<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 quarterly period ended June 30, 1999
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ________ to ___________
Commission file number: 0-16084
CITIZENS & NORTHERN CORPORATION
(Exact name of Registrant as specified in its charter)
Pennsylvania 23-2451943
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
90-92 Main Street
Wellsboro, Pa. 16901
(Address of principal executive offices) (Zip code)
570-724-3411
(Registrant's telephone number including area code)
Not applicable
(Former name, former address, and former fiscal year, if changed since
last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ____
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes ____ No ____
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
<TABLE>
<CAPTION>
Title Outstanding
<S> <C>
Common Stock $1.00 par value 5,272,239 Shares at July 1, 1999
</TABLE>
1
<PAGE>
CITIZENS & NORTHERN CORPORATION
Index
Part I. Financial Information
Item 1. Financial Statements
<TABLE>
<S> <C>
Consolidated Statement of Condition - June 30, 1999 and December 31, 1998 Page 3
Consolidated Statement of Income - Six Months Ended
June 30, 1999 and June 30, 1998 Page 4
Consolidated Statement of Cash Flows - Six Months Ended
June 30, 1999 and June 30, 1998 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 16
Item 3. Information About Market Risk Pages 17 Through 19
Item 4. Year 2000 Compliance Pages 20 through 22
Part II. Other Information Pages 23 and 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>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEET
(In Thousands Except Share Data)
<TABLE>
<CAPTION>
Unaudited Audited
(In Thousands) June 30, December 31,
1999 1998
-----------------------------------
<S> <C> <C>
ASSETS
Cash & Due From Banks $13,082 $15,428
Interest Bearing Deposits 690 700
Available-for-Sale Securities:
U.S. Treasury Securities 2,522 2,556
Securities of Other U.S. Government Agencies 106,196 61,840
Mortgage Backed Securities 112,713 131,046
Obligations of States and Municipal Subdivisions 81,777 81,423
Other Securities 54,377 52,410
-----------------------------------
Total Available-for-Sale Securities 357,585 329,275
Held-to-Maturity Securities:
U.S. Treasury Securities 622 622
Securities of Other U.S. Government Agencies 949 849
Mortgage Backed Securities 375 437
-----------------------------------
Total Held-to-Maturity Securities 1,946 1,908
Loans:
Loans to Political Subdivisions 7,429 8,078
Other Loans 295,283 282,954
-----------------------------------
Total Loans 302,712 291,032
Less - Allowance for Loan Losses (5,094) (4,820)
Unearned Income (39) (29)
-----------------------------------
Loans, Net 297,579 286,183
Bank Premises and Equipment 7,988 7,416
Other Real Estate 662 652
Accrued Interest on Bonds and Loans 4,581 4,109
Other Assets 2,404 627
-----------------------------------
TOTAL ASSETS $686,517 $646,298
-----------------------------------
-----------------------------------
LIABILITIES
Deposits:
Demand 60,071 57,871
Interest Checking 37,142 36,751
Money Market 122,145 121,082
Savings 47,193 45,301
Other Time 215,237 215,513
-----------------------------------
Total Deposits 481,788 476,518
Dividends Payable 1,134 1,123
Short - Term Borrowings 53,572 12,080
Long - Term Borrowings 60,034 60,044
Other Liabilities 5,183 5,966
-----------------------------------
TOTAL LIABILITIES 601,711 555,731
SHAREHOLDERS' EQUITY
Common Stock, Par Value $ 1.00 per Share 5,272 5,220
Authorized 10,000,000; Issued 5,272,239
and 5,220,038 in 1999 and 1998, respectively
Stock Dividend Distributable 1,931
Paid in Capital 17,355 15,468
Retained Earnings 60,672 57,477
-----------------------------------
Total 83,299 80,096
Accumulated Other Comprehensive Income, Net 2,951 11,922
Less: Treasury Stock at Cost
118,610 Shares at June 30, 1999 (1,444)
118,010 Shares at December 31, 1998 (1,451)
-----------------------------------
TOTAL SHAREHOLDERS' EQUITY 84,806 90,567
-----------------------------------
TOTAL LIABILITIES &
-----------------------------------
SHAREHOLDERS' EQUITY $686,517 $646,298
-----------------------------------
-----------------------------------
</TABLE>
3
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATED STATEMENT OF INCOME
(In Thousands) (Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Fiscal Year-to-Date
June 30, June 30, Six Months Ended June 30,
1999 1998 1999 1998
INTEREST INCOME (Current) (Prior Year) (Current) (Prior Year)
<S> <C> <C> <C> <C>
Interest and Fees on Loans $6,365 $6,448 $12,678 $12,816
Interest on Balances with Depository Institutions 9 10 14 20
Interest on Loans to Political Subdivisions 103 96 220 185
Interest on Federal Funds Sold 32 104 37 164
Income from Available-for-Sale and
Held-to-Maturity Securities:
Taxable 3,910 3,427 7,404 6,972
Tax Exempt 1,147 985 2,261 1,913
Dividends 285 223 552 451
------------------------------------------------------------
Total Interest and Dividend Income 11,851 11,293 23,166 22,521
INTEREST EXPENSE
Interest on Deposits 4,610 4,512 9,139 9,006
Interest on Short-Term Borrowings 502 148 581 428
Interest on Long-Term Borrowings 796 1,041 1,585 1,991
------------------------------------------------------------
Total Interest Expense 5,908 5,701 11,305 11,425
------------------------------------------------------------
Interest Margin 5,943 5,592 11,861 11,096
Provision for Loan Losses 225 191 450 382
------------------------------------------------------------
Interest Margin After Provision for Possible Loan Losses 5,718 5,401 11,411 10,714
OTHER INCOME
Service Charges on Deposit Accounts 264 550 514
280
Service Charges and Fees 62 137 139
68
Trust Department Income 329 771 645
401
Insurance Commissions, Fees and Premiums 113 95 246 197
Fees Related to Credit Card Operation 760 729 1,425 1,374
Other Operating Income 32 38 60 59
------------------------------------------------------------
Total Other Income Before Realized Gains on Securities, 1,654 1,517 3,189 2,928
Net Realized Gains on Securities, (Net) 568 1,860 1,058 2,614
------------------------------------------------------------
Total Other Income 2,222 3,377 4,247 5,542
OTHER EXPENSES
Salaries and Wages 1,706 1,596 3,267 3,195
Pensions and Other Employee Benefits 437 429 908 871
