-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VfVVQP2ec/Mbd2TbLay+zzDEX47YO5ABMsWHxO9SimbZUY0SuEVIBc7Zb/embiw7 kJkn/vWEu2WE9gftTis30w== 0000950152-02-002002.txt : 20020415 0000950152-02-002002.hdr.sgml : 20020415 ACCESSION NUMBER: 0000950152-02-002002 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020320 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CITIZENS & NORTHERN CORP CENTRAL INDEX KEY: 0000810958 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 232451943 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-16084 FILM NUMBER: 02579715 BUSINESS ADDRESS: STREET 1: THOMPSON ST CITY: RALSTON STATE: PA ZIP: 17763 BUSINESS PHONE: 7172656171 MAIL ADDRESS: STREET 1: 90-92 MAIN ST CITY: WELLSBORO STATE: PA ZIP: 16901 10-K405 1 l93169ae10-k405.txt CITIZENS & NORTHERN CORPORATION 10-K405 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (Mark One) |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001 Commission file number: 0-16084 CITIZENS & NORTHERN CORPORATION (Exact name of Registrant as specified in its charter) PENNSYLVANIA 23-2451943 - ------------ ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 90-92 MAIN STREET, WELLSBORO, PA 16901 - --------------------------------------------------- (Address of principal executive offices) (Zip code) 570-724-3411 ------------ (Registrant's telephone number including area code) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |X| The aggregate market value of the registrant's common stock held by non-affiliates at February 28, 2002 was $149,474,705. The number of shares of common stock outstanding at February 28, 2002 was 5,291,140. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's proxy statement for the annual meeting of its shareholders to be held April 16, 2002 are incorporated by reference into Parts III and IV of this report. PART I ITEM 1. BUSINESS Citizens & Northern Corporation ("Corporation") is a one-bank holding company whose principal subsidiary is Citizens & Northern Bank ("Bank"). The Corporation's principal office is located in Wellsboro, Pennsylvania. The Corporation's other wholly-owned subsidiaries are Citizens & Northern Investment Corporation and Bucktail Life Insurance Company ("Bucktail"). Citizens & Northern Investment Corporation was formed in 1999 to engage in investment activities. Bucktail reinsures mortgage life and accident and health insurance on behalf of the Bank. The operations of Citizens & Northern Investment Corporation and Bucktail are insignificant in relation to the total business of the Corporation. The Bank is a Pennsylvania banking institution that was formed by the consolidation of Northern National Bank of Wellsboro and Citizens National Bank of Towanda on October 1, 1971. Subsequent mergers included: First National Bank of Ralston in May 1972; Sullivan County National Bank in October 1977; Farmers National Bank of Athens in January 1984; and First National Bank of East Smithfield in May 1990. The Bank has held its current name since May 6, 1975, at which time the Bank changed its charter from a National bank to a Pennsylvania bank. The Bank provides an extensive range of banking services, including deposit and loan products for personal and commercial customers. The Bank also maintains a trust division that provides a wide range of financial services. In January 2000, the Bank formed a subsidiary, C&N Financial Services Corporation ("C&NFSC"). C&NFSC is a licensed insurance agency that provides insurance products to individuals and businesses. In 2001, C&NFSC added a broker-dealer division, which offers mutual funds, annuities, educational savings accounts and other investment products through registered agents. In 2001, C&NFSC's operations were not significant in relation to the total operations of the Bank. All phases of the Bank's business are competitive. The Bank primarily competes in Tioga and Bradford counties and portions of Lycoming and Sullivan counties. The Bank competes with local commercial banks headquartered in our market area as well as other commercial banks with branches in our market area. Some of the banks that have branches in the Bank's market area are larger in overall size than the Bank. With respect to lending activities and attracting deposits, the Bank also competes with savings banks, savings and loan associations, insurance companies, regulated small loan companies and credit unions. Also, the Bank competes with mutual funds for deposits. The Bank competes with insurance companies, investment counseling firms, mutual funds and other business firms and individuals for trust, investment management and insurance services. The Bank is generally competitive with all financial institutions in its service area with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans. The Bank serves a diverse customer base, and is not economically dependent on any small group of customers or on any individual industry. Although there have been no mergers or acquisitions within the last 5 years, the Bank has engaged in several ventures designed to improve customer service and generate financial growth. These ventures included the following major initiatives: - - expanded trust and financial services capabilities, including investment management, employee benefits and insurance services; - - installed automated teller machines, beginning in 1997; - - created the "customer repurchase agreement" cash management service for commercial customers in 1998; - - established internet banking services in 1999; and - - constructed and opened new branches in Mansfield (1998) and Muncy (2000). At December 31, 2001, the Bank had total assets of $847,405,000, total deposits of $576,981,000 and net loans outstanding of $373,963,000. At December 31, 2001, the Bank had a total of 252 full-time equivalent employees. Most of the activities of the Corporation and its subsidiaries are regulated by federal or state agencies. The primary regulatory relationships are described as follows: - - The Corporation is a one-bank holding company formed under the provisions of Section 3 of the Federal Reserve Act. The Corporation is under the direct supervision of the Federal Reserve and must comply with the reporting requirements of the Federal Bank Holding Company Act. 2 - - The Bank is a state-chartered, nonmember bank, supervised by the Pennsylvania Department of Banking and the Federal Deposit Insurance Corporation. - - C&NFSC is a Pennsylvania corporation. The Pennsylvania Department of Insurance regulates C&NFSC's insurance activities. The broker dealer division offers brokerage products through its operations as an office of supervisory jurisdiction of Hackett Associates, Inc. The National Association of Securities Dealers and the Pennsylvania State Securities Commission are the primary regulators of Hackett Associates, Inc. - - Bucktail is incorporated in the state of Arizona and supervised by the Arizona Department of Insurance. ITEM 2. PROPERTIES The Bank owns each of its properties, except for the facility located at 68 Main Street, Wellsboro, which is leased. All of the properties are in good condition. In 2001, the Bank entered into a lease of the property at 68 Main Street, Wellsboro. This facility is being renovated, and will be used for C&NFSC's operations and for a training facility. The cost of renovating this building is not expected to be significant in relation to the Bank's financial condition. None of the owned properties are subject to encumbrance. A listing of properties is as follows: Main administrative office: 90-92 Main Street Wellsboro, PA 16901 Branch offices: 428 S. Main Street Main Street 41 Main Street Athens, PA 18810 Liberty, PA 16930 Tioga, PA 16946 111 Main Street 1085 S. Main Street 428 Main Street Dushore, PA 18614 Mansfield, PA 16933 Towanda, PA 18848 Main Street Route 220 Courthouse Square East Smithfield, PA 18817 Monroeton, PA 18832 Troy, PA 16947 104 Main Street 3461 Route 405 Highway 90-92 Main Street Elkland, PA 16920 Muncy, PA 17756 Wellsboro, PA 16901 102 E. Main Street Thompson Street Route 6 Knoxville, PA 16928 Ralston, PA 17763 Wysox, PA 18854 Main Street 503 N. Elmira Street Laporte, PA 18626 Sayre, PA 18840 Other offices: Bankcard Services Facilities Management RR7 Box 503 One Brewery Lane Wellsboro, PA 16901 Wellsboro,PA 16901 C&N Financial Services Corp. Audit and Compliance 68 Main Street Water Street Wellsboro, PA 16901 Wellsboro, PA 16901
3 ITEM 3. LEGAL PROCEEDINGS Neither the Corporation nor any of its subsidiaries is a party to any material pending legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS During the fourth quarter of 2001, no matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise. 4 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS QUARTERLY SHARE DATA Trades of the Corporation's stock are executed through various brokers who maintain a market in the Corporation's stock. Information regarding sales prices of the Corporation's stock is available through the OTC Bulletin Board (www.otcbb.com). The Corporation's stock is not listed or traded on Nasdaq or a national securities exchange. The following table sets forth the approximate high and low sales prices of the common stock during 2001 and 2000:
2001 2000 Dividend Dividend Declared Declared per per High Low Quarter High Low Quarter - ------------------------------------------------------------------------------------ First quarter $ 22.00 $ 20.00 $ 0.26 $ 29.50 $ 24.75 $ 0.24 Second quarter 21.75 20.41 0.26 26.25 21.50 0.24 Third quarter 23.45 21.00 0.26 23.75 22.00 0.24 Fourth quarter 26.50 23.10 0.28 22.88 19.50 0.26 plus 1% plus 1% stock dividend stock dividend
Known "market makers" who handle Citizens & Northern Corporation stock transactions are: F. J. MORRISSEY & CO., INC. RBC DAIN RAUSCHER RYAN, BECK & COMPANY 1700 Market Street, Suite 1420 3 Times Square, 24th Floor 3 Parkway Philadelphia, PA 19103-3913 New York, NY 10036 Philadelphia, PA 19102 (215) 563-8500 (800) 526-6371 (800) 342-2325 FERRIS, BAKER WATTS, INC. SANDLER O'NEILL & PARTNERS, LP 6 Bird Cage Walk 919 Third Avenue Holidaysburg, PA 16648 New York, NY 10022 (800) 343-5149 (800) 635-6851
INVESTOR INFORMATION GENERAL SHAREHOLDER INQUIRIES INDEPENDENT AUDITORS SHOULD BE SENT TO: ANNUAL MEETING OF PARENTE RANDOLPH, PC SHAREHOLDERS CITIZENS & NORTHERN 400 Market Street CORPORATION Williamsport, PA 17701 The Annual Meeting of Shareholders 90-92 Main Street, P.O. Box 58 Will be held at the Arcadia Theatre in Wellsboro, PA 16901 Wellsboro, PA, at 2:00 p.m. on Tuesday, April 16, 2002. STOCK TRANSFER AGENT American Stock Transfer & Trust Co. 59 Maiden Lane, Plaza Level New York, NY 10038 (800) 278-4353
COMMON STOCK AND PER SHARE DATA 5
2001 2000 1999 1998 1997 Net income per share - basic $ 2.28 $ 1.60 $ 2.16 $ 2.08 $ 1.90 Net income per share - diluted 2.27 1.60 2.16 2.08 1.90 Cash dividends declared per share 1.05 0.96 0.87 0.79 0.70 Cash dividends declared per share - historical basis 1.06 0.98 0.90 0.82 0.74 Stock dividend 1% 1% 1% 1% 1% Stockholders' equity per share (a) 18.95 16.75 14.43 17.06 16.07 Stockholders' equity per share, excluding accumulated other comprehensive income (loss) (a) 17.95 16.73 16.10 14.81 13.57 Weighted average shares outstanding - basic 5,296,003 5,310,131 5,309,763 5,314,353 5,320,612 Weighted average shares outstanding - diluted 5,297,723 5,311,274 5,315,173 5,324,150 5,325,560 Number of shares outstanding at year-end 5,234,800 5,207,244 5,153,729 5,102,028 5,063,043 Number of shares authorized 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000
(a) For purposes of this computation, the number of outstanding shares has been increased for the effects of 1% stock dividends issued in January following each year-end. 6 ITEM 6. SELECTED FINANCIAL DATA (IN THOUSANDS)
INCOME STATEMENT 2001 2000 1999 1998 1997 Interest income $ 55,140 $ 52,155 $ 48,415 $ 45,459 $ 45,642 Interest expense 28,356 30,145 24,571 22,693 23,312 - ---------------------------------------------------------------------------------------------------------- Interest margin 26,784 22,010 23,844 22,766 22,330 Provision for loan losses 600 676 760 763 797 - ---------------------------------------------------------------------------------------------------------- Interest margin after provision for loan losses 26,184 21,334 23,084 22,003 21,533 Other income 5,641 4,490 6,444 6,083 5,834 Securities gains 1,920 1,377 3,043 3,001 1,001 Other expenses 18,671 16,906 17,732 16,483 15,095 - ---------------------------------------------------------------------------------------------------------- Income before income tax provision 15,074 10,295 14,839 14,604 13,273 Income tax provision 3,022 1,819 3,354 3,527 3,166 - ---------------------------------------------------------------------------------------------------------- Net income $ 12,052 $ 8,476 $ 11,485 $ 11,077 $ 10,107 ========================================================================================================== BALANCE SHEET AT YEAR END Total securities (1) $445,527 $350,844 $363,535 $331,883 $308,988 Gross loans, excluding unearned discount 379,228 328,305 310,892 291,003 285,426 Total assets 866,999 719,335 705,898 646,298 615,353 Total deposits 576,274 528,967 500,474 476,518 442,256 Stockholders' equity, excluding accumulated other comprehensive income 94,903 88,887 85,507 78,645 72,200 Total stockholders' equity 100,187 88,969 76,623 90,567 85,535 AVERAGE BALANCE SHEET Total securities, at amortized cost (1) 412,654 371,360 349,133 300,692 296,067 Gross loans, excluding unearned discount 346,353 318,382 301,584 285,275 282,580 Earning assets 759,007 689,743 650,717 585,966 578,647 Total assets 805,229 704,221 680,864 626,102 608,277 Total assets, excluding unrealized gains/ Losses 798,590 717,052 672,999 606,163 598,370 Total deposits 544,579 503,848 483,858 448,601 435,190 Stockholders' equity, excluding accumulated other comprehensive income 91,703 87,258 81,767 74,810 69,440 Stockholders' equity 96,021 78,792 87,143 87,997 76,005 FINANCIAL RATIOS Return on stockholders' equity, excluding Accumulated other comprehensive income (2) 13.14% 9.71% 14.05% 14.81% 14.56% Return on stockholders' equity (2) 12.55% 10.76% 13.18% 12.59% 13.30% Return on assets (2) 1.50% 1.20% 1.69% 1.77% 1.66% Stockholders' equity to assets, excluding Accumulated other comprehensive income (2) 11.48% 12.17% 12.15% 12.34% 11.60% Stockholders' equity to assets (2) 11.92% 11.19% 12.80% 14.05% 12.50% Stockholders' equity to loans (2) 27.72% 24.75% 28.90% 30.85% 26.90% Net income to: Total interest income 21.86% 16.25% 23.72% 24.37% 22.14% Interest margin 45.00% 38.51% 48.17% 48.66% 45.26% Dividends as a % of net income 46.08% 60.19% 40.39% 37.81% 37.04%
(1) Includes available-for-sale and held-to-maturity securities, and interest-bearing cash and due from banks (2) Financial ratios calculated based on average balance sheet data 7 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain statements in this section and elsewhere in Form 10-K 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 based on certain assumptions and describe future plans, business objectives and expectations, are generally identifiable by the use of words such as, "believe", "expect", "intend", "anticipate", "estimate", "project", and similar expressions. The Corporation's ability to predict results or the actual effect of future plans or occurrences is inherently uncertain. 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 U.S. Treasury and the Federal Reserve Board, 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 (see "Critical Accounting Policies," later in Management's Discussion and Analysis). These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. EARNINGS OVERVIEW Net income for 2001 was $12,052,000, or $2.28 per share - basic and $2.27 per share - diluted. This represents a 42.2% increase over 2000 net income of $8,476,000, or $1.60 per share (basic and diluted). In 1999, net income was $11,485,000, or $2.16 per share (basic and diluted). The most significant income statement changes between 2001 and 2000, and between 2000 and 1999, are as follows: - - The interest margin increased significantly ($4,774,000, or 21.7%), to $26,784,000 in 2001 from $22,010,000 in 2000. In contrast, the interest margin for 2000 was $1,834,000, or 7.7%, lower than 1999's interest margin of $23,844,000. The Corporation is liability sensitive, which means that rates on its interest-bearing liabilities - deposits and borrowed funds - change more rapidly than rates on its interest-earning assets. Traditionally, the Corporation earns a positive spread by investing in longer-term assets such as residential and other loans, bonds and mortgage-backed securities. As widely publicized, the Federal Reserve Board lowered its targeted federal funds rate 11 times during 2001. The Fed's actions have led to a decline in short-term interest rates in the Corporation's market area. Long-term rates, on the other hand, have declined, but not as much as short-term rates, and the Corporation has been able to generate loans and purchase mortgage-backed securities at interest rates that are only slightly lower (on average) than the Corporation's holdings in 2000. The Fed raised its targeted federal funds rate several times in 2000, resulting in higher average interest rates for the Corporation's deposits and borrowed funds than in 1999. Fluctuations in interest income and expense are discussed in more detail in the Net Interest Margin section of Management's Discussion and Analysis. - - In 2001, the Corporation recorded an increase in cash surrender value of insurance of $905,000. In late December 2000, the Corporation purchased bank-owned life insurance (BOLI) at a cost of $15,000,000. Prior to December 2000, the Corporation had no BOLI holdings. - - Net realized securities gains amounted to $1,920,000 in 2001, $1,377,000 in 2000 and $3,043,000 in 1999. Most of the gains realized throughout the 3-year period ended December 31, 2001, were from sales of bank stocks. The amounts of such gains realized in any accounting period depends on management's evaluation of the specific stocks owned by the Corporation. In 1999, the Corporation recorded gains of $1,271,000 (pre-tax) from holding stocks of banks that were acquired by other entities. 8 - - Other operating expenses, excluding credit card operations, increased 11.4% in 2001 over 2000, and 9.0% in 2000 over 1999. In 2001, the Corporation increased average staffing levels, and incurred higher depreciation and other costs, related to the opening of the Muncy, PA branch (opened in October 2000). The Corporation also increased its lending and trust and financial management staffing levels in 2001. In 2000, start-up costs were incurred related to establishing the Muncy branch, and the Corporation increased its trust and financial management staffing levels over 1999. Noninterest expenses are discussed in more detail later in Management's Discussion and Analysis. - - The income tax provision increased to $3,022,000 in 2001 from $1,819,000 in 2000, primarily because pre-tax income was higher. The income tax provision, as a percentage of pre-tax income, is lower in 2001 than in 1999 (when pre-tax income was more comparable to 2001 than in 2000). The lower tax rate in 2001 than in 1999 resulted from several factors, including the exemption from taxable income of income from the BOLI contract. OUTLOOK FOR 2002 Overall, management believes the Corporation is well-positioned for another year of good financial performance in 2002. The hiring of additional lending staff, along with the opening of the Muncy office, contributed to significant loan growth in 2001, and should continue to provide opportunities in 2002. If the U.S. stock market begins to recover in 2002, management expects that revenues from trust and financial management services will increase. Of course, management has concerns about the impact of adverse economic conditions. If the economy within the Corporation's market areas weakens, loan growth will be difficult to achieve. Further, adverse economic conditions could result in loan collection problems, including the possibility of higher than historical levels of charge-offs. There was some evidence of deterioration in past due loans in the fourth quarter 2001. Total loans past due 30 days or more as of December 31, 2001 was 2.39% of gross loans, as compared to 2.15% as of September 30, 2001 and 2.20% as of December 31, 2000. It is too early to determine whether the higher level of past due loans is an indicator of higher charge-offs to come in the near term. The other significant economic concern is the prospect of rising short-term interest rates. As occurred in 2000, increases in short-term interest rates would increase the Corporation's average costs of deposits and borrowed funds. If the national economy shows ongoing signs of recovery, the Federal Reserve Board would be expected to increase its federal funds target rate, in an effort to limit inflation. If this occurs, short-term interest rates would most likely increase in the Corporation's market area. Management has taken some actions to reduce the Corporation's exposure to lower earnings in a rising short-term interest rate environment. However, the Corporation remains liability sensitive, and management expects that some reduction in the net interest margin would occur if short-term interest rates were to rise and remain at higher than current levels for a period of several months or more. The Corporation's exposure to interest rate risk is discussed in more detail in Item 7A, Quantitative and Qualitative Disclosures About Market Risk. CRITICAL ACCOUNTING POLICIES The presentation of financial statements in conformity with 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. Further, a task force of the American Institute of Certified Public Accountants is working on detailed implementation guidance for calculating the allowance for loan losses. Implementation of that detailed implementation guidance, which may be issued in 2002, could result in an adjustment to the allowance. 9 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. As described in Notes 1 and 11 of the consolidated financial statements, 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 2001/2000/1999 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 I, II and III include information regarding the Corporation's net interest margin in 2001, 2000 and 1999. 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 presented in these tables exceed the amounts presented in the consolidated financial statements. The discussion that follows is based on amounts in the Tables. The net interest margin (also referred to as net interest income), on a taxable-equivalent basis, was $29,029,000 in 2001, an increase of $4,896,000 or 20.3% over 2000. In 1999, fully taxable-equivalent net interest income was $26,010,000, or 7.3% higher than in 2000. As described in the "Earnings Overview" section of Management's Discussion and Analysis, these fluctuations in the net interest margin were caused mainly by fluctuations in interest rates on the Corporation's deposits and borrowed funds. Table III shows the effect of volume and rate changes on the Corporation's major interest earning assets and interest-bearing liabilities. Most significantly, Table III shows that interest rate changes had the effect of increasing net interest income $4,305,000 in 2001 and decreasing net interest income $3,281,000 in 2000. Similarly, Table II, which shows average daily balances and rates, shows a widening of the "Interest Rate Spread" (excess of average rate of return on interest-earning assets over average cost of funds on interest-bearing liabilities) to 3.16% in 2001 from 2.54% in 2000. The interest rate spread in 1999 was 3.19%. INTEREST INCOME AND EARNING ASSETS The Corporation's major categories of interest-bearing assets are available-for-sale investment securities and loans. Total interest income increased $3,107,000, or 5.7%, in 2001 over 2000. Interest and dividends from available-for-sale securities increased $1,402,000, or 5.4%, and interest and fees from loans increased $1,644,000, or 5.9%. In Table III, the growth in interest income is broken down between the impact of volume changes and the impact of interest rate changes. Higher average balances of available-for-sale securities and loans in 2001 than in 2000 resulted in increases in interest income in 2001, despite lower average rates of return. In 2000, total interest income increased $3,697,000, or 7.3%, over 1999. Most of the increase - $2,944,000 - was caused by increases in the average volume of earning assets. Higher average interest rates in 2000 than in 1999 also contributed to the growth in interest income. As shown in Table II, the average balance of the available-for-sale investment portfolio (at amortized cost) was $403,304,000 in 2001, $366,513,000 in 2000 and $345,823,000 in 1999. The major components of the portfolio are mortgage-backed securities, U. S. Agency securities and obligations of state and political subdivisions (municipal bonds). Also, the Corporation holds equity securities, primarily stocks of banks and bank holding companies and the Federal Home Loan Bank of Pittsburgh, and other corporate debt securities. 