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 Six month period ended June 30, 1998 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ___________ Commission file number: 0-16084 CITIZENS & NORTHERN CORPORATION (Exact name of Registrant as specified in its charter) <TABLE> <CAPTION> Pennsylvania 23-2451943 <S> <C> (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) </TABLE> 717-724-3411 (Registrant's telephone number including area code) Not applicable (Former name, former address, and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ____ No ____ (APPLICABLE ONLY TO CORPORATE REGISTRANTS) Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.
Title Outstanding Common Stock ( $1.00 par value) 5,220,038 Shares Issued and Outstanding July 1, 1998
CITIZENS & NORTHERN CORPORATION Index Part I. Financial Information Item 1. Financial Statements <TABLE> <CAPTION> <S> <C> Consolidated Statement of Condition - June 30, 1998 and December 31, 1997 Page 3 Consolidated Statement of Income - Six Months Ended June 30, 1998 and June 30, 1997 Page 4 Consolidated Statement of Cash Flows - Six Months Ended June 30, 1998 and June 30, 1997 Page 5 Notes to Consolidated Financial Statements Page 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation Pages 7 through 19 Item 3. Information About Market Risk Pages 15 Through 17 Part II. Other Information Page 20 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 21 </TABLE>
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q Part I - Financial Information Item 1. Financial Statements CONSOLIDATED BALANCE SHEET (In Thousands) <TABLE> <CAPTION> Unaudited Audited June 30, December 31, 1998 1997 <S> <C> <C> ASSETS Cash & Due From Banks $ 16,348 $ 13,449 Interest Bearing Deposits 666 804 Available-for-Sale Securities: U.S. Treasury Securities 2,538 2,538 Securities of Other U.S. Government Agencies 76,576 74,449 Mortgage Backed Securities 115,118 129,190 Obligations of States and Municipal Subdivisions 69,137 64,614 Other Securities 50,115 35,796 --------- --------- Total Available-for-Sale Securities 313,484 306,587 Held-to-Maturity Securities: U.S. Treasury Securities 626 632 Securities of Other U.S. Government Agencies 699 350 Mortgage Backed Securities 499 615 --------- --------- Total Held-to-Maturity Securities 1,824 1,597 Loans: Loans to Political Subdivisions 6,007 5,975 Other Loans 280,197 279,488 --------- --------- Total Loans 286,204 285,463 Less - Allowance for Possible Loan Losses (4,697) (4,913) Unearned Income (40) (37) --------- --------- Loans, Net 281,467 280,513 Bank Premises and Equipment 6,724 6,720 Other Real Estate 574 230 Accrued Interest on Bonds and Loans 4,530 4,808 Other Assets 881 645 --- --- TOTAL ASSETS $626,498 $615,353 --------- --------- --------- --------- LIABILITIES Deposits: Demand $ 50,287 $ 46,916 Interest Checking 36,854 40,880 Money Market 114,809 104,894 Savings 45,631 45,332 Other Time 197,872 204,234 --------- --------- Total Deposits 445,453 442,256 Dividends Payable 1,023 1,013 Borrowed Funds 50,652 40,661 Federal Funds Purchased --- 10,000 Securities Sold Under Agreement to Repurchase 30,400 29,800 Other Liabilities 8,995 6,088 --------- --------- TOTAL LIABILITIES 536,523 529,818 SHAREHOLDERS' EQUITY Common Stock, Par Value $ 1.00 per Share 5,220 5,168 Authorized 10,000,000; Issued 5,220,038 and 5,168,354 in 1998 and 1997, respectively Stock Dividend Distributable 1,706 Paid in Capital 15,468 13,799 Retained Earnings 56,616 52,519 --------- --------- Total 77,304 73,192 Unrealized Gains on Available-for-Sale Securities 14,121 13,335 Less: Treasury Stock at Cost 118,010 shares at June 30, 1998 (1,450) (992) 105,311 shares at December 31, 1997 --------- --------- TOTAL SHAREHOLDERS' EQUITY 89,975 85,535 --------- --------- TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $626,498 $615,353 -------- -------- -------- -------- </TABLE> The accompanying notes are an integral part of these condensed financial statements. 4
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q Part I - Financial Information (Continued) Item 1. Financial Statements (Continued) CONSOLIDATED STATEMENT OF INCOME (In Thousands, Except Per Share Data) (Unaudited) <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, June 30, 1998 1997 1998 1997 (Current) (PriorYear) (Current) (PriorYear) <S> <C> <C> <C> <C> INTEREST INCOME Interest and Fees on Loans $7,177 $7,129 $14,190 $14,128 Interest on Balances with Depository Institutions 10 10 20 19 Interest on Loans to Political Subdivisions 96 101 185 195 Interest on Federal Funds Sold 104 68 164 124 Income from Available-for-Sale and Held-to-Maturity Securities: Taxable 3,427 3,539 6,972 7,174 Tax Exempt 985 893 1,913 1,752 Dividends 223 205 451 412 ------ ------ ------ ------- Total Interest and Dividend Income 12,022 11,945 23,895 23,804 INTEREST EXPENSE Interest on Deposits 4,512 4,554 9,006 8,973 Interest on Other Borrowings 1,189 1,292 2,419 2,610 ------ ------ ------ ------- Total Interest Expense 5,701 5,846 11,425 11,583 ------ ------ ------ ------- Interest Margin 6,321 6,099 12,470 12,221 Provision for Possible Loan Losses 191 181 382 362 ------ ------ ------ ------- Interest Margin After Provision for Possible Loan Losses 6,130 5,918 12,088 11,859 OTHER INCOME Service Charges on Deposit Accounts 264 274 514 540 Service Charges and Fees 62 72 139 131 Trust Department Income 329 249 645 510 Insurance Commissions, Fees and Premiums 95 124 197 233 Other Operating Income 38 319 59 363 ------ ------ ------ ------- Total Other Income Before Realized Gains on Securities, Net 788 1,038 1,554 1,777 Realized Gains on Securities, (Net) 1,860 20 2,614 807 ------ ------ ------ ------- Total Other Income 2,648 1,058 4,168 2,584 OTHER EXPENSES Salaries and Wages 1,596 1,470 3,195 2,966 Pensions and Other Employee Benefits 429 401 871 870 Occupancy Expense, Net 214 183 414 355 Furniture and Equipment Expense 198 173 392 335 Other Operating Expense 1,652 1,522 3,154 3,026 ------ ------ ------ ------- Total Other Expenses 4,089 3,749 8,026 7,552 ------ ------ ------ ------- Income Before Income Tax Provision 