UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(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, 2006
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: 000-16084
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)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to section 12(g) of the Act:
COMMON STOCK Par Value $1.00
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 [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date.
Common Stock ($1.00 par value) 8,249,290 Shares Outstanding on August 2, 2006
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheet - June 30, 2006 and
December 31, 2005 Page 3
Consolidated Statement of Income - Three Months and Six
Months Ended June 30, 2006 and 2005 Page 4
Consolidated Statement of Cash Flows - Six Months
Ended June 30, 2006 and 2005 Page 5
Notes to Consolidated Financial Statements Pages 6 through 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS Pages 11 through 25
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK Pages 25 through 28
ITEM 4. CONTROLS AND PROCEDURES Page 28
PART II. OTHER INFORMATION Pages 28 through 30
SIGNATURES Page 31
Exhibit 31.1. Rule 13a-14(a)/15d-14(a) Certification -
Chief Executive Officer Page 32
Exhibit 31.2. Rule 13a-14(a)/15d-14(a) Certification -
Chief Financial Officer Page 33
Exhibit 32. Section 1350 Certifications Page 34
2
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEET
(In Thousands Except Share Data)
JUNE 30, DECEMBER 31,
2006 2005
----------- ------------
(UNAUDITED) (NOTE)
ASSETS
Cash and due from banks:
Noninterest-bearing $ 19,242 $ 20,922
Interest-bearing 22,842 5,524
---------- ----------
Total cash and cash equivalents 42,084 26,446
Available-for-sale securities 362,573 427,298
Held-to-maturity securities 418 422
Loans, net 650,294 644,938
Bank-owned life insurance 18,943 18,643
Accrued interest receivable 4,890 5,500
Bank premises and equipment, net 23,306 22,605
Foreclosed assets held for sale 654 194
Intangible Asset - Core Deposit Intangible 400 464
Intangible Asset - Goodwill 2,919 2,919
Other assets 17,226 13,525
---------- ----------
TOTAL ASSETS $1,123,707 $1,162,954
========== ==========
LIABILITIES
Deposits:
Noninterest-bearing $ 104,827 $ 96,644
Interest-bearing 651,647 660,421
---------- ----------
Total deposits 756,474 757,065
Dividends payable 1,987 1,973
Short-term borrowings 50,950 34,734
Long-term borrowings 180,889 232,205
Accrued interest and other liabilities 4,781 5,009
---------- ----------
TOTAL LIABILITIES 995,081 1,030,986
---------- ----------
STOCKHOLDERS' EQUITY
Common stock, par value $1.00 per share; authorized 20,000,000 shares,
issued 8,472,382 in 2006 and 8,389,418 in 2005 8,472 8,389
Stock dividend distributable -- 2,183
Paid-in capital 27,059 24,964
Retained earnings 95,773 93,728
---------- ----------
Total 131,304 129,264
Accumulated other comprehensive (loss) income (89) 4,698
Unamortized stock compensation (30) (50)
Treasury stock, at cost:
193,557 shares at June 30, 2006 (2,559)
168,627 shares at December 31, 2005 (1,944)
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 128,626 131,968
---------- ----------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $1,123,707 $1,162,954
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
Note: The balance sheet at December 31, 2005 has been derived from the audited
financial statements at that date but does not include all the information and
notes required by U.S. generally accepted accounting principles for complete
financial statements.
3
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
CONSOLIDATED STATEMENT OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
3 MONTHS ENDED FISCAL YEAR TO DATE
------------------------- 6 MONTHS ENDED JUNE 30,
JUNE 30, JUNE 30, -------------------------
2006 2005 2006 2005
(CURRENT) (PRIOR YEAR) (CURRENT) (PRIOR YEAR)
---------- ------------ ---------- ------------
INTEREST INCOME
Interest and fees on loans $ 10,695 $ 9,318 $ 20,861 $ 18,324
Interest on balances with depository institutions 23 9 35 13
Interest on loans to political subdivisions 335 268 646 515
Interest on federal funds sold 53 22 96 30
Income from available-for-sale and
held-to-maturity securities:
Taxable 3,550 3,618 7,277 7,279
Tax-exempt 1,046 1,415 2,382 2,887
Dividends 282 258 550 553
---------- ---------- ---------- ----------
Total interest and dividend income 15,984 14,908 31,847 29,601
---------- ---------- ---------- ----------
INTEREST EXPENSE
Interest on deposits 5,298 3,628 10,307 7,054
Interest on short-term borrowings 623 332 1,049 557
Interest on long-term borrowings 1,645 2,195 3,488 4,501
---------- ---------- ---------- ----------
Total interest expense 7,566 6,155 14,844 12,112
---------- ---------- ---------- ----------
Interest margin 8,418 8,753 17,003 17,489
(Credit) provision for loan losses (300) 375 300 750
---------- ---------- ---------- ----------
Interest margin after (credit) provision for loan losses 8,718 8,378 16,703 16,739
---------- ---------- ---------- ----------
OTHER INCOME
Service charges on deposit accounts 513 383 963 725
Service charges and fees 109 109 174 196
Trust and financial management revenue 547 571 1,058 1,050
Insurance commissions, fees and premiums 121 86 260 184
Increase in cash surrender value of life insurance 153 140 300 279
Fees related to credit card operation -- 203 -- 390
Other operating income 494 395 971 768
---------- ---------- ---------- ----------
Total other income before realized gains on securities, net 1,937 1,889 3,726 3,592
Realized gains on securities, net 1,333 929 2,648 1,995
---------- ---------- ---------- ----------
Total other income 3,270 2,818 6,374 5,587
---------- ---------- ---------- ----------
OTHER EXPENSES
Salaries and wages 3,364 3,048 6,686 5,923
Pensions and other employee benefits 1,005 953 2,148 1,985
Occupancy expense, net 594 461 1,140 925
Furniture and equipment expense 668 650 1,318 1,298
Pennsylvania shares tax 244 197 488 412
Other operating expense 2,101 1,864 4,039 3,758
---------- ---------- ---------- ----------
Total other expenses 7,976 7,173 15,819 14,301
---------- ---------- ---------- ----------
Income before income tax provision 4,012 4,023 7,258 8,025
Income tax provision 813 725 1,239 1,432
---------- ---------- ---------- ----------
NET INCOME $ 3,199 $ 3,298 $ 6,019 $ 6,593
========== ========== ========== ==========
PER SHARE DATA:
Net income - basic $ 0.39 $ 0.40 $ 0.73 $ 0.80
Net income - diluted $ 0.39 $ 0.39 $ 0.72 $ 0.79
---------- ---------- ---------- ----------
Dividend per share $ 0.24 $ 0.23 $ 0.48 $ 0.46
---------- ---------- ---------- ----------
Number of shares used in computation - basic 8,281,011 8,292,574 8,288,921 8,283,921
Number of shares used in computation - diluted 8,303,913 8,356,885 8,319,241 8,351,384
The accompanying notes are an integral part of these consolidated financial
statements.
4
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
6 MONTHS ENDED
--------------------
JUNE 30, JUNE 30,
2006 2005
-------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 6,019 $ 6,593
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 300 750
Realized gains on securities, net (2,648) (1,995)
Gain on sale of premises and equipment (26) --
Gain on sale of foreclosed assets, net (52) (113)
Depreciation expense 1,266 1,111
Loss from writedown of impaired premises and equipment 169 --
Accretion and amortization of securities, net 245 142
Increase in cash surrender value of life insurance (300) (279)
Amortization of restricted stock 20 46
Amortization of core deposit intangible 64 --
Increase in accrued interest receivable and other assets (2,902) (1,980)
Increase in accrued interest payable and other liabilities 656 1,835
-------- ---------
Net Cash Provided by Operating Activities 2,811 6,110
-------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturity of held-to-maturity securities 3 5
Proceeds from sales of available-for-sale securities 68,962 103,978
Proceeds from calls and maturities of available-for-sale securities 17,469 32,764
Purchase of available-for-sale securities (26,556) (116,208)
Purchase of Federal Home Loan Bank of Pittsburgh stock (958) (3,053)
Redemption of Federal Home Loan Bank of Pittsburgh stock 2,352 3,554
Net increase in loans (6,215) (32,637)
Purchase of premises and equipment (2,332) (2,845)
Proceeds from sales of premises and equipment 222 --
Proceeds from sale of foreclosed assets 151 643
-------- ---------
Net Cash Provided by (Used in) Investing Activities 53,098 (13,800)
-------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in deposits (591) 8,560
Net increase in short-term borrowings 16,216 16,384
Proceeds from long-term borrowings -- 19,557
Repayments of long-term borrowings (51,316) (35,785)
Purchase of treasury stock (651) --
Sale of treasury stock 49 453
Tax benefit from compensation plans 7 --
Dividends paid (3,985) (3,779)
-------- ---------
Net Cash (Used In) Provided by Financing Activities (40,271) 5,390
-------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 15,638 (2,300)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 26,446 18,953
-------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 42,084 $ 16,653
======== =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Assets acquired through foreclosure of real estate loans $ 559 $ 199
Interest paid $ 14,958 $ 10,503
Income taxes paid $ 1,500 $ 1,325
The accompanying notes are an integral part of these consolidated financial
statements.
5
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF INTERIM PRESENTATION
The financial information included herein, with the exception of the
consolidated balance sheet dated December 31, 2005, is unaudited; however, such
information reflects all adjustments (consisting solely of normal recurring
adjustments) that are, in the opinion of management, necessary for a fair
presentation of the financial position, results of operations and cash flows for
the interim periods.
Results reported for the three-month and six-month periods ended June 30, 2006
might not be indicative of the results for the year ending December 31, 2006.
Certain merchant services revenue previously included in fees related to credit
card operations has been reclassified to Other Operating Income. Merchant
services revenue was $45,000 and $35,000 for the three months ended June 30,
2006 and 2005. Merchant services revenue was $80,000 and $58,000 for the six
months ended June 30, 2006 and 2005.
