-----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, WlQT1rXo1EVRciF2gP0BODh6EwJWNMwf8ecwFH+nRtQpSehnbqg2jcELnD7h4wBZ 2p2nYiGGEfo0XvLEy75r8A== 0000950152-05-002064.txt : 20050314 0000950152-05-002064.hdr.sgml : 20050314 20050314102011 ACCESSION NUMBER: 0000950152-05-002064 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20041231 FILED AS OF DATE: 20050314 DATE AS OF CHANGE: 20050314 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-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-16084 FILM NUMBER: 05677283 BUSINESS ADDRESS: STREET 1: 90-92 MAIN ST CITY: WELLSBORO STATE: PA ZIP: 16901 BUSINESS PHONE: 7172656171 MAIL ADDRESS: STREET 1: 90-92 MAIN ST CITY: WELLSBORO STATE: PA ZIP: 16901 10-K 1 l12593ae10vk.txt CITIZENS & NORTHERN CORPORATION 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (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, 2004 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. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [X] No [ ] The aggregate market value of the registrant's common stock held by non-affiliates at June 30, 2004 was $204,103,368. The number of shares of common stock outstanding at March 9, 2005 was 8,190,990. DOCUMENTS INCORPORATED BY REFERENCE ----------------------------------- Portions of the registrant's proxy statement for the annual meeting of its shareholders to be held April 19, 2005 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 credit and mortgage life and accident and health insurance on behalf of the Bank. 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, such as 401(k) Plans, retirement planning, estate planning, estate settlements and asset management. 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. C&NFSC's operations are 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, Bradford, Sullivan and Lycoming 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, broker dealer 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 completed 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; - - constructed and opened a branch in Muncy, PA in 2000; - - purchased and remodeled a former bank operations center in Williamsport, PA, and began offering trust and financial management, commercial lending, branch banking and other services, in 2004; - - opened a branch office at a leased facility in South Williamsport, PA in 2004; and - - replaced the core banking computer system in 2004. - 2 - In November 2004, the Corporation, along with Canisteo Valley Corporation ("Canisteo"), announced the signing of a definitive agreement and plan of merger. Canisteo is the parent company of First State Bank; a New York State chartered commercial bank with two offices in Steuben County, NY, and assets of $42.5 million as of September 30, 2004. Under the agreement, the Corporation will acquire Canisteo in an all-cash merger transaction. The transaction, which has been approved by the Boards of Directors of both companies, is expected to be completed during the third quarter 2005, pending Canisteo stockholder approval, regulatory approval, and other customary conditions of closing. At December 31, 2004, the Bank had total assets of $1,093,273,000, total deposits of $677,537,000 and net loans outstanding of $572,826,000. At December 31, 2004, the Bank had a total of 324 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. - - The Bank is a state-chartered, nonmember bank, supervised by the Federal Deposit Insurance Corporation and the Pennsylvania Department of Banking. - - C&NFSC is a Pennsylvania corporation. The Pennsylvania Department of Insurance regulates C&NFSC's insurance activities. Brokerage products are offered through a third party networking agreement between the Bank and UVEST Financial Services, Inc. - - Bucktail is incorporated in the state of Arizona and supervised by the Arizona Department of Insurance. A copy of the Corporation's annual report on Form 10-K, quarterly reports on Form 10-Q, current events reports on Form 8-K, and amendments to these reports, will be furnished without charge upon written request to the Corporation's Treasurer at P.O. Box 58, Wellsboro, PA 16901. Copies of these reports will be furnished as soon as reasonably possible, after they are filed electronically with the Securities and Exchange Commission. The information is also available through the Corporation's web site at www.cnbankpa.com. ITEM 2. PROPERTIES The Bank owns each of its properties, except for the facilities located at 68 Main Street, Wellsboro, and 2 East Mountain Avenue, South Williamsport, which are leased. All of the properties are in good 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 1085 S. Main Street 428 Main Street Athens, PA 18810 Mansfield, PA 16933 Towanda, PA 18848 111 Main Street Route 220 Courthouse Square Dushore, PA 18614 Monroeton, PA 18832 Troy, PA 16947 Main Street 3461 Route 405 Highway 90-92 Main Street East Smithfield, PA 18817 Muncy, PA 17756 Wellsboro, PA 16901 104 Main Street Thompson Street 130 Court Street Elkland, PA 16920 Ralston, PA 17763 Williamsport, PA 17701 - 3 - 102 E. Main Street 503 N. Elmira Street Route 6 Knoxville, PA 16928 Sayre, PA 18840 Wysox, PA 18854 Main Street 2 East Mountain Avenue Laporte, PA 18626 South Williamsport, PA 17702 Main Street 41 Main Street Liberty, PA 16930 Tioga, PA 16946 Other offices: Bankcard Services C&N Financial Services Corp. Internal Audit RR 7 Box 503 68 Main Street Water Street Wellsboro, PA 16901 Wellsboro, PA 16901 Wellsboro, PA 16901 ITEM 3. LEGAL PROCEEDINGS The Corporation and the Bank are involved in various legal proceedings incidental to their business. Management believes the aggregate liability, if any, resulting from such pending and threatened legal proceedings will not have a material, adverse effect on the Corporation's financial condition or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS During the fourth quarter of 2004, no matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise. 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. Effective January 13, 2005, the Corporation's stock began to be listed on the NASDAQ SmallCap Market with the trading symbol CZNC. Previously, the Corporation's stock was available through the Over-The-Counter Bulletin Board. As of March 1, 2005, there were 2,444 shareholders of record of the Corporation's common stock. The following table sets forth the approximate high and low sales prices of the common stock during 2004 and 2003.
2004 2003 Dividend Dividend Declared Declared per Per High Low Quarter High Low Quarter ------- ------- --------- ------- ------- --------- First quarter $ 27.00 $ 25.00 $ 0.22 $ 21.63 $ 20.37 $ 0.21 Second quarter 25.50 24.45 0.22 26.95 21.00 0.21 Third quarter 25.90 24.20 0.22 26.95 25.80 0.21 Fourth quarter 27.00 24.80 0.23 27.00 25.80 0.22 plus 1% plus 1% stock dividend stock dividend
While the Corporation expects to continue its policy of regular quarterly dividend payments, future dividend payments will depend upon maintenance of a strong financial condition, future earnings and capital and regulatory requirements. Also, the Corporation and the Bank are subject to restrictions on the amount of dividends that may be paid without approval of banking regulatory authorities. These restrictions are described in Note 18 to the consolidated financial statements. Known "market makers" who handle Citizens & Northern Corporation stock transactions are: - 4 - Boenning & Scattergood, Inc. Monroe Securities, Inc. RBC Capital Markets Corp. 4 Tower Bridge, Suite 300 343 West Erie 60 South 6th St. 200 Barr Harbor Drive Suite 410 P.O. Box 1160 West Conshohocken, PA 19428 Chicago, IL 60610 Minneapolis, MN 55402 Ferris, Baker, Watts, Inc. Knight Equity Markets, LP Ryan Beck & Co. 100 Light Street - Eighth Floor Newport Tower 18 Columbia Turnpike Baltimore, MD 21201 525 Washington Blvd Florham Park, NJ 07932 Jersey City, NJ 07310 Hill Thompson Magid, L.P. Pershing Trading Company, LP Sandler, O'Neill & Partners, LP 15 Exchange Place 1 Pershing Plaza 919 Third Avenue Suite 800 Jersey City, NJ 07399 Sixth Floor Jersey City, NJ 07302 New York, NY 10022 Janney Montgomery Scott, LLC Schwab Capital Markets, LP 1801 Market Street 111 Pavonia Avenue Philadelphia, PA 19103 East Jersey City, NJ 07310
EQUITY COMPENSATION PLAN INFORMATION The following table sets forth information concerning the Stock Incentive Plan and Independent Directors Stock Incentive Plan, both of which have been approved by the Corporation's shareholders. The figures shown in the table below are as of December 31, 2004.
NUMBER OF NUMBER OF WEIGHTED- SECURITIES SECURITIES TO BE AVERAGE REMAINING ISSUED UPON EXERCISE FOR FUTURE EXERCISE OF PRICE OF ISSUANCE UNDER OUTSTANDING OUTSTANDING EQUITY COMPEN- OPTIONS OPTIONS SATION PLANS ---------------- ----------- -------------- EQUITY COMPENSATION PLANS APPROVED BY SHAREHOLDERS 212,463 $ 20.03 195,823 EQUITY COMPENSATION PLANS NOT APPROVED BY SHAREHOLDERS 0 N/A 0
Effective January 3, 2005, the Corporation granted options to purchase a total of 37,176 shares of common stock through the Stock Incentive and Independent Directors Stock Incentive Plans. The exercise price for these options is $27.00 per share, which was the market price at the date of grant. Also, effective January 3, 2005, the Corporation awarded a total of 4,128 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 2005 are not included in the tables above. More details related to the Corporation's equity compensation plans are provided in Notes 1 and 12 to the consolidated financial statements. - 5 - ITEM 6. SELECTED FINANCIAL DATA
INCOME STATEMENT (IN THOUSANDS) 2004 2003 2002 2001 2000 Interest income $ 57,922 $ 55,223 $ 57,285 $ 54,661 $ 51,643 Interest expense 22,606 23,537 26,315 28,356 30,145 ------------ ------------ ----------- ----------- ----------- Interest margin 35,316 31,686 30,970 26,305 21,498 Provision for loan losses 1,400 1,100 940 600 676 ------------ ------------ ----------- ----------- ----------- Interest margin after provision for loan losses 33,916 30,586 30,030 25,705 20,822 Other income 6,922 6,595 6,624 6,120 5,002 Securities gains 2,877 4,799 2,888 1,920 1,377 Other expenses 26,001 22,114 20,849 18,671 16,906 ------------ ------------ ----------- ----------- ----------- Income before income tax provision 17,714 19,866 18,693 15,074 10,295 Income tax provision 2,851 3,609 3,734 3,022 1,819 ------------ ------------ ----------- ----------- ----------- Net income $ 14,863 $ 16,257 $ 14,959 $ 12,052 $ 8,476 ============ ============ =========== =========== =========== BALANCE SHEET AT YEAR END (IN THOUSANDS) Total securities (1) $ 479,626 $ 484,825 $ 513,597 $ 437,398 $ 343,596 Gross loans, excluding unearned discount 579,613 524,897 451,145 379,228 328,305 Total assets 1,123,002 1,066,901 1,018,768 866,999 719,335 Total deposits 676,545 658,065 640,304 576,274 528,967 Stockholders' equity, excluding accumulated other comprehensive income (4) 121,050 113,306 103,691 94,903 88,887 Total stockholders' equity 131,585 125,343 115,837 100,187 88,969 AVERAGE BALANCE SHEET (IN THOUSANDS) Total securities, at amortized cost (1) 485,182 474,406 470,764 412,654 371,360 Gross loans, excluding unearned discount 551,352 485,150 410,670 346,353 318,382 Earning assets 1,036,534 959,556 881,434 759,007 689,743 Total assets 1,114,040 1,034,720 943,001 805,229 704,221 Total assets, excluding unrealized gains/ losses (4) 1,097,858 1,014,424 930,539 798,590 717,052 Total deposits 669,307 651,026 613,392 544,579 503,848 Stockholders' equity, excluding accumulated other comprehensive income (4) 117,695 108,876 99,361 91,703 87,258 Stockholders' equity 128,374 122,271 107,595 96,021 78,792 COMMON STOCK AND PER SHARE DATA Net income per share - basic $ 1.82 $ 1.99 $ 1.83 $ 1.47 $ 1.03 Net income per share - diluted 1.81 1.98 1.83 1.47 1.03 Cash dividends declared per share 0.89 0.85 0.77 0.71 0.65 Stock dividend 1% 1% 1% 1% 1% Stockholders' equity per share (2) 16.08 15.33 14.18 12.26 10.84 Stockholders' equity per share, excluding accumulated other comprehensive income (loss) (2), (4) 14.79 13.86 12.69 11.61 10.83 Weighted average shares outstanding - basic 8,185,466 8,170,651 8,170,159 8,184,716 8,206,549 Weighted average shares outstanding - diluted 8,233,992 8,219,366 8,192,047 8,206,604 8,208,297 Number of shares outstanding at year-end 8,102,646 8,014,625 5,285,606 5,234,800 5,207,244 Number of shares authorized 20,000,000 10,000,000 10,000,000 10,000,000 10,000,000
- 6 -
FINANCIAL RATIOS 2004 2003 2002 2001 2000 Return on stockholders' equity, excluding accumulated other comprehensive income (3), (4) 12.63% 14.93% 15.06% 13.14% 9.71% Return on stockholders' equity (3) 11.58% 13.30% 13.90% 12.55% 10.76% Return on assets (3) 1.33% 1.57% 1.59% 1.50% 1.20% Stockholders' equity to assets, excluding accumulated other comprehensive income (3), (4) 10.72% 10.73% 10.68% 11.48% 12.17% Stockholders' equity to assets (3) 11.52% 11.82% 11.41% 11.92% 11.19% Stockholders' equity to loans (3) 23.28% 25.20% 26.20% 27.72% 24.75% Net income to: Total interest income 25.66% 29.44% 26.11% 22.05% 16.41% Interest margin 42.09% 51.31% 48.30% 45.82% 39.43% Dividends as a % of net income 48.54% 41.96% 41.17% 46.08% 60.19%
(1) Includes available-for-sale and held-to-maturity securities, and interest-bearing cash and due from banks. (2) For purposes of this computation, the number of outstanding shares has been increased for the effects of a 3-for-2 stock split issued in April 2003 and for 1% stock dividends issued in January following each year-end. (3) Ratios calculated using average balance sheet data. (4) Generally accepted accounting principles ("GAAP") require that available-for-sale securities be reported at fair value, with unrealized gains and losses excluded from earnings and reported separately through stockholders' equity, net of tax. Management believes there is an inherent mismatch between the income statement and balance sheet related to unrealized gains/losses that may create a material inconsistency in earnings-based ratios. Further, the amount of unrealized gains/losses may vary widely from period-to-period, depending on the financial markets as a whole and interest rate movements. Therefore, management has provided these "non-GAAP" amounts and ratios because we believe they provide meaningful information for evaluating the Corporation's financial position and results of operations. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain statements in this section and elsewhere in this Annual Report on 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 not historical facts, are based on certain assumptions and describe future plans, business objectives and expectations, and are generally identifiable by the use of words such as, "should", "likely", "expect", "plan", "anticipate", "target", "forecast", and "goal". These forward-looking statements are subject to risks and uncertainties that are difficult to predict, may be beyond management's control and could cause results to differ materially from those expressed or implied by such forward-looking statements. Factors which could have a material, adverse impact on the operations and future prospects of the Corporation include, but are not limited to, the following: - - changes in monetary and fiscal policies of the Federal Reserve Board and the U.S. Government, particularly related to changes in interest rates - - changes in general economic conditions - - legislative or regulatory changes - - downturn in demand for loan, deposit and other financial services in the Corporation's market area - - increased competition from other banks and non-bank providers of financial services - - technological changes and increased technology-related costs - - changes in accounting principles, or the application of generally accepted accounting principles. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. - 7 - EARNINGS OVERVIEW Net income in 2004 was $14,863,000, or $1.82 per share - - basic and $1.81 per share - - diluted. Net income for 2004 was $1,394,000, or 8.6%, lower than the $16,257,000 ($1.99 per share - - basic and $1.98 per share - - diluted) recorded in 2003. In comparing earnings for 2004 with 2003's results, it is important to note the lower level of realized securities gains generated in 2004, as described below. Assuming an income tax rate of 34%, the lower securities gains in 2004 reduced net income for 2004 by $1,269,000 from 2003. Excluding the effects of lower securities gains, net income for 2004 was approximately 1% lower than the amount recorded in 2003. In 2002, net income totaled $14,959,000 ($1.83 per share - basic and diluted). The most significant income statement changes are as follows: 2004 VS. 2003 - The interest margin increased $3,630,000, or 11.5% in 2004 from $31,686,000 in 2003. Higher interest income, primarily from growth in loans, combined with lower interest expense, combined to drive the increase in the interest margin. The "Net Interest Margin" section of Management's Discussion and Analysis provides a more detailed discussion of factors that affected interest income and interest expense. - Realized securities gains, net of realized losses, decreased $1,922,000 to $2,877,000 in 2004 from $4,799,000 in 2003. In both 2004 and 2003. the Corporation sold selected bank stocks that management believed to be fully valued, generating substantial realized gains. Net gains from sales of equity securities, which consisted primarily of bank stocks, amounted to $2,011,000 in 2004 and $3,384,000 in 2003. Net gains from sales and calls of debt securities amounted to $866,000 in 2004, and $1,415,000 in 2003. - Other (noninterest) operating expenses increased $1,363,000, or 25.9%, in 2004 over 2003. Overall, this increase is the result of higher volumes of loans and other transactions, start-up of the Williamsport and South Williamsport facilities, the implementation of the core computer system conversion and other activities have resulted in more expense incidental to additional personnel and technology. A further explanation of these costs is provided in the "Noninterest Expense" section of Management's Discussion and Analysis. - Pre-tax income was lower in 2004 than in 2003 and the income tax provision decreased to $2,851,000 in 2004 from $3,609,000 in 2003. The income tax provision, as a percentage of pre-tax income, was 16.09% in 2004, down from 18.17% in 2003. Note 13 to the Consolidated Financial Statements presents more detail concerning the Corporation's accounting for income taxes. 2003 VS. 2002 - The interest margin increased $716,000, or 2.3%, to $31,686,000 in 2003 from $30,970,000 in 2002. In 2003, interest rates were at very low levels by historical standards. In that rate environment, on average, interest earning assets repriced faster than interest-bearing liabilities, which had the effect of driving down the Corporation's net interest margin. However, substantial growth in loans generated higher interest income, which more than offset the effects of lower rates on the net interest margin. - Realized securities gains, net of realized losses, increased $1,911,000, to $4,799,000 in 2003 from $2,888,000 in 2002. In both 2003 and 2002, the Corporation sold selected bank stocks that management believed to be fully valued, generating substantial realized gains. - Other (noninterest) operating expenses increased $1,265,000, or 6.1%, in 2003 over 2002. This increase includes higher employee benefits and payroll costs. As described in more detail in the "Noninterest Expense" section of Management's Discussion and Analysis, these cost increases reflect a higher number of employees, as well as increases in expense related to the defined benefit pension and employee health insurance plans. - Although pre-tax income was higher in 2003 than in 2002, the income tax provision decreased to $3,609,000 in 2003 from $3,734,000 in 2002. The income tax provision, as a percentage of pre-tax income, was 18.17% in 2003, down from 19.98% in 2002. This lower effective tax rate reflects management's decision to increase the weighting of tax-exempt investment securities as a percentage of total assets. Note 13 to the Consolidated Financial Statements presents more detail concerning the Corporation's accounting for income taxes. - 8 - OUTLOOK FOR 2005 The Corporation is in a growth mode. In addition to the pending acquisition of Canisteo Valley Corporation (see Note 21 to the consolidated financial statements), management has several projects planned for 2005. The growth in administrative, trust and commercial lending staff has resulted in the need for more room. In order to meet that need, a new administrative building will be erected within 2 blocks of the Wellsboro main office. The facility will provide about 17,000 square feet of room. In Lycoming County, the Corporation has signed agreements for the acquisition of 2 sites for future full-service offices. Management hopes to begin construction in Jersey Shore by the second quarter 2005. Construction of the second building will most likely begin by the end of 2005. Total capital purchases for 2005 are estimated to range from $6 million to $8.5 million. Management expects the expansion and investments in new markets to provide future, continuing opportunities for earnings growth. It may be difficult in 2005, however, to achieve a level of earnings comparable to 2004's results. Management expects the Lycoming County expansion to help achieve significant loan growth in 2005, which would provide a boost to earnings. Over the last 6 months of 2004 and first 2 months of 2005, however, the Federal Reserve has raised the Fed Funds Target rate 6 times, from 1% to its current level of 2.5%. Further increases are expected, as various economic pundits speculate the Fed's "equilibrium" rate to range anywhere from 3% to 5%. Meanwhile, long-term rates have not changed much over the last year, and many economists believe they will not move much during 2005. Rising short-term rates, combined with flat long-term rates, would be expected to have a negative effect on the Corporation's net interest margin in 2005. Further, noninterest expense in 2005 will include payroll and other start-up costs related to the new branches, as well as costs from the planned administrative facility and a full year of depreciation and maintenance from the core computer system that was placed in service in October 2004. Another major variable that affects the Corporation's earnings is securities gains and losses. Management's decisions regarding sales of securities are based on a variety of factors, with the overall goal of maximizing portfolio return over a long-term horizon. It is difficult to predict, with much precision, the amount of net securities gains and losses that will be realized in 2005. CRITICAL ACCOUNTING POLICIES The presentation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect many of the reported amounts and disclosures. Actual results could differ from these estimates. A material estimate that is particularly susceptible to significant change is the determination of the allowance for loan losses. Management believes that the allowance for loan losses is adequate and reasonable. The Corporation's methodology for determining the allowance for loan losses is described in a separate section later in Management's Discussion and Analysis. Given the very subjective nature of identifying and valuing loan losses, it is likely that well-informed individuals could make materially different assumptions, and could, therefore calculate a materially different allowance value. While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation's allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination. Another material estimate is the calculation of fair values of the Corporation's debt securities. The Corporation receives estimated fair values of debt securities from an independent valuation service, or from brokers. In developing these fair values, the valuation service and the brokers use estimates of cash flows, based on historical performance of similar instruments in similar interest rate environments. Based on experience, management is aware that estimated fair values of debt securities tend to vary among brokers and other valuation services. Accordingly, when selling debt securities, management typically obtains price quotes from more than one source. As described in Note 1 to 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). - 9 - NET INTEREST MARGIN 2004/2003/2002 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 2004, 2003 and 2002. 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, on a taxable-equivalent basis, was $39,218,000 in 2004, an increase of $3,736,000 or 10.5%, over 2003. As reflected in Table III, increased interest income from higher volumes of earning assets exceeded increases in interest expense attributable to higher volumes of interest-bearing liabilities by $2,830,000 in 2004 compared to 2003. Table III also shows that interest rate changes had the effect of increasing net interest income $906,000 in 2004 compared to 2003. As shown in Table II, the Interest Rate Spread was 3.43% in 2004, up from 3.31% in 2003. In 2003, the net interest margin of $35,482,000 was $1,519,000, or 4.5%, higher than the net interest margin in 2002. In 2003, the increase in net interest margin resulted mainly from increases in volume of earning assets, and from declining interest rates on the Corporation's deposits and borrowed funds. Table III shows that changes in volume of earning assets and interest-bearing liabilities resulted in an increase in net interest income of $4,129,000 in 2003, while changes in rates reduced net interest income $2,610,000. INTEREST INCOME AND EARNING ASSETS The Corporation's major categories of earning assets are loans and available-for-sale investment securities. As shown in Table I, total interest income increased to $61,824,000 in 2004 from $59,019,000 in 2003, an increase of 4.8%. Interest and fees on loans increased $2,274,000, or 6.8%. Interest and dividends from available-for-sale securities rose $532,000, or 2.1%. In 2004, the positive effect on earnings of higher average balances of loans and available-for-sale securities outstanding more than offset the dampening effect of lower average rates of return. Total interest income decreased $1,259,000, or 2.1%, in 2003 as compared to 2002. Interest and fees on loans increased $1,880,000, or 6.0% while interest and dividends from available-for-sale securities decreased $3,073,000, or 10.7%. In 2003, interest rates continued a fall to 40-year low levels. In 2003, the Corporation's lending growth produced an increase in interest income, despite significantly declining rates. Over the course of 2003, as falling rates caused principal repayments on mortgage-backed securities and calls of U.S. Government agency securities to accelerate, the Corporation was forced to reinvest at lower yields on available-for-sale securities or use the proceeds to help fund loan growth. Table II shows the composition of the available-for-sale securities portfolio, based on average balances. In 2004, the average balance of municipal bonds was $151,049,000, or 31% of the total portfolio. Municipals bonds were also 31% of the total portfolio in 2003 and 24% in 2002. On a taxable equivalent basis, municipal bonds are the highest yielding category of available-for-sale security. The Corporation determines the levels of its municipal bond holdings based on income tax planning and other considerations. The Corporation's other major categories of available-for-sale securities are mortgage-backed securities, U.S. Government agency bonds, equity securities and other securities. Most of the Corporation's mortgage-backed securities are "Hybrid ARMs," issued by U.S. Government agencies. Hybrid ARMs have a fixed rate for some period of time (fixed rates on the Corporation's holdings range from 3-10 years), then reprice once a year thereafter, based on changes in a market rate (index), subject to annual and lifetime caps. Looking ahead to the possibility of a rising long-term interest rate environment, Hybrid ARMs would typically provide a shorter average life, and faster principal repayments, than longer-term, fixed rate mortgage-backed securities. Equity securities consist mainly of bank stocks, and are discussed in more detail in the "Equity Securities" section of Item 7A. Other securities include corporate obligations, mainly "Trust Preferred Securities" issued by financial institutions, and whole loan collateralized mortgage obligations. Trust Preferred Securities are long-term obligations (usually 20-40 year maturities, often callable at the issuer's option after 5-10 years) that bear interest at fixed or variable rates. - 10 - Average loans outstanding increased $66,202,000, or 13.6%, in 2004, and $74,480,000, or 18.1%, in 2003. Much of the growth in the loan portfolio in 2004 and 2003 has been in real estate secured loans, including commercial as well as residential real estate loans. Historically low market interest rates, which spurred significant levels of refinancing throughout 2001-2003, have resulted in many individuals' and businesses' willingness to take on more debt. Also, the Corporation's loan growth is attributable to the opening of the Muncy office in 2000 and the Williamsport and South Williamsport offices in 2004, along with the hiring of several additional lending personnel. Excluding credit card loans, the mix between residential mortgage and other consumer loans outstanding, and commercial loans outstanding, was 58% mortgage and consumer, 42% commercial, as of December 31, 2004. The average return on the total loan portfolio for 2004 was 6.47%, down from 6.88% in 2003 and 7.67% in 2002. The lower returns in 2004 and 2003 resulted mainly from significant levels of mortgage refinancings, and by lower average returns on commercial loans with variable or adjustable rates. INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES Interest expense fell to $22,606,000 in 2004 from $23,537,000 in 2003 and $26,315,000 in 2002. As reflected in Table III, lower average rates had the effect of lowering interest expense $3,161,000 in 2004 and $5,069,000 in 2003. The impact of lower rates more than offset the effects on interest expense of higher average balances of interest-bearing liabilities. As shown in Table II, the average balance of total interest-bearing liabilities increased 7.8%, to $894,975,000 in 2004, and 9.1%, to $829,889,000 in 2003. As reflected in Table III, interest expense from certificates of deposit (CDs) decreased $824,000 in 2004 and $1,793,000 in 2003. Much of the lower interest expense from CDs in 2004 and 2003 was rate-related. However, the average balance also fell in both years, to $180,332,000 in 2004 from $190,019,000 in 2003 and $195,099,000 in 2002. The lower average balance of CDs in 2004 and 2003 was impacted by a reduction in average balances maintained by a few governmental and not-for-profit customers. The average rate incurred on CDs was 2.85% in 2004, 3.14% in 2003 and 3.97% in 2002. Table III shows that interest expense from money market accounts decreased $198,000 in 2004, and $1,258,000 in 2003. 