4,689 3,227 8,230 6,891 Income Tax Provision 1,227 743 2,087 1,644 ------ ------ ------ ------- NET INCOME $3,462 $2,484 $6,143 $5,247 ------ ------ ------ ------ ------ ------ ------ ------ PER SHARE DATA: Net Income - Basic $0.68 $0.49 $1.20 $1.03 Net Income - Diluted $0.68 $0.49 $1.20 $1.03 ------ ------ ------ ------- Dividend Per Share $0.20 $0.18 $0.40 $0.36 ------ ------ ------ ------- Number Shares Used in Computation - Basic 5,112,218 5,113,138 5,112,218 5,113,138 Number Shares Used in Computation - Diluted 5,121,113 5,116,437 5,121,113 5,116,437 Number Shares Issued 5,220,038 5,168,354 5,220,038 5,168,354 Number Shares Authorized 10,000,000 10,000,000 10,000,000 10,000,000 ---------- ---------- ---------- ---------- Dividends Actually Paid $0.20 $0.18 $0.40 $0.36 ----- ----- ----- ----- ----- ----- ----- ----- CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME Net Income $3,462 $2,484 $6,143 $5,247 Other Comprehensive Income : Unrealized holding gains on available-for-sale securities Gains arising during the period 3,211 6,435 3,806 3,021 Reclassification adjustment (1,860) (20) (2,614) (807) ------ ------ ------ ------- Other comprehensive income before income tax 1,351 6,415 1,192 2,214 Income tax related to other comprehensive income 459 2,181 405 753 ------ ------ ------ ------- 5
<S> <C> <C> <C> <C> Other comprehensive income 892 4,234 787 1,461 ------ ------ ------ ------ Comprehensive Income $4,354 $6,718 $6,930 $6,708 ------ ------ ------ ------ ------ ------ ------ ------ </TABLE> The accompanying notes are an integral part of these condensed financial statements. CITIZENS & NORTHERN CORPORATION - FORM 10 - Q Part I - Financial Information (Continued) Item 1. Financial Statements (Continued) CONSOLIDATED STATEMENT OF CASH FLOWS (In Thousands) <TABLE> <CAPTION> Six Months Ended June 30,1998 June 30, 1997 <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $ 6,143 $ 5,247 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities Provision for Possible Loan Losses 382 362 Realized (Gain), on Available-for-Sale and Held-to-Maturity Securities, Net (2,614) (807) Provision for Depreciation 392 346 Accretion and Amortization 138 284 Deferred Income Tax (116) (130) (Increase) Decrease in Accrued Interest Receivable and Other Assets 42 404 Increase Accrued Interest Payable and Other Liabilities 2,627 2,099 Net Cash Provided by Operating Activities 6,994 7,805 CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from the Maturity of Held-to-Maturity Securities 116 189 Purchase of Held-to-Maturity Securities (348) (250) Proceeds from Sales of Available-for-Sale Securities 72,940 17,358 Proceeds from Maturities of Available-for-Sale Securities 63,817 23,360 Purchase of Available-for-Sale Securities (139,981) (26,739) Net (Increase) Decrease in Loans (1,336) (6,567) Purchase of Premises and Equipment (396) (297) Sale of Foreclosed Assets 70 356 Purchase of Other Real Estate (413) (60) Net Cash Used in Investing Activities (5,531) 7,350 CASH FLOWS FROM FINANCING ACTIVITIES: Net Increase in Deposits 3,197 8,750 Decrease in Short Term Borrowings (9,400) (10,850) Proceeds from (Repayment of) Long Term Borrowings 9,991 (8,931) Sale of Treasury Stock 24 3 Purchase of Treasury Stock (468) Dividends Declared (2,046) (1,822) Net Cash Provided by Financing Activities 1,298 (12,850) INCREASE IN CASH AND CASH EQUIVALENTS $ 2,761 $ 2,305 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR $14,253 14,975 CASH AND CASH EQUIVALENTS, END OF YEAR $17,014 $17,280 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Interest Paid $9,221 $8,297 </TABLE>
<TABLE> <S> <C> <C> Income Taxes Paid $2,065 $1,617 </TABLE> The accompanying notes are an integral part of these consolidated financial statements. CITIZENS & NORTHERN CORPORATION - FORM 10 - Q Part I - Financial Information (Continued) Item 1. Financial Statements (Continued) Notes to Consolidated Financial Statements 1. The financial information included herein, with the exception of the Consolidated Balance Sheet dated December 31, 1997, is unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary to a fair presentation of the financial position, results of operations and changes in financial position for the interim periods. Results reported for the six-month period ended June 30, 1998 may not be indicative of the results for the year ended December 31, 1998. This document has not been reviewed or confirmed for accuracy or relevance by the Federal Deposit Insurance Corporation or any other regulatory agency. 2. New Statement of Financial Accounting Standards SFAS No. 130 "Reporting Comprehensive Income", adopted in 1997, is effective for all fiscal years beginning after December 15, 1997, and as such, it will be effective for reporting periods in 1998. Comprehensive income includes all changes in equity during a period from transactions and events from nonowner sources. Before SFAS No. 130, some elements of comprehensive income were presented in the income statement and others were reported in the equity section of the statement of financial position. All elements now are required to be brought together in a single amount of comprehensive income. SFAS No. 131 "Disclosures About Segments of an Enterprise and Related Information" was also adopted in 1997. SFAS No. 131 establishes standards for disclosures about products, services, geographic areas and major customers. The standard is effective for fiscal years beginning after December 15, 1997. The adoption of SFAS No. 131 will not have a material effect on Citizens and Northern's financial condition or results of operations. SFAS No. 132 "Employers' Disclosure About Pensions and Other Post Retirement Benefits" was adopted in January 1998. SFAS No. 132 revises current note disclosure requirements for employers' pensions and other retiree benefits. It does not address recognition or measurement issues. SFAS No. 132 is effective for fiscal years beginning after December 15, 1997. The adoption of SFAS No. 132 will not have a material effect on Citizens and Northern's financial condition or results of operations.
