<PAGE>
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 Nine month period ended September 30, 1998
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)
717-724-3411
(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.
<TABLE>
<CAPTION>
Title Outstanding
<S> <C>
Common Stock ($1.00 par value) 5,220,038 Shares Issued and
Outstanding October 1, 1998
1
</TABLE>
<PAGE>
CITIZENS & NORTHERN CORPORATION
Index
<TABLE>
<S> <C>
Part I. Financial Information
Item 1. Financial Statements
Consolidated Statement of Condition - September 30, 1998 and
December 31, 1997 Page 3
Consolidated Statement of Income - Nine Months Ended
September 30, 1998 and September 30, 1997 Page 4
Consolidated Statement of Cash Flows - Nine Months Ended
September 30, 1998 and September 30, 1997 Page 5
Notes to Consolidated Financial Statements Page 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operation Pages 7 through 18
Item 3. Information About Market Risk Pages 19 And 20
Item 4. Year 2000 Compliance Pages 21 through 23
Part II. Other Information Page 24
Item 1. Legal Proceedings
Items 2 and 3 have been omitted as they are not applicable to registrant.
Item 6. Exhibits and Reports on Form 8-K
Signatures Page 25
</TABLE>
2
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEET
(In Thousands Except Per Share Data)
<TABLE>
<CAPTION>
Unaudited Audited
(In Thousands) September 30, December 31,
1998 1997
----------------------------------------
<S> <C> <C>
ASSETS
Cash & Due From Banks 11,667 13,449
Interest Bearing Deposits 676 804
Available-for-Sale Securities:
U.S. Treasury Securities 2,573 2,538
Securities of Other U.S. Government Agencies 54,469 74,449
Mortgage Backed Securities 139,876 129,190
Obligations of States and Municipal Subdivisions 76,968 64,614
Other Securities 49,658 35,796
---------------------------------------
Total Available-for-Sale Securities 323,544 306,587
Held-to-Maturity Securities:
U.S. Treasury Securities 624 632
Securities of Other U.S. Government Agencies 699 350
Mortgage Backed Securities 476 615
---------------------------------------
Total Held-to-Maturity Securities 1,799 1,597
Loans:
Loans to Political Subdivisions 6,006 5,975
Other Loans 281,184 279,488
---------------------------------------
Total Loans 287,190 285,463
Less - Allowance for Possible Loan Losses (4,748) (4,913)
Unearned Income (34) (37)
---------------------------------------
Loans, Net 282,408 280,513
Bank Premises and Equipment 7,163 6,720
Other Real Estate 606 230
Accrued Interest on Bonds and Loans 4,263 4,808
Other Assets 717 645
---------------------------------------
TOTAL ASSETS 632,843 615,353
---------------------------------------
---------------------------------------
LIABILITIES
Deposits:
Demand 46,173 46,916
Interest Checking 35,751 40,880
Money Market 118,341 104,894
Savings 44,313 45,332
Other Time 210,780 204,234
---------------------------------------
Total Deposits 455,358 442,256
Dividends Payable 1,020 1,013
Borrowed Funds 50,651 40,661
Securities Sold Under Agreement to Repurchase 24,400 29,800
Federal Funds Purchased 2,000 10,000
Other Liabilities 9,793 6,088
---------------------------------------
TOTAL LIABILITIES 543,222 529,818
SHAREHOLDERS' EQUITY
Common Stock, Par Value $ 1.00 per Share 5,220 5,168
Authorized 10,000,000; Issued 5,220,038
and 5,168,354 in 1998 and 1997, respectively
Stock Dividend Distributable 1,706
Paid in Capital 15,468 13,799
Retained Earnings 58,111 52,519
---------------------------------------
Total 78,799 73,192
Unrealized Gains (Losses) on 12,272 13,335
Available-for-Sale Securities
Less: Treasury Stock at Cost
118,010 shares at September 30, 1998 (1,450)
104,311 Shares at December 31, 1997 (992)
---------------------------------------
TOTAL SHAREHOLDERS' EQUITY 89,621 85,535
---------------------------------------
TOTAL LIABILITIES &
SHAREHOLDERS' EQUITY 632,843 615,353
---------------------------------------
---------------------------------------
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
3
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 1. Financial Statements (Continued)
CONSOLIDATED STATEMENT OF INCOME
(In Thousands, Except Per Share Data) (Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
INTEREST INCOME (Current) (Prior Year) (Current) (Prior Year)
<S> <C> <C> <C> <C>
Interest and Fees on Loans $7,395 $7,254 $21,585 $21,382
Interest on Balances with 9 16 29 35
Depository Institutions
Interest on Loans to Political 93 100 278 295
Subdivisions
Interest on Federal Funds Sold 51 118 215 242
Income from Available-for-Sale
and Held-to-Maturity Securities:
Taxable 3,612 3,525 10,584 10,699
Tax Exempt 1,005 916 2,918 2,668
Dividends 230 217 681 629
----------------------------------------------------------
Total Interest and Dividend Income 12,395 12,146 36,290 35,950
INTEREST EXPENSE
Interest on Deposits 4,691 4,697 13,697 13,670
Interest on Other Borrowings 1,078 1,189 3,497 3,799
----------------------------------------------------------
Total Interest Expense 5,769 5,886 17,194 17,469
----------------------------------------------------------
Interest Margin 6,626 6,260 19,096 18,481
Provision for Possible Loan Losses 191 181 573 543
----------------------------------------------------------
Interest Margin After Provision 6,435 6,079 18,523 17,938
for Possible Loan Losses
OTHER INCOME
Service Charges on Deposit Accounts 261 272 775 812
Service Charges and Fees 73 79 212 210
Trust Department Income 307 264 952 774
Insurance Commissions, Fees 126 110 323 343
and Premiums
Other Operating Income 16 19 75 382
----------------------------------------------------------
Total Other Income Before Realized 783 744 2,337 2,521
Gains on Securities, Net
Realized Gains on Securities, (Net) 235 62 2,849 869
----------------------------------------------------------
Total Other Income 1,018 806 5,186 3,390
OTHER EXPENSES
Salaries and Wages 1,618 1,493 4,813 4,459
Pensions and Other Employee 424 396 1,295 1,266
Benefits
Occupancy Expense, Net 203 180 617 535
Furniture and Equipment 207 178 599 513
Expense
Other Operating Expense 1,702 1,475 4,856 4,501
----------------------------------------------------------
Total Other Expenses 4,154 3,722 12,180 11,274
----------------------------------------------------------
Income Before Income Tax 3,299 3,163 11,529 10,054
Provision
Income Tax Provision 785 724 2,872 2,368
----------------------------------------------------------
NET INCOME $2,514 $2,439 $8,657 $7,686
----------------------------------------------------------
----------------------------------------------------------
PER SHARE DATA:
Net Income - Basic $0.49 $0.48 $1.69 $1.50
Net Income - Diluted $0.49 $0.48 $1.69 $1.50
----------------------------------------------------------
Dividend Per Share $0.20 $0.18 $0.60 $0.53
----------------------------------------------------------
Number Shares Used in Computation 5,102,028 5,113,224 5,108,784 5,113,138
- Basic
Number Shares Used in Computation 5,120,085 5,123,052 5,122,426 5,117,740
- Diluted
Number Shares Issued 5,220,038 5,168,354 5,220,038 5,168,354
Number Shares Authorized 10,000,000 10,000,000 10,000,000 10,000,000
---------- ---------- ---------- ----------
Dividends Actually Paid $0.20 $0.18 $0.60 $0.54
---------- ---------- ---------- ----------
CONSOLIDATED STATEMENT OF
COMPREHENSIVE INCOME
Net Income $2,514 $2,439 $8,657 $7,686
Other Comprehensive Income:
Unrealized holding gains
(losses) on available-for-sale
securities
Gains (Losses) arising during (2,567) 5,070 1,238 8,091
the period
Reclassification adjustment (235) (62) (2,849) (869)
-----------------------------------------------------------