Occupancy Expense, Net 221 214 454 414
Furniture and Equipment Expense 259 198 468 392
Expenses Related to Credit Card Operation 720 706 1,296 1,280
Pennsylvania Shares Tax 181 164 362 329
Other Operating Expense 877 782 1,899 1,545
------------------------------------------------------------
Total Other Expenses 4,401 4,089 8,654 8,026
------------------------------------------------------------
Income Before Income Tax Provision 3,539 4,689 7,004 8,230
Income Tax Provision 751 1,227 1,540 2,087
------------------------------------------------------------
NET INCOME $2,788 $3,462 $5,464 $6,143
------------------------------------------------------------
------------------------------------------------------------
PER SHARE DATA:
Net Income - Basic $0.54 $0.67 $1.06 $1.19
Net Income - Diluted $0.54 $0.67 $1.06 $1.19
------------------------------------------------------------
Dividend Per Share $0.22 $0.20 $0.44 $0.40
------------------------------------------------------------
Number Shares Used in Computation - Basic 5,153,506 5,163,239 5,153,506 5,163,239
Number Shares Used in Computation - Diluted 5,159,735 5,173,481 5,160,213 5,172,645
Number Shares Issued 5,272,239 5,220,038 5,272,239 5,220,038
Number Shares Authorized 10,000,000 10,000,000 10,000,000 10,000,000
------------------------------------------------------------
Dividends Actually Paid $0.22 $0.20 $0.44 $0.40
------------------------------------------------------------
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
Net Income $2,788 $3,462 $5,464 $6,143
Other Comprehensive Income :
Unrealized holding gains (losses) on available-for-sale securities
Gains (Losses) arising during the period (8,608) 18,720 (12,535) 3,806
Reclassification adjustment (568) (1,860) (1,058) (2,614)
------------------------------------------------------------
Other comprehensive income (loss) before income tax (9,176) 16,860 (13,593) 1,192
Income tax related to other comprehensive income 3,120 (5,732) 4,622 (405)
------------------------------------------------------------
Other comprehensive income (loss) (6,056) 11,128 (8,971) 787
------------------------------------------------------------
Comprehensive Income ($3,268) $14,590 ($3,507) $6,930
------------------------------------------------------------
------------------------------------------------------------
</TABLE>
4
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
(In Thousands) Six Months Ended
June 30 1999 June 30 1998
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $5,464 $6,143
Adjustments to Reconcile Net Income to
Net Cash Provided by Operating Activities
Provision for Possible Loan Losses 450 382
Realized (Gain), on Available-for-Sale and
Held-to-Maturity Securities, Net (1,058) (2,614)
Provision for Depreciation 450 392
Accretion and Amortization (798) 138
Deferred Income Tax (75) (116)
(Increase) Decrease in Accrued Interest
Receivable and Other Assets (2,249) 42
Increase Accrued Interest Payable and
Other Liabilities 3,924 2,627
- ----------------------------------------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 6,108 6,994
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the Maturity of Held-to-Maturity Securities 312 116
Purchase of Held-to-Maturity Securities (354) (348)
Proceeds from Sales of Available-for-Sale Securities 10,934 72,940
Proceeds from Maturities of Available-for-Sale Securities 26,946 63,817
Purchase of Available-for-Sale Securities (77,922) (139,981)
Net ( Increase) Decrease in Loans (11,846) (1,336)
Purchase of Premises and Equipment (1,022) (396)
Sale of Foreclosed Assets 118 70
Purchase of Other Real Estate (128) (413)
- ----------------------------------------------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (52,962) (5,531)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net Increase in Deposits 5,270 3,197
Increase (Decrease) in Short-Term Borrowings 41,492 (9,400)
Proceeds from (Repayment of) Long-Term Borrowings (10) 9,991
Sale of Treasury Stock 14 24
Purchase of Treasury Stock (468)
Dividends Declared (2,268) (2,046)
- ----------------------------------------------------------------------------------------------------------------------------
Net Cash Provided by Financing Activities 44,498 1,298
INCREASE IN CASH AND CASH EQUIVALENTS (2,356) 2,761
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR $16,128 $14,253
- ----------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF YEAR $13,772 $17,014
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest Paid $8,363 $9,221
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
Income Taxes Paid $1,338 $2,065
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the financial statements
5
<PAGE>
Notes to Consolidated Financial Statements
1. The financial information included herein, with the exception of the
Consolidated Balance Sheet dated December 31, 1998, 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 six-month period ended June 30, 1999 may not be
indicative of the results for the year ended December 31, 1999.
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. 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>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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
EARNINGS OVERVIEW
Net Income after income tax for the six months ended June 30, 1999 totaled
$5,464,000 or $1.06 per share on a basic and diluted basis. Earnings for the
same period in 1998 amounted to $6,143,000 or $1.19 on a basic and diluted
basis. Earnings for the six-month period ended June 30, 1998 included the
realized gain on the sale of stock obtained through a loan default in 1919 and
carried on the Corporation's books at $1.00. The net after tax gain amounted to
just over 1.1 million dollars or $.22 per share.
Excluding securities gains from both six-month periods and reflecting on only
operating income the current six-month period would have exceeded last year by
$348,000 or nearly $.07 per share, an increase of 8 percent.
Results for the six months ended June 30, 1999 are slightly ahead of budget
projections and as mentioned slightly ahead of the same period last year. It is
expected that the balance of 1999 will be reflective of the first six months
barring dramatic changes in the economy or interest rates.