This document has not been reviewed or confirmed for accuracy or relevance by
the Federal Deposit Insurance Corporation or any other regulatory agency.
2. PER SHARE DATA
Net income per share is based on the weighted-average number of shares of common
stock outstanding. The number of shares used in calculating net income and cash
dividends per share reflect the retroactive effect of stock dividends for all
periods presented. The following data show the amounts used in computing net
income per share and the weighted average number of shares of dilutive stock
options. As shown in the table that follows, diluted earnings per share is
computed using weighted average common shares outstanding, plus weighted-average
common shares available from the exercise of all dilutive stock options, less
the number of shares that could be repurchased with the proceeds of stock option
exercises based on the average share price of the Corporation's common stock
during the period.
WEIGHTED-
AVERAGE EARNINGS
NET COMMON PER
INCOME SHARES SHARE
----------- --------- --------
SIX MONTHS ENDED JUNE 30, 2006
Earnings per share - basic $6,019,000 8,288,921 $0.73
Dilutive effect of potential common stock
arising from stock options:
Exercise of outstanding stock options 140,995
Hypothetical share repurchase at $24.44 (110,675)
---------- --------- -----
Earnings per share - diluted $6,019,000 8,319,241 $0.72
========== ========= =====
SIX MONTHS ENDED JUNE 30, 2005
Earnings per share - basic $6,593,000 8,283,921 $0.80
Dilutive effect of potential common stock
arising from stock options:
Exercise of outstanding stock options 231,305
Hypothetical share repurchase at $30.05 (163,842)
---------- --------- -----
Earnings per share - diluted $6,593,000 8,351,384 $0.79
========== ========= =====
6
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
WEIGHTED-
AVERAGE EARNINGS
NET COMMON PER
INCOME SHARES SHARE
----------- --------- --------
QUARTER ENDED JUNE 30, 2006
Earnings per share - basic $3,199,000 8,281,011 $0.39
Dilutive effect of potential common stock
arising from stock options:
Exercise of outstanding stock options 122,005
Hypothetical share repurchase at $22.70 (99,103)
---------- --------- -----
Earnings per share - diluted $3,199,000 8,303,913 $0.39
========== ========= =====
QUARTER ENDED JUNE 30, 2005
Earnings per share - basic $3,298,000 8,292,574 $0.40
Dilutive effect of potential common stock
arising from stock options:
Exercise of outstanding stock options 220,808
Hypothetical share repurchase at $30.11 (156,497)
---------- --------- -----
Earnings per share - diluted $3,298,000 8,356,885 $0.39
========== ========= =====
3. STOCK COMPENSATION PLANS
Effective in the first quarter of 2006, the Financial Accounting Standards Board
issued SFAS No. 123R, which replaces SFAS No. 123 and supersedes APB Opinion 25.
SFAS No. 123R requires the Corporation to record stock option expense based on
estimated fair value calculated using an option valuation model. The provisions
of SFAS 123R must be applied to any new awards granted, and to any modifications
of existing awards. Since the Corporation has neither modified, nor issued, any
new options in 2006, and all options issued prior to December 31, 2005 are fully
vested, the provisions of SFAS No. 123R have no impact on net income in 2006.
In previous years, the Corporation used the intrinsic value method of accounting
for stock compensation plans, with compensation cost measured by the excess of
the quoted market price of the stock as of the grant date (or other measurement
date) over the amount an employee or director must pay to acquire the stock.
Stock options issued under the Corporation's stock option plans have had no
intrinsic value; therefore, no compensation cost was recorded for them.
The Corporation has also made prior awards of restricted stock. Compensation
cost related to restricted stock has been recognized based on the market price
of the stock at the grant date over the vesting period.
The following table illustrates the effect on net income and earnings per share
if the Corporation had applied the fair value provisions of SFAS No. 123 to
stock options.
7
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
3 MONTHS ENDED 6 MONTHS ENDED
JUNE 30, JUNE 30,
--------------- ---------------
(NET INCOME IN THOUSANDS) 2006 2005 2006 2005
------ ------ ------ ------
Net income, as reported $3,199 $3,298 $6,019 $6,593
Deduct: Total stock option compensation
expense determined under fair value
method for all awards, net of tax effects -- (34) -- (69)
------ ------ ------ ------
Pro forma net income $3,199 $3,264 $6,019 $6,524
====== ====== ====== ======
Earnings per share-basic
As reported $ 0.39 $ 0.40 $ 0.73 $ 0.80
Pro forma $ 0.39 $ 0.39 $ 0.73 $ 0.79
Earnings per share-diluted
As reported $ 0.39 $ 0.39 $ 0.72 $ 0.79
Pro forma $ 0.39 $ 0.39 $ 0.72 $ 0.78
4. COMPREHENSIVE INCOME
U.S. generally accepted accounting principles generally require that recognized
revenue, expenses, gains and losses be included in net income. Although
unrealized gains and losses on available-for-sale securities are reported as a
separate component of the equity section of the balance sheet, changes in
unrealized gains and losses on available-for-sale securities, along with net
income, are components of comprehensive income.
The components of comprehensive income, and the related tax effects, are as
follows:
3 MONTHS ENDED 6 MONTHS ENDED
------------------- -------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
(IN THOUSANDS) 2006 2005 2006 2005
-------- -------- -------- --------
Net income $ 3,199 $ 3,298 $ 6,019 $ 6,593
Unrealized holding gains (losses) on available-for-sale securities (2,342) 4,759 (4,607) (1,122)
Reclassification adjustment for gains realized in income (1,333) (929) (2,648) (1,995)
------- ------- ------- -------
Other comprehensive income (loss) before income tax (3,675) 3,830 (7,255) (3,117)
Income tax related to other comprehensive income/loss 1,254 (1,302) 2,468 1,060
------- ------- ------- -------
Other comprehensive income (loss) (2,421) 2,528 (4,787) (2,057)
------- ------- ------- -------
Comprehensive income $ 778 $ 5,826 $ 1,232 $ 4,536
======= ======= ======= =======
8
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
5. SECURITIES
Amortized cost and fair value of securities at June 30, 2006 are summarized as
follows:
JUNE 30, 2006
----------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING FAIR
(IN THOUSANDS) COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
AVAILABLE-FOR-SALE SECURITIES:
Obligations of other U.S. Government agencies $ 34,000 $ -- $(1,179) $ 32,821
Obligations of states and political subdivisions 74,495 852 (1,054) 74,293
Mortgage-backed securities 123,153 65 (4,843) 118,375
Other securities 107,456 844 (2,083) 106,217
-------- -------- ------- --------
Total debt securities 339,104 1,761 (9,159) 331,706
Marketable equity securities 23,612 7,569 (314) 30,867
-------- -------- ------- --------
Total $362,716 $ 9,330 $(9,473) $362,573
======== ======== ======= ========
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury $ 312 $ 2 $ -- $ 314
Obligations of other U.S. Government agencies 98 5 -- 103
Mortgage-backed securities 8 -- -- 8
-------- -------- ------- --------
Total $ 418 $ 7 $ -- $ 425
======== ======== ======= ========
The following table presents gross unrealized losses and fair value of
investments aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position at June 30, 2006.
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL
--------------------- --------------------- ---------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
(IN THOUSANDS) VALUE LOSSES VALUE LOSSES VALUE LOSSES
-------- ---------- -------- ---------- -------- ----------
AVAILABLE-FOR-SALE SECURITIES:
Obligations of other U.S. Government agencies $ 26,119 $ (881) $ 6,702 $ (298) $ 32,821 $(1,179)
Obligations of states and political subdivisions 33,281 (741) 9,048 (313) 42,329 (1,054)
Mortgage-backed securities 27,021 (696) 88,247 (4,147) 115,268 (4,843)
Other securities 50,681 (653) 36,070 (1,430) 86,751 (2,083)
-------- ------- -------- ------- -------- -------
Total debt securities 137,102 (2,971) 140,067 (6,188) 277,169 (9,159)
Marketable equity securities 1,949 (116) 2,772 (198) 4,721 (314)
-------- ------- -------- ------- -------- -------
Total temporarily impaired available-for-sale
securities $139,051 $(3,087) $142,839 $(6,386) $281,890 $(9,473)
======== ======= ======== ======= ======== =======
Management evaluates securities for other-than-temporary impairment at least on
a quarterly basis, and more frequently when economic or market concerns warrant
such evaluation. Consideration is given to (1) the length of time and the extent
to which the fair value has been less than cost, (2) the financial condition and
near-term prospects of the issuer, and (3) the intent and ability of the
Corporation to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in fair value.
The unrealized losses on debt securities are primarily the result of volatility
in interest rates. Based on the credit worthiness of the issuers, management
believes the Corporation's debt securities at June 30, 2006 were not
other-than-temporarily impaired.
9
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
6. DEFINED BENEFIT PLANS
The Corporation has a noncontributory defined benefit pension plan for all
employees meeting certain age and length of service requirements. Benefits are
based primarily on years of service and the average annual compensation during
the highest five consecutive years.
In addition, the Corporation sponsors a defined benefit health care plan that
provides postretirement medical benefits and life insurance to employees who
meet certain age and length of service requirements. This plan contains a
cost-sharing feature, which causes participants to pay for all future increases
in costs related to benefit coverage. Accordingly, actuarial assumptions related
to health care cost trend rates do not affect the liability balance at June 30,
2006 and December 31, 2005, and will not affect the Corporation's future
expenses.
The Corporation uses a December 31 measurement date for its plans.