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
CITIZENS & NORTHERN CORPORATION - FORM 10-Q Part 1 - Financial Information (Continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations EARNINGS OVERVIEW Net after-tax income for the six month period ended June 30, 1998 amounted to $6,143 million or $1.20 per share (on a basic and diluted basis). This compares to $5,247 million or $1.03 per share (on a basic and diluted basis) for the same period in 1997. Total assets at June 30, 1998 were $626,498 million compared to total assets at June 30,1997 of $606,904 million. Net income for the period reflects the after-tax gain on the sale of stock of a closely held company that had been carried on the books of the Corporation for $1.00. The stock was obtained in 1919 as collateral for a loan that was later written off. The company represented by the stock was sold in June 1998 and the stock was purchased for cash. The realized gain, after tax, amounted to approximately $1,132,000 or $.22 per basic share. The same period in 1997 also benefited from the sale of a registered trademark amounting to $199,000 after tax or $.04 per basic share. Excluding extraordinary income for the six-month periods ended June 30, 1998 and June 30, 1997, earnings per common share would have amounted to $.98 and $.99, respectively. Results for the first six months of 1998 were in-line with management's expectations that net income for the first half of 1998 would be about the same as that of the first half of 1997. These expectations are contingent upon the current interest rate environment and could change if interest rates increase or decrease dramatically. NET INTEREST MARGIN Net interest margin or net interest income is the dollar amount of difference between all interest income received and interest expense paid. The net interest spread or interest margin is the difference, stated as a percentage, between the average rate received on all interest-earning assets and the average rate paid on all interest-bearing liabilities. Net interest income for the six months ended June 30, 1998 increased $250,000 or 2 percent when compared to the same six-month period in 1997. Respectively, gross interest income for the periods ended June 30, 1998 and June 30, 1997 amounted to $23,895,000 and $23,804,000. Gross interest expense for the same periods amounted to $11,425,000 and $11,583,000. Gross interest income and gross interest expense for the six months ended December 31, 1997 totaled $24,465,000 and $11,729,000, respectively. The increase in both numbers when compared to the six months ended June 30, 1998 can be attributed in a large part to the three additional days in the last six months of 1997. When making a comparison of the quarters ended June 30, 1998, March 31, 1998 and December 31, 1997 the net interest margins are $6,321,000, $6,149,000 and $6,476,000, respectively. The numbers represented by the three quarters would appear to reflect a decline in net interest income, however the amount of net interest income is affected by the number of days in the respective quarters which were 91, 90 and 92. Normally net interest income per day amounts to about $70,000. Average interest-bearing assets for the six months ended June 30, 1998 and June 30, 1997 were, respectively, $579,822,000 and $578,166,000. Average earning assets for the year ended December 31, 1997 were $578,647,000. Average interest-bearing liabilities for the six-month periods ended June 30, 1998, and June 30, 1997 amounted to $479,623,000 and $484,819,000, respectively. Average interest-bearing liabilities for the year ended December 31, 1997 were $481,281,000. 8
Neither the composition or volume of interest-bearing assets and interest-bearing liabilities has changed significantly during the six months periods being compared. A portion of the available-for-sale portfolio was restructured during the first half of 1998 due to the prepayment speed of the mortgage pools. The pools were replaced with FNMA zero coupon bonds and lower coupon Federal Home Loan Mortgage Corporation instruments. A loss amounting to $50,000 was realized as a result of the sale of the investments. Total deposits at June 30, 1998 have increased $6,392,000 since June 30, 1997, primarily Money Market accounts, Certificates of Deposit and Demand Deposit accounts. The net interest spread, the difference between total interest earned on all earning assets and the interest paid on all interest-bearing liabilities, was 3.51 percent, 3.48 percent and 3.50 percent for the six months ended June 30, 1998, June 30, 1997 and the year ended December 31, 1997, respectively. On March 2, 1998 management lowered its prime lending rate from 8.50 percent to 8.25 percent, offsetting the decrease with a reduction in rates paid on long-term certificates of deposit. Management expects that the net interest spread for the balance of 1998 will remain in the 3.40 percent to 3.50 percent range and that net interest income will approximate that of 1997. CITIZENS & NORTHERN CORPORATION - FORM 10 - Q Part I - Financial Information (Continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Table II - Average Balances and Rates (In Thousands) <TABLE> <CAPTION> Rate of Rate of Rate of Return/ Return/ Return/ Cost of Cost of Cost of funds funds funds <S> <C> <C> <C> <C> <C> <C> EARNING ASSETS 06/30/98 % 12/31/97 % 06/30/97 % Available-for-Sale Securities: U. S. Treasury Securities $ 2,518 6.01 $ 2,514 5.53 $ 2,504 5.15 Securities of Other U.S. Government Agencies and 74,654 7.22 41,968 7.15 29,778 7.00 Corporations Mortgage Backed Securities 116,262 6.52 163,942 6.75 180,623 6.68 Obligations of States and Political Subdivisions 65,671 5.87 59,554 6.04 57,902 6.10 Stock 17,250 5.27 15,039 5.81 15,197 5.47 Other Securities 11,771 7.04 4,536 1.15 4,429 1.64 Total Available-for-Sale Securities 288,126 6.50 287,553 6.51 290,433 6.45 Held-to-Maturity Securities: U. S. Treasury Securities 628 6.10 601 5.66 598 6.41 Securities of Other U. S. Government Agencies and 508 6.75 297 7.41 242 6.67 Corporations Mortgage Backed Securities 548 7.73 689 7.55 725 7.79 Total Held-to-Maturity Securities 1,684 6.83 1,587 6.81 1,565 7.09 Interest -bearing Due from Banks 796 5.07 795 6.79 428 8.95 Federal Funds Sold 5,913 5.59 6,132 5.45 4,681 5.34 Loans: Real Estate Loans 225,221 8.99 223,510 9.05 221,674 9.05 Consumer 30,962 20.67 32,293 20.08 32,527 19.85 Agricultural 2,425 10.15 2,689 10.12 2,749 10.05 Commercial/Industrial 17,623 9.31 16,743 9.59 16,923 9.63 Other 708 7.69 754 8.22 558 8.31 Political Subdivisions 6,147 6.07 6,355 6.15 6,394 6.15 Leases 217 9.29 236 7.63 234 4.32 Total Loans 283,303 10.23 282,580 10.28 281,059 10.28 Total Earning Assets 579,822 8.31 578,647 8.34 578,166 8.30 Cash 12,352 12,228 12,162 Securities Valuation Reserve 20,040 9,907 6,537 Allowance for Possible Loan Losses (4,868) (4,844) (4,796) Other Assets 5,317 5,745 5,790 Bank Premises & Equipment 6,764 6,594 6,521 Total Assets $619,427 $608,277 $604,380 INTEREST-BEARING LIABILITIES Interest Checking $ 36,773 2.45 $ 38,334 2.47 38,738 2.46 Money Market 110,183 4.56 107,287 4.55 106,093 4.53 Savings 45,380 2.48 46,338 2.48 46,696 2.48 Certificates of Deposit 121,380 5.53 119,226 5.49 118,019 5.46 Individual Retirement Accounts 78,313 5.55 78,662 5.99 79,014 5.93 Other Time Deposits 2,076 2.14 2,223 2.52 2,138 2.36 9