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 1.31% in 2004, 1.43% in 2003 and 2.31% in 2002. Table II shows that the average balance of money market deposits increased 1.2%, to $192,450,000 in 2004, and 10.7%, to $190,161,000, in 2003. Interest expense from Individual Retirement Accounts (IRAs) decreased $806,000 in 2004 and increased $654,000 in 2003. As shown in Table II, the average balance of IRAs increased 9.8%, to $116,622,000 in 2004, and 16.9%, to $106,216,000 in 2003. Throughout 2004 and 2003, the Corporation offered one of the highest IRA rates in its marketplace, which was instrumental in this growth. For several years, the Corporation's IRA product was adjustable rate, repriced quarterly based on an index, with a floor of 5%. Effective September 1, 2002, the Corporation made changes to its IRA products, including: (1) for new IRAs, reduced the floor to 3%, and removed the tie to an external index, on the quarterly repricing IRA product, and (2) began to offer the Index Powered CD as an additional IRA product. (Index Powered CDs are described in detail in Note 10 to the consolidated financial statements.) Many of the 5% IRAs repriced in April 2004, resulting in the reduction in average rate incurred on IRAs to 3.75% in 2004, from 4.88% in 2003 and 4.98% in 2002. 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 FHLB - Pittsburgh. Other borrowed funds include overnight repurchase agreements with customers (the Corporation's "RepoSweep" accounts), borrowings from FHLB - Pittsburgh and other repurchase agreements. Interest expense on average other borrowed funds increased $1,076,000 in 2004, after decreasing $171,000 in 2003. Average other borrowed funds balances increased to $300,585,000 in 2004 from $242,358,000 in 2003 and $211,092,000 in 2002. In 2004, new borrowings were required to help fund growth in loans and to sustain management's desired level of available-for-sale securities. Average interest rates on other borrowed funds fell to 3.31% in 2004, from 3.67% in 2003 and 4.29% in 2002. - 11 - TABLE I - ANALYSIS OF INTEREST INCOME AND EXPENSE
YEARS ENDED DECEMBER 31, INCREASE(DECREASE) (IN THOUSANDS) 2004 2003 2002 04/03 03/02 INTEREST INCOME Available-for-sale securities: U.S. Treasury securities $ - $ - $ 75 $ - $ (75) Securities of other U.S. Government agencies and corporations 2,521 3,174 4,728 (653) (1,554) Mortgage-backed securities 7,654 7,427 11,097 227 (3,670) Obligations of states and political subdivisions 10,708 10,768 8,641 (60) 2,127 Equity securities 1,443 1,168 1,148 275 20 Other securities 3,797 3,054 2,975 743 79 ---------- -------- -------- ------- -------- Total available-for-sale securities 26,123 25,591 28,664 532 (3,073) ---------- -------- -------- ------- -------- Held-to-maturity securities: U.S. Treasury securities 17 17 27 - (10) Securities of other U.S. Government agencies and corporations 8 11 20 (3) (9) Mortgage-backed securities 2 3 9 (1) (6) ---------- -------- -------- ------- -------- Total held-to-maturity securities 27 31 56 (4) (25) ---------- -------- -------- ------- -------- Interest-bearing due from banks 11 10 17 1 (7) Federal funds sold 10 8 42 2 (34) Loans: Real estate loans 28,603 27,116 25,454 1,487 1,662 Consumer 2,659 2,834 2,974 (175) (140) Agricultural 146 199 199 (53) - Commercial/industrial 2,810 2,025 1,934 785 91 Other 30 56 69 (26) (13) Political subdivisions 1,402 1,144 858 258 286 Leases 3 5 11 (2) (6) ---------- -------- -------- ------- -------- Total loans 35,653 33,379 31,499 2,274 1,880 ---------- -------- -------- ------- -------- Total Interest Income 61,824 59,019 60,278 2,805 (1,259) ---------- -------- -------- ------- -------- INTEREST-BEARING LIABILITIES Interest checking 232 266 425 (34) (159) Money market 2,514 2,712 3,970 (198) (1,258) Savings 283 425 504 (142) (79) Certificates of deposit 5,135 5,959 7,752 (824) (1,793) Individual Retirement Accounts 4,376 5,182 4,528 (806) 654 Other time deposits 5 17 36 (12) (19) Overnight borrowings 100 91 44 9 47 Other borrowed funds 9,961 8,885 9,056 1,076 (171) ---------- -------- -------- ------- -------- Total Interest Expense 22,606 23,537 26,315 (931) (2,778) ---------- -------- -------- ------- -------- Net Interest Income $ 39,218 $ 35,482 $ 33,963 $ 3,736 $ 1,519 ========== ======== ======== ======= ========
(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 $987,000 in 2004, $1,323,000 in 2003 and $1,268,000 in 2002. - 12 - TABLE II - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES
RATE OF RATE OF RATE OF RETURN/ RETURN/ RETURN/ 2004 COST OF 2003 COST OF 2002 COST OF AVERAGE FUNDS AVERAGE FUNDS AVERAGE FUNDS (DOLLARS IN THOUSANDS) BALANCE % BALANCE % BALANCE % EARNING ASSETS Available-for-sale securities, at amortized cost: U.S. Treasury securities $ - 0.00 $ - 0.00 $ 1,241 6.04 Securities of other U.S. Government agencies and corporations 55,443 4.55 67,218 4.72 75,646 6.25 Mortgage-backed securities 181,012 4.23 176,800 4.20 209,539 5.30 Obligations of states and political subdivisions 151,049 7.09 146,371 7.36 113,540 7.61 Equity securities 29,346 4.92 28,084 4.16 21,858 5.25 Other securities 65,646 5.78 52,980 5.76 43,826 6.79 ---------- ---- ---------- ---- --------- ----- Total available-for-sale securities 482,496 5.41 471,453 5.43 465,650 6.16 ---------- ---- ---------- ---- --------- ----- Held-to-maturity securities: U.S. Treasury securities 318 5.35 320 5.31 511 5.28 Securities of other U.S. Government agencies and corporations 113 7.08 220 5.00 331 6.04 Mortgage-backed securities 29 6.90 64 4.69 131 6.87 ---------- ---- ---------- ---- --------- ----- Total held-to-maturity securities 460 5.87 604 5.13 973 5.76 ---------- ---- ---------- ---- --------- ----- Interest-bearing due from banks 1,449 0.76 1,669 0.60 1,444 1.18 Federal funds sold 778 1.29 680 1.18 2,698 1.56 Loans: Real estate loans 446,004 6.41 399,353 6.79 338,133 7.53 Consumer 34,637 7.68 32,386 8.75 29,720 10.01 Agricultural 2,243 6.51 2,924 6.81 2,556 7.79 Commercial/industrial 46,635 6.03 32,909 6.15 28,182 6.86 Other 478 6.28 851 6.58 1,028 6.71 Political subdivisions 21,307 6.58 16,649 6.87 10,929 7.85 Leases 48 6.25 78 6.41 122 9.02 ---------- ---- ---------- ---- --------- ----- Total loans 551,352 6.47 485,150 6.88 410,670 7.67 ---------- ---- ---------- ---- --------- ----- Total Earning Assets 1,036,535 5.96 959,556 6.15 881,435 6.84 Cash 14,273 13,583 13,318 Unrealized gain/loss on securities 16,182 20,296 12,462 Allowance for loan losses (6,523) (5,908) (5,453) Bank premises and equipment 14,953 11,090 10,246 Other assets 38,621 36,103 30,993 ---------- ---------- --------- Total Assets $1,114,041 $1,034,720 $ 943,001 ========== ========== ========= INTEREST-BEARING LIABILITIES Interest checking $ 39,188 0.59 $ 37,647 0.71 $ 37,984 1.12 Money market 192,450 1.31 190,161 1.43 171,767 2.31 Savings 57,439 0.49 54,789 0.78 49,779 1.01 Certificates of deposit 180,332 2.85 190,019 3.14 195,099 3.97 Individual Retirement Accounts 116,622 3.75 106,216 4.88 90,856 4.98 Other time deposits 1,275 0.39 1,666 1.02 1,814 1.98 Overnight borrowings 7,084 1.41 7,033 1.29 2,347 1.87 Other borrowed funds 300,585 3.31 242,358 3.67 211,092 4.29 ---------- ---- ---------- ---- --------- ----- Total Interest-bearing Liabilities 894,975 2.53 829,889 2.84 760,738 3.46 Demand deposits 82,001 70,528 66,093 Other liabilities 8,691 12,032 8,575 ---------- ---------- --------- Total Liabilities 985,667 912,449 835,406 ---------- ---------- --------- Stockholders' equity, excluding other comprehensive income/loss 117,695 108,876 99,361 Other comprehensive income/loss 10,679 13,395 8,234 ---------- ---------- --------- Total Stockholders' Equity 128,374 122,271 107,595 ---------- ---------- --------- Total Liabilities and Stockholders' Equity $1,114,041 $1,034,720 $ 943,001 ========== ========== ========= Interest Rate Spread 3.43 3.31 3.38 Net Interest Income/Earning Assets 3.78 3.70 3.85
(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. - 13 - TABLE III - THE EFFECT OF VOLUME AND RATE CHANGES ON INTEREST INCOME AND INTEREST EXPENSE
YEARS ENDED 12/31/04 VS. 03 YEARS ENDED 12/31/03 VS. 02 CHANGE IN CHANGE IN TOTAL CHANGE IN CHANGE IN TOTAL (IN THOUSANDS) VOLUME RATE CHANGE VOLUME RATE CHANGE EARNING ASSETS Available-for-sale securities: U.S. Treasury securities $ - $ - $ - $ (38) $ (37) $ (75) Securities of other U.S. Government agencies and corporations (539) (114) (653) (487) (1,067) (1,554) Mortgage-backed securities 178 49 227 (1,579) (2,091) (3,670) Obligations of states and political sub-divisions 338 (398) (60) 2,424 (297) 2,127 Equity securities 54 221 275 288 (268) 20 Other securities 733 10 743 567 (488) 79 ------- ------- ------- ------- -------- ------- Total available-for-sale securities 764 (232) 532 1,175 (4,248) (3,073) ------- ------- ------- ------- -------- ------- Held-to-maturity securities: U.S. Treasury securities - - - (10) - (10) Securities of other U.S. Government agencies and corporations (6) 3 (3) (6) (3) (9) Mortgage-backed securities (2) 1 (1) (4) (2) (6) ------- ------- ------- ------- -------- ------- Total held-to-maturity securities (8) 4 (4) (20) (5) (25) ------- ------- ------- ------- -------- ------- Interest-bearing due from banks (1) 2 1 2 (9) (7) Federal funds sold 1 1 2 (26) (8) (34) Loans: Real estate loans 3,049 (1,562) 1,487 4,316 (2,654) 1,662 Consumer 188 (363) (175) 253 (393) (140) Agricultural (44) (9) (53) 27 (27) - Commercial/industrial 828 (43) 785 304 (213) 91 Other (23) (3) (26) (12) (1) (13) Political subdivisions 308 (50) 258 404 (118) 286 Leases (2) - (2) (3) (3) (6) ------- ------- ------- ------- -------- ------- Total loans 4,304 (2,030) 2,274 5,289 (3,409) 1,880 ------- ------- ------- ------- -------- ------- Total Interest Income 5,060 (2,255) 2,805 6,420 (7,679) (1,259) ------- ------- ------- ------- -------- ------- INTEREST-BEARING LIABILITIES Interest checking 11 (45) (34) (4) (155) (159) Money market 33 (231) (198) 389 (1,647) (1,258) Savings 20 (162) (142) 47 (126) (79) Certificates of deposit (294) (530) (824) (197) (1,596) (1,793) Individual Retirement Accounts 473 (1,279) (806) 751 (97) 654 Other time deposits (3) (9) (12) (3) (16) (19) Overnight borrowings 1 8 9 65 (18) 47 Other borrowed funds 1,989 (913) 1,076 1,243 (1,414) (171) ------- ------- ------- ------- -------- ------- Total Interest Expense 2,230 (3,161) (931) 2,291 (5,069) (2,778) ------- ------- ------- ------- -------- ------- Net Interest Income $ 2,830 $ 906 $ 3,736 $ 4,129 $ (2,610) $ 1,519 ======= ======= ======= ======= ======== =======
(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. - 14 - NONINTEREST INCOME 2004/2003/2002 Total noninterest income decreased $1,595,000, or 14.0%, in 2004 as compared to 2003. In 2003, total noninterest income increased $1,882,000, or 19.8%, compared to 2002. The decreases and increases in net realized security gains in 2004 and 2003 are discussed in the "Earnings Overview" section of Management's Discussion and Analysis. Other items of significance are as follows: 2004 VS. 2003 - - Trust and financial management revenue rose $372,000, or 21.5% for 2004 compared to 2003. Trust and financial management revenue is affected significantly by the market value of assets under management. As of December 31, 2004, the value of trust assets under management amounted to $383,062,000, an increase of $53,447,000 or 16.2% from $329,615,000 as of December 31, 2003. - - The increase in cash surrender value of life insurance fell $105,000 to $610,000 in 2004 from $715,000 in 2003. The Corporation's policy return is determined, in part, by the amount of earnings generated from a pooled separate investment trust held by the life insurance company. In 2004, earnings on that pooled separate trust fund were lower than in 2003, which is reflective of lower market yields on debt securities. 2003 VS. 2002 - - Insurance commissions and fees dropped $186,000, or 32.2%, for 2003 compared to 2002. The decrease in insurance-related revenues had 2 components: (1) a decrease in revenues of $135,000 from Bucktail Life Insurance Company ("Bucktail"), a subsidiary of the Corporation that reinsures credit and mortgage life and accident and health insurance, and (2) a decrease in revenues of $51,000 from the insurance division of C & N Financial Services Corporation ("C&NFSC"). The decrease in Bucktail revenues is mainly attributed to timing items which are not expected to be indicative of a long-term decline. The chief reason for the decline in Bucktail revenues is the implementation of credit insurance changes to comply with the Home Owners Equity Protection Act (HOEPA) that became effective October 1, 2002. Under HOEPA, it is necessary to provide insurance protection on an outstanding daily balance method, rather than on a single premium basis. C&NFSC, a subsidiary of Citizens & Northern Bank, began its insurance agency operations in 2000, with limited activity to date. C&NFSC insurance revenues amounted to $110,000 in 2003 and $161,000 in 2002. - - The increase in cash surrender value of life insurance fell $138,000 to $715,000 in 2003 from $853,000 in 2002. The Corporation's policy return is determined, in part, by the amount of earnings generated from a pooled separate investment trust held by the life insurance company. In 2003, earnings on that pooled separate trust fund were lower than in 2002, which is reflective of lower market yields on debt securities. - - Credit card fee income increased mainly due to the formation of a "Reward Card Program" which pays users a rebate for using their credit card. This program was started in April 2003 and had the desired effect of raising card usage. This, along with an increased rate on interchange fees, has raised overall credit card fees 24.2% in 2003. - - Other operating income increased 13.8% due mainly to an increase in gains from the sales of other real estate of $51,000 and from the receipt of a grant of $33,000 for staff training. - 15 - TABLE IV - COMPARISON OF NONINTEREST INCOME
(IN THOUSANDS) 2004 % CHANGE 2003 % CHANGE 2002 Service charges on deposit accounts $ 1,717 (1.7) $ 1,746 1.2 $ 1,725 Service charges and fees 308 7.3 287 11.2 258 Trust and financial management revenue 2,105 21.5 1,733 (1.3) 1,755 Insurance commissions, fees and premiums 439 12.3 391 (32.2) 577 Increase in cash surrender value of life insurance 610 (14.7) 715 (16.2) 853 Fees related to credit card operation 773 (1.4) 784 24.2 631 Other operating income 970 3.3 939 13.8 825 ------- ---- ------- ---- ------- Total other income before realized gains on securities, net 6,922 5.0 6,595 (0.4) 6,624 Realized gains on securities, net 2,877 (40.1) 4,799 66.2 2,888 ------- ---- ------- ---- ------- Total Other Income $ 9,799 (14.0) $11,394 19.8 $ 9,512 ======= ===== ======= ==== =======
OTHER NONINTEREST EXPENSE 2004/2003/2002 Total noninterest expense increased 17.6% in 2004, to $26,001,000. In 2003, total noninterest expense was $22,114,000,000, or 6.1% higher than in 2002. 2004 VS. 2003 Salaries and wages increased $1,552,000, or 16.0%, for 2004 compared to 2003. The number of full-time equivalent employees (FTEs) increased 10.6%, to 324 at December 31, 2004 from 293 at December 31, 2003. The increased number of employees includes 10 FTEs for the new Willamsport and South Williamsport branches opened in 2004. Other positions added in 2004 include staff for Trust, Commercial Lending, Loan Administration, Accounting and Employee Training functions, as well as 5 Management Trainees who worked primarily on the core computer system conversion in 2004 and are now being groomed to assume new roles. In addition, paid overtime increased approximately $90,000 in 2004 over 2003, mainly due to core system conversion efforts. Pensions and other employee benefits increased $87,000, or 2.6%, in 2004 over 2003. As a percentage of salaries and wages, pensions and other employee benefits fell to 30.3% in 2004 from 34.2% in 2003. In 2004, employer contributions to the 401(k) profit sharing plan totaled 6.7% of salaries and wages, down from 7.8% in 2003. The lower percentage of profit sharing contributions in 2004 reflects a higher proportion of new employees hired in 2004, as the new hires will begin to qualify for contributions in 2005. Other expense reductions in 2004 included professional fees related to employee benefit matters, which decreased $89,000 to $167,000, defined benefit pension plan expense, which decreased $45,000 to $388,000 and supplemental executive retirement plan expense, which fell $41,000 to $4,000. Occupancy expense increased $369,000, or 28.5%, in 2004 over 2003. The greatest portion of the increase in occupancy expense is attributable to increased costs of $112,000 for building maintenance and repairs. Depreciation expense also rose $93,000 from 2003's level, as the Corporation recorded depreciation on the new Williamsport facility and on building renovation costs that have taken place in several locations. Total energy costs increased $68,000, primarily due to higher utility rates in several locations, as well as the initial expenses associated with the Williamsport and South Williamsport facilities during 2004. Furniture and equipment expense increased $433,000, or 31.6%, in 2004 compared to 2003. The largest increase within this category was in depreciation expense, which increased $283,000. The depreciation expense related to the Corporation's Management Information Systems function increased $180,000 in 2004, including $143,000 related to software and hardware for the new core system that was placed in service in October 2004. Depreciation expense also increased due to the addition of computer equipment and furniture for the Williamsport and South Williamsport locations. - 16 - In addition to the increase in depreciation, maintenance and repairs expense increased $121,000 in 2004, mainly due to maintenance contracts associated with the new software and hardware. In total, other operating expense increased $1,363,000, or 25.9%, in 2004 over 2003. This category includes many different types of expenses. The most significant changes within this category are as follows: - Bank professional fees increased $374,000, to $745,000. Included in this category was approximately $347,000 in expenses for training and other professional services related to the core banking software implementation. - Supplies expense increased $204,000, to $645,000 in 2004. This increase included costs associated with new locations and an increased number of employees as well as supplies used in the new core system training. - Travel, lodging and meal expenses increased $171,000 to $284,000 mainly from costs related to teams of employees who traveled to the vendor's headquarters for training on the new core system. - Fees paid to Corporation, Bank and Advisory Board Directors increased $106,000 in 2004, to $406,000. This reflected increases in rates paid for meeting fees, and retainers, based on recommendations from a competitive survey completed by a consultant early in 2004. Prior to 2004, no Director fee rates had increased since 1999. - Software-related expense increased $101,000 in 2004, to $250,000. This increase was mainly attributable to costs associated with a new Human Resources Information System that was installed in 2004. - Advertising expense increased $90,000 in 2004, to $464,000, mainly due to advertising programs in the Williamsport marketplace. 2003 VS. 2002 Salaries and wages increased $278,000, or 3.0%, for 2003 compared to 2002. The increase is mainly the result of annual merit raises, generally ranging from 2%-5%, and an increase in number of employees. Included in salaries and wages expense is incentive bonus expense. The incentive bonus plan provides for compensation to be paid to certain key officers, with the payment amounts based on a combination of personal and corporate performance. Incentive bonus expense for 2003 decreased $423,000 from the 2002 amount, as a lower amount of growth in noninterest revenue (as defined) limited the amount of bonuses attributable to overall corporate performance. Excluding incentive bonus expense, salaries and wages increased 8.4% in 2003 over 2002. Pensions and other employee benefits increased $666,000, or 25.1%, in 2003 over 2002. Pension expense from the Corporation's defined benefit pension plan increased $248,000 in 2003 over 2002. Although the defined benefit pension plan remained adequately funded, a decline in the market value of plan assets, along with an increased number of covered employees, contributed to the increase in expense in 2003. Group health insurance expense increased $112,000 in 2003, mainly due to increases in rates. Professional fees related to employee benefit plan matters increased $113,000 in 2003 over 2002. Occupancy expense increased $201,000, or 18.4%, in 2003 over 2002. The greatest portion of the increase in occupancy expense is attributable to increased costs of $57,000 for building maintenance and repairs. Depreciation expense also rose $47,000 from 2002's level, as the Corporation recorded depreciation on building renovation costs that have taken place in several locations. Total energy costs increased $44,000, primarily due to higher utility rates in several locations, as well as the initial expenses associated with the Williamsport facility during the latter portion of 2003. Furniture and equipment expense decreased $160,000, or 10.4%, in 2003 compared to 2002. The largest decrease within this category was in depreciation expense, which decreased $182,000 or 19.9%. There were several substantial capital expenditures, which became fully depreciated in 2002, reducing the expense for 2003. In total, other expense increased $122,000, or 2.4%, in 2003 over 2002. This category includes many different types of expenses. The most significant changes within this category are as follows: - Bank professional fees increased $94,000, to $371,000. Included in this category was approximately $80,000 in expenses for a consulting firm that has assisted with the core banking software evaluation and search. - 17 - - Telephone - data line expenses increased $68,000, to $325,000. These expenses increased due to upgrades of several lines. - Marketing research expenses increased $54,000, to $68,000. In 2003, increased expenses were incurred for demographic and other marketing-related data. - Expenses of Bucktail Life Insurance Company decreased $230,000, to $105,000. In 2003, a lower amount of life insurance claims were incurred than in 2002. In addition to the direct effect of lower claims, the lower amount of claims also had the effect of lowering reserves for future claims. - Expenses related to maintaining other real estate properties decreased $50,000, to $33,000. TABLE V - COMPARISON OF NONINTEREST EXPENSE
(IN THOUSANDS) 2004 % CHANGE 2003 % CHANGE 2002 Salaries and wages $ 11,248 16.0 $ 9,696 3.0 $ 9,418 Pensions and other employee benefits 3,404 2.6 3,317 25.1 2,651 Occupancy expense, net 1,664 28.5 1,295 18.4 1,094 Furniture and equipment expense 1,805 31.6 1,372 (10.4) 1,532 Expenses related to credit card operation 414 7.5 385 35.1 285 Pennsylvania shares tax 846 6.8 792 7.9 734 Other operating expense 6,620 25.9 5,257 2.4 5,135 -------- ---- -------- -------- -------- Total Other Expense $ 26,001 17.6 $ 22,114 6.1 $ 20,849 ======== ==== ======== ======== ========