The components of net periodic benefit costs from these defined benefit plans
are as follows:
PENSION POSTRETIREMENT
SIX SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
------------- --------------
(IN THOUSANDS) 2006 2005 2006 2005
----- ----- ---- ----
Service cost $ 305 $ 238 $32 $24
Interest cost 315 309 31 33
Expected return on plan assets (416) (397) -- --
Amortization of transition (asset) obligation (12) (12) 18 18
Recognized net actuarial loss (gain) 39 19 1 1
----- ----- --- ---
Net periodic benefit cost (benefit) $ 231 $ 157 $82 $76
===== ===== === ===
PENSION POSTRETIREMENT
THREE THREE
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
------------- --------------
(IN THOUSANDS) 2006 2005 2006 2005
----- ----- ---- ----
Service cost $ 153 $ 119 $16 $12
Interest cost 158 154 16 16
Expected return on plan assets (208) (199) -- --
Amortization of transition (asset) obligation (6) (6) 9 9
Recognized net actuarial loss (gain) 19 9 -- --
----- ----- --- ---
Net periodic benefit cost (benefit) $ 116 $ 77 $41 $37
===== ===== === ===
For 2006, the minimum funding requirement for the defined benefit pension plan
is $379,000; however, the Board of Directors authorized funding, in April 2006,
up to the maximum funding limit of $640,000. For the six months to date of 2006,
the Corporation funded postretirement contributions totaling $26,000, with
estimated annual postretirement contributions of $62,000 expected in 2006 for
the full year.
7. CONTINGENCIES
In the normal course of business, the Corporation may be subject to pending and
threatened lawsuits in which claims for monetary damages could be asserted. In
management's opinion, the Corporation's financial position and results of
operations would not be materially affected by the outcome of such pending legal
proceedings.
10
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
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
Certain statements in this section and elsewhere in this quarterly report on
Form 10-Q are forward-looking statements. Citizens & Northern Corporation and
its wholly-owned subsidiaries (collectively, the Corporation) intend such
forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements contained in the Private Securities Reform Act of
1995. Forward-looking statements, which are not historical facts, are based on
certain assumptions and describe future plans, business objectives and
expectations, and are generally identifiable by the use of words such as,
"should", "likely", "expect", "plan", "anticipate", "target", "forecast", and
"goal". These forward-looking statements are subject to risks and uncertainties
that are difficult to predict, may be beyond management's control and could
cause results to differ materially from those expressed or implied by such
forward-looking statements. Factors which could have a material, adverse impact
on the operations and future prospects of the Corporation include, but are not
limited to, the following:
- changes in monetary and fiscal policies of the Federal Reserve Board and
the U. S. Government, particularly related to changes in interest rates
- changes in general economic conditions
- legislative or regulatory changes
- downturn in demand for loan, deposit and other financial services in the
Corporation's market area
- increased competition from other banks and non-bank providers of financial
services
- technological changes and increased technology-related costs
- changes in accounting principles, or the application of generally accepted
accounting principles.
These risks and uncertainties should be considered in evaluating forward-looking
statements and undue reliance should not be placed on such statements.
REFERENCES TO 2006 AND 2005
Unless otherwise noted, all references to "2006" in the following discussion of
operating results are intended to mean the six months ended June 30, 2006, and
similarly, references to "2005" relate to the six months ended June 30, 2005.
EARNINGS OVERVIEW
Net income in 2006 was $6,019,000, which represents a decrease of 8.7% in net
income compared to net income of $6,593,000 for 2005. Net income per share was
$0.73 (basic) and $0.72 (diluted) for 2006. Return on average assets was 1.05%
in 2006, as compared to 1.17% in 2005. Return on average equity was 9.17% for
2006, as compared to 9.96% for the same period in 2005.
The most significant income statement changes between 2006 and 2005 were as
follows:
- The net interest margin was $17,003,000 in 2006, a decrease of
$486,000, or 2.8%, from $17,489,000 in 2005. Despite growth in both
loans and deposits, the continued decrease in Net Interest Margin is
attributed primarily to increases in short-term interest rates,
compared to relatively flat long-term rates associated with the loan
portfolio. Changes in the net interest margin are discussed in more
detail later in Management's Discussion and Analysis.
- Other (non-interest) expenses increased $1,518,000, or 10.6%, in 2006
compared to 2005. For the first six months of 2006, a total of
$1,200,000 of the total increase related to operations and start-up
costs in new markets. New branch operations include First State Bank,
our Jersey Shore office (opened August 2005) and our Old Lycoming
Township office (opened March 2006). The other significant
organizational change affecting the comparison of noninterest expense
between 2006 and 2005 is the sale of the credit card portfolio that
took place in the fourth quarter 2005. Total noninterest expense
attributable to the credit card operation was $534,000 in 2005.
Additional discussion of Other Expenses is described in the
"Non-interest Expense" section of Management's Discussion and
Analysis.
- The provision for loan losses was $300,000 in the first six months of
2006, which is a decrease of $450,000 compared to the same period in
2005. In 2006, the negotiations and workout of a few large commercial
loans were completed which resulted in actual charge-offs being less
than the previously established estimated allowances by approximately
$500,000.
11
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
- Net realized gains on securities were $2,648,000 in the first six
months of 2006, an increase of $653,000, compared to $1,995,000 in
2005. Sales of bank stocks provided most of the gains realized in
2006.
Net income in the second quarter 2006 was $3,199,000, down 3.0% from second
quarter 2005 net income, but up $379,000 (13.4%) from the first quarter 2006.
Net income per share (basic and diluted) was $0.39 in the second quarter 2006,
as compared to $0.40 (basic) and $0.39 (diluted) in the second quarter 2005, and
up from $0.34 (basic and diluted) in the first quarter 2006. In the second
quarter 2006, the Corporation recorded a credit for loan losses (reduction in
expense) of $300,000, as compared to loan loss expense of $375,000 in the second
quarter 2005 and $600,000 in the first quarter 2006. The credit for loan losses
in the second quarter 2006 was mainly the result of the commercial loan workout
situations previously mentioned.
TABLE I - QUARTERLY FINANCIAL DATA
(IN THOUSANDS)
JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
2006 2006 2005 2005 2005 2005
-------- -------- -------- --------- -------- --------
Interest income $15,984 $15,863 $15,936 $15,571 $14,908 $14,693
Interest expense 7,566 7,278 7,149 6,426 6,155 5,957
------- ------- ------- ------- ------- -------
Interest margin 8,418 8,585 8,787 9,145 8,753 8,736
(Credit) provision for loan losses (300) 600 901 375 375 375
------- ------- ------- ------- ------- -------
Interest margin after provision for loan losses 8,718 7,985 7,886 8,770 8,378 8,361
Other income 1,937 1,789 1,895 2,149 1,889 1,703
Securities gains (losses) 1,333 1,315 (586) 393 929 1,066
Gain from sale of credit card loans -- -- 1,906 -- -- --
Other expenses 7,976 7,843 7,358 7,303 7,173 7,128
------- ------- ------- ------- ------- -------
Income before income tax provision 4,012 3,246 3,743 4,009 4,023 4,002
Income tax provision 813 426 639 722 725 707
------- ------- ------- ------- ------- -------
Net income $ 3,199 $ 2,820 $ 3,104 $ 3,287 $ 3,298 $ 3,295
======= ======= ======= ======= ======= =======
Net income per share - basic $ 0.39 $ 0.34 $ 0.37 $ 0.40 $ 0.40 $ 0.40
======= ======= ======= ======= ======= =======
Net income per share - diluted $ 0.39 $ 0.34 $ 0.37 $ 0.39 $ 0.39 $ 0.39
======= ======= ======= ======= ======= =======
The number of shares used in calculating net income per share for each quarter
presented in Table I reflects the retroactive effect of stock dividends.
PROSPECTS FOR THE REMAINDER OF 2006
Management expects 2006 to continue as a year for building on recent capital
investments. The opening of new branches in Jersey Shore (August 2005) and Old
Lycoming Township (March 2006) provide growth opportunities in the Lycoming
County market, especially for expansion of commercial lending and Trust and
financial management relationships. The August 2005 acquisition of Canisteo
Valley Corporation, including the First State Bank branches in Canisteo and
South Hornell, creates opportunities for market development along the northern
border of our current market operations. Excluding any allocation of
administrative costs, the Jersey Shore and Old Lycoming branch operations
generated a pre-tax loss totaling $279,000 in the first six months of 2006,
while Canisteo Valley Corporation and First State Bank produced a modest pre-tax
profit of $140,000. Management expects these investments to result in
profitability growth within the next 2-4 years; however, in the aggregate, these
investments will probably not result in a positive earnings contribution over
the second half of 2006.
The yield curve has been flat or slightly inverted (meaning there is little or
no difference between short-term and long-term interest rates, or that
short-term rates are higher than long-term rates) throughout much of 2005 and
all of 2006 to date. In this type of interest rate environment, there is little
opportunity for the Corporation to earn a positive spread between earnings on
available-for-sale securities and interest costs associated with borrowings.
Accordingly, unless the shape of the yield curve changes from its current
structure, management expects to utilize cash flows from operations to pay off
borrowings as they mature in 2006, effectively reducing total assets and
liabilities. Management hopes to use earnings from growth in loans and deposits
to offset the anticipated reduction in net interest income associated with the
lack of opportunity for a positive spread between earnings on securities and the
interest costs on borrowings.
12
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
On November 30, 2005, the Corporation sold substantially its entire credit card
portfolio, and recognized a gain of $1.9 million. As part of the sale, the
Corporation continued to provide servicing of these credit cards through May 18,
2006. The Corporation recorded a $280,000 liability for the estimated direct
costs of providing servicing, net of servicing fees to be received from the
buyer. Also in 2005, the Corporation recorded an accrual of $175,000 for
estimated losses associated with credit card receivables sold with recourse. The
$1.9 million gain recorded in 2005 was net of the servicing and recourse
liabilities. Through June 30, 2006, direct servicing costs, net of fees
received, have totaled $43,000, with a remaining liability balance for servicing
of $237,000. Losses charged against the recourse liability through June 30,
2006, have totaled $58,000, with a remaining liability balance of $117,000. The
liabilities for servicing and recourse losses are included in accrued interest
and other liabilities in the consolidated balance sheet. Management expects to
pay for additional expenditures related to servicing the credit card portfolio,
and for losses on receivables sold with recourse, over the remainder of 2006,
with the total amount of the expenditures to be determined by mid-December 2006
(the Corporation's recourse obligation expires as of November 30, 2006).