<S> <C> <C> <C> <C> <C> <C> Federal Funds Purchased 2,036 6.83 663 4.98 448 6.30 Other Borrowed Funds 83,482 5.67 88,548 5.63 93,673 5.59 Total Interest-bearing Liabilities 479,623 4.80 481,281 4.84 484,819 4.82 Demand Deposits 44,381 42,780 40,996 Other Liabilities 9,040 8,211 6,600 TOTAL LIABILITIES 533,044 532,272 532,415 Stockholders' Equity 73,101 69,440 67,598 Securities Valuation Reserve 13,282 6,565 4,367 Total Liabilities and Stockholders' Equity $619,427 $608,277 $604,380 Interest Rate Spread 3.51 3.50 3.48 </TABLE> CITIZENS & NORTHERN CORPORATION - FORM 10 - Q Part I - Financial Information (Continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Table II - Effect of Volume and Rate Changes in Interest Income and Interest Expense <TABLE> <CAPTION> Six-Month Periods Ended June 30, 1998/1997 (In Thousands) Change in Change in Total Volume Rate Change <S> <C> <C> <C> EARNING ASSETS Available-for-Sale Securities: U. S. Treasury Securities 11 11 Securities of Other U.S. Government Agencies and 1,605 33 1,638 Corporations Mortgage Backed Securities (2,083) (145) (2,228) Obligations of States and Political Subdivisions 223 (62) 161 Stock 53 (14) 39 Other Securities 125 250 375 Total Available-for-Sale Securities (77) 73 (4) Held-to-Maturity Securities: U. S. Treasury Securities (0) 0 (0) Securities of Other U.S. Government Agencies and 9 9 Corporations Mortgage Backed Securities (7) (0) (7) Total Held-to-Maturity Securities 2 0 2 Interest -bearing Due from Banks 2 (1) 1 Federal Funds Sold 34 6 40 Loans: Real Estate Loans 157 (66) 91 Consumer (197) 168 (29) Agricultural (16) 1 (15) Commercial/Industrial 28 (22) 6 Other 6 (2) 4 Political Subdivisions (7) (3) (10) Leases (0) 5 5 Total Loans (29) 81 52 Total Interest Income (68) 159 91 INTEREST-BEARING LIABILITIES Interest Checking (24) (3) (27) Money Market 92 18 110 Savings (16) 0 (16) Certificates of Deposit 92 45 137 Individual Retirement Accounts (20) (148) (168) Other Time Deposits (1) (2) (3) Federal Funds Purchased 54 1 55 Other Borrowed Funds (287) 40 (247) Total Interest Expense (110) (49) (159) NET INTEREST INCOME 42 208 250 </TABLE> 10
The change in interest due to both volume and rates has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amount of the change in each. CITIZENS & NORTHERN CORPORATION - FORM 10 - Q Part I - Financial Information (Continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) ALLOWANCE FOR POSSIBLE LOAN LOSSES The Allowance for Possible Loan Losses is a reserve established by management and the Board of Directors, which they believe will absorb future loan losses based on management's assessment of the quality and volume of the loan portfolio. The assessment is performed on an ongoing basis and reviewed by the board of Directors quarterly. The quarterly review process is performed by a loan quality committee consisting of the President, Chief Financial Officer, Executive Vice-Presidents in charge of loans and branch administration and monitored by the Corporation's auditor. The committee reviews the "Watch List" (a collection of loans that have had a history of delinquency), past due reports, nonperforming loans and historical information related to charge-offs and recoveries by loan category. The reserve balance is then allocated across the various loan categories to determine the unallocated or excess reserve balance. The allocation is performed using two different methods. The first method, a historical method based on five years of information, calculates the ratio of average losses by type to the average outstanding balance by type. The ratio is then applied to the current outstanding balance of the various loan categories to determine the amount of reserve to be allocated to the loan category. In addition to the historical calculated amount, at times the committee will add additional amounts to the calculated total if it is aware of a particular problem or the five-year average is not representative of current conditions. The second allocation method extracts loans by a quality rating system. The ratings are substandard, doubtful and loss. Regulatory guidelines are then applied: 15 percent of the substandard category, 50 percent of the doubtful classification and 100 percent of the loss category loans. Other factors used to measure the level of the reserve are loan growth, economic conditions of the market area and peer group comparisons. The Corporation also retains the services of an independent loan appraiser who reviews all credit relationships in excess of $175,000 and loans of $100,000 or more in offices where there is perceived to be excess delinquency. The latest review was started on May 15, 1998 and concluded June 15, 1998. The results of the latest review are disclosed in Table VI The following tables present current and historical information on the loan portfolio and the Reserve for Possible Loan Losses. TABLE III 11