Other comprehensive income (loss) (2,802) 5,008 (1,611) 7,222
before income tax
Income tax related to other 953 (1,703) 548 (2,455)
comprehensive income
-----------------------------------------------------------
Other comprehensive income (loss) (1,849) 3,305 (1,063) 4,767
------------------------------------------------------------
Comprehensive Income $665 $5,744 $7,594 $12,453
------------------------------------------------------------
------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
4
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 1. Financial Statements (Continued)
CONSOLIDATED STATEMENT OF CASH FLOWS
(In Thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------
1998 1997
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income 8,657 7,686
Adjustments to Reconcile Net Income to
Net Cash Provided by Operating Activities
Provision for Possible Loan Losses 573 543
Realized Gain on Available-for-Sale and
Held-to-Maturity Securities, Net (2,849) (869)
Provision for Depreciation 592 530
Accretion and Amortization (164) 507
Deferred Income Tax 110 (118)
Decrease in Accrued Interest Receivable and Other 473 759
Liabilities
Increase in Accrued Interest Payable and Other 4,150 3,246
Liabilities
Net Cash Provided by Operating Activities 11,542 12,284
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the Maturity of Held-to-Maturity Securities 140 206
Purchase of Held-to-Maturity Securities (348) (250)
Proceeds from Sales of Available-for-Sale Securities 73,411 131,333
Proceeds from Maturities of Available-for-Sale 107,404 36,371
Securities
Purchase of Available-for-Sale Securities (196,363) (160,547)
Net Increase in Loans (2,468) (7,110)
Purchase of Premises and Equipment (1,035) (549)
Sale of Foreclosed Assets 224 487
Purchase of Other Real Estate (600) (93)
Net Cash Used in Investing Activities (19,635) (152)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net Increase in Deposits 13,102 7,575
Increase (Decrease) in Short Term Borrowings (13,400) (7,850)
Proceeds from (Repayment of) Long Term Borrowings 9,990 (8,935)
Sale of Treasury Stock 24 3
Purchase of Treasury Stock (468)
Dividends Declared (3,064) (2,734)
Net Cash Provided by Financing Activities 6,184 (11,941)
INCREASE IN CASH AND CASH EQUIVALENTS (1,909) 191
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 14,253 14,975
CASH AND CASH EQUIVALENTS, END OF YEAR 12,344 15,166
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest Paid 13,942 14,048
Income Taxes Paid 2,678 2,466
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
5
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 1. Financial Statements (Continued)
Notes to Consolidated Financial Statements
1. The financial information included herein, with the exception of the
Consolidated Balance Sheet dated December 31, 1997, is unaudited; however, such
information reflects all adjustments (consisting solely of normal recurring
adjustments) that are, in the opinion of management, necessary to a fair
presentation of the financial position, results of operations and changes in
financial position for the interim periods.
Results reported for the nine-month period ended September 30, 1998 might not be
indicative of the results for the year ended December 31, 1998.
This document has not been reviewed or confirmed for accuracy or relevance by
the Federal Deposit Insurance Corporation or any other regulatory agency.
2. New Statement of Financial Accounting Standards
SFAS No. 130 "Reporting Comprehensive Income", adopted in 1997, is effective for
all fiscal years beginning after December 15, 1997, and as such, it will be
effective for reporting periods in 1998. Comprehensive income includes all
changes in equity during a period from transactions and events from nonowner
sources. Before SFAS No. 130, some elements of comprehensive income were
presented in the income statement and others were reported in the equity section
of the statement of financial position. All elements now are required to be
brought together in a single amount of comprehensive income.
SFAS No. 131 "Disclosures About Segments of an Enterprise and Related
Information" was also adopted in 1997. SFAS No. 131 establishes standards for
disclosures about products, services, geographic areas and major customers. The
standard is effective for fiscal years beginning after December 15, 1997. The
adoption of SFAS No. 131 will not have a material effect on Citizens and
Northern's financial condition or results of operations.
SFAS No. 132 "Employers' Disclosure About Pensions and Other Post Retirement
Benefits" was adopted in January 1998. SFAS No. 132 revises current note
disclosure requirements for employers' pensions and other retiree benefits. It
does not address recognition or measurement issues. SFAS No. 132 is effective
for fiscal years beginning after December 15, 1997. The adoption of SFAS No. 132
will not have a material effect on Citizens and Northern's financial condition
or results of operations.
6
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Within this report and included in past reports are "forward-looking"
statements. The statements may concern plans, objectives, future events (Year
2000 issues) or performance and assumptions and other statements that are
other than statements of historical fact. Citizens and Northern Corporation
and its subsidiaries wish to caution readers that the following important
factors, among others, may have affected and could in the future affect the
Corporation's actual results and cause the Corporation's actual results for
subsequent periods to differ materially from those expressed in any
forward-looking statement made by or on behalf of the Corporation herein: the
effect of changes in laws and regulations, including federal and state
banking laws and regulations, with which the Corporation must comply, and the
associated cost of compliance with such laws and regulations either currently
or in the future as applicable; the effect of changes in accounting policies
and practices, as may be adopted by the regulatory agencies as well as the
Financial Accounting Standards Board, or of changes in the Corporation's
organization, compensation and benefit plans; the effect on the Corporation's
competitive position within its market area of the increasing consolidation
within the banking and financial services industries, including the increased
competition from the larger regional banking organizations as well as nonbank
providers of various financial services; the effect of changes in interest
rates; and the effect of changes in the business cycle and downturns in the
local, regional and national economies.
EARNINGS OVERVIEW
Net after-tax income for the nine-month period ended September 30, 1998 amounted
to $8,657 million or $1.69 per share (on a basic and diluted basis). This
compares to $7,686 million or $1.50 per share (on a basic and diluted basis) for
the same period in 1997. Total assets at September 30, 1998 were $632,843
million compared to total assets at September 30,1997 of $616,406 million.
Net income for the period includes the after-tax gain on the sale of stock of a
closely held company that had been carried on the books of the Corporation for
$1.00. The stock was obtained in 1919 as collateral for a loan that later became
a loss. The company represented by the stock was sold in June 1998 and the stock
was purchased for cash. The realized gain, after tax, amounted to approximately
$1,132 million or $.22 per basic share. The same period in 1997 also benefited
from the sale of a registered trademark amounting to $199,000 after tax or $.04
per basic share.