Management expects to record the difference between the total amount of the
additional servicing expenditures and recourse losses, and the related liability
balances, as a gain or loss in the fourth quarter 2006.
Another major variable that affects the Corporation's earnings is securities
gains and losses, particularly from bank stocks and other equity securities.
Management's decisions regarding sales of securities are based on a variety of
factors, with the overall goal of maximizing portfolio return over a long-term
horizon. It is difficult to predict, with much precision, the amount of net
securities gains and losses that will be realized throughout the remainder of
2006.
CRITICAL ACCOUNTING POLICIES
The presentation of financial statements in conformity with U.S. generally
accepted accounting principles requires management to make estimates and
assumptions that affect many of the reported amounts and disclosures. Actual
results could differ from these estimates.
A material estimate that is particularly susceptible to significant change is
the determination of the allowance for loan losses. Management believes that the
allowance for loan losses is adequate and reasonable. The Corporation's
methodology for determining the allowance for loan losses is described in a
separate section later in Management's Discussion and Analysis. Given the very
subjective nature of identifying and valuing loan losses, it is likely that
well-informed individuals could make materially different assumptions, and
could, therefore, calculate a materially different allowance value. While
management uses available information to recognize losses on loans, changes in
economic conditions may necessitate revisions in future years. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Corporation's allowance for loan losses. Such agencies
may require the Corporation to recognize adjustments to the allowance based on
their judgments of information available to them at the time of their
examination.
Another material estimate is the calculation of fair values of the Corporation's
debt securities. The Corporation receives estimated fair values of debt
securities from an independent valuation service, or from brokers. In developing
these fair values, the valuation service and the brokers use estimates of cash
flows, based on historical performance of similar instruments in similar
interest rate environments. Based on experience, management is aware that
estimated fair values of debt securities tend to vary among brokers and other
valuation services. Accordingly, when selling debt securities, management
typically obtains price quotes from more than one source. The large majority of
the Corporation's securities are classified as available-for-sale. Accordingly,
these securities are carried at fair value on the consolidated balance sheet,
with unrealized gains and losses excluded from earnings and reported separately
through accumulated other comprehensive income (included in stockholders'
equity).
NET INTEREST MARGIN
The Corporation's primary source of operating income is represented by the net
interest margin. The net interest margin is equal to the difference between the
amounts of interest income and interest expense. Tables II, III and IV include
information regarding the Corporation's net interest margin for 2006 and 2005.
In each of these tables, the amounts of interest income earned on tax-exempt
securities and loans have been adjusted to a fully taxable-equivalent basis.
Accordingly, the net interest margin amounts reflected in these tables exceed
the amounts presented in the consolidated financial statements. The discussion
that follows is based on amounts in the Tables.
13
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
The net interest margin, on a tax-equivalent basis, of $18,379,000 in 2006
decreased $699,000, or 3.7% from 2005. As reflected in Table IV, interest rate
changes had the most significant impact on net interest margin with reductions
of $1,753,000 in the net interest margin compared to 2005. The reduction in net
interest income from higher rates reflects the Corporation's "liability
sensitive" position, that is, deposits and borrowings reprice more quickly, on
average, than the earning assets base of loans and available-for-sale
securities. Table IV also shows that volume increases had the effect of
increasing net interest income of $1,054,000 in 2006 compared to 2005, and was
primarily attributed to increased volume of loans. As presented in Table III,
the "Interest Rate Spread" (excess of average rate of return on interest-bearing
assets over average cost of funds on interest-bearing liabilities) tightened
further to 2.98% compared to 3.22% for the year ended December 31, 2005 and
3.28% for the first six months of 2005.
INTEREST INCOME AND EARNING ASSETS
Interest income increased 6.5%, to $33,223,000 in 2006 from $31,190,000 in 2005.
Interest and fees from loans increased $2,720,000, or 14.3%, while income from
available-for-sale securities decreased $775,000, or 6.4%.
As indicated in Table III, average available-for-sale securities in the first
six months of 2006 amounted to $406,914,000, a decrease of 9.5% from the first
six months of 2005. Proceeds from sales and maturities of securities have been
used, in part, to help fund the continued growth in loans. Also, since
short-term interest rates have been rising faster than long-term rates, there
have been few opportunities to purchase mortgage-backed securities or other
bonds at spreads sufficient to justify the applicable interest rate risk. The
average rate of return on available-for-sale securities of 5.59% for the first
six months of 2006 was higher than the 5.41% level in the first six months of
2005, and the 5.35% rate for the year ended December 31, 2005. The higher
average yield on available-for-sale securities is attributed, in part, to the
sale of certain lower yielding securities in the fourth quarter 2005. Such lower
yielding securities were acquired in 2003 and 2004, when market yields were
lower than current conditions. In addition, increased holdings of adjustable
rate trust preferred securities in 2005 and 2006 have contributed to the
increased yield since the yield on these securities generally rises consistent
with short-term rates.
The average balance of gross loans increased 8.9% to $653,577,000 for the first
six months of 2006 from $600,163,000 in the first six months of 2005. The
acquisition of First State Bank in the third quarter of 2005 provided
$22,128,000 of the growth in average gross loans compared to the previous year.
Excluding loans acquired from First State Bank, average loans increased 5.2%.
The average rate of return on loans was 6.73% in the first six months of 2006,
as compared to 6.41% in first six months of 2005, and 6.53% for the year 2005.
INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES
Interest expense rose $2,732,000, or 22.6%, to $14,844,000 in 2006 from
$12,112,000 in 2005. Table III reflects the current trend in interest rates
incurred on liabilities, as the overall cost of funds on interest-bearing
liabilities rose to 3.30% for the first six months of of 2006, from 2.81% for
the year ended December 31, 2005, and 2.69% for the first six months of 2005. In
addition, Table III shows the impact of rising short-term interest rates, by
category, on the Corporation's primary sources of funds: (1) money market
accounts, which increased to an average rate of 3.18% in 2006 compared to 1.86%
in 2005, (2) interest checking accounts, which increased to an average rate of
2.60% from .63%, (3) certificates of deposit, which increased to an average rate
of 3.75% from 3.14%, (4) short-term borrowings, which rose to an average rate of
3.92% from 2.46%. The average rate incurred on long-term borrowings remained
substantially unchanged, and reflects the replacement of such borrowings with
either short-term instruments or repayment using the proceeds from the
available-for-sale securities portfolio.
From Table III, you can calculate that total average deposits (interest-bearing
and noninterest-bearing) increased to $752,127,000 in the first six months of
2006, or a 10.9% increase, from $678,209,000 in the first six months of 2005.
The increase in the average deposit balances for the first six months of each
year has been significantly impacted by fluctuations in deposits from municipal
and non-profit customers. In addition, the acquisition of First State Bank
provided an increase in average deposits of $26,627,000 in 2006 compared to
2005. The most significant increases in average deposits by categories were
$34,490,000 for interest checking accounts (90.7%), $25,618,000 for certificates
of deposit (13.7%), $20,562,000 (25.8%) for demand deposit accounts. Most of the
increase in interest checking balances is attributable to one local governmental
customer, for which the Corporation became the primary depository institution in
September 2005. Average money market account balances decreased $13,993,000, or
7.2%, in the first six months of 2006 as compared to the same period in 2005, as
some depositors' have moved balances to higher-rate certificates of deposit or
withdrawn funds to invest in equities.
14
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
The combined average total short-term and long-term borrowed funds decreased
$54,282,000 to $255,225,000 in the first six months of 2006 from $309,507,000 in
the first six months of 2005. Throughout most of 2005 and 2006, the yield curve
has been flat or inverted, limiting opportunities for the Corporation to earn a
positive spread over interest costs associated with maintaining borrowed funds.
Accordingly, the Corporation has been paying off borrowings as they mature, or
rolling them over at terms of less than one year. The pace of such changes or
trends is reflected in the Corporation's consolidated balance sheet, as total
short-term borrowings increased to $50,950,000 at June 30, 2006 from $34,734,000
at December 31, 2005, while total long-term borrowings decreased to $180,889,000
at June 30, 2006 from $232,205,000 at December 31, 2005.
15
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
TABLE II - ANALYSIS OF INTEREST INCOME AND EXPENSE
SIX MONTHS ENDED
JUNE 30,
----------------- INCREASE/
(IN THOUSANDS) 2006 2005 (DECREASE)
------- ------- ----------
INTEREST INCOME
Available-for-sale securities:
Taxable $ 7,815 $ 7,820 $ (5)
Tax-exempt 3,467 4,237 (770)
------- ------- -------
Total available-for-sale securities 11,282 12,057 (775)
------- ------- -------
Held-to-maturity securities,
Taxable 12 12 --
Interest-bearing due from banks 35 13 22
Federal funds sold 96 30 66
Loans:
Taxable 20,861 18,324 2,537
Tax-exempt 937 754 183
------- ------- -------
Total loans 21,798 19,078 2,720
------- ------- -------
Total Interest Income 33,223 31,190 2,033
------- ------- -------
INTEREST EXPENSE
Interest checking 936 118 818
Money market 2,828 1,782 1,046
Savings 172 141 31
Certificates of deposit 3,952 2,906 1,046
Individual Retirement Accounts 2,416 2,104 312
Other time deposits 3 3 --
Short-term borrowings 1,049 557 492
Long-term borrowings 3,488 4,501 (1,013)
------- ------- -------
Total Interest Expense 14,844 12,112 2,732
------- ------- -------
Net Interest Income $18,379 $19,078 $ (699)
======= ======= =======
Note: Interest income from tax-exempt securities and loans has been adjusted to
a fully tax-equivalent basis, using the Corporation's marginal federal income
tax rate of 34%.