Reserve for Possible Loan Losses Reconciliation <TABLE> <CAPTION> Estimated Actual Actual Actual Actual Actual Dec. 31, Jun. 30, Dec. 31, Dec. 31, Dec. 31, Dec 31, 1998 1998 1997 1996 1995 1994 <S> <C> <C> <C> <C> <C> <C> Beginning Balance January 1, $4,913,334 $4,913,334 $4,775,960 $4,579,210 $4,228,741 $3,816,982 Provision Charged to Earnings 763,416 381,708 797,032 700,500 736,500 737,496 Ea381708rnings Year-to-Date Recoveries 125,000 66,119 124,407 167,926 187,473 194,312 Year-to-Date Charge-offs (900,000) (664,310) (784,065) (671,676) (573,504) (520,049) Ending Balance $4,901,750 $4,696,851 $4,913,334 $4,775,960 $4,579,210 $4,228,741 </TABLE> CITIZENS & NORTHERN CORPORATION - FORM 10 - Q Part I - Financial Information (Continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) <TABLE> <CAPTION> TABLE IV - FIVE YEAR HISTORY OF LOAN LOSSES Projected (In Thousands) 1998 1997 1996 1995 1994 1993 AVERAGE <S> <C> <C> <C> <C> <C> <C> <C> Net Loans * 298,838 285,426 278,639 264,182 258,472 238,755 265,086 Net Charge-offs 775 660 504 387 326 247 425 Allowance for Possible Loan Losses Balance 4,902 4,913 4,776 4,579 4,229 3,817 4,463 Provision for Loan Losses Charged to Earnings 768 797 701 737 737 708 736 Earnings 9,876 10,107 9,255 7,866 7,494 8,127 8,570 Earnings Coverage of Net Charge-offs 12.7 x 15.3 x 18.4 x 20.3 x 23.0 x 32.9 x 22 Allowance Coverage of Net Charge-offs 6.3 x 7.4 x 9.5 x 11.8 x 13.0 x 15.5 x 11 Loans Ninety Days or More Past Due and Still Accruing 2,925 2,900 2,994 2,915 2,743 2,899 2,890 Net Charge-offs as a Percentage of the Provision 100.9% 82.8 % 71.9 % 52.5 % 44.2 % 34.9 % 57 Year-End Nonperforming Loans 1,200 1,412 864 279 624 843 804 Allowance as a Percentage of Gross Loans: * Bank (1) March 31, 1998 1.64% 1.72 % 1.71 % 1.73 % 1.64 % 1.60 % 2 Peer Group (2) December 31, 1997 1.40% 1.43 % 1.50 % 1.61 % 1.65 % 1.82 % 2 * Gross Loans less Unearned Discount </TABLE> TABLE V - Reserve Allocation - Historical <TABLE> <CAPTION> Est. LOAN CLASSIFICATION 1998 1997 1996 1995 1994 1993 Average LossRatio Balance <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Commercial, Agricultural, Municipal & 30,338 25,751 30,054 26,481 22,794 26,530 26,322 0.00115 X 30,338 = 35 Other Real Estate - Mortgage 225,000 220,358 215,123 201,350 195,688 172,756 201,055 0.00043 X 225,000 = 97 Credit Card & Related Plans 10,000 9,084 8,902 9,934 9,896 9,212 9,406 0.01667 X 10,000 = 440 All Other Loans to Individuals 33,500 30,270 24,518 26,417 30,094 30,282 28,316 0.00587 X 33,500 = 262 Total Loans 298,838 285,426 278,639 264,182 258,472 238,755 265,099 0.00166 298,838 12
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Letter of Credit Commitments 5,500 5,012 5,106 2,633 4,415 5,046 4,442 0.00115 X 5,500 = 6 All Other Commitments Consumer 30,000 27,728 28,049 24,811 24,202 23,323 25,623 0.00587 X 30,000 = 176 Mortgage 11,000 10,497 5,802 7,276 9,566 9,466 8,521 0.00043 X 11,000 = 5 Commercial 13,000 13,045 10,825 10,201 9,901 9,790 10,752 0.00115 X 13,000 = 15 Impaired Loans 500 274 113 228 500 Total Allocated 1,536 Unallocated 3,366 Reserve Balance 4,902 </TABLE> The reserve balance allocation ratio is determined using the six-year average net charge-offs divided by the six-year average loan balance by type. 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 VI -Reserve Allocation Based on Regulatory Standards May 15, 1998 as compiled by the independent loan appraiser. <TABLE> <CAPTION> Loan Classifications Total Classified Loans Allocation - ------------------------------------------ <S> <C> <C> Substandard 15 % $7,959,216 $1,193,882 Doubtful 50 % 1,060,290 530,145 Loss 100 % 13,289 13,289 FASB 114 Allocation 397,209 ------- Required Reserve 2,134,525 Unallocated 2,562,326 --------- Total Reserve 4,696,851 --------- --------- </TABLE> 13
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q Part I - Financial Information (Continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) <TABLE> <CAPTION> Six-Month Periods Ended June 30, June 30, % $ 1998 1997 Change Change <S> <C> <C> <C> <C> Service Charges on Deposit Accounts $ 514 $ 540 (4.8) ($26) Service Charges and Fees 139 131 6.1 8 Trust Department Income 645 510 26.5 135 Insurance Commissions, Fees and Premiums 197 233 (15.5) (36) Other Operating Income 59 363 (83.7) (304) Total Other Operating Income before Realized Gains on Securities, Net 1,554 1,777 (12.5) (223) Realized Gains on Securities, Net 2,614 807 223.9 1,807 Total Other Income $4,168 $2,584 61.3 $1,584 </TABLE>
Total Other Operating Income before Realized Gains on Securities decreased 13 percent or $223,000 during the six-month period ended June 30, 1998 when compared to the six-month period ended June 30, 1997. The decrease was caused by the recognition of extraordinary income from the sale of a copyright or trademark. the before-tax effect was $301,000. A comparison of the six-month periods ended June 30, 1998 and December 31, 1997 reflect an increase of 8 percent. Categories of Other Operating Income include Service Charges on Deposit Accounts, Other Service Charges and Fees, Trust Department Income, Bucktail Life Insurance Co. Premiums and Other Operating Income. Service Charges on Deposit Accounts, consisting of account activity charges and overdraft charges, has declined slightly during the past two years. During the six-month periods ended June 30, 1997, December 31, 1997 and June 30, 1998 monthly service charges generated amounted to $90,000, $89,000 and $86,000 , respectively. The fees consistently average about 56 percent service charges and 44 percent overdraft fees. The decrease is due to a decline in the number of daily overdrafts and an increase in the number of customers utilizing Money Market Accounts, free payroll accounts and senior citizens accounts. Payroll accounts are free if direct deposit is utilized; the total number of accounts has increased by nearly 600 since June 30, 1997. Also, the number of free accounts offered to senior citizens has risen dramatically during the past year. Service Charges and Fees, consisting of debit card fees, credit card annual fees, official check sales and check cashing fees, has not changed significantly when comparing the six-month periods ended June 30, 1997, December 31, 1997 and June 30, 1998. Those fees average between $23,000 and $25,000 per month. Trust Department Income is the largest contributor to Other Operating Income and has posted a gain of 26 percent or $135,000 during the six-month period ended June 30, 1998 when compared to the same period in 1997. The gain was even more impressive at 31 percent or $151,000 when comparing the current six-month period to the six-month period ended December 31, 1997. The significant increase posted during the current period is directly related to the amount of trust assets under management. For the periods ended June 30, 1998, June 30, 1997 and December 31, 1997, trust assets under management amounted to $260,554, $211,841 and $229,500, respectively. The growth in trust assets is the result of an aggressive sales program and increases in the market values of account holdings. Insurance Commissions, Fees and Premiums decreased $36,000 when comparing the six-month periods ended June 30, 1998 and June 30, 1997 and $32,000 when comparing the six-month periods ended June 30, 1998 and December 31, 1997. The decrease is the result of a lack of loan activity and alternate sources of credit life and accident and health insurance. CITIZENS & NORTHERN CORPORATION - FORM 10 - Q Part I - Financial Information (Continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Other Operating Income is made up primarily of safe deposit box rentals, earnings or losses on the "Supplemental Employees Retirement Plan" ("SERP") and gains received on the sale of bank assets. The amounts reflected for the periods ended June 30, 1998, June 30, 1997 and December 31, 1997 were $$59,000, $363,000 and $21,000, respectively. The fluctuation in the recorded amounts is due to the timing of the posting of "SERP" income and the variance in "SERP" income caused by fluctuations in the balance of the "SERP" plan. Normally, Other Operating Income will average $12,000 to $15,000 per quarter. Also, during the six-month period ended June 30, 1997 $301,000 in extraordinary income was realized from the sale of a Corporation trademark. Realized Securities Gains during the six-month period ended June 30, 1998 amounted to $2,614,000. A substantial portion, or $1,711,000, was due to the sale of stock that was carried on the books at $1.00. The stock was acquired as collateral on a defaulted loan in 1919. The Corporation was recently liquidated with the resulting gain. The balance of the realized gains are from the sale of equity investments that management felt would be prudent to realize the gain on the holdings. Also included were losses amounting to $49,000 that were part of a small restructuring of the available-for-sale investment portfolio. During the six months ended June 30, 1997 realized gains on the sale of equity investments totaled $807,000. Also during the six months ended December 31, 1997 realized gains on equity investments amounted to 15
$194,000. Gains realized on equity investments are part of the total investment return on equity securities, which include both dividends appreciation. Dividends alone from equity investments are inadequate to compensate the Corporation for its investment. <TABLE> <CAPTION> Six-month Periods Ended June 30, June 30, % $ 1998 1997 Change Change <S> <C> <C> <C> <C> (In Thousands) Salaries and Wages $3,195 $2,966 7.7 $229 Pensions and Other Employee Benefits 871 870 0.1 1 Occupancy Expense, Net 414 355 16.6 59 Furniture and Equipment Expense 392 335 17.0 57 Other Operating Expense 3,154 3,026 4.2 128 Total Other Expense $8,026 $7,552 6.3 474 </TABLE> Salaries and Wages increased 7.7 percent or $229,000 during the six-month period ended June 30, 1998 when compared to the six-month period ended June 30, 1997. The increase is the result of annual merit raises as the number of full time equivalent employees ranges between 197 to 202. When comparing the salaries and wage totals for the six-month periods ended June 30, 1998 and December 31, 1997, the increase amounted to $186,000 or 6 percent. Pensions and Other Employee Benefits consists primarily of social security taxes, group life and health insurance, contributions to the 401 (k) plan and pension expense. The cost of Pensions and Other Employee Benefits did not change between the six-month periods ended June 30, 1998 and June 30, 1997. A comparison of the six-month periods ended June 30, 1998 and December 31, 1997 reflects an increase of $50,000 or 6 percent. The primary cause was a decrease in social security expense and year-end adjustments to the 401 (k) Plan. Occupancy Expense, consisting of insurance, maintenance, real estate taxes, depreciation and other utilities, increased 16 percent or $59,000 when comparing the six-month periods ended June 30, 1998 and June 30, 1997. The increase was due to increased depreciation costs caused by the replacement of roofs on two branch offices, an extensive remodeling of one of the branch locations and ATM site preparation. An adjacent property was also purchased at our Wellsboro location at a cost of $75,000. When comparing the six-month periods ended June 30, 1998 and December 31, 1997 the increase amounted to 9 percent or $32,000 due an increase in depreciation and increased maintenance costs. CITIZENS & NORTHERN CORPORATION - FORM 10 - Q Part I - Financial Information (Continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Furniture and Equipment Expense has also increased $57,000 or 17 percent when comparing the six-month periods ended June 30, 1998 and June 30, 1997. The increase is due to the replacement of several vehicles and the purchases of a statement folder inserter, a new data card embosser and a new item processing image storage system. The combined cost of the equipment was in excess of $150,000. A comparison of the six-month periods ended June 30, 1998 and December 31, 1997 reflects a minimal increase of only $4,000. It is expected that for the balance of 1998 equipment maintenance will increase significantly with the recent installation of ten ATMs and plans for the installation of three or four additional machines. Other Operating Expense increased 4 percent or $128,000 when comparing the six-month period ended June 30, 1998 to the same period ended June 30, 1997. Other Operating Expense is comprised of several components, the largest components are the Pennsylvania Shares Tax and credit card expense; combined they constitute just over half of Other Operating Expense. Those components posted a combined increase of 13 percent or $193,000 when the six-month 16
periods ended June 30, 1998 and June 30, 1997 are compared. When comparing the six-month periods ended June 30, 1998 and December 31, 1997 those same expenditures increased slightly over 6 percent or $99,0000. The increased credit card costs are the result of increases in credit card interchange fees or increased merchant usage fees. It should be noted that the increase in interchange fees is more than offset in increased income The increase in Pennsylvania Shares Tax is due to bank earnings and an increase in the market value adjustment of the Bank's investment portfolio. Also included in Other Operating Expense are expenses related to Bucktail Life Insurance Company, a subsidiary of Citizens & Northern Corporation. Expenses incurred by the subsidiary dropped $121,000 between the comparable six-month periods due to the decline in underwriting business. There were no other material increases in expenses classified as Other Operating Expense. The Corporation continually monitors Other Operating Expense and has been successful in holding those expenses to a minimum. STATEMENT OF CONDITION Average total assets of the Corporation were $619,427,000 and $604,380,000 for the six-month periods ended June 30, 1998 and June 30, 1997, respectively. The increase in average assets between the two periods can be attributed to an increase in average deposits of $6,700,000 and an increase