10 There was a much larger volume of turnover in the available-for-sale securities portfolio in 2001 than in 2000 or 1999. As indicated in the consolidated statement of cash flows, maturities of available-for-sale securities increased to $152,568,000 in 2001, compared to $15,337,000 in 2000 and $33,436,000 in 1999. In 2001, calls and maturities of U.S. Agency securities amounted to $91,174,000, and principal repayments of mortgage-backed securities totaled $54,456,000. These high levels of calls and principal repayments resulted from the relatively low interest rate environment in 2001, as U.S. Government Agencies refinanced many of their debts at lower current rates, and many individual mortgage borrowers did the same. Much of the proceeds was reinvested in mortgage-backed securities, as reflected in the growth in average balance to $150,838,000 (37% of the portfolio) in 2001 from $101,155,000 (28% of the portfolio) in 2000. The Corporation also funded purchases of mortgage-backed securities and other securities with proceeds from long-term borrowings, as management identified opportunities to earn a positive spread between the cost of funds and yields on securities. Mortgage-backed securities were attractive in 2001, because yields were slightly higher than other alternatives, and because they provide a source of monthly cash inflow, in the form of principal and interest payments. This cash inflow should help to mitigate some of the Corporation's exposure to increases in interest rates in the future, as management will be able to reinvest the proceeds at higher rates or pay off borrowings. In 2000, short-term and intermediate-term market interest rates were high, and there were few opportunities to create growth in the available-for-sale securities portfolio utilizing borrowed funds to purchase securities. Accordingly, most of the growth in average balances in 2000 compared to 1999 resulted from significant purchases made in 1999. Inclusion of these assets for the full year 2000 had the effect of increasing the average balance amounts presented in Table II. The rate of return on the available-for-sale investment portfolio was 6.79% in 2001, 7.09% in 2000 and 6.93% in 1999. The lower return in 2001 was caused primarily by purchases of securities at market yields in 2001 that were lower than in the prior few years. The 2001 purchases had the effect of lowering the overall return gradually over the course of 2001. The average return on available-for-sale securities was 6.46% for the fourth quarter 2001. The loan portfolio makes up most of the balance of the earning asset base and is the largest contributor to total interest income. The Corporation's market area consists of small rural communities. Consequently, the loan portfolio is retail-oriented, consisting mostly of real estate secured mortgages on one-to-four family dwellings. Total average real estate secured mortgage loans made up approximately 80% of the loan portfolio during 2001, 2000 and 1999. In 2001 and 2000, there has been significant growth in lending activities. Average loans outstanding increased $27,971,000, or 8.8%, in 2001, and $16,798,000, or 5.6%, in 2000. Much of the growth in the loan portfolio in 2001 and 2000 has been in real estate secured loans, including commercial as well as residential real estate loans. The opening of the Muncy office, along with the hiring of 5 additional lending personnel in 2001, have contributed to this growth. The balance of the loan portfolio includes consumer installment loans and commercial loans. The Corporation also has an extensive credit card operation, which is operated for the Corporation's customers and for other banks. In late 1999, the Corporation sold its merchant processing program, which significantly decreased the level of processing activity for non-Corporation customers. The average return on the total loan portfolio for 2001 was 8.56%, down from 8.79% in 2000 and 8.76% in 1999. The lower return in 2001 was impacted by significant levels of mortgage refinancings, and by lower returns on commercial loans with variable rates. The average return on loans for the fourth quarter 2001 was 8.33%. INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES Despite an increase of $78,267,000, or 13.8%, in average interest-bearing liabilities, interest expense fell to $28,356,000 in 2001 from $30,145,000 in 2000. As reflected in Table III, lower average interest rates had the effect of lowering expense $5,994,000 in 2001, as compared to 2000. This was a complete reversal of 2000, when rate increases caused an increase in interest expense of $4,035,000, and total interest expense increased $5,574,000. These rate-driven fluctuations are a product of the Corporation's interest rate sensitivity, as described in the "Earnings Overview" section of Management's Discussion and Analysis. As reflected in Table III, interest expense from money market accounts fell $2,518,000 in 2001 compared to 2000 ($2,906,000 due to lower rates), while interest expense from IRAs fell $756,000 ($942,000 due to lower rates). In contrast, interest expense from money market accounts increased $2,157,000 in 2000 over 1999 ($1,483,000 due to higher rates), and interest expense from IRAs increased $873,000 in 2000 ($844,000 due to higher rates). Money market accounts are repriced weekly, and thus are highly rate sensitive. As shown in Table II, the average cost of money market funds was 3.49% in 2001, 5.39% in 2000 and 4.34% in 1999. IRAs are variable rate, repriced quarterly. The average cost of IRA funds was 5.12% in 2001, 6.32% in 2000 and 5.21% in 1999. 11 Interest expense from CDs increased $1,109,000 in 2001 and $847,000 in 2000. Because CDs have terms that may range from 3 months to 5 years, they usually do not reprice as quickly as money market accounts or IRAs. The average rate incurred on CDs was 5.48% in 2001, 5.64% in 2000 and 5.24% in 1999. The average rate incurred on CDs was 4.86% for the fourth quarter 2001. The major cause of the increase in interest expense from CDs in 2001 was higher volume. Average CD balances increased $24,278,000, or 16.7%, in 2001, and $5,081,000, or 3.6%, in 2000. Growth in CDs in both 2001 and 2000 included substantial deposits from governmental entities and school districts. Total CDs of $100,000 or more, much of which consisted of balances from governmental entities and school districts, increased to $54,272,000 as of December 31, 2001, compared to $34,405,000 as of December 31, 2000. Further, management believes growth in CDs has been affected by declines in the U.S. stock market, which may have caused some investors to move to less volatile investments. Average total deposits increased $40,731,000, or 8.1%, in 2001 compared to 2000. In 2000, average total deposits increased $19,990,000, or 4.1%. In addition to the factors cited above, deposit growth has been enhanced by the expansion of the branch system in recent years, with relatively new offices opened in Mansfield (1998) and Muncy (2000). Interest expense on borrowed funds is presented in Table I in 2 categories - "Overnight borrowings" and "Other borrowed funds." Overnight borrowings include federal funds purchased from other banks and overnight repurchase agreements with the Federal Home Loan Bank of Pittsburgh. Other borrowed funds include overnight repurchase agreements with customers (the Corporation's "RepoSweep" accounts), borrowings from the Federal Home Loan Bank of Pittsburgh and other repurchase agreements. Interest expense on average other borrowed funds increased $1,125,000 in 2001 and $1,433,000 in 2000. Average interest rates on other borrowed funds amounted to 5.13% in 2001, 6.13% in 2000 and 5.35% in 1999. The average rate on other borrowed funds was 4.69% in the fourth quarter 2001. As discussed in the INTEREST INCOME - EARNING ASSETS section above, the Corporation borrowed funds in 2001 to fund purchases of available-for-sale securities. Average other borrowed funds balances also reflected a higher average balance of RepoSweep accounts in 2001 ($16,118,000, as compared to $9,475,000 in 2000). Also, because of a favorable interest rate environment, the Corporation extended the terms of most of its borrowings from very short term to a "ladder" of staggered maturities extending out over 5 years. Note 9 to the consolidated financial statements provides more details regarding the composition of borrowed funds as of December 31, 2001 and 2000. Overall, Table III shows that lower rates had the effect of reducing interest expense associated with other borrowed funds in 2001 by $1,208,000, while the increase in average borrowings increased interest expense by $2,333,000. In 2000, the increase in interest expense on other borrowed funds included an increase attributable to volume of $625,000 and an increase attributable to rate of $808,000. Approximately half of the volume-related increase in 2000 was caused by increases in RepoSweep accounts. The average balance of RepoSweep accounts increased to $9,475,000 in 2000 from $3,887,000 in 1999. The remainder of the volume-related increase resulted from borrowings initiated in 1999 to fund security purchases. In 2000, management elected to stay short-term in its new borrowings (new borrowings in 2000 were mainly renewals of loans that matured) because of an unwillingness to lock in relatively high interest rates for a long time period. 12 TABLE I - ANALYSIS OF INTEREST INCOME AND EXPENSE
(IN THOUSANDS) YEARS ENDED DECEMBER 31, INCREASE (DECREASE) 2001 2000 1999 01/00 00/99 - ----------------------------------------------------------------------------------------------------------- INTEREST INCOME Available-for-sale securities: U.S. Treasury securities $ 151 $ 154 $ 148 $ (3) $ 6 Securities of other U.S. Government agencies and corporations 7,718 9,417 7,007 (1,699) 2,410 Mortgage-backed securities 9,487 6,874 7,791 2,613 (917) Obligations of states and political subdivisions 6,216 6,342 6,464 (126) (122) Equity securities 1,569 1,472 1,207 97 265 Other securities 2,244 1,724 1,355 520 369 - ----------------------------------------------------------------------------------------------------------- Total available-for-sale securities 27,385 25,983 23,972 1,402 2,011 - ----------------------------------------------------------------------------------------------------------- Held-to-maturity securities: U.S. Treasury securities 40 37 34 3 3 Securities of other U.S. Government agencies and corporations 43 68 58 (25) 10 Mortgage-backed securities 16 21 27 (5) (6) - ----------------------------------------------------------------------------------------------------------- Total held-to-maturity securities 99 126 119 (27) 7 - ----------------------------------------------------------------------------------------------------------- Interest-bearing due from banks 82 114 30 (32) 84 Federal funds sold 184 64 42 120 22 Loans: Real estate loans 23,431 21,895 20,620 1,536 1,275 Consumer 3,055 3,056 3,170 (1) (114) Agricultural 190 191 194 (1) (3) Commercial/industrial 1,831 1,847 1,590 (16) 257 Other 68 71 55 (3) 16 Political subdivisions 1,043 909 776 134 133 Leases 17 22 13 (5) 9 - ----------------------------------------------------------------------------------------------------------- Total loans 29,635 27,991 26,418 1,644 1,573 - ----------------------------------------------------------------------------------------------------------- Total Interest Income 57,385 54,278 50,581 3,107 3,697 - ----------------------------------------------------------------------------------------------------------- INTEREST-BEARING LIABILITIES Interest checking 651 1,036 844 (385) 192 Money market 5,362 7,880 5,723 (2,518) 2,157 Savings 1,012 1,144 1,157 (132) (13) Certificates of deposit 9,284 8,175 7,328 1,109 847 Individual Retirement Accounts 4,073 4,829 3,956 (756) 873 Other time deposits 35 44 44 (9) -- Overnight borrowings 161 384 299 (223) 85 Other borrowed funds 7,778 6,653 5,220 1,125 1,433 - ----------------------------------------------------------------------------------------------------------- Total Interest Expense 28,356 30,145 24,571 (1,789) 5,574 - ----------------------------------------------------------------------------------------------------------- Net Interest Income $ 29,029 $24,133 $ 26,010 $ 4,896 $(1,877) ===========================================================================================================
(1) Interest income from tax-exempt securities and loans has been adjusted to a fully taxable-equivalent basis, using the Corporation's marginal federal income tax rate of 34%. (2) Fees on loans are included with interest on loans and amounted to $1,054,000 in 2001, $761,000 in 2000 and $987,000 in 1999. 13 TABLE II - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES
2001 2000 1999 (DOLLARS IN THOUSANDS) RATE OF RATE OF RATE OF RETURN/ RETURN/ RETURN/ AVERAGE COST OF AVERAGE COST OF AVERAGE COST OF BALANCE FUNDS BALANCE FUNDS BALANCE FUNDS % % % EARNING ASSETS Available-for-sale securities, at amortized cost: U.S. Treasury securities $ 2,506 6.03 $ 2,512 6.13 $ 2,510 5.90 Securities of other U.S. Government agencies and corporations 113,186 6.82 133,063 7.08 101,205 6.92 Mortgage-backed securities 150,838 6.29 101,155 6.80 117,902 6.61 Obligations of states and political subdivisions 78,741 7.89 81,312 7.80 80,970 7.98 Equity securities 28,456 5.51 25,899 5.68 22,288 5.42 Other securities 29,577 7.59 22,572 7.64 20,948 6.47 - ----------------------------------------------------------------------------------------------------------------------- Total available-for-sale securities 403,304 6.79 366,513 7.09 345,823 6.93 - ----------------------------------------------------------------------------------------------------------------------- Held-to-maturity securities: U.S. Treasury securities 742 5.39 685 5.40 615 5.53 Securities of other U.S. Government agencies and corporations 680 6.32 1,019 6.67 895 6.48 Mortgage-backed securities 205 7.80 283 7.42 368 7.34 - ----------------------------------------------------------------------------------------------------------------------- Total held-to-maturity securities 1,627 6.08 1,987 6.34 1,878 6.34 - ----------------------------------------------------------------------------------------------------------------------- Interest-bearing due from banks 2,659 3.08 1,861 6.13 566 5.30 Federal funds sold 5,064 3.63 1,000 6.40 866 4.85 Loans: Real estate loans 279,828 8.37 254,225 8.61 240,951 8.56 Consumer 28,062 10.89 27,760 11.01 28,982 10.94 Agricultural 2,070 9.18 1,963 9.73 1,961 9.89 Commercial/industrial 22,212 8.24 21,336 8.66 19,271 8.25 Other 892 7.62 886 8.01 714 7.70 Political subdivisions 13,108 7.96 12,009 7.57 9,499 8.17 Leases 181 9.39 203 10.84 206 6.31 - ----------------------------------------------------------------------------------------------------------------------- Total loans 346,353 8.56 318,382 8.79 301,584 8.76 - ----------------------------------------------------------------------------------------------------------------------- Total Earning Assets 759,007 7.56 689,743 7.87 650,717 7.77 Cash 11,871 10,887 14,028 Unrealized gain/loss on securities 6,639 (12,831) 7,865 Allowance for loan losses (5,370) (5,233) (5,083) Bank premises and equipment 9,602 8,712 7,828 Other assets 23,480 12,943 5,509 - ----------------------------------------------------------------------------------------------------------------------- Total Assets $ 805,229 $ 704,221 $ 680,864 ======================================================================================================================= INTEREST-BEARING LIABILITIES Interest checking $ 37,192 1.75 $ 36,086 2.87 $ 37,248 2.27 Money market 153,738 3.49 146,209 5.39 131,741 4.34 Savings 46,750 2.16 45,963 2.49 46,643 2.48 Certificates of deposit 169,275 5.48 144,997 5.64 139,916 5.24 Individual Retirement Accounts 79,482 5.12 76,439 6.32 75,882 5.21 Other time deposits 1,916 1.83 1,717 2.56 1,641 2.68 Overnight borrowings 4,012 4.01 5,721 6.71 6,085 4.91 Other borrowed funds 151,615 5.13 108,581 6.13 97,585 5.35 - ----------------------------------------------------------------------------------------------------------------------- Total Interest-bearing Liabilities 643,980 4.40 565,713 5.33 536,741 4.58 Demand deposits 56,226 52,437 50,787 Other liabilities 9,002 7,279 6,193 - --------------------------------------------------------------- --------- --------- Total Liabilities 709,208 625,429 593,721 - --------------------------------------------------------------- --------- --------- Stockholders' equity, excluding other comprehensive income/loss 91,703 87,258 81,767 Other comprehensive income/loss 4,318 (8,466) 5,376 - --------------------------------------------------------------- --------- --------- Total Stockholders' Equity 96,021 78,792 87,143 - --------------------------------------------------------------- --------- --------- Total Liabilities and Stockholders' Equity $ 805,229 $ 704,221 $ 680,864 =============================================================== ========= ========= Interest Rate Spread 3.16 2.54 3.19 Net Interest Income/Earning Assets 3.82 3.50 4.00
(1) Rates of return on tax-exempt securities and loans are calculated on a fully-taxable equivalent basis, using the Corporation's marginal federal income tax rate of 34%. (2) Nonaccrual loans are included in the loan balances above. 14 TABLE III - THE EFFECT OF VOLUME AND RATE CHANGES ON INTEREST INCOME AND INTEREST EXPENSE
YEAR ENDED 12/31/01 VS. 00 YEAR ENDED 12/31/00 VS. 99 (IN THOUSANDS) CHANGE IN CHANGE IN TOTAL CHANGE IN CHANGE IN TOTAL VOLUME RATE CHANGE VOLUME RATE CHANGE EARNING ASSETS Available-for-sale securities: U.S. Treasury securities $ -- $ (3) $ (3) $ -- $ 6 $ 6 Securities of other U.S. Government agencies and corporations (1,364) (335) (1,699) 2,246 164 2,410 Mortgage-backed securities 3,158 (545) 2,613 (1,135) 218 (917) Obligations of states and political subdivisions (202) 76 (126) 27 (149) (122) Equity securities 142 (45) 97 204 61 265 Other securities 531 (11) 520 111 258 369 - ---------------------------------------------------------------------------------------------------------------------------------- Total available-for-sale securities 2,265 (863) 1,402 1,453 559 2,012 - ---------------------------------------------------------------------------------------------------------------------------------- Held-to-maturity securities: U.S. Treasury securities 3 -- 3 4 (1) 3 Securities of other U.S. Government agencies and corporations (21) (4) (25) 8 2 10 Mortgage-backed securities (6) 1 (5) (6) -- (6) - ---------------------------------------------------------------------------------------------------------------------------------- Total held-to-maturity securities (24) (3) (27) 6 1 7 - ---------------------------------------------------------------------------------------------------------------------------------- Interest-bearing due from banks 38 (70) (32) 78 6 84 Federal funds sold 159 (39) 120 7 15 22 Loans: Real estate loans 2,157 (621) 1,536 1,153 122 1,275 Consumer 33 (34) (1) (134) 20 (114) Agricultural 10 (11) (1) -- (3) (3) Commercial/industrial 74 (90) (16) 175 82 257 Other -- (3) (3) 14 2 16 Political subdivisions 86 48 134 192 (59) 133 Leases (2) (3) (5) -- 9 9 - ---------------------------------------------------------------------------------------------------------------------------------- Total loans 2,358 (714) 1,644 1,400 173 1,573 - ---------------------------------------------------------------------------------------------------------------------------------- Total Interest Income 4,796 (1,689) 3,107 2,944 753 3,697 - ---------------------------------------------------------------------------------------------------------------------------------- INTEREST-BEARING LIABILITIES Interest checking 31 (416) (385) (27) 219 192 Money market 388 (2,906) (2,518) 674 1,483 2,157 Savings 20 (152) (132) (18) 5 (13) Certificates of deposit 1,337 (228) 1,109 273 574 847 Individual Retirement Accounts 186 (942) (756) 29 844 873 Other time deposits 5 (14) (9) 2 (2) -- Overnight borrowings (95) (128) (223) (19) 104 85 Other borrowed funds 2,333 (1,208) 1,125 625 808 1,433 - ---------------------------------------------------------------------------------------------------------------------------------- Total Interest Expense 4,205 (5,994) (1,789) 1,539 4,035 5,574 - ---------------------------------------------------------------------------------------------------------------------------------- Net Interest Income $ 591 $ 4,305 $ 4,896 $ 1,405 $ (3,282) $ (1,877) ==================================================================================================================================
(1) Changes in interest 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 amounts of the change in each. 15 NONINTEREST INCOME 2001/2000/1999 2001 VS. 2000 Total noninterest income increased $1,694,000, or 28.9%, in 2001 compared to 2000. The most significant changes - the increase in security gains and income from the (BOLI) life insurance contract - 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 $226,000, or 19.7%. This increase resulted from increased numbers of accounts and higher average balances, as well as fee increases on certain types of services. - - Trust and financial management revenue decreased $37,000, or 2.3%. Trust and financial management revenue is affected significantly by the market value of assets under management. In 2001, equity markets have been down substantially, which has had the effect of reducing the earnings base. Trust assets under management amounted to $303,868,000 at December 31, 2001, or 7.6% less than the value of assets under management a year earlier. - - Insurance revenue increased $210,000, or 56.5%. This increase is mainly attributable to revenue from the insurance agency division of C&N Financial Services Corporation (C&NFSC). C&NFSC began operations in 2000, with minimal revenues. C&NFSC generated insurance revenue of $216,000 in 2001 and $22,000 in 2000. - - Noninterest fees from the credit card operation decreased $347,000, or 38.7%. In late 1999, the Corporation sold its merchant processing program, which dramatically reduced the amount of interchange fees earned and costs incurred. In the first quarter 2000, the Corporation recorded final residual fees. - - Other operating income increased $179,000. In 2001, C&NFSC began operating a broker dealer division, which offers annuities, mutual funds and other non-bank investment products. The broker dealer division generated revenue of $84,000 in 2001. Another significant change within the items included in other operating income is interchange fees received from the Bank's VISA check card product. This product was introduced in late 1999, and has grown in numbers of accounts and usage. These fees increased to $87,000 in 2001 from $42,000 in 2000. Also within other operating income, gains from sales of other real estate properties increased to $135,000 in 2001 from $104,000 in 2000. 2000 VS. 1999 In total, noninterest income was $5,867,000 in 2000 compared to $9,487,000 in 1999, a decrease of 38.2%. However, excluding the substantial decreases in realized gains on securities and credit card fees, other income increased $213,000, or 6.3%, in 2000. The decrease in realized gains on securities is discussed in the "EARNINGS OVERVIEW" section of Management's Discussion and Analysis. Credit card fees decreased due to the sale of the merchant processing program in late 1999, which resulted in reductions of interchange fees and costs. As shown in Table V, the reduction in these fees was accompanied by a reduction in related expenses. Other items of significance are as follows: - - Trust department revenue increased 10.8% in 2000 compared to 1999 because assets held in trust had increased significantly over the 1998-2000 time period. Trust assets under management totaled $327,063,000 at December 31, 2000, compared to $320,385,000 at December 31, 1999 and $283,262,000 at December 31, 1998. - - Among the other categories of noninterest income, the most significant change in 2000 was an increase in other operating income to $226,000 from $99,000. This increase resulted mainly from an increase in gains from the sale of foreclosed assets of $82,000. 16 TABLE IV - COMPARISON OF NONINTEREST INCOME
(IN THOUSANDS) 2001 % CHANGE 2000 % CHANGE 1999 Service charges on deposit accounts $1,376 19.7 $1,150 3.3 $1,113 Service charges and fees 247 6.5 232 (15.3) 274 Trust and financial management revenue 1,576 (2.3) 1,613 10.8 1,456 Insurance commissions, fees and premiums 582 56.5 372 (15.1) 438 Increase in cash surrender value of life insurance 905 -- -- -- -- Fees related to credit card operation 550 (38.7) 897 (70.7) 3,064 Other operating income 405 79.2 226 128.3 99 - ---------------------------------------------------------------------------------------------- Total other income before realized gains on securities, net 5,641 25.6 4,490 (30.3) 6,444 Realized gains on securities, net 1,920 39.4 1,377 (54.7) 3,043 - ---------------------------------------------------------------------------------------------- Total Other Income $7,561 28.9 $5,867 (38.2) $9,487 ==============================================================================================
