UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2000

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 0-13222

CITIZENS FINANCIAL SERVICES, INC.

(Exact name of registrant as specified in its charter)

PENNSYLVANIA 23-2265045

(State or other jurisdiction of (I.R.S. Employer

incorporation or organization) Identification No.)

15 South Main Street, Mansfield, Pennsylvania 16933

(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (570) 662-2121

Indicate by checkmark whether the registrant (1) has filed all reports

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_____

The number of shares outstanding of the Registrant's Common Stock, as of

November 1, 2000, 2,772,247 shares of Common Stock, par value $1.00.

Citizens Financial Services, Inc.

Form 10-Q

INDEX

Page

Part I FINANCIAL INFORMATION (UNAUDITED)

Item 1-Financial Statements

Consolidated Balance Sheet as of September 30, 2000, and

December 31, 1999 1

Consolidated Statement of Income for the

Three Months and Nine Months Ended September 30, 2000 and 1999 2

Consolidated Statement of Comprehensive Income for the

Three Months and Nine Months Ended September 30, 2000 and 1999 3

Consolidated Statement of Cash Flows for the Nine Months Ended

September 30, 2000 and 1999 4

Notes to Consolidated Financial Statements 5

Item 2 -Management's Discussion and Analysis of Financial Condition

and Results of Operations 5-21

Item 3-Quantitative and Qualitative Disclosure About Market Risk 21

Part II OTHER INFORMATION

Item 1-Legal Proceedings 22

Item 2-Changes in Securities and use of Proceeds 22

Item 3-Defaults upon Senior Securities 22

Item 4-Submission of Matters to a Vote of Security Holders 22

Item 5-Other Information 22

Item 6-Exhibits and Reports on Form 8-K 23

SIGNATURES 24

The accompanying notes are an integral part of these financial statements

CITIZENS FINANCIAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 - Basis of Presentation

The consolidated financial statements include the accounts of Citizens Financial Services, Inc. and its wholly-owned subsidiary, First Citizens National Bank. All material inter-company balances and transactions have been eliminated in consolidation.

The accompanying interim financial statements have been prepared by the company without audit and, in the opinion of management, reflect all adjustments (which include only normal recurring adjustments) necessary to present fairly the company's financial position as of September 30, 2000, and the results of operations for the interim periods presented. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. For further information refer to the consolidated financial statements and footnotes thereto incorporated by reference in the company's Annual Report on Form 10-K for the year ended December 31, 1999.

Note 2 - Earnings per Share

Earnings per share calculations give retroactive effect to the July 7, 2000 stock dividend declared by the company. The number of shares used in the earnings per share and dividends per share calculation was 2,772,247 for 2000 and 2,826,425 for 1999.

Note 3 - Acquisition

On October 27, we acquired all Bradford County Pennsylvania offices of Sovereign Bank. These six offices located in Sayre, Troy, State Line, Leraysville and Towanda, have total deposits of nearly $80 million. This transaction includes Sovereign's Bradford County loan portfolio of approximately $30 million.

Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

The following is management's discussion and analysis of the significant changes in the results of operations, capital resources and liquidity presented in its accompanying consolidated financial statements for Citizens Financial Service, Inc., a bank holding company and its subsidiary. Our company's consolidated financial condition and results of operations consist almost entirely of our wholly owned subsidiary First Citizens National Bank. Our discussion should be read in conjunction with the preceding September 30, 2000 financial information. The results of operations for the three months and nine months ended September 30, 2000 and 1999 are not necessarily indicative of the results you may expect for the full year.

Forward-looking statements may prove inaccurate. We have made forward-looking statements in this document, and in documents that we incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include the information concerning possible or assumed future results of operations of Citizens Financial Services, Inc., First Citizens National Bank, or the combined company. When we use words like "believes", "expects", "anticipates", or similar expressions, we are making forward-looking statements.