Excluding investment security gains and other extraordinary income for the
nine-month periods ended September 30, 1998 and September 30, 1997, earnings per
common share would have amounted to $1.47 and $1.46, respectively.
Results for the first nine months of 1998, although slightly under budget, were
in-line with management's expectations that net income for the nine-month period
ended September 30, 1998 would be about the same as that of the same period in
1997. These expectations are contingent upon the current interest rate
environment and could change if interest rates increase or decrease abnormally.
NET INTEREST MARGIN
Net interest margin or net interest income is the dollar amount of difference
between all interest income received and interest expense paid. The net interest
spread or interest margin is the difference, stated as a percentage, between the
average rate received on all interest-earning assets and the average rate paid
on all interest-bearing liabilities. The net interest margin as reflected in the
income statement has not been adjusted for federal income taxes.
Nine Months Period Ended September 30, 1998/1997
Net interest income for the nine-months ended September 30, 1998 increased
$615,000 or 3 percent when compared to the same period in 1997. Respectively,
gross interest income for the periods ended September 30, 1998 and September 30,
1997 amounted to $36,290,000 and $35,950,000, an increase of 1 percent. Gross
interest expense for the same periods amounted to $17,194,000 and $17,469,000, a
decrease of 1.5 percent. The net interest margin as a percentage for the current
nine month-period was 3.58 percent ; the interest margin for the same period
last year was 3.47 percent.
7
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Average earning assets did not change appreciably between the comparable
periods. Average earning assets for the current nine-month period were
$579,822,000 and $578,014,000 for the nine-month period ended September 30,
1997. The meager growth between the periods was due to a lack of deposit
growth and the repayment of borrowings with the growth that was available.
Money Market accounts and Certificates of Deposit did post some growth while
other deposit categories remained unchanged or declined slightly. Average
borrowed funds during the period were reduced by $3,693,000.
The overall rate of return on earning assets for the nine months ended September
30, 1998 was 8.37 percent; the return for last year's comparable period was 8.32
percent. The cost of interest-bearing liabilities for the current nine-month
period was 4.79 percent and 4.84 percent for the same period last year.
The increase in net interest income between the comparable periods is
attributable primarily to changes in interest rates as changes in the volume of
interest-bearing assets and interest-bearing liabilities posted were minimal.
Three Months Ended September 30, 1998/1997
When comparing the respective quarters ended September 30, the net interest
margins are $6,626,000 and $6,260,000. Gross interest income for the current
three-month period amounted to $12,395,000 and $12,146,000 for the prior year's
same three-month period. Gross interest expense for the same periods was
$5,769,000 and $5,886,000, respectively. The net interest margins for the
three-month periods was approximately 3.55 percent and 3.48 percent,
respectively. Again the increase in net interest income and net interest margin
for the quarterly periods can be attributed to changes in interest rates.
Average interest-bearing assets for the three-month periods ended September 30,
1998 and September 30, 1997 were, respectively, $588,382,000 and $577,885,000.
Average interest-bearing liabilities for the three-month periods ended September
30, 1998, and September 30, 1997 amounted to $481,125,000 and $477,406,000,
respectively.
The composition of average earning assets did not change significantly when
comparing the quarters ended September 30, 1998 and September 30, 1997. Gross
loans account for 46 percent of the asset base and the investment portfolio
accounts for 47 percent. The make up of the available-for-sale investment
portfolio did change however, as a portion of the holdings of mortgage-backed
securities was sold and reinvested in U.S. Agency investments. The restructuring
was necessary to maintain the yield on the portfolio. Neither the composition
nor the average balance of the loan portfolio changed significantly during the
comparable periods.
Average interest-bearing deposit liabilities for the three-months ended
September 30, 1998 totaled $481,125,000; this compares to average
interest-bearing liabilities for the quarter ended September 30, 1997 of
$477,406,000, an increase of $3,719,000. The change consists of an increase in
average deposits of $10,799,000 and a decrease in average borrowings of
$7,080,000.
The increase in deposits for the quarter was one of the largest in recent
memory. A large portion of the increase was the result of a Certificate of
Deposit marketing campaign and a new Municipal Money Market account that paid
rates competitive to nonbank purchasers of municipal accounts. It is also highly
likely that a portion of the funds came from customers who had pulled money from
the stock market or mutual funds as the markets were in turmoil. Other deposit
categories, Interest Checking accounts and Regular Savings accounts posted
slight declines.
The net interest spread, the difference between total interest earned on all
earning assets and the interest paid on all interest-bearing liabilities, was
3.58 percent, 3.48 percent and 3.50 percent for the nine-months ended September
30, 1998, September 30, 1997 and the year ended December 31, 1997, respectively.
On March 2, 1998 management lowered its prime lending rate from 8.50 percent to
8.25 percent, offsetting the decrease with a reduction in rates paid on
long-term certificates of deposit. Management expects that the net interest
spread for the balance of 1998 will remain in the 3.50 percent to 3.60 percent
range and that net interest income will approximate that of 1997.