INCOME TAXES The "Earnings Overview" section of Management's Discussion and Analysis includes a discussion of the Corporation's income tax provision in 2004, 2003 and 2002. 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. That discussion provides useful information regarding changes in the Corporation's balance sheet over the 2-year period ended December 31, 2004, and is sufficient to explain the overall change in the year-end balances of deposits and borrowed funds in 2004 compared to 2003. Other significant balance sheet items - the allowance for loan losses and stockholders' equity - are discussed in separate sections of Management's Discussion and Analysis. Table VI shows the composition of the investment portfolio at December 31, 2004, 2003 and 2002. While the average balance of available-for-sale securities (at amortized cost, as shown in Table II) was slightly higher in 2004 than in 2003, the year-end balance (at fair value) fell to $475,085,000 at December 31, 2004 from $483,032,000 at December 31, 2003. Overall, management's decision to maintain a securities portfolio that was approximately flat in size was attributable to 2 primary factors: (1) substantial loan growth, and (2) the need to manage interest rate risk within acceptable parameters. The overall lack of growth in the securities portfolio continued a trend begun in 2003, as the available-for-sale securities balance fell to $483,032,000 at December 31, 2003 from $512,175,000 at December 31, 2002. The Corporation's liquidity position is discussed in a separate section of Management's Discussion and Analysis, and interest rate risk is discussed in more detail in Section 7A. As described in the Net Interest Margin section of Management's Discussion and Analysis, loans outstanding grew substantially in both 2004 and 2003. In fact, as reflected in Table VII, the year-end balance of loans, net of the allowance for loan losses, has grown more than 10% compared to the previous year-end, for each of the last 4 years. Table VIII - 18 - presents a table of loan maturities. Fixed rate loans are included in Table VIII based on their contractually scheduled principal repayments, while variable rate loans are included based on contractual principal repayments, with the remaining balance reflected in the Table as of the date of the next change in rate. Table VIII shows that the majority ($396,299,000 or 68%) of the loan portfolio is fixed rate, including $225,575,000 or 39% fixed rate beyond 5 years. This substantial investment in long-term, fixed rate loans is one of the major concerns management attempts to address through interest rate risk management practices. See Section 7A for a more detailed discussion of the Corporation's interest rate risk. Premises and equipment, net of accumulated depreciation, increased to $16,725,000 at December 31, 2004 from $12,482,000 at December 31, 2003. The total cost of premises and equipment purchases was $5,830,000 in 2004, $3,360,000 in 2003 and $1,712,000 in 2002. In 2004, capital purchases for Management Information System purposes totaled $2,624,000, including the new core banking software, as well as related software, network servers and other equipment. Also in 2004, the Corporation completed the renovation of the Williamsport facility, and opened the branch in early June (Trust and Commercial Lending staff moved in a few months prior to the opening of the branch). Total cost allocated to the Williamsport land and building amounted to $2,428,000, of which approximately $1,800,000 was incurred in 2003 with the remainder in 2004. Capital purchases for furniture and equipment for operations in the Williamsport facility amounted to $461,000 in 2004. Other significant capital purchases in 2004 included land and excavation costs related to a planned new administrative building in Wellsboro, several new and replacement ATMs and related equipment, remodeling and equipment for the new South Williamsport location and renovations in the Athens branch. In 2003, the most significant projects included remodeling and addition to the Sayre facility, remodeling of the Elkland facility, and purchases of an additional 80 thin client computer stations for teller lines throughout the branch network. In 2002, the most significant capital projects included renovations to the Tioga and Athens offices, and completion of renovations to a leased facility in Wellsboro. Other major categories of capital purchases in 2002 included purchases of computer hardware and software, and purchase and demolition of property adjacent to the Wysox office. Depreciation expense increased to $1,587,000 in 2004, from $1,211,000 in 2003 and $1,346,000 in 2002. Total capital purchases for 2005 are estimated to range from $6 million to $8.5 million. More information concerning anticipated capital projects in 2005 is provided in the "Outlook for 2005" section of Management's Discussion and Analysis. In light of the Corporation's strong capital position and ample sources of liquidity, management does not expect capital expenditures to have a material, detrimental effect on the Corporation's financial condition or results of operations in 2005. TABLE VI - INVESTMENT SECURITIES
AS OF DECEMBER 31, 2004 2003 2002 AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE COST VALUE AVAILABLE-FOR-SALE SECURITIES: Obligations of the U.S. Treasury $ - $ - $ - $ - $ - $ - Obligations of other U.S. Government agencies 37,009 36,312 61,437 61,070 71,657 72,348 Obligations of states and political subdivisions 125,809 129,370 159,128 162,418 127,690 130,879 Other securities 100,871 103,107 45,992 47,648 62,296 63,592 Mortgage-backed securities 169,046 168,033 168,285 169,208 207,244 212,276 --------- ---------- --------- ---------- ----------- ---------- Total debt securities 432,735 436,822 434,842 440,344 468,887 479,095 Marketable equity securities 26,388 38,263 29,951 42,688 24,886 33,080 --------- ---------- --------- ---------- ----------- ---------- Total $ 459,123 $ 475,085 $ 464,793 $ 483,032 $ 493,773 $ 512,175 ========= ========== ========= ========== =========== ========== HELD-TO-MATURITY SECURITIES: Obligations of the U.S. Treasury $ 316 $ 339 $ 319 $ 349 $ 321 $ 359 Obligations of other U.S. Government agencies 98 112 199 216 297 322 Mortgage-backed securities 19 20 42 44 89 93 --------- ---------- --------- ---------- ----------- ---------- Total $ 433 $ 471 $ 560 $ 609 $ 707 $ 774 ========= ========== ========= ========== =========== ==========
- 19 - TABLE VII - FIVE-YEAR SUMMARY OF LOANS BY TYPE
(IN THOUSANDS) 2004 % 2003 % 2002 % 2001 % 2000 % Real estate - construction $ 4,178 0.72 $ 2,856 0.54 $ 103 0.02 $ 1,814 0.48 $ 452 0.14 Real estate - residential mortgage 347,705 59.98 330,807 63.03 292,136 64.76 245,997 64.87 207,100 63.08 Real estate - commercial mortgage 128,073 22.10 100,240 19.10 78,317 17.36 60,267 15.89 56,225 17.13 Consumer 31,702 5.47 33,977 6.47 31,532 6.99 29,284 7.72 28,141 8.57 Agricultural 2,872 0.50 2,948 0.56 3,024 0.67 2,344 0.62 1,983 0.60 Commercial 43,566 7.52 34,967 6.66 30,874 6.84 24,696 6.51 20,776 6.33 Other 1,804 0.31 1,183 0.23 2,001 0.44 1,195 0.32 948 0.29 Political subdivisions 19,713 3.40 17,854 3.40 13,062 2.90 13,479 3.55 12,462 3.80 Lease receivables - 0.00 65 0.01 96 0.02 152 0.04 218 0.07 -------- ------ -------- ------ -------- ------ --------- ------ --------- ------ Total 579,613 100.00 524,897 100.00 451,145 100.00 379,228 100.00 328,305 100.00 Less: unearned discount - - - - - -------- -------- -------- --------- --------- 579,613 524,897 451,145 379,228 328,305 Less: allowance for loan losses (6,787) (6,097) (5,789) (5,265) (5,291) -------- -------- -------- --------- --------- Loans, net $572,826 $518,800 $445,356 $ 373,963 $ 323,014 ======== ======== ======== ========= =========
TABLE VIII - LOAN MATURITY DISTRIBUTION
AS OF DECEMBER 31, 2004 VARIABLE OR ADJUSTABLE FIXED RATE LOANS: RATE LOANS: 1 YEAR OR 1 YEAR OR (IN THOUSANDS) LESS 1-5 YEARS > 5 YEARS TOTAL LESS 1-5 YEARS > 5 YEARS TOTAL Real estate $ 25,132 $ 73,322 $ 180,983 $ 279,437 $ 29,210 $ 62,595 $ 10,887 $ 102,692 Commercial 13,384 34,650 39,454 87,488 69,178 605 386 70,169 Consumer 9,947 14,289 5,138 29,374 10,453 - - 10,453 -------- --------- --------- --------- --------- -------- -------- --------- Total $ 48,463 $ 122,261 $ 225,575 $ 396,299 $ 108,841 $ 63,200 $ 11,273 $ 183,314 ======== ========= ========= ========= ========= ======== ======== =========
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 provision for loan losses. This assessment is conducted under the direction of the Bank's Chief Financial Officer and Executive Vice President in charge of Commercial Lending, with input from the Bank's Credit Administration Department, other Branch and Lending Staff, and the President. The assessment process includes review of 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. One of the key aspects of the quarterly assessment is the evaluation of each Watch List relationship with an outstanding balance of $200,000 or more. This evaluation includes an updated assessment of collection activities and planning for each such relationship, as well as evaluation of the Bank's probable loss (if any). - 20 - The Bank also engages a consulting firm each year to perform an independent credit review. Their review is performed annually on credit relationships of $250,000 and higher as well as other selected credit relationships. Management gives substantial consideration to the classifications and recommendations of the independent credit reviewer in determining the allowance for loan losses. 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 (Watch List) loans and historical loss experience, as modified for identified trends and concerns, for each loan category. The historical loan loss experience element is determined based on the ratio of net charge-offs to average loan balances over a five-year period, for each significant type of loan, modified for risk adjustment factors identified by management for each type of loan. The charge-off ratio, as modified, is then applied to the current outstanding loan balance for each type of loan (net of Watch List 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 management's knowledge of specific losses within the portfolio may be incomplete. As indicated in Table XI, total impaired loans amounted to $8,261,000 at December 31 2004. This amount of impaired loans is higher than the December 31, 2003 amount of $4,621,000. Table XI also shows that the amount of loans classified as nonaccrual increased to $7,796,000 at December 31, 2004 from $1,145,000 at December 31, 2003. These fluctuations resulted mainly from certain large commercial loan relationships, including one commercial loan relationship with total outstanding loan balances of approximately $3.7 million as of December 31, 2004. In 2004, management moved most of the loans outstanding related to this large relationship, as well as certain other commercial loans, into nonaccrual status. As of December 31, 2004, management has established a valuation allowance of $173,000 related to this large relationship. In total, the valuation allowance related to impaired loans decreased to $1,378,000 at December 31, 2004, from $1,542,000 at December 31, 2003. Management believes it has been conservative in its decisions concerning identification of impaired loans, estimates of loss and nonaccrual status. However, the actual losses realized from these relationships could vary materially from the allowances calculated as of December 31, 2004. Management continues to closely monitor these commercial loan relationships, and will adjust its estimates of loss and decisions concerning nonaccrual status, if appropriate. The allowance for loan losses was $6,787,000 at December 31, 2004, an increase of $690,000 from the balance at December 31, 2003. As reflected in Table X, the increase in the allowance included an increase in the unallocated portion to $2,578,000 at December 31, 2004 from $2,117,000 at December 31, 2003. Management's decision to increase the unallocated allowance in 2004 resulted primarily from concerns stemming from the increase in impaired loans in 2004, as discussed above. Table IX shows that gross charge-offs totaled $786,000, and net charge-offs totaled $710,000, in 2004. These amounts were lower than the corresponding totals for 2003 of $968,000 (gross charge-offs) and $792,000 (net charge-offs). The provision for loan losses amounted to $1,400,000 in 2004, $1,100,000 in 2003 and $940,000 in 2002. 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 IX through XII present historical data related to the allowance for loan losses. - 21 - TABLE IX - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
YEARS ENDED DECEMBER 31, (IN THOUSANDS) 2004 2003 2002 2001 2000 -------- -------- -------- -------- -------- Balance, beginning of year $ 6,097 $ 5,789 $ 5,265 $ 5,291 $ 5,131 -------- -------- -------- -------- -------- Charge-offs: Real estate loans 375 168 123 144 272 Installment loans 217 326 116 138 77 Credit cards and related plans 178 171 190 200 214 Commercial and other loans 16 303 123 231 53 -------- -------- -------- -------- -------- Total charge-offs 786 968 552 713 616 -------- -------- -------- -------- -------- Recoveries: Real estate loans 3 75 30 6 26 Installment loans 32 52 30 27 23 Credit cards and related plans 23 17 18 20 28 Commercial and other loans 18 32 58 34 23 -------- -------- -------- -------- -------- Total recoveries 76 176 136 87 100 -------- -------- -------- -------- -------- Net charge-offs 710 792 416 626 516 Provision for loan losses 1,400 1,100 940 600 676 -------- -------- -------- -------- -------- Balance, end of year $ 6,787 $ 6,097 $ 5,789 $ 5,265 $ 5,291 ======== ======== ======== ======== ========
TABLE X - ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES BY TYPE
(IN THOUSANDS) 2004 2003 2002 2001 2000 Commercial $ 1,909 $ 1,578 $ 1,315 $ 1,837 $ 1,612 Consumer 404 378 494 409 471 Consumer mortgage 456 460 674 513 952 Impaired loans 1,378 1,542 1,877 73 273 Unallocated 2,578 2,117 1,759 2,187 1,983 ------- ------- ------- ------- ------- Total Allowance $ 6,787 $ 6,097 $ 5,789 $ 5,265 $ 5,291 ======= ======= ======= ======= =======
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. TABLE XI - PAST DUE AND IMPAIRED LOANS
(IN THOUSANDS) 2004 2003 2002 Impaired loans without a valuation allowance $ 3,552 $ 114 $ 675 Impaired loans with a valuation allowance 4,709 4,507 3,039 ------- ------- ------- Total impaired loans $ 8,261 $ 4,621 $ 3,714 ======= ======= ======= Valuation allowance related to impaired loans $ 1,378 $ 1,542 $ 1,877 Total nonaccrual loans $ 7,796 $ 1,145 $ 1,252 Total loans past due 90 days or more and still accruing $ 1,307 $ 2,546 $ 2,318
- 22 - TABLE XII - FIVE-YEAR HISTORY OF LOAN LOSSES (IN THOUSANDS)
2004 2003 2002 2001 2000 AVERAGE Average gross loans $ 551,352 $ 485,150 $ 410,670 $ 346,353 $ 318,382 $ 422,381 Year-end gross loans 579,613 524,897 451,145 379,228 328,305 452,638 Year-end allowance for loan losses 6,787 6,097 5,789 5,265 5,291 5,846 Year-end nonaccrual loans 7,796 1,145 1,252 1,050 1,608 2,570 Year-end loans 90 days or more past due and still accruing 1,307 2,546 2,318 2,067 1,221 1,892 Net charge-offs 710 792 416 626 516 612 Provision for loan losses 1,400 1,100 940 600 676 943 Earnings coverage of charge-offs 20.9 20.5 36.0 19.3 16.4 21.8 Allowance coverage of charge-offs 9.6 7.7 13.9 8.4 10.3 9.6 Net charge-offs as a % of provision for loan losses 50.71% 72.00% 44.26% 104.33% 76.33% 64.90% Net charge-offs as a % of average gross loans 0.13% 0.16% 0.10% 0.18% 0.16% 0.14%
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS Table XIII presents the Corporation's significant fixed and determinable contractual obligations as of December 31, 2004, by payment date. The payment amounts represent the principal amounts of time deposits and borrowings, and do not include interest. Operating leases and software maintenance commitments are presented at the amounts due to the recipients, and are not discounted to present value. TABLE XIII - CONTRACTUAL OBLIGATIONS
(IN THOUSANDS) 1 YEAR 1-3 3-5 OVER 5 CONTRACTUAL OBLIGATIONS OR LESS YEARS YEARS YEARS TOTAL - --------------------------- --------- --------- -------- --------- -------- Time deposits $ 168,450 $ 104,024 $ 26,404 $ 1 $298,879 Short-term borrowings: Federal Home Loan Bank of Pittsburgh 8,000 - - - 8,000 Repurchase agreements 5,000 - - - 5,000 Long-term borrowings: Federal Home Loan Bank of Pittsburgh 40,000 124,767 25,884 17,790 208,441 Repurchase agreements 15,666 34,720 12,000 - 62,386 Operating leases 94 106 33 - 233 Software maintenance 360 720 660 - 1,740 --------- --------- -------- -------- -------- Total $ 237,570 $ 264,337 $ 64,981 $ 17,791 $584,679 ========= ========= ======== ======== ========
In addition to the amounts described in Table XIII, the Corporation has obligations related to deposits without a stated maturity with outstanding principal balances totaling $377,666,000 at December 31, 2004. The Corporation also has obligations related to overnight customer repurchase agreements with principal balances totaling $21,178,000 at December 31, 2004. As described more fully in Note 16 to the consolidated financial statements, the Corporation has a contingent obligation to pay additional licensing fees, based on the Bank's asset size, through October 2009. The Corporation's significant off-balance sheet arrangements consist of commitments to extend credit and standby letters of credit. Off-balance sheet arrangements are described in Note 15 to the consolidated financial statements. - 23 - LIQUIDITY Liquidity is the ability to quickly raise cash at a reasonable cost. An adequate liquidity position permits the Corporation to pay creditors, compensate for unforeseen deposit fluctuations and fund unexpected loan demand. The Corporation maintains overnight borrowing facilities with several correspondent banks that provide a source of day-to-day liquidity. Also, the Corporation maintains borrowing facilities with FHLB - Pittsburgh, secured by various securities and mortgage loans. At December 31, 2004, the Corporation had unused borrowing availability with correspondent banks and FHLB - Pittsburgh totaling approximately $154,000,000. 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. Historically, one of the tools used to monitor a bank's longer-term liquidity situation has been the loan-to-deposit ratio. As of December 31, 2004, this ratio was 85%, which is an average ratio by banking industry standards, but much higher than the Corporation's position has been in many years. The higher than historical level of loans-to-deposits reflects the Corporation's very strong loan growth over the past few years. The loan-to-deposit ratio was 79% at December 31, 2003, 70% at December 31, 2002 and 65% at December 31, 2001. Management believes the current, higher loan-to-deposit ratio is an indicator that some of the Corporation's historical liquidity "cushion" has been reduced; however, the current position continues to provide sufficient funds for maintenance of a substantial investment securities portfolio. If required to raise cash in an emergency situation, the Corporation could sell non-pledged investment securities to meet its obligations. At December 31, 2004, the carrying value of non-pledged securities was $289,063,000. Management believes the combination of its strong capital position (discussed in the next section), ample available borrowing facilities and moderate-to-low loan to deposit ratio have placed the Corporation in a position of minimal short-term and long-term liquidity risk. STOCKHOLDERS' EQUITY AND CAPITAL ADEQUACY The Corporation and the 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 18 to the consolidated financial statements. As reflected in Note 18, at December 31, 2004 and 2003, 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 regulatory capital requirements. 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. 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 was $13,361,000 in 2004, $16,148,000 in 2003 and $21,821,000 in 2002. Other comprehensive income (loss) amounted to ($1,502,000) in 2004, ($109,000) in 2003 and $6,862,000 in 2002. INFLATION Over the last several years, direct inflationary pressures on the Corporation's payroll-related and other noninterest costs have been modest. 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 pressures, in managing interest rate and other financial risks. - 24 - RECENT ACCOUNTING PRONOUNCEMENTS In April 2003, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS 133. The amendments set forth in SFAS 149 require that contracts with comparable characteristics be accounted for similarly. In particular, this statement clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative as discussed in SFAS 133. In addition, it clarifies when a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS 149 amends certain other existing pronouncements. Those changes will result in more consistent reporting of contracts that are derivatives in their entirety or that contain embedded derivatives that warrant separate accounting. This statement was effective for contracts entered into or modified after June 30, 2003, with certain exceptions. The adoption of this statement did not have an effect on the Corporation's earnings, financial condition or equity. In May 2003, the FASB issued SFAS 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement establishes how an issuer classifies financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify these financial instruments as a liability (or, in certain circumstances, an asset). Previously, these financial instruments would have been classified entirely as equity, or between the liabilities and equity section of the balance sheet. This statement also addresses questions about the classification of certain financial instruments that embody obligations to issue equity shares. The provisions of this statement were effective for interim periods beginning after June 15, 2003. The adoption of this statement did not have an effect on the Corporation's earnings, financial condition or equity. In January 2003, the FASB issued Interpretation 46, "Consolidation of Variable Interest Entities." The FASB then revised Interpretation 46 in December 2003. Interpretation 46, as revised, is intended to expand upon and strengthen existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity. Prior to this interpretation, as revised, one company generally has included another entity in its consolidated financial statements only if it controlled the entity through voting interests. This interpretation, as revised, changes that by requiring a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns or both. Certain of the requirements of this interpretation, as revised, were effective in 2003, while other requirements became effective in 2004. The adoption of the interpretation, as revised, did not have an effect on the Corporation's earnings, financial condition or equity. In March 2004, the FASB issued Emerging Issues Task Force (EITF) Issue 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. This statement provides guidance for evaluating whether an investment is other-than-temporarily impaired and was effective for the other-than-temporary impairment evaluations made in the reporting periods beginning after June 15, 2004. The FASB staff has issued a proposed Board-directed FASB Staff Position, FSP EITF Issue 03-1-a, Implementation Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1. The proposed FSP would provide implementation guidance with respect to debt securities that are impaired solely due to interest rates and/or sector spreads and analyzed for other-than-temporary impairment under paragraph 16 of Issue 03-1. In September 2004, based on comment letters received by constituents, the Board decided to further consider whether application guidance is necessary for all securities analyzed for impairment under paragraphs 10-20 of Issue 03-1. The delay did not include the disclosure provisions, which will remain in effect until the full reconsideration of Issue 03-01 guidance is completed. The Corporation will delay the effective application until the implementation guidance is finalized. In December 2004, the FASB issued SFAS 123R, which replaces SFAS 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion 25, Accounting for Stock Issued to Employees. SFAS 123R will require the Corporation to record stock option expense based on estimated fair value determined using an option valuation model. SFAS 123R applies to new awards granted, and to modifications of existing awards, on or after July 1, 2005. - 25 - ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK The Corporation's two major categories of market risk, interest rate risk and equity securities risk, are discussed in the following sections. INTEREST RATE RISK Business risk arising from changes in interest rates is 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 other assets and liabilities, such as premises and equipment and accrued expenses. The model measures and projects potential changes in net interest income, and calculates the discounted present value of anticipated cash flows of financial instruments, assuming an immediate increase or decrease in interest rates. Management ordinarily runs a variety of scenarios within a range of plus or minus 50-300 basis points of current rates. The Bank's Board of Directors has established policy guidelines for acceptable levels of interest rate risk, based on an immediate increase or decrease in interest rates. In September 2004, the Bank's policy was expanded to provide policy limits at +/- 100, 200 and 300 basis points from current rates (the prior policy included limits based on +/- 200 basis points change from current rates). The new policy limits for fluctuations in net interest income are tiered from the baseline one-year scenario. The new policy limits for market value variances are also tiered from the baseline values based on current rates. The most sensitive scenario presented in Table XIV presented below is the "+300 basis points" scenario. As the table shows, as of December 31, 2004, if interest rates were to immediately rise 300 basis points, the Bank's calculations based on the model show that although the change in net interest income is within the policy threshold, the market value of portfolio equity would decrease 49.2%, which exceeds the policy limit of 45%. Management will continue to evaluate whether to make any changes to asset or liability holdings in an effort to reduce exposure to decline in market value or net interest income in a rising interest rate environment. 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. - 26 - TABLE XIV - THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES DECEMBER 31, 2004 DATA (IN THOUSANDS)
PERIOD ENDING DECEMBER 31, 2005 INTEREST INTEREST NET INTEREST NII NII BASIS POINT CHANGE IN RATES INCOME EXPENSE INCOME (NII) % CHANGE RISK LIMIT +300 62,724 34,583 28,141 -16.8% 20.0% +200 61,066 30,840 30,226 -10.7% 15.0% +100 59,327 27,098 32,229 -4.7% 10.0% 0 57,343 23,510 33,833 0.0% 0.0% -100 54,581 20,676 33,905 0.2% 10.0% -200 51,800 17,924 33,876 0.1% 15.0% -300 49,090 16,850 32,240 -4.7% 20.0%
MARKET VALUE OF PORTFOLIO EQUITY AT DECEMBER 31, 2004
PRESENT PRESENT PRESENT VALUE VALUE VALUE BASIS POINT CHANGE IN RATES EQUITY % CHANGE RISK LIMIT +300 71,244 -49.2% 45.0% +200 94,088 -32.9% 35.0% +100 117,491 -16.2% 25.0% 0 140,168 0.0% 0.0% -100 153,026 9.2% 25.0% -200 162,400 15.9% 35.0% -300 171,463 22.3% 45.0%
PERIOD ENDING DECEMBER 31, 2004 DECEMBER 31, 2003 DATA (IN THOUSANDS)
INTEREST INTEREST NET INTEREST NII NII BASIS POINT CHANGE IN RATES INCOME EXPENSE INCOME (NII) % CHANGE RISK LIMIT +300 60,287 29,227 31,060 -7.1% 20.0% +200 58,319 26,047 32,272 -3.5% 15.0% +100 56,293 23,003 33,290 -0.5% 10.0% 0 54,126 20,676 33,450 0.0% 0.0% -100 50,844 18,349 32,495 -2.9% 10.0% -200 48,386 16,343 32,043 -4.2% 15.0% -300 46,232 15,645 30,587 -8.6% 20.0%
MARKET VALUE OF PORTFOLIO EQUITY AT DECEMBER 31,2003
PRESENT PRESENT PRESENT VALUE VALUE VALUE BASIS POINT CHANGE IN RATES EQUITY % CHANGE RISK LIMIT +300 59,637 -51.7% 45.0% +200 79,649 -35.5% 35.0% +100 101,318 -18.0% 25.0% 0 123,499 0.0% 0.0% -100 138,591 12.2% 25.0% -200 152,462 23.5% 35.0% -300 171,534 38.9% 45.0%
- 27 - EQUITY SECURITIES RISK The Corporation's equity securities portfolio consists primarily of investments in stocks of banks and bank holding companies, mainly based in Pennsylvania. The Corporation also owns some other stocks and mutual funds. Included in "Other equity securities" in the table that follows are preferred stocks issued by U.S. Government agencies with a fair value of $6,130,000 at December 31, 2004 and $11,347,000 at December 31, 2003. 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, 2004 and 2003 are as follows:
HYPOTHETICAL HYPOTHETICAL 10% 20% DECLINE IN DECLINE IN (IN THOUSANDS) FAIR MARKET MARKET AT DECEMBER 31, 2004 COST VALUE VALUE VALUE Banks and bank holding companies $ 17,426 $ 29,880 $ (2,988) $ (5,976) Other equity securities 8,962 8,383 (838) (1,677) -------- -------- ----------- ------------ Total $ 26,388 $ 38,263 $ (3,826) $ (7,653) ======== ======== =========== ============
HYPOTHETICAL HYPOTHETICAL 10% 20% DECLINE IN DECLINE IN (IN THOUSANDS) FAIR MARKET MARKET AT DECEMBER 31, 2003 COST VALUE VALUE VALUE Banks and bank holding companies $ 16,375 $ 29,288 $ (2,929) $ (5,858) Other equity securities 13,576 13,400 (1,340) (2,680) -------- -------- ----------- ------------ Total $ 29,951 $ 42,688 $ (4,269) $ (8,538) ======== ======== =========== ============