You should note that many factors, some of which are discussed elsewhere in this document and in the documents we incorporate by reference, could affect the future financial results. These factors include, but are not limited to, the following:

• operating, legal and regulatory risks;
• economic, political and competitive forces affecting our banking,

securities, asset management and credit services; and

• the risk that our analysis of these risks and forces could be incorrect

and/or the strategies developed to address them could be unsuccessful.

Readers should carefully review the risk factors described in other documents our company files, from time to time, with the Securities and Exchange Commission, including the Annual Report on Form 10-K for the year ended December 31, 1999, filed by our company and any Current Reports on Form 8-K filed by our company.

We currently engages in the general business of banking throughout our service area of Potter, Tioga and Bradford counties in North Central Pennsylvania and Allegany, Steuben, Chemung and Tioga counties in Southern New York. We maintain our central office in Mansfield, Pennsylvania. Presently, we operate banking facilities in Mansfield, Mansfield Wal-Mart, Blossburg, Ulysses, Genesee, Wellsboro, Wellsboro Weis Market, Troy, Sayre (Lockhart St.), Canton, and Gillett. As of October 27, 2000, we have offices in Millerton, Towanda, Sayre (Keystone Ave.), and Leraysville. (We are considering having the offices located at Desmond St., Sayre and 103 West Main St., Troy for consolidation.) Additionally, we have automatic teller machines (ATMs) located in Soldiers and Sailors Memorial Hospital in Wellsboro, Mansfield Wal-Mart and at Mansfield University. Our company's lending and deposit products and investment services are offered primarily within our service area.

On October 27, we acquired all Bradford County Pennsylvania offices of Sovereign Bank. These six offices located in Sayre, Troy, State Line, Leraysville and Towanda, have total deposits of nearly $80 million. This transaction includes Sovereign's Bradford County loan portfolio of approximately $30 million.

We face strong competition in the communities we serve from other commercial banks, savings banks, and savings and loan associations, some of which are substantially larger institutions than our subsidiary. In addition insurance companies, investment counseling firms, and other business firms and individuals offer personal and corporate trust services.

We also compete with credit unions, issuers of money market funds, securities brokerage firms, consumer finance companies, mortgage brokers and insurance companies. These entities are strong competitors for virtually all types of financial services.

In recent years, the financial services industry has experienced tremendous change to competitive barriers between bank and non-bank institutions. We not only must compete with traditional financial institutions, but also with other business corporations that have begun to deliver competing financial services. Competition for banking services is based on price, nature of product, quality of service, and in the case of certain activities, convenience of location.

Our company offers the following investment and trust services:

• Investment management accounts that assume managerial duties for

investment accounts;

• Custody services for safekeeping and preservation of assets;
• Mutual funds that provide an asset allocation program;
• Personal trust services that include stand-by, living and testamentary

Trusts;

• Estate planning and administration to provide financial planning; and
• Retirement plan services for individuals and businesses.

FINANCIAL CONDITION

INVESTMENTS

The investment portfolio increased by $6.1 million or 6.6% from December 31, 1999 to September 30, 2000. These investments were made in Agency Mortgage-backed securities to supplement the slow loan growth.

LOANS

Historically, we have originated loans to customers in North Central Pennsylvania and the Southern Tier of New York. The loans are primarily direct loans to our existing customer base, with new customers generated by referrals from real estate brokers, building contractors, attorneys, accountants and existing customers. We also do a limited amount of indirect loans through new and used car dealers in our primary lending area.

As shown in the following tables (dollars in thousands), the change in loans grew by $4.5 million or 1.9% for the period compared to the December 31, 1999. Residential mortgage lending is a principal business activity and one our company expects to continue by providing a full complement of competitively priced conforming, nonconforming and home equity mortgages. Loans to individuals decreased because we sold $3.4 million of our student loans in July of this year.

High interest rates have slowed loan growth during 2000. We expect that loan growth will continue to be flat for the rest of the year.

We focus our commercial lending activity primarily on small businesses and our company's commercial lending officers have been successful in attracting new business loans.

We expect that loans to state and political subdivisions will increase for the remainder of 2000 as we continue to focus on this segment of our customers.