OTHER NONINTEREST EXPENSE 2001/2000/1999 Total noninterest expense in 2001 was $18,671,000, a 10.4% increase over 2000. In 2000, total noninterest expense decreased 4.7% compared to 1999. Excluding the decrease in expenses related to the credit card operation (which is discussed in the "NONINTEREST INCOME" section), noninterest expense increased 11.4% in 2001 and 9.0% in 2000. 2001 VS. 2000 Salaries and wages increased $896,000, or 11.8%, in 2001 compared to 2000. The increase is the result of annual merit raises ranging from 2%-5%, and an increase in the number of employees. Higher staffing levels were required for the Muncy branch, commercial and retail lending, trust and financial management and insurance sales and service. There were 252 full-time equivalent employees at December 31, 2001, an increase of 5.0% over December 31, 2000. Pensions and other employee benefits increased $274,000, or 14.1%, in 2001. In addition to increased costs resulting from the higher number of employees, the Corporation experienced an increase in medical insurance premium rates. Occupancy expense increased $90,000, or 9.7%, in 2001. This increase is mainly due to additional facilities. In 2000, the Corporation constructed a new branch in Muncy, purchased a building for credit card operations, and purchased 2 buildings near the Wellsboro branch/administrative building for additional administrative space. Furniture and equipment expense increased $237,000, or 19.8%, in 2001. The major categories of furniture and equipment expense that increased in 2001 compared to 2000 were maintenance costs associated with computer hardware and software, and depreciation. The increase in computer maintenance costs is mainly attributable to the timing of certain expenses. Increased depreciation expense resulted primarily from the addition of the Muncy branch, which began operations in the 4th quarter 2000, and the opening of the new credit card operations facility in mid-2000. Credit card expenses decreased in 2001 because of lower interchange fees paid. This change resulted from the sale of the merchant banking program, as discussed in the "Noninterest Income" section of Management's Discussion and Analysis. Other expense increased $346,000, or 8.5%, in 2001. This category includes many different types of expenses. Some of the overall increase in this category was caused by increases in number of transactions processed and number of employees. The most significant fluctuations in individual types of expenses between years are as follows: - - Customer support and maintenance charges related to software products increased $74,000, to $144,000, in 2001. This reflects increased use of third-party software programs for specialized applications, which are used as a complement to the Corporation's core, in house programs. 17 - - In 2001, the Corporation incurred consulting expense of $51,000 related to sales and service training. This training program is a substantial undertaking, aimed at improving the sales and service skills of virtually all employees. The amount of expense noted here does not include costs of miscellaneous training materials, nor more significantly, any allocation of internal payroll-related costs associated with sales and service training. - - Telephone expenses related to data lines increased $47,000, to $254,000, in 2001. These costs are mainly related to the Corporation's computer network that allows all branches and operating locations to access mainframe and PC applications. The Corporation's monthly data line costs increased to approximately the current level starting in the 2nd quarter 2000. - - Public relations expense increased $45,000, to $189,000, in 2001. This increase includes new sponsorships of several community-oriented programs located in the Corporation's market area, as well as costs related to promotion of the Muncy office. - - Expenses associated with maintaining other real estate properties increased $42,000, to $76,000, in 2001. - - In 2000, the Corporation incurred professional fees of $193,000 related to a proposed merger with Peoples, Ltd. of Wyalusing, PA. In November 2000, the vote by Peoples, Ltd.'s shareholders did not result in the 75% affirmative count required to approve the deal. 2000 VS. 1999 Salaries and wages increased $671,000, or 9.7%. This increase is the result of average merit increases of 4% and an increase in the number of employees. New employees were added in trust and financial services, management information services, the new insurance agency and the Muncy branch, as well as in other areas. The number of full-time equivalent employees increased 12.6%, to 240 at December 31, 2000 from 213 a year earlier. Pensions and employee benefits increased $108,000, or 5.9%. This increase is directly related to the increase in number of employees. Furniture and equipment expense increased $116,000, or 10.8%. This increase is mainly due to higher depreciation expense, including costs associated with the internet banking system and furniture and equipment used in the new credit card facility and the Muncy branch. Other operating expense increased $404,000, or 11.0%. Professional fees related to the terminated, proposed merger with Peoples, Ltd. amounted to $193,000. Telephone expense increased $126,000, primarily from costs for data connections among the branches. Supply costs increased $109,000, mainly from the increased number of employees and price increases on supplies used in proof of deposit operations. TABLE V - COMPARISON OF NONINTEREST EXPENSE
(IN THOUSANDS) 2001 % CHANGE 2000 % CHANGE 1999 Salaries and wages $ 8,493 11.8 $ 7,597 9.7 $ 6,926 Pensions and other employee benefits 2,213 14.1 1,939 5.9 1,831 Occupancy expense, net 1,018 9.7 928 3.6 896 Furniture and equipment expense 1,431 19.8 1,194 10.8 1,078 Pennsylvania shares tax 790 756 723 Other operating expense 4,431 8.5 4,085 11.0 3,681 - --------------------------------------------------------------------------------------------------------- Total other operating expense, excluding expenses related to credit card operation 18,376 11.4 16,499 9.0 15,135 Expenses related to credit card operation 295 (27.5) 407 (84.3) 2,597 - --------------------------------------------------------------------------------------------------------- Total Other Expense $18,671 10.4 $16,906 (4.7) $17,732 =========================================================================================================
18 INCOME TAXES The income tax provision increased to $3,022,000 in 2001 from $1,819,000 in 2000, primarily because pre-tax income was higher. The income tax provision for 2000 declined to $1,819,000 from $3,354,000 in 1999. The tax provision as a percentage of pre-tax income was 20.1% in 2001, 17.7% in 2000 and 22.6% in 1999. The income tax provision, as a percentage of pre-tax income, is lower in 2001 than in 1999 (when pre-tax income was more comparable to 2001 than in 2000). The lower tax rate in 2001 than in 1999 resulted from several factors, including the exemption from taxable income of income from the BOLI contract. A more complete analysis of income taxes is presented in Note 13 to the consolidated financial statements. 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. In particular, the discussion of changes in average deposit balances and borrowed funds in 2001 is sufficient to explain the overall change in the year-end balances in 2001 compared to 2000. This section addresses changes in the Corporation's balance sheet (excluding the allowance for loan losses and stockholders' equity, which are discussed in separate sections) that are not adequately addressed in that discussion. As presented in Table II, the average balance of available-for-sale securities (excluding unrealized gain or loss) was $403,304,000 in 2001 compared to $366,513,000 in 2000. As of December 31, 2001, the balance of available-for-sale securities, as shown in the consolidated balance sheet, was $442,098,000, an increase of 27.5% over December 31, 2000. This significant increase resulted from leveraged purchases, as described in the NET INTEREST MARGIN discussion, and from market appreciation. As reflected in Table VI, the fair value of available-for-sale securities exceeded historical cost by $8,007,000 at December 31, 2001, as compared to an excess of fair value over historical cost of $124,000 at December 31, 2000. As discussed in the NET INTEREST MARGIN section, average gross loans increased 8.8% in 2001. When comparing year-end 2001 to year-end 2000, the increase in gross loans is $50,923,000, or 15.5%. As reflected in Table X, most of the loan growth in 2001 has occurred in real estate secured lending. Growth in both residential and commercial lending was substantial. Virtually all of the 2001 growth occurred from April through December 2001. After a "quiet" first quarter, the Corporation posted annualized rates of increases in gross loans outstanding of 17.7% in the second quarter, 23.1% in the third quarter and 16.5% in the fourth quarter 2001. Premises and equipment, net of accumulated depreciation, increased to $9,967,000 at December 31, 2001 from $9,332,000 at December 31, 2000. The total cost of premises and equipment purchases in 2001 was $1,935,000. Comparatively, the total cost of premises and equipment purchases was $2,426,000 in 2000 and $1,547,000 in 1999. In 2001, the most significant capital purchases were for new proof of deposit software, renovations to branches and a new telephone system. The most significant capital investment in 2000 was the addition of the Muncy branch, for which land, building construction and initial furniture and equipment cost slightly more than $1,000,000. Significant capital additions over the last several years have resulted in increases in depreciation expense to $1,300,000 in 2001 from $1,086,000 in 2000 and $971,000 in 1999. Other assets decreased to $2,532,000 at December 31, 2001 from $4,238,000 at December 31, 2000. This decrease was primarily caused by the change in deferred income taxes from a net asset of $1,388,000 at December 31, 2000 to a net liability of $943,000 at December 31, 2001 (included in "Accrued interest and other liabilities" in the consolidated balance sheet). Details of deferred income tax balances are provided in Note 13 to the consolidated financial statements. 19 TABLE VI - INVESTMENT SECURITIES
AS OF DECEMBER 31, 2001 2000 1999 AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE COST VALUE AVAILABLE-FOR-SALE SECURITIES: Obligations of the U.S. Treasury $ 2,503 $ 2,557 $ 2,509 $ 2,533 $ 2,514 $ 2,498 Obligations of other U.S. Government agencies 75,295 75,172 132,713 128,883 128,494 116,691 Obligations of states and political subdivisions 95,835 95,261 68,236 69,065 81,219 76,748 Other securities 34,315 34,532 22,111 20,964 22,829 21,707 Mortgage-backed securities 198,269 198,975 91,708 91,240 111,605 107,816 - ------------------------------------------------------------------------------------------------------------------------ Total debt securities 406,217 406,497 317,277 312,685 346,661 325,460 Marketable equity securities 27,874 35,601 29,346 34,062 25,730 33,469 - ------------------------------------------------------------------------------------------------------------------------ Total $ 434,091 $ 442,098 $ 346,623 $ 346,747 $ 372,391 $ 358,929 ======================================================================================================================== HELD-TO-MATURITY SECURITIES: Obligations of the U.S. Treasury $ 726 $ 735 $ 707 $ 708 $ 617 $ 609 Obligations of other U.S. Government agencies 547 561 946 947 949 910 Mortgage-backed securities 175 181 258 259 314 311 - ------------------------------------------------------------------------------------------------------------------------ Total $ 1,448 $ 1,477 $ 1,911 $ 1,914 $ 1,880 $ 1,830 ========================================================================================================================
PROVISION AND ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio. In evaluating collectibility, management considers a number of factors, including the status of specific impaired loans, trends in historical loss experience, delinquency trends, credit concentrations, comparison of historical loan loss data to that of other financial institutions and economic conditions within the Corporation's market area. Allowances for impaired loans are determined based on collateral values or the present value of estimated cash flows. The allowance is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. Each quarter, management performs a detailed assessment of the allowance and the provision for loan losses. The loan quality committee performs this assessment. This committee includes the Bank's President, Chief Financial Officer, Executive Vice Presidents in charge of loans and branch administration and additional commercial lending staff. The committee reviews the identified risk elements in the loan portfolio, including the "Watch List", past due reports and other information. The "Watch List" is a collection of loans that have a history of delinquency, collateral deficiency, cash flow problems, or other factors that have come to management's attention to create the need for special monitoring. Total "Watch List" loans amounted to $12,679,000 at December 31, 2001 and $11,412,000 at December 31, 2000. The allowance for loan losses includes two components, allocated and unallocated. The allocated component of the allowance for loan losses reflects expected losses resulting from the analysis of individual loans, specific allowances for loans in certain industries and historical loss experience 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 five-year period, for each significant type of loan. The charge-off ratio is then applied to the current outstanding loan balance for each type of loan (net of "Watch List" and other loans that are individually evaluated). The unallocated portion of the allowance is determined based on management's assessment of general economic conditions as well as specific economic factors in the market area. This determination inherently involves a higher degree of uncertainty and considers current risk factors that may not have yet manifested themselves in the Bank's historical loss factors used to determine the allocated component of the allowance, and it recognizes that knowledge of the portfolio may be incomplete. 20 The Bank also engages a consulting firm each year to perform an independent credit review. Their review is performed annually on loans of $175,000 and higher. The loan quality committee gives substantial consideration to the classifications and recommendations of the independent credit reviewer in determining the allowance for loan losses. As noted in Table IX, the unallocated portion of the allowance for loan losses was $2,187,000 at December 31, 2001 and $1,983,000 at December 31, 2000. The unallocated balances ranged from $1,983,000 to $2,364,000 during 2001. The larger unallocated allowances in 2001 reflect management's concerns regarding possible adverse changes that may have occurred in the local economy. In addition to concerns based on general economic reports, management is aware of lay-offs that have occurred at some local manufacturing plants. Further, there has been some deterioration in loan delinquency data. Total 90 day or more past due loans, plus nonaccrual loans, increased 10.2%, to $3,117,000 at December 31, 2001 from $2,829,000 at December 31, 2000. The reduction in the allocated portion of the allowance resulted mainly from charge-offs of some delinquent Watch List loans. As reflected in Table VIII, total charge-offs increased to $713,000 in 2001 from $616,000 in 2000 and $630,000 in 1999. The provision for loan losses decreased to $600,000 in 2001 from $676,000 in 2000 and $760,000 in 1999. The amount of the provision in each year is determined based on the amount required to maintain an appropriate allowance in light of the factors described above. Tables VII, VIII, IX and X present an analysis of the loan portfolio, the allowance for loan losses, the allocation of the allowance and a five-year summary of loans by type. TABLE VII - FIVE-YEAR HISTORY OF LOAN LOSSES (IN THOUSANDS)
2001 2000 1999 1998 1997 AVERAGE Year-end gross loans, excluding unearned discount $379,228 $328,305 $310,892 $291,003 $285,426 $318,971 Year-end allowance for loan losses 5,265 5,291 5,131 4,820 4,913 5,084 Year-end nonaccrual loans 1,050 1,608 1,956 1,135 1,412 1,432 Year-end loans 90 days or more past due and still accruing 2,067 1,221 1,797 1,628 1,986 1,740 Net charge-offs 626 516 449 856 660 621 Provision for loan losses 600 676 760 763 797 719 Earnings coverage of charge- offs 19.3 16.4 25.6 12.9 15.3 17.1 Allowance coverage of charge- offs 8.4 10.3 11.4 5.6 7.4 8.2 Net charge-offs as a % of provision for loan losses 104.3% 76.3% 59.1% 112.2% 82.8% 86.4%
21 TABLE VIII - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
(IN THOUSANDS) YEARS ENDED DECEMBER 31, 2001 2000 1999 1998 1997 Balance, beginning of year $5,291 $5,131 $4,820 $4,913 $4,776 - ----------------------------------------------------------------------------- Charge-offs: Real estate loans 144 272 81 257 246 Installment loans 138 77 138 144 230 Credit cards and related plans 200 214 192 264 305 Commercial and other loans 231 53 219 301 3 - ----------------------------------------------------------------------------- Total charge-offs 713 616 630 966 784 - ----------------------------------------------------------------------------- Recoveries: Real estate loans 6 26 81 12 21 Installment loans 27 23 60 43 64 Credit cards and related plans 20 28 30 40 30 Commercial and other loans 34 23 10 15 9 - ----------------------------------------------------------------------------- Total recoveries 87 100 181 110 124 - ----------------------------------------------------------------------------- Net charge-offs 626 516 449 856 660 Provision for loan losses 600 676 760 763 797 - ----------------------------------------------------------------------------- Balance, end of year $5,265 $5,291 $5,131 $4,820 $4,913 =============================================================================
TABLE IX - ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES BY TYPE (IN THOUSANDS)
2001 2000 1999 1998 1997 Commercial $1,837 $1,612 $2,081 $ 650 $ 625 Consumer mortgage 674 952 834 97 350 Impaired loans 73 273 609 290 274 Consumer 494 471 437 702 375 All other commitments -- -- 150 202 343 Unallocated 2,187 1,983 1,020 2,879 2,946 - ------------------------------------------------------------------------------- Total Allowance $5,265 $5,291 $5,131 $4,820 $4,913 ===============================================================================
The above allocation is based on estimates and subjective judgments and is not necessarily indicative of the specific amounts or loan categories in which losses may occur. The calculation for years prior to 1999 did not include specific amounts for "Watch List" loans. These loans were included in the total population of loans and historical loss ratios applied. In 2000 and 1999, these loans were segregated from total loans prior to applying the historical loss ratios. TABLE X - FIVE-YEAR SUMMARY OF LOANS BY TYPE (IN THOUSANDS)
2001 % 2000 % 1999 % 1998 % 1997 % Real estate - construction $ 1,814 0.48 $ 452 0.14 $ 649 0.21 $ 1,004 0.34 $ 406 0.14 Real estate - mortgage 306,264 80.76 263,325 80.21 247,604 79.64 230,815 79.31 219,952 77.05 Consumer 29,284 7.72 28,141 8.57 29,140 9.37 30,924 10.63 33,094 11.59 Agricultural 2,344 0.62 1,983 0.60 1,899 0.61 1,930 0.66 2,424 0.85 Commercial 24,696 6.51 20,776 6.33 18,050 5.81 17,630 6.06 17,176 6.02 Other 1,195 0.32 948 0.29 1,025 0.33 1,062 0.36 6,260 2.19 Political subdivisions 13,479 3.55 12,462 3.80 12,332 3.97 7,449 2.56 5,895 2.07 Lease receivables 152 0.04 218 0.07 222 0.07 218 0.07 256 0.09 - ----------------------------------------------------------------------------------------------------------------------------------- Total 379,228 100.00 328,305 100.00 310,921 100.00 291,032 100.00 285,463 100.00 Less: unearned discount -- -- (29) (29) (37) - ----------------------------------------------------------------------------------------------------------------------------------- 379,228 328,305 310,892 291,003 285,426 Less: allowance for loan losses (5,265) (5,291) (5,131) (4,820) (4,913) - ----------------------------------------------------------------------------------------------------------------------------------- Loans, net $373,963 $323,014 $305,761 $286,183 $280,513 ===================================================================================================================================
Certain types of home improvement loans classified as "Other" in 1997 were classified as "Real Estate - mortgage" in 1998-2001. 22 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 the Federal Home Loan Bank of Pittsburgh, secured by mortgage loans and mortgage-backed securities. At December 31, 2001, the Corporation had unused borrowing availability with correspondent banks and the Federal Home Loan Bank of Pittsburgh totaling approximately $202,923,000. Additionally, the Corporation uses repurchase agreements placed with brokers to borrow short-term funds secured by investment assets, and uses "RepoSweep" arrangements to borrow funds from commercial banking customers on an overnight basis. STOCKHOLDERS' EQUITY AND CAPITAL ADEQUACY The Corporation and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. For many years, the Corporation and the Bank have maintained extremely strong capital positions. Details concerning the Corporation's and the Bank's regulatory capital amounts and ratios are presented in Note 16 to the consolidated financial statements. As reflected in Note 16, at December 31, 2001 and 2000, the ratios of total capital to risk-weighted assets, tier 1 capital to risk-weighted assets and tier 1 capital to average total assets are well in excess of the amounts necessary to be classified as "well-capitalized" by the banking agencies. The Corporation's total stockholders' equity is affected by fluctuations in the fair values of available-for-sale securities. The difference between amortized cost and fair value of available-for-sale securities, net of deferred income tax, is classified as "Accumulated Other Comprehensive Income" within stockholders' equity. Changes in accumulated other comprehensive income are excluded from earnings and directly increase or decrease stockholders' equity. Capital expenditures for 2002 are estimated at between $1,000,000 and $1,500,000. Capital expenditures will not have a detrimental effect on the Corporation's financial condition in 2002. COMPREHENSIVE INCOME Comprehensive income is a measure of all changes in the equity of a corporation, excluding transactions with owners in their capacity as owners (such as proceeds from issuances of stock and dividends). The difference between net income and comprehensive income is termed "Other Comprehensive Income". For the Corporation, other comprehensive income consists of unrealized gains and losses on available-for-sale securities, net of deferred income tax. Comprehensive income should not be construed to be a measure of net income. The amount of unrealized gains or losses reflected in comprehensive income may vary widely from period-to-period, depending on the financial markets as a whole and how the portfolio of available-for-sale securities is affected by interest rate movements. Total comprehensive income (loss) was $17,254,000 in 2001, $17,442,000 in 2000 and ($9,321,000) in 1999. Other comprehensive income (loss) amounted to $5,202,000 in 2001, $8,966,000 in 2000 and ($20,806,000) in 1999. INFLATION Over the last several years, direct inflationary pressures on the Corporation's payroll-related and other noninterest costs have been modest. However, the Corporation is significantly affected by the Federal Reserve Board's efforts to control inflation through changes in interest rates. Management monitors the impact of economic trends, including any indicators of inflationary pressure, in managing interest rate and other financial risks. RECENT ACCOUNTING PRONOUNCEMENTS In September 2000, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This statement supercedes and replaces the guidance in Statement No. 125. It revises the standards for accounting for securitization and other transfers of financial assets and collateral and requires certain disclosures, although it carries over most of Statement No. 125's provisions without reconsideration. The Statement is effective for transfers and servicing of 23 financial assets and extinguishments of liabilities occurring after March 31, 2001 and for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. This Statement is to be applied prospectively with certain exceptions. Other than those exceptions, earlier or retroactive application of its accounting provisions is not permitted. The adoption of this statement had no impact on the Corporation's financial condition, equity, results of operations or disclosure. In June 2001, the FASB issued SFAS No. 141, "Business Combinations." Statement No. 141 addresses financial accounting and reporting for business combinations and supersedes Accounting Principles Board (APB) Opinion No. 16, "Business Combinations," and FASB Statement No. 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises." All business combinations in the scope of the Statement are to be accounted for using the purchase method. The provisions of the Statement apply to all business combinations initiated after June 30, 2001. The Statement also applies to all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001 or later. There is no expected impact on earnings, financial conditions or equity upon adoption of Statement No. 141. In June 2001, the FASB issued Statement No. 142, "Goodwill and Other Intangible Assets." The Statement addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, "Intangible Assets." It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. The Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. The provisions of the Statement are required to be applied starting with fiscal years beginning after December 15, 2001, except that goodwill and intangible assets acquired after June 30, 2001 will be subject immediately to the nonamortization and amortization provisions of the Statement. The Corporation has not been involved in any business acquisitions in recent years, and accordingly, there was no impact on earnings, financial condition or equity in 2001. In June 2001, the FASB issued Statement No. 143, "Accounting for Asset Retirement Obligations." This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) the normal operation of a long-lived asset, except for certain obligations of lessees. As used in this Statement, a legal obligation is an obligation that a party is required to settle as a result of an existing or enacted law, statute, ordinance or written or oral contract or by legal construction of a contract under the doctrine of promissory estopped. This Statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. This Statement amends FASB Statement No. 19, "Financial Accounting and Reporting by Oil and Gas Producing Companies," and it applies to all entities. It is effective for financial statements issued for fiscal years beginning after June 15, 2002. Earlier application is encouraged. The Corporation does not expect the adoption of the Statement to have an impact on its earnings, financial condition or equity. In August 2001, the FASB issued Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This Statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." However, the Statement retains the fundamental provisions of Statement No. 121 for (a) recognition and measurement of the impairment of long-lived assets to be held and used and (b) measurement of long-lived assets to be disposed of by sale. This Statement supersedes the accounting and reporting provision of APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of a segment of a business. However, this Statement retains the requirement of Opinion No. 30 to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that either has been disposed of (by sale, by abandonment or in distribution to owners) or is classified as held for sale. This Statement also amends APB No. 51, "Consolidated Financial Statements," to eliminate the exception to consolidation for a temporarily-controlled subsidiary. The provisions of this Statement are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with earlier application encouraged. The provisions of this Statement generally are to be applied prospectively. The Corporation does not expect the adoption of the Statement to have an impact on its earnings, financial condition or equity. 24 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK The Corporation's two major categories of market risk, interest rate and equity securities risk, are discussed in the following sections. INTEREST RATE RISK Business risk arising from changes in interest rates is an inherent 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 shorter-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. The 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 the Bank are included in management's monthly simulation model calculations. Since the Bank makes up more than 90% of the Corporation's total assets and liabilities, and because the 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 interest. The model measures and projects potential changes in net interest income, and calculates the discounted present value of anticipated cash flows of financial instruments, under the "base most likely" and "what if" scenarios. Typically, management runs these calculations assuming increases and decreases of 100 basis points (1%), 200 basis points and 300 basis points from the base most likely scenario. The Bank's Board of Directors has established policy guidelines for acceptable levels of interest rate risk, based on an increase or decrease in interest rates of 200 basis points. The policy limit for fluctuation in net interest income is minus 20% from the base most likely one-year scenario. The policy limit for market value variance is minus 30% from the base most likely one-year scenario. The most sensitive scenario presented is the "+200 basis points" scenario. If interest rates were to immediately increase 200 basis points, the Bank's calculations using December 31, 2001 data show that net interest income would decrease 18.92% over the next 12 months, and the market value of portfolio equity would decrease 28.29%. Throughout most of 2000, the Bank's calculations showed projected decreases in net interest income and market value of portfolio equity, in the plus 200 basis point scenario, that exceeded the policy thresholds. This condition is reflected in the prior year amounts reflected in the table below. In 2000, management and the Bank's Board of Directors considered various alternatives, including hedging strategies and restructuring of the securities portfolio, but decided not to implement any of these alternatives. In light of the Bank's very strong equity position, it was deemed appropriate to wait out the high short-term interest rate market environment. In the first quarter 2001, management changed some of the key assumptions within the model regarding maturities of callable agency securities and discount rates associated with assets and liabilities. These changes were made in an effort to improve the quality of the calculations. At the time these changes were made, they resulted in a lesser decline in net interest income and market value of portfolio equity in the "+200 basis points" scenario. These changes were still in effect in the calculations done using December 31, 2001 data below, and affect comparability of the amounts presented in the table. 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. 25 THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES (IN THOUSANDS)
