             18,898
Intangible Asset - Core Deposit Intangible                              132                204
Intangible Asset - Goodwill                                          11,942             11,942
Other assets                                                         43,376             48,282
Total Assets                                                     $1,251,679         $1,302,682

INTEREST-BEARING LIABILITIES
Interest-bearing deposits:
Interest checking                                                  $174,149   0.12%   $161,524   0.13%
Money market                                                        202,129   0.14%    205,866   0.19%
Savings                                                             116,538   0.10%    104,532   0.10%
Certificates of deposit                                             160,011   1.17%    191,924   1.73%
Individual Retirement Accounts                                      134,076   0.50%    146,241   0.96%
Other time deposits                                                     845   0.00%        942   0.00%
Total interest-bearing deposits                                     787,748   0.40%    811,029   0.67%
Borrowed funds:
Short-term                                                            4,220   0.10%      7,422   0.16%
Long-term                                                            83,341   4.00%    115,607   4.00%
Total borrowed funds                                                 87,561   3.81%    123,029   3.77%
Total Interest-bearing Liabilities                                  875,309   0.74%    934,058   1.08%
Demand deposits                                                     184,890            189,275
Other liabilities                                                     8,875              9,452
Total Liabilities                                                 1,069,074          1,132,785
Stockholders' equity, excluding  other comprehensive income/loss    172,578            158,801
Other comprehensive income/loss                                      10,027             11,096
Total Stockholders' Equity                                          182,605            169,897
Total Liabilities and Stockholders' Equity                       $1,251,679         $1,302,682
Interest Rate Spread                                                          4.00%              4.17%
Net Interest Income/Earning Assets                                            4.18%              4.41%

Total Deposits (Interest-bearing and Demand)                       $972,638         $1,000,304

(1) Rates of return on tax-exempt securities and loans are presented on a fully taxable-equivalent basis, using the Corporation's marginal federal income tax rate of 35%.

(2) Nonaccrual loans have been included with loans for the purpose of analyzing net interest earnings.

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

TABLE IV - ANALYSIS OF VOLUME AND RATE CHANGES



(In Thousands)                       3 Months Ended 3/31/13 vs. 3/31/12
                                     Change in    Change in      Total
                                       Volume        Rate       Change
EARNING ASSETS
Available-for-sale securities:
Taxable                                   ($124)       ($810)      ($934)
Tax-exempt                                    31        (101)        (70)
Total available-for-sale securities         (93)        (911)     (1,004)
Interest-bearing due from banks              (4)            4           0
Loans held for sale                           11            1          12
Loans receivable:
Taxable                                    (483)        (658)     (1,141)
Tax-exempt                                    33         (55)        (22)
Total loans receivable                     (450)        (713)     (1,163)
Total Interest Income                      (536)      (1,619)     (2,155)

INTEREST-BEARING LIABILITIES
Interest-bearing deposits:
Interest checking                              3          (2)           1
Money market                                 (2)         (23)        (25)
Savings                                        3            0           3
Certificates of deposit                    (123)        (242)       (365)
Individual Retirement Accounts              (27)        (159)       (186)
Total interest-bearing deposits            (146)        (426)       (572)
Borrowed funds:
Short-term                                   (1)          (1)         (2)
Long-term                                  (327)          (1)       (328)
Total borrowed funds                       (328)          (2)       (330)
Total Interest Expense                     (474)        (428)       (902)

Net Interest Income                        ($62)     ($1,191)    ($1,253)

(1) Changes in income on tax-exempt securities and loans are presented on a fully tax-equivalent basis, using the Corporation's marginal federal income tax rate of 35%.

(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.

CITIZENS & NORTHERN CORPORATION - FORM 10-Q

TABLE V - COMPARISON OF NONINTEREST INCOME

(In Thousands)



                                                     3 Months Ended
                                                       March 31,        $       %
                                                     2013     2012    Change  Change
Service charges on deposit accounts                  $1,159   $1,161    ($2)   (0.2)
Service charges and fees                                201      220    (19)   (8.6)
Trust and financial management revenue                  944      929      15     1.6
Brokerage revenue                                       144      168    (24)  (14.3)
Insurance commissions, fees and premiums                 45       34      11    32.4
Interchange revenue from debit card transactions        464      495    (31)   (6.3)
. . .
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