8
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Table I - Analysis of Average
Daily Balances and Rates
<TABLE>
<CAPTION>
Rate of Rate of Rate of
(In Thousands) Return/ Return/ Return/
Cost of Cost of Cost of
funds Funds funds
09/30/98 % 12/31/97 % 09/30/97 %
<S> <C> <C> <C> <C> <C> <C>
EARNING ASSETS
Available-for-Sale Securities:
U. S. Treasury Securities 2,518 6.00 2,514 5.53 2,511 5.38
Securities of Other U.S. 74,654 7.00 41,968 7.15 32,502 7.03
Government Agencies and
Corporations
Mortgage Backed Securities 116,262 6.67 163,942 6.75 174,409 6.71
Obligations of States and 65,671 5.94 59,554 6.04 58,840 6.06
Political Subdivisions
Stock 17,250 5.28 15,039 5.81 14,941 5.64
Other Securities 11,771 7.64 4,536 1.15 4,756 1.38
Total Available-for-Sale 288,126 6.54 287,553 6.51 287,959 6.46
Securities
Held-to-Maturity Securities:
U. S. Treasury Securities 628 5.96 601 5.66 598 6.26
Securities of Other U. S. 508 7.63 297 7.41 279 7.19
Government Agencies and
Corporations
Mortgage Backed Securities 548 7.32 689 7.55 707 7.56
Total Held-to-Maturity 1,684 6.91 1,587 6.81 1,584 7.01
Securities
Interest -bearing Due from Banks 796 4.87 795 6.79 698 6.70
Federal Funds Sold 5,913 4.86 6,132 5.45 5,999 5.39
Loans:
Real Estate Loans 225,221 9.05 223,510 9.05 222,935 9.03
Consumer 30,962 21.12 32,293 20.08 32,122 20.24
Agricultural 2,425 9.59 2,689 10.12 2,720 10.08
Commercial/Industrial 17,623 9.26 16,743 9.59 16,682 9.65
Other 708 7.74 754 8.22 679 8.27
Political Subdivisions 6,147 6.05 6,355 6.15 6,397 6.17
Leases 217 9.24 236 7.63 239 7.83
Total Loans 283,303 10.32 282,580 10.28 281,774 10.29
Total Earning Assets 579,822 8.37 578,647 8.34 578,014 8.32
Cash 12,352 12,228 12,252
Securities Valuation Reserve 20,040 9,907 7,968
Allowance for Possible Loan Losses (4,868) (4,844) (4,814)
Other Assets 5,317 5,745 5,858
Bank Premises & Equipment 6,764 6,594 6,549
Total Assets 619,427 608,277 605,827
INTEREST-BEARING LIABILITIES
Interest Checking 36,773 2.40 38,334 2.47 38,614 2.47
Money Market 110,183 4.67 107,287 4.55 106,712 4.54
Savings 45,380 2.48 46,338 2.48 46,629 2.48
Certificates of Deposit 121,380 5.62 119,226 5.49 118,599 5.48
Individual Retirement Accounts 78,313 5.48 78,662 5.99 78,999 6.03
Other Time Deposits 2,076 2.45 2,223 2.52 2,417 2.43
Federal Funds Purchased 2,036 5.65 663 4.98 498 6.17
Other Borrowed Funds 83,482 5.46 88,548 5.63 89,793 5.62
Total Interest-bearing 479,623 4.79 481,281 4.84 482,261 4.84
Liabilities
Demand Deposits 44,381 42,780 42,296
Other Liabilities 9,040 8,211 7,121
TOTAL LIABILITIES 533,044 532,272 531,678
Stockholders' Equity 73,101 69,440 68,855
Securities Valuation Reserve 13,282 6,565 5,294
Total Liabilities and Stockholders' Equity 619,427 608,277 605,827
Interest Rate Spread 3.58 3.50 3.48
</TABLE>
9
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Table II - Effect of Volume and Rate Changes in Interest
Income and Interest Expense
<TABLE>
<CAPTION>
Nine-month Periods Ended September 30, 1998/1997
(In Thousands) Change in Change in Total
Volume Rate Change
<S> <C> <C> <C>
EARNING ASSETS
Available-for-Sale Securities:
U. S. Treasury Securities 12 12
Securities of Other U.S. Government Agencies and 2,207 (9) 2,198
Corporations
Mortgage Backed Securities (2,903) (48) (2,951)
Obligations of States and Political Subdivisions 302 (52) 250
Stock 87 (36) 51
Other Securities 153 471 624
Total Available-for-Sale Securities (154) 338 184
Held-to-Maturity Securities:
U. S. Treasury Securities
Securities of Other U.S. Government Agencies and 13 13
Corporations
Mortgage Backed Securities (9) (1) (10)
Total Held-to-Maturity Securities 4 (1) 3
Interest-bearing Due from Banks 6 (12) (6)
Federal Funds Sold (3) (24) (27)
Loans:
Real Estate Loans 155 34 189
Consumer (138) 166 28
Agricultural (21) (10) (31)
Commercial/Industrial 59 (42) 17
Other 2 (3) (1)
Political Subdivisions (11) (6) (17)
Leases (1) 2 1
Total Loans 43 143 186
Total Interest Income (104) 444 340
INTEREST BEARING LIABILITIES
Interest Checking (33) (18) (51)
Money Market 120 102 222
Savings (23) (2) (25)
Certificates of Deposit 115 127 242
Individual Retirement Accounts (31) (326) (357)
Other Time Deposits (6) (6)
Federal Funds Purchased 65 (2) 63
Other Borrowed Funds (260) (103) (363)
Total Interest Expense (53) (222) (275)
NET INTEREST INCOME (51) 666 615
</TABLE>
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.
10
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
ALLOWANCE FOR POSSIBLE LOAN LOSSES
The Allowance for Possible Loan Losses is a reserve established by management
and the Board of Directors, which they believe will absorb future loan losses,
based on management's assessment of the quality and volume of the loan
portfolio. The assessment is performed on an ongoing basis and reviewed by the
Board of Directors quarterly.
The quarterly review process is performed by a loan quality committee consisting
of the President, Chief Financial Officer, Executive Vice-Presidents in charge
of loans and branch administration and monitored by the Corporation's Auditor.
The committee reviews the "Watch List" (a collection of loans that have had a
history of delinquency), past due reports, non-performing loans and historical
information related to charge-offs and recoveries by loan category.
The reserve balance is then allocated across the various loan categories to
determine the unallocated or excess reserve balance. The allocation is performed
using two different methods. The first method, a historical method based on five
years of information, calculates the ratio of average losses by type to the
average outstanding balance by type. The ratio is then applied to the current
outstanding balance of the various loan categories to determine the amount of
reserve to be allocated to the loan category. In addition to the historical
calculated amount, at times the committee will add additional amounts to the
calculated total if it is aware of a particular problem or the five-year average
is not representative of current conditions. The second allocation method
extracts loans by a quality rating system. The ratings are substandard, doubtful
and loss. Regulatory guidelines are then applied: 15 percent of the substandard
category, 50 percent of the doubtful category and 100 percent of the loss
category loans.
Other factors used to measure the level of the reserve are loan growth, economic
conditions of the market area and peer group comparisons.
The Corporation also retains the services of an independent loan appraiser who
reviews all credit relationships in excess of $175,000 and loans of $100,000 or
more in offices where there is perceived to be excess delinquency. The latest
review was started on May 15, 1998 and concluded June 15, 1998. The results of
the latest review are disclosed in Table VI
The following tables present current and historical information on the loan
portfolio and the Reserve for Possible Loan Losses.