DECEMBER 31, 2001 DATA PERIOD ENDING DECEMBER 31, 2002 PLUS 200 MINUS 200 MOST LIKELY BASIS BASIS FORECAST POINTS POINTS AMOUNT AMOUNT % CHANGE AMOUNT % CHANGE Interest income: Securities $ 24,657 $ 26,156 6.08 $ 23,082 (6.39) Interest-bearing due from banks and federal funds sold 121 147 21.49 38 (68.60) Loans 32,165 33,889 5.36 29,647 (7.83) - --------------------------------------------------------------------------------------------------------------- Total interest income 56,943 60,192 5.71 52,767 (7.33) - --------------------------------------------------------------------------------------------------------------- Interest expense: Interest on deposits 18,894 26,452 40.00 11,453 (39.38) Interest on borrowed funds 7,758 9,181 18.34 6,374 (17.84) - --------------------------------------------------------------------------------------------------------------- Total interest expense 26,652 35,633 33.70 17,827 (33.11) - --------------------------------------------------------------------------------------------------------------- Net Interest Income $ 30,291 $ 24,559 (18.92) $ 34,940 15.35 =============================================================================================================== Market Value of Portfolio Equity, December 31, 2001 $ 97,585 $ 69,980 (28.29) $ 118,667 21.60 ===============================================================================================================
DECEMBER 31, 2000 DATA PERIOD ENDING DECEMBER 31, 2001 PLUS 200 MINUS 200 MOST LIKELY BASIS BASIS FORECAST POINTS POINTS AMOUNT AMOUNT % CHANGE AMOUNT % CHANGE Interest income: Securities $ 22,235 $ 23,384 5.17 $ 21,654 (2.61) Interest-bearing due from banks and federal funds sold 228 291 27.63 202 (11.40) Loans 29,104 30,876 6.09 27,216 (6.49) - --------------------------------------------------------------------------------------------------------------- Total interest income 51,567 54,551 5.79 49,072 (4.84) - --------------------------------------------------------------------------------------------------------------- Interest expense: Interest on deposits 22,575 31,667 40.27 19,719 (12.65) Interest on borrowed funds 5,579 7,306 30.96 4,990 (10.56) - --------------------------------------------------------------------------------------------------------------- Total interest expense 28,154 38,973 38.43 24,709 (12.24) - --------------------------------------------------------------------------------------------------------------- Net Interest Income $ 23,413 $ 15,578 (33.46) $ 24,363 4.06 =============================================================================================================== Market Value of Portfolio Equity, December 31, 2000 $ 95,337 $ 53,588 (43.79) $ 107,346 12.60 ===============================================================================================================
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 stocks of other banks and bank holding companies, mainly based 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 (decline in value on an other than temporary basis) are primarily regulatory in 26 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 affecting the banking industry generally, including competition from non-bank entities, credit risk, interest rate risk and other factors that 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 its holdings in Pennsylvania banks, these investments could decline in value if there were a downturn in the state's economy. The Corporation's management monitors its risk associated with its equity securities holdings by reviewing its holdings on a detailed, individual security basis, at least monthly, considering all of the factors described above. Equity securities held as of December 31, 2001 and 2000 are as follows:
HYPOTHETICAL HYPOTHETICAL 10% DECLINE 20% DECLINE FAIR IN IN COST VALUE MARKET VALUE MARKET VALUE AT DECEMBER 31, 2001 Banks and bank holding companies $18,922 $26,636 $ (2,664) $ (5,327) Other equity securities 823 836 (84) (167) Restricted stock 8,129 8,129 (813) (1,626) - --------------------------------------------------------------------------------- Total $27,874 $35,601 $ (3,561) $ (7,120) =================================================================================
HYPOTHETICAL HYPOTHETICAL 10% DECLINE 20% DECLINE FAIR IN IN COST VALUE MARKET VALUE MARKET VALUE AT DECEMBER 31, 2000 Banks and bank holding companies $22,098 $26,814 $ (2,681) $ (5,363) Restricted stock 7,248 7,248 (725) (1,450) - --------------------------------------------------------------------------------- Total $29,346 $34,062 $ (3,406) $ (6,813) =================================================================================
27 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLIDATED BALANCE SHEET
(IN THOUSANDS EXCEPT SHARE DATA) DECEMBER 31, DECEMBER 31, 2001 2000 ASSETS Cash and due from banks: Noninterest-bearing $ 14,055 $ 11,638 Interest-bearing 1,981 2,186 - --------------------------------------------------------------------------------------------- Total cash and cash equivalents 16,036 13,824 Available-for-sale securities 442,098 346,747 Held-to-maturity securities 1,448 1,911 Loans, net 373,963 323,014 Bank-owned life insurance 15,905 15,000 Accrued interest receivable 4,871 4,953 Bank premises and equipment, net 9,967 9,332 Foreclosed assets held for sale 179 316 Other assets 2,532 4,238 - --------------------------------------------------------------------------------------------- TOTAL ASSETS $ 866,999 $ 719,335 - --------------------------------------------------------------------------------------------- LIABILITIES Deposits: Noninterest-bearing $ 63,858 $ 55,275 Interest-bearing 512,416 473,692 - --------------------------------------------------------------------------------------------- Total deposits 576,274 528,967 Dividends payable 1,466 1,353 Short-term borrowings 58,064 94,691 Long-term borrowings 125,584 605 Accrued interest and other liabilities 5,424 4,750 - --------------------------------------------------------------------------------------------- TOTAL LIABILITIES 766,812 630,366 - --------------------------------------------------------------------------------------------- STOCKHOLDERS' EQUITY Common stock, par value $1.00 per share; authorized 10,000,000 shares; issued 5,378,212 in 2001 and 5,324,962 in 2000 5,378 5,325 Stock dividend distributable 1,369 1,054 Paid-in capital 19,758 18,756 Retained earnings 70,352 65,206 - --------------------------------------------------------------------------------------------- Total 96,857 90,341 Accumulated other comprehensive income 5,284 82 Unamortized stock compensation (17) (35) Treasury stock, at cost: 143,412 shares at December 31, 2001 (1,937) 117,718 shares at December 31, 2000 (1,419) - --------------------------------------------------------------------------------------------- TOTAL STOCKHOLDERS' EQUITY 100,187 88,969 - --------------------------------------------------------------------------------------------- TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $ 866,999 $ 719,335 =============================================================================================
The accompanying notes are an integral part of the consolidated financial statements. 28 CONSOLIDATED STATEMENT OF INCOME
YEARS ENDED DECEMBER 31, (IN THOUSANDS EXCEPT PER SHARE DATA) 2001 2000 1999 INTEREST INCOME Interest and fees on loans $28,592 $27,082 $25,642 Interest on balances with depository institutions 82 114 30 Interest on loans to political subdivisions 719 644 541 Interest on federal funds sold 184 64 42 Income from available-for-sale and held-to-maturity securities: Taxable 19,752 18,296 16,421 Tax-exempt 4,242 4,483 4,534 Dividends 1,569 1,472 1,205 - --------------------------------------------------------------------------------------------- Total interest and dividend income 55,140 52,155 48,415 - --------------------------------------------------------------------------------------------- INTEREST EXPENSE Interest on deposits 20,417 23,108 19,053 Interest on short-term borrowings 3,944 6,102 2,454 Interest on long-term borrowings 3,995 935 3,064 - --------------------------------------------------------------------------------------------- Total interest expense 28,356 30,145 24,571 - --------------------------------------------------------------------------------------------- Interest margin 26,784 22,010 23,844 Provision for loan losses 600 676 760 - --------------------------------------------------------------------------------------------- Interest margin after provision for loan losses 26,184 21,334 23,084 - --------------------------------------------------------------------------------------------- OTHER INCOME Service charges on deposit accounts 1,376 1,150 1,113 Service charges and fees 247 232 274 Trust and financial management revenue 1,576 1,613 1,456 Insurance commissions, fees and premiums 582 372 438 Increase in cash surrender value of life insurance 905 -- -- Fees related to credit card operation 550 897 3,064 Other operating income 405 226 99 - --------------------------------------------------------------------------------------------- Total other income before realized gains on securities, net 5,641 4,490 6,444 Realized gains on securities, net 1,920 1,377 3,043 - --------------------------------------------------------------------------------------------- Total other income 7,561 5,867 9,487 - --------------------------------------------------------------------------------------------- OTHER EXPENSES Salaries and wages 8,493 7,597 6,926 Pensions and other employee benefits 2,213 1,939 1,831 Occupancy expense, net 1,018 928 896 Furniture and equipment expense 1,431 1,194 1,078 Expenses related to credit card operation 295 407 2,597 Pennsylvania shares tax 790 756 723 Other operating expense 4,431 4,085 3,681 - --------------------------------------------------------------------------------------------- Total other expenses 18,671 16,906 17,732 - --------------------------------------------------------------------------------------------- Income before income tax provision 15,074 10,295 14,839 Income tax provision 3,022 1,819 3,354 - --------------------------------------------------------------------------------------------- NET INCOME $12,052 $ 8,476 $11,485 ============================================================================================= NET INCOME PER SHARE - BASIC $ 2.28 $ 1.60 $ 2.16 ============================================================================================= NET INCOME PER SHARE - DILUTED $ 2.27 $ 1.60 $ 2.16 =============================================================================================
The accompanying notes are an integral part of the consolidated financial statements. 29 CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (IN THOUSANDS EXCEPT PER SHARE DATA)
STOCK COMMON DIVIDEND PAID-IN RETAINED STOCK DISTRIBUTABLE CAPITAL EARNINGS - -------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1998 $5,220 $1,931 $15,468 $ 57,477 Comprehensive income: Net income 11,485 Unrealized loss on securities, net of reclassification adjustment and tax effects - ------------------------------------------------------------------------------------------- Total comprehensive loss - ------------------------------------------------------------------------------------------- Cash dividends declared, $.87 per share (4,639) Shares issued from treasury related to Exercise of stock options 8 Stock dividend issued 52 (1,931) 1,879 -- Stock dividend declared, 1% 1,437 (1,437) - ------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1999 5,272 1,437 17,355 62,886 Comprehensive income: Net income 8,476 Unrealized gain on securities, net of reclassification adjustment and tax effects - ------------------------------------------------------------------------------------------- Total comprehensive income - ------------------------------------------------------------------------------------------- Cash dividends declared, $.96 per share (5,102) Shares issued from treasury related to Exercise of stock options 3 Stock dividend issued 53 (1,437) 1,384 Stock dividend declared, 1% 1,054 (1,054) -- Restricted stock granted 14 - ------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 2000 5,325 1,054 18,756 65,206 Comprehensive income: Net income 12,052 Unrealized gain on securities, net of reclassification adjustment and tax effects - ------------------------------------------------------------------------------------------- Total comprehensive income - ------------------------------------------------------------------------------------------- Cash dividends declared, $1.05 per share (5,554) Treasury stock purchased Amortization of restricted stock Tax benefit from employee benefit plan 17 Stock dividend issued 53 (1,054) 1,001 Stock dividend declared, 1% 1,369 (1,369) Restricted stock granted 1 - ------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 2001 $5,378 $1,369 $19,758 $ 70,352 ===========================================================================================
ACCUMULATED OTHER UNAMORTIZED COMPREHENSIVE STOCK TREASURY INCOME COMPENSATION STOCK TOTAL - --------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1998 $ 11,922 $ -- $ (1,451) $ 90,567 Comprehensive income: Net income 11,485 Unrealized loss on securities, net of reclassification adjustment and tax effects (20,806) (20,806) - --------------------------------------------------------------------------------------------------- Total comprehensive loss (9,321) - --------------------------------------------------------------------------------------------------- Cash dividends declared, $.87 per share (4,639) Shares issued from treasury related to Exercise of stock options 8 16 Stock dividend issued Stock dividend declared, 1% -- - --------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1999 (8,884) -- (1,443) 76,623 Comprehensive income: Net income 8,476 Unrealized gain on securities, net of reclassification adjustment and tax effects 8,966 8,966 - --------------------------------------------------------------------------------------------------- Total comprehensive income 17,442 - --------------------------------------------------------------------------------------------------- Cash dividends declared, $.96 per share (5,102) Shares issued from treasury related to Exercise of stock options 3 6 Stock dividend issued -- Stock dividend declared, 1% Restricted stock granted (35) 21 -- - --------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 2000 82 (35) (1,419) 88,969 Comprehensive income: Net income 12,052 Unrealized gain on securities, net of reclassification adjustment and tax effects 5,202 5,202 - --------------------------------------------------------------------------------------------------- Total comprehensive income 17,254 - --------------------------------------------------------------------------------------------------- Cash dividends declared, $1.05 per share (5,554) Treasury stock purchased (521) (521) Amortization of restricted stock 22 22 Tax benefit from employee benefit plan 17 Stock dividend issued -- Stock dividend declared, 1% -- Restricted stock granted (4) 3 -- - --------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 2001 $ 5,284 $ (17) $ (1,937) $ 100,187 ===================================================================================================
The accompanying notes are an integral part of the consolidated financial statements. 30 CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS) YEARS ENDED DECEMBER 31, 2001 2000 1999 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 12,052 $ 8,476 $ 11,485 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 600 676 760 Realized gains on securities, net (1,920) (1,377) (3,043) (Gain) loss on sale of foreclosed assets, net (88) (59) 44 Depreciation expense 1,300 1,086 971 Accretion and amortization, net (1,869) (2,491) (1,837) Increase in cash surrender value of life insurance (905) -- -- Amortization of restricted stock 22 -- -- Deferred income taxes (349) (63) 423 Increase in accrued interest receivable and other assets (126) (88) (2,282) Increase in accrued interest payable and other liabilities 579 1,247 2,003 - --------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 9,296 7,407 8,524 - --------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturity of held-to-maturity securities 1,083 156 372 Purchase of held-to-maturity securities (626) (196) (354) Proceeds from sales of available-for-sale securities 26,657 32,173 30,027 Proceeds from maturities of available-for-sale securities 152,568 15,337 33,436 Purchase of available-for-sale securities (262,898) (17,865) (119,753) Net increase in loans (51,984) (18,374) (20,503) Purchase of bank-owned life insurance -- (15,000) -- Purchase of interest in low-income housing partnerships (306) (697) -- Purchase of premises and equipment (1,935) (2,426) (1,547) Proceeds from sale of foreclosed assets 660 498 463 - --------------------------------------------------------------------------------------------------- Net Cash Used in Investing Activities (136,781) (6,394) (77,859) - --------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposits 47,307 28,493 23,956 Net (decrease) increase in short-term borrowings (36,627) 5,655 76,956 Proceeds from long-term borrowings 125,000 -- -- Repayments of long-term borrowings (21) (34,420) (25,019) Proceeds from sale of treasury stock -- 6 16 Purchase of treasury stock (521) -- -- Dividends paid (5,441) (4,986) (4,639) - --------------------------------------------------------------------------------------------------- Net Cash Provided by (Used in) Financing Activities 129,697 (5,252) 71,270 - --------------------------------------------------------------------------------------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,212 (4,239) 1,935 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 13,824 18,063 16,128 - --------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 16,036 $ 13,824 $ 18,063 =================================================================================================== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Assets acquired through foreclosure of real estate loans $ 435 $ 445 $ 165 Interest paid $ 28,665 $ 29,446 $ 24,006 Income taxes paid $ 2,961 $ 1,801 $ 2,973
The accompanying notes are an integral part of the consolidated financial statements. 31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF CONSOLIDATION - The consolidated financial statements include the accounts of Citizens & Northern Corporation ("Corporation"), and its subsidiaries, Citizens & Northern Bank ("Bank"), Bucktail Life Insurance Company and Citizens & Northern Investment Corporation. The consolidated financial statements also include the accounts of the Bank's wholly-owned subsidiary, C&N Financial Services Corporation, which began operations in 2000. All material intercompany balances and transactions have been eliminated in consolidation. NATURE OF OPERATIONS - The Corporation is primarily engaged in providing a full range of banking and mortgage services to individual and corporate customers in Northcentral Pennsylvania. Lending products include mortgage loans, commercial loans, consumer loans and credit cards, as well as specialized instruments such as commercial letters-of-credit. Deposit products include various types of checking accounts, passbook and statement savings, money market accounts, interest checking accounts, individual retirement accounts and certificates of deposit. The Corporation also offers non-insured "Repo Sweep" accounts. The Corporation provides Trust and Financial Management services, including administration of trusts and estates, retirement plans, and other employee benefit plans, and investment management services. In 2000, the Corporation began offering a variety of personal and commercial insurance products through C&N Financial Services Corporation. In 2001, C&N Financial Services Corporation added a broker-dealer division, which offers mutual funds, annuities, educational savings accounts and other investment products through registered agents. The Corporation is subject to competition from other financial institutions. It is also subject to regulation by certain federal and state agencies and undergoes periodic examination by those regulatory authorities. USE OF ESTIMATES - The presentation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect 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. 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. INVESTMENT SECURITIES - Investment securities are accounted for as follows: HELD-TO-MATURITY SECURITIES - includes debt securities that the Corporation has the positive intent and ability to hold to maturity. These securities are reported at cost adjusted for amortization of premiums and accretion of discounts, computed using the level-yield method. AVAILABLE-FOR-SALE SECURITIES - includes debt securities not classified as held-to-maturity and both restricted and unrestricted equity securities. Such securities, except for restricted equity securities, are reported at fair value, with unrealized gains and losses excluded from earnings and reported separately through accumulated other comprehensive income, net of tax. The restricted equity securities consist primarily of Federal Home Loan Bank stock, and are carried at cost and evaluated for impairment. Amortization of premiums and accretion of discounts on available-for-sale securities are recorded using the level yield method over the remaining contractual life of the securities, adjusted for actual prepayments. Realized gains and losses on sales of available-for-sale securities are computed on the basis of specific identification of the adjusted cost of each security. LOANS - Loans are stated at unpaid principal balances, less the allowance for loan losses and net deferred loan fees. Loan origination and commitment fees, as well as certain direct origination costs, are deferred and amortized as a yield adjustment over the lives of the related loans using the interest method. Amortization of deferred loan fees is discontinued when a loan is placed on nonaccrual status. 32 Loans are placed on nonaccrual status when, in the opinion of management, collection of interest is doubtful. Any unpaid interest previously accrued on those loans is reversed from income. Interest income is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction of the loan principal balance. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received. The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, based on factors such as credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. Allowances for impaired loans are determined based on collateral values or the present value of estimated cash flows. The allowance is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. BANK PREMISES AND EQUIPMENT - Bank premises and equipment are stated at cost less accumulated depreciation. Repair and maintenance expenditures which extend the useful lives of assets are capitalized, and other repair and maintenance expenditures are expensed as incurred. Depreciation expense is computed using the straight-line method. FORECLOSED ASSETS HELD FOR SALE - Foreclosed assets held for sale consist of real estate acquired by foreclosure and are carried at estimated fair value, less selling cost. INCOME TAXES - Provisions for deferred income taxes are made as a result of temporary differences in financial and income tax methods of accounting. These differences relate principally to loan losses, securities gains or losses, depreciation, pension and other postretirement benefits and amortization of loan origination fees and costs. STOCK COMPENSATION PLANS - As permitted by Accounting Principles Board Opinion No. 25, the Corporation uses the intrinsic value method of accounting for stock compensation plans. Utilizing the intrinsic value method, compensation cost is 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 no intrinsic value, and accordingly, no compensation cost is recorded for them. Statement of Financial Accounting Standards No. 123 provides an alternative method of accounting for stock options, based on the estimated fair value of stock option awards. In Note 12, the Corporation has provided pro forma disclosures of net income and earnings per share and other disclosures, as if the fair value based method of accounting had been applied. The Corporation has also made awards of restricted stock. Compensation cost related to restricted stock is recognized based on the market price of the stock at the grant date, adjusted for subsequent fluctuations in market price, over the vesting period. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS - In the ordinary course of business, the Corporation has entered into off-balance sheet financial instruments consisting of commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they become payable. CASH FLOWS - The Corporation utilizes the net reporting of cash receipts and cash payments for certain deposit and lending activities. The Corporation considers all cash and amounts due from depository institutions, interest-bearing deposits in other banks, and federal funds sold to be cash equivalents. TRUST ASSETS AND INCOME - Assets held by the Corporation in a fiduciary or agency capacity for its customers are not included in the financial statements since such items are not assets of the Corporation. Trust income is recorded on a cash basis, which is not materially different from the accrual basis. RECLASSIFICATION - Certain 2000 amounts have been reclassified to conform to the 2001 presentation. 33 2. COMPREHENSIVE INCOME Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income. The components of other comprehensive income and the related tax effects are as follows:
YEARS ENDED DECEMBER 31, (IN THOUSANDS) 2001 2000 1999 Unrealized holding gains (losses) on available-for-sale securities $ 9,802 $ 14,963 $(28,481) Less: Reclassification adjustment for gains realized in income (1,920) (1,377) (3,043) - ---------------------------------------------------------------------------------------------------- Net unrealized gains (losses) 7,882 13,586 (31,524) Tax effect (2,680) (4,620) 10,718 - ---------------------------------------------------------------------------------------------------- Net-of-tax amount $ 5,202 $ 8,966 $(20,806) ====================================================================================================
3. 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 declared in the fourth quarter of each year presented, payable in the first quarter of the following year. The following data show the amounts used in computing basic and diluted net income per share. The dilutive effect of stock options is computed as the 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 2001 Earnings per share - basic $12,052,000 5,296,003 $ 2.28 Dilutive effect of stock options 1,720 - -------------------------------------------------------------------------------- Earnings per share - diluted $12,052,000 5,297,723 $ 2.27 ================================================================================ 2000 Earnings per share - basic $ 8,476,000 5,310,131 $ 1.60 Dilutive effect of stock options 1,143 - -------------------------------------------------------------------------------- Earnings per share - diluted $ 8,476,000 5,311,274 $ 1.60 ================================================================================ 1999 Earnings per share - basic $11,485,000 5,309,763 $ 2.16 Dilutive effect of stock options 5,410 - -------------------------------------------------------------------------------- Earnings per share - diluted $11,485,000 5,315,173 $ 2.16 ================================================================================
34 4. CASH AND DUE FROM BANKS Banks are required to maintain reserves consisting of vault cash and deposit balances with the Federal Reserve Bank in their district. The reserves are based on deposit levels during the year and account activity and other services provided by the Federal Reserve Bank. Average daily currency, coin, and cash balances with the Federal Reserve Bank needed to cover reserves against deposits for 2001 ranged from $1,489,000 to $5,293,000. For 2000, these balances ranged from $1,211,000 to $4,868,000. Average daily cash balances with the Federal Reserve Bank required for services provided to the Bank amounted to $1,500,000 throughout 2001 and ranged from $25,000 to $1,500,000 in 2000. Total balances restricted amounted to $4,735,000 at December 31, 2001 and $3,121,000 at December 31, 2000. Deposits with one financial institution are insured up to $100,000. The Corporation maintains cash and cash equivalents with certain financial institutions in excess of the insured amount. 5. SECURITIES Amortized cost and fair value of securities at December 31, 2001 and 2000 are summarized as follows:
(IN THOUSANDS) DECEMBER 31, 2001 GROSS GROSS UNREALIZED UNREALIZED AMORTIZED HOLDING HOLDING FAIR COST GAINS LOSSES VALUE AVAILABLE-FOR-SALE SECURITIES: Obligations of the U.S. Treasury $ 2,503 $ 54 $ -- $ 2,557 Obligations of other U.S. Government agencies 75,295 698 (821) 75,172 Obligations of states and political subdivisions 95,835 1,422 (1,996) 95,261 Other securities 34,315 395 (178) 34,532 Mortgage-backed securities 198,269 1,045 (339) 198,975 - -------------------------------------------------------------------------------------------------- Total debt securities 406,217 3,614 (3,334) 406,497 Marketable equity securities 27,874 7,993 (266) 35,601 - -------------------------------------------------------------------------------------------------- Total $ 434,091 $ 11,607 $ (3,600) $442,098 ================================================================================================== HELD-TO-MATURITY SECURITIES: Obligations of the U.S. Treasury $ 726 $ 9 $ -- $ 735 Obligations of other U.S. Government agencies 547 14 -- 561 Mortgage-backed securities 175 6 -- 181 - -------------------------------------------------------------------------------------------------- Total $ 1,448 $ 29 $ -- $ 1,477 ==================================================================================================
35
(IN THOUSANDS) DECEMBER 31, 2000 GROSS GROSS UNREALIZED UNREALIZED AMORTIZED HOLDING HOLDING FAIR COST GAINS LOSSES VALUE AVAILABLE-FOR-SALE SECURITIES: Obligations of the U.S. Treasury $ 2,509 $ 24 $ -- $ 2,533 Obligations of other U.S. Government agencies 132,713 163 (3,993) 128,883 Obligations of states and political subdivisions 68,236 1,513 (684) 69,065 Other securities 22,111 -- (1,147) 20,964 Mortgage-backed securities 91,708 531 (999) 91,240 - ------------------------------------------------------------------------------------------------- Total debt securities 317,277 2,231 (6,823) 312,685 Marketable equity securities 29,346 6,556 (1,840) 34,062 - ------------------------------------------------------------------------------------------------- Total $ 346,623 $ 8,787 $ (8,663) $346,747 ================================================================================================= HELD-TO-MATURITY SECURITIES: Obligations of the U.S. Treasury $ 707 $ 3 $ (2) $ 708 Obligations of other U.S. Government agencies 946 6 (5) 947 Mortgage-backed securities 258 5 (4) 259 - ------------------------------------------------------------------------------------------------- Total $ 1,911 $ 14 $ (11) $ 1,914 =================================================================================================
The amortized cost and fair value of investment debt securities at December 31, 2001 follow. Maturities of debt securities (including mortgage-backed securities) are presented based on contractual maturities. Expected maturities differ from contractual maturities because monthly principal payments are received from mortgage-backed securities, and because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
(IN THOUSANDS) DECEMBER 31, 2001 AMORTIZED FAIR COST VALUE AVAILABLE-FOR-SALE SECURITIES: Due in one year or less $ 725 $ 738 Due after one year through five years 6,783 7,008 Due after five years through ten years 67,225 66,853 Due after ten years 331,484 331,898 - -------------------------------------------------------------------------------- Total $ 406,217 $ 406,497 ================================================================================ HELD-TO-MATURITY SECURITIES: Due in one year or less $ 403 $ 410 Due after one year through five years 473 478 Due after five years through ten years 519 536 Due after ten years 53 53 - -------------------------------------------------------------------------------- Total $ 1,448 $ 1,477 ================================================================================
36 The following table shows the amortized cost and maturity distribution of the debt securities portfolio at December 31, 2001: (IN THOUSANDS, EXCEPT FOR PERCENTAGES)
WITHIN ONE - FIVE - ONE FIVE TEN YEAR YIELD YEARS YIELD YEARS AVAILABLE-FOR-SALE SECURITIES: Obligations of the U.S. Treasury $ -- -- $ 2,503 6.01% $ -- Obligations of other U.S. Government agencies -- -- -- 31,121 Obligations of states and political subdivisions 725 5.37% 2,605 6.78% 3,070 Other securities -- -- 1,550 9.07% 1,000 Mortgage-backed securities -- -- 125 8.34% 32,034 - ---------------------------------------------------------------------------------------------------------- Total $ 725 5.37% $ 6,783 7.05% $ 67,225 ========================================================================================================== HELD-TO-MATURITY SECURITIES: Obligations of the U.S. Treasury $ 403 5.65% $ 323 5.30% $ -- Obligations of other U.S. Government agencies -- -- 100 5.63% 447 Mortgage-backed securities -- -- 50 8.54% 72 - ---------------------------------------------------------------------------------------------------------- Total $ 403 5.65% $ 473 5.71% $ 519 ==========================================================================================================
AFTER TEN YIELD YEARS YIELD TOTAL YIELD AVAILABLE-FOR-SALE SECURITIES: Obligations of the U.S. Treasury -- $ -- -- $ 2,503 6.01% Obligations of other U.S. Government agencies 6.00% 44,174 7.02% 75,295 6.60% Obligations of states and political subdivisions 5.95% 89,435 5.31% 95,835 5.37% Other securities 8.09% 31,765 7.07% 34,315 7.19% Mortgage-backed securities 5.04% 166,110 5.97% 198,269 5.82% - -------------------------------------------------------------------------------------------------------- Total 5.57% $331,484 6.04% $406,217 5.98% ======================================================================================================== HELD-TO-MATURITY SECURITIES: Obligations of the U.S. Treasury -- $ -- -- $ 726 5.49% Obligations of other U.S. Government agencies 6.66% -- -- 547 6.47% Mortgage-backed securities 6.19% 53 3.93% 175 6.16% - -------------------------------------------------------------------------------------------------------- Total 6.59% $ 53 3.93% $ 1,448 5.95% ========================================================================================================
Investment securities, carried at $57,938,000 at December 31, 2001 and $58,280,000 at December 31, 2000, were pledged as collateral for public deposits, trusts and certain other deposits as provided by law. Gross realized gains and losses from the sales of available-for-sale securities, and the income tax provision related to net realized gains, for 2001, 2000 and 1999 were as follows: (IN THOUSANDS)
2001 2000 1999 Gross realized gains $ 2,408 $ 2,163 $ 3,186 Gross realized losses (488) (786) (143) - ---------------------------------------------------------------------------------- Net realized gains $ 1,920 $ 1,377 $ 3,043 ================================================================================== Income tax provision related to net realized gains $ 653 $ 468 $ 1,035 ==================================================================================
6. LOANS Major categories of loans and leases included in the loan portfolio are summarized as follows:
AT DECEMBER 31, (IN THOUSANDS) % OF % OF 2001 TOTAL 2000 TOTAL Real estate - construction $ 1,814 0.48% $ 452 0.14% Real estate - mortgage 306,264 80.76% 263,325 80.21% Consumer 29,284 7.72% 28,141 8.57% Agricultural 2,344 0.62% 1,983 0.60% Commercial 24,696 6.51% 20,776 6.33% Other 1,195 0.32% 948 0.29% Political subdivisions 13,479 3.55% 12,462 3.80% Lease receivables 152 0.04% 218 0.07% - ---------------------------------------------------------------------------- Total 379,228 100.00% 328,305 100.00% Less: allowance for loan losses (5,265) (5,291) - ---------------------------------------------------------------------------- Loans, net $ 373,963 $ 323,014 ============================================================================
37 Net unamortized loan fees and costs of $1,512,000 at December 31, 2001 and $1,583,000 at December 31, 2000 have been offset against the carrying value of loans. There is no concentration of loans to borrowers engaged in similar businesses or activities that exceed 10% of total loans at December 31, 2001. The Corporation grants commercial, residential and personal loans to customers primarily in Tioga, Bradford, Sullivan and Lycoming counties. Although the Corporation has a diversified loan portfolio, a significant portion of it's debtors' ability to honor their contracts is dependent on the local economic conditions within the region. LOAN MATURITY DISTRIBUTION
DECEMBER 31, 2001 (IN THOUSANDS) OVER ONE YEAR BUT AFTER ONE YEAR LESS THAN FIVE OR LESS FIVE YEARS YEARS TOTAL Real estate - construction $ 1,814 $ -- $ -- $ 1,814 Real estate - mortgage 88,702 70,891 146,671 306,264 Consumer 9,530 10,664 9,090 29,284 Agricultural 759 1,145 440 2,344 Commercial 15,196 8,203 1,297 24,696 Other 177 730 288 1,195 Political subdivisions 1,010 3,598 8,871 13,479 Lease receivables 24 96 32 152 - -------------------------------------------------------------------------------- Total $117,212 $ 95,327 $166,689 $379,228 ================================================================================
Loans in the preceding table with maturities over one year are all fixed rate loans. All loans due on demand or at a variable rate are shown as one year or less. Loans on which the accrual of interest has been discontinued or reduced amounted to $1,050,000 at December 31, 2001 and $1,608,000 at December 31, 2000. Interest income on such loans is recorded only as received. Loans on which the original terms have been restructured totaled $75,000 at December 31, 2001 and $77,000 at December 31, 2000. None of the loans on which the original terms were changed were past due at December 31, 2001 and 2000. Loans which were more than 90 days past due and still accruing interest totaled $2,067,000 at December 31, 2001 and $1,221,000 at December 31, 2000. Transactions in the allowance for loan losses were as follows: (IN THOUSANDS)
2001 2000 1999 Balance at beginning of year $ 5,291 $ 5,131 $ 4,820 Provision charged to operations 600 676 760 Loans charged off (713) (616) (630) Recoveries 87 100 181 - ------------------------------------------------------------------------------- Balance at end of year $ 5,265 $ 5,291 $ 5,131 ===============================================================================
38 Information related to impaired loans as of December 31, 2001 and 2000 is as follows: (IN THOUSANDS)
2001 2000 Balance of impaired loans $582 $1,025 Specific allowance related to impaired loans $ 73 $ 273
The average balance of impaired loans amounted to $781,000 in 2001, $1,079,000 in 2000 and $1,582,000 in 1999. The following is a summary of cash receipts on impaired loans and how they were applied. (IN THOUSANDS)
2001 2000 1999 Cash receipts applied to principal $35 $503 $233 Cash receipts recognized as interest income 14 87 35 - -------------------------------------------------------------------------------- Total cash receipts $49 $590 $268 ================================================================================
7. BANK PREMISES AND EQUIPMENT Bank premises and equipment are summarized as follows: (IN THOUSANDS)
DECEMBER 31, 2001 2000 Land $ 1,126 $ 1,126 Buildings and improvements 11,313 10,725 Furniture and equipment 8,565 7,285 - ------------------------------------------------------------------------------- Total 21,004 19,136 Less: accumulated depreciation (11,037) (9,804) - ------------------------------------------------------------------------------- Net $ 9,967 $ 9,332 ===============================================================================
Depreciation expense included in occupancy expense and furniture and equipment expense was comprised of the following: (In Thousands)
2001 2000 1999 Occupancy expense $ 401 $ 370 $362 Furniture and equipment expense 899 716 609 - -------------------------------------------------------------------------------- Total $1,300 $1,086 $971 ================================================================================
39 8. DEPOSITS Balances and maturities of time deposits are as follows: (IN THOUSANDS)
DECEMBER 31, 2001 2002 2003 2004 2005 2006 THEREAFTER TOTAL Certificates of Deposit $136,845 $25,406 $7,004 $3,808 $6,289 $ 169 $179,521 Yield 4.59% 4.53% 4.99% 5.32% 5.01% 5.00% 4.63% Individual Retirement Accounts 54,607 29,533 -- -- -- -- 84,140 Yield 5.00% 5.00% -- -- -- -- 5.00% - -------------------------------------------------------------------------------------------------------- Total Time Deposits $191,452 $54,939 $7,004 $3,808 $6,289 $ 169 $263,661 - -------------------------------------------------------------------------------------------------------- Yield 4.71% 4.78% 4.99% 5.32% 5.01% 5.00% 4.75% ========================================================================================================
DECEMBER 31, 2000 2001 2002 2003 2004 2005 THEREAFTER TOTAL Certificates of Deposit $111,579 $26,205 $8,191 $3,652 $1,841 $ -- $151,468 Yield 5.96% 6.15% 5.60% 5.41% 5.89% -- 5.96% Individual Retirement Accounts 57,070 22,313 -- -- -- -- 79,383 Yield 5.55% 5.55% -- -- -- -- 5.55% - ---------------------------------------------------------------------------------------------------------------------------------- Total Time Deposits $168,649 $48,518 $8,191 $3,652 $1,841 $ -- $230,851 - ---------------------------------------------------------------------------------------------------------------------------------- Yield 5.82% 5.87% 5.60% 5.41% 5.89% -- 5.82% ==================================================================================================================================
Included in interest-bearing deposits are time deposits in the amount of $100,000 or more. As of December 31, 2001, the remaining maturities or repricing frequency of time deposits of $100,000 or more are as follows: (IN THOUSANDS) Three months or less $28,495 Over 3 months through 12 months 34,838 Over 1 year through 3 years 3,303 Over 3 years 1,144 - -------------------------------------------------------------------------------- Total $67,780 ================================================================================
Interest expense from deposits of $100,000 or more amounted to $3,220,000 in 2001, $1,925,000 in 2000 and $1,760,000 in 1999. 9. BORROWED FUNDS SHORT-TERM BORROWINGS Short-term borrowings include the following:
(IN THOUSANDS) AT DECEMBER 31, 2001 2000 Overnight borrowings (a) $ 6,300 $ 5,000 Federal Home Loan Bank borrowings (b) 22,000 70,000 Customer repurchase agreements (c) 19,764 10,241 Other repurchase agreements (d) 10,000 9,450 - -------------------------------------------------------------------------------- Total short-term borrowings $58,064 $94,691 ================================================================================
40 The weighted average interest rate on total short-term borrowings outstanding was 3.44% at December 31, 2001 and 6.66% at December 31, 2000. The maximum amount of total short-term borrowings outstanding at any month-end was $96,167,000 in 2001 and $104,216,000 in 2000. (a) Overnight borrowings include federal funds purchased overnight from correspondent banks and overnight borrowings from the Federal Home Loan Bank on the "Open Repo Plus" facility. The maximum month-end amount of such borrowings was $20,000,000 in 2001, $16,500,000 in 2000 and $14,500,000 in 1999. The average amount of such borrowings was $4,012,000 in 2001, $5,721,000 in 2000 and $6,085,000 in 1999. Weighted average interest rates were 4.58% in 2001, 6.70% in 2000, and 4.91% in 1999. (b) Short-term Federal Home Loan Bank loans are as follows:
(IN THOUSANDS) AT DECEMBER 31, 2001 2000 Fixed Rate 6.64% matured January 2, 2001 $ -- $15,000 Fixed Rate 6.72% matured January 30, 2001 -- 15,000 Fixed Rate 7.00% matured April 20, 2001 -- 15,000 Variable Rate 6.70% matured July 11, 2001 -- 10,000 Variable Rate 6.70% matured August 28, 2001 -- 5,000 Fixed Rate 6.65% matured October 22, 2001 -- 10,000 Fixed Rate 5.25% maturing January 24, 2002 5,000 -- Fixed Rate 5.20% maturing February 19, 2002 7,000 -- Fixed Rate 2.38% maturing October 30, 2002 10,000 -- - ------------------------------------------------------------------------------- Total short-term Federal Home Loan Bank borrowings $22,000 $70,000 ===============================================================================
Collateral for Federal Home Loan Bank loans is described below under long-term borrowings. (c) Customer repurchase agreements mature overnight, and are collateralized by securities with a carrying value of $19,764,000 at December 31, 2001 and $10,241,000 at December 31, 2000. (d) Repurchase agreements included in short-term borrowings are as follows:
AT DECEMBER 31, (IN THOUSANDS) 2001 2000 Fixed Rate 7.04% matured June 16, 2001 $ -- $9,450 Fixed Rate 5.72% maturing January 3, 2002 10,000 -- - -------------------------------------------------------------------------------- Total repurchase agreements $10,000 $9,450 ================================================================================
Securities sold under repurchase agreements were delivered to the broker-dealers who arranged the transactions. The broker-dealers may have sold, loaned or otherwise disposed of such securities to other parties in the normal course of their operations, and have agreed to resell to the Corporation substantially identical securities at the maturities of the agreements. The carrying value of the underlying securities was $9,975,000 at December 31, 2001 and $9,940,000 at December 31, 2000. Average daily repurchase agreement borrowings amounted to $14,217,000 in 2001, $14,372,000 in 2000, and $41,940,000 in 1999. During 2001, 2000 and 1999, the maximum amounts of outstanding borrowings under repurchase agreements with broker-dealers were $19,450,000, $35,731,000 and $53,731,000. The weighted average interest rate on repurchase agreements was 6.20% in 2001, 5.68% in 2000, and 5.70% in 1999. 41 LONG-TERM BORROWINGS Long-term borrowings from the Federal Home Loan Bank of Pittsburgh are as follows:
(IN THOUSANDS) AT DECEMBER 31, 2001 2000 Fixed rate at 5.095%, maturing May 1, 2002 $ 15,000 $ -- Fixed rate at 5.380%, maturing July 24, 2002 5,000 -- Fixed rate at 5.370%, maturing January 12, 2003 10,000 -- Fixed rate at 5.480%, maturing January 24, 2003 5,000 -- Fixed rate at 4.790%, maturing April 26, 2003 10,000 -- Fixed rate at 4.820%, maturing May 14, 2003 10,000 -- Fixed rate at 4.630%, maturing July 11, 2003 10,000 -- Fixed rate at 4.650%, maturing August 30, 2004 10,000 -- Fixed rate at 3.840%, maturing October 22, 2004 10,000 -- Fixed rate at 5.050%, maturing August 29, 2005 5,000 -- Fixed rate at 4.145%, maturing October 30, 2005 5,000 -- Fixed rate at 4.830%, maturing February 20, 2006 20,000 -- Fixed rate at 4.455%, maturing October 30, 2006 5,000 -- Fixed rate at 4.980%, maturing March 23, 2011 5,000 -- Fixed rate at 6.86%, maturing December 30, 2016 518 537 Fixed rate at 6.83%, maturing June 5, 2017 66 68 - -------------------------------------------------------------------------------- Total long-term Federal Home Loan Bank borrowings $125,584 $605 ================================================================================
All Federal Home Loan Bank loans are collateralized by Federal Home Loan Bank Stock, mortgage-backed securities and first mortgage loans with a book value totaling $429,310,000 at December 31, 2001. 10. DERIVATIVE FINANCIAL INSTRUMENTS In June 2001, the Corporation began to utilize derivative financial instruments related to a new 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. 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 pays a fee of 0.75% to a consulting firm at inception of each deposit. This fee is amortized to interest 42 expense over the term of the IPCDs.) Swap liabilities are carried at fair value, and included in other liabilities in the consolidated balance sheet. Changes in fair value of swap liabilities are included in other expense in the consolidated income statement. Amounts recorded as of and through December 31, 2001 related to IPCDs are as follows (in thousands): Contractual amount of IPCDs (equal to notional amount of Swap contracts) $1,410 Carrying value of IPCDs 1,154 Carrying value of embedded derivative liabilities 233 Carrying value of Swap contract liabilities 31 Interest expense 17 Other expense 7
11. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Corporation's financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Statement of Financial Accounting Standards No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Therefore, the aggregate fair value amounts presented may not represent the underlying fair value of the Corporation. The Corporation used the following methods and assumptions in estimating fair value disclosures for financial instruments: CASH AND CASH EQUIVALENTS - The carrying amounts of cash and short-term instruments approximate fair values. SECURITIES - Fair values for securities, excluding restricted equity securities, are based on quoted market prices. The carrying value of restricted equity securities approximates fair value based on applicable redemption provisions. LOANS - Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, commercial real estate, residential mortgage, credit card and other consumer. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories. The fair value of performing loans, except residential mortgage and credit card loans, is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loans. The estimate of maturity is based on the Corporation's historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. For performing residential mortgage loans, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates based on historical experience. For credit card loans, cash flows and maturities are estimated based on contractual interest rates and historical experience. Fair value of nonperforming loans is based on recent appraisals or estimates prepared by the Corporation's lending officers. 43 DEPOSITS - The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, money market and interest checking accounts, is (by definition) equal to the amount payable on demand at December 31, 2001 and 2000. The fair value of all other deposit categories is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value estimates of deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market, commonly referred to as the core deposit intangible. BORROWED FUNDS - The fair value of borrowings is estimated using discounted cash flow analyses based on rates currently available to the Corporation for similar types of borrowing arrangements. ACCRUED INTEREST - The carrying amounts of accrued interest receivable and payable approximate fair values. EMBEDDED DERIVATIVE LIABILITIES - IPCDS - The fair values of embedded derivatives are calculated by a third party. Factors that affect the fair value of embedded derivatives include term to maturity, market interest rates and other market factors that affect the present value of the Corporation's obligation to pay each IPCD depositor a return based on appreciation in the S&P 500 index. EMBEDDED DERIVATIVE LIABILITIES - EQUITY OPTION SWAP CONTRACTS - The fair values of equity option Swap contracts are calculated by a third party. Factors that affect the fair value of equity option Swap contracts include: (1) the negotiated rate associated with the Corporation's obligation to make quarterly payments to the FHLB-Pittsburgh over the term of each IPCD; and (2) term to maturity, market interest rates and other market factors that affect the present value of the FHLB-Pittsburgh's obligation to pay the Corporation a return based on appreciation in the S&P 500 index. The estimated fair values, and related carrying amounts, of the Corporation's financial instruments are as follows:
(IN THOUSANDS) AT DECEMBER 31, 2001 2000 CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE Financial assets: Cash and cash equivalents $ 16,036 $ 16,036 $ 13,824 $ 13,824 Available-for-sale securities 442,098 442,098 346,747 346,747 Held-to-maturity securities 1,448 1,477 1,911 1,914 Loans, net 373,963 377,124 323,014 323,355 Accrued interest receivable 4,871 4,871 4,953 4,953 Financial liabilities: Deposits 576,274 578,319 528,967 530,265 Short-term borrowings 58,064 58,148 94,691 94,771 Long-term borrowings 125,584 128,977 605 699 Accrued interest payable 1,420 1,420 1,725 1,725 Embedded derivative liabilities - IPCDs 233 233 -- -- Equity option Swap contracts - IPCDs 31 31 -- --
44 12. EMPLOYEE AND POSTRETIREMENT BENEFIT PLANS 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 within the final ten years of employment. Also 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 December 31, 2001 and 2000, and will not affect the Corporation's future expenses. The following tables show the funded status and components of net periodic benefit cost from these defined benefit plans: (IN THOUSANDS)
PENSION POSTRETIREMENT BENEFITS BENEFITS 2001 2000 2001 2000 CHANGE IN BENEFIT OBLIGATION: Benefit obligation at beginning of year $ 7,646 $ 7,141 $ 790 $ 771 Service cost 271 308 19 27 Interest cost 497 491 58 52 Plan participants' contributions -- -- 80 56 Actuarial (gain) loss (338) 14 79 (1) Benefits paid (397) (308) (138) (115) - ------------------------------------------------------------------------------------ Benefit obligation at end of year $ 7,679 $ 7,646 $ 888 $ 790 ====================================================================================
2001 2000 2001 2000 CHANGE IN PLAN ASSETS: Fair value of plan assets at beginning of year $ 9,317 $ 9,237 $ -- $ -- Actual return on plan assets (497) 388 -- -- Employer contribution -- -- 58 59 Plan participants' contributions -- -- 80 56 Benefits paid (397) (308) (138) (115) - ------------------------------------------------------------------------------------ Fair value of plan assets at end of year $ 8,423 $ 9,317 $ -- $ -- ==================================================================================== Funded status $ 744 $ 1,671 $(888) $(790) Unrecognized net actuarial (gain) loss 90 (886) (17) (95) Unrecognized transition obligation (asset) (205) (228) 401 438 - ------------------------------------------------------------------------------------ Prepaid (accrued) benefit cost $ 629 $ 557 $(504) $(447) ====================================================================================
2001 2000 2001 2000 WEIGHTED-AVERAGE ASSUMPTIONS: Discount rate 7.00% 7.00% 7.00% 7.00% Expected return on plan assets 8.50% 8.50% N/A N/A Rate of compensation increase 5.00% 5.00% N/A N/A
45
PENSION BENEFITS POSTRETIREMENT BENEFITS COMPONENTS OF NET PERIODIC BENEFIT COST: 2001 2000 1999 2001 2000 1999 (IN THOUSANDS) Service cost $ 271 $ 308 $ 302 $ 19 $ 27 $ 28 Interest cost 497 491 460 58 52 50 Expected return on plan assets (787) (815) (749) -- -- -- Amortization of transition obligation (asset) (23) (23) (23) 37 37 36 Recognized net actuarial (gain) loss (30) (64) -- 1 (2) -- - ------------------------------------------------------------------------------------------------- Net periodic benefit cost (benefit) $ (72) $(103) $ (10) $115 $ 114 $114 =================================================================================================
PROFIT SHARING AND DEFERRED COMPENSATION PLANS The Corporation has a profit sharing plan that incorporates the deferred salary savings provisions of Section 401(k) of the Internal Revenue Code. The Corporation's matching contributions to the plan depend upon the tax deferred contributions of employees. The Corporation's basic and matching contributions were $588,000 in 2001, $511,000 in 2000 and $513,000 in 1999. The Corporation also has a nonqualified supplemental deferred compensation arrangement with its key officers. Charges to expense for officers' supplemental deferred compensation were $38,000 in 2001, $70,000 in 2000 and $54,000 in 1999. STOCK-BASED COMPENSATION PLANS The Corporation has a Stock Incentive Plan for a selected group of senior officers. A total of 180,000 shares of common stock may be issued under the Stock Incentive Plan. Awards may be made under the Stock Incentive Plan in the form of qualified options ("Incentive Stock Options," as defined in the Internal Revenue Code), nonqualified options, stock appreciation rights or restricted stock. Through 1999, all awards under the Stock Incentive Plan were Incentive Stock Options, with exercise prices equal to the market price of the stock at the date of grant, ratable vesting over 5 years and a contractual expiration of 10 years. In 2000, there were awards of Incentive Stock Options and restricted stock. The Incentive Stock Options granted in 2000 have an exercise price equal to the market value of the stock at the date of grant, vest after 6 months and expire after 10 years. The restricted stock awards vest ratably over 3 years. Also, the Corporation has an Independent Directors Stock Incentive Plan (formerly called the Independent Directors Stock Option Plan). In 2001, this plan was amended to permit awards of nonqualified stock options and/or restricted stock to non-employee directors. As amended, a total of 50,000 shares of common stock may be issued under the Independent Directors Stock Incentive Plan. The recipients' rights to exercise stock options under this plan expire 10 years from the date of grant. The exercise prices of all stock options awarded under the Independent Directors Stock Incentive Plan are equal to market value as of the dates of grant. The restricted stock awards vest ratably over 3 years. Effective January 2, 2002, the Corporation granted options to purchase a total of 40,423 shares of common stock through the Stock Incentive and Independent Directors Stock Incentive Plans. The exercise price for these options is $25.50 per share, which was the market price at the date of grant. Also, effective January 2, 2002, the Corporation awarded a total of 4,560 shares of restricted stock under the Stock Incentive and Independent Directors Stock Incentive Plans. The stock options and restricted stock awards that were awarded in January 2002 are not included in the tables that follow. The Corporation applies Accounting Principles Board Opinion 25 and related interpretations in accounting for stock options. Accordingly, no compensation expense has been recognized for the stock options. Had compensation cost for the stock options been determined based on the fair value at the grant dates for awards consistent with the method of SFAS No. 123, the effect on the Corporation's net income and earnings per share would have been adjusted to the pro forma amounts indicated in the following table. 46 (NET INCOME IN THOUSANDS)
2001 2000 1999 Net income As reported $12,052 $8,476 $11,485 Pro forma $11,989 $8,399 $11,428 Earnings per share-basic As reported $2.28 $1.60 $2.16 Pro forma $2.26 $1.58 $2.15 Earnings per share-diluted As reported $2.27 $1.60 $2.16 Pro forma $2.26 $1.58 $2.15
For purposes of the calculations of SFAS No. 123, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:
2001 2000 1999 Volatility 17% 18% 18% Expected option lives 6 Years 6 Years 6 Years Risk-free interest rate 5.08% 5.00% 6.46% Dividend yield 3.57% 3.96% 3.76%
A summary of the status of the Corporation's stock option plans is presented below:
2001 2000 1999 - ---------------------------------------------------------------------------------------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE Outstanding, beginning of year 100,810 $ 28.04 82,420 $ 29.63 58,850 $ 30.38 Granted 1,976 $ 21.25 18,615 $ 20.91 25,550 $ 27.67 Exercised -- -- (225) $ 20.00 (680) $ 24.06 Forfeited (19,550) $ 28.72 -- -- (1,300) $ 27.89 - ---------------------------------------------------------------------------------------------------- Outstanding, end of year 83,236 $ 27.73 100,810 $ 28.04 82,420 $ 29.63 ==================================================================================================== Options exercisable at year-end 64,906 $ 26.94 48,215 $ 28.69 30,700 $ 28.69 Fair value of options granted $ 3.48 $ 3.14 $ 5.27
The following table summarizes information about stock options outstanding as of December 31, 2001:
OUTSTANDING EXERCISABLE AT REMAINING AT DECEMBER 31, CONTRACTUAL DECEMBER 31, EXERCISE PRICES 2001 LIFE IN YEARS 2001 $20.00 5,595 4 5,595 $25.50-$27.84 9,700 5 9,700 $33.25-$36.50 12,850 6 10,800 $33.13-$36.38 16,500 7 11,020 $25.00-$27.00 20,600 8 9,800 $20.25 16,015 9 16,015 $21.25 1,976 9 1,976 - -------------------------------------------------------------------------------- 83,236 64,906 ================================================================================
47 The following table summarizes restricted stock awards through December 31, 2001:
2001 2000 Number of shares awarded 221 1,752 Market price of stock at date of grant $ 21.25 $ 20.25
Compensation expense related to restricted stock was $22,000 in 2001. There was no compensation expense related to restricted stock awards in 2000 or 1999. 13. INCOME TAXES The following temporary differences gave rise to the net deferred tax liability (asset) at December 31, 2001 and 2000: (IN THOUSANDS)
2001 2000 Deferred tax liabilities: Realized gains on securities $ -- $ 432 Depreciation 240 218 Prepaid pension 220 195 Accretion on securities 2 16 Investments in limited partnerships 24 -- Unrealized holding gains on securities 2,722 42 - ------------------------------------------------------------------------------- Total 3,208 903 - ------------------------------------------------------------------------------- Deferred tax assets: Allowance for loan losses (1,843) (1,852) Postretirement and sick benefits (194) (175) Loan fees and costs (60) (89) Supplemental executive retirement plan (168) (158) Writedown of foreclosed assets -- (17) - ------------------------------------------------------------------------------- Total (2,265) (2,291) - ------------------------------------------------------------------------------- Deferred tax liability (asset), net $ 943 $(1,388) ===============================================================================
Tax provision:
2001 2000 1999 Currently payable $ 3,371 $ 1,882 $2,931 Deferred (349) (63) 423 - -------------------------------------------------------------------------------- Total provision $ 3,022 $ 1,819 $3,354 ================================================================================
Reconciliation of tax provision:
2001 2000 1999 AMOUNT % AMOUNT % AMOUNT % Expected provision $ 5,276 35.00% $ 3,603 35.00% $ 5,194 35.00% Tax-exempt interest income (1,730) (11.48) (1,738) (16.88) (1,727) (11.64) Nondeductible interest expense 226 1.50 280 2.72 232 1.56 Dividends received deduction (267) (1.77) (235) (2.28) (203) (1.37) Increase in cash surrender value of Life insurance (317) (2.10) -- -- -- -- Surtax exemption (151) (1.00) (103) (1.00) (102) (0.69) Other, net (15) (0.10) 12 0.11 (40) (0.26) - ------------------------------------------------------------------------------------------------ Effective income tax provision $ 3,022 20.05% $ 1,819 17.67% $ 3,354 22.60% ================================================================================================
48 14. RELATED PARTY TRANSACTIONS Loans to executive officers, directors of the Corporation and its subsidiaries and any associates of the foregoing persons are as follows: (IN THOUSANDS)
BEGINNING NEW OTHER ENDING BALANCE LOANS REPAYMENTS CHANGES BALANCE 14 directors, 6 executive officers 2001 $5,730 $ 658 $(1,833) $ 1,980 $6,535 14 directors, 6 executive officers 2000 6,640 724 (1,450) (184) 5,730 15 directors, 6 executive officers 1999 4,709 2,551 (789) 169 6,640
The above transactions were made in the ordinary course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and do not involve more than normal risks of collectibility. Other changes represent net increases in existing lines of credit and transfers in and out of the related party category. 15. OFF-BALANCE SHEET RISK The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit, interest rate or liquidity risk in excess of the amount recognized in the consolidated balance sheet. The contract amounts of these instruments express the extent of involvement the Corporation has in particular classes of financial instruments. The Corporation's exposure to credit loss from nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Financial instruments whose contract amounts represent credit risk at December 31, 2001 and 2000 are as follows:
(IN THOUSANDS) 2001 2000 Commitments to extend credit $86,498 $68,809 Standby letters of credit $ 5,508 $ 4,792
Commitments to extend credit are legally binding agreements to lend to customers. Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future liquidity requirements. The Corporation evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation, for extensions of credit is based on management's credit assessment of the counterparty. Standby letters of credit are conditional commitments issued by the Corporation guaranteeing performance by a customer to a third party. Those guarantees are issued primarily to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. 49 16. REGULATORY MATTERS The Corporation (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken could have a direct material effect on the Corporation's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2001 and 2000, that the Corporation and the Bank meet all capital adequacy requirements to which they are subject. To be categorized as well capitalized, an institution must maintain minimum total risk based, Tier I risk based and Tier I leverage ratios as set forth in the following table. The Corporation's and the Bank's actual capital amounts and ratios are also presented in the following table.
(DOLLARS IN THOUSANDS) MINIMUM TO BE WELL MINIMUM CAPITALIZED UNDER CAPITAL PROMPT CORRECTIVE ACTUAL REQUIREMENT ACTION PROVISIONS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO -------------------------------------------------------- DECEMBER 31, 2001: Total capital to risk- weighted assets: Consolidated $103,645 22.94% $36,144 > = 8% $45,180 > = 10% Bank 87,070 19.69% 35,372 > = 8% 44,215 > = 10% Tier 1 capital to risk- weighted assets: Consolidated 94,903 21.01% 18,072 > = 4% 27,108 > = 6% Bank 79,855 18.06% 17,686 > = 4% 26,529 > = 6% Tier 1 capital to average assets: Consolidated 94,903 11.18% 33,960 > = 4% 42,450 > = 5% Bank 79,855 9.63% 33,164 > = 4% 41,455 > = 5%
50
(DOLLARS IN THOUSANDS) MINIMUM TO BE WELL MINIMUM CAPITALIZED UNDER CAPITAL PROMPT CORRECTIVE ACTUAL REQUIREMENT ACTION PROVISIONS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO -------------------------------------------------------- DECEMBER 31, 2000: Total capital to risk- weighted assets: Consolidated $ 96,295 22.77% $33,828 > = 8% $42,285 > = 10% Bank 81,498 22.10% 29,498 > = 8% 36,873 > = 10% Tier 1 capital to risk- weighted assets: Consolidated 88,887 21.02% 16,914 > = 4% 25,371 > = 6% Bank 75,187 20.39% 14,749 > = 4% 22,124 > = 6% Tier 1 capital to average assets: Consolidated 88,887 12.56% 28,309 > = 4% 35,386 > = 5% Bank 75,187 10.89% 27,623 > = 4% 34,529 > = 5%
Restrictions imposed by Federal Reserve Regulation H limit dividend payments in any year to the current year's net income plus the retained net income of the prior two years without approval of the Federal Reserve Board. Accordingly, the Corporation's dividends in 2002 may not exceed $9,872,000, plus consolidated net income for 2002. Additionally, banking regulators limit the amount of dividends that may be paid by the Bank to the Corporation. Retained earnings against which dividends may be paid without prior approval of the banking regulators amounted to approximately $69,828,000 at December 31, 2001, subject to the minimum capital ratio requirements noted above. Restrictions imposed by federal law prohibit the Corporation from borrowing from the Bank unless the loans are secured in specific amounts. Such secured loans to the Corporation are generally limited to 10% of the Bank's stockholder's equity (excluding accumulated other comprehensive income) or $7,986,000 at December 31, 2001. 17. PARENT COMPANY ONLY The following is condensed financial information for Citizens & Northern Corporation. CONDENSED BALANCE SHEET
DECEMBER 31, (IN THOUSANDS) 2001 2000 ASSETS Cash $ 333 $ 63 Investment in subsidiaries: Citizens & Northern Bank 82,914 74,597 Citizens & Northern Investment Corporation 16,383 13,566 Bucktail Life Insurance Company 2,010 2,085 Other assets 13 28 - -------------------------------------------------------------------------------- TOTAL ASSETS $101,653 $90,339 ================================================================================ LIABILITIES AND STOCKHOLDERS' EQUITY Dividends payable $ 1,466 $ 1,353 Other liabilities -- 17 Stockholders' equity 100,187 88,969 - -------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $101,653 $90,339 ================================================================================
51 CONDENSED INCOME STATEMENT
YEARS ENDED DECEMBER 31, (IN THOUSANDS) 2001 2000 1999 Dividends from Citizens & Northern Bank $ 6,286 $ 4,077 $ 7,000 Other dividend income 250 -- 224 Securities gains -- -- 159 Expenses (74) (179) (184) - -------------------------------------------------------------------------------- Income before equity in undistributed income of subsidiaries 6,462 3,898 7,199 Equity in undistributed income of subsidiaries 5,590 4,578 4,286 - -------------------------------------------------------------------------------- NET INCOME $ 12,052 $ 8,476 $ 11,485 ================================================================================
CONDENSED STATEMENT OF CASH FLOWS
YEARS ENDED DECEMBER 31, (IN THOUSANDS) 2001 2000 1999 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 12,052 $ 8,476 $ 11,485 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of Subsidiaries (5,590) (4,578) (4,286) Securities gains -- -- (159) Amortization of restricted stock 22 -- -- Decrease (increase) in other assets 14 (28) 1,300 Increase (decrease) in other liabilities -- 17 (144) - -------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 6,498 3,887 8,196 - -------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Cash investment in subsidiary (266) (225) (1,888) Purchase of available-for-sale securities -- -- (753) Proceeds from sale of available-for-sale Securities -- -- 360 - -------------------------------------------------------------------------------- Net Cash Used in Investing Activities (266) (225) (2,281) - -------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from sale of treasury stock -- 6 16 Purchase of treasury stock (521) -- -- Dividends paid (5,441) (4,986) (4,639) - -------------------------------------------------------------------------------- Net Cash Used in Investing Activities (5,962) (4,980) (4,623) - -------------------------------------------------------------------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 270 (1,318) 1,292 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 63 1,381 89 - -------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 333 $ 63 $ 1,381 ================================================================================
52 18. SUMMARY OF QUARTERLY CONSOLIDATED FINANCIAL DATA (UNAUDITED) The following table presents summarized quarterly financial data for 2001 and 2000:
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2001 QUARTER ENDED Mar. 31, June 30, Sept. 30, Dec. 31, Interest income $ 13,214 $ 13,947 $ 14,086 $ 13,893 Interest expense 7,492 7,278 7,037 6,549 - ----------------------------------------------------------------------------------------------- Interest margin 5,722 6,669 7,049 7,344 Provision for loan losses 150 150 150 150 - ----------------------------------------------------------------------------------------------- Interest margin after provision for loan losses 5,572 6,519 6,899 7,194 Other income 1,313 1,399 1,476 1,453 Securities gains 455 742 520 203 Other expenses 4,598 4,580 4,575 4,918 - ----------------------------------------------------------------------------------------------- Income before income tax provision 2,742 4,080 4,320 3,932 Income tax provision 477 891 914 740 - ----------------------------------------------------------------------------------------------- Net income $ 2,265 $ 3,189 $ 3,406 $ 3,192 =============================================================================================== Net income per share - basic $ 0.43 $ 0.60 $ 0.64 $ 0.60 =============================================================================================== Net income per share - diluted $ 0.43 $ 0.60 $ 0.64 $ 0.60 ===============================================================================================
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2000 QUARTER ENDED Mar. 31, June 30, Sept. 30, Dec. 31, Interest income $ 12,857 $ 12,949 $ 13,125 $ 13,224 Interest expense 7,145 7,396 7,790 7,814 - ----------------------------------------------------------------------------------------------- Interest margin 5,712 5,553 5,335 5,410 Provision for loan losses 226 150 150 150 - ----------------------------------------------------------------------------------------------- Interest margin after provision for loan losses 5,486 5,403 5,185 5,260 Other income 1,358 1,050 963 1,119 Securities gains 15 322 230 810 Other expenses 4,209 4,116 4,171 4,410 - ----------------------------------------------------------------------------------------------- Income before income tax provision 2,650 2,659 2,207 2,779 Income tax provision 501 446 374 498 - ----------------------------------------------------------------------------------------------- Net income $ 2,149 $ 2,213 $ 1,833 $ 2,281 =============================================================================================== Net income per share - basic $ 0.40 $ 0.42 $ 0.35 $ 0.43 =============================================================================================== Net income per share - diluted $ 0.40 $ 0.42 $ 0.35 $ 0.43 ===============================================================================================
53 INDEPENDENT AUDITORS' REPORT To the Stockholders and Board of Directors of Citizens & Northern Corporation: We have audited the accompanying consolidated balance sheet of Citizens & Northern Corporation and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Citizens & Northern Corporation and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. Parente Randolph, PC /s/ Williamsport, Pennsylvania February 15, 2002 54 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information concerning Directors and Executive Officers is incorporated herein by reference to the Corporation's proxy statement dated March 19, 2002 for the annual meeting of stockholders to be held on April 16, 2002. ITEM 11. EXECUTIVE COMPENSATION Executive compensation information is incorporated herein by reference to the Corporation's proxy statement dated March 19, 2002 for the annual meeting of stockholders to be held on April 16, 2002. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference to the Corporation's proxy statement dated March 19, 2002 for the annual meeting of stockholders to be held on April 16, 2002. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information concerning loans to Directors and Executive Officers is provided in Note 14 to the Consolidated Financial Statements, which is included in Part II, Item 8 of Form 10-K. Additional information is incorporated herein by reference to disclosure appearing under the caption "Certain Transactions" of the Corporation's proxy statement dated March 19, 2002 for the annual meeting of stockholders to be held on April 17, 2002. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (1). The following consolidated financial statements are set forth in Part II, Item 8:
Page ---- Independent Auditors' Report 54 Financial Statements: Consolidated Balance Sheet - December 31, 2001 and 2000 28 Consolidated Statement of Income - Years Ended December 31, 2001, 2000 and 1999 29 Consolidated Statement of Changes in Stockholders' Equity - Years Ended December 31, 2001, 2000 and 1999 30 Consolidated Statement of Cash Flows - Years Ended December 31, 2001, 2000 and 1999 31 Notes to Consolidated Financial Statements 32 - 53
(a) (2) Financial statement schedules are either omitted because inapplicable or included in the financial statements or related notes. Individual financial statements of Bucktail Life Insurance Company and Citizens & Northern Investment Corporation, consolidated subsidiaries, have been omitted, as neither the assets nor the income from continuing operations before tax exceeded ten percent of the consolidated totals. (a) (3) Exhibits (numbered as in Item 601 of Regulation S-K): 2. Plan of acquisition, reorganization, arrangement, Liquidation or succession Not applicable 3. (i) Articles of Incorporation Incorporated by reference to the exhibits
55 filed with the Corporation's registration statement on Form S-4 on March 27, 1987. 3. (ii) By-laws Incorporated by reference to the exhibits filed with the Corporation's registration statement on Form S-4 on March 27, 1987. 4. Instruments defining the rights of security holders, Including indentures Not applicable 9. Voting trust agreement Not applicable 10. Material contracts Not applicable 11. Statement re: computation of per share earnings Information concerning the computation of earnings per share is provided in Note 3 to the Consolidated Financial Statements, which is included in Part II, Item 8 of Form 10-K. 12. Statements re: computation of ratios Not applicable 13. Annual report to security holders, Form 10-Q or quarterly report to security holders Not applicable 16. Letter re: change in certifying accountant Not applicable 18. Letter re: change in accounting principles Not applicable 21. Subsidiaries of the registrant Filed herewith 22. Published report regarding matters submitted to vote of security holders Not applicable 23. Consents of experts and counsel Not applicable 24. Power of attorney Not applicable 99. Additional exhibits: 99.1 Additional information mailed to stockholders with proxy statement and Form 10-K on March 19, 2002 Filed herewith
(b) On October 11, 2001, a Current Report on Form 8-K was filed to report the Corporation's consolidated earnings results for the three-month and nine-month periods ended September 30, 2001. (c) Exhibits - The required exhibits are listed under Part IV, Item 14(a)(3) of Form 10-K. (d) Financial statement schedules are omitted because the required information is not applicable or is included elsewhere in Form 10-K. 56 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Citizens & Northern Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized: CITIZENS & NORTHERN CORPORATION By: Craig G. Litchfield /s/ - --------------------------- Craig G. Litchfield Chairman, President and Chief Executive Officer Date: March 19, 2002 By: Mark A. Hughes /s/ - ---------------------- Treasurer and Principal Accounting Officer Date: March 19, 2002 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
BOARD OF DIRECTORS Dennis F Beardslee /s/ Edward L. Learn /s/ Dennis F. Beardslee Edward L. Learn Date: March 19, 2002 Date: March 19, 2002 J Robert Bower /s/ Craig G Litchfield /s/ J Robert Bower Craig G Litchfield Date: March 19, 2002 Date: March 19, 2002 R Robert DeCamp /s/ Lawrence F Mase /s/ R Robert DeCamp Lawrence F Mase Date: March 19, 2002 Date: March 19, 2002 R Bruce Haner /s/ Edward H Owlett, III /s/ R Bruce Haner Edward H Owlett, III Date: March 19, 2002 Date: March 19, 2002 Susan E Hartley /s/ F David Pennypacker /s/ Susan E Hartley F David Pennypacker Date: March 19, 2002 Date: March 19, 2002 Karl W. Kroeck /s/ Leonard Simpson /s/ Karl W. Kroeck Leonard Simpson Date: March 19, 2002 Date: March 19, 2002 Leo F. Lambert /s/ James E. Towner /s/ Leo F. Lambert James E. Towner Date: March 19, 2002 Date: March 19, 2002
57 EX-21 3 l93169aex21.txt EXHIBIT 21 EXHIBIT 21
Jurisdiction or Name State of Incorporation - ---- ---------------------- Citizens & Northern Bank (A) Pennsylvania Bucktail Life Insurance Company (A) Arizona Citizens & Northern Investment Corporation (A) Delaware C&N Financial Services Corporation (B) Pennsylvania
(A) Wholly-owned subsidiary of Citizens & Northern Corporation (B) Wholly-owned subsidiary of Citizens & Northern Bank EX-99.1 4 l93169aex99-1.txt EXHIBIT 99.1 Exhibit 99.1 [THREE PHOTOS OF RURAL SCENES] 2001 ANNUAL REPORT professionals dedicated to meeting your lifetime financial needs, with a personal touch(TM) [CITIZENS & NORTHERN CORPORATION LOGO] ON OUR COVER The photographs on the cover of our annual report were taken by local professional photographer Dick Allyn and were featured on C&N Bank's 2002 calendar. For a look at Mr. Allyn's other work, log onto www.dickallyn.com. [CITIZENS & NORTHERN CORPORATION LOGO] Athens/Dushore/East Smithfield/Elkland/Knoxville/Laporte/Liberty/Mansfield Monroeton/Muncy/Ralston/Sayre/Tioga/Towanda/Troy/Wellsboro/Wysox Member FDIC Stock Symbol CZNC www.cnbankpa.com Page 1 SAVINGS PLANS FOR STUDENTS AND LOOKING AHEAD TO RETIREMENT EDUCATION SAVINGS ACCOUNT offered by Citizens &Northern Bank A new offering this year is our Education Savings Account, an account created for the purpose of paying education expenses for the beneficiary of the account at a qualified education institution. The funds grow tax-free and beginning in January of this year, contribution limits have increased. C&N Bank in January launched a marketing and sales campaign to acquaint customers with regulation changes relating to this valuable savings tool. ESAs carry two investment options - Time Deposit ESA or Mutual Funds*. More information is available by contacting Nancy Tubbs at nancyt@cnbankpa.com IRAs C&N Bank offers both Traditional and Roth IRAs utilizing a variable-rate, FDIC insured product. 529 PLAN* offered by C&N Financial Services Corporation This plan offers important benefits for the donor, while offering the beneficiary the opportunity of a college education. For account owners, 529 Plans feature the benefit of tax-free earnings if withdrawals are used for qualified education expenses. There are no income or age limitations and distributions are controlled by the owner. FOR MORE INFORMATION CALL, TOLL FREE, 1.866.ASK.CNFS. IRAs Citizens &Northern Financial Services Corporation offers non-FDIC insured IRAs, utilizing the various investment options available through mutual funds and annuities.* For more information, contact any C&N branch office. *Note: Some products are not FDIC insured, not a deposit or other obligation of the bank, not guaranteed by the bank and are subject to investment risk, including the possible loss of the principal amount invested and are not insured by any other federal government agency. Securities offered through Hackett Associates,Inc., Member NASD & SIPC, 90-92 Main Street, Wellsboro, PA 16901. [PHOTO OF GIRL] These three savings products have been heavily promoted by C&N Bank in the first quarter of 2002. They offer our customers and prospective customers excellent opportunities to save for their own and their children's future. THE POWER TO SAVE The Index Powered(SM) CD, a new offering in 2001, combines the power of the stock market with the security of the bank. Unlike traditional Certificates of Deposit, which generally provide a fixed rate of return, the Index Powered(SM) CD is tied to the performance of Standard &Poor's 500(R) Index, and therefore has the potential to outperform traditional fixed income investments. Index Powered CD features include: - - Interest tied to the performance of the S&P 500(R); - $1,000 minimum deposit; - - Return of principal guaranteed by C&N at maturity; - 5 year term; - Annual withdrawal feature*; - FDIC insured up to $100,000; - No management or sales fees. *There are no specific fees or penalties assessed against the depositor as a part of the Annual Withdrawal Feature. However, the annual withdrawal amount may be less than the amount of principal committed. Contact your local office of C&N Bank for more information on how the Index Powered(SM) CD gives you the power to SAVE. DISCLAIMER: FDIC Insurance protects each depositor up to $100,000. S&P 500(R) and "Standard & Poor's 500" are trademarks of The McGraw-Hill Companies, Inc., and have been licensed for use by the Bank. "The Product is not sponsored, endorsed, sold or promoted by Standard & Poor's and Standard & Poor's makes no representation regarding the advisability of investing in the Product." IPCD "Indexed Powered"is a service mark of Risk Analytics, Inc. Any unauthorized use of this name without the express written consent of Risk Analytics, Inc. is prohibited. NEW THIS YEAR Page 2 A MESSAGE TO OUR SHAREHOLDERS... Certainly, the successes of your company during 2001 must be viewed against the grim backdrop of the terrorist attacks of September 11th and the ensuing war on terrorism. Additionally, we remain ever vigilant to the effects of the national and global recessions that began in early 2001, and which were exacerbated by the terrorist-related events in September. While we can all take pleasure that Citizens & Northern achieved record earnings for the year, we must recognize the challenges and opportunities that lie ahead. We continue to focus our personnel development on leadership and sales skills. It is our desire that our focus on client needs and service will be unmatched in our market. Our efforts to broaden our revenue sources continue unabated. We are positive and enthusiastic about the future of Citizens & Northern and the communities we serve. We continue to make substantial positive contributions to our major constituencies. Our belief is founded in the fact that we have assembled and trained a highly competent staff, who look forward to serving our clients' financial needs. Without our people and their commitment to service and excellence, none of our past successes would have been possible. And without them our future success would be impossible. 2001 FINANCIAL HIGHLIGHTS Last year, I reported here that the effects of the rapid increases in interest rates that began in the last quarter of 1999 and continued through all of 2000 had a significant dampening effect upon our interest margin and thus our net income. The eleven reductions in the Fed Funds target rate during 2001, for a total of 4.75%, has had an equally significant positive impact upon our net income for 2001. The Interest Margin increased by 21.7% in 2001 as compared to 2000 for a total of $4.77 million. While deposits and borrowed funds increased by 21.7%, interest expense decreased by 5.9%. Net Income increased by over 42% to over $12 million. The changes in the interest rate environment created opportunities for us to grow the asset base without substantially increasing our interest rate risk exposure profile. Thus, Total Assets increased to nearly $867 million, or a year over year increase of 20.5%. Loans increased by nearly 15.8%, or more than $50 million. We also increased the securities portfolio by 27.5%, or over $95 million. Our Trust and Asset Management Group experienced a decrease in their assets-under-management of about 7%, due primarily to market value declines in equities during the year. Shareholders' equity continues to provide a solid base on which we can grow the company. Shareholders' equity increased to over $100 million from about $89 million during the year. The increase consists of net income after dividends and the increase in net unrealized gains in our investment portfolio. Non-performing assets decreased as a percentage of total assets from 0.22% to 0.12%. Our loan delinquencies continue to remain at historical lows, as we continue to monitor any weaknesses that may appear in our loan portfolio. Dividends declared and paid for 2001 totaled $1.06 per share, which is an increase over 2000 of 8.16%. We also paid a 1% stock dividend for the 29th consecutive year. The market value of a share of our stock increased from $20.00 at the end of 2000 to $26.15 as of the end of 2001, a 30.75% increase. During 2001 and as we begin 2002, we are implementing changes in our deposit and borrowing pricing that should reduce some, but not all, of the negative effects on net interest income we could experience if rapid increases in interest rates were to occur. CONT. PAGE 3 [PHOTO OF CRAIG G. LITCHFIELD] We are positive and enthusiastic about the future of Citizens & Northern and its communities. We believe that we continue to make substantial positive contributions to our major constituencies. STATE OF THE BANK Page 3 A MESSAGE TO OUR SHAREHOLDERS... (Cont.) TRUST AND FINANCIAL MANAGEMENT GROUP In a difficult equity climate, investment results achieved by the clients of our Trust and Financial Management Group were comparable to appropriate benchmarks. Client portfolios benefited from adherence to our disciplined approach, which includes diversification among asset classes, as well as across economic sectors, and continued focus on their long-term investment objectives. Ongoing dialogue between administrators and clients concerning the philosophy of investing for the long-term ensured that clients were prepared to weather the volatility experienced in 2001 and use the opportunity to restructure and enhance portfolios. SALES AND SERVICE CULTURE INITIATIVE During 2001, we launched our sales and service initiative by training all of our people in the basics of extraordinary sales leadership, leading breakthrough service performance, breakthrough service performance and proactive relationship banking. We are all committed to the success of this program, because the results are very consistent with our vision to provide exceptional service for every client. This endeavor will yield long-term benefits for our clients and our organization. PRODUCTS AND SERVICES In March of 2001, Citizens & Northern Financial Services (CNFS) added a broker/dealer affiliation. We offer this service and the related products through an affiliation with Hackett Associates of Reading. In addition to the sale of group and individual life and disability insurance products, long-term care insurance, and fixed annuities, we now offer a full range of mutual funds and variable annuity products. By February 2002, CNFS will have moved its operations to a separate Wellsboro Main Street location to provide better access to our clients and greater visibility of its operation. We were the first bank in our market to begin offering the Index Powered(SM) Certificates of Deposit. The Index Powered(SM) CD combines the power of the stock market and the security of the bank. Unlike traditional certificates of deposit, which generally provide a fixed rate of return, the Index Powered(SM) CD is tied to the performance of the Standard & Poor's 500(R) Index, and therefore has the potential to outperform traditional fixed income investments. Like traditional certificates of deposit, your return of principal is guaranteed by C&N Bank and insured by the FDIC up to $100,000. These are five-year Certificates of Deposit, which are excellent for long-term investment objectives like retirement or college expenses. We will be introducing the Index Powered(SM) Certificate of Deposit IRA and Educational Saving Accounts prior to the end of the first quarter of 2002. We debuted two new business-related products in 2001: the Visa Business Card and Super Business 25 or Super B Checking. The Visa Business Card provides our business clients with a master account and sub-accounts for each authorized employee/user. This helps the business client segregate and track the charges. Our Super B Checking is a low cost business-checking alternative for low volume users. By maintaining a $1,000 collected balance, businesses with qualifying volume can eliminate checking fees. Our Internet Banking service continues to attract new users. We have over 4,400 consumer clients and over 500 business clients using the convenient and secure service. Internet Banking allows clients to view balances, transaction histories, checking statements and check images and permits transfers of funds between accounts and bill payment. Our business clients can direct deposit payroll for their employees and transfer funds between their accounts with Citizens & Northern Bank and other banks. RETIREMENTS Four long-time employees, with a total of 99 years of service with C&N, retired after January 1, 2001. They are Peggy Clark, Trust, 22 years; Joan Johnson, Tioga Branch, 29 years; Dan Clark, Ralston, 41 years and Donna Gorzycki, Knoxville, 7 years. We wish them long and fulfilling retirements. THE CHALLENGES The financial service and banking worlds continue to evolve. This evolutionary change creates both challenges and opportunities for organizations with the skills and the determination to succeed. Citizens & Northern has been, is and will be successful because of our talented people who are committed to serving our communities and our clients. We see continuing opportunities to expand our services and our market share. We know that by listening to our clients and by delivering world-class extraordinary service, our ability to achieve success for all our constituents (customers, communities, shareholders and employees) is assured. POSTSCRIPT In response to the terrorist attacks of September 11th, our clients, employees and directors raised nearly $17,000.00 to which we added our corporate donation of $10,000.00. Those funds were forwarded to assist and comfort the people who lost loved ones in the attacks. Our prayers and thoughts will be with those people who must rebuild their lives and also with the brave and courageous people serving in the U. S. military in the war on terrorism. America will survive this time of infamy because as Americans UNITED WE STAND! STATE OF THE BANK Page 4 FIVE-YEAR PERFORMANCE [NET INCOME BAR GRAPH]
(IN MILLIONS) 1997 $10.1 1998 $11.1 1999 $11.3 2000 $ 8.5 2001 $12.1
[TOTAL ASSETS BAR GRAPH]
(IN MILLIONS) 1997 $515 1998 $646 1999 $708 2000 $719 2001 $887
[TOTAL STOCKHOLDERS' EQUITY BAR GRAPH]
(IN MILLIONS) 1997 $ 65.5 1998 $ 90.6 1999 $ 76.8 2000 $ 89.0 2001 $100.2
[DEPOSITS BAR GRAPH]
(IN MILLIONS) 1997 $442 1998 $477 1999 $500 2000 $522 2001 $576
[NET LOANS BAR GRAPH]
(IN MILLIONS) 1997 $281 1998 $288 1999 $306 2000 $323 2001 $374
[CASH DIVIDENDS DECLARED BAR GRAPH]
(PER SHARE, HISTORICAL BASIS)* 1997 $0.74 1998 $0.82 1999 $0.90 2000 $0.96 2001 $1.06
*Plus 1 stock dividend each year OUR FINANCIALS Page 5 QUARTERLY SHARE DATA Trades of the Corporation's stock are executed through various brokers who maintain a market in the Corporation's stock. Information regarding sales prices of the Corporation's stock is available through the OTC Bulletin Board (www.otcbb.com). The Corporation's stock is not listed or traded on NASDAQ or a national securities exchange. The Corporation's stock symbol is CZNC.OB. The following table sets forth the approximate high and low sales prices of the common stock during 2001 and 2000:
2001 2000 ---- ---- High Low Dividend Declared High Low Dividend Declared per Quarter per Quarter First Quarter $ 22.00 $ 20.00 $ 0.26 $ 29.50 $ 24.75 $ 0.24 Second Quarter 21.75 20.41 0.26 26.25 21.50 0.24 Third Quarter 23.45 21.00 0.26 23.75 22.00 0.24 Fourth Quarter 26.50 23.10 0.28 22.88 19.50 0.26 plus 1% plus 1% stock dividend stock dividend
COMMON STOCK AND PER SHARE DATA
2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- Net income per share - basic $ 2.28 $ 1.60 $ 2.16 $ 2.08 $ 1.90 Net income per share - diluted $ 2.27 $ 1.60 $ 2.16 $ 2.08 $ 1.90 Cash dividends declared per share $ 1.05 $ 0.96 $ 0.87 $ 0.79 $ 0.70 Cash dividends declared per share - historical basis $ 1.06 $ 0.98 $ 0.90 $ 0.82 $ 0.74 Stock dividend 1% 1% 1% 1% 1% Stockholders' equity per share (a) $ 18.95 $ 16.75 $ 14.43 $ 17.06 $ 16.07 Stockholders' equity per share, excluding accumulated other comprehensive income (loss) (a) $ 17.95 $ 16.73 $ 16.10 $ 14.81 $ 13.57 Weighted average shares outstanding - basic 5,296,003 5,310,131 5,309,763 5,314,353 5,320,612 Weighted average shares outstanding - diluted 5,297,723 5,311,274 5,315,173 5,324,150 5,325,560 Number of shares outstanding at year end 5,234,800 5,207,244 5,153,729 5,102,028 5,063,043 Number of shares authorized 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000
(a) For purposes of this computation, the number of shares outstanding has been increased for the effects of the 1% stock dividend issued in January following each year-end. KNOWN "MARKET MAKERS" WHO HANDLE CITIZENS & NORTHERN CORPORATION STOCK TRANSACTIONS ARE: F.J. MORRISSEY & CO., INC. 1700 Market Street, Suite 1420 Philadelphia, PA 19103-3913 (215).563.8500 FERRIS, BAKER WATTS, INC. 6 Bird Cage Walk Holidaysburg, PA 16648 (800).343.5149 RBC DAIN RAUSCHER 3 Times Square, 24th Floor New York, NY 10036 (800).526.6371 RYAN, BECK & COMPANY 3 Parkway Philadelphia, PA 19102 (800).342.2325 SANDLER O'NEILL & PARTNERS, LP 919 Third Avenue New York, NY 10022 (800).635.6851 INDEPENDENT AUDITORS PARENTE RANDOLPH, PC 400 Market Street Williamsport, PA 17701 INVESTOR INFORMATION ANNUAL MEETING OF SHAREHOLDERS The Annual Meeting of Shareholders will be held in the Arcadia Theater, Wellsboro, PA, at 2:00 p.m. Tuesday, April 16, 2002. General shareholder inquiries should be sent to: CITIZENS & NORTHERN CORPORATION 90-92 Main Street, P.O. Box 58 Wellsboro, PA 16901 STOCK TRANSFER AGENT American Stock Transfer & Trust Co. 59 Maiden Lane, Plaza Level New York, NY 10038 (800).278.4353 OUR FINANCIALS Page 6 FIVE-YEAR SUMMARY OF OPERATIONS
(IN THOUSANDS) 2001 2000 1999 1998 1997 -------- -------- -------- -------- -------- INCOME STATEMENT Interest income ................................. $ 55,140 $ 52,155 $ 48,415 $ 45,459 $ 45,642 Interest expense ................................ 28,356 30,145 24,571 22,693 23,312 ================================================================================================================= Interest margin ................................. 26,784 22,010 23,844 22,766 22,330 Provision for loan losses ....................... 600 676 760 763 797 ================================================================================================================= Interest margin after provision for loan losses . 26,184 21,334 23,084 22,003 21,533 Other income .................................... 5,641 4,490 6,444 6,083 5,834 Securities gains ................................ 1,920 1,377 3,043 3,001 1,001 Other expenses .................................. 18,671 16,906 17,732 16,483 15,095 ================================================================================================================= Income before income tax provision .............. 15,074 10,295 14,839 14,604 13,273 Income tax provision ............................ 3,022 1,819 3,354 3,527 3,166 ================================================================================================================= Net income ...................................... $ 12,052 $ 8,476 $ 11,485 $ 11,077 $ 10,107 ================================================================================================================= BALANCE SHEET AT YEAR END Total securities (1) ............................ $445,527 $350,844 $363,535 $331,883 $308,988 Gross loans, excluding unearned discount ........ 379,228 328,305 310,892 291,003 285,426 Total assets .................................... 866,999 719,335 705,898 646,298 615,353 Total deposits .................................. 576,274 528,967 500,474 476,518 442,256 Stockholders' equity, excluding accumulated other comprehensive income .................. 94,903 88,887 85,507 78,645 72,200 Total stockholders' equity ...................... 100,187 88,969 76,623 90,567 85,535 AVERAGE BALANCE SHEET Total securities, at amortized cost (1) ......... 412,654 371,360 349,133 300,692 296,067 Gross loans, excluding unearned discount ........ 346,353 318,382 301,584 285,275 282,580 Earning assets .................................. 759,007 689,743 650,717 585,966 578,647 Total assets .................................... 805,229 704,221 680,864 626,102 608,277 Total assets excluding unrealized gains or losses 798,590 717,052 672,999 606,163 598,370 Total deposits .................................. 544,579 503,848 483,858 448,601 435,190 Stockholders' equity, excluding accumulated other comprehensive income .................. 91,703 87,258 81,767 74,810 69,440 Stockholders' equity ............................ 96,021 78,792 87,143 87,997 76,005 FINANCIAL RATIOS Return on stockholders' equity, excluding accumulated other comprehensive income (2) .. 13.14% 9.71% 14.05% 14.81% 14.56% Return on stockholders' equity (2) .............. 12.55% 10.76% 13.18% 12.59% 13.30% Return on assets (2) ............................ 1.50% 1.20% 1.69% 1.77% 1.66% Stockholders' equity to assets, excluding accumulated other comprehensive income (2) .. 11.48% 12.17% 12.15% 12.34% 11.60% Stockholders' equity to assets (2) .............. 11.92% 11.19% 12.80% 14.05% 12.50% Stockholders' equity to loans (2) ............... 27.72% 24.75% 28.90% 30.85% 26.90% Net income to: Total interest income ....................... 21.86% 16.25% 23.72% 24.37% 22.14% Interest margin ............................. 45.00% 38.51% 48.17% 48.66% 45.26% Dividends as a % of net income .................. 46.08% 60.19% 40.39% 37.81% 37.04%
(1) Includes available-for-sale and held-to-maturity securities, and interest-bearing cash and due from banks (2) Calculated based on average balance sheet data OUR FINANCIALS Page 7 QUARTERLY FINANCIAL DATA (unaudited) The following table presents summarized quarterly financial data for 2001 and 2000.