Comprehensive Income which includes the change in equity during the period
arising from market value changes in the investment portfolio amounted to
($3,507,000) for the period ended June 30, 1999 and $6,930,000 for the six-month
period ended June 30, 1998. The noticeable decrease in comprehensive income for
the current period is the result of rising interest rates during the current
period.
NET INTEREST MARGIN
Net interest margin or net interest income is the difference between interest
income earned on all interest-bearing assets and the interest expense paid on
all interest-bearing liabilities.
Gross average interest-bearing assets for the periods ended June 30, 1999 and
June 30, 1998, respectively, amounted to $605,863,000 and $575,846,000. The
increase was provided by deposit growth and earnings.
Net interest income for the periods ended June 30, 1999 and 1998, respectively,
amounted to $11,861,000 and $11,096,000, an increase of 7 percent. Net interest
income for the three-month periods ended June 30, 1999 and 1998 was $5,943,000
and $5,592,000, respectively, an increase of 6 percent.
Gross interest income for the respective six-month periods ended June 30, 1999
and 1998 amounted to $23,166,000 and $22,521,000. The increase can be attributed
to the investment portfolio. Average investment balances carried during the
first six months of 1999 were $326,862,000 in comparison to average balances of
$289,810,000 during the same period in 1998.
The increase in average volume of the portfolio provided an additional
$1,068,000 in interest income while a decrease in the rate of return on the
portfolio from 6.50 percent for the first six months of 1998 to 6.30 percent in
1999 decreased gross interest income $187,000.
Funding for the increase in the investment portfolio was provided by an increase
in average deposits of $40,148,000 between the periods ended June 30, 1999 and
June 30, 1998.
Average total loans increased $10,907,000 between the comparable periods,
however the interest income derived from the increased volume was offset by a
decrease in the rate of return on the portfolio of 41 basis points between the
comparable periods.
A comparison of gross interest income for the respective quarters ended June 30,
1999 and June 30, 1998 reflects an increase of $558,000 during the current
three-month period. This increase can also be attributed to interest earned on
the investment portfolio. Gross interest income derived from the loan portfolio
decreased $72,000 when comparing the most current three-month period to that of
last year.
Beginning with the quarter ended March 31, 1999 certain credit card merchant
fees were reclassified from Interest and Fees on Loans to Other Income. All
previous periods have been restated to reflect the change.
Average interest-bearing liabilities including borrowed funds for the respective
six-month periods were $512,152,000 and $479,623,000, an increase of $32,529,000
or 6.8 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)
Deposit categories reflecting the largest increase were Money Market Accounts
and Certificates of Deposit. Money Market Accounts have always been very popular
because of the high rates paid and recently a very rate competitive Municipal
Money Market account was added to attract and hold the accounts of local school
districts and other municipal subdivisions.
Also contributing to deposit growth was the introduction of a Repo Sweep Account
that customers may use to sweep excess funds into an interest-bearing liability
account overnight. The account is also tied to lines of credit maintained by the
bank's customers.
Daily balances in the Repo sweep account have been averaging about $4,000,000.
Growth in Certificate of Deposit balances is primarily the result of a
successful marketing effort aimed at local school districts.
Balances in other interest-bearing accounts have remained relatively unchanged.
Average borrowings for the six-month period ended June 30, 1999 amounted to
$79,842,000. Average balances for the same period in 1998 amounted to
$83,482,000. Rates paid on the borrowed funds for the respective periods were
5.19 percent and 5.67 percent.
Gross interest expense for the respective six-month periods amounted to
$11,305,000 and $11,425,000 and the average rate for the same periods
respectively, was 4.45 percent and 4.80 percent, an improvement of 35 basis
points.
The net interest spread or the difference between the average rate of return on
earning assets and the average rate paid on all interest-bearing liabilities for
the periods ended June 30, 1999, December 31, 1998 and June 30, 1998,
respectively, was 3.04 percent, 3.04 percent and 3.03 percent.
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
EARNING ASSETS 06/30/99 % 12/31/98 % 06/30/98 %
<S> <C> <C> <C> <C> <C> <C>
Available-for-Sale Securities:
U. S. Treasury Securities 2,510 6.03 2,516 6.00 2,518 6.01
Securities of Other U.S. Government Agencies and Corporations 79,677 6.83 68,512 7.07 74,654 7.22
Mortgage Backed Securities 122,397 6.55 121,466 6.58 116,262 6.52
Obligations of States and Political Subdivisions 80,155 5.69 68,942 5.78 65,671 5.87
Stock 22,564 4.93 18,725 5.07 17,250 5.27
Other Securities 17,751 6.74 13,960 6.88 11,771 7.04
- ------------------------------------------------------------------------------------------------------------------------------------
Total Available-for-Sale Securities 325,054 6.30 294,121 6.42 288,126 6.50
Held-to-Maturity Securities:
U. S. Treasury Securities 625 5.49 626 5.91 628 6.10
Securities of Other U. S. Government Agencies and Corporations 698 8.09 629 6.52 508 6.75
Mortgage Backed Securities 485 6.24 507 7.50 548 7.73
- ------------------------------------------------------------------------------------------------------------------------------------
Total Held-to-Maturity Securities 1,808 6.69 1,762 6.58 1,684 6.83
Interest -bearing Due from Banks 818 3.20 671 5.66 796 5.07
Federal Funds Sold 1,570 4.75 4,139 5.53 5,913 5.59
Loans:
Real Estate Loans 235,371 8.65 227,845 8.94 225,221 8.99
Consumer 29,431 11.21 30,366 11.62 30,962 11.62