in the market value adjustment of the investment portfolio. When comparing the year ended December 31, 1997 to the six-month period ended June 30, 1998 average total assets increased $11,150,000, which also is attributable to an increase in the market value adjustment of the investment portfolio. Unrealized gains included in total assets for the periods ended June 30, 1998, December 31, 1997 and June 30, 1997 amounted to $20,040,000, $9,907,000 and $6,537,000, respectively. The asset structure of the Corporation changed very little during the periods being compared; average total available-for- sale securities changed less than 1 percent. The mix of investments making up the available-for-sale investment portfolio did change however. Due to the high volume of prepayments and a restructuring caused by declining interest rates, the average portfolio of mortgage-backed investments decreased $64,361,000 between June 30, 1997 and June 30, 1998. The decline between December, 31, 1997 and June 30, 1998 amounted to $47,680,000. The restructuring occurred in February of 1998 with the sale of approximately $27,000,000 of higher coupon mortgage-backed investments purchased at substantial premiums. The amortization of the premiums caused the yield on those investments to decline significantly. The loss booked as a result of the sale amounted to just over $49,000. The sold investments were replaced with U. S. Agency instruments, primarily Federal National Mortgage Association and Federal Home Loan Mortgage Corporation instruments. For tax purposes the portfolio of tax free municipal bonds has been grown by 13 percent between June 30, 1997 and June 30, 1998. The Corporation continuously monitors its regular versus alternate minimum federal income tax to take advantage of attractive tax free rates. The loan portfolio has remained nearly unchanged both in total loans and make-up of total loans. Real estate secured loans still comprise nearly 80 percent of total loans. The average loan-to-deposit ratio of the Corporation for the six-month period ended June 30, 1998 was 64 percent. Loan demand has shown some improvement since June 30, 1998; at this writing total loans amount to just over $288,000,000. CITIZENS & NORTHERN CORPORATION - FORM 10 - Q Part I - Financial Information (Continued) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) The Corporation has installed 10 new automated teller machines at strategic locations in the market area with an additional 3 or 4 units scheduled for installation later this year. Also, the Corporation has begun the construction a new office in Mansfield, Pennsylvania. The new office is scheduled to open in September or October 1998 and will cost approximately $350,000 to $450,000. On the liability side of the balance sheet the growth of interest-bearing deposits June 30, 1997 through June 30, 1998 has been relatively flat at less than 1 percent. The Money Market accounts and Certificates of Deposit have shown some growth due to aggressive marketing efforts and higher rates. Average demand deposits balances have shown significant 17
growth, increasing 8 percent between the periods ended June 30, 1997 and June 30, 1998. The growth can be attributed to the opening of nearly 3,500 new accounts since June 30, 1997. Management expects that 1998 will bring continued competition for deposits from credit unions, brokerage houses and other nonbank competitors and it will continue to look for innovative deposit products to hold current customers and attract new business. Average borrowed funds has declined 9 percent between the comparable periods primarily because of the lack of investment opportunities with the flatness of the yield curve. LIQUIDITY Liquidity is the ability to raise cash quickly and at a reasonable cost. An adequate liquidity position permits the Corporation to pay creditors, compensate for unforeseen deposit fluctuations and fund unexpected loan demand. Daily deposit decreases normally do not exceed $4,000,000 to $6,000,000 and new loan advances net of loan repayments has 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. 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 are also calculated using the same model and the same rate shock of plus and minus 100, 200, and 300 basis point swings in rates. Market values are estimated by applying present value calculations to the cash flow generated by the Corporation's balance sheet. The Asset and Liability Committee and Board of Directors have also imposed a market loss limit of 25 percent at a 200 basis point rate shock. The model utilized to create Table IX makes estimates, at each level of interest rate change, regarding cash flows from principal repayments on loans and mortgage-backed securities and call activity on other investment securities. Actual results could vary significantly from these estimates which could result in significant differences in the calculation of projected changes in net interest margin and market value of portfolio equity. Also, the model does not make estimates related to changes in the composition of the deposit portfolio that could occur due to rate competition and the table does not necessarily reflect changes that management would make to realign the portfolio as a result of changes in interest rates. 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 IX - EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES NIM = Net Interest Margin MVPE = Market Value of Portfolio Equity (In Thousands) <TABLE> <CAPTION> At June 30, 1999 At June 30, 1998 18
Estimated Estimated Estimated Estimated Change in Estimated Change in Change in Estimated Change in Change in Interest Rates NIM NIM NIM MVPE MVPE MVPE (Basis Points) $ $ % $ % <S> <C> <C> <C> <C> <C> <C> Plus 300 20,722 (3,202) -13.38 57,929 (25,716) -30.74 Plus 200 21,840 (2,083) -8.71 66,287 (17,358) -20.75 Plus 100 22,894 (1,030) -4.30 74,782 (8,863) -10.60 Flat 23,924 83,645 Minus 100 24,820 897 3.75 92,386 8,741 10.45 Minus 200 25,558 1,635 6.83 101,058 17,413 20.82 Minus 300 26,277 2,354 9.84 109,868 26,223 31.35 </TABLE> 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, that could result in a decline in market prices. Also, losses could occur in individual stock held by the Corporation because of specific circumstances related to each bank. Further, since the stocks held are bank and bank holding companies concentrated in Pennsylvania, these investments could decline in market value if there is a downturn in the state's economy. Equity securities held as of June 30, 1998 and June 30, 1997 are presented in Table X. TABLE X - EQUITY SECURITIES <TABLE> <CAPTION> Hypothetical Hypothetical 10 % Decline 20 % Decline In In (In Thousands) Fair Market Market At June 30, 1998 Cost Value Value Value <S> <C> <C> <C> <C> Bank & Bank Holding Companies $14,911 $33,554 $(3,355) $(6,711) Fed. Home Loan Bank and Other Restricted Stocks 4,152 4,152 (415) (830) Total $19,063 $37,706 $(3,770) $(7,541) </TABLE> <TABLE> <CAPTION> Hypothetical Hypothetical 10 % Decline 20 % Decline In In (In Thousands) Fair Market Market At June 30, 1997 Cost Value Value Value <S> <C> <C> <C> <C> Bank & Bank Holding Companies $11,564 $23,581 $(2,358) $(4,716) Fed. Home Loan Bank and Other Restricted Stocks 3,361 3,361 (336) (672) Total $14,925 $26,942 $(2,694) $(5,388) </TABLE> 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)