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2001 QUARTER ENDED MAR. 31, JUNE 30, SEPT. 30, DEC. 31, Interest income ............................... $13,214 $13,947 $14,086 $13,893 Interest expense .............................. 7,492 7,278 7,037 6,549 ============================================================================================ Interest margin ............................... 5,722 6,669 7,049 7,344 Provision for loan losses ..................... 150 150 150 150 ============================================================================================ Interest margin after provision for loan losses 5,572 6,519 6,899 7,194 Other income .................................. 1,313 1,399 1,476 1,453 Securities gains .............................. 455 742 520 203 Other expenses ................................ 4,598 4,580 4,575 4,918 ============================================================================================ Income before income tax provision ............ 2,742 4,080 4,320 3,932 Income tax provision .......................... 477 891 914 740 ============================================================================================ Net income .................................... $ 2,265 $ 3,189 $ 3,406 $ 3,192 ============================================================================================ Net income per share - basic .................. $ 0.43 $ 0.60 $ 0.64 $ 0.60 ============================================================================================ Net income per share - diluted ................ $ 0.43 $ 0.60 $ 0.64 $ 0.60 ============================================================================================
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2000 QUARTER ENDED MAR. 31, JUNE 30, SEPT. 30, DEC. 31, Interest income ............................... $12,857 $12,949 $13,125 $13,224 Interest expense .............................. 7,145 7,396 7,790 7,814 ============================================================================================ Interest margin ............................... 5,712 5,553 5,335 5,410 Provision for loan losses ..................... 226 150 150 150 ============================================================================================ Interest margin after provision for loan losses 5,486 5,403 5,185 5,260 Other income .................................. 1,358 1,050 963 1,119 Securities gains .............................. 15 322 230 810 Other expense ................................. 4,209 4,116 4,171 4,410 ============================================================================================ Income before income tax provision ............ 2,650 2,659 2,207 2,779 Income tax provision .......................... 501 446 374 498 ============================================================================================ Net income .................................... $ 2,149 $ 2,213 $ 1,833 $ 2,281 ============================================================================================ Net income per share - basic .................. $ 0.40 $ 0.42 $ 0.35 $ 0.43 ============================================================================================ Net income per share - diluted ................ $ 0.40 $ 0.42 $ 0.35 $ 0.43 ============================================================================================
OUR FINANCIALS Page 8 TRUST AND FINANCIAL MANAGEMENT GROUP
(IN THOUSANDS) 2001 2000 1999 1998 1997 -------- -------- -------- -------- -------- Assets ....... $303,868 $327,063 $320,385 $283,262 $230,149 Revenue ...... $ 1,576 $ 1,613 $ 1,456 $ 1,288 $ 1,004
The composition of trust assets and liabilities as of December 31, 2001, 2000 and 1999 are shown in the following table: (IN THOUSANDS) INVESTMENTS
2001 2000 1999 -------- -------- -------- Bonds ........................ $ 98,364 $ 95,496 $ 85,615 Stocks ....................... 97,193 98,802 108,279 Mutual funds ................. 79,942 97,320 102,635 Savings and money market funds 26,799 31,291 18,411 Real estate .................. 722 2,304 3,430 Mortgages .................... 640 1,104 1,003 Miscellaneous ................ 208 746 1,012 ================================================================== Total ........................ $303,868 $327,063 $320,385 ==================================================================
ACCOUNTS
2001 2000 1999 -------- -------- -------- Pension/profit sharing ....... $ 94,111 $107,553 $102,893 Trusts ....................... 85,379 85,154 87,828 Investment management ........ 84,648 95,298 88,759 Custody ...................... 36,941 35,521 36,007 Guardianships ................ 1,557 2,042 2,642 Estates ...................... 1,232 1,495 2,256 ================================================================== Total ........................ $303,868 $327,063 $320,385 ==================================================================
STOCKHOLDER INQUIRIES A copy of the Corporation's Annual Report on Form 10-K for the year ended December 31, 2001, as required to be filed with the Securities and Exchange Commission, will be furnished to a stockholder without charge upon written request to the Corporation's Treasurer at the principal office at P.O. Box 58, Wellsboro, PA 16901. The information is also available at the website of the Securities and Exchange Commission at www.sec.gov. This statement has not been reviewed or confirmed for accuracy or relevance by the Federal Deposit Insurance Corporation. OUR FINANCIALS Page 9 CITIZENS & NORTHERN CORPORATION OFFICERS Craig G. Litchfield Chairman of the Board, President and Chief Executive Officer Mark A. Hughes Treasurer Kathleen M. Osgood Corporate Secretary ADVISORY BOARD ATHENS & SAYRE Virginia L. Reap Brenda L. May Warren J. Croft Max P. Gannon, Jr. R. Bruce Haner Susan E. Hartley George D. Howell Wayne E. Lowery Laurance A. Reagan, Jr. David Rosenbloom DUSHORE Helen W. Ferris Ronald A. Gutosky Leo F. Lambert Dennis K. McCarty Kerry A. Meehan EAST SMITHFIELD Peggy A. Brown Roy L. Beardslee Thomas G. Furman Liston D. Pepper Bennett R. Young ELKLAND Roberta C. Heck Mark R. Howe John C. Kenyon Edward L. Learn KNOXVILLE Mary Rose Sacks Gerald L. Bliss L. Grant Gehman Karl W. Kroeck William W. Roosa LAPORTE Linda M. Etzel David L. Baumunk William B. Saxe Leonard Simpson LIBERTY Ann L. Yuscavage Lyle R. Brion Gary L. Dinnison Lawrence F. Mase Ray E. Wheeland MANSFIELD Robin K. Carleton Gary Ray Butters David Kurzejewski John F. Wise, Jr. MUNCY Dawn L. Myers Kenneth F. Fry Roger D. Jarrett Daniel Mathers Ann Tyler RALSTON William C. Holmes George E. Bittner William W. Brooks, III Richard T. Demitras TIOGA Lois C. Wood John E. Brackley C. Frederick LaVancher Leisa L. LaVancher Donald E. Treat TOWANDA & MONROETON Valerie W. Kinney James A. Bowen Adelbert E. Eldridge W. John Greenland Robert J. Murphy Jeffrey A. Smith James E. Towner Deborah J. Weisbrod TROY Mark C. Griffis Dennis F. Beardslee Roy W. Cummings, Jr. J. Robert Garrison Gregory W. Powers Evan S. Williams, Jr. WELLSBORO Jan L. Southworth Donald R. Abplanalp J. Robert Bower Robert F. Cox, Jr. R. Robert DeCamp Craig Eccher Jan E. Fisher Edward H. Owlett III F. David Pennypacker WYSOX Debra S. Kithcart Lucille P. Donovan Robert L. Fulmer Mark W. Smith Walter E. Warburton, Jr. CITIZENS & NORTHERN BANK OFFICERS OPERATIONS Craig G. Litchfield Chairman, President and Chief Executive Officer Brian L. Canfield Senior Executive Vice President and Branch System Administrator Dawn A. Besse Executive Vice President and Sales and Service Coordinator Mark A. Hughes Executive Vice President and Chief Financial Officer Matthew P. Prosseda Executive Vice President and Commercial Loan Coordinator Harold F. Hoose III Vice President Scott A. Keck Vice President and Bank Operations Coordinator Kathleen M. Osgood Corporate Secretary Klas G. Anderson Assistant Vice President Robert E. Bolt Assistant Vice President Carl M. Chambers Assistant Vice President Joan L. Grenell Assistant Vice President Michelle M. Karas Assistant Vice President and Marketing Coordinator Karen L. Keck Assistant Vice President, Account Services Jeffrey B. Osgood Human Resource Director Joseph A. Snell Assistant Controller Kevin Weinhoffer Assistant Vice President Sandra G. Andrews Assistant Cashier Rosalie L. Bordas Assistant Cashier Account Services Nancy L. Tubbs IRA Administrator Sandra A. Parulas Training Officer Linda M. Prough-Shuey Assistant Cashier Joan E. Rohe Staff Accountant TRUST & FINANCIAL OFFICERS AND BOARDS Page 10 CITIZENS & NORTHERN BANK OFFICERS (Continued) TRUST & FINANCIAL MANAGEMENT GROUP Thomas L. Briggs Executive Vice President and Senior Trust Officer Deborah E. Scott Executive Vice President and Senior Trust Officer Linda L. Kriner Vice President and Trust Officer Renee D. Laychur Vice President and Trust Officer Rhonda J. Litchfield Vice President and Trust Investment Officer Larry D. Alderson Assistant Vice President and Trust Officer Michael G. Charles Assistant Vice President and Trust Officer Mary J. Wood Trust Officer James D. Butters Assistant Trust Officer MANAGEMENT INFORMATION SYSTEMS Rick J. Cisco Vice President and Senior Systems Analyst James H. Shelmire Vice President and Senior Systems Analyst AUDIT AND COMPLIANCE Russell H. Bauman Vice President and Auditor Shawn M. Schreck Vice President, Compliance Officer and Security Officer Glenda R. Marzo Assistant Vice President and Assistant Auditor BANKCARD SERVICES Keith C. Cavanaugh Assistant Vice President Eileen K. Ranck Assistant Vice President Bankcard Manager INTERNET BANKING Shelley L. D'Haene Internet Banking Coordinator C&N FINANCIAL SERVICES CORPORATION INSURANCE DIVISION Thomas L. Rudy, Jr. President BROKER/DEALER DIVISION Philip A. Prough Assistant Vice President OFFICES ATHENS 428 SOUTH MAIN ST. ATHENS, PA 18810 570.888.2291 Virginia L. Reap Assistant Cashier Terry R. Depew Vice President Kathy L. Griffis Assistant Cashier James R. Heffner Assistant Cashier DUSHORE 111 W. MAIN ST. DUSHORE, PA 18614 570.928.8124 Helen W. Ferris Assistant Vice President Bonnie L. Bennett Assistant Cashier Raechelle N. Curry Assistant Cashier Brenda B. Whiteley Assistant Cashier EAST SMITHFIELD MAIN STREET EAST SMITHFIELD, PA 18817 570.596.3131 Peggy A. Brown Assistant Vice President Elaine F. Johnston Assistant Vice President Diane B. Elvidge Assistant Cashier Sandra J. McNeal Assistant Cashier ELKLAND 104 MAIN STREET ELKLAND, PA 16920 814.258.5111 Roberta C. Heck Assistant Vice President Leonard Mitchell, III Assistant Cashier KNOXVILLE 102 EAST MAIN ST. KNOXVILLE, PA 16928 814.326.4151 Mary Rose Sacks Assistant Vice President Lynette M. Burrous Assistant Cashier LAPORTE MAIN STREET LAPORTE, PA 18626 570.946.4011 Linda M. Etzel Assistant Cashier Margaret J. Black Assistant Cashier LIBERTY MAIN STREET LIBERTY, PA 16930 570.324.2331 Ann L. Yuscavage Vice President Joan M. Blackwell Assistant Cashier MANSFIELD 1085 SOUTH MAIN ST. MANSFIELD, PA 16933 570.662.1111 Robin K. Carleton Vice President Diane K. Wilson Assistant Cashier MONROETON ROUTE 220 MONROETON, PA 18832 570.265.2157 MUNCY 3461 ROUTE 405 HIGHWAY MUNCY, PA 17756 570.546.6666 Dawn L. Myers Assistant Cashier Randy R. Meckes Vice President Larry N. Pick Assistant Vice President RALSTON THOMPSON STREET RALSTON, PA 17763 570.995.5421 William C. Holmes Assistant Vice President SAYRE 503 NORTH ELMIRA ST. SAYRE, PA 18840 570.888.2220 Brenda L. May Assistant Vice President Stacey A. Sickler Mortgage Specialist Marcella J. Chaykosky Assistant Cashier Mark W. Elsbree Assistant Cashier TIOGA 41 MAIN STREET TIOGA, PA 16946 570.835.5236 Lois C. Wood Assistant Vice President Deborah K. Beck Assistant Cashier TOWANDA 428 MAIN ST. TOWANDA, PA 18848 570.265.6171 James E. Parks Vice President Valerie W. Kinney Assistant Vice President TROY COURTHOUSE SQUARE TROY, PA 16947 570.297.2159 Mark C. Griffis Vice President David S. Schucker Assistant Vice President Rosalie H. Hall Assistant Cashier WELLSBORO 90-92 MAIN STREET WELLSBORO, PA 16901 570.724.3411 Richard L. Wilkinson Vice President Jan L. Southworth Vice President Kim L. Miller Vice President Brett W. Kennedy Assistant Cashier WYSOX ROUTE 6 WYSOX, PA 18854 570.265.9148 Debra S. Kithcart Assistant Vice President Jeffery E. Aeppli Assistant Vice President BANK OFFICERS/OFFICES Page 11 CITIZENS & NORTHERN CORPORATION AND CITIZENS & NORTHERN BANK BOARD OF DIRECTORS Dennis F. Beardslee Owner, Terrace Lanes Bowling Center J. Robert Bower Pharmacist R. Robert DeCamp President, Patterson Lumber Co., Inc. R. Bruce Haner Auto Buyer for New Car Dealers Susan E. Hartley Attorney at Law Karl W. Kroeck Farmer Leo F. Lambert President & General Manager Fitzpatrick & Lambert, Inc. Edward L. Learn Owner of Learn Hardware and Building Supply Craig G. Litchfield Chairman of the Board, President and Chief Executive Officer Lawrence F. Mase Retired, formerly President of Mase's Inc. Edward H. Owlett, III President & CEO of Putnam Company F. David Pennypacker President of Wellsboro Industrial Park, Inc. Leonard Simpson Attorney at Law James E. Towner Publisher of "The Daily and Sunday Review" DIRECTORS EMERITI Adelbert E. Eldridge Retired Regional Director of Susquehanna Region of Pennsylvania Electric Co. William K. Francis Retired, formerly Chairman of the Board Robert J. Murphy Retired, formerly attorney in law firm of Davis, Murphy, Niemiec & Smith Donald E. Treat Retired, formerly owner of Treat Hardware OUR BOARD INTERNET BANKING CONNECTS YOU TO YOUR WORLD Statistics will tell you that more and more people are attracted to businesses which offer the convenience of online services. Through C&NOW(R) Internet Banking, our customers stay connected to their hometown financial institution, even after they move away or simply go on vacation. With our internet banking services, our customers are always just a click away! C&NOW(R) Internet Banking gives our customers immediate access to their account information from the convenience of their home or office computer. Now they can do their banking over the internet, simply & securely! Customers can use Internet Banking to do any of the following: - - View account balances - - View account history - - Search history by check number, amount or date - - Export history to personal finance software - - View transactions in checkbook format - - Transfer funds between accounts - - Pay bills - - Request stop payments - - Re-order checks and change address. Account options include: - - BALANCES The Account Balances Menu is the main menu. After logging onto your account, the Account Balances screen automatically appears, showing balances on the accounts with C&N Bank. This screen allows customers access to information about checking, savings, loans, or other bank accounts. - - HISTORY The View History Screen allows customers to view previous transactions for selected accounts. They may view a check and/or print copies of checks. - - PAY BILLS As an added convenience, C&N offers online bill payment. Customers need only follow the on-screen steps to add payees, enter the amount, date and account from which they are paying. Signing up for Internet Banking is easy. Just call or visit any C&N Bank branch office, visit us online at www.cnbankpa.com or email us at cnemail@cnbankpa.com. [PHOTO OF THREE EARTHS] Internet Banking continues to be an integral part of the future of banking in general and C&N Bank in particular. TIDBITS Page 12 SERVICES YOU CAN "TRUST" The Trust and Financial Management Group of C&N Bank has the experience and track record of someone you would trust with your investments, your future and the future of your family. Among the varied services handled by this group are: ESTATE ADMINISTRATION C&N can serve as the executor of your estate, performing complete administration services to settle your estate in accordance with your wishes. GUARDIANSHIP ADMINISTRATION C&N can serve as the financial guardian, either by will appointment or court appointment, for minors or the incapacitated. ESTATE & RETIREMENT PLANNING This group can develop estate and retirement plans that best meet your needs and objectives. INVESTMENT MANAGEMENT C&N's Trust and Financial Services staff serves individuals, organizations and corporations with comprehensive investment strategies. FINANCIAL CUSTODY SERVICES If you employ investment services from a third party, C&N can provide asset custody, income collection and transaction/asset reporting to complement those services. TAX PREPARATION We offer full income tax preparation as a convenience for clients of our Trust and Financial Services Division. EMPLOYEE BENEFIT PLANS Complete retirement plan services are offered for 401-k, profit sharing, money purchase pension, defined benefit pension plans and all types of IRAs. NOTE Some products are: - - Not FDIC Insured - - Not a Deposit or Other Obligation of the Bank - - Not Guaranteed by the Bank - - Subject to Investment Risk, Including the Loss of the Principal Amount Invested - - Not Insured by any Federal Government Agency WE'VE MOVED! C&N Financial Services Corporation has packed up and moved to 68 Main Street, the former Huffman's store. The move gives Financial Services a downtown presence, facilitating access for clients and keeping CNFS in the mainstream and minds-eye of prospective customers. The building, which also houses training facilities for C&N Bank, has been extensively remodeled. An open house will be held this month to introduce the new facility and CNFS to the community. We invite everyone to stop in and look over this exciting C&N facility. CONTACT US Our service departments may be contacted directly. BANKCARD SERVICES RR #7, Wellsboro, PA 16901 1.800.676.6639 ACCOUNT SERVICES 90-92 Main Street, Wellsboro, PA 16901 1.800.726.2265 TRUST & FINANCIAL MANAGEMENT GROUP 90-92 Main Street, Wellsboro, PA 16901 1.800.487.8784 428 Main Street, Towanda, PA 18848 1.888.987.8784 428 South Main Street, Athens, PA 18810 1.888.760.8192 3461 Route 405 Highway, Muncy, PA 17756 570.546.6666 C&N FINANCIAL SERVICES CORPORATION 68 Main Street, Wellsboro, PA 16901 1.866.ASK.CNFS www.cnfinancialservices.com INTERNET BANKING 90-92 Main Street, Wellsboro, PA 16901 570.724.0266 www.cnbankpa.com TIDBITS [CITIZENS & NORTHERN CORPORATION LOGO] Athens/Dushore/East Smithfield/Elkland/Knoxville/Laporte/Liberty/Mansfield Monroeton/Muncy/Ralston/Sayre/Tioga/Towanda/Troy/Wellsboro/Wysox Member FDIC Stock Symbol CZNC www.cnbankpa.com [PHOTO OF CRAIG G. LITCHFIELD] [PICTURE] "We must train, coach and empower our employees to best serve our customers. By serving customers, we ultimately build value for our shareholders. Craig G. Litchfield Chairman, President & Chief Executive Officer Complete message to shareholders on Pages 2-3 OUR PEOPLE, OUR STRENGTH [CITIZENS & NORTHERN CORPORATION LOGO] Athens/Dushore/East Smithfield/Elkland/Knoxville/Laporte/Liberty/Mansfield Monroeton/Muncy/Ralston/Sayre/Tioga/Towanda/Troy/Wellsboro/Wysox Member FDIC Stock Symbol CZNC www.cnbankpa.com -----END PRIVACY-ENHANCED MESSAGE-----