Agricultural 1,965 10.26 2,219 10.05 2,425 10.15
Commercial/Industrial 18,689 8.75 17,698 9.16 17,623 9.31
Other 726 7.78 707 7.78 708 7.69
Political Subdivisions 7,841 5.66 6,227 6.10 6,147 6.07
Leases 187 3.24 214 9.35 217 9.29
Total Loans 294,210 8.84 285,276 9.18 283,303 9.25
- ------------------------------------------------------------------------------------------------------------------------------------
Total Earning Assets 623,460 7.49 585,969 7.76 579,822 7.83
Cash 13,439 12,694 12,352
Securities Valuation Reserve 13,388 19,939 20,040
Allowance for Possible Loan Losses (4,968) (4,822) (4,868)
Other Assets 5,197 5,337 5,317
Bank Premises & Equipment 7,668 6,985 6,764
- ------------------------------------------------------------------------------------------------------------------------------------
Total Assets 658,184 626,102 619,427
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES
Interest Checking 36,970 2.15 36,556 2.33 36,773 2.45
Money Market 126,475 4.17 115,143 4.42 110,183 4.56
Savings 46,632 2.48 45,207 2.48 45,380 2.48
Certificates of Deposit 139,485 5.27 126,902 5.50 121,380 5.53
Individual Retirement Accounts 76,446 4.98 76,557 5.42 78,313 5.55
Other Time Deposits 1,570 2.44 1,900 2.58 2,076 2.14
Federal Funds Purchased 4,732 4.73 2,801 4.75 2,036 6.83
Other Borrowed Funds 79,842 5.19 76,040 5.67 83,482 5.67
- ------------------------------------------------------------------------------------------------------------------------------------
Total Interest-bearing Liabilities 512,152 4.45 481,106 4.72 479,623 4.80
Demand Deposits 50,324 46,336 44,381
Other Liabilities 6,827 10,663 9,040
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 569,303 538,105 533,044
Stockholders' Equity 81,728 74,810 73,101
Securities Valuation Reserve 7,153 13,187 13,282
- ------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity 658,184 626,102 619,427
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
Interest Rate Spread 3.04 3.04 3.03
</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 I I - ANALYSIS OF THE EFFECT OF VOLUME AND RATE CHANGES IN INTEREST INCOME
AND INTEREST EXPENSE
<TABLE>
<CAPTION>
Periods Ended June 30, 1999/1998
(In Thousands) Change in Change in Total
Volume Rate Change
<S> <C> <C> <C>
EARNING ASSETS Available-for-Sale Securities:
U. S. Treasury Securities -- -- --
Securities of Other U.S. Government Agencies and 131 (105) 26
Corporations
Mortgage Backed Securities 199 23 222
Obligations of States and Political Subdivisions 406 (58) 348
Stock 128 (27) 101
Other Securities 199 (17) 182
- ------------------------------------------------------------------------------------------------------------
Total Available-for-Sale Securities 1,063 (184) 879
Held-to-Maturity Securities:
U. S. Treasury Securities -- (2) (2)
Securities of Other U.S. Government Agencies and 7 3 10
Corporations
Mortgage Backed Securities (2) (4) (6)
- ------------------------------------------------------------------------------------------------------------
Total Held-to-Maturity Securities 5 (3) 2
Interest -bearing Due from Banks 1 (7) (6)
Federal Funds Sold (105) (22) (127)
Loans:
Real Estate Loans 347 (291) 56
Consumer (87) (76) (163)
Agricultural (23) 1 (22)
Commercial/Industrial -- (3) (3)
Other 1 -- 1
Political Subdivisions 46 (11) 35
Leases (1) (6) (7)
- ------------------------------------------------------------------------------------------------------------
Total Loans 283 (386) (103)
- ------------------------------------------------------------------------------------------------------------
Total Interest Income 1,247 (602) 645
INTEREST BEARING LIABILITIES
Interest Checking 2 (53) (51)
Money Market 294 (170) 124
Savings 15 1 16
Certificates of Deposit 463 (145) 318
Individual Retirement Accounts (50) (221) (271)
Other Time Deposits (7) 4 (3)
Federal Funds Purchased 55 (13) 42
Other Borrowed Funds (100) (195) (295)
- ------------------------------------------------------------------------------------------------------------
Total Interest Expense 672 (792) (120)
- ------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 575 190 765
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
</TABLE>
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)
RESERVE 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, an 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 amounts to the calculated
total if it is aware of a particular problem or if the five-year average is not
representative of current conditions. The historical method is used only to
observe past trends and is not relied on to predict the future because as we
know, the last five years have been part of a stable economic climate with very
low unemployment. 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. Since the
allocation only encompasses about 4.0 percent of total loans and ignores the
balance of the loan portfolio, management applies .005 percent of the remainder
of the portfolio. Management feels that the additional allocation will provide
added protection in an economic downturn with a resulting increase in
unemployment.
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 June 14, 1999 and concluded July 1, 1999. The results of
that review have not been issued at this writing. Also, each year the Board of
Directors invites all branch managers to the meeting to perform a comprehensive
review of all loans that equal or exceed $400,000.
At June 30, 1999 the Reserve for Possible Loan Losses as a percentage of gross
loans was 1.68 percent. Beginning with the month of July 1999 the monthly charge
to earnings will be lowered from the current charge of $75,000 to $40,000 as net
charge-offs for the current year have been less than projected. The estimated
projected net charge-offs for 1999 should total about $400,000. This projection
does not include any unexpected occurrences.
At year-end 1999 an assessment of the reserve balance will be made after a
definite determination of actual losses for the year can be ascertained. The
Board of Directors desires a reserve to gross ratio in the range of 1.65
percent.