- 28 - ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED BALANCE SHEET DECEMBER 31, DECEMBER 31, (In Thousands Except Share Data) 2004 2003 ASSETS Cash and due from banks: Noninterest-bearing $ 14,845 $ 13,938 Interest-bearing 4,108 1,233 ------------ ------------ Total cash and cash equivalents 18,953 15,171 Available-for-sale securities 475,085 483,032 Held-to-maturity securities 433 560 Loans, net 572,826 518,800 Bank-owned life insurance 18,083 17,473 Accrued interest receivable 5,094 5,632 Bank premises and equipment, net 16,725 12,482 Foreclosed assets held for sale 497 101 Other assets 15,306 13,650 ------------ ------------ TOTAL ASSETS $ 1,123,002 $ 1,066,901 ============ ============ LIABILITIES Deposits: Noninterest-bearing $ 80,378 $ 75,616 Interest-bearing 596,167 582,449 ------------ ------------ Total deposits 676,545 658,065 Dividends payable 1,864 1,763 Short-term borrowings 34,178 37,763 Long-term borrowings 270,827 235,190 Accrued interest and other liabilities 8,003 8,777 ------------ ------------ TOTAL LIABILITIES 991,417 941,558 ------------ ------------ STOCKHOLDERS' EQUITY Common stock, par value $1.00 per share; authorized 20,000,000 shares in 2004 and 10,000,000 shares in 2003; issued 8,307,305 in 2004 and 8,226,033 in 2003 8,307 8,226 Stock dividend distributable 2,188 2,164 Paid-in capital 22,456 20,104 Retained earnings 90,484 84,940 ------------ ------------ Total 123,435 115,434 Accumulated other comprehensive income 10,535 12,037 Unamortized stock compensation (46) (54) Treasury stock, at cost: 204,659 shares at December 31, 2004 (2,339) 211,408 shares at December 31, 2003 (2,074) ------------ ------------ TOTAL STOCKHOLDERS' EQUITY 131,585 125,343 ------------ ------------ TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $ 1,123,002 $ 1,066,901 ============ ===========
The accompanying notes are an integral part of the consolidated financial statements. - 29 - CONSOLIDATED STATEMENT OF INCOME (IN THOUSANDS EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31, 2004 2003 2002 INTEREST INCOME Interest and fees on loans $ 34,251 $ 32,235 $ 30,641 Interest on balances with depository institutions 11 10 17 Interest on loans to political subdivisions 952 781 587 Interest on federal funds sold 10 8 42 Income from available-for-sale and held-to-maturity securities: Taxable 13,999 13,686 19,051 Tax-exempt 7,256 7,335 5,799 Dividends 1,443 1,168 1,148 -------- -------- -------- Total interest and dividend income 57,922 55,223 57,285 -------- -------- -------- INTEREST EXPENSE Interest on deposits 12,545 14,561 17,215 Interest on short-term borrowings 542 487 916 Interest on long-term borrowings 9,519 8,489 8,184 -------- -------- -------- Total interest expense 22,606 23,537 26,315 -------- -------- -------- Interest margin 35,316 31,686 30,970 Provision for loan losses 1,400 1,100 940 -------- -------- -------- Interest margin after provision for loan losses 33,916 30,586 30,030 -------- -------- -------- OTHER INCOME Service charges on deposit accounts 1,717 1,746 1,725 Service charges and fees 308 287 258 Trust and financial management revenue 2,105 1,733 1,755 Insurance commissions, fees and premiums 439 391 577 Increase in cash surrender value of life insurance 610 715 853 Fees related to credit card operation 773 784 631 Other operating income 970 939 825 -------- -------- -------- Total other income before realized gains on securities, net 6,922 6,595 6,624 Realized gains on securities, net 2,877 4,799 2,888 -------- -------- -------- Total other income 9,799 11,394 9,512 -------- -------- -------- OTHER EXPENSES Salaries and wages 11,248 9,696 9,418 Pensions and other employee benefits 3,404 3,317 2,651 Occupancy expense, net 1,664 1,295 1,094 Furniture and equipment expense 1,805 1,372 1,532 Expenses related to credit card operation 414 385 285 Pennsylvania shares tax 846 792 734 Other operating expense 6,620 5,257 5,135 -------- -------- -------- Total other expenses 26,001 22,114 20,849 -------- -------- -------- Income before income tax provision 17,714 19,866 18,693 Income tax provision 2,851 3,609 3,734 -------- -------- -------- NET INCOME $ 14,863 $ 16,257 $ 14,959 ======== ======== ======== NET INCOME PER SHARE - BASIC $ 1.82 $ 1.99 $ 1.83 ======== ======== ======== NET INCOME PER SHARE - DILUTED $ 1.81 $ 1.98 $ 1.83 ======== ======== ========
The accompanying notes are an integral part of the consolidated financial statements -30- CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (IN THOUSANDS EXCEPT PER SHARE DATA)
STOCK ACCUM. OTHER UNAMORTIZED COMMON DIVIDEND PAID-IN RETAINED COMPREHENSIVE STOCK TREASURY STOCK DISTRIBUTABLE CAPITAL EARNINGS INCOME COMPENSATION STOCK TOTAL ------- ------------- -------- -------- ------------- ------------ -------- --------- BALANCE, DECEMBER 31, 2001 $ 5,378 $ 1,369 $ 19,758 $ 70,352 $ 5,284 $ (17) $ (1,937) $ 100,187 Comprehensive income: Net income 14,959 14,959 Unrealized gain on securities, net of reclassification adjustment and tax effects 6,862 6,862 ------------- --------- Total comprehensive income 21,821 --------- Cash dividends declared, $0.7733 per share (6,158) (6,158) Treasury stock purchased (239) (239) Amortization of restricted stock 80 80 Shares issued from treasury related to exercise of stock options 26 50 76 Tax benefit from employee benefit plan 70 70 Stock dividend issued 53 (1,369) 1,316 - Stock dividend declared, 1% 1,639 (1,639) - Restricted stock granted 55 (116) 61 - Forfeiture of restricted stock (2) 4 (2) - -------- ------------ -------- --------- BALANCE, DECEMBER 31, 2002 5,431 1,639 21,153 77,584 12,146 (49) (2,067) 115,837 Comprehensive income: Net income 16,257 16,257 Unrealized loss on securities, net of reclassification adjustment and tax effects (109) (109) ------------- --------- Total comprehensive income 16,148 --------- Cash dividends declared, $0.85 per share (6,821) (6,821) Treasury stock purchased (174) (174) Amortization of restricted stock 102 102 Shares issued from treasury related to exercise of stock options 78 119 197 Tax benefit from employee benefit plan 84 84 Stock dividend issued 53 (1,639) 1,556 (30) 3-for-2 stock split, April 2003 2,742 (2,742) - Stock dividend declared, 1% 2,164 (2,164) - Restricted stock granted 59 (107) 48 - -------- ------------ -------- --------- BALANCE, DECEMBER 31, 2003 8,226 2,164 20,104 84,940 12,037 (54) (2,074) 125,343 Comprehensive income: Net income 14,863 14,863 Unrealized loss on securities, net of reclassification adjustment and tax effects (1,502) (1,502) ------------- --------- Total comprehensive income 13,361 --------- Cash dividends declared, $.89 per share (7,214) (7,214) Treasury stock purchased (575) (575) Shares issued from treasury related to exercise of stock options 245 283 528 Amortization of restricted stock 85 85 Tax benefit from employee benefit plan 83 83 Stock dividend issued 81 (2,164) 2,057 (26) Stock dividend declared, 1% 2,188 (2,188) - Restricted stock granted 62 (99) 37 - Forfeiture of restricted stock (12) 22 (10) - -------- ------------ -------- --------- BALANCE, DECEMBER 31, 2004 $ 8,307 $ 2,188 $ 22,456 $ 90,484 $ 10,535 $ (46) $ (2,339) $ 131,585 ======= ============= ======== ======== ============= ============ ======== =========
The accompanying notes are an integral part of the consolidated financial statements. - 31 - CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS)
YEARS ENDED DECEMBER 31, 2004 2003 2002 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 14,863 $ 16,257 $ 14,959 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 1,400 1,100 940 Realized gains on securities, net (2,877) (4,799) (2,888) Gain on sale of foreclosed assets, net (9) (105) (39) Depreciation expense 1,587 1,211 1,346 Accretion and amortization, net 718 1,241 (376) Increase in cash surrender value of life insurance (610) (715) (853) Amortization of restricted stock 85 102 80 Deferred income taxes 96 (25) (284) (Increase) Decrease in accrued interest receivable and other assets (424) 487 (958) Increase (Decrease) in accrued interest payable and other liabilities 78 (164) 669 --------- --------- --------- Net Cash Provided by Operating Activities 14,907 14,590 12,596 --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturity of held-to-maturity securities 122 145 731 Proceeds from sales of available-for-sale securities 111,585 53,562 29,345 Proceeds from calls and maturities of available-for-sale securities 96,265 178,682 155,811 Purchase of available-for-sale securities (200,015) (199,705) (249,693) Purchase of Federal Home Loan Bank of Pittsburgh stock (3,299) (1,855) (3,943) Redemption of Federal Home Loan Bank of Pittsburgh stock 2,514 482 1,870 Net increase in loans (56,015) (74,824) (72,819) Purchase of premises and equipment (5,830) (3,360) (1,712) Proceeds from sale of foreclosed assets 202 340 648 --------- --------- --------- Net Cash Used in Investing Activities (54,471) (46,533) (139,762) --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposits 18,480 17,761 64,030 Net decrease in short-term borrowings (3,585) (5,872) (14,429) Proceeds from long-term borrowings 84,112 64,500 117,653 Repayments of long-term borrowings (48,475) (37,524) (35,023) Purchase of treasury stock (575) (174) (239) Sale of treasury stock 528 197 76 Dividends paid (7,139) (6,674) (6,038) --------- --------- --------- Net Cash Provided by Financing Activities 43,346 32,214 126,030 --------- --------- --------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 3,782 271 (1,136) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 15,171 14,900 16,036 --------- --------- --------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 18,953 $ 15,171 $ 14,900 ========= ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Assets acquired through foreclosure of real estate loans $ 589 $ 280 $ 486 Interest paid $ 22,070 $ 23,736 $ 26,424 Income taxes paid $ 2,999 $ 3,195 $ 4,509
The accompanying notes are an integral part of the consolidated financial statements. - 32 - 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. 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. The Corporation offers a variety of personal and commercial insurance products through C&N Financial Services Corporation. C&N Financial Services Corporation also has 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 accounting principles generally accepted in the United States of America 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 unrestricted equity securities. Such 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. 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. RESTRICTED EQUITY SECURITIES - Restricted equity securities consist primarily of Federal Home Loan Bank of Pittsburgh stock, and are carried at cost and evaluated for impairment. Holdings of restricted equity securities are included in Other Assets in the Consolidated Balance Sheet, and dividends received on restricted securities are included in Other Income in the Consolidated Statement of Income. 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. - 33 - 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, past due or delinquency status, trends in historical loss experience, specific impaired loans, and economic conditions. Past due or delinquency status of loans is computed based on the contractual terms of the loans. 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. Loan balances are charged off when it becomes evident that such balances are not fully collectible. 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. INTEREST COSTS - The Corporation capitalizes interest as a component of the cost of premises and equipment constructed or acquired for its own use. In 2004, total interest incurred was $22,649,000, of which $22,606,000 was charged to expense and $43,000 was capitalized. Total interest incurred amounted to $23,537,000 in 2003 and $26,315,000 in 2002, all of which was charged to expense. 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, alternate minimum tax, investments in limited partnerships and amortization of loan origination fees and costs. STOCK COMPENSATION PLANS - As permitted by Accounting Principles Board (APB) Opinion 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. 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 over the vesting period. The following table illustrates the effect on net income and earnings per share if the Corporation had applied the fair value provisions of Statement of Financial Accounting Standards (SFAS) 123, "Accounting for Stock-based Compensation," to stock options. - 34 -
(NET INCOME IN THOUSANDS) 2004 2003 2002 Net income, as reported $ 14,863 $ 16,257 $ 14,959 Deduct: Total stock option compensation expense determined under fair value method for all awards, net of tax effects (90) (124) (191) --------- -------- -------- Pro forma net income $ 14,773 $ 16,133 $ 14,768 ========= ======== ======== Earnings per share-basic As reported $ 1.82 $ 1.99 $ 1.83 Pro forma $ 1.80 $ 1.97 $ 1.81 Earnings per share-diluted As reported $ 1.81 $ 1.98 $ 1.83 Pro forma $ 1.79 $ 1.96 $ 1.80
In December 2004, the Financial Accounting Standards Board issued SFAS 123R, which replaces SFAS 123 and supersedes APB Opinion 25. SFAS 123R will require the Corporation to record stock option expense based on estimated fair value determined using an option valuation model. SFAS 123R applies to new awards granted, and to modifications of existing awards, on or after July 1, 2005. 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. 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) 2004 2003 2002 Unrealized holding gains on available-for-sale securities $ 600 $ 4,636 $ 13,283 Less: Reclassification adjustment for gains realized in income (2,877) (4,799) (2,888) -------- -------- -------- Net unrealized (losses) gains (2,277) (163) 10,395 Tax effect 775 54 (3,533) -------- -------- -------- Net-of-tax amount $ (1,502) $ (109) $ 6,862 ======== ======== ========
- 35 - 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 a 3-for-2 stock split issued in April 2003, as well as 1% 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 ------ ------ ----- 2004 Earnings per share - basic $ 14,863,000 8,185,466 $ 1.82 Dilutive effect of potential common stock arising from stock options: Exercise of outstanding stock options 188,514 Hypothetical share repurchase at $25.39 (139,988) ------------ --------- ----------- Earnings per share - diluted $ 14,863,000 8,233,992 $ 1.81 ============ ========= =========== 2003 Earnings per share - basic $ 16,257,000 8,170,651 $ 1.99 Dilutive effect of potential common stock arising from stock options: Exercise of outstanding stock options 195,624 Hypothetical share repurchase at $24.27 (146,909) ------------ --------- ----------- Earnings per share - diluted $ 16,257,000 8,219,366 $ 1.98 ============ ========= =========== 2002 Earnings per share - basic $ 14,959,000 8,170,159 $ 1.83 Dilutive effect of potential common stock arising from stock options: Exercise of outstanding stock options 139,374 Hypothetical share repurchase at $19.45 (117,486) ------------ --------- ----------- Earnings per share - diluted $ 14,959,000 8,192,047 $ 1.83 ============ ========= ===========
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 2004 ranged from $2,984,000 to $4,541,000. For 2003, theses balances ranged from $2,402,000 to $4,434,000. Average daily cash balances with the Federal Reserve Bank required for services provided to the Bank were $2,500,000 in 2004 and 2003. Total balances restricted amounted to $6,248,000 at December 31, 2004 and $6,324,000 at December 31, 2003. - 36 - 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, 2004 and 2003 are summarized as follows:
DECEMBER 31, 2004 GROSS GROSS UNREALIZED UNREALIZED AMORTIZED HOLDING HOLDING FAIR (IN THOUSANDS) COST GAINS LOSSES VALUE AVAILABLE-FOR-SALE SECURITIES: Obligations of the U.S. Treasury $ - $ - $ - $ - Obligations of other U.S. Government agencies 37,009 67 (764) 36,312 Obligations of states and political subdivisions 125,809 4,147 (586) 129,370 Other securities 100,871 2,675 (439) 103,107 Mortgage-backed securities 169,046 1,002 (2,015) 168,033 -------- ------- ------- -------- Total debt securities 432,735 7,891 (3,804) 436,822 Marketable equity securities 26,388 12,874 (999) 38,263 -------- ------- ------- -------- Total $459,123 $20,765 $(4,803) $475,085 ======== ======= ======= ======== HELD-TO-MATURITY SECURITIES: Obligations of the U.S. Treasury $ 316 $ 23 $ - $ 339 Obligations of other U.S. Government agencies 98 14 - 112 Mortgage-backed securities 19 1 - 20 -------- ------- ------- -------- Total $ 433 $ 38 $ - $ 471 ======== ======= ======= ========
DECEMBER 31, 2004 GROSS GROSS UNREALIZED UNREALIZED AMORTIZED HOLDING HOLDING FAIR (IN THOUSANDS) COST GAINS LOSSES VALUE AVAILABLE-FOR-SALE SECURITIES: Obligations of the U.S. Treasury $ - $ - $ - $ - Obligations of other U.S. Government agencies 61,437 562 (929) 61,070 Obligations of states and political subdivisions 159,128 4,791 (1,501) 162,418 Other securities 45,992 1,764 (108) 47,648 Mortgage-backed securities 168,285 1,933 (1,010) 169,208 -------- ------- ------- -------- Total debt securities 434,842 9,050 (3,548) 440,344 Marketable equity securities 29,951 13,609 (872) 42,688 -------- ------- ------- -------- Total $464,793 $22,659 $(4,420) $483,032 ======== ======= ======= ======== HELD-TO-MATURITY SECURITIES: Obligations of the U.S. Treasury $ 319 $ 30 $ - $ 349 Obligations of other U.S. Government agencies 199 17 - 216 Mortgage-backed securities 42 2 - 44 -------- ------- ------- -------- Total $ 560 $ 49 $ - $ 609 ======== ======= ======= ========
- 37 - The following table presents gross unrealized losses and fair value of investments aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2004:
(IN THOUSANDS) LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED VALUE LOSSES VALUE LOSSES VALUE LOSSES AVAILABLE-FOR-SALE SECURITIES: Obligations of the U.S. Treasury $ - $ - $ - $ - $ - $ - Obligations of other U.S. Government agencies 19,675 (325) 9,550 (439) 29,225 (764) Obligations of states and political subdivisions 15,497 (260) 12,265 (326) 27,762 (586) Other securities 41,837 (316) 4,975 (123) 46,812 (439) Mortgage-backed securities 94,435 (1,440) 25,646 (575) 120,081 (2,015) -------- ------- ------- ------- -------- ------- Total debt securities 171,444 (2,341) 52,436 (1,463) 223,880 (3,804) Marketable equity securities 1,366 (52) 4,958 (947) 6,324 (999) -------- ------- ------- ------- -------- ------- Total temporarily impaired available-for-sale securities $172,810 $(2,393) $57,394 $(2,410) $230,204 $(4,803) ======== ======= ======= ======= ======== ======= HELD-TO-MATURITY SECURITIES: Obligations of the U.S. Treasury $ - $ - $ - $ - $ - $ - Obligations of other U.S. Government agencies - - - - - - Mortgage-backed securities - - - - - - -------- ------- ------- ------- -------- ------- Total temporarily impaired held-to-maturity securities $ - $ - $ - $ - $ - $ - ======== ======= ======= ======= ======== =======
The unrealized losses on debt securities are primarily the result of volatility in interest rates. Based on the credit worthiness of the issuers, which are almost exclusively U.S. Government-sponsored agencies or state and political subdivisions, management believes the Corporation's debt securities at December 31, 2004 were not other-than-temporarily impaired. Of the total $999,000 unrealized losses on equity securities at December 31, 2004, $870,000 was from a preferred stock issued by an U.S. Government-sponsored agency. Management believes this security's fair value is affected primarily by volatility in interest rates, and although not guaranteed by the U.S. Government, that there is very little credit risk associated with this security. For the remaining equity securities for which fair value was less than cost at December 31, 2004, management believes the financial condition and near-term prospects of those issuers indicate those securities were not other-than-temporarily impaired. The amortized cost and fair value of investment debt securities at December 31, 2004 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 prepay obligations with or without prepayment penalties. - 38 - (IN THOUSANDS)
DECEMBER 31, 2004 ----------------------- AMORTIZED FAIR COST VALUE AVAILABLE-FOR-SALE SECURITIES: Due in one year or less $ 342 $ 348 Due after one year through five years 2,052 2,084 Due after five years through ten years 46,110 45,753 Due after ten years 384,231 388,637 -------- -------- Total $432,735 $436,822 ======== ======== HELD-TO-MATURITY SECURITIES: Due in one year or less $ - $ - Due after one year through five years 11 11 Due after five years through ten years 414 452 Due after ten years 8 8 -------- -------- Total $ 433 $ 471 ======== ========
The following table shows the amortized cost and maturity distribution of the debt securities portfolio at December 31, 2004: (IN THOUSANDS, EXCEPT FOR PERCENTAGES)
WITHIN ONE - FIVE - AFTER ONE FIVE TEN TEN YEAR YIELD YEARS YIELD YEARS YIELD YEARS YIELD TOTAL YIELD AVAILABLE-FOR-SALE SECURITIES: Obligations of the U.S. Treasury $ - - $ - - $ - - $ - - $ - - Obligations of other U.S. Government agencies - - - - 22,018 3.99% 14,991 5.19% 37,009 4.48% Obligations of states and political subdivisions 335 6.55% 2,040 5.15% 2,609 5.79% 120,825 4.76% 125,809 4.79% Other securities - - - - 13,177 4.99% 87,694 5.63% 100,871 5.55% Mortgage-backed securities 7 8.41% 12 8.50% 8,306 3.26% 160,721 4.54% 169,046 4.48% ----- ---- ------- ---- --------- ---- ---------- ---- -------- ---- Total $ 342 6.59% $ 2,052 5.17% $ 46,110 4.25% $ 384,231 4.88% $432,735 4.82% ===== ==== ======= ==== ========= ==== ========== ==== ======== ==== HELD-TO-MATURITY SECURITIES: Obligations of the U.S. Treasury $ - - $ - - $ 316 5.30% $ - - $ 316 5.30% Obligations of other U.S. Government agencies - - - 98 7.16% - - 98 7.16% Mortgage-backed securities - - 11 6.38% - - 8 5.12% 19 5.89% ----- ---- ------- ---- --------- ---- ---------- ---- -------- ---- Total $ - - $ 11 6.38% $ 414 5.74% $ 8 5.12% $ 433 5.75% ===== ==== ======= ==== ========= ==== ========== ==== ======== ====
Investment securities carried at $89,158,000 at December 31, 2004 and $80,308,000 at December 31, 2003, were pledged as collateral for public deposits, trusts and certain other deposits as provided by law. Also, see Note 9 for information concerning securities pledged to secure borrowing arrangements. Gross realized gains and losses from the sales of available-for-sale securities, and the income tax provision related to net realized gains, for 2004, 2003 and 2002 were as follows: (IN THOUSANDS)
2004 2003 2002 Gross realized gains $ 3,880 $ 4,860 $ 2,926 Gross realized losses (1,003) (61) (38) ------- ------- ------- Net realized gains $ 2,877 $ 4,799 $ 2,888 ======= ======= ======= Income tax provision related to net realized gains $ 978 $ 1,632 $ 982 ======= ======= =======
- 39 - 6. LOANS Major categories of loans and leases included in the loan portfolio are as follows:
DECEMBER 31, % OF DECEMBER 31, % OF (IN THOUSANDS) 2004 TOTAL 2003 TOTAL Real estate - construction $ 4,178 0.72% $ 2,856 0.54% Real estate - residential mortgage 347,705 59.99% 330,807 63.02% Real estate - commercial mortgage 128,073 22.09% 100,240 19.10% Consumer 31,702 5.47% 33,977 6.47% Agricultural 2,872 0.50% 2,948 0.56% Commercial 43,566 7.52% 34,967 6.66% Other 1,804 0.31% 1,183 0.23% Political subdivisions 19,713 3.40% 17,854 3.40% Lease receivables - 0.00% 65 0.01% --------- ------ --------- ------ Total 579,613 100.00% 524,897 100.00% Less: allowance for loan losses (6,787) (6,097) --------- --------- Loans, net $ 572,826 $ 518,800 ========= =========
Net unamortized loan fees and costs of $1,704,000 at December 31, 2004 and $1,629,000 at December 31, 2003 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, 2004. 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 its debtors' ability to honor their contracts is dependent on the local economic conditions within the region. Transactions in the allowance for loan losses were as follows:
(IN THOUSANDS) 2004 2003 2002 Balance at beginning of year $ 6,097 $ 5,789 $ 5,265 Provision charged to operations 1,400 1,100 940 Loans charged off (786) (968) (552) Recoveries 76 176 136 ------- ------- ------- Balance at end of year $ 6,787 $ 6,097 $ 5,789 ======= ======= =======
Information related to impaired and nonaccrual loans, and loans past due 90 days or more, as of December 31, 2004 and 2003 is as follows:
(IN THOUSANDS) 2004 2003 Impaired loans without a valuation allowance $ 3,552 $ 114 Impaired loans with a valuation allowance 4,709 4,507 ------- ------- Total impaired loans $ 8,261 $ 4,621 ======= ======= Valuation allowance related to impaired loans $ 1,378 $ 1,542 Total nonaccrual loans $ 7,796 $ 1,145 Total loans past due 90 days or more and still accruing $ 1,307 $ 2,546
- 40 - The following is a summary of information related to impaired loans for 2004, 2003 and 2002:
(IN THOUSANDS) 2004 2003 2002 Average investment in impaired loans $7,458 $3,425 $3,838 ====== ====== ====== Interest income recognized on impaired loans $ 352 $ 313 $ 247 ====== ====== ====== Interest income recognized on a cash basis on impaired loans $ 352 $ 313 $ 247 ====== ====== ======
No additional funds are committed to be advanced in connection with impaired loans. 7. BANK PREMISES AND EQUIPMENT Bank premises and equipment are summarized as follows:
DECEMBER 31, (IN THOUSANDS) 2004 2003 Land $ 1,449 $ 1,275 Buildings and improvements 15,734 13,125 Furniture and equipment 13,539 9,663 Construction in progress 874 1,807 -------- -------- Total 31,596 25,870 Less: accumulated depreciation (14,871) (13,388) -------- -------- Net $ 16,725 $ 12,482 ======== ========
Depreciation expense included in occupancy expense and furniture and equipment expense was as follows:
(IN THOUSANDS) 2004 2003 2002 Occupancy expense $ 572 $ 479 $ 432 Furniture and equipment expense 1,015 732 914 ------- ------- ------- Total $ 1,587 $ 1,211 $ 1,346 ======= ======= =======
8. DEPOSITS At December 31, 2004, the scheduled maturities of time deposits are as follows:
(IN THOUSANDS) 2005 $168,450 2006 75,742 2007 28,282 2008 15,024 2009 11,380 THEREAFTER 1 -------- $298,879 ========
- 41 - Included in interest-bearing deposits are time deposits in the amount of $100,000 or more. As of December 31, 2004, the remaining maturities or repricing frequency of time deposits of $100,000 or more are as follows:
(IN THOUSANDS) Three months or less $39,959 Over 3 months through 12 months 12,020 Over 1 year through 3 years 13,128 Over 3 years 7,546 ------- Total $72,653 =======
Interest expense from deposits of $100,000 or more amounted to $2,214,000 in 2004, $2,693,000 in 2003 and $3,238,000 in 2002. 9. BORROWED FUNDS SHORT-TERM BORROWINGS Short-term borrowings include the following:
AT DECEMBER 31, (IN THOUSANDS) 2004 2003 Overnight borrowings (a) $ - $ 6,900 Federal Home Loan Bank of Pittsburgh borrowings (b) 8,000 7,500 Customer repurchase agreements (c) 21,178 23,363 Other repurchase agreements (d) 5,000 - ------- ------- Total short-term borrowings $34,178 $37,763 ======= =======
The weighted average interest rate on total short-term borrowings outstanding was 1.72% at December 31, 2004 and 1.21% at December 31, 2003. The maximum amount of total short-term borrowings outstanding at any month-end was $55,278,000 in 2004 and $45,166,000 in 2003. (a) Overnight borrowings include federal funds purchased overnight from correspondent banks and overnight borrowings from the Federal Home Loan Bank of Pittsburgh (FHLB-Pittsburgh) on the "Open Repo Plus" facility. The maximum month-end amount of such borrowings was $17,100,000 in 2004, $16,950,000 in 2003 and $14,350,000 in 2002. The average amount of such borrowings was $6,258,000 in 2004, $6,044,000 in 2003 and $2,347,000 in 2002. Weighted average interest rates were 1.59% in 2004, 1.50% in 2003 and 1.86% in 2002. (b) Short-term FHLB - Pittsburgh loans are as follows:
AT DECEMBER 31, (IN THOUSANDS) 2004 2003 Fixed Rate 1.47% maturing February 23, 2005 $3,000 Fixed Rate 2.67% maturing March 17, 2005 5,000 Fixed Rate 1.33% maturing April 28, 2004 - $2,000 Fixed Rate 1.28% maturing May 13, 2004 - 2,500 Fixed Rate 1.25% maturing June 29, 2004 - 1,500 Fixed Rate 1.26% maturing July 28, 2004 - 1,500 ------ ------ Total short-term FHLB - Pittsburgh borrowings $8,000 $7,500 ====== ======
Collateral for FHLB - Pittsburgh loans is described under the "Long-term Borrowings" section of this note. - 42 - (c) Customer repurchase agreements mature overnight, and are collateralized by securities with a carrying value of $26,336,000 at December 31, 2004 and $35,680,000 at December 31, 2003. (d) Other repurchase agreements included in short-term borrowings are as follows:
AT DECEMBER 31, (IN THOUSANDS) 2004 2003 Fixed Rate 1.45% matures April 26, 2005 $ 5,000 $ - -------- --- Total other repurchase agreements $ 5,000 $ - ======== ===
The terms and collateral related to repurchase agreements are described under the "Long-term Borrowings" section of this note. LONG-TERM BORROWINGS Long-term borrowings are as follows:
AT DECEMBER 31, (IN THOUSANDS) 2004 2003 FHLB - Pittsburgh borrowings (e) $ 208,441 $ 185,037 Repurchase agreements (f) 62,386 50,153 --------- --------- Total long-term borrowings $ 270,827 $ 235,190 ========= =========
(e) Long-term borrowings from FHLB - Pittsburgh are as follows:
AT DECEMBER 31, (IN THOUSANDS) 2004 2003 Loans matured in 2004 with rates ranging from 2.16% to 4.65% $ - $ 28,000 Loans maturing in 2005 with rates ranging from 1.64% to 5.05% 40,000 40,000 Loans maturing in 2006 with rates ranging from 2.07% to 4.83% 50,700 40,000 Loans maturing in 2007 with rates ranging from 2.68% to 4.58% 74,067 45,000 Loans maturing in 2008 with rates ranging from 2.07% to 3.67% 19,500 14,500 Loans maturing in 2009 with rates ranging from 3.60% to 3.62% 6,384 2,000 Loan maturing in 2011 with a rate of 4.98% 5,000 5,000 Loan maturing in 2012 with a rate of 4.54% 10,000 10,000 Loan maturing in 2016 with a rate of 6.86% 453 476 Loan maturing in 2017 with a rate of 6.83% 58 61 Loan maturing in 2020 with a rate of 4.79% 2,279 - --------- --------- Total long-term FHLB - Pittsburgh borrowings $ 208,441 $ 185,037 ========= =========
The FHLB - Pittsburgh loan facilities are collateralized by qualifying securities and mortgage loans with a book value totaling $350,935,000 at December 31, 2004. Also, the FHLB - Pittsburgh loan facilities require the Corporation to invest in established amounts of FHLB - Pittsburgh stock. The carrying values of the Corporation's holdings of FHLB - Pittsburgh stock were $12,360,000 at December 31, 2004 and $11,575,000 at December 31, 2003. - 43 - (f) Repurchase agreements included in long-term borrowings are as follows:
AT DECEMBER 31, (IN THOUSANDS) 2004 2003 Agreements matured in 2004 with rates ranging from 1.62% to 3.96% $ - $19,767 Agreements maturing in 2005 with rates ranging from 2.01% to 4.63% 15,666 15,666 Agreements maturing in 2006 with rates ranging from 2.02% to 4.63% 20,220 10,220 Agreements maturing in 2007 with rates ranging from 2.53% to 3.23% 14,500 2,500 Agreements maturing in 2008 with rates ranging from 3.00% to 3.60% 12,000 2,000 ------- ------- Total long-term repurchase agreements $62,386 $50,153 ======= =======
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 $70,528,000 at December 31, 2004 and $58,086,000 at December 31, 2003. Average daily repurchase agreement borrowings amounted to $58,663,000 in 2004, $40,333,000 in 2003 and $36,482,000 in 2002. During 2004, 2003 and 2002, the maximum amounts of outstanding borrowings under repurchase agreements with broker-dealers were $67,386,000, $50,153,000 and $44,720,000. The weighted average interest rate on repurchase agreements was 3.20% in 2004, 3.68% in 2003 and 3.72% in 2002. 10. DERIVATIVE FINANCIAL INSTRUMENTS The Corporation utilizes derivative financial instruments related to a certificate of deposit product called the "Index Powered Certificate of Deposit" (IPCD). IPCDs have a term of 5 years, with interest paid at maturity based on 90% of the appreciation (as defined) in the S&P 500 index. There is no guaranteed interest payable to a depositor of an IPCD - however, assuming an IPCD is held to maturity, a depositor is guaranteed the return of his or her principal, at a minimum. 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 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 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 related to IPCDs are as follows (in thousands): - 44 -
AT DECEMBER 31, 2004 2003 Contractual amount of IPCDs (equal to notional amount of Swap contracts) $4,045 $3,593 Carrying value of IPCDs 3,695 3,160 Carrying value of embedded derivative liabilities 297 298 Carrying value of Swap contract liabilities 42 130
FOR THE YEARS ENDED DECEMBER 31, 2004 2003 2002 Interest expense $ 143 $ 112 $ 88 Other expense 9 10 8
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. SFAS 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. 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, 2004 and 2003. 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. - 45 - 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)
DECEMBER 31, 2004 DECEMBER 31, 2003 CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE Financial assets: Cash and cash equivalents $ 18,953 $ 18,953 $ 15,171 $ 15,171 Available-for-sale securities 475,085 475,085 483,032 483,032 Held-to-maturity securities 433 471 560 609 Restricted equity securities 12,360 12,360 11,575 11,575 Loans, net 572,826 578,720 518,800 524,407 Accrued interest receivable 5,094 5,094 5,632 5,632 Financial liabilities: Deposits 676,545 677,182 658,065 661,141 Short-term borrowings 34,178 34,133 37,763 37,762 Long-term borrowings 270,827 270,015 235,190 240,527 Accrued interest payable 1,639 1,639 1,105 1,105 Embedded derivative liabilities - IPCDs 297 297 298 298 Equity option Swap contracts - IPCDs 42 42 130 130
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, 2004 and 2003, and will not affect the Corporation's future expenses. The Corporation uses a December 31 measurement date for its plans. - 46 - The following tables show the funded status and amounts recognized in the consolidated balance sheet from these defined benefit plans: (IN THOUSANDS)
PENSION POSTRETIREMENT BENEFITS BENEFITS 2004 2003 2004 2003 CHANGE IN BENEFIT OBLIGATION: Benefit obligation at beginning of year $ 10,086 $ 8,769 $ 1,029 $ 886 Service cost 474 394 43 32 Interest cost 620 590 63 60 Plan participants' contributions - - 164 147 Actuarial loss (gain) 478 755 46 105 Benefits paid (463) (422) (216) (201) ---------- ---------- ---------- ---------- Benefit obligation at end of year $ 11,195 $ 10,086 $ 1,129 $ 1,029 ========== ========== ========== ========== CHANGE IN PLAN ASSETS: Fair value of plan assets at beginning of year $ 8,654 $ 7,668 $ - $ - Actual return on plan assets 794 1,013 - - Employer contribution 328 395 52 54 Plan participants' contributions - - 164 147 Benefits paid (463) (422) (216) (201) ---------- ---------- ---------- ---------- Fair value of plan assets at end of year $ 9,313 $ 8,654 $ - $ - ========== ========== ========== ========== Funded status $ (1,882) $ (1,432) $ (1,129) $ (1,029) Unrecognized net actuarial loss (gain) 2,364 1,997 105 61 Unrecognized transition (asset) obligation (137) (160) 292 328 ---------- ---------- ---------- ---------- Prepaid (accrued) benefit cost $ 345 $ 405 $ (732) $ (640) ========== ========== ========== ==========
The accumulated benefit obligation for the defined benefit pension plan was $8,380,000 at December 31, 2004 and $7,595,000 at December 31, 2003. The components of net periodic benefit costs from these defined benefit plans are as follows: (IN THOUSANDS)
PENSION BENEFITS POSTRETIREMENT BENEFITS 2004 2003 2002 2004 2003 2002 Service cost $ 474 $ 394 $ 349 $ 43 $ 32 $ 24 Interest cost 620 590 553 63 60 57 Expected return on plan assets (748) (615) (702) - - - Amortization of transition (asset) obligation (23) (22) (23) 36 37 36 Recognized net actuarial loss (gain) 65 86 8 2 1 1 ------- ------- ------- ------- ------- ------- Net periodic benefit cost (benefit) $ 388 $ 433 $ 185 $ 144 $ 130 $ 118 ======= ======= ======= ======= ======= =======
- 47 - The weighted-average assumptions used to determine benefit obligations as of December 31, 2004 and 2003 are as follows:
PENSION POSTRETIREMENT BENEFITS BENEFITS 2004 2003 2004 2003 Discount rate 6.00% 6.25% 6.00% 6.25% Expected return on plan assets 8.50% 8.50% N/A N/A Rate of compensation increase 4.50% 4.50% N/A N/A
The expected return on pension plan assets is a significant assumption used in the calculation of net periodic benefit cost. This assumption reflects the average long-term rate of earnings expected on the funds invested or to be invested to provide for the benefits included in the projected benefit obligation. The selected rate considers the historical and expected future investment trends of the present and expected future assets in the plan. Management believes the assumed 8.50% return on plan assets, which was used for net periodic benefit cost calculations in 2002, 2003 and 2004, is reasonable. Management has calculated the average annual return on pension plan assets over the period 1991-2004 to be 9.45%, with annual returns ranging from a low of - -7.23% to a high of +19.87% over that period. The Corporation's pension plan weighted-average asset allocations at December 31, 2004 and 2003 are as follows:
2004 2003 Cash and cash equivalents 5% 3% Debt securities 34% 40% Equity securities 61% 57% --- --- Total 100% 100% === ===
The Bank's Trust and Financial Management Department manages the investment of pension plan assets. The targeted asset allocation for the pension plan is 60% equity securities, 35% debt securities and 5% cash. This targeted asset allocation reflects a balanced approach, considering the need for growth of plan assets to meet future demand, as well as the need for ongoing liquidity to fund benefit payments. Specifically, the Trust Department attempts to match the maturities of zero-coupon bonds with the estimated amounts of benefit payments over the ensuing 10-year period. Within the equity portion of pension plan investments, the Trust Department employs a strategy of diversification. Holdings include large capitalization stocks from many different industries, as well as mid-cap and foreign mutual funds. The pension plan's assets do not include any shares of the Corporation's common stock. The Corporation expects to contribute $365,000 to the defined benefit pension plan, and $61,000 to the postretirement benefit plan, in 2005. Estimated future benefit payments (including, for the postretirement plan, only the estimated employer contributions), which reflect expected future service, are as follows: (IN THOUSANDS)
PENSION POSTRETIREMENT BENEFITS BENEFITS 2005 $ 419 $ 61 2006 412 61 2007 420 61 2008 439 67 2009 492 69 2010-2014 2,970 407
In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act (the "Act") was signed into law. The Act introduces a prescription drug benefit under Medicare (Medicare Part D) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least "actuarially equivalent" to Medicare Part D. - 48 - The Corporation has not yet determined whether benefits provided under the postretirement plan are actuarially equivalent to benefits that will be available under Medicare Part D. Accordingly, the financial statement amounts and disclosures related to the postretirement benefits plan do not reflect the effects of the Act. 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 total basic and matching contributions were $727,000 in 2004, $728,000 in 2003 and $667,000 in 2002. The profit sharing/401(k) Plan includes an Employee Stock Ownership Plan (ESOP). A portion of the Corporation's basic contributions to the Plan are made to the ESOP, and the Plan uses these funds to purchase Corporation stock for the accounts of Plan participants. These purchases are made on the market (not directly from the Corporation), and employees are not permitted to purchase Corporation stock under the Plan. The Plan includes a diversification feature which permits Plan participants, upon reaching age 55 and 10 years of service (as defined), to sell up to 50% of their Corporation shares back to the Plan over a period of 6 years. As of December 31, 2004, there were no shares allocated for repurchase by the Plan. Dividends paid on shares held by the ESOP are charged to retained earnings. All Corporation shares owned through the ESOP are included in the calculation of weighted-average shares outstanding for purposes of calculating earnings per share - basic and diluted. As of December 31, 2004, the ESOP held 292,614 shares of Corporation stock, all of which had been allocated to Plan participants. The Corporation's contributions to the ESOP portion of the Plan (included in total contributions reported above) totaled $385,000 in 2004, $377,000 in 2003 and $343,000 in 2002. The Corporation also has a nonqualified supplemental deferred compensation arrangement with its key officers. Charges to expense for officers' supplemental deferred compensation were $4,000 in 2004, $45,000 in 2003 and $44,000 in 2002. STOCK-BASED COMPENSATION PLANS The Corporation has a Stock Incentive Plan for a selected group of senior officers. A total of 400,000 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, 2002, 2003 and 2004, there were awards of Incentive Stock Options and restricted stock. The Incentive Stock Options granted in 2000, 2002, 2003 and 2004 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. This plan permits awards of nonqualified stock options and/or restricted stock to non-employee directors. A total of 75,000 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 3, 2005, the Corporation granted options to purchase a total of 37,176 shares of common stock through the Stock Incentive and Independent Directors Stock Incentive Plans. The exercise price for these options is $27.00 per share, which was the market price at the date of grant. Also, effective January 3, 2005, the Corporation awarded a total of 4,128 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 2005 are not included in the tables that follow. As described in Note 1, 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. - 49 - (NET INCOME IN THOUSANDS)
2004 2003 2002 Net income As reported $ 14,863 $ 16,257 $ 14,959 Pro forma $ 14,773 $ 16,133 $ 14,768 Earnings per share-basic As reported $ 1.82 $ 1.99 $ 1.83 Pro forma $ 1.80 $ 1.97 $ 1.81 Earnings per share-diluted As reported $ 1.81 $ 1.98 $ 1.83 Pro forma $ 1.79 $ 1.96 $ 1.80
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:
2004 2003 2002 Volatility 15% 15% 17% Expected option lives 6 Years 6 Years 6 Years Risk-free interest rate 3.87% 3.55% 5.00% Dividend yield 4.46% 4.30% 4.16%
A summary of the status of the Corporation's stock option plans is presented below:
2004 2003 2002 ---- ---- ---- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE Outstanding, beginning of year 213,058 $ 18.81 180,722 $ 18.11 124,842 $ 18.49 Granted 33,249 $ 26.59 46,411 $ 20.73 61,223 $ 17.00 Exercised (29,795) $ 18.32 (12,066) $ 16.28 (5,343) $ 13.98 Forfeited (4,049) $ 21.80 (2,009) $ 16.19 - $ - --------- --------- --------- --------- --------- --------- Outstanding, end of year 212,463 $ 20.03 213,058 $ 18.81 180,722 $ 18.11 ========= ========= ========= ========= ========= ========= Options exercisable at year-end 212,463 $ 20.03 207,898 $ 18.82 165,824 $ 17.97 Fair value of options granted $ 2.57 $ 2.11 $ 2.45
- 50 - The following table summarizes information about stock options outstanding as of December 31, 2004:
OUTSTANDING EXERCISABLE AT REMAINING AT DECEMBER 31, CONTRACTUAL DECEMBER 31, EXERCISE PRICES 2004 LIFE IN YEARS 2004 $ 13.33 1,818 1 1,818 $ 17.00 5,850 2 5,850 $ 18.03-$ 22.17 16,119 3 16,119 $ 24.25-$ 24.33 21,900 4 21,900 $ 18.00-$ 22.08 25,440 5 25,440 $ 13.50-$ 16.67 21,108 6 21,108 $ 17.00 49,732 7 49,732 $ 20.73 39,117 8 39,117 $ 26.59 31,379 9 31,379 ------- -- ------- 212,463 212,463 ======= =======
The following table summarizes restricted stock awards in 2004, 2003 and 2002:
2004 2003 2002 Number of shares awarded 3,714 5,166 6,647 Market price of stock at date of grant $ 26.59 $ 20.73 $ 17.00
Compensation expense related to restricted stock was $85,000 in 2004, $102,000 in 2003 and $80,000 in 2002. 13. INCOME TAXES The following temporary differences gave rise to the net deferred tax liability at December 31, 2004 and 2003: (IN THOUSANDS)
2004 2003 Deferred tax liabilities: Depreciation $ 1,151 $ 340 Prepaid pension 120 142 Accretion on securities 8 9 Investments in limited partnerships - 13 Realized gains on securities 75 62 Interest expense - Index Powered CDs 16 - Unrealized holding gains on securities 5,427 6,201 -------- -------- Total 6,797 6,767 -------- -------- Deferred tax assets: Allowance for loan losses (2,375) (2,134) Credit for alternative minimum tax paid (300) - Postretirement and sick benefits (276) (243) Investments in limited partnerships (125) - Loan fees and costs (60) (63) Supplemental executive retirement plan (178) (182) Restricted stock compensation (48) (32) -------- -------- Total (3,362) (2,654) -------- -------- Deferred tax liability, net $ 3,435 $ 4,113 ======== ========
-51- Tax provision:
2004 2003 2002 Currently payable $ 2,755 $ 3,634 $ 4,018 Deferred 96 (25) (284) ------- ------- ------- Total provision $ 2,851 $ 3,609 $ 3,734 ======= ======= =======
Reconciliation of tax provision:
2004 2003 2002 AMOUNT % AMOUNT % AMOUNT % Expected provision $ 6,200 35.00% $ 6,953 35.00% $ 6,543 35.00% Tax-exempt interest income (2,790) (15.75) (2,766) (13.92) (2,223) (11.89) Nondeductible interest expense 238 1.34 242 1.22 239 1.28 Dividends received deduction (347) (1.96) (284) (1.43) (280) (1.50) Increase in cash surrender value of life insurance (214) (1.21) (250) (1.26) (299) (1.60) Surtax exemption (84) (0.47) (185) (0.93) (176) (0.94) Other, net (152) (0.86) (101) (0.51) (70) (0.37) -------- -------- -------- -------- -------- -------- Effective income tax provision $ 2,851 16.09% $ 3,609 18.17% $ 3,734 19.98% ======== ======== ======== ======== ======== ========
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 THOUSAND
BEGINNING NEW OTHER ENDING BALANCE LOANS REPAYMENTS CHANGES BALANCE 13 directors, 5 executive officers 2004 $ 7,193 $ 1,501 $ (2,054) $ 1,055 $ 7,695 13 directors, 5 executive officers 2003 6,623 612 (956) 914 7,193 14 directors, 6 executive officers 2002 6,535 2,464 (2,722) 346 6,623
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. Deposits from related parties held by the Corporation amounted to $1,887,000 at December 31, 2004 and $3,078,000 at December 31, 2003. 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 financial 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. -52- The Corporation's exposure to credit loss from nonperformance by the other party to the financial instruments for commitments to extend credit and financial 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, 2004 and 2003 are as follows:
(IN THOUSANDS) 2004 2003 Commitments to extend credit $ 226,121 $ 111,843 Standby letters of credit 17,049 14,064
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. Financial 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. Some of the financial standby letters of credit are collateralized by real estate or other assets, while others are unsecured. The extent to which proceeds from liquidation of collateral would be expected to cover the maximum potential amount of future payments related to financial standby letters of credit is not estimable. The Corporation has recorded no liability associated with financial standby letters of credit as of December 31, 2004 and 2003. Financial standby letters of credit as of December 31, 2004 expire as follows: (IN THOUSANDS)
Year of Expiration Amount - ------------------ ------- 2005 $11,568 2006 5,051 2007 430 ------- Total $17,049 =======
16. OPERATING LEASES AND OTHER PURCHASE COMMITMENTS The Corporation leases facilities and office equipment under operating leases expiring through 2009. Rental expense under these operating leases totaled approximately $89,000 in 2004. Minimum future rental payments under non-cancelable operating leases having remaining terms in excess of 1 year as of December 31, 2004 are as follows: (IN THOUSANDS) 2005 $ 94 2006 75 2007 31 2008 22 2009 11 THEREAFTER -
The facility leases contain renewal options for an additional 5-15 years at rental amounts established in the leases. -53- In 2004, the Corporation purchased the license to utilize banking software, and entered into contractual commitments to pay annual maintenance fees associated with the software. Maintenance expense amounted to $60,000 in 2004, and maintenance fees payable will be approximately $360,000 per year through 2008 and $300,000 in 2009. Through October 2009, the Corporation would also be required to pay additional software license fees, based on the Bank's asset size, determined based on the following schedule (additional licensing fees in thousands):
ASSET SIZE ADDITIONAL LICENSING FEE - ----------------------------- ----------------------------------------------- $1.75 BILLION TO $2 BILLION $ 250 $2 BILLION TO $2.25 BILLION 150 in addition to the $250 noted above $2.25 BILLION TO $2.5 BILLION 250 in addition to the $400 noted above ABOVE $2.5 BILLION Based on the vendor's then-current fee schedule
Effective in October 2007, the Corporation has the right to terminate its contractual commitment to the software vendor, subject to payment of 25% of any remaining annual maintenance fees. The agreement between the software vendor and the Corporation contains options for an unlimited number of additional 5-year renewals. The agreement includes formulas to determine the amounts of maintenance fees and additional licensing fees, if the Corporation exercises the renewal options. 17. CONTINGENCIES In the normal course of business, the Corporation is subject to pending and threatened litigation in which claims for monetary damages are asserted. In management's opinion, the Corporation's financial position and results of operations would not be materially affected by the outcome of these legal proceedings. 18. 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 following table) 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, 2004 and 2003, 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. -54-
(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, 2004: Total capital to risk-weighted assets: Consolidated $133,181 18.89% $ 56,399 >or=8% $ n/a n/a Bank 107,974 15.66% 55,172 >or=8% 68,965 >or=10% Tier 1 capital to risk-weighted assets: Consolidated 121,050 17.17% 28,200 >or=4% n/a n/a Bank 98,637 14.30% 27,586 >or=4% 41,379 >or=6% Tier 1 capital to average assets: Consolidated 121,050 10.69% 45,276 >or=4% n/a n/a Bank 98,637 8.95% 44,103 >or=4% 55,129 >or=5% DECEMBER 31, 2003: Total capital to risk-weighted assets: Consolidated $125,136 20.61% $ 48,564 >or=8% $ n/a n/a Bank 102,050 17.31% 47,160 >or=8% 58,950 >or=10% Tier 1 capital to risk-weighted assets: Consolidated 113,307 18.67% 24,282 >or=4% n/a n/a Bank 93,289 15.83% 23,580 >or=4% 35,370 >or=6% Tier 1 capital to average assets: Consolidated 113,307 10.80% 41,968 >or=4% n/a n/a Bank 93,289 9.13% 40,854 >or=4% 51,068 >or=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 2005 may not exceed $17,085,000, plus consolidated net income for 2005. 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 $88,610,000 at December 31, 2004, 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 $9,864,000 at December 31, 2004. -55- 19. PARENT COMPANY ONLY The following is condensed financial information for Citizens & Northern Corporation. CONDENSED BALANCE SHEET
DECEMBER 31, (IN THOUSANDS) 2004 2003 ASSETS Cash $ 725 $ 329 Investment in subsidiaries: Citizens & Northern Bank 104,989 100,754 Citizens & Northern Investment Corporation 25,270 23,758 Bucktail Life Insurance company 2,373 2,223 Other assets 99 54 -------- -------- TOTAL ASSETS $133,456 $127,118 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Dividends payable $ 1,864 $ 1,763 Other liabilities 7 12 Stockholders' equity 131,585 125,343 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $133,456 $127,118 ======== ========
CONDENSED INCOME STATEMENT
YEARS ENDED DECEMBER 31, (IN THOUSANDS) 2004 2003 2002 Dividends from Citizens & Northern Bank $ 7,582 $ 6,870 $ 7,063 Other dividend income and security gains 5 - 174 Expenses (123) (183) (140) ------- ------- ------- Income before equity in undistributed income of subsidiaries 7,464 6,687 7,097 Equity in undistributed income of subsidiaries 7,399 9,570 7,862 ------- ------- ------- NET INCOME $14,863 $16,257 $14,959 ======= ======= =======
-56- CONDENSED STATEMENT OF CASH FLOWS
YEARS ENDED DECEMBER 31, (IN THOUSANDS) 2004 2003 2002 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $14,863 $16,257 $14,959 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of subsidiaries (7,399) (9,570) (7,862) Amortization of restricted stock 85 102 80 (Increase) decrease in other assets (45) (9) (32) Increase in other liabilities 78 68 98 ------- ------- ------- Net Cash Provided by Operating Activities 7,582 6,848 7,243 ------- ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES, Investment in subsidiary - (460) (783) ------- ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from sale of treasury stock 528 197 76 Purchase of treasury stock (575) (174) (239) Dividends paid (7,139) (6,674) (6,038) ------- ------- ------- Net Cash Used in Financing Activities (7,186) (6,651) (6,201) ------- ------- ------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 396 (263) 259 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 329 592 333 ------- ------- ------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 725 $ 329 $ 592 ======= ======= =======
20. SUMMARY OF QUARTERLY CONSOLIDATED FINANCIAL DATA (UNAUDITED) The following table presents summarized quarterly financial data for 2003 and 2002:
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2004 QUARTER ENDED MAR. 31, JUNE 30, SEPT. 30, DEC. 31, Interest income $ 14,015 $ 14,343 $ 14,573 $ 14,991 Interest expense 5,703 5,493 5,665 5,745 --------- --------- ---------- --------- Interest margin 8,312 8,850 8,908 9,246 Provision for loan losses 350 350 350 350 --------- --------- ---------- --------- Interest margin after provision for loan losses 7,962 8,500 8,558 8,896 Other income 1,625 1,855 1,627 1,815 Securities gains 964 321 459 1,133 Other expenses 6,228 6,289 6,738 6,746 --------- --------- ---------- --------- Income before income tax provision 4,323 4,387 3,906 5,098 Income tax provision 617 698 501 1,035 --------- --------- ---------- --------- Net income $ 3,706 $ 3,689 $ 3,405 $ 4,063 ========= ========= ========== ========= Net income per share - basic $ 0.45 $ 0.45 $ 0.42 $ 0.50 ========= ========= ========== ========= Net income per share - diluted $ 0.45 $ 0.45 $ 0.41 $ 0.49 ========= ========= ========== =========
-57-
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2003 QUARTER ENDED MAR. 31, JUNE 30, SEPT. 30, DEC. 31, Interest income $ 13,930 $ 13,943 $ 13,553 $ 13,797 Interest expense 6,243 6,089 5,655 5,550 --------- --------- ---------- -------- Interest margin 7,687 7,854 7,898 8,247 Provision for loan losses 350 250 250 250 --------- --------- ---------- -------- Interest margin after provision for loan losses 7,337 7,604 7,648 7,997 Other income 1,540 1,628 1,705 1,722 Securities gains 1,721 908 660 1,510 Other expenses 5,532 5,356 5,336 5,890 --------- --------- ---------- -------- Income before income tax provision 5,066 4,784 4,677 5,339 Income tax provision 994 864 759 992 --------- --------- ---------- -------- Net income $ 4,072 $ 3,920 $ 3,918 $ 4,347 ========= ========= ========== ======== Net income per share - basic $ 0.50 $ 0.48 $ 0.48 $ 0.53 ========= ========= ========== ======== Net income per share - diluted $ 0.50 $ 0.48 $ 0.48 $ 0.53 ========= ========= ========== ========