16
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
TABLE III - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES
6 MONTHS YEAR 6 MONTHS
ENDED RATE OF ENDED RATE OF ENDED RATE OF
6/30/2006 RETURN/ 12/31/2005 RETURN/ 6/30/2005 RETURN/
AVERAGE COST OF AVERAGE COST OF AVERAGE COST OF
(DOLLARS IN THOUSANDS) BALANCE FUNDS % BALANCE FUNDS % BALANCE FUNDS %
---------- ------- ---------- ------- ---------- -------
EARNING ASSETS
Available-for-sale securities, at amortized cost:
Taxable $ 299,648 5.26% $ 319,230 4.83% $ 328,307 4.80%
Tax-exempt 107,266 6.52% 123,295 6.72% 121,179 7.05%
---------- ---- ---------- ---- ---------- ----
Total available-for-sale securities 406,914 5.59% 442,525 5.35% 449,486 5.41%
---------- ---- ---------- ---- ---------- ----
Held-to-maturity securities,
Taxable 420 5.76% 427 5.85% 430 5.63%
Interest-bearing due from banks 1,973 3.58% 1,293 2.63% 1,089 2.41%
Federal funds sold 3,388 5.71% 2,600 3.73% 2,242 2.70%
Loans:
Taxable 622,647 6.76% 592,227 6.55% 576,291 6.41%
Tax-exempt 30,930 6.11% 26,117 6.25% 23,872 6.37%
---------- ---- ---------- ---- ---------- ----
Total loans 653,577 6.73% 618,344 6.53% 600,163 6.41%
---------- ---- ---------- ---- ---------- ----
Total Earning Assets 1,066,272 6.28% 1,065,189 6.03% 1,053,410 5.97%
Cash 19,351 9,014 8,975
Unrealized gain/loss on securities 4,757 11,197 13,385
Allowance for loan losses (8,792) (7,297) (6,997)
Bank premises and equipment 23,519 19,247 17,452
Intangible Asset - Core Deposit Intangible 410 169 --
Intangible Asset - Goodwill 2,919 983 --
Other assets 38,036 46,117 44,648
---------- ---------- ----------
Total Assets $1,146,472 $1,144,619 $1,130,873
========== ========== ==========
INTEREST-BEARING LIABILITIES
Interest checking $ 72,519 2.60% $ 46,408 1.15% $ 38,029 0.63%
Money market 179,277 3.18% 188,507 2.20% 193,270 1.86%
Savings 63,701 0.54% 60,203 0.50% 57,325 0.50%
Certificates of deposit 212,494 3.75% 197,165 3.26% 186,876 3.14%
Individual Retirement Accounts 122,544 3.98% 121,013 3.46% 121,643 3.49%
Other time deposits 1,065 0.57% 1,152 0.52% 1,101 0.57%
Short-term borrowings 54,004 3.92% 44,267 2.80% 45,643 2.46%
Long-term borrowings 201,221 3.50% 254,987 3.47% 263,864 3.44%
---------- ---- ---------- ---- ---------- ----
Total Interest-bearing Liabilities 906,825 3.30% 913,702 2.81% 907,751 2.69%
Demand deposits 100,527 87,956 79,965
Other liabilities 7,915 10,496 10,748
---------- ---------- ----------
Total Liabilities 1,015,267 1,012,154 998,464
---------- ---------- ----------
Stockholders' equity, excluding other
comprehensive income/loss 128,088 125,076 123,575
Other comprehensive income/loss 3,117 7,389 8,834
---------- ---------- ----------
Total Stockholders' Equity 131,205 132,465 132,409
---------- ---------- ----------
Total Liabilities and Stockholders' Equity $1,146,472 $1,144,619 $1,130,873
========== ========== ==========
Interest Rate Spread 2.98% 3.22% 3.28%
Net Interest Income/Earning Assets 3.48% 3.62% 3.65%
(1) Rates of return on tax-exempt securities and loans are presented on a fully
taxable-equivalent basis.
(2) Nonaccrual loans have been included with loans for the purpose of analyzing
net interest earnings.
17
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
TABLE IV - ANALYSIS OF VOLUME AND RATE CHANGES
YTD ENDED 6/30/06 VS. 6/30/05
-------------------------------
CHANGE IN CHANGE IN TOTAL
(IN THOUSANDS) VOLUME RATE CHANGE
--------- --------- -------
EARNING ASSETS
Available-for-sale securities:
Taxable $ (714) $ 709 $ (5)
Tax-exempt (464) (306) (770)
------- ------- -------
Total available-for-sale securities (1,178) 403 (775)
------- ------- -------
Held-to-maturity securities,
Taxable -- -- --
Interest-bearing due from banks 14 8 22
Federal funds sold 20 46 66
Loans:
Taxable 1,521 1,016 2,537
Tax-exempt 215 (32) 183
------- ------- -------
Total loans 1,736 984 2,720
------- ------- -------
Total Interest Income 592 1,441 2,033
------- ------- -------
INTEREST-BEARING LIABILITIES
Interest checking 182 636 818
Money market (138) 1,184 1,046
Savings 17 14 31
Certificates of deposit 430 616 1,046
Individual Retirement Accounts 16 296 312
Other time deposits -- -- --
Short-term borrowings 116 376 492
Long-term borrowings (1,085) 72 (1,013)
------- ------- -------
Total Interest Expense (462) 3,194 2,732
------- ------- -------
Net Interest Income $ 1,054 $(1,753) $ (699)
======= ======= =======
(1) Changes in income on tax-exempt securities and loans are presented on a
fully taxable-equivalent basis, using the Corporation's marginal federal
income tax rate of 34%.
(2) The change in interest due to both volume and rates has been allocated to
volume and rate changes in proportion to the relationship of the absolute
dollar amount of the change in each.
18
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
TABLE V - COMPARISON OF NON-INTEREST INCOME
(IN THOUSANDS)
6 MONTHS ENDED
-------------------
JUNE 30, JUNE 30,
2006 2005
-------- --------
Service charges on deposit accounts $ 963 $ 725
Service charges and fees 174 196
Trust and financial management revenue 1,058 1,050
Insurance commissions, fees and premiums 260 184
Increase in cash surrender value of life insurance 300 279
Fees related to credit card operation -- 390
Other operating income 971 768
------ ------
Total other operating income, before realized
gains on securities, net 3,726 3,592
Realized gains on securities, net 2,648 1,995
------ ------
Total Other Income $6,374 $5,587
====== ======
Total non-interest income increased $787,000, or 14.1%, in 2006 compared to
2005, primarily related to an increase in net realized gains on securities of
$653,000. Securities gains are discussed in the Earnings Overview section of
Management's Discussion and Analysis. Other items of significance are as
follows:
- Service charges on deposit accounts increased $238,000, or 32.8%, in 2006
as compared to 2005. Overdraft charges represent the primary increase year
over year with $114,000, of which $41,000 represents overdraft charges to
customers of First State Bank. The aggregate increase includes
approximately $85,000 associated with a rate change initiated in August
2005.
- Fees related to credit card operation decreased $390,000 to due to the sale
of the Citizens & Northern Bank's credit card operations in the fourth
quarter 2005.
- Other operating income increased $260,000, or 36.6%, in 2006 over 2005.
Included in this category were an increase of $119,000 in dividend income
on Federal Home Loan Bank of Pittsburgh stock, mainly due to a change in
the record date for such distributions, and an increase of $54,000 in debit
and ATM card fees.
TABLE VI- COMPARISON OF NON-INTEREST EXPENSE
(IN THOUSANDS)
6 MONTHS ENDED
-------------------
JUNE 30, JUNE 30,
2006 2005
-------- --------
Salaries and wages $ 6,686 $ 5,923
Pensions and other employee benefits 2,148 1,985
Occupancy expense, net 1,140 925
Furniture and equipment expense 1,318 1,298
Pennsylvania shares tax 488 412
Other expense 4,039 3,758
------- -------
Total Other Expense $15,819 $14,301
======= =======
Salaries and wages increased $763,000, or 12.9%, for 2006 compared to 2005. The
increase in salaries expense relates primarily to the increase in the number of
full-time equivalent employees, which increased 12.1%, to 376 as of June 30,
2006 from 335 as of June 30, 2005. For 2006, new branch operations at Jersey
Shore, Old Lycoming Township and First State Bank added $475,000 to salaries
expense.
19
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
Pension and other employee benefits associated with the new branch operations
added $128,000 in 2006 to this category. Pension plan expense increased 37.3%,
or $62,000, in 2006 due to lower investment returns for 2005 than included in
the actuarial assumptions, as well as increases in the number of employees and
covered compensation, which include employees from First State Bank.
Occupancy expense increased $215,000, or 23.2%, in 2006 compared to 2005. Total
occupancy costs in 2006 include $129,000 for the Jersey Shore, Old Lycoming and
First State Bank locations, and $93,000 for the new administration building in
Wellsboro (which opened in March 2006).
Other (noninterest) expense increased $281,000 or 7.5% in 2006 compared to 2005.
The increase in other expenses includes $362,000 for First State Bank in 2006,
including $64,000 for the amortization of core deposit intangibles. In addition,
in the second quarter 2006, other expense included a one-time charge of $169,000
for impairment of leasehold improvements from early termination of a property
lease. Other expenses include legal and professional fees, as well as expenses
associated with maintaining and preparing other real estate (ORE) properties for
sale. In 2006, attorney fees related to collection activities on a large
commercial credit decreased $98,000, and ORE properties expenses decreased
$73,000 in 2006 compared to 2005. In addition, 2005 costs associated with the
2005 NASDAQ Small Cap registration of $34,000 did not recur in 2006; NASDAQ
annual fees were at the same level in both years.
FINANCIAL CONDITION
Significant changes in the average balances of the Corporation's earning assets
and interest-bearing liabilities are described in the "Net Interest Margin"
section of Management's Discussion and Analysis. Also included in the Net
Interest Margin section is a discussion of management's decision to reduce the
Corporation's balances of available-for-sale securities and borrowings, in
response to the flat and inverted yield curve prevalent throughout much of 2005
and 2006. The allowance for loan losses and stockholders' equity are discussed
in separate sections of Management's Discussion and Analysis.