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 III
RESERVE FOR LOAN LOSSES
<TABLE>
<CAPTION>
Projected Actual Actual Actual Actual Actual Actual
Dec. 31, 1999 June 30, Dec. 31, 1998 Dec. 31, 1997 Dec. 31, 1996 Dec. 31, 1995 Dec 31,
1999 1994
<S> <C> <C> <C> <C> <C> <C> <C>
Beginning Balance January 1, $4,820,323 $4,820,323 $4,913,334 $4,775,960 $4,579,210 $4,228,741 $3,816,982
Provision Charged to 700,000 450,156 763,400 797,032 700,500 736,500 737,496
Earnings
Year-to-Date Recoveries 100,000 67,247 110,077 124,407 167,926 187,473 194,312
Year-to-Date Charge-offs (500,000) (243,977) (966,488) (784,065) (671,676) (573,504) (520,049)
Ending Balance $5,120,323 $5,093,749 $4,820,323 $4,913,334 $4,775,960 $4,579,210 $4,228,741
</TABLE>
<TABLE>
<CAPTION>
TABLE IV - 6 YEAR HISTORY OF LOAN LOSSES Projected
(In Thousands) 1999 1998 1997 1996 1995 1994
<S> <C> <C> <C> <C> <C> <C>
Net Loans * 311,000 291,032 285,463 278,597 264,182 258,418
Net Charge offs 400 856 386 504 387 326
Allowance for Possible Loan Losses Balance 5,120 4,820 4,912 4,776 4,579 4,229
Provision for Loan Losses Charged to Earnings 700 763 797 701 737 737
Earnings 10,500 11,077 10,107 9,255 7,866 7,494
Earnings Coverage of Net Charge offs 26.3 X 12.9 x 26.2 x 18.4 x 20.3 x 23.0
Allowance Coverage of Net Charge offs 12.8 X 5.6 x 12.7 x 9.5 x 11.8 x 13.0
Loans Ninety Days or More Past Due and
Still Accruing 1,908 1,628 1,986 2,994 2,915 2,743
Net Charge offs as a Percent of the Provision 57.1% 112.2% % 48.4 % 71.9 % 52.5 % 44.2
Year-End Nonperforming Loans** 1,130 1,130 1,412 864 279 624
Allowance as a Percentage of Gross Loans: *
Bank (1) 1.65% 1.66% % 1.72 % 1.71 % 1.73 % 1.64
Peer Group (2) 1.51% 1.66% % 1.43 % 1.50 % 1.61 % 1.65
</TABLE>
* Gross Loans less Unearned Discount
(1) Projected December 31, 1999
(2) At March 31, 1999
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
<TABLE>
<CAPTION>
Reserve Allocation-Historical (In Est.
Thousands)
LOAN CLASSIFICATION 1999 1998 1997 1996 1995 1994 Average
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial, Agriculture, 33,165 34,255 25,751 30,054 26,481 22,794 28,750 0.00408 X 33,165 = 235
Municipal & Other
Real Estate Loans 246,122 225,853 220,358 215,123 201,350 195,634 217,407 0.00075 X 246,122= 285
Credit Card & Related Plans 9,023 8,523 9,084 8,902 9,934 9,896 9,268 0.02244 X 9,023 = 253
All Other Loans to Individuals 22,690 22,402 30,270 24,518 26,417 30,094 26,740 0.00758 X 22,690 = 222
- ------------------------------------------------------------------------------------------------------------------------------
Total Loans 311,000 291,033 285,463 278,597 264,182 258,418 282,165 0.00237 x 311,000 994
Letter of Credit Commitments 5,500 5,400 5,012 5,106 2,633 4,415 4,513 0.00000 X 5,500 = 500
All Other Commitments
Consumer 32,000 14,768 27,728 28,049 24,811 24,202 23,912 0.00781 X 32,000 = 250
Mortgage 12,000 15,477 10,497 5,802 7,276 9,566 9,724 0.00064 X 12,000 = 8
Commercial 13,000 17,366 13,045 10,825 10,201 9,901 12,268 0.00479 X 13,000 = 62
Impaired Loans 700 290 274 113 228 700
Total allocated 2,514
Unallocated 2,606
- ------------------------------------------------------------------------------------------------------------------------------
Total Loans and Commitments and 374,200 344,334 342,019 328,492 309,331 306,502 332,581 5,120
Reserve Balance
- ------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Table VI
Reserve Allocation
At June 30, 1999
<TABLE>
<CAPTION>
Allocation Total
Percentage Loans Allocation
<S> <C> <C> <C>
Substandard 15 8,424,572 1,263,686
Doubtful 50 3,016,680 1,508,340
Loss 100 76,635 76,635
Fasb 114 Loans (Nonperforming) Estimated 1,622,854 568,516
- ----------------------------------------------------------------------------
Total Loans and Allocation 13,140,741 3,417,177
Remaining Loans 0.005 289,532,529 1,447,663
Unallocated 228,909
- ----------------------------------------------------------------------------
Reserve Balance 302,673,270 5,093,749
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------
</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>
Six-Month Periods Ended
June 30,
$ %
(In Thousands) 1999 1998 Change Change
<S> <C> <C> <C> <C>
Service Charges on Deposit Accounts $550 $514 $ 36 7.00
Service Charges and Fees 137 139 (1.44)
(2)
Trust Department Income 771 645 126 19.53
Insurance Commissions, Fees and Premiums 246 197 24.87
49
Fees Related to Credit Card Operation 1,425 1,374 3.71
51
Other Operating Income 60 59 1.69
1
- --------------------------------------------------------------------------------------------------------------------
Total Other Operating Income before Realized
Gains (Losses) on Securities, Net 3,189 2,928 261 8.91
Realized Gains (Losses) on Securities, Net 1,058 2,614 (1,556) (59.53)
- --------------------------------------------------------------------------------------------------------------------
Total Other Income $4,247 $5,542 $(1,295) (23.37)
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
Total Other Operating Income before Realized Gains on Securities increased 8.91
percent or $261,000. Fees generated by the Trust Department contributed the most
to the increase. The increase in Trust Department Fees was generated by an
increase in trust accounts and the market value of those accounts. Other
categories of Other Income did not post significant increases when comparing the
periods ended June 30, 1999 and 1998.