21. PENDING MERGER In November 2004, the Corporation, along with Canisteo Valley Corporation ("Canisteo"), announced the signing of a definitive agreement and plan of merger. Canisteo is the parent company of First State Bank; a New York State chartered commercial bank with two offices in Steuben County, NY, and assets of $42.5 million as of September 30, 2004. Under the agreement, the Corporation will acquire Canisteo in an all-cash merger transaction. The transaction, which has been approved by the Boards of Directors of both companies, is expected to be completed during the third quarter 2005, pending Canisteo stockholder approval, regulatory approval, and other customary conditions of closing. -58- REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 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, 2004 and 2003, 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, 2004. 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 the standards of the Public Company Accounting Oversight Board (United States). 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, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. Parente Randolph, LLC /s/ Williamsport, Pennsylvania February 24, 2005 -59- ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None ITEM 9A. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES The Corporation's management, under the supervision of and with the participation of the Corporation's Chief Executive Officer and Chief Financial Officer, has carried out an evaluation of the design and effectiveness of the Corporation's disclosure controls and procedures as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Securities Exchange Act of 1934 as of the end of period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Corporation's disclosure controls and procedures are effective to ensure that all material information required to be disclosed in reports the Corporation files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. There were no significant changes in the Corporation's internal control over financial reporting that occurred during the period covered by this report that has materially affected, or that is reasonably likely to affect, our internal control over financial reporting. MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The Corporation's management is responsible for establishing and maintaining adequate internal control over financial reporting, as that term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of the Corporation's management, including the principal executive officer and principal financial officer, the Corporation is in the process of conducting an evaluation of its internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Corporation's evaluation of its internal control over financial reporting has not yet been completed. Accordingly, as permitted by Securities and Exchange Act of 1934 Release No. 50754, management's annual report on internal control over financial reporting and the related attestation report of the registered public accounting firm are not included in this Form 10-K. ITEM 9B. OTHER INFORMATION There was no information the Corporation was required to disclose in a report on Form 8-K during the fourth quarter 2004 that was not disclosed. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information concerning Directors and Executive Officers is incorporated herein by reference to disclosure under the captions "Proposal 1 - Election of Directors," "Corporation's and Bank's Executive Officers," "Section 16(a) Beneficial Ownership Reporting Compliance," "Board of Director Committees, Attendance at Meetings and Compensation of Directors" and "Stockholder Proposals" of the Corporation's proxy statement dated March 22, 2005 for the annual meeting of stockholders to be held on April 19, 2005. The Corporation's Board of Directors has adopted a Code of Ethics, available on the Corporation's web site at www.cnbankpa.com for the Corporation's employees, officers and directors. (The provisions of the Code of Ethics are also included in the Corporation's employee handbook.) -60- ITEM 11. EXECUTIVE COMPENSATION Information concerning executive compensation is incorporated herein by reference to disclosure under the captions "Executive Compensation," "Stock Incentive plan," "Option Grants," "Aggregated Stock Options Exercised During 2004 and Year-end Option Values," "Pension Plan," "Savings Plan," "Incentive Award Plan" and "Change in Control Agreements" of the Corporation's proxy statement dated March 22, 2005 for the annual meeting of stockholders to be held on April 19, 2005. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED MATTERS Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference to disclosure under the caption "Security Ownership of Management" of the Corporation's proxy statement dated March 22, 2005 for the annual meeting of stockholders to be held on April 19, 2005. "Equity Compensation Plan Information" as required by Item 201(d) of Regulation S-K is incorporated by reference herein from Item 5 (Market for Registrant's Common Equity and Related Stockholder Matters) of this Form 10-K. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information concerning loans and deposits with Directors and Executive Officers is provided in Note 14 to the Consolidated Financial Statements, which is included in Part II, Item 8 of this Annual Report on 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 22, 2005 for the annual meeting of stockholders to be held on April 19, 2005. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information concerning services provided by the Corporation's independent auditors, Parente Randolph, LLC, the audit committee's pre-approval policies and procedures for such services, and fees paid by the Corporation to that firm, is incorporated herein by reference to disclosure under the caption "Audit Committee" of the Corporation's proxy statement dated March 22, 2005 for the annual meeting of stockholders to be held on April 19, 2005. PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) (1). The following consolidated financial statements are set forth in Part II, Item 8:
Page ----- Report of Independent Registered Public Accounting Firm 59 Financial Statements: Consolidated Balance Sheet - December 31, 2004 and 2003 29 Consolidated Statement of Income - Years Ended December 31, 2004, 2003 and 2002 30 Consolidated Statement of Changes in Stockholders' Equity - Years Ended December 31, 2004, 2003 and 2002 31 Consolidated Statement of Cash Flows - Years Ended December 31, 2004, 2003 and 2002 32 Notes to Consolidated Financial Statements 33-58
(a)(2) Financial statement schedules are not applicable or included in the financial statements or related notes. (a)(3) Exhibits (numbered as in Item 601 of Regulation S-K): -61- 2. Plan of acquisition, reorganization, arrangement, liquidation or succession Not applicable 3. (i)Articles of Incorporation Incorporated by reference to the exhibits filed with the Corporation's registration statement on Form S-4 on March 27, 1987. 3. (ii) By-laws Incorporated by reference to Exhibit 3.1 of the Corporation's Form 8-K filed August 25, 2004 4. Instruments defining the rights of security holders, including indentures Not applicable 9. Voting trust agreement Not applicable 10.Material contracts: 10.1 Form of Indemnification Agreements dated May 2004 between the Corporation and the Directors and certain officers Filed herewith 10.2 Change in Control Agreement dated December 31, 2003 between the Corporation and Thomas L. Rudy, Jr. Filed herewith Change in Control Agreement dated Incorporated by reference to the December 31, 2003 between the exhibits filed with the Corporation's Corporation and Craig G. Form 10-K on March 10, 2004 Litchfield Change in Control Agreement dated Incorporated by reference to the December 31, 2003 between the exhibits filed with the Corporation's Corporation and Mark A. Hughes Form 10-K on March 10, 2004 Change in Control Agreement dated Incorporated by reference to the December 31, 2003 between the exhibits filed with the Corporation's Corporation and Matthew P. Prosseda Form 10-K on March 10, 2004 Change in Control Agreement dated Incorporated by reference to the December 31, 2003 between the exhibits filed with the Corporation's Corporation and Deborah E. Scott Form 10-K on March 10, 2004 Second Amendment to Citizens & Incorporated by reference to the Northern Corporation Stock exhibits filed with the Corporation's Incentive Plan Form 10-K on March 10, 2004 First Amendment to Citizens & Incorporated by reference to the Northern Corporation Stock exhibits filed with the Corporation's Incentive Plan Form 10-K on March 10, 2004 Citizens & Northern Corporation Incorporated by reference to the Stock Incentive Plan exhibits filed with the Corporation's Form 10-K on March 10, 2004 - 62 - Citizens & Northern Corporation Incorporated by reference to the Independent Directors Incentive exhibits Stock filed with the Plan Corporation's proxy statement dated March 19, 2001 for the annual meeting of stockholders held on April 17, 2001. 11. Statement re: computation of per Information concerning the computation share earnings 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 14. Code of ethics The Code of Ethics is available through the Corporation's website at www.cnbankpa.com. To access the Code of Ethics, click on "Shareholder News & Info.," followed by "Corporate Governance" and "Code of Ethics." 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 31. Rule 13a-14(a)/15d-14(a) certifications: 31.1 Certification of Chief Executive Officer Filed herewith 31.2 Certification of Chief Financial Officer Filed herewith 32. Section 1350 certifications Filed herewith 99. Additional exhibits: 99.1 Additional information mailed to stockholders with proxy statement and Form 10-K on March 22, 2005 Filed herewith - 63 - (b) Exhibits - The required exhibits are listed under Part IV, Item 15(a)(3) of Form 10-K. (c) Financial statement schedules are omitted because the required information is not applicable or is included elsewhere in Form 10-K. - 64 - 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: By: Craig G. Litchfield /s/ - --------------------------- Craig G. Litchfield Chairman, President and Chief Executive Officer Date: March 11, 2005 By: Mark A. Hughes /s/ - ---------------------- Treasurer and Principal Accounting Officer Date: March 11, 2005 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 /s/ Dennis F. Beardslee /s/ Edward L. Learn Dennis F. Beardslee Edward L. Learn Date: March 11, 2005 Date: March 11, 2005 /s/ R. Robert DeCamp /s/ Craig G. Litchfield R. Robert DeCamp Craig G. Litchfield Date: March 11, 2005 Date: March 11, 2005 /s/ Jan E. Fisher /s/ Edward H. Owlett, III Jan E. Fisher Edward H. Owlett, III Date: March 11, 2005 Date: March 11, 2005 /s/ R. Bruce Haner /s/ Leonard Simpson R. Bruce Haner Leonard Simpson Date: March 11, 2005 Date: March 11, 2005 /s/ Susan E. Hartley /s/ James E. Towner Susan E. Hartley James E. Towner Date: March 11, 2005 Date: March 11, 2005 /s/ Karl W. Kroeck /s/ Ann M. Tyler Karl W. Kroeck Ann M. Tyler Date: March 11, 2005 Date: March 11, 2005 /s/ Leo F. Lambert Leo F. Lambert Date: March 11, 2005 - 65 - EX-10.1 2 l12593aexv10w1.txt EXHIBIT 10.1 EXHIBIT 10.1 INDEMNIFICATION AGREEMENT This Agreement made this ___ day of _________, 2004, between CITIZENS & NORTHERN CORPORATION, a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and a Pennsylvania corporation (the "Company") and __________________, a director, officer or representative (as hereinafter defined) of the Company (the "Indemnitee"); WHEREAS, the Company and the Indemnitee are each aware of the exposure to litigation of officers, directors and representatives of the Company as such persons exercise their duties to the Company; WHEREAS, the Company and the Indemnitee are also aware of conditions in the insurance industry that have affected and may continue to affect the Company's ability to obtain appropriate directors' and officers' liability insurance on an economically acceptable basis; WHEREAS, the Company desires to continue to benefit from the services of highly qualified, experienced and competent persons such as the Indemnitee; WHEREAS, the Indemnitee desires to serve or to continue to serve the Company as a director, officer or as a director, officer or trustee of another corporation, joint venture, trust or other enterprise in which the Company has a direct or indirect ownership interest, for so long as the Company continues to provide on an acceptable basis adequate and reliable indemnification against certain liabilities and expenses which may be incurred by the Indemnitee. NOW, THEREFORE, in consideration of the foregoing premises and the mutual covenants herein contained, the parties hereto agree as follows: 1. Indemnification. Subject to the terms of this Agreement, the Company shall indemnify the Indemnitee with respect to his activities as a director or officer of the Company and/or as a person who is serving or has served on behalf of the Company ("representative") as a director, officer, or trustee of another corporation, joint venture, trust or other enterprise, domestic or foreign, in which the Company has a direct or indirect ownership interest (an "affiliated entity") against expenses (including, without limitation, attorneys' fees, judgments, fines, and amounts paid in settlement) actually and reasonably incurred by him ("Expenses") in - 66 - connection with any claim against Indemnitee which is the subject of any threatened, pending, or completed action, suit, or proceeding, whether civil, criminal, administrative, investigative or otherwise and whether formal or informal (a "Proceeding"), to which Indemnitee was, is, or is threatened to be made a party by reason of facts which include Indemnitee's being or having been such a director, officer or representative, to the extent of the highest and most advantageous to the Indemnitee, as determined by the Indemnitee, of one or any combination of the following: (a) The benefits provided by the Company's Articles of Incorporation in effect on the date hereof; (b) The benefits provided by the Articles of Incorporation or By-Laws or their equivalent of the Company in effect at the time Expenses are incurred by Indemnitee; (c) The benefits allowable under Pennsylvania law in effect at the date hereof; (d) The benefits allowable under the law of the jurisdiction under which the Company exists at the time Expenses are incurred by the Indemnitee; (e) The benefits available under liability insurance obtained by the Company; (f) The benefits available under the $5,000,000 D&O Selectplus Insurance Policy obtained by the Company from The Fidelity and Deposit Companies in effect for 2004; and (g) Such other benefits as are or may be otherwise available to Indemnitee. Combination of two or more of the benefits provided by (a) through (g) shall be available to the extent that the Applicable Document, as hereafter defined, does not require that the benefits provided therein be exclusive of other benefits. The document or law providing for the benefits listed in items (a) through (g) above is called the "Applicable Document" in this Agreement. Company hereby undertakes to use its best efforts to assist Indemnitee, in all proper legal ways, to obtain the benefits selected by Indemnitee under items (a) through (g) above. For purposes of this Agreement, references to "other enterprises" shall include employee benefit plans for employees of the Company or of any affiliated entity without regard to ownership of such plans; references to "fines" shall include any excise taxes assessed on the Indemnitee with respect to any employee benefit plan; - 67 - references to "serving on behalf of the company" shall include any services as a director, officer, employee or agent of the Company which imposes duties on, or involves services by, the Indemnitee with respect to an employee benefits plan, its participants or beneficiaries; references to the singular shall include the plural and vice versa; and if the Indemnitee acted in good faith and in a manner he or she reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan Indemnitee shall be deemed to have acted in a manner consistent with the standards required for indemnification by the Company under the Applicable Documents. 2. Insurance. The Company shall maintain directors' and officers' liability insurance for so long as Indemnitee's services are covered hereunder, provided and only to the extent that such insurance is available in amounts and on terms and conditions determined by the Company to be acceptable. However, the Company agrees that the provisions hereof shall remain in effect regardless of whether liability or other insurance coverage is at any time obtained or retained by the Company; except that any payments in fact made to Indemnitee under an insurance policy obtained or retained by the Company shall reduce the obligation of the Company to make payments hereunder by the amount of the payments made under any such insurance policy. 3. Payment of Expenses. At Indemnitee's request, the Company shall pay the Expenses as and when incurred by Indemnitee, after receipt of written notice pursuant to Section 6 hereof and an undertaking in the form of Exhibit I attached hereto by or on behalf of Indemnitee (i) to repay such amounts so paid on Indemnitee's behalf if it shall ultimately be determined under the Applicable Document or applicable law that Indemnitee is required to repay such amounts and (ii) to reasonably cooperate with the Company concerning such Proceeding. That portion of Expenses which represents attorneys' fees and other costs incurred in defending any Proceeding shall be paid by the Company within thirty (30) days of its receipt of such request, together with reasonable documentation (consistent, in the case of attorneys' fees, with Company practice in payment of legal fees for outside counsel generally) evidencing the amount and nature of such Expenses, subject to its also having received such notice and undertaking. - 68 - It is understood and agreed before the Company pays the Expenses incurred in a Proceeding brought by a banking agency in which a final order has not been entered, the following conditions must be met: (1) The Board of Directors, in good faith, shall determine in writing after due investigation and consideration that the Indemnitee acted in a manner believed to be in the best interests of the Company; (2) The Board of Directors, in good faith, shall determine after due investigation and consideration that the payment of such Expenses will not materially or adversely affect the Company's safety and soundness. (3) The Indemnitee shall agree in writing to reimburse the Company for Expenses, which subsequently are deemed "prohibited indemnification payments", as defined in 12 C.F.R. Section. 359.1(1). The Indemnitee shall not participate in any way in the Board's discussion and approval of Expenses, provided however, that the Indemnitee may present his or her request to the Board and respond to any inquiries from the Board concerning his or her involvement in the circumstances giving rise to the banking agency Proceeding or civil action. 4. Escrow. The Company may dedicate such amounts as the Board of Directors of the Company may from time to time authorize, as collateral security for the funding of its obligations hereunder (and under similar agreements with other directors, officers and representatives) by depositing assets or bank letters of credit in escrow or reserving lines of credit that may be drawn down by an escrow agent in the dedicated amount (the "Escrow Reserve"). The Company shall promptly provide Indemnitee with a true and complete copy of the agreement relating to the establishment and operation of the Escrow Reserve, together with such additional documentation or information with respect to the escrow as Indemnitee may from time to time reasonably request. The Company shall promptly deliver an executed copy of the Agreement to the escrow agent for the Escrow Reserve to evidence to that agent that Indemnitee is a beneficiary of that Escrow Reserve and shall deliver to Indemnitee the escrow agent's signed receipt evidencing that delivery. 5. Additional Rights. The indemnification provided in this Agreement shall not be exclusive of any other indemnification or right to which Indemnitee may be entitled and shall continue after Indemnitee has ceased to occupy a position as an officer, director or representative as described in Paragraph 1 above with - 69 - respect to Proceedings relating to or arising out of Indemnitee's acts or omissions during his or her service in such position. 6. Notice to Company. Indemnitee shall provide to the Company prompt written notice of any Proceeding brought, threatened, asserted or commenced against Indemnitee with respect to which Indemnitee may assert a right to indemnification hereunder; provided that failure to provide such notice shall not in any way limit Indemnitee's rights under this Agreement. 7. Cooperation in Defense and Settlement. Indemnitee shall not make any admission or effect any settlement of any Proceeding without the Company's written consent unless Indemnitee shall have determined to undertake his or her own defense in such matter and has waived the benefits of this Agreement. The Company shall not settle any Proceeding to which Indemnitee is a party in any manner which would impose any Expense on Indemnitee without his written consent. Neither Indemnitee nor the Company will unreasonably withhold consent to any proposed settlement. Indemnitee and the Company shall cooperate to the extent reasonably possible with each other and with the Company's insurers, in attempts to defend and/or settle such Proceeding. 8. Assumption of Defense. Except as otherwise provided below, to the extent that it may wish, the Company (jointly with any other indemnifying party similarly notified), will be entitled to assume Indemnitee's defense in any Proceeding, with counsel mutually satisfactory to Indemnitee and the Company. Indemnitee shall have the right to employ counsel in such Proceeding, but the fees and expenses of such counsel incurred after notice from the Company of its assumption of the defense thereof shall be at Indemnitee's expense unless: (a) the employment of counsel by Indemnitee has been authorized by the Company; (b) counsel employed by the Company initially is unacceptable or later becomes unacceptable to Indemnitee and such unacceptability is reasonable under then existing circumstances; (c) Indemnitee shall have reasonably concluded that there may be a conflict of interest between Indemnitee and the Company in the conduct of the defense of such Proceeding; or - 70 - (d) the Company shall not have employed counsel promptly to assume the defense of such Proceeding, in each of which case fees and expenses of counsel shall be at the expense of the Company and subject to payment pursuant to this Agreement. The Company shall not be entitled to assume the defense of Indemnitee in any Proceeding brought on behalf of the Company or as to which Indemnitee shall have drawn either of the conclusions provided for in clauses (b) or (c) above. 9. Enforcement. In the event that any dispute or controversy shall arise under this Agreement between Indemnitee and the Company with respect to whether the Indemnitee is entitled to indemnification in connection with any Proceeding or with respect to the amount of Expenses incurred, then with respect to each such dispute or controversy Indemnitee may seek to enforce the Agreement through legal action or, at Indemnitee's sole option and written request, through arbitration. If arbitration is requested, such dispute or controversy shall be submitted by the parties to binding arbitration in the Borough of Wellsboro in the Commonwealth of Pennsylvania, before a single arbitrator agreeable to both parties. If the parties cannot agree on a designated arbitrator within fifteen (15) days after arbitration is requested in writing by Indemnitee, the arbitration shall proceed in the Borough of Wellsboro in the Commonwealth of Pennsylvania, before an arbitrator appointed by the American Arbitration Association. In either case, the arbitration proceeding shall commence promptly under the rules then in effect of that Association and the arbitrator agreed to by the parties or appointed by that Association shall be an attorney other than an attorney who has, or is associated with a firm having associated with it an attorney which has been retained by or performed services for the Company or Indemnitee at any time during the five years preceding the commencement of arbitration. The award shall be rendered in such form that judgment may be entered thereon in any court having jurisdiction thereof. The prevailing party shall be entitled to prompt reimbursement of any costs and expenses (including, without limitation, reasonable attorneys' fees) incurred in connection with such legal action or arbitration; provided that Indemnitee shall not be obligated to reimburse the Company unless the arbitrator or court which resolves the dispute determines that Indemnitee acted in bad faith in bringing such action or arbitration. - 71 - 10. Exclusions. Notwithstanding the scope of indemnification which may be available to Indemnitee from time to time under any Applicable Document, no indemnification, reimbursement or payment shall be required of the Company hereunder with respect to: (a) Any claim or any part thereof as to which Indemnitee shall have been determined by a court of competent jurisdiction from which no appeal is or can be taken, by clear and convincing evidence, to have acted or failed to act with deliberate intent to cause injury to the Company or with reckless disregard for the best interest of the Company; (b) Any claim or any part thereof arising under Section 16(b) of the Securities Exchange Act of 1934 pursuant to which Indemnitee shall be obligated to pay any penalty, fine, settlement or judgment; (c) Any civil money penalty or judgment resulting from any Proceeding instituted by any federal banking agency, or any other liability or legal expense with regard to any administrative proceeding or civil action by any banking agency that results in a final order or settlement pursuant to which Indemnitee: (1) is assessed a civil money penalty; (2) is removed from office or prohibited from participating in the conduct of the affairs of the Company or its affiliates; (3) is required to cease and desist from taking any affirmative action described under the Federal Deposit Insurance Act or other applicable banking laws with respect to the Company and its affiliates; (d) Any obligation of Indemnitee based upon or attributable to the Indemnitee gaining in fact any personal gain, profit or advantage to which he was not entitled; or (e) Any Proceeding initiated by Indemnitee without the consent or authorization of the Board of Directors of the Company, provided that this exclusion shall not apply with respect to any claims brought by Indemnitee (i) to enforce his rights under this Agreement or (ii) in any Proceeding initiated by another person or entity whether or not such claims were brought by Indemnitee against a person or entity who was otherwise a party to such Proceeding. - 72 - Nothing in this Section 10 shall eliminate or diminish Company's obligations to advance that portion of Indemnitee's Expenses which represent attorneys' fees and other costs incurred in defending any Proceeding pursuant to Section 3 of this Agreement; subject however to the undertaking by Indemnitee in the form attached hereto as Exhibit 1 and incorporated by reference herein. 11. Extraordinary Transactions. The Company covenants and agrees that, in the event of any merger, consolidation or reorganization in which the Company is not the surviving entity, any sale of all or substantially all of the assets of the Company or any liquidation of the Company (each such event is hereinafter referred to as an "extraordinary transaction"), the Company shall: (a) have the obligations of the Company under this Agreement expressly assumed by the survivor, purchaser or successor, as the case may be, in such extraordinary transaction; or (b) otherwise adequately provide for the satisfaction of the Company's obligations under this Agreement in a manner acceptable to Indemnitee. 