As reflected in the consolidated balance sheet, total cash and cash equivalents
as of June 30, 2006 amounted to $42,084,000, up from $26,446,000 at December 31,
2005. The level of cash and cash equivalents maintained at June 30, 2006 is
higher than the average level maintained by the Corporation throughout the last
several years. The high cash and cash equivalents balance resulted in part from
proceeds from sales of available-for-sale securities in June that had not been
reinvested in other securities or used for origination of loans. Management
expects to use some of the cash to help pay off borrowings totaling $12,200,000
that mature in the third quarter 2006. Also, management may utilize some of the
cash to repurchase shares of its common stock pursuant to a Board-approved plan
that ends August 31, 2006, and which would permit the Corporation to acquire
additional shares (in excess of purchases completed through June 30, 2006) at a
total cost up to approximately $12,290,000.
The Corporation has completed several planned building construction projects
during the first six months of 2006, which required additional expenditures for
completion costs, furnishings, and related equipment of approximately
$2,332,000. Additional capital expenditures for the remainder of 2006 are
expected to be less than $2,500,000, mainly for technology-related and other
equipment upgrades and replacements.
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses reflects probable losses resulting from the
analysis of individual loans and historical loss experience, as modified for
identified trends and concerns, for each loan category. The historical loan loss
experience element is determined based on the ratio of net charge-offs to
average loan balances over a three-year period, for each significant type of
loan, modified for qualitative risk adjustment factors identified by management
for each type of loan. The charge-off ratio and qualitative factors are then
applied to the current outstanding loan balance for each type of loan (net of
other loans that are individually evaluated).
20
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
Effective in 2005, management changed its process for determining and disclosing
the components of the allowance for loan losses. A management committee
evaluates qualitative factors, including economic conditions, lending policies,
changes in the portfolio, risk profile of the portfolio, competition and
regulatory requirements, and other factors. This analysis is performed
separately for the following categories of lending activity: commercial,
mortgage and consumer. Based on the results of these evaluations, allocations
have been made to the components of the allowance shown in Table VIII. For
periods prior to 2005, Table VIII includes the portion of the allowance
determined by management's subjective assessment of economic conditions and
other factors in the unallocated component of the allowance. Primarily as a
result of this change in process, Table VIII shows the amounts allocated to the
allowance for commercial, consumer mortgage and consumer loans at June 30, 2006
and December 31, 2005 have increased in comparison to the corresponding amounts
at December 31, 2004 and previous years, while the unallocated portion of the
allowance was $550,000 at June 30, 2006 and $0 at December 31, 2005, down from
$2,578,000 at December 31, 2004.
In the second quarter 2006, settlements were reached related to two large
commercial loan relationships that had been classified as impaired. Total
charge-offs related to these relationships were $568,000, leading to a
comparatively high level of net charge-offs for the six months ended June 30,
2006 (as shown in Table VII) of $599,000. As of the end of the first quarter
2006, the estimated allowance for loan losses associated with these two
relationships totaled $1,018,000, with the favorable difference of $450,000
between management's previous estimated losses and the actual charge-off amounts
contributing to a reduction in the provision for loan losses during the second
quarter 2006. These favorable differences led to a lower provision for loan
losses of $300,000 for the first six months of 2006 as compared to $750,000 for
the same period in 2005, with a credit (negative) provision for loan losses of
$300,000 for the second quarter 2006.
As indicated in Table IX, total impaired loans fell to $5,673,000 at June 30,
2006 from $8,967,000 at March 31, 2006 and $8,216,000 at December 31, 2005. In
total, the valuation allowance related to impaired loans fell to $1,530,000 at
June 30, 2006, from $2,603,000 at March 31, 2006 and $2,374,000 at December 31,
2005. Table IX also shows that the amount of loans classified as non-accrual
fell to $5,901,000 at June 30, 2006, from $9,176,000 at March 31, 2006 and
$6,365,000 at December 31, 2005. The reductions in impaired and non-accrual loan
balances resulted mainly from the settlements of the two large commercial loan
relationships discussed above. In the first quarter 2006, a commercial loan with
a balance of $2,025,000 was identified as impaired, and an estimated valuation
allowance of $500,000 was established. As of June 30, 2006, the outstanding
balance of this loan was $1,996,000 and management's estimate of loss was
lowered to $400,000. Management believes it has been conservative in its
decisions concerning identification of impaired loans, estimates of loss and
non-accrual status. However, the actual losses realized from these relationships
could vary materially from the allowances calculated as of June 30, 2006.
Management continues to closely monitor its commercial loan relationships for
possible credit losses, and will adjust its estimates of loss and decisions
concerning non-accrual status, if appropriate.
Tables VII, VIII, IX and X present an analysis of the allowance for loan losses,
the allocation of the allowance, information concerning impaired and past due
loans and a five-year summary of loans by type.
21
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
TABLE VII- ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
(IN THOUSANDS)
SIX MONTHS SIX MONTHS
ENDED ENDED YEARS ENDED DECEMBER 31,
JUNE 30, JUNE 30, ------------------------------------------
2006 2005 2005 2004 2003 2002 2001
---------- ---------- ------ ------ ------ ------ ------
Balance, beginning of year $8,361 $6,787 $6,787 $6,097 $5,789 $5,265 $5,291
------ ------ ------ ------ ------ ------ ------
Charge-offs:
Real estate loans 443 175 264 375 168 123 144
Installment loans 99 78 224 217 326 116 138
Credit cards and related plans 18 114 198 178 171 190 200
Commercial and other loans 171 202 298 16 303 123 231
------ ------ ------ ------ ------ ------ ------
Total charge-offs 731 569 984 786 968 552 713
------ ------ ------ ------ ------ ------ ------
Recoveries:
Real estate loans -- 12 14 3 75 30 6
Installment loans 35 33 61 32 52 30 27
Credit cards and related plans 17 14 30 23 17 18 20
Commercial and other loans 80 10 50 18 32 58 34
------ ------ ------ ------ ------ ------ ------
Total recoveries 132 69 155 76 176 136 87
------ ------ ------ ------ ------ ------ ------
Net charge-offs 599 500 829 710 792 416 626
Allowance for loan losses
recorded in acquisition -- -- 377 -- -- -- --
Provision for loan losses 300 750 2,026 1,400 1,100 940 600
------ ------ ------ ------ ------ ------ ------
Balance, end of period $8,062 $7,037 $8,361 $6,787 $6,097 $5,789 $5,265
====== ====== ====== ====== ====== ====== ======
TABLE VIII - ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES BY TYPE
(IN THOUSANDS)
AS OF AS OF DECEMBER 31,
JUNE 30, ------------------------------------------
2006 2005 2004 2003 2002 2001
-------- ------ ------ ------ ------ ------
Commercial $2,368 $2,705 $1,909 $1,578 $1,315 $ 852
Consumer mortgage 3,047 2,806 513 456 460 188
Impaired loans 1,530 2,374 1,378 1,542 1,877 1,736
Consumer 567 476 409 404 378 302
Unallocated 550 -- 2,578 2,117 1,759 2,187
------ ------ ------ ------ ------ ------
Total Allowance $8,062 $8,361 $6,787 $6,097 $5,789 $5,265
====== ====== ====== ====== ====== ======
TABLE IX - PAST DUE AND IMPAIRED LOANS
(IN THOUSANDS)
JUNE 30, MAR. 31, DEC. 31, DEC. 31, DEC. 31,
2006 2006 2005 2004 2003
-------- -------- -------- -------- --------
Impaired loans without a valuation allowance $ 448 $ 819 $ 910 $3,552 $ 114
Impaired loans with a valuation allowance 5,225 8,148 7,306 4,709 4,507
------ ------ ------ ------ ------
Total impaired loans $5,673 $8,967 $8,216 $8,261 $4,621
====== ====== ====== ====== ======
Valuation allowance related to impaired loans $1,530 $2,603 $2,374 $1,378 $1,542
Total nonaccrual loans $5,901 $9,176 $6,365 $7,796 $1,145
Total loans past due 90 days or more and
still accruing $1,035 $1,139 $1,369 $1,307 $2,546
22
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
TABLE X - SUMMARY OF LOANS BY TYPE
(IN THOUSANDS)
AS OF DECEMBER 31,
JUNE 30, ----------------------------------------------------
2006 2005 2004 2003 2002 2001
-------- -------- -------- -------- -------- --------
Real estate - construction $ 9,160 $ 5,552 $ 4,178 $ 2,856 $ 103 $ 1,814
Real estate - residential mortgage 372,345 361,857 347,705 330,807 292,136 245,997
Real estate - commercial mortgage 177,263 153,661 128,073 100,240 78,317 60,267
Consumer 31,155 31,559 31,702 33,977 31,532 29,284
Agricultural 2,373 2,340 2,872 2,948 3,024 2,344
Commercial 38,767 69,396 43,566 34,967 30,874 24,696
Other 1,628 1,871 1,804 1,183 2,001 1,195
Political subdivisions 25,665 27,063 19,713 17,854 13,062 13,479
Lease receivables -- -- -- 65 96 152
-------- -------- -------- -------- -------- --------
Total 658,356 653,299 579,613 524,897 451,145 379,228
Less: allowance for loan losses (8,062) (8,361) (6,787) (6,097) (5,789) (5,265)
-------- -------- -------- -------- -------- --------
Loans, net $650,294 $644,938 $572,826 $518,800 $445,356 $373,963
======== ======== ======== ======== ======== ========
RECENT ACCOUNTING PRONOUNCEMENT
The Financial Accounting Standards Board recently issued FASB Interpretation No.
48, "Accounting for Uncertainty in Income Taxes." This pronouncement, which will
be effective for the Corporation in 2007, clarifies accounting for income tax
positions that are either: (1) complex, and therefore, subject to varied
interpretation, or (2) controversial. Management does not expect this
pronouncement to have a significant impact on the Corporation's financial
position or results of operations in 2007.