TABLE VIII- COMPARISON OF NONINTEREST EXPENSE
<TABLE>
<CAPTION>
Six-Month Periods Ended
June 30,
(In Thousands) $ %
1999 1998 Change Change
<S> <C> <C> <C> <C>
Salaries and Wages $3,267 $3,195 $72 2.25
Pensions and Other Employee Benefits 908 871 4.25
37
Occupancy Expense, Net 454 414 9.66
40
Furniture and Equipment Expense 468 392 19.39
76
Expenses Related to Credit Card Operation 1,296 1,280 1.25
16
Pennsylvania Shares Tax 362 329 10.03
33
Other Operating Expense 1,899 1,545 354 22.91
- --------------------------------------------------------------------------------------------------------------------
Total Other Expense $8,654 $8,026 $628 7.82
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
Gross Other Expense increased $628,000 or 7.82 percent. The most significant
portion of the increase was Other Operating Expense which increased nearly 23
percent. The increase in Other Operating Expense was caused by increases in the
following expense items: school and educational seminars, supplies, telephone
expense and repairs and maintenance of personal computers. Nearly all of the
expense items are related to the newly installed Internet Banking system.
Installation of the system began in early 1999 and went online in June.
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)
STATEMENT OF CONDITION
Average total assets of the Corporation for the six-month periods ended June 30,
1999 and June 30, 1998, respectively, totaled $658,184,000 and $619,427,999. The
increase in average total assets between the comparable periods was the result
of an increase in average deposit totals and the introduction of the Money
Management Repo Sweep account.
On the asset side of the balance sheet average total Available-for-Sale
investments has increased $36,928,000 between the comparable periods. Average
municipal bonds increased $14,484,000 with the balance of the increase being
spread evenly across other categories of investments. The mix of U. S. Agency
investments has changed with the inclusion of zero-coupon Federal Home Loan Bank
and Federal National Mortgage Association instruments totaling approximately
$30,000,000. The return on these instruments is slightly higher than the overall
portfolio.
The composition of the loan portfolio has not changed during the comparable
periods. Average loan volume increased $10,907,000 almost entirely in real
estate secured. Loan growth was sluggish during 1998 and the first quarter of
1999 but the volume began to increase during the second quarter of 1999.
Presently total loans amount to about $304,000,000 and are expected to end the
year at about $311,000,000.
On the liability side of the balance sheet average deposits increased
$39,416,000. Average balances in Money Market Accounts increased nearly 15
percent or $16,292,000. The increase was the result of the introduction of a new
Municipal Money Market Account. The account targets local school districts and
other municipalities. The account is popular because of the competitive rates
paid, thus the municipalities no longer have to send funds out of the market
area to obtain higher rates.
Average balances in Certificates of Deposit increased $18,105,000, also a result
of a marketing program targeting local school districts.
The Money Management Repo Sweep Account introduced in the Fall of 1998
automatically sweeps funds above a predetermined level from a
noninterest-bearing account to an interest-bearing account on a daily basis. The
rate paid is based on the 91-day treasury bill and a tiered balance approach.
Currently average daily balances amount to approximately $4,000,000.
Average borrowed funds have not changed significantly between the two periods
due to the lack of leveraging opportunities.
Average Capital of the Corporation increased from $73,101,000 to $81,728,000 for
the six months ended June 30, 1999, a nearly 12 percent increase.
The net after-tax market value adjustment for Available-for-Sale Securities
decreased significantly between the periods compared. At June 30, 1998 the
adjustment amounted to $14,121,000 and at June 30, 1999 the after-tax adjustment
was $2,151,000. The decline is the result of the June 30, 1999 increase of 25
basis points in the Federal Funds rate and a change in the composition of the
investment portfolio to include FNMA and FHLB zero-coupon bonds. The bonds
provide a rate of return slightly higher than the balance of the portfolio but
do not price well in a rising rate environment because of the lack of cash flow.
At March 31, 1999 the adjustment was $9,007,000. It should be noted that the
market did recover somewhat in mid-July providing a recovery of nearly
$4,000,000.
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)
LIQUIDITY
Liquidity is the ability to raise cash quickly and at a reasonable cost. An
adequate liquidity position allows 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. The estimated borrowing capacity
available from the Federal Home Loan Bank and correspondent relationships is
approximately $270,000,000.
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, subordinated debt and 45
percent of unrealized gains on equity investments.
Risk-based capital guidelines published in 1990 require banks to maintain a
risk-based capital ratio of 8 percent, 4 percent of which must be tier one; the
remainder may be tier two. The total risk-based capital ratios at June 30, 1999,
June 30, 1998 and December 31, 1998 were 24.35 percent, 23.93 percent and 22.74
percent, respectively.
Total capital of the Corporation (excluding unrealized gains on
available-for-sale securities) at June 30, 1999, June 30, 1998 and December 31,
1998 was $81,855,000, $75,854,000 and $78,645,000, respectively.
The leverage ratio (capital divided by total liabilities), excluding unrealized
gains on available-for-sale securities, at June 30, 1999, June 30, 1998 and
December 31, 1998 was 13.6 percent, 14.1 percent and 14.1 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.
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
1999 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 1999.
16
<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 30 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.