DEPOSITS

The following table shows deposit composition by type (dollars in thousands).

Total deposits increased during the September 30, 2000 period by $3.3 million or 1.2%.

NOW accounts increased by $4.4 million. Money market funds decreased, as customers moved funds to certificates of deposit to "lock-in" higher long-term rates.

BORROWED FUNDS

Borrowed funds increased $5.9 million during the first nine months of 2000. The company's daily cash requirements or short-term investments are met by using the financial instruments available through the Federal Home Loan Bank. On October 30, 2000, we paid down all of our borrowings (approximately $30 million) at the Federal Home Loan Bank with the funds obtained from the acquisition of the Sovereign branches discussed previously.

In November, 2000, the holding company will borrow between $2 and $3 million to invest in the bank subsidiary. This will increase the bank's capital and improve the negative impact on the regulatory capital ratios as a result of the branch acquisition (approximately $9.7 million in goodwill).

CAPITAL

The company computed its risk-based capital ratios as follows (dollars in thousands):

September 30, December 31,

2000 1999

Amount Ratio Amount Ratio

Total capital (to risk-weighted assets)

Company $31,941 13.75% $30,610 14.09%

For capital adequacy purposes 18,580 8.00% 17,382 8.00%

To be well capitalized 23,224 10.00% 21,728 10.00%

Tier I capital (to risk-weighted assets)

Company $29,484 12.70% $28,341 13.04%

For capital adequacy purposes 9,290 4.00% 8,691 4.00%

To be well capitalized 13,935 6.00% 13,037 6.00%

Tier I capital (to average assets)

Company $29,484 8.53% $28,341 8.32%

For capital adequacy purposes 13,824 4.00% 13,620 4.00%

To be well capitalized 17,281 5.00% 17,025 5.00%

Based on our fore mentioned acquisition, we anticipate our capital ratios to fall approximately 500 basis points for both Total Capital and Tier I Capital ratios and our Tier I Capital to Average Assets ratio falling approximately 300 basis points. Our Company will be adequately capitalized for regulatory purposes.

See the discussion of liquidity below for details regarding future expansion

plans and the impact on capital.

Due to the significant rise in market interest rate levels during 1999 and 2000 the market value of our investment portfolio declined. During the third quarter of 2000 interest rates beyond 2 years fell and the market value of our portfolio recovered by $963,000, net of federal taxes, compared to December 31, 1999.

Net income and the rise in market rates resulted in an increase in total shareholders' equity of $1,988,000 from December 31, 1999.

July 30, 1999, our company began a plan to purchase, in open market or privately negotiated transactions, up to 135,000 shares of its outstanding common stock. This stock repurchase program was suspended in April 2000 because of the branch acquisition. However, a total of 55,162 shares were repurchased at a cost of approximately $1 million as of September 30, 2000.

RESULTS OF OPERATIONS

General

Net income for the three-month period ending September 30, 2000 was $911,000, an increase of $106,000 or 13.2% from the $805 for the 1999 related period. Earnings per share was $0.33 during the three month period ending September 30, 2000 compared with $0.28 during the comparable 1999 period.

Net income for the nine-month period ending September 30, 2000 was $2,746,000, an increase of $100,000, or 3.8%, compared to the 1999 related period. Earnings per share was $0.99 during the first nine months of 2000 compared with $0.94 during the comparable 1999 period. Details of the reasons for this change are discussed on the following pages.

Operating cash earnings (net income before amortization of intangible assets and merger and acquisition costs, net of tax) for the three-month period ending September 30, 2000 was $937,000, an increase of $114,000 or 13.9% from the $823 for the 1999 related period. Operating cash earnings per share was $0.34 during the first three months of 2000 compared with $0.29 during the comparable 1999 period.

Operating cash earnings for the nine-month period ending September 30, 2000 was $2,813, an increase of $113 or 4.2% from the $2,700 for the 1999 related period. Operating cash earnings per share was $0.99 during the first nine months of 2000 compared with $0.94 during the comparable 1999 period.