12. No Personal Liability. Indemnitee agrees that neither the directors nor any officer, employee, representative or agent of the Company shall be personally liable for the satisfaction of the Company's obligations under this Agreement, and Indemnitee shall look solely to the assets of the Company and the escrow the Company may establish, as referred to in Section 4 hereof, for satisfaction of any claims hereunder. 13. Severability. If any provision, phrase, or other portion of this Agreement should be determined by any court of competent jurisdiction to be invalid, illegal or unenforceable, in whole or in part, and such determination should become final, such provision, phrase or other portion shall be deemed to be severed or limited, but only to the extent required to render the remaining provisions and portions of the Agreement enforceable, and the Agreement as thus amended shall be enforced to give effect to the intention of the parties insofar as that is possible. 14. Subrogation. In the event of any payment under this Agreement, the Company shall be subrogated to the extent thereof to all rights to indemnification or reimbursement against any insurer or other - 73 - entity or person vested in the Indemnitee, who shall execute all instruments and take all other actions as shall be reasonably necessary for the Company to enforce such rights. 15. Governing Law. The parties hereto agree that this Agreement shall be construed and enforced in accordance with and governed by the laws of the Commonwealth of Pennsylvania. 16. Notices. All notices, requests, demands and other communications hereunder shall be in writing and shall be considered to have been duly given if delivered by hand and receipted for by the party to whom the notice, request, demand or other communication shall have been directed, or mailed by certified mail, return receipt requested, with postage prepaid: (a) If to the Company, to: Citizens & Northern Corporation 90-92 Main Street P.O. Box 58 Wellsboro, PA 16901 (b) If to Indemnitee, to: _________________________ _________________________ _________________________ or to such other or further address as shall be designated from time to time by the Indemnitee or the Company to the other. 17. Termination. This Agreement may be terminated by either party upon not less than sixty (60) days prior written notice delivered to the other party, but such termination shall not in any way diminish the obligations of Company hereunder with respect to the Indemnitee's activities prior to the effective date of termination. 18. Amendments and Binding Effect. This Agreement and the Undertaking and the rights and duties of Indemnitee and the Company hereunder and thereunder may not be amended, modified or terminated except by written instrument signed and delivered by the parties hereto. This Agreement is and shall be binding upon and shall inure to the benefits of the parties thereto and their respective heirs, executors, administrator, successors and assigns. - 74 - IN WITNESS WHEREOF, the undersigned have executed this Agreement in triplicate as of the date first above written. INDEMNITEE CITIZENS & NORTHERN CORPORATION By: __________________________ By: ________________________________ Title: _______________________ Title: _____________________________ - 75 - EXHIBIT 1 FORM OF UNDERTAKING THIS UNDERTAKING has been entered into by ____________________________ (hereinafter "Indemnitee") pursuant to an Indemnification Agreement dated ___________, 20__ (the "Indemnification Agreement"), by and between CITIZENS & NORTHERN CORPORATION, a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and a Pennsylvania corporation (the "Company"), and Indemnitee. WITNESSETH: WHEREAS, pursuant to the Indemnification Agreement, Company agreed to pay Expenses (within the meaning of the Indemnification Agreement) as and when incurred by Indemnitee in connection with any claim against Indemnitee which is the subject of any threatened, pending, or completed action, suit, or proceeding, whether civil, criminal, administrative or investigative, to which Indemnitee was, is, or is threatened to be made a party by reason of facts which include Indemnitee's being or having been a director, officer or representative (within the meaning of the Indemnification Agreement) of the Company; WHEREAS, such a claim has arisen against Indemnitee and Indemnitee has notified Company thereof in accordance with the terms of Section 6 of the Indemnification Agreement (hereinafter the "Proceeding"); NOW, THEREFORE, Indemnitee hereby agrees that in consideration of Company's advance payment of Indemnitee's Expenses incurred prior to a final disposition of the Proceeding, Indemnitee hereby undertakes to reimburse Company for any and all Expenses paid by Company on behalf of Indemnitee prior to a final disposition of the Proceeding in the event that Indemnitee is determined under the Applicable Document (within the meaning of the Indemnification Agreement) or applicable law to be required to repay such amounts to the Company, provided that if Indemnitee is entitled under the Applicable Document or applicable law to indemnification for some or a portion of such Expenses, Indemnitee's obligation to reimburse Company shall only be for those Expenses for which Indemnitee is determined to be required to so repay such amounts to the Company pursuant to the Indemnification Agreement or applicable law. 76 If the Indemnitee is involved in an administrative proceeding or action instituted by an appropriate banking agency and requests the Company to pay the Expenses incurred before a final order is entered, the Indemnitee shall reimburse the Company for all Expenses paid by the Company if a final order is entered (i) assessing civil money penalties; (ii) removing Indemnitee from office or prohibiting Indemnitee from participating in the conduct of the affairs of the Company or its affiliates; or (iii) requiring Indemnitee to cease and desist from taking any affirmative action described under the Federal Deposit Insurance Act or other applicable banking laws with respect to the Company and its affiliates. The Indemnitee hereby agrees to reimburse the Company for Expenses which subsequently are deemed "prohibited indemnification payments", as defined in 12 C.F.R. Section 359.1(1). Further, the Indemnitee agrees to reasonably cooperate with the Company concerning such Proceeding. IN WITNESS WHEREOF, the undersigned has set his hand this _____ day of ______________, 20__. INDEMNITEE _______________________________ 77 EX-10.2 3 l12593aexv10w2.txt EXHIBIT 10.2 EXHIBIT 10.2 CHANGE IN CONTROL AGREEMENT THIS CHANGE IN CONTROL AGREEMENT ("Agreement") is entered into as of the 31st day of December, 2003, by and among CITIZENS & NORTHERN CORPORATION, a Pennsylvania corporation (the "Corporation"), CITIZENS & NORTHERN BANK, a Pennsylvania bank (the "Bank"), and THOMAS L. RUDY, JR., an employee of the Corporation and/or the Bank and/or of a subsidiary of either (the "Employee"). The Corporation and the Bank are collectively referred to herein as the "Employer." WHEREAS, the Employer wishes to assure itself of the continuity of the Employee's services in the event of any actual change in control of the Corporation; and WHEREAS, the Employer and the Employee accordingly desire to enter into this Agreement on the terms and conditions set forth below; NOW, THEREFORE, in consideration of the premises and mutual covenants set forth herein, it is hereby agreed by and between the parties as follows: 1. TERM OF AGREEMENT. The "Term" of this Agreement shall commence on the date hereof and shall continue through December 31, 2004; provided, however, that on such date and on each December 31 thereafter, the Term of this Agreement shall automatically be extended for one additional year unless, not later than the preceding January 1 either party shall have given written notice to the other that such party does not wish to extend the Term; and provided, however, that if a Change in Control (as defined in Section 3 below) shall have occurred during the original or any extended Term of this Agreement, the Term of this Agreement shall continue for a period of twenty-four (24) calendar months commencing with the calendar month in which such Change in Control occurs and shall end upon the expiration of such 24 month period. 2. EMPLOYMENT AFTER A CHANGE IN CONTROL. If the Employee is in the employ of the Bank on the date of a Change in Control, the Bank hereby agrees to continue the Employee in its employ for the period commencing on the date of the Change in Control and ending on the last day of the Term of this Agreement (the "Employment Period"). During the Employment Period, the Employee shall hold such position with the Bank and exercise such authority and perform such employment duties as are commensurate with the Employee's position, authority and duties immediately prior to the Change in Control. The Employee agrees that during the Employment Period the Employee shall devote full business time exclusively to the Employee's duties and perform such duties faithfully and efficiently; provided, however, that nothing in this Agreement shall prevent either (i) the Employee from voluntarily resigning from employment upon at least sixty (60) days' written notice to the Bank under circumstances which do not constitute a Termination (as defined below in Section 5), or (ii) the Bank terminating the Employee for "Cause" as defined in Section 5 hereof or for any other reason or no reason. 3. CHANGE IN CONTROL. For purposes of this Agreement, a "Change in Control" means the happening of any of the following: the merger of the Corporation into, or the consolidation of the Corporation with, another entity; the sale or other disposition of all or substantially all of the Corporation's assets; or the liquidation of the Corporation; provided, however, that a Change in Control shall not be deemed to have occurred by reason of a transaction, or a substantially concurrent or otherwise related series of transactions, upon the completion of which 50 percent or more of the beneficial ownership of the voting power of the Corporation (or of the surviving corporation or corporation directly or indirectly controlling the Corporation) is held by (i) employee benefit plans of the Corporation ; or (ii) an "Affiliate" of the Corporation (as defined in the Securities Exchange Act of 1934, as amended). 4. COMPENSATION DURING THE EMPLOYMENT PERIOD. During the Employment Period, the Employee shall be compensated as follows: a. The Employee shall receive compensation which is not less than compensation paid by the Employer to the Employee immediately prior to the Employment Period; and 78 b. The Employee shall be eligible to participate in the Employer employee benefit plans which are not materially less favorable to the Employee than the Employer employee benefit plans in which the Employee participated in immediately prior to the Employment Period. 5. TERMINATION. For purposes of this Agreement, the term "Termination" shall mean termination of the employment of the Employee during the Employment Period either (i) by the Employer, for any reason other than death, Disability (as defined below), or Cause (as described below), or (ii) by resignation of the Employee upon the occurrence of one or more of the following events: a. A significant change in the nature or scope of the Employee's authorities or duties from those described in Section 2 above, a breach of any of the provisions of Section 4 above, or the breach by the Employer of any other provision of this Agreement; b. The relocation of the Employee's office to a location more than 35 miles from the location of the Employee's office immediately prior to the Employment Period; c. A reasonable determination by the Employee that, as a result of a Change in Control and a change in circumstances thereafter significantly affecting the nature and scope of Employee's authorities and duties from those described in Section 2 above, the Employee is unable to exercise the authorities, powers, functions or duties associated with the Employee's position as contemplated by Section 2 above; or d. The failure of the Corporation to obtain a satisfactory agreement from any successor to assume and agree to perform this Agreement as contemplated in Section 15 below. The date of the Employee's Termination under this Section 5 shall be the date specified by the Employee or the Employer, as the case may be, in a written notice to the other party complying with the requirements of Section 11 below. For purposes of this Agreement, the Employee shall be considered to have a "Disability" during the period in which the Employee is unable, by reason of a medically determinable physical or mental impairment, to engage in the material and substantial duties of the Employee's regular occupation, which condition is expected to be permanent. For purposes of this Agreement, the term "Cause" means, in the reasonable judgment of the Board of Directors of the Employer, (i) the willful and continued failure by the Employee to substantially perform the Employee's duties with the Employer after written notification by the Employer, or (ii) the willful engaging by the Employee in conduct which is demonstrably injurious to the Employer, monetarily or otherwise, or (iii) the engaging by the Employee in egregious misconduct involving moral turpitude. For purposes of this Agreement, no act, or failure to act, on the Employee's part shall be deemed "willful" unless done, or omitted to be done, by the Employee not in good faith and without reasonable belief that such action was in the best interest of the Employer. 6. SEVERANCE PAYMENTS. In the event of a Termination described in Section 5 above, in lieu of the amounts otherwise payable under Section 4 above, the Employee shall be entitled to receive (i) Employer-paid COBRA premiums (relating to the Employee's group medical insurance continuation premiums) for a period of eighteen (18) months after the date of Termination, and (ii) a lump sum payment in cash no later than thirty (30) business days after the date of Termination equal to the sum of: a. the Employee's unpaid salary, accrued vacation pay and unreimbursed business expenses through and including the date of Termination; and b. an amount equal to one times the Employee's base salary in effect immediately prior to the date of Termination. 7. EXCESS PARACHUTE PAYMENT LIMITATION. Notwithstanding any other provision of this Agreement, if the sum of the payments to the Employee described in this Agreement and in any other agreement, program, or plan between the Employee and the Employer (or an affiliate of the Employer) attributable to the same Change in Control constitute "excess parachute payments" (as defined in Section 280G(b)(1) of the Internal Revenue Code of 1986, as amended ("Code")), the Employer shall reduce the amounts otherwise payable to the Employee under this Agreement so that the Employee's total "parachute payment" (as defined in Code Section 280G(b)(2)(A)) under this Agreement and any 79 other agreements, programs, or plans shall be One Thousand Dollars ($1,000) less than the amount that would be an "excess parachute payment." 8. WITHHOLDING. All payments to the Employee under this Agreement will be subject to all applicable withholding of state and federal taxes. 9. CONFIDENTIALITY AND NON-SOLICITATION. The Employee agrees that: a. Except as may be required by the lawful order of a court or agency of competent jurisdiction, or except to the extent that the Employee has express authorization from the Employer, the Employee agrees to keep secret and confidential all non-public information concerning the Employer (or any entity controlled by the Employer) which was acquired by or disclosed to the Employee during the course of the Employee's employment with the Employer (or any entity controlled by the Employer), and not to disclose the same, either directly or indirectly, to any other person, firm or business entity or to use it in any way. b. While the Employee is employed by the Employer (or any entity controlled by the Employer) and for a period of twelve (12) months after the date of the Employee's Termination or other termination of employment with the Employer, the Employee covenants and agrees that Employee will not, whether for Employee or for any other person, business, partnership, association, firm, company or corporation, initiate contact with, solicit, divert or take away any of the customers (entities or individuals from which the Employer or any entity controlled by the Employer receives payment for services) of the Employer (or any entity controlled by the Employer) or employees of the Employer (or any entity controlled by the Employer) in existence from time to time during Employee's employment with the Employer (or any entity controlled by the Employer) and at the time of such initiation, solicitation or diversion. 10. MITIGATION AND SET-OFF. The Employee shall not be required to mitigate the amount of any payment provided for in this Agreement by seeking other employment or otherwise. The Employer shall not be entitled to set off against the amounts payable to the Employee under this Agreement any amounts earned by the Employee in other employment after termination of employment with the Employer, or any amounts which might have been earned by the Employee in other employment had he sought such other employment. 11. NOTICES. Any notice of Termination of the Employee's employment by the Employer or the Employee for any reason under Section 5 above shall be upon no less than fifteen (15) days' and no greater than forty-five (45) days' advance written notice to the other party. Any notices, requests, demand and other communications provided for by this Agreement shall be sufficient if in writing and if sent by registered or certified mail to the Employee at the last address the Employee has filed in writing with the Employer or, in the case of the Employer, to the attention of the Secretary of the Employer, at its principal executive offices. 12. NON-ALIENATION. The Employee shall not have any right to pledge, hypothecate, anticipate or in any way create a lien upon any amounts provided under this Agreement; and no amounts payable hereunder shall be assignable in anticipation of payment either by voluntary or involuntary acts, or by operation of law. Nothing in this Section 12 shall limit the Employee's rights or powers to dispose of the Employee's property by Last Will and Testament or limit any rights or powers which the Employee's executor or administrator would otherwise have. This Agreement shall inure to the benefit of and be enforceable by the Employee's personal or legal representatives, executors, administrators, successors, heirs, designees, devisees, and legatees. If the Employee should die while any amount is still payable to the Employee hereunder had the Employee continued to live, all such amounts shall be paid in accordance with the terms of this Agreement to the Employee's designees, devisees, or legatee, or if there are none, to the Employee's estate. 13. GOVERNING LAW. The provisions of this Agreement shall be construed in accordance with the laws of the State of Pennsylvania, without application of conflict of laws provisions thereunder. 14. AMENDMENT. This Agreement may be amended or canceled by mutual agreement of the parties in writing without the consent of any other person and, except as specifically provided in Section 15 hereto, so long as the Employee lives, no person, other than the parties hereto, shall have any rights under or interest in this Agreement or the subject matter hereof. 80 15. SUCCESSORS TO THE EMPLOYER. This Agreement shall be binding upon and inure to the benefit of the Employer and any successor of the Employer. The Employer shall require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Employer to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Employer would be required to perform it if no succession had taken place. 16. EMPLOYMENT STATUS. Nothing herein contained shall be deemed to create an employment agreement between the Employer and the Employee, providing for the employment of the Employee by the Employer for any fixed period of time. The Employee's employment with the Employer is terminable at will by the Employer or the Employee, and each shall have the right to terminate the Employee's employment with the Employer at any time, with or without Cause, subject to (i) the notice provisions of this Agreement, and (ii) the Employer's obligation to provide severance payments if and as required by Section 6. Upon a termination of the Employee's employment prior to the date of a Change in Control, there shall be no rights of the Employee under this Agreement. 17. SEVERABILITY. In the event that any provision or portion of this Agreement shall be determined to be invalid or unenforceable for any reason, the remaining provisions of this Agreement shall be unaffected thereby and shall remain in full force and effect. 18. SURVIVAL. Notwithstanding any other provision of this Agreement to the contrary, Sections 9 and 15 shall survive the termination of this Agreement and the termination of the Employee's employment with the Employer. 19. COUNTERPARTS. This Agreement may be executed in two or more counterparts, any one of which shall be deemed the original without reference to the others. 81 IN WITNESS WHEREOF, the Employee and the Employer have executed this Agreement as of the day and year first above written, but on the dates indicated below each. EMPLOYEE: Signature: _____________________________ Printed Name: THOMAS L. RUDY, JR. Address: __________________________ __________________________ Date: __________________________ CORPORATION: CITIZENS & NORTHERN CORPORATION By: _________________________________ Title: _________________________________ Date: _________________________________ BANK: CITIZENS & NORTHERN BANK By: _________________________________ Title: _________________________________ Date: _________________________________ 82 EX-21 4 l12593aexv21.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 83 EX-31.1 5 l12593aexv31w1.txt EXHIBIT 31.1 EXHIBIT 31.1 CERTIFICATION I, Craig G. Litchfield, Chairman, Chief Executive Officer and President of Citizens & Northern Corporation, certify that: 1. I have reviewed this annual report on Form 10-K of Citizens & Northern Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. March 11, 2005 By: Craig G. Litchfield /s/ - ------------------ ----------------------- Date Chairman, President and Chief Executive Officer 84 EX-31.2 6 l12593aexv31w2.txt EXHIBIT 31.2 EXHIBIT 31.2 CERTIFICATION I, Mark A. Hughes, Treasurer and Chief Financial Officer of Citizens & Northern Corporation, certify that: 1. I have reviewed this annual report on Form 10-K of Citizens & Northern Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. March 11, 2005 By: Mark A. Hughes /s/ - -------------------- ------------------ Date Treasurer and Chief Financial Officer 85 EX-32 7 l12593aexv32.txt EXHIBIT 32 EXHIBIT 32 SECTION 1350 CERTIFICATIONS In connection with the Annual Report of Citizens & Northern Corporation (the Corporation) on Form 10-K for the year ended December 31, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned hereby certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to each of the undersigned's best knowledge and belief: (a) the Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and (b) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation. CITIZENS & NORTHERN CORPORATION March 11, 2005 By: Craig G. Litchfield /s/ - ----------------- ----------------------- Date Chairman, President and Chief Executive Officer March 11, 2005 By: Mark A. Hughes /s/ - ----------------- ------------------ Date Treasurer and Chief Financial Officer These certifications accompany this report on Form 10-K pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by such Act, be deemed filed by the Corporation for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the Corporation specifically incorporates them by reference. A signed original of this written statement required by Section 906 has been provided to the Corporation and will be retained by the Corporation and furnished to the Securities and Exchange Commission or its staff upon request. 86 EX-99.1 8 l12593aexv99w1.txt EXHIBIT 99.1 EXHIBIT 13 annual highlights 2004 [PICTURE] [CITIZENS & NORTHERN CORPORATION LOGO] annual highlights 2004 investor information invest Known Market Makers who handle Citizens & Northern Corporation stock transactions follow: ARCHIPELAGO TRADING SERVICES, INC. 100 South Wacker Drive, Suite 1800, Chicago, IL 60606 BOENNING & SCATTERGOOD, INC. 4 Tower Bridge, Suite 300, 200 Barr Harbor Drive, West Conshocken, PA 19428 COMMERCE CAPITAL MARKETS, INC. 90 Fifth Avenue, New York, NY 10011 FERRIS, BAKER, WATTS, INC. 100 Light Street - Eighth Floor, Baltimore, MD 21202 HILL THOMPSON MAGID, L.P. 15 Exchange Place, Suite 800, Jersey City, NJ 07302 JANNEY MONTGOMERY SCOTT, LLC 1801 Market Street, Tenth Floor, Philadelphia, PA 19103 KNIGHT EQUITY MARKETS, LP Newport Tower, 525 Washington Boulevard, Jersey City, NJ 07310 MONROE SECURITIES, INC. 343 West Erie, Suite 410, Chicago, IL 60610 PERSHING TRADING COMPANY, LP 1 Pershing Plaza, Jersey City, NJ 07399 RBC CAPITAL MARKETS CORPORATION 60 South Street, PO Box 1160, Minneapolis, MN 55402 RYAN BECK & CO., INC. 18 Columbia Turnpike, Florham Park, NJ 07932 SANDLER O'NEILL & PARTNERS, LP 919 Third Avenue, Sixth Floor, New York, NY 10022 SCHWAB SOUNDVIEW CAPITAL MARKETS 111 Pavonia Avenue, East Jersey City, NJ 07310 annual highlights 2004 citizens & northern bank offices ATHENS MUNCY 428 South Main Street, Athens, PA 18810 3461 Route 405 Highway, Muncy, PA 17756 570-888-2291 570-546-6666 DUSHORE RALSTON 111 Main Street, Dushore, PA 18614 Thompson Street, Ralston, PA 17763 570-928-8124 570-995-5421 EAST SMITHFIELD SAYRE Main Street, East Smithfield, PA 18817 503 North Elmira Street, Sayre, PA 18840 570-596-3131 570-888-2220 ELKLAND SOUTH WILLIAMSPORT 104 Main Street, Elkland, PA 16920 2 East Mountain Ave., South Williamsport, PA 17702 814-258-5111 570-601-3016 KNOXVILLE TIOGA 102 East Main Street, Knoxville, PA 16928 Main Street, Tioga, PA 16946 814-326-4151 570-835-5236 LAPORTE TOWANDA Main Street, Laporte, PA 18626 428 Main Street, Towanda, PA 18848 570-946-4011 570-265-6171 LIBERTY TROY Main Street, Liberty, PA 16930 Court House Square, Troy, PA 16947 570-324-2331 570-297-2158 MANSFIELD WELLSBORO 1085 South Main Street, Mansfield, PA 16933 90-92 Main Street, Wellsboro, PA 16901 570-662-1111 570-724-3411 MONROETON WILLIAMSPORT Route 220, Monroeton, PA 18832 130 Court Street, Williamsport, PA 17701 570-265-2157 570-320-0100 WYSOX Route 6, Wysox, PA 18854 570-265-9148