17
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (continued)
Item 3. Interest Rate Risk and Market Risk(continued)
<TABLE>
<CAPTION>
Twelve-Month Period Ended June 30, 2000
TABLE IX -Effect of Hypothetical Changes in Interest
Rates
NIM = Net Interest Margin
MVPE= Market Value of Portfolio Equity Plus 2% Plus 2 % Minus 2% Minus 2%
Estimated Estimated Estimated Estimated
Expected Change in Change in Change in Change in
NIM NIM NIM NIM NIM
INTEREST INCOME $ $ % $ %
<S> <C> <C> <C> <C> <C>
Investment Securities 21,160 21,407 1.17 20,402 (3.58)
Interest-bearing Due From Banks 464 648 39.66 284 (38.79)
Loan Income 28,861 30,710 6.41 26,015 (9.86)
- ---------------------------------------------------------------------------------------------------------------------------
Total Interest Income 50,485 52,765 4.52 46,701 (7.50)
- ---------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Now Accounts and Regular Savings 2,175 2,976 36.83 1,385 (36.32)
Money Market Accounts 5,848 8,392 43.50 3,307 (43.45)
All Other Deposits 11,081 12,882 16.25 9,288 (16.18)
- ---------------------------------------------------------------------------------------------------------------------------
Total Deposits 19,104 24,250 26.94 13,980 (26.82)
Borrowed Funds 4,897 5,531 12.95 4,326 (11.66)
- ---------------------------------------------------------------------------------------------------------------------------
Total Interest Expense 24,001 29,781 24.08 18,306 (23.73)
- ---------------------------------------------------------------------------------------------------------------------------
Net Interest Income 26,484 22,984 (13.22) 28,395 7.22
- ---------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
As of June 30, 1999
Effect of Hypothetical Changes in Market
Value of Portfolio Equity Plus 2% Plus 2 % Minus 2% Minus 2%
Estimated Estimated Estimated Estimated
Change in Change in Change in Change in
MVPE MVPE MVPE MVPE MVPE
$ $ % $ %
<S> <C> <C> <C> <C> <C>
Investment Portfolio 352,203 323,684 (8.10) 384,101 9.06
Total Loans 299,254 292,343 (2.31) 303,274 1.34
Other Assets 28,991 28,991 28,991
- ---------------------------------------------------------------------------------------------------------------------------
Total Assets 680,448 645,018 (5.21) 716,366 5.28
Deposits 484,748 472,441 (2.54) 498,484 2.83
Borrowed Funds 112,981 111,146 (1.62) 114,915 1.71
Other Liabilities 3,532 3,532 3,532
- ---------------------------------------------------------------------------------------------------------------------------
Total Liabilities 601,261 587,119 (2.35) 616,931 2.61
- ---------------------------------------------------------------------------------------------------------------------------
Net Change in Portfolio Equity 79,187 57,899 (26.88) 99,435 25.57
- ---------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
18
<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 Investments held as of June 30, 1999 and June 30, 1998 are presented in
Table X.
Table X - Equity Investments
<TABLE>
<CAPTION>
Hypothetical Hypothetical
10 % Decline 20 % Decline
in in
(In Thousands) Fair Market Market
Cost Value value value
<S> <C> <C> <C> <C>
At June 30, 1999
Banks and Bank Holding Companies 17,849 31,093 (3,109) (6,219)
Federal Home Loan Bank and Other Restricted Securities 5,275 5,275 (528) (1,055)
- -----------------------------------------------------------------------------------------------------------------------------
Total 23,124 36,368 (3,637) (7,274)
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
At June 30, 1998
Banks and Bank Holding Companies 14,911 33,554 (3,355) (6,711)
Federal Home Loan Bank and Other Restricted Securities 4,152 4,152 (415) (830)
- -----------------------------------------------------------------------------------------------------------------------------
Total 19,063 37,706 (3,770) (7,541)
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
19
<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 as it is commonly referred to, is a computer
problem that originated when computers were first utilized to store and process
information and computer memory and storage space was very expensive. To make
efficient use of this memory and storage limitation, the year was stored as a
two-digit number. For example, the year 1998 was stored as 98. Without
corrective action being taken, when the date rolls forward to 2000, many
computers would read the date as 00 or 1900. This would have a major impact on
many calculations if appropriate action was not taken.
Citizens & Northern Corporation began working on the problem in 1996 with the
formation of a "Year 2000 Committee". This committee, consisting of various key
people throughout the organization, meets periodically and reports to the Board
of Directors on a quarterly basis. The Board of Directors has approved and
implemented a formal Year 2000 Plan.
Overall, the Corporation has made substantial progress on Y2K issues. To date,
the corporation's progress is as follows:
- Mainframe software upgrades have been completed.
- All mission-critical applications have been tested by the MIS
department and were retested independently by our Audit and Compliance
departments.
- A contingency/business resumption plan is completed and approved by
the Board of Directors.
- Customer risk (both funds users and funds providers) has been
assessed.
- Several steps have been taken to increase customer awareness, such as
statement stuffers, seminars and internet banking statement.
TESTING:
A Year 2000 readiness-testing plan was developed to guide the testing process.
This plan covers various areas of the Bank such as mainframe computers, personal
computers, environmental systems and various third-parties.
Our current programming and systems analyst staff has written and developed the
majority of mission-critical software for the mainframe system. This software
processes most of the core banking systems. All critical in-house software has
been modified to be ready for the Year 2000 and tested by the Management
Information Systems (MIS) department. Those modified programs are being used for
our current day-to-day processing. In addition to the testing performed by the
MIS department, the plan calls for additional independent testing. The Audit and
Compliance departments performed the independent testing and for main frame
mission-critical systems the majority of the testing is complete.
MAINFRAME AND SOFTWARE TESTING:
Independent testing of software for Y2K compliance was done utilizing our HP 937
backup computer system. Through initial independent testing in July of 1998, it
was discovered that new operating systems were required. Subsequently, both the
main frame and backup computer systems were upgraded with new operating systems
certified to be compliant. All internally written software has been revised and
tested by the MIS staff.
KEY EXTERNAL THIRD PARTY SUPPLIERS:
- Trust - The department's primary, mission-critical software,
TrustRite, has been reviewed, modified and tested by the vendor. The
department has partnered with a TrustRite users group, which has hired
a third-party software specialist firm to perform independent testing
of the system. That independent testing has been completed.
Additionally, all other software and hardware in the department have
been identified and reviewed for Y2K compliance.
- Electronic Funds Transfer - All software has been tested and is Y2K
compliant. (ACH and Wire Transfer).
- Check and Document Imaging - Our independent testing is complete.
20
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (continued)
Item 4. Year 2000 Compliance (continued)
- Credit Card - Internal testing has been performed. Third-party testing
is scheduled for the near future.
- ATM - All automated teller machines are compliant based on the
manufacturer's warranties. Third-party testing is scheduled for the
near future.
- Postage machines are compliant.
- Various security systems, elevators, vaults, etc. were determined to
be Y2K compliant or are not date sensitive.