TABLE III
Reserve for Possible Loan Losses Reconciliation
<TABLE>
<CAPTION>
Estimated Actual Actual Actual Actual Actual
Dec. 31, 1998 Sept. 30, 1998 Dec. 31, 1997 Dec. 31, 1996 Dec. 31, 1995 Dec 31, 1994
<S> <C> <C> <C> <C> <C> <C>
Beginning Balance January 1, $ 4,913,334 $ 4,913,334 $ 4,775,960 $ 4,579,210 $ 4,228,741 $ 3,816,982
Provision Charged to Earnings 763,416 572,562 797,032 700,500 736,500 737,496
Year-to-Date Recoveries 140,000 86,713 124,407 167,926 187,473 194,312
Year-to-Date Charge-Offs (1,225,000) (823,861) (784,065) (671,676) (573,504) (520,049)
Ending Balance $ 4,591,750 $ 4,748,748 $ 4,913,334 $ 4,775,960 $ 4,579,210 $ 4,228,741
</TABLE>
11
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
<TABLE>
<CAPTION>
TABLE IV - FIVE YEAR HISTORY OF LOAN LOSSES Projected
(In Thousands) 1998 1997 1996 1995 1994 1993 AVERAGE
<S> <C> <C> <C> <C> <C> <C> <C>
Net Loans * 292,000 285,426 278,597 264,182 258,472 238,755 265,086
Net Charge-Offs 1,085 660 504 387 326 247 425
Allowance for Possible Loan Losses Balance 4,592 4,913 4,776 4,579 4,229 3,817 4,463
Provision for Loan Losses Charged to Earnings 763 797 701 737 737 708 736
Earnings 10,893 10,107 9,255 7,866 7,494 8,127 8,570
Earnings Coverage of Net Charge-Offs 10.0 x 15.3 x 18.4 x 20.3 x 23.0 x 32.9 x 22 x
Allowance Coverage of Net Charge-Offs 4.5 x 7.4 x 9.5 x 11.8 x 13.0 x 15.5 x 11 x
Loans Ninety Days or More Past Due and
Still Accruing 2,925 2,900 2,994 2,915 2,743 2,899 2,890
Net Charge-Offs as a Percent of the Provision 142.2% 82.8% 71.9% 52.5% 44.2% 34.9% 57%
Year-End Nonperforming Loans** 1,130 1,412 864 279 624 843 804
Allowance as a Percentage of Gross Loans: *
Bank (1) 1.64% 1.72% 1.71% 1.73% 1.64% 1.60% 2%
Peer Group (2) 1.53% 1.43% 1.50% 1.61% 1.65% 1.82% 2%
</TABLE>
* Gross Loans less Unearned Discount
(1) At September 30, 1998
(2) At June 30, 1998
** At September 30, 1998
12
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
TABLE V - Reserve Allocation - Historical
Reserve
Allocation-Historical
<TABLE>
<CAPTION>
Est.
LOAN CLASSIFICATION 1998 1997 1996 1995 1994 1993 Average
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial, Agricultural, 30,338 25,751 30,054 26,481 22,794 26,530 26,322 0.00115X 30,338= 35
Municipal & Other
Real Estate - Mortgage 225,000 220,358 215,123 201,350 195,688 172,756 201,055 0.00043X 225,000= 97
Credit Card & Related Plan 10,000 9,084 8,902 9,934 9,896 9,212 9,406 0.01667X 10,000= 440
All Other Loans to Individuals 33,500 30,270 24,518 26,417 30,094 30,282 28,316 0.00587X 33,500= 262
Total Loans 298,838 285,463 278,597 264,182 258,472 238,780 265,099 0.00166 298,838
Letter of Credit Commitments 5,500 5,012 5,106 2,633 4,415 5,046 4,442 0.00115X 5,500= 6
All Other Commitments
Consumer 30,000 27,728 28,049 24,811 24,202 23,323 25,623 0.00587X 30,000= 176
Mortgage 11,000 10,497 5,802 7,276 9,566 9,466 8,521 0.00043X 11,000= 5
Commercial 13,000 13,045 10,825 10,201 9,901 9,790 10,752 0.00115X 13,000= 15
Impaired Loans 742 274 113 228 742
Total allocated 1,77
8
Unallocated 2,971
Reserve Balance 4,749
</TABLE>
The reserve balance allocation ratio is determined using the six-year average
net charge-offs divided by the six-year average loan balance by type.
TABLE VI -Reserve Allocation Based on Regulatory Standards September 30,1998
Regulatory Reserve Allocation
<TABLE>
<CAPTION>
September 30,
1998
Loan Classifications
- --------------------
<S> <C>
Substandard 15% 1,234,129
Doubtful 50% 727,873
Loss 100% 50,605
FASB 114 Allocation 742,430
- -------------------------------------------------------------
Required Reserve 2,755,037
Unallocated 1,993,707
- -------------------------------------------------------------
Total Reserve 4,748,744
</TABLE>
13
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
TABLE VII - COMPARISON OF NONINTEREST INCOME
<TABLE>
<CAPTION>
Nine-Month Periods Ended
September 30 September 30 % $
1998 1997 Change Change
<S> <C> <C> <C> <C>
Service Charges on Deposit Accounts $775 $812 (4.6%) ($37)
Service Charges and Fees 212 210 1.0% 2
Trust Department Income 952 774 23.0% 178
Insurance Commissions, Fees and Premiums 323 343 (5.8%) (20)
Other Operating Income 75 382 (80.4%) (307)
Total Other Operating Income before Realized
Securities Gains (Losses) on Securities, Net 2,337 2,521 (7.3%) (184)
Gains (Losses) on Securities, Net 2,849 869 227.8% 1,980
Total Other Income $5,186 $3,390 53.0% $1,796
</TABLE>
Total Other Operating Income before Realized Gains on Securities decreased 7
percent or $184,000 during the nine-month period ended September 30, 1998
when compared to the nine-month period ended September 30, 1997. The decrease
was caused by the recognition of extraordinary income from the sale of a
copyright or trademark during the nine-month period ended September 30, 1997.
The before-tax effect was $301,000. Categories of Other Operating Income
include Service Charges on Deposit Accounts, Other Service Charges and Fees,
Trust Department Income, Bucktail Life Insurance Co. Premiums and Other
Operating Income.
Service Charges on Deposit Accounts, consisting of account activity charges and
overdraft charges, has declined slightly during the past two years. During the
nine-month periods ended September 30, 1997 and September 30, 1998 average
monthly service charges generated amounted to $86,000 and $90,000 ,
respectively. The fees consistently average about 56 percent service charges and
44 percent overdraft fees. The decrease is due to a decline in the number of
daily overdrafts and an increase in the number of customers utilizing Money
Market Accounts, free payroll accounts and senior citizens accounts. Payroll
accounts are free if direct deposit is utilized; the total number of accounts
has increased by nearly 400 since September 30, 1997. Also, the number of
accounts utilizing free services has increased by 724 during the past year. This
includes new accounts and accounts that have changed service charge type.
Service Charges and Fees, consisting of debit card fees, credit card annual
fees, official check sales and check cashing fees, has not changed significantly
when comparing the nine-month periods ended September 30, 1998 and September 30,
1997. Those fees average between $23,000 and $25,000 per month.
Trust Department Income is the largest contributor to Other Operating Income and
has posted a gain of 23 percent or $178,000 during the nine-month period ended
September 30, 1998 when compared to the same period in 1997. The significant
increase posted during the current period is directly related to the amount of
trust assets under management. For the periods ended September 30, 1998 and
September 30, 1997, trust assets under management amounted to $254,162, 000 and
$228,119,000, respectively. The growth in trust assets is the result of an
aggressive sales program and investment management.
Insurance Commissions, Fees and Premiums decreased $20,000 when comparing the
nine-month periods ended September 30, 1998 and September 30, 1997. The decrease
is the result of a lack of loan activity and alternate sources of credit life
and accident and health insurance.
14
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Other Operating Income is made up primarily of safe deposit box rentals,
earnings or losses on the "Supplemental Employees Retirement Plan" ("SERP") and
gains received on the sale of bank assets. The amounts reflected for the
nine-month periods ended September 30, 1998 and September 30, 1997 were $75,000
and $382,000, respectively. Normally, Other Operating Income will average about
$20,000 per quarter. The nine-month period ended September 30, 1997 includes a
gain of $301,000 from the sale of a Corporation owned copyright.