annual highlights 2004 [PHOTO OF CRAIG G. LITCHFIELD] shareholders' message insight craig g. litchfield, chairman, president, CEO the year in review We had plenty to keep us busy during 2004. Among the many initiatives were a core processing system conversion, the opening of two new offices in the Williamsport area, executing a definitive agreement to acquire Canisteo Valley Corporation and its subsidiary First State Bank, reorganizing our commercial banking management structure, complying with new SEC corporate governance requirements, applying for listing on the NASDAQ Small Cap market and striving for continued excellence in customer service. With the commitment of your board of directors and the smart and dedicated people of Citizens & Northern, we have achieved our objectives. We are well positioned for more growth throughout our existing and new market areas. Our future plans for the Lycoming/Williamsport market include the addition of two new offices that should provide the delivery platforms for expanding our share of the retail market. For many years, we have believed that entry into the Southern Tier of New York holds opportunity for a locally focused community bank. With the future acquisition of First State Bank as a subsidiary of Citizens & Northern Corporation, we will be positioned to expand the Citizens & Northern market. It is hoped that the acquisition will be finalized by the second quarter of 2005. We are pleased that the First State Bank board and employees share our commitment to customer excellence. This combination will be beneficial to all stakeholders. Your board of directors authorized us to apply for listing our stock on the NASDAQ Small Cap market. It is hoped and expected that listing on the NASDAQ will provide more liquidity for current investors and will attract investment managers looking to add a strong company like C&N to their portfolios. On January 13th, 2005, our stock began trading on the NASDAQ SM under the symbol CZNC. Last year, our prediction for the equity and bond markets was right on target. The equity markets ended the year with respectable gains. The NASDAQ Composite was up 8.59%, the S&P 500 was up 10.87% and the Dow Jones industrial Average increased 3.15%. And as expected, the Federal Reserve began increasing its Fed Funds rate by 25 basis point increments beginning in June 2004. In total, the Federal Reserve increased the Fed Funds rate 5 times during the second half of 2004 to 2.25%. At the same time longer-term treasury rates (5-year and longer) remained relatively stable with inflation concerns under control. For banking, this means higher costs for funds and little, if any, increase in rates on loans and fixed income investments. It would appear that the Fed is positioned to increase the Fed Funds rate few more times during 2005, increasing the rate to the 3% to 4% range. Unless fears of inflation appear, it is likely that the longer-term rates will not increase at a similar pace. The national economic growth is still strong, albeit slowing, thus the year should be another good one for the equity markets. (Continued Page 2) page ---- ONE annual highlights 2004 [PHOTO OF CRAIG G. LITCHFIELD] shareholders' message insight craig g. litchfield, chairman, president, CEO financial highlights During 2004, we continued to grow our interest and dividend income while we reduced our interest expense. As a result, our interest margin increased by $3.63 million, or nearly 11.5% over 2003. This growth in interest margin was primarily driven by the 10.4% increase in our loan portfolio. During 2003, several of the bank stocks we held in our investment portfolios had appreciated to, what we believed to be, exceptionally high levels, and we decided to reap the gains that those levels offered. That strategy proved correct because many of those stocks later dropped in price during 2004. The same environment was not prevalent during 2004, and the opportunities for gains in what we believed to be well-valued securities were not as numerous. As a result, our gains on securities dropped by $1.9 million, or 40%. an investment in the future During 2004, we had substantial increases in operating expenses related to the core computer conversion and the start-up expenses and operations for the two new Williamsport area offices. Those additional expenses totaled more than $1.5 million. Another increase in expenses, $1.3 million, was due to the addition of new positions. These increased expenses are an investment in the future growth potential of your company's market share and net income. Total assets increased to $1.123 billion, up 5.3%. Deposits, including repo sweeps, increased to $697.7 million, 2.39%, despite the runoff of nearly $30 million in municipal deposits due to new school building projects. Trust assets under management increased $16.2% to $383 million. Shareholder equity, excluding unrealized gains and losses on available-for-sale securities, as a percentage of total assets remained fairly stable at 10.72%. Non-performing loans increased substantially above our historical average, and we are closely monitoring the portfolio and are continuing to maintain an adequate allowance for loan losses. Our 4th quarter dividend increased to 23 cents per share, bringing total dividends declared for 2004 to 89 cents, up 4.7%. (Continued Page 3) page - ---- TWO annual highlights 2004 [PHOTO OF CRAIG G. LITCHFIELD] shareholders' message insight craig g. litchfield, chairman, president, CEO products and services Our Trust and Financial Management Group saw substantial growth in its assets under management during 2004. This growth will continue for some time to come. The Daily Valuation 401 (k) product is proving very attractive to area employers. Our Internet Banking Service has over 8,500 retail customers realizing the convenience and security of banking over the Internet. Internet Banking is one more way we enhance our value to our customers. projects In addition to the acquisition of First State Bank, we have several projects planned for 2005. The growth in administrative, trust and commercial lending staff has put us in need of more room. To meet that need, a new administrative building will be erected within two blocks of the Wellsboro main office. The facility will provide about 17,000 square feet of room. In Lycoming County, we have sales agreements on two sites for future full service offices. We will begin the construction of a full service facility in Jersey Shore by the second quarter of the year. The construction of the second building will most likely begin by the end of the year. We are in a growth mode that positions us for continued increases in assets and net income. people It is our people who provide us the opportunity for optimism about our future. Without the commitment and dedication of our team members, our expectations for success as we enter new markets would not exist. The C&N team is committed to continually improving its customer service. As time passes, the proverbial change of the guard occurs. During 2004, six of our longer term employees retired from banking: Russ Bauman after 33 years, Brian Canfield after 25 years, Carol Tobias after 21 years, Elaine Johnston after 20 years, Beverly Heatley after 17 years and Klas Anderson after 16 years. We will miss their 132 years of experience and commitment to C&N. We wish them the best for the future. page ---- THREE annual highlights 2004 five-year performance [PICTURE] net income (in millions) [BAR CHART] 2000 $ 8.5 2001 $12.1 2002 $15.0 2003 $16.3 2004 $14.9
total shareholders' equity (in millions) [BAR CHART] 2000 $ 89.0 2001 $100.2 2002 $115.8 2003 $125.3 2004 $131.6
total assets (in millions) [BAR CHART] 2000 $ 719 2001 $ 867 2002 $1,019 2003 $1,067 2004 $1,123
deposits (in millions) [BAR CHART] 2000 $529 2001 $576 2002 $640 2003 $658 2004 $677
page - ---- FOUR annual highlights 2004 five-year performance [PICTURE] net loans (in millions) [BAR CHART] 2000 $323 2001 $374 2002 $445 2003 $519 2004 $573
cash dividends declared [BAR CHART] 2000 $0.65 2001 $0.71 2002 $0.77 2003 $0.85 2004 $0.89
*Cash dividends per share for 2000-2002 adjusted for the effects of a 3-for-2 stock split issued in April, 2003. In addition to cash dividends, a 1% stock dividend has been declared for each year. stockholder inquiries A copy of the Corporation's Annual Report on Form 10-K for the year ended December 31, 2004, 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 through C&N's website at www.cnbankpa.com and 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. page ---- FIVE annual highlights 2004 quarterly share data [PICTURE] Trades of the Corporation's stock are executed through various brokers who maintain a market in the Corporation's stock. Effective January 13, 2005 the Corporation's stock began to be listed on the NASDAQ SmallCap Market with the trading symbol CZNC. Previously, the Corporation's stock was available through the Over-The-Counter Bulletin Board. The following table sets forth the approximate high and low sales prices of the common stock during 2004 and 2003: 2004
Dividend Declared High Low per quarter First Quarter $27.00 $25.00 $0.22 Second Quarter $25.50 $24.45 $0.22 Third Quarter $25.90 $24.20 $0.22 Fourth Quarter $27.00 $24.80 $0.23
plus 1% stock dividend 2003
Dividend Declared High Low per quarter First Quarter $21.63 $20.37 $0.21 Second Quarter $26.95 $21.00 $0.21 Third Quarter $26.95 $25.80 $0.21 Fourth Quarter $27.00 $25.80 $0.22
plus 1% stock dividend page - ---- SIX annual highlights 2004 common stock and per share data [PICTURE]
2004 2003 2002 2001 2000 Net income per share - basic $ 1.82 $ 1.99 $ 1.83 $ 1.47 $ 1.03 Net income per share - diluted $ 1.81 $ 1.98 $ 1.83 $ 1.47 $ 1.03 Cash dividends declared per share $ 0.89 $ 0.85 $ 0.77 $ 0.71 $ 0.65 Stock dividend 1% 1% 1% 1% 1% Stockholders' equity per share (a) $ 16.08 $ 15.33 $ 14.18 $ 12.26 $ 10.84 Stockholders' equity per share, excluding accumulated other comprehensive income (loss) (a) $ 14.79 $ 13.86 $ 12.69 $ 11.61 $ 10.83 Weighted average shares outstanding- basic 8,185,466 8,170,651 8,170,159 8,184,716 8,206,549 Weighted average shares outstanding - diluted 8,233,992 8,219,366 8,192,047 8,206,604 8,208,297 Number of shares outstanding at year-end 8,102,646 8,014,625 5,285,606 5,234,800 5,207,244 Number of shares authorized 20,000,000 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 a 3-for-2 stock split issued in April, 2003, and for 1% stock dividends issued in January following each year-end. Contact us [PICTURE] Our service departments may be contacted directly: FUNDS MANAGEMENT: 90-92 Main St., Wellsboro, PA 16901 - 1-800-577-9397 ACCOUNT SERVICES: 90-92 Main St., Wellsboro, PA 16901 - 1-800-726-2265 BANKCARD SERVICES: RR#7, Wellsboro, PA 16901 - 1-800-676-6639 INTERNET BANKING: 90-92 Main St., Wellsboro, PA 16901 - 570-724-0266 www.cnbankpa.com C&N FINANCIAL SERVICES CORP: 64 Main St., Wellsboro, PA 16901 1-866-ASK-CNFS www.cnfinancialservices.com TRUST & FINANCIAL MANAGEMENT GROUP: 90-92 Main St., Wellsboro, PA 16901 - 1-800-487-8784 503 North Elmira St., Sayre, PA 18840 - 1-888-760-8192 428 Main St., Towanda, PA 18848 - 1-888-987-8784 130 Court St., Williamsport, PA 17701 - 1-866-732-7213 page ----- SEVEN annual highlights 2004 five-year summary of operations Profit [PICTURE] (In thousands) INCOME STATEMENT
2004 2003 2002 2001 2000 Interest income $ 57,922 $ 55,223 $ 57,285 $ 54,661 $ 51,643 Interest expense $ 22,606 $ 23,537 $ 26,315 $ 28,356 $ 30,145 ========== ========== ========== ========== ========== Interest margin $ 35,316 $ 31,686 $ 30,970 $ 26,305 $ 21,498 Provision for loan losses $ 1,400 $ 1,100 $ 940 $ 600 $ 676 ========== ========== ========== ========== ========== Interest margin after provision for loan losses $ 33,916 $ 30,586 $ 30,030 $ 25,705 $ 20,822 Other income $ 6,922 $ 6,595 $ 6,624 $ 6,120 $ 5,002 Securities gains $ 2,877 $ 4,799 $ 2,888 $ 1,920 $ 1,377 Other expenses $ 26,001 $ 22,114 $ 20,849 $ 18,671 $ 16,906 ========== ========== ========== ========== ========== Income before income tax provision $ 17,714 $ 19,866 $ 18,693 $ 15,074 $ 10,295 Income tax provision $ 2,851 $ 3,609 $ 3,734 $ 3,022 $ 1,819 ========== ========== ========== ========== ========== Net income $ 14,863 $ 16,257 $ 14,959 $ 12,052 $ 8,476 ========== ========== ========== ========== ========== BALANCE SHEET AT YEAR END Total securities (1) $ 479,626 $ 484,825 $ 513,597 $ 437,398 $ 343,596 Gross loans, excluding unearned discount $ 579,613 $ 524,897 $ 451,145 $ 379,228 $ 328,305 Total assets $1,123,002 $1,066,901 $1,018,768 $ 866,999 $ 719,335 Total deposits $ 676,545 $ 658,065 $ 640,304 $ 576,274 $ 528,967 Stockholders' equity, excluding accumulated other comprehensive income (3) $ 121,050 $ 113,306 $ 103,691 $ 94,903 $ 88,887 Total stockholders' equity $ 131,585 $ 125,343 $ 115,837 $ 100,187 $ 88,969 ========== ========== ========== ========== ==========
page - ----- EIGHT annual highlights 2004 five-year summary of operations Profit [PICTURE] (In thousands) AVERAGE BALANCE SHEET
2004 2003 2002 2001 2000 Total securities, at amortized cost (1) $ 485,182 $ 474,406 $ 470,764 $ 412,654 $ 371,360 Gross loans, excluding unearned discount $ 551,352 $ 485,150 $ 410,670 $ 346,353 $ 318,382 Earning assets $ 1,036,534 $ 959,556 $ 881,434 $ 759,007 $ 689,743 Total assets $ 1,114,040 $ 1,034,720 $ 943,001 $ 805,229 $ 704,221 Total assets excluding unrealized gains/losses (3) $ 1,097,858 $ 1,014,424 $ 930,539 $ 798,590 $ 717,052 Total deposits $ 669,307 $ 651,026 $ 613,392 $ 544,579 $ 503,848 Stockholders' equity, excluding accumulated other comprehensive income (3) $ 117,695 $ 108,876 $ 99,361 $ 91,703 $ 87,258 Stockholders' equity $ 128,374 $ 122,271 $ 107,595 $ 96,021 $ 78,792 =========== =========== ========= ========= ========= FINANCIAL RATIOS Return on stockholders' equity, excluding accumulated other comprehensive income (2), (3) 12.63% 14.93% 15.06% 13.14% 9.71 Return on stockholders' equity (2) 11.58% 13.30% 13.90% 12.55% 10.76% Return on assets (2) 1.33% 1.57% 1.59% 1.50% 1.20% Stockholders' equity to assets, excluding accumulated other comprehensive income (2), (3) 10.72% 10.73% 10.68% 11.48% 12.17% Stockholders' equity to assets (2) 11.52% 11.82% 11.41% 11.92% 11.19% Stockholders' equity to loans (2) 23.28% 25.20% 26.20% 27.72% 24.75% Net income to: Total interest income 25.66% 29.44% 26.11% 22.05% 16.41% Interest margin 42.09% 51.31% 48.30% 45.82% 39.43% Dividends as a % of net income 48.54% 41.96% 41.17% 46.08% 60.19% =========== =========== ========= ========= =========
(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. (3) Generally accepting accounting principles ("GAAP") require that available-for-sale securities be reported at fair value, with unrealized gains and losses excluded from earnings and reported separately through stockholders' equity, net of tax. Management believes there is an inherent mismatch between the income statement and balance sheet related to unrealized gains/losses that may create a material inconsistency in earnings-based ratios. Further, the amount of unrealized gains/losses may vary widely from period-to-period, depending on the financial markets as a whole and interest rate movements. Therefore, management has provided these "non-GAAP" amounts and ratios because we believe they provide meaningful information for evaluating the Corporation's financial position and results of operations. page ---- NINE ANNUAL HIGHLIGHTS 2004 quarterly financial DATA [PICTURE] The following table presents summarized quarterly financial data for 2004 (unaudited) (In thousands, except per share data) 2004 QUARTER ENDED
MARCH 31 JUNE 30 SEPT. 30 DEC. 31 -------- -------- -------- -------- Interest income $ 14,015 $ 14,343 $ 14,573 $ 14,991 Interest expense $ 5,703 $ 5,493 $ 5,665 $ 5,745 ======== ======== ======== ======== Interest margin $ 8,312 $ 8,850 $ 8,908 $ 9,246 Provision for loan losses $ 350 $ 350 $ 350 $ 350 ======== ======== ======== ======== Interest margin after provision for loan losses $ 7,962 $ 8,500 $ 8,558 $ 8,896 Other income $ 1,625 $ 1,855 $ 1,627 $ 1,815 Securities gains $ 964 $ 321 $ 459 $ 1,133 Other expenses $ 6,228 $ 6,289 $ 6,738 $ 6,746 ======== ======== ======== ======== Income before income tax provision $ 4,323 $ 4,387 $ 3,906 $ 5,098 Income tax provision $ 617 $ 698 $ 501 $ 1,035 ======== ======== ======== ======== Net income $ 3,706 $ 3,689 $ 3,405 $ 4,063 ======== ======== ======== ======== Net income per share - basic $ 0.45 $ 0.45 $ 0.42 $ 0.50 ======== ======== ======== ======== Net income per share - diluted $ 0.45 $ 0.45 $ 0.41 $ 0.49 ======== ======== ======== ========
INVESTOR INFORMATION [PICTURE] Independent Auditors PARENTE RANDOLPH, PC 400 Market Street, Williamsport, PA 17701 INFORMATION FOR INVESTORS The Annual Meeting of Shareholders will be held in the Arcadia Theater, Wellsboro, PA at 2:00 p.m. Tuesday, April 19th, 2005. General shareholder inquiries should be sent to: CITIZENS & NORTHERN CORPORATION 90-92 Main Street, PO 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 page - ---- TEN ANNUAL HIGHLIGHTS 2004 quarterly financial DATA [PICTURE] The following table presents summarized quarterly financial data for 2003 (unaudited) (In thousands, except per share data) 2003 QUARTER ENDED
MARCH 31 JUNE 30 SEPT. 30 DEC. 31 -------- ------- -------- ------- Interest income $13,930 $13,943 $13,553 $13,797 Interest expense $ 6,243 $ 6,089 $ 5,655 $ 5,550 ======= ======= ======= ======= Interest margin $ 7,687 $ 7,854 $ 7,898 $ 8,247 Provision for loan losses $ 350 $ 250 $ 250 $ 250 ======= ======= ======= ======= Interest margin after provision for loan losses $ 7,337 $ 7,604 $ 7,648 $ 7,997 Other income $ 1,540 $ 1,628 $ 1,705 $ 1,722 Securities gains $ 1,721 $ 908 $ 660 $ 1,510 Other expenses $ 5,532 $ 5,356 $ 5,336 $ 5,890 ======= ======= ======= ======= Income before income tax provision $ 5,066 $ 4,784 $ 4,677 $ 5,339 Income tax provision $ 994 $ 864 $ 759 $ 992 ======= ======= ======= ======= Net income $ 4,072 $ 3,920 $ 3,918 $ 4,347 ======= ======= ======= ======= Net income per share - basic $ 0.50 $ 0.48 $ 0.48 $ 0.53 ======= ======= ======= ======= Net income per share - diluted $ 0.50 $ 0.48 $ 0.48 $ 0.53 ======= ======= ======= =======
page ---- ELEVEN annual highlights 2004 trust and financial management group
2004 2003 2002 2001 2000 (IN THOUSANDS) ---- ---- ---- ---- ---- Assets $ 383,062 $ 329,493 $ 285,221 $ 303,868 $ 327,063 Revenue $ 2,105 $ 1,733 $ 1,755 $ 1,576 $ 1,613
The composition of trust assets under management and accounts as of December 31, 2004 and 2003 are shown in the following table: (IN THOUSANDS)
INVESTMENTS 2004 2003 ACCOUNTS 2004 2003 - ----------- ---- ---- -------- ---- ---- Mutual Funds $129,299 $ 93,804 Pension/profit Stocks $118,334 $109,145 sharing $162,129 $130,986 Bonds $107,954 $ 99,307 Investment Savings and management $120,237 $ 98,652 Money Market Trusts $ 84,043 $ 82,890 Funds $ 24,826 $ 24,893 Custody $ 12,459 $ 8,583 Real Estate $ 1,199 $ 901 Guardianships $ 1,177 $ 903 Miscellaneous $ 1,007 $ 1,217 Estates $ 3,017 $ 7,479 Mortgages $ 443 $ 226 ======== ======== =============== ======== ======== Total $383,062 $329,493 Total $383,062 $329,493
TRUST AND FINANCIAL MANAGEMENT GROUP OFFICERS [PICTURE] Deborah E. Scott, CFP, Executive Vice President and Senior Trust Officer Mark A. Huffman, Vice President and Trust Officer Rhonda J. Litchfield, Vice President and Trust Investment Officer Renee D. Laychur, Vice President and Trust Officer Larry D. Alderson, CFP, Assistant Vice President and Trust Officer Michael G. Charles, Assistant Vice President and Tax Officer Keith T. Safford, Employee Benefit Officer Mary J. Wood, Trust Officer Lori Brown, Trust Officer James D. Butters, Assistant Trust Officer Marla McIlvain, Assistant Trust officer page ---- TWELVE annual highlights 2004 citizens & northern corporation, bank officers [PICTURE] 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 MEMBERS ATHENS AND SAYRE --------------------- ----------------------- --------------------- ----------------- Virginia L. Reap Warren J. Croft Max P. Gannon, Jr. R. Bruce Haner Susan E. Hartley George D. Howell Wayne E. Lowery David Rosenbloom Mary Theresa Sullivan 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 Edward L. Learn ELKLAND --------------------- ----------------------- --------------------- ----------------- Lynette Burrous Mary C. Heitzenrater Mark R. Howe John C. Kenyon William W. Roosa KNOXVILLE --------------------- ----------------------- --------------------- ----------------- Amy Wherley Gerald L. Bliss L. Grant Gehman Karl W. Koreck Leonard Simpson LAPORTE --------------------- ----------------------- --------------------- ----------------- Linda M. Etzel David L. Baumunk Robin A. Fiester William B. Saxe Ray E. Wheeland LIBERTY --------------------- ----------------------- --------------------- ----------------- Ann L. Yuscavage Lyle R. Brion Gary L. Dinnison Lawrence F. Mase John F. Wise, Jr. MANSFIELD --------------------- ----------------------- --------------------- ----------------- Diane Wilson Gary Ray Butters Clifford L. Cross, Jr. David Kurzejewski Roger D. Jarrett MUNCY --------------------- ----------------------- --------------------- ----------------- Dawn Myers James R. Fetter, Jr. Kenneth F. Fry Thomas D. Hess RALSTON --------------------- ----------------------- --------------------- ----------------- Courtney Baker George E. Bittner William W. Brooks, III Richard T. Demitras TIOGA --------------------- ----------------------- --------------------- ----------------- Brett Kennedy C.Frederick LaVancher Leisa L. LaVancher Dirk D'Haene TOWANDA AND MONROETON --------------------- ----------------------- --------------------- ----------------- Valerie W. Kinney James A. Bowen W. John Greenland 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 --------------------- ----------------------- --------------------- ----------------- Todd Coolidge 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 WILLIAMSPORT AND SOUTH WILLIAMSPORT --------------------- ----------------------- --------------------- ----------------- Keith Boatman James Bower, Jr. Daniel Mathers Raymond Mattie Ann M. Tyler Steven Uzupis WYSOX --------------------- ----------------------- --------------------- ----------------- Debra S. Kitchart Lucille P. Donovan Robert L. Fulmer Gary Hennip Mark W. Smith Walter E. Warburton, Jr.
page ---- THIRTEEN annual highlights 2004 citizens & northern, bank officers [PICTURE] CITIZENS & NORTHERN BANK OFFICERS
Name Title Branch Craig G. Litchfield Chairman, President and Chief Executive Officer Wellsboro Dawn A. Besse Executive Vice President and Director of Sales, Service Wellsboro and Employee Development Mark A. Hughes Executive Vice President and Chief Financial Officer Wellsboro Thomas L. Rudy, Jr. Executive Vice President and Director of Branch Delivery Wellsboro Deborah E. Scott Executive Vice President and Senior Trust Officer Wellsboro Thomas L. Briggs Vice President - Facilities Management Wellsboro Carl M. Chambers Vice President/Western Region Commercial Team Leader Wellsboro Rick J. Cisco Vice President and Senior Systems Analyst Wellsboro Terry R. Depew Vice President/Regional Lending Specialist Sayre Helen W. Ferris Vice President and Branch Manager Dushore Marisa A. Flynn Vice President/Loan Administrator Williamsport Mark C. Griffis Vice President/Branch Manager Troy Roberta C. Heck Vice President and Western Regional Executive Wellsboro Harold F. Hoose, III Vice President/Eastern Region Commercial Team Leader Sayre Mark A. Huffman Vice President and Trust Officer Williamsport Michelle M. Karas Vice President and Marketing Coordinator Williamsport Scott A. Keck Vice President and Branch Operations Coordinator Wellsboro Karen L. Keck Vice President and Deposit Operations Coordinator Wellsboro Renee D. Laychur Vice President and Trust Officer Williamsport James P. Lazorka Vice President and Southern Regional Executive Williamsport Rhonda J. Litchfield Vice President and Trust Investment Officer Wellsboro Daniel Manetta Vice President and Director of Education Williamsport Glenda R. Marzo Vice President and Internal Auditor Wellsboro Kim L. Miller Vice President and Regional Lending Specialist Wellsboro Kathleen M. Osgood Corporate Secretary Wellsboro James E. Parks Vice President and Eastern Regional Executive Towanda Philip A. Prough Vice President/Manager of Brokerage Services Wellsboro John M. Reber Vice President and Director of Risk Management Wellsboro James H. Shelmire Vice President and Senior Systems Analyst Wellsboro Bruce Smithgall Vice President/Southern Regional Commercial Team Leader Williamsport Joseph A. Snell Vice President and Comptroller Towanda Nancy L. Tubbs Vice President, Compliance Officer and IRA Administrator Wellsboro Kevin Weinhoffer Vice President/Commercial Lending Williamsport Ann L. Yuscavage Vice President and Branch Manager Liberty Jeffery E. Aeppli Assistant Vice President/Commercial Loan Officer Wysox Larry D. Alderson Assistant Vice President and Trust Officer Sayre Darci Baird Assistant Vice President-Senior Financial Consultant Sayre Keith A. Boatman Assistant Vice President and Branch Manager Williamsport Peter J. Boergermann Assistant Vice President-Senior Network Engineer Wellsboro Rosalie L. Bordas Assistant Vice President/Account Services Manager Wellsboro Coleen Bowen Assistant Vice President/Mortgage Lending Specilist Wellsboro Lori Brown Trust Officer Towanda Peggy A. Brown Assistant Vice President and Branch Manager East Smithfield Keith C. Cavanaugh Assistant Vice President/BankCard Sales Manager BankCard Services Michael G. Charles Assistant Vice President and Tax Officer Wellsboro
page ---- FOURTEEN annual highlights 2004 CITIZENS & NORTHERN BANK OFFICERS
Name Title Branch ---- ----- ------ Todd Coolidge Assistant Vice President and Branch Manager Wellsboro Shelley L. D'Haene Internet Banking Coordinator Wellsboro Linda M. Etzel Assistant Vice President and Branch Manager Laporte Joan L. Grenell Assistant Vice President/Staff Accountant Towanda William C. Holmes Assistant Vice President/Loan Officer Troy Brett W. Kennedy Assistant Vice President and Branch Manager Tioga Valerie W. Kinney Assistant Vice President and Branch Manager Towanda Debra S. Kithcart Assistant Vice President and Branch Manager Wysox Steven J. Moore Assistant Vice President/Workout and Recovery Officer Williamsport Dawn L. Myers Assistant Vice President and Branch Manager Muncy Jeffrey B. Osgood Human Resource Director Wellsboro Eileen K. Ranck Assistant Vice President and BankCard Services Manager BankCard Services Virginia L. Reap Assistant Vice President and Branch Manager Athens Christopher J. Rell Assistant Vice President/Appraisal Department Manager Williamsport David C. Schucker Assistant Vice President/Loan Officer Troy Stacey A. Sickler Assistant Vice President/Manager Mortgage Lending Sayre Mary J. Wood Assistant Vice President and Trust Officer Wellsboro Sandra G. Andrews Assistant Cashier/Customer Investment Rep/Trust Wellsboro Courtney Baker Assistant Cashier and Branch Manager Ralston Deborah K. Beck Assistant Cashier/Loan Officer Tioga Margaret J. Black Assistant Cashier/Loan Officer Laporte Joan M. Blackwell Assistant Cashier/Loan Officer Liberty Alison S. Broughton Assistant Cashier/Loan Officer Wellsboro Claudia Brown Assistant Cashier and Operations Manager Wellsboro Lynette M. Burrous Assistant Cashier and Branch Manager Elkland James D. Butters Assistant Trust Officer Wellsboro Marcella J. Chaykosky Assistant Cashier/Loan Officer Sayre Charlene R. Clark Assistant Cashier and Operations Manager Wellsboro William O. Cook Assistant Cashier/Assistant BankCard Sales Manager Wellsboro Dorine M. Crisman Assistant Cashier/Loan Officer Wysox Raechelle N. Curry Assistant Cashier/Loan Officer Dushore Mark W. Elsbree Assistant Cashier/Loan Officer Sayre Diane B. Elvidge Assistant Cashier/Teller East Smithfield Yvonne M. Gill Assistant Cashier/Advertising and PR Manager Wellsboro Linda L. Gordner Assistant Cashier/Loan Officer Muncy George M. Greeley Assistant Cashier/Loan Officer Wellsboro Kathy L. Griffis Assistant Cashier/Loan Officer Athens Teri L. Hackett Assistant Cashier and Funds Management Officer Wellsboro Rosalie H. Hall Assistant Cashier and Branch Operations Manager Troy Kelly Isaacson Assistant Cashier/Loan Officer Mansfield Matthew A. Kranz Assistant Cashier/Mortgage Lending Specialist South Williamsport Marla Mcllvain Assistant Trust Officer Wellsboro Sandra J. McNeal Assistant Cashier/Loan Officer East Smithfield Sandra A. Parulas Assistant Cashier/Teller and CSR Specialist Wellsboro David Poust Assistant Cashier/Commercial Loan Officer Muncy Joan E. Rohe Assistant Cashier and Staff Accountant Towanda Amir Sabanovic Assistant Cashier/Commercial Loan Officer Sayre Keith T. Safford Employee Benefit Officer/Trust Williamsport Linda Prough-Shuey Assistant Cashier/Human Resource Administrator Wellsboro Chad R. Smith Assistant Cashier/Loan Officer Towanda Wendy Smith Assistant Cashier/Assistant Account Services Manager Wellsboro Debra J. Topf Assistant Cashier/Loan and CSR Specialist