CAPITAL ADEQUACY Under regulations published by the Federal Deposit Insurance Corporation and other bank regulators, a bank's capital must be divided into two tiers. The first tier or tier one capital consists primarily of common stock, retained earnings, surplus and non-cumulative perpetual preferred stock. Tier two includes the allowance for possible loan losses (limited to 1.25 percent of risk-weighted assets), cumulative preferred stock and subordinated debt. Risk-based capital guidelines published in 1990 require banks to maintain a risk-based capital ratio of 8 percent, 4 percent of which must be tier one; the remainder may be tier two. The total risk-based capital ratios at June 30, 1998, June 30, 1997 and December 31, 1997 were 23.91 percent, 22.92 percent and 22.98 percent, respectively. The primary source of capital growth for the Corporation is earnings. Capital growth for the six-month period ended June 30, 1998 and June 30, 1997 on an annualized basis was 10.06 percent and 10.42 percent, respectively; capital growth for the year ended December 31, 1997 was 9.7 percent. Total capital of the Corporation (excluding unrealized gains on available-for-sale securities) at June 30, 1998, June 30, 1997 and December 31, 1997 was $75,854,000, $69,257,000 and $72,200,000, respectively. The leverage ratio (capital divided by total liabilities), excluding unrealized gains on available-for-sale securities, at June 30, 1998, June 30, 1997 and December 31, 1997, was 14.1 percent, 13.1 percent and 13.6 percent, respectively. Planned capital expenditures, including the new Mansfield office and main frame computer upgrade, during the next 12 months will amount to an estimated $500,000 to $750,000. These capital expenditures will not have a detrimental effect on capital ratios or 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 (Continued) 20
YEAR 2000 COMPLIANCE The "Year 2000" or "Y2K" problem is a computer problem that began when computers began to store and process information. The problem occurs as a result of the date format used in most older software and older computers. The year has often been stored as a two digit number, e.g., 1998 as 98. When the date rolls forward to 2000, most computers and computer software will look at the date as 00 or 1900. This could have a major impact on many calculations if not corrected. Citizens & Northern Corporation began working on the problem in 1996 and changes to mission critical mainframe computer software making it year 2000 complaint are nearly complete. Testing is to begin in August of this year and expected to be completed by December 31, 1998. It is difficult to estimate the total cost of compliance since the work has been done in-house and over a very long period of time. The main frame computer and network modems will be replaced in late 1998 or early 1999 at a cost of about $300,000. Several PCs and PC software will be replaced, and item processing software will have to be updated. The cost of PC replacement is estimated to be between $50,000 and $75,000 software upgrades will probably be equal to that. Citizens & Northern Corporation has ascertained through correspondence that most of its significant vendors are Year 2000 compliant. The Corporation is in the process of contacting its larger commercial loan customers and has held a seminars to discuss and explain the problem to interested customers. INFLATION Inflation affects nearly every aspect of banking, primarily interest rates. The effect of inflation, when it is high, also has an impact on the cost of goods, such as supplies, services and labor. Growth in the consumer Price Index for 1998 is projected at about 2 percent which is considered not to be inflationary. In essence, inflation does not appear to be a problem in the near-term and should not impact the results of operations for the balance of 1998. CITIZENS & NORTHERN CORPORATION - FORM 10 - Q Part II - Other Information 21
CITIZENS & NORTHERN CORPORATION - FORM 10 - Q Part II - Other Information Item 1. Legal Proceedings There are currently no pending lawsuits against Citizens & Northern Corporation. Item 4. Submission of matters to a vote of security holders. The Annual Meeting of Shareholders of Citizens and Northern Corporation was held on Tuesday, April 21, 1998. The Board of Directors fixed the close of business on March 9, 1998 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 5,114,234 shares of Common Stock. The total number of votes cast were 3,883,878. 2,393 were voted in person by owners or representatives and 3,881,485 were voted by proxy for the following purposes and with the following results. 1. The election of the following as Class II Directors to serve for a term of three years: <TABLE> <CAPTION> <S> <C> R. Bruce Haner Leonard Simpson Susan E. Hartley Donald E. Treat Edward L. Learn </TABLE> The total votes in favor of any one of the above-listed Directors were not less than 3,841,257. 2. The ratification of the action of the Board of Directors in the appointment of the firm of Parente, Randolph, Orlando Carey and Associates as independent auditors of the Corporation. <TABLE> <CAPTION> <S> <C> Total Votes in Favor 3,861,816 Total Votes Against 7,247 Total Votes Abstained 14,815 </TABLE> Item 5. Other Events a. None Item 6. Exhibits and Reports on Form 8 - K a. Exhibits filed as a part of this report - None b. No reports on Form 8 - K were filed during the period ended March 31, 1998. CITIZENS AND NORTHERN CORPORATION - FORM 10 - Q Signature Page 22
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, 1998 By: /s/ Craig G. Litchfield - -------------- ------------------------------------- Date President and Chief Executive Officer August 6, 1998 By: /s/ James W. Seipler - -------------- -------------------------------------- Date Executive Vice President and Treasurer 23