Realized Securities Gains during the nine-month period ended September 30, 1998
amounted to $2,849,000. A substantial portion, or $1,711,000, was due to the
sale of stock that was carried on the books at $1.00. The stock was acquired as
collateral on a loan that defaulted in 1919. The Corporation was recently
liquidated with the resulting gain. The balance of the realized gains is from
the sale of equity investments that management felt would be prudent to
liquidate and lock in realized gains. Also included were losses amounting to
$50,000 that were part of a small restructuring of the available-for-sale
investment portfolio. During the nine months ended September 30, 1997 realized
gains on the sale of equity investments totaled $869,000. Gains realized on
equity investments are part of the total investment return on equity securities,
which include both dividends and appreciation. Dividends alone from equity
investments are inadequate to compensate the Corporation for its investment.
TABLE VIII- COMPARISON OF NONINTEREST EXPENSE
<TABLE>
<CAPTION>
Nine-month Periods Ended
September 30 September 30 % $
(In Thousands) 1998 1997 Change Change
<S> <C> <C> <C> <C>
Salaries and Wages $4,813 $4,459 7.94% $354
Pensions and Other Employee Benefits 1,295 1,266 2.29% 29
Occupancy Expense, Net 617 535 15.33% 82
Furniture and Equipment Expense 599 513 16.76% 86
Other Operating Expense 4,856 4,501 7.89% 355
Total Other Expense $12,180 $11,274 8.04% 906
</TABLE>
Salaries and Wages increased 7.8 percent or $229,000 during the nine-month
period ended September 30, 1998 when compared to the nine-month period ended
September 30, 1997. The increase is the result of annual merit raises and the
number of full time equivalent employees increased to 206.
Pensions and Other Employee Benefits consists primarily of social security
taxes, group life and health insurance, contributions to the 401 (k) plan and
pension expense. The cost of Pensions and Other Employee Benefits did not change
significantly when comparing the nine-month periods ended September 30, 1998 and
September 30, 1997. The total change amounted to $29,000 or just over 2 percent.
Occupancy Expense, consisting of insurance, maintenance, real estate taxes,
depreciation and other utilities, increased 15 percent or $82,000 when comparing
the nine-month periods ended September 30, 1998 and September 30, 1997. The
increase was due to increased depreciation costs caused by the replacement of
roofs on two branch offices, an extensive remodeling of one of the branch
locations and ATM site preparation. An adjacent property was also purchased at
our Wellsboro location at a cost of $75,000.
15
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Furniture and Equipment Expense increased $86,000 or 16.7 percent when comparing
the nine-month periods ended September 30, 1998 and September 30, 1997. The
increase is due to the replacement of several vehicles and the purchases of a
statement folder inserter, a new data card embosser and a new item processing
image storage system. The combined cost of the equipment was in excess of
$150,000. It is expected that for the balance of 1998 equipment maintenance will
continue to increase with the installation of 12 ATMs and plans for the
installation of additional machines.
Other Operating Expense increased 8 percent or $355,000 when comparing the
nine-month period ended September 30, 1998 to the same period in 1997. Other
Operating Expense is comprised of several components. The largest components are
the Pennsylvania Shares Tax and credit card expense; combined they constitute
just over half of Other Operating Expense. Those components posted a combined
increase of 15 percent or $358,000 when the nine-month periods ended September
30, 1998 and September 30, 1997 are compared. The increased credit card costs
are the result of increases in credit card interchange fees or increased
merchant usage fees. It should be noted that the increase in interchange fees is
more than offset in increased income. The increase in Pennsylvania Shares Tax is
due to bank earnings and an increase in the market value adjustment of the
Bank's investment portfolio. Also included in Other Operating Expense are
expenses related to Bucktail Life Insurance Company, a subsidiary of Citizens &
Northern Corporation. Expenses incurred by the subsidiary dropped $89,000
between the comparable nine-month periods due to the decline in underwriting
business. There were no other material increases in expenses classified as Other
Operating Expense.
The Corporation continually monitors Other Operating Expense and has been
successful in holding those expenses to a minimum.
STATEMENT OF CONDITION Nine-Month Period Ended September 30, 1998/1997 --
Twelve-Month Period Ended December 31, 1997
Average total assets of the Corporation were $619,427,000 and $605,827,000 for
the comparable periods ended September 30, 1998/1997, respectively. The increase
in average assets between the two periods can be attributed to an increase in
average deposits of $4,220,000 and an increase in the average after-tax market
value adjustment of the investment portfolio amounting to 5,000,000. Average
total assets for the year ended December 31, 1997 totaled $608,277,000. When
comparing the year ended December 31, 1997 to the current period, average total
assets increased $11,150,000, which also is attributable to an increase in the
market value adjustment of the investment portfolio and increased average
deposit totals. Unrealized gains included in total assets for the periods ended
September 30, 1998/1997 respectively, amounted to $13,282,000 and $5,294,000. At
December 31, 1997 the average adjustment was $6,565,000.
The asset structure of the Corporation changed very little during the periods
being compared; average total loans comprise 46 percent of the asset base and
the investment portfolio 47 percent . The same percentages are applicable to all
comparable periods. The structure of the investment portfolio has changed
somewhat during 1998. Principal prepayments precipitated by a decline in
interest rates caused the return on the holdings of mortgage-backed investments
to be reduced to unacceptable levels. To increase the rate of return
approximately $71,000,000 of the mortgage-backed instruments were sold at a loss
of approximately $50,000; the funds made available by the sale were reinvested
in U. S. Agency securities, primarily FNMA zero coupon bonds and Federal Home
Loan Bank bonds. Also, for tax purposes the level of municipal bond holdings was
increased nearly $7,000,000 between the nine-month comparable periods.
The loan portfolio has remained nearly unchanged both in total loans and make-up
of total loans. Real estate secured loans still comprise nearly 80 percent of
total loans. The average loan-to-deposit ratio of the Corporation for the
nine-month periods and the year ended December 31, 1997 was 64 percent. Loan
demand has shown some improvement since September 30, 1998; at this writing
total loans amount to just over $289,000,000.
16
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The Corporation has installed 12 new automated teller machines at strategic
locations in the market area with an additional 1 or 2 units scheduled for
installation later this year. Also, the Corporation has opened a new office in
Mansfield, Pennsylvania. The new office opened in October 1998. The cost of the
new facility was approximately $525,000.
On the liability side of the balance sheet the growth of average
interest-bearing deposits September 30, 1997 through September 30, 1998 has been
relatively flat at less than 1 percent; however, during the months of July,
August, and September of this year deposits have grown by 5 percent. The deposit
growth has been primarily Money Market accounts and Certificates of Deposit .
The growth can be attributed to an aggressive marketing effort and higher
interest rates.
Management expects that 1998 will bring continued competition for deposits from
credit unions, brokerage houses and other nonbank competitors and it will
continue to look for innovative deposit products to hold current customers and
attract new business.
Average borrowed funds have declined about 4 percent between the comparable
periods primarily because of the lack of investment opportunities with the
flatness of the yield curve. However, it appears at this time, as short term
rates continue to decline that a spread is beginning to open between short and
longer term rates and that leverage opportunities may be forthcoming.