VENDORS:
To date, a few vendors have not yet responded concerning their Y2K readiness.
However, these vendors are not considered mission-critical. All mission-critical
vendors have responded stating that they will be able to support Y2K.
THOSE VENDORS NOT INDICATING YEAR 2000 READINESS WILL BE REPLACED.
CONTINGENCY PLAN/BUSINESS RESUMPTION:
A contingency plan for the Year 2000 is complete. Key operational areas have
been identified such as Trust, Credit Card/ATM, Accounting, Fedwire/ACH and the
overall Management Information System and will be evaluated with plans developed
to use in case of Y2K related issues. Plans are being developed for each of
these areas using staff input to determine how processing could be performed
without computerization. Items such as paper forms necessary to complete manual
posting to the need for a backup generator (which could be used in case of any
loss of power, not just Y2K) were analyzed. Plans will be developed accordingly.
CUSTOMER RISK AND AWARENESS:
To date, the following efforts have been made to inform our customers of the Y2K
problem:
- Y2K letter sent to commercial loan customers.
- Y2K press release in all newspapers in market area.
- Y2K Seminars were held in June 1998 and March 1999 for all commercial
customers.
- Bankcard Services sent Y2K updates to all member banks.
- Y2K informational brochures were distributed to all offices for
customers inquiring into the Y2K problem.
- Y2K informational flyers were distributed in the C&N 1999 calendars
that were made available to customers, free of charge, at all
branches.
The bank developed a Y2K questionnaire for selected loan customers. This
questionnaire, based on Appendix A of the FFIEC Inter Agency Statement on
Y2K concerning the impact of customers, is for all commercial loan
customers with aggregate balances over $150,000. Deposit customers with
aggregate balances over $100,000 were selected for review. Letters were
sent to these customers with follow-up phone calls to be made on a selected
basis. Loan officers met independently with all loan customers with
borrowing availability totaling $150,000 or more to review and assess the
customer's Y2K readiness.
COSTS:
Citizens & 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 was begun in 1996. A reasonable estimate
would put programming costs in excess of $250,000. The current telephone banking
system, installed in 1997, is not Y2K compliant, has been replaced with a Y2K
compliant Internet and Telephone Banking System that incorporates telephone
banking during the second quarter of 1999. The Internet and Telephone Banking
System cost approximately $100,000. Item-processing software has been updated at
a cost of $32,000. The cost of PC replacements is estimated to be between
$50,000 and $75,000; software upgrades will probably be equal to that. The main
frame computer network has been upgraded for Y2K and non-Y2K reasons at a cost
of $200,000. The Corporation is in the process of installing a natural gas
generator for the operations center in Wellsboro. The price of the generator
will be about $85,000. The primary purpose of the generator is to provide a
back-up electricity source for our MIS department and the main office in the
event of power interruptions caused by weather or other non-Y2K related
unforeseen situations.
21
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
Part I - Financial Information (continued)
Item 4. Year 2000 Compliance (continued)
The Corporation wishes to caution shareholders and customers that although it
believes all aspects of the year 2000 issue have been addressed (i.e., software,
hardware, customers, vendors, and facilities) internal problems (Y2K or
otherwise) may occur that could temporarily prevent the Corporation from
carrying on business-as-usual. Nevertheless, it is the judgment of management
and the Board of Directors that the Corporation has a highly qualified MIS
staff, which has proven its ability to quickly correct problems with minimal
disruption to business. If problems arise that are caused by external sources,
such as power outages, or vendor failure of certified Y2K-compliant equipment or
software, for which the Corporation must rely on the outside source, business
could be disrupted. Therefore, the Corporation has developed contingency plans
to allow the Corporation to function satisfactorily in the unlikely event that
such failure should occur.
No one can predict with certainty what will occur when the century date changes;
however, your Corporation's Board of Directors and management team have expended
all reasonable time and effort to solve the problem and will deal with
unforeseen problems as they arise.
22
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There is currently no pending litigation against Citizens & Northern
Corporation.
ITEM 2. CHANGES IN SECURITIES
No disclosure required.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
No disclosure required.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Shareholders of Citizens and Northern Corporation
was held on Tuesday, April 20, 1999. The Board of Directors fixed the close of
business on March 8, 1999 as the record date for the determination of
stockholders entitled to notice of and to vote at the Annual Meeting and any
adjournment thereof. On this record date, there were outstanding and entitled to
vote 5,153,629 shares of Common Stock.
The total number of votes cast were 3,975,952. 183,968 were voted
in person by owners or representatives and 3,791,984 were voted by proxy for the
following purposes and with the following results.
1. The election of the following as Class lII Directors to serve
for a term of three years:
Dennis F. Beardslee Craig G. Litchfield
J. Robert Bower Lawrence F. Mase
Karl W. Kroeck
The total votes in favor of any one of the above-listed
Directors was not less than 3,949,985.
2. The approval and adoption of the Amendments to the Citizens &
Northern Corporation 1995 Stock Incentive Plan.
<TABLE>
<S> <C>
Total Votes in Favor 3,659,812
Total Votes Against 197,695
Total Votes Abstained 118,445
</TABLE>
3. The ratification of the action of the Board of Directors in
the appointment of the firm of Parente, Randolph, Orlando,
Carey & Associates as independent Auditors of the
Corporation.
<TABLE>
<S> <C>
Total Votes in Favor 3,935,480
Total Votes Against 5,637
Total Votes Abstained 34,835
</TABLE>
23
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
PART II. OTHER INFORMATION (CONTINUED)
ITEM 5. OTHER INFORMATION
No disclosure required.
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 six-month period
ended June 30, 1999.
24
<PAGE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q
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
August 6, 1999 By: /s/
- -------------- --------------------------------------------------
Date Craig G. Litchfield - Chairman, President, and
Chief Executive Officer
August 6, 1999 By: /s/
- -------------- --------------------------------------------------
Date James W. Seipler - Executive Vice President and
Treasurer
25
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