DERIVATIVE FINANCIAL INSTRUMENTS
The Corporation has utilized derivative financial instruments related to a
certificate of deposit product called the "Index Powered Certificate of Deposit"
(IPCD). IPCDs have a term of 5 years, with interest paid at maturity based on
90% of the appreciation (as defined) in the S&P 500 index. There is no
guaranteed interest payable to a depositor of an IPCD - however, assuming an
IPCD is held to maturity, a depositor is guaranteed the return of his or her
principal, at a minimum. In 2004, the Corporation stopped originating new IPCDs,
but continues to maintain and account for IPCDs and the related derivative
contracts entered into between 2001 and 2004.
Statement of Financial Accounting Standards No. 133 requires the Corporation to
separate the amount received from each IPCD issued into 2 components: (1) an
embedded derivative, and (2) the principal amount of each deposit. Embedded
derivatives are derived from the Corporation's obligation to pay each IPCD
depositor a return based on appreciation in the S&P 500 index. Embedded
derivatives are carried at fair value, and are included in other liabilities in
the consolidated balance sheet. Changes in fair value of the embedded derivative
are included in other expense in the consolidated income statement. The
difference between the contractual amount of each IPCD issued, and the amount of
the embedded derivative, is recorded as the initial deposit (included in
interest-bearing deposits in the consolidated balance sheet). Interest expense
is added to principal ratably over the term of each IPCD at an effective
interest rate that will increase the principal balance to equal the contractual
IPCD amount at maturity.
In connection with IPCD transactions, the Corporation has entered into Equity
Indexed Call Option (Swap) contracts with the Federal Home Loan Bank of
Pittsburgh (FHLB-Pittsburgh). Under the terms of the Swap contracts, the
Corporation must pay FHLB-Pittsburgh quarterly amounts calculated based on the
contractual amount of IPCDs issued times a negotiated rate. In return,
FHLB-Pittsburgh is obligated to pay the Corporation, at the time of maturity of
the IPCDs, an amount equal to 90% of the appreciation (as defined) in the S&P
500 index. If the S&P 500 index does not appreciate over the term of the related
IPCDs, the FHLB-Pittsburgh would make no payment to the Corporation. The effect
of the Swap contracts is to limit the Corporation's cost of IPCD funds to the
market rate of interest paid to FHLB-Pittsburgh. (In addition, the Corporation
paid a fee of 0.75% to a consulting firm at inception of each deposit. These
fees are being amortized to interest expense over the term of the IPCDs.) Swap
assets or liabilities are carried at fair value, and included in other assets or
other liabilities in the consolidated balance sheet. Changes in fair value of
swap liabilities are included in other expense in the consolidated income
statement.
23
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
Amounts recorded as of June 30, 2006 and December 31, 2005, and for the first
six months of 2006 and 2005, related to IPCDs are as follows (in thousands):
JUNE 30, DEC. 31,
2006 2005
-------- --------
Contractual amount of IPCDs (equal to notional
amount of Swap contracts) $3,665 $3,952
Carrying value of IPCDs 3,540 3,733
Carrying value of embedded derivative liabilities 532 558
Carrying value of Swap contract (assets)
liabilities (388) (346)
6 MONTHS 6 MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
2006 2005
-------- --------
Interest expense $94 $78
Other expense 8 (5)
LIQUIDITY
Liquidity is the ability to quickly raise cash at a reasonable cost. An adequate
liquidity position permits the Corporation to pay creditors, compensate for
unforeseen deposit fluctuations and fund unexpected loan demand. The Corporation
maintains overnight borrowing facilities with several correspondent banks that
provide a source of day-to-day liquidity. Also, the Corporation maintains
borrowing facilities with FHLB - Pittsburgh, secured by mortgage loans and
various investment securities. At June 30, 2006, the Corporation had unused
borrowing availability with correspondent banks and the Federal Home Loan Bank
of Pittsburgh totaling approximately $177,000,000. Additionally, the Corporation
uses repurchase agreements placed with brokers to borrow funds secured by
investment assets, and uses "RepoSweep" arrangements to borrow funds from
commercial banking customers on an overnight basis. Further, if required to
raise cash in an emergency situation, the Corporation could sell non-pledged
investment securities to meet its obligations. At June 30, 2006, the carrying
value of non-pledged securities was $121,495,000.
Management believes the combination of its strong capital position (discussed in
the next section), ample available borrowing facilities and substantial
non-pledged securities portfolio have placed the Corporation in a position of
minimal short-term and long-term liquidity risk.
STOCKHOLDERS' EQUITY AND CAPITAL ADEQUACY
The Corporation and the subsidiary banks (Citizens & Northern Bank and First
State Bank) are subject to various regulatory capital requirements administered
by the federal banking agencies. The Corporation's consolidated capital ratios
at June 30, 2006 are as follows:
Total capital to risk-weighted assets 17.58%
Tier 1 capital to risk-weighted assets 16.12%
Tier 1 capital to average total assets 11.00%
Management expects the Corporation and the subsidiary banks to maintain capital
levels that exceed the regulatory standards for well-capitalized institutions
for the next 12 months and for the foreseeable future, including the effects of
any repurchases of common stock that may occur (as discussed in the "Financial
Condition" section of Management's Discussion and Analysis).
24
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
As shown in the consolidated balance sheet, Accumulated Other Comprehensive
(Loss) Income fell to ($89,000) at June 30, 2006 from $4,698,000 at December 31,
2005. The Accumulated Other Comprehensive Income balance represents unrealized
gains and losses on available-for-sale securities, net of deferred income tax.
Rising interest rates, which reduce the market prices of debt securities, were a
significant factor in the decline in Accumulated Other Comprehensive (Loss)
Income at June 30, 2006 compared to December 31, 2005, as well as the effect of
gains realized from the sales of securities during the same period.
INFLATION
The Corporation is significantly affected by the Federal Reserve Board's efforts
to control inflation through changes in interest rates. Since mid-2004, the
Federal Reserve Board has increased the Fed funds target rate 17 times from 1%
to its current level of 5.25%. Further concerns about the possibility of
inflation could lead to further increases in the Fed funds target rate, which
management believes would be detrimental to the corporation's net interest
margin. Although management cannot predict future changes in the rate of
inflation, management monitors the impact of economic trends, including any
indicators of inflationary pressure, in managing interest rate and other
financial risks.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
The Corporation's two major categories of market risk, interest rate risk and
equity securities risk, are discussed in the following sections.
INTEREST RATE RISK
Business risk arising from changes in interest rates is a significant factor in
operating a bank. The Corporation's assets are predominantly long-term, fixed
rate loans and debt securities. Funding for these assets comes principally from
short-term deposits and borrowed funds. Accordingly, there is an inherent risk
of lower future earnings or decline in fair value of the Corporation's financial
instruments when interest rates change.
Citizens & Northern Bank uses a simulation model to calculate the potential
effects of interest rate fluctuations on net interest income and the market
value of portfolio equity. Only assets and liabilities of Citizens & Northern
Bank are included in management's monthly simulation model calculations. Since
Citizens & Northern Bank makes up more than 90% of the Corporation's total
assets and liabilities, and because Citizens & Northern Bank is the source of
the most volatile interest rate risk, management does not consider it necessary
to run the model for the remaining entities within the consolidated group. For
purposes of these calculations, the market value of portfolio equity includes
the fair values of financial instruments, such as securities, loans, deposits
and borrowed funds, and the book values of nonfinancial assets and liabilities,
such as premises and equipment and accrued expenses. The model measures and
projects potential changes in net interest income, and calculates the discounted
present value of anticipated cash flows of financial instruments, assuming an
immediate increase or decrease in interest rates. Management ordinarily runs a
variety of scenarios within a range of plus or minus 50-300 basis points of
current rates.
Citizens & Northern Bank's Board of Directors has established policy guidelines
for acceptable levels of interest rate risk, based on an immediate increase or
decrease in interest rates. The Bank's policy provides limits at +/- 100, 200
and 300 basis points from current rates for fluctuations in net interest income
from the baseline (flat rates) one-year scenario. The policy also limits
acceptable market value variances from the baseline values based on current
rates. As Table XI shows, as of June 30, 2006 and December 31, 2005, the decline
in net interest income and market value exceed the policy threshold marks, if
interest rates rise immediately by 200 or 300 basis points. The "out of policy"
positions are a reflection of the Corporation's liability sensitive position (on
average, deposits and borrowings reprice more quickly than loans and debt
securities). Management has reviewed these positions with the Board of Directors
monthly throughout 2005 and to date in 2006. In addition, management will
continue to evaluate whether to make any changes to asset or liability holdings
in an effort to reduce exposure to rising interest rates.
25
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
The table that follows was prepared using the simulation model described above.
The model makes estimates, at each level of interest rate change, regarding cash
flows from principal repayments on loans and mortgage-backed securities and call
activity on other investment securities. Actual results could vary significantly
from these estimates, which could result in significant differences in the
calculations of projected changes in net interest margin and market value of
portfolio equity. Also, the model does not make estimates related to changes in
the composition of the deposit portfolio that could occur due to rate
competition and the table does not necessarily reflect changes that management
would make to realign the portfolio as a result of changes in interest rates.