LIQUIDITY
Liquidity is the ability to raise cash quickly and at a reasonable cost. An
adequate liquidity position permits the Corporation to pay creditors, compensate
for unforeseen deposit fluctuations and fund unexpected loan demand. Daily
deposit decreases normally do not exceed $4,000,000 to $6,000,000 and new loan
advances net of loan repayments have not been significant.
In addition to the daily sources of cash, such as loan repayments, amortization
of mortgage-backed investments, maturing bonds and deposit growth, the
Corporation has several additional sources of liquidity: the sale of assets
(primarily available-for-sale investment securities), short-term or long-term
borrowing. Sources of borrowing include the Federal Home Loan Bank of Pittsburgh
and several correspondent bank relationships.
CAPITAL ADEQUACY
Under regulations published by the Federal Deposit Insurance Corporation and
other bank regulators, a bank's capital must be divided into two tiers. The
first tier or tier one capital consists primarily of common stock, retained
earnings, surplus and non-cumulative perpetual preferred stock. Tier two
includes the allowance for possible loan losses (limited to 1.25 percent of
risk-weighted assets), cumulative preferred stock and subordinated debt.
Risk-based capital guidelines published in 1990 require banks to maintain a
risk-based capital ratio of 8 percent, 4 percent of which must be tier one; the
remainder may be tier two. The total risk-based capital ratios at September 30,
1998, September 30, 1997 and December 31, 1997 were 22.66 percent, 22.92 percent
and 23.86 percent, respectively.
The primary source of capital growth for the Corporation is earnings. Capital
growth for the nine-month periods ended September 30, 1998 and September 30,
1997 on an annualized basis was 9.50 percent and 10.06 percent, respectively;
capital growth for the year ended December 31, 1997 was 9.7 percent. Dividend
payments as a percentage of net income amounted to 35.4 percent for the nine
months ended September 30, 1998 and 35.6 percent for the same period in 1997.
Total capital of the Corporation (excluding unrealized gains on
available-for-sale securities) at September 30, 1998, September 30, 1997 and
December 31, 1997 was $77,349,000, $70,781,000 and $72,200,000, respectively.
The leverage ratio (capital divided by total liabilities), excluding unrealized
gains on available-for-sale securities, at September 30, 1998, September 30,
1997 and December 31, 1997, was 14.2 percent, 13.2 percent and 13.6 percent,
respectively.
Planned capital expenditures during the next 12 months will amount to an
estimated $1,000,000. These expenditures will not have a detrimental effect on
capital ratios or results of operations.
17
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
INFLATION
Inflation affects nearly every aspect of banking, primarily interest rates. The
effect of inflation, when it is high, also has an impact on the cost of goods,
such as supplies, services and labor. Growth in the Consumer Price Index for
1998 is projected at about 2 percent which is considered not to be inflationary.
In essence, inflation does not appear to be a problem in the near-term and
should not impact the results of operations for the balance of 1998.
18
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 3. Interest Rate Risk and Market Risk
INTEREST RATE RISK AND MARKET RISK
The risk that arises from changes in interest rates is an inherent factor in
operating a bank. The risk associated with changes in interest rates is two
fold: the risk to earnings and the risk to the market values of assets and
liabilities.
From an earnings risk perspective, an asset sensitive institution (positive gap)
will normally benefit from rising rates and a liability sensitive (negative gap)
will benefit from falling interest rates. Citizens & Northern Corporation uses a
simulation model that calculates earnings under varying interest rate shock
scenarios, most commonly up 100, 200 and 300 basis points and the same rate
scenarios in a falling rate environment. The Asset and Liability Committee and
the Board of Directors have established a 20 percent decrease in net interest
income as a parameter at a 200 basis point (2 percent) increase in interest
rates. The model is run monthly using the current maturity schedule of the
Corporation's assets and liabilities and certain prepayment assumptions.
The risk associated with interest rate increases and decreases as they relate to
the market value of the assets and liabilities of the Corporation is also
calculated using the same model and the same rate shock of plus and minus 100,
200, and 300 basis point swings in rates. Market values are estimated by
applying present value calculations to the cash flow generated by the
Corporation's balance sheet. The Asset and Liability Committee and Board of
Directors have also imposed a market loss limit of 25 percent at a 200 basis
point rate shock.
The model utilized to create Table IX 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 calculation of projected changes in net
interest margin and market value of portfolio equity. Also, the model does not
make estimates related to changes in the composition of the deposit portfolio
that could occur due to rate competition and the table does not necessarily
reflect changes that management would make to realign the portfolio as a result
of changes in interest rates.
TABLE IX - EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES
NIM = Net Interest Margin
MVPE = Market Value of Portfolio Equity
<TABLE>
<CAPTION>
(In Thousands) At September 30, 1999 At September 30, 1998
Estimated Estimated Estimated Estimated
Change in Estimated Change in Change in Estimated Change in Change in
Interest Rates NIM NIM NIM MVPE MVPE MVPE
(Basis Points) $ $ % $ $ %
<S> <C> <C> <C> <C> <C> <C> <C>
Plus 300 20,851 (3,402) (12.73) 59,925 (29,055) (32.65)
Plus 200 21,926 (1,967) (8.23) 69,180 (19,800) (22.25)
Plus 100 22,967 (926) (3.88) 78,963 (10,017) (11.26)
Flat 23,893 88,980
Minus 100 24,653 760 3.18 98,828 9,848 11.07
Minus 200 25,357 1,464 6.13 109,230 20,250 22.76
Minus 300 26,224 2,331 9.76 116,540 27,560 30.97
</TABLE>
19
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 3. Interest Rate Risk and Market Risk (Continued)
EQUITY SECURITIES RISK
The Corporation's equity securities portfolio consists of restricted stock,
primarily of the Federal Home Loan Bank of Pittsburgh ("FHLB") and investments
in stock of banks and bank holding companies located mainly in Pennsylvania.
FHLB stock can only be sold back to the FHLB or to another member institution at
par value. Accordingly, the Corporation's investment in FHLB stock is carried at
cost, which equals par value, and is evaluated for impairment. Factors that
might cause FHLB stock to become impaired are primarily regulatory in nature and
are related to potential problems in the residential lending market; for
example, the FHLB may be required to make dividend or other payments to the
Financing Corporation, the Resolution Funding Corporation, or other entities, in
amounts that could exceed the FHLB's total equity.
Investments in bank stocks are subject to the risk factors 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 stock held by the
Corporation because of specific circumstances related to each bank. Further,
since the stocks held are bank and bank holding companies concentrated in
Pennsylvania, these investments could decline in market value if there is a
downturn in the state's economy.
Equity securities held as of September 30, 1998 and September 30, 1997 are
presented in Table X.