Net interest income, the most significant component of earnings, is the amount by which interest generated from earning assets exceeds interest expense on interest-bearing liabilities.

Net interest income for the nine month period ending September 30, 2000, after provision for loan losses, was $8,480,000 an increase of $195,000 compared to an increase of $134,000 at September 30, 1999.

We have experienced a narrowing interest margin percentage during 1999 and the nine months of 2000, continuing the trend in recent years. The 1998 flat yield curve limited our opportunity to increase margin with new business as the existing investments and loans mature or repay. When the yield curve became steeper in 1999, interest rates began to rise resulting in our short-term liabilities repricing faster than our short-term assets. Currently the yield curve is inverted (not a normal up slope) beyond 6 months. Most of the company's investments, loans, deposits and borrowings are priced or repriced along the three month to five year portion of the yield curve and an inverted yield curve will continue to reduce our net interest margin.

We continue to review various pricing and investment strategies to enhance deposit growth while maintaining or expanding the current interest margin.

As can be seen from the preceding tables, tax equivalent net interest income rose from $8,699,000 in 1998 to $9,138,000 in 1999 and increased to $9,550,000 in 2000. In the period ending September 30, 2000, net interest income increased $412,000 while overall spread decreased from 3.45% to 3.30%. The increased volume of interest-earning assets generated an increase in interest income of $1,621,000 while increased volume of interest-bearing liabilities produced $1,108,000 of interest expense. The change in volume resulted in an increase of $513,000 in net interest income. The net change in rate was a negative $101,000 resulting in a total positive net change of $412,000 when combined with change in volume. The yield on interest-earning assets increased 15 basis points from 7.90% to 8.05% and the average interest rate on interest-bearing liabilities increased 31 basis points from 4.45% to 4.76% because of the previously describe changes to the yield curve.

The provision for loan losses was $100,000 for the three-month period ended September 30, 2000 compared to $90,000 for the same period in 1999.

For the nine-month period ended September 30, 2000 the provision for loan losses was $300,000 compared to $210,000 for the same period in 1999.

This provision was appropriate given management's quarterly review of the allowance for loan losses that is based on the following information: migration analysis of delinquent and non accrual loans, estimated future losses on loans, recent review of large problem credits, local and national economic conditions, historical loss experience, OCC qualitative adjustments and peer comparisons.

OTHER OPERATING INCOME (dollars in thousands)

As indicated in the above table, other income was $652,000 and $1,905,000 for the three-month and nine-month periods ended September 30, 2000 compared to $489,000 and $1,870,000 for the same periods in 1999.

The increase in service charges is directly attributable to increased checking account, ATM and MasterMoney Card charges.

The trust income increase for the nine-month period is the result of a change in our fee structure and additional business.

The decrease in other income was primarily a result of an adjustment to insurance income.

Realized securities gains are significantly less as we have finished restructuring our investment portfolio. During 1997, 1998 and 1999, sold U.S. Treasury notes to restructure the investment portfolio. We reinvested the proceeds by purchasing AAA municipal bonds, investment grade corporate bonds and U S agency mortgage backed securities.

We continue to evaluate means of increasing other operating income to off-set the loss of net interest margin described above. Our approach is to apply service charges on business transaction accounts by charging fees on transaction activity (reduced by earnings credit based on customers' balances) to more equitably recover costs. We expect to continue this analysis for our other products.

OTHER OPERATING EXPENSES (dollars in thousands)

Other operating expenses detailed above were $2.4 million and $7.0 million for the three-month and nine-month periods ended September 30, 2000 compared to $2.2 million and $6.7 million for the same periods in 1999.

The increase in salaries and employee benefits was a result of normal merit increases and increased staff for our new branch in Wal-Mart.

Occupancy and furniture and equipment expense increased because of the new operations center in 1999 and normal increases.

The other operating expense increase reflects the cost of normal operating expenses.

PROFESSIONAL FEES (dollars in thousands)