TABLE XI - THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES
JUNE 30, 2006 DATA
(IN THOUSANDS)
PERIOD ENDING JUNE 30, 2007
----------------------------------------------------------
INTEREST INTEREST NET INTEREST NII NII
BASIS POINT CHANGE IN RATES INCOME EXPENSE INCOME (NII) % CHANGE RISK LIMIT
--------------------------- -------- -------- ------------ -------- ----------
+300 $67,958 $45,617 $22,341 -23.6% 20.0%
+200 65,996 41,282 24,714 -15.5% 15.0%
+100 63,983 36,946 27,037 -7.6% 10.0%
0 61,862 32,611 29,251 0.0% 0.0%
-100 59,261 28,311 30,950 5.8% 10.0%
-200 56,185 24,194 31,991 9.4% 15.0%
-300 52,819 21,009 31,810 8.7% 20.0%
JUNE 30, 2006 DATA, CONTINUED
(IN THOUSANDS)
MARKET VALUE OF PORTFOLIO EQUITY
AT JUNE 30, 2006
--------------------------------
PRESENT PRESENT PRESENT
VALUE VALUE VALUE
BASIS POINT CHANGE IN RATES EQUITY % CHANGE RISK LIMIT
--------------------------- -------- -------- ----------
+300 $ 48,494 -57.4% 45.0%
+200 69,795 -38.7% 35.0%
+100 91,791 -19.4% 25.0%
0 113,865 0.0% 0.0%
-100 131,103 15.1% 25.0%
-200 142,625 25.3% 35.0%
-300 150,309 32.0% 45.0%
26
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
DECEMBER 31, 2005 DATA
(IN THOUSANDS)
PERIOD ENDING DECEMBER 31, 2006
----------------------------------------------------------
INTEREST INTEREST NET INTEREST NII NII
BASIS POINT CHANGE IN RATES INCOME EXPENSE INCOME (NII) % CHANGE RISK LIMIT
--------------------------- -------- -------- ------------ -------- ----------
+300 $66,381 $43,764 $22,617 -24.8% 20.0%
+200 64,649 39,466 25,183 -16.3% 15.0%
+100 62,850 35,168 27,682 -7.9% 10.0%
0 60,942 30,871 30,071 0.0% 0.0%
-100 58,178 26,573 31,605 5.1% 10.0%
-200 55,000 23,098 31,902 6.1% 15.0%
-300 51,805 19,877 31,928 6.2% 20.0%
MARKET VALUE OF PORTFOLIO EQUITY
AT DECEMBER 31, 2005
--------------------------------
PRESENT PRESENT PRESENT
VALUE VALUE VALUE
BASIS POINT CHANGE IN RATES EQUITY % CHANGE RISK LIMIT
--------------------------- -------- -------- ----------
+300 $ 54,493 -56.8% 45.0%
+200 77,762 -38.3% 35.0%
+100 102,136 -19.0% 25.0%
0 126,029 0.0% 0.0%
-100 142,377 13.0% 25.0%
-200 151,148 19.9% 35.0%
-300 160,867 27.6% 45.0%
EQUITY SECURITIES RISK
The Corporation's equity securities portfolio consists primarily of investments
in stock of banks and bank holding companies located mainly in Pennsylvania. The
Corporation also owns some other stocks and mutual funds. Included in "Other
Equity Securities" in the table that follows are preferred stocks issued by U.S.
Government agencies with a fair value of $2,000,000 at June 30, 2006 and
$1,997,000 at December 31, 2005.
Investments in bank stocks are subject to the risk factors that affect the
banking industry in general, including competition from non-bank entities,
credit risk, interest rate risk and other factors, which could result in a
decline in market prices. Also, losses could occur in individual stocks held by
the Corporation because of specific circumstances related to each bank. Further,
because of the concentration of bank and bank holding companies located in
Pennsylvania, these investments could decline in market value if there is a
downturn in the state's economy.
Equity securities held as of June 30, 2006 and December 31, 2005 are presented
in Table XII.
27
CITIZENS & NORTHERN CORPORATION - FORM 10-Q
TABLE XII -- EQUITY SECURITIES
(IN THOUSANDS)
HYPOTHETICAL HYPOTHETICAL
10% 20%
FAIR DECLINE IN DECLINE IN
AT JUNE 30, 2006 COST VALUE MARKET VALUE MARKET VALUE
---------------- ------- ------- ------------ ------------
Banks and bank holding companies $19,567 $26,354 $(2,635) $(5,271)
Other equity securities 4,045 4,513 (451) (903)
------- ------- ------- -------
Total $23,612 $30,867 $(3,086) $(6,174)
======= ======= ======= =======
HYPOTHETICAL HYPOTHETICAL
10% 20%
FAIR DECLINE IN DECLINE IN
AT DECEMBER 31, 2005 COST VALUE MARKET VALUE MARKET VALUE
-------------------- ------- ------- ------------ ------------
Banks and bank holding companies $20,010 $28,879 $(2,888) $(5,776)
Other equity securities 4,023 4,387 (439) (877)
------- ------- ------- -------
Total $24,033 $33,266 $(3,327) $(6,653)
======= ======= ======= =======
ITEM 4. CONTROLS AND PROCEDURES
The Corporation's management, under the supervision of and with the
participation of the Corporation's Chief Executive Officer and Chief Financial
Officer, has carried out an evaluation of the design and effectiveness of the
Corporation's disclosure controls and procedures as defined in Rule 13a-15(e)
and Rule 15d-15(e) of the Securities Exchange Act of 1934 as of the end of
period covered by this report. Based upon that evaluation, the Chief Executive
Officer and Chief Financial Officer have concluded that, as of the end of such
period, the Corporation's disclosure controls and procedures are effective to
ensure that all material information required to be disclosed in reports the
Corporation files or submits under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported, within the time periods specified
in the Securities and Exchange Commission's rules and forms.
There were no significant changes in the Corporation's internal control over
financial reporting that occurred during the period covered by this report that
has materially affected, or that is reasonably likely to affect, our internal
control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Corporation and the subsidiary banks are involved in various legal
proceedings incidental to their business. Management believes the aggregate
liability, if any, resulting from such pending and threatened legal
proceedings will not have a material, adverse effect on the Corporation's
financial condition or results of operations.
ITEM 1A. RISK FACTORS
There have been no material changes from the risk factors previously
disclosed in Item 1A of the Corporation's Form 10-K filed March 3, 2006
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
a. Issuer Sales of Equity Securities
During the quarter ended June 30, 2006, the Corporation issued 1,056 shares
of common stock held in treasury upon the exercise of stock options by
employees under the Corporation's equity compensation plans. Exercise
prices for the stock options ranged from $14.17 to $22.08 per share, with
an average exercise price of $19.29 per share. The aggregate cash proceeds
to the Corporation from exercises of stock options during the quarter ended
June 30, 2006 was $20,365. Treasury shares were issued upon exercise of
these options by a small number of directors or employees in reliance upon
the private placement exemption from registration under Section 4(2) of the
Securities Act of 1933.
28
CITIZENS & NORTHERN CORPORATION -- FORM 10-Q
c. Issuer Purchases of Equity Securities
On August 19, 2005, the Corporation announced a plan to repurchase shares
of its outstanding common stock up to a total of $3 million over the period
ending August 31, 2006. On May 18, 2006, the plan was amended to increase
the total value of common stock that could be repurchased to $13 million.
Also, on June 22, 2006, the Corporation adopted a written trading plan
under Rule 10b5-1 of the Securities Exchange Act of 1934 to facilitate the
repurchase of its common stock at times when it would ordinarily be
prevented from doing so because of insider trading laws or self-imposed
trading blackout periods. Under the Rule 10b5-1 plan, a broker selected by
the Corporation was given the authority under terms and limitations
specified in the Rule 10b5-1 plan to repurchase shares on behalf of the
Corporation, up to the total that remained under the existing repurchase
authorization. Purchases were permitted under the Rule 10b5-1 plan
beginning June 26, 2006, and ending July 19, 2006. The Corporation remains
authorized to repurchase shares after the termination of the Rule 10b5-1
plan through August 31, 2006. As of June 30, 2006, the maximum additional
value available for purchases under this program is $12,289,625.
The following table sets forth a summary of the purchases by the
Corporation, on the open market, of its equity securities for the second
quarter of 2006:
TOTAL MAXIMUM DOLLAR
NUMBER OF SHARES VALUE OF SHARES
PURCHASED AS PART THAT MAY YET BE
TOTAL NUMBER OF SHARES AVERAGE PRICE OF PUBLICLY ANNOUNCED PURCHASED UNDER THE
PERIOD PURCHASED PAID PER SHARE PLANS OR PROGRAMS PLANS OR PROGRAMS
------------------ ---------------------- -------------- --------------------- -------------------
April 1 - 30, 2006 10,000 $24.25 10,000 $ 2,289,625
May 1 - 31, 2006 0 -- 0 $12,289,625
June 1 - 30, 2006 0 -- 0 $12,289,625
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Shareholders of Citizens & Northern Corporation was
held on Tuesday, April 18, 2006. The Board of Directors fixed the close of
business on February 28, 2006 as the record date for the determination of
stockholders entitled to notice of and to vote at the Annual Meeting and at
any adjournment thereof. On this record date, there were outstanding and
entitled to vote 8,295,569 shares of Common Stock.
The total number of votes cast was 5,620,528, including 8,627 voted in
person by owners or representatives and 5,611,901 voted by proxy. The only
issue voted on was election of Class I Directors, with the following
results:
R. Robert DeCamp
Total Votes in Favor 5,555,689
Total Votes Withheld 64,839
Edward H. Owlett, III
Total Votes in Favor 5,531,284
Total Votes Withheld 89,244
James E. Towner
Total Votes in Favor 5,523,667
Total Votes Withheld 99,861
There were 287,207 shares non-voted by brokers related to the election of
the Class I Directors noted above.
ITEM 5. OTHER INFORMATION
None
29
CITIZENS & NORTHERN CORPORATION -- FORM 10-Q
ITEM 6. EXHIBITS
3. (i) Articles of Incorporation Incorporated by reference to the exhibits
filed with the Corporation's registration
statement on Form S-4 on March 27, 1987.
3. (ii) By-laws Incorporated by reference to Exhibit 3.1
of the Corporation's Form 8-K
filed August 25, 2004
11. Statement re: computation of per share earnings Information concerning the computation of
earnings per share is provided in Note 2
to the Consolidated Financial Statements,
which is included in Part I, Item 1 of Form 10-Q
31. Rule 13a-14(a)/15d-14(a) certifications:
31.1 Certification of Chief Executive Officer Filed herewith
31.2 Certification of Chief Financial Officer Filed herewith
32. Section 1350 certifications Filed herewith
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CITIZENS & 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
August 4, 2006 By: /s/ Craig G. Litchfield
Date ------------------------------------
Chairman, President and Chief
Executive Officer
August 4, 2006 By: /s/ Mark A. Hughes
Date ------------------------------------
Treasurer and Chief Financial
Officer
31