TABLE X - EQUITY SECURITIES
<TABLE>
<CAPTION>
Hypothetical Hypothetical
10 % 20 %
Decline Decline
In In
(In Thousands) Fair Market Market
At September 30, 1998 Cost Value Value Value
<S> <C> <C> <C> <C>
Bank & Bank Holding Companies 15,642 28,648 (2,865) (5,730)
Fed. Home Loan Bank and Other Restricted Stocks 4,367 4,367 (437) (873)
Total 20,009 33,015 (3,302) (6,603)
</TABLE>
<TABLE>
<CAPTION>
Hypothetical Hypothetical
10 % 20 %
Decline Decline
In In
(In Thousands) Fair Market Market
At September 30, 1997 Cost Value Value Value
<S> <C> <C> <C> <C>
Bank & Bank Holding Companies 10,801 23,324 (2,332) (4,665)
Fed. Home Loan Bank and Other Restricted Stocks 3,533 3,533 (353) (707)
Total 14,334 26,857 (2,685) (5,372)
</TABLE>
20
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 4. Year 2000 Compliance
YEAR 2000 COMPLIANCE
The "Year 2000" or "Y2K" problem is a computer problem that began when computers
began to store and process information. The problem occurs as a result of the
date format used in most older software and older computers. The year has often
been stored as a two digit number, e.g., 1998 as 98. When the date rolls forward
to 2000, most computers and computer software will look at the date as 00 or
1900. This could have a major impact on many calculations if not corrected.
Citizens & Northern Corporation began working on the problem in 1996 with the
formation of a "Year 2000 Committee" that meets periodically and reports to the
Board of Directors regularly.
The most critical phase of the "Year 2000" problem is the testing function, to
be implemented as follows:
1. Computers
A. Hewlett Packard Mainframe
1. Application software
2. System software
3. Hardware
B. Personal computers
1. Purchased software
2. Hardware
2. Environmental Systems
A. Heating and cooling systems
B. Vaults
C. Security systems
D. Elevators
E. Utilities
3. Other Third Parties
A. Customers
B. Financial Institutions
C. Automated Clearing House System (Federal Reserve)
D. Vendors
Testing Strategy
The testing strategy will vary depending on the area being tested. Various
detailed elements of this plan will be developed as the particular areas are
being reviewed. The proposed testing schedule follows:
6/30/98 Completion of testing strategies and plans
12/31/98 Application and integrated application testing complete
3/31/99 External testing with third parties (customers, financial institutions,
etc.)
6/30/99 Testing and implementation of all mission critical systems complete
21
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 4. Year 2000 Compliance (Continued)
Critical Dates to be Tested
1. Dates less than 2000
2. System roll dates from 12/31/99 to 1/1/2000
3. Validate all accrual calculations made from last business day of 1999,
December 31, 1999, to the first day of business on January 3, 2000
4. Test date rollover from 1/31/2000 to 2/1/2000
5. Test date rollovers from 2/28/2000 to 2/29/2000 and on to 3/1/2000
6. Test 1/7/2000 and 1/10/2000 to verify first Friday and first Monday
Other date testing procedures
1. Test end of quarter processing
2. Test year display fields on profiles and maintenance records
3. Test system sorts
4. Test date calculations
5. Test acceptance of date from operating systems
6. Calculate resultant values from dates
7. Test age calculations
8. Validate financial calculations (Interest, etc.)
9. Test expiration date processing
10. Test historical decision analysis
11. Test inventory processing
12. Test billing calculations
13. Validate cycle processing dates
14. Test archival date processing
15. Test system record purges
Documentation
For each area of testing, the following information shall be maintained by the
Compliance Department.
(1) Tests performed, (2) how the test types are determined, (3), test results,
(4) plans for further remediation and testing, if required and (5) individuals
responsible for testing and acceptance of testing results.
Testing of Main Frame Computer.
The objective is to test all applicable hardware, system software, purchased
software and software developed in-house to determine that appropriate steps and
changes have been made to minimize "Year 2000" risk.
The testing strategy is to test all applications, giving major consideration to
mission critical systems. A list of all applications will be reviewed to
determine the testing order. To facilitate the testing, our backup system will
be utilized to run the tests. The tests will be performed by the Data Processing
Department and monitored by the Audit and Compliance Departments. For each
application, testing criteria, including critical test dates and testing
methodology, will be developed and a certification form will be completed
stating the level of compliance and any remedial efforts required. After the
completion of application testing, integration testing will begin. These tests
will determine if all application systems will run properly as they interact
with each other in a simulation environment.
22
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (Continued)
Item 4. Year 2000 Compliance (Continued)
Personal Computers
The Corporation uses approximately 70 personal computers to perform a variety of
functions. The uses of personal computers follow:
<TABLE>
<S> <C> <C>
Demand Deposit Imaging System (2 Locations) ATMs Telephone Banking
Trust Department Bankcard Services Personnel
Asset and Liability System Fixed Asset Accounting Call Report Software
Credit Bureau System Appraisal Department Automated Clearinghouse
Correspondent Banking Corporate and Subsidiary Accounting Investment Accounting
</TABLE>
Personal Computer Software
Letters were sent to all software vendors to determine if the software is "Year
2000" compliant or will be in the near future. All results will be reviewed and
second letters sent if no response is forthcoming. If the software is not
compliant new software will be purchased.
Personal Computer Hardware
All personal computers have been tested to determine if the BIOS is compliant;
those that did not pass the test were flagged and will be fitted with a new BIOS
or replaced.
Environmental Systems
All environmental systems, e.g., elevators, heating and cooling, security
systems utilities and fax equipment will be checked to see what impact the year
change might have on them.
Third Parties
A list of third parties has been prepared and will be reviewed for compliance.
The list includes, but is not limited to, Credit Bureaus, Federal Reserve,
Clearinghouses, Fedline (part of the Federal Reserve) and larger Customers.
Vendors (nonsoftware)
Vendor testing for compliance will be nearly impossible. A list of major
suppliers will be prepared and contacts will be made to determine if the vendors
will be able to provide the required services or products at the century date
change.
Citizens and Northern Corporation employs a staff of system analysts and
programmers and it is difficult to estimate the total cost of compliance since
the work has been done in-house and over a long period of time, beginning in
1996. The main frame computer and network modems will be replaced in late 1998
or early 1999 at a cost of about $300,000. Several PCs and PC software will be
replaced and item processing software will have to be updated. The cost of PC
replacement is estimated to be between $50,000 and $75,000; software upgrades
will probably be equal to that. Upgrading the item processing image system will
cost approximately $32,000.
23
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part II - Other Information
Item 1. Legal Proceedings
There are currently no pending lawsuits against Citizens & Northern Corporation.
Item 4. Not Applicable
Item 5. Other Events
a. None
Item 6. Exhibits and Reports on Form 8 - K
a. Exhibits filed as a part of this report - None
b. No reports on Form 8 - K were filed during the period ended
September 30, 1998.
24
<PAGE>
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
November 9, 1998 By: /s/ Craig G. Litchfield
- ---------------- -----------------------
Date President and Chief Executive Officer
November 9, 1998 By: /s/ James W. Seipler
- ---------------- --------------------
Date Executive Vice President and Treasurer
25
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<PAGE>
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<NAME>Citizens and Northern Corp
<S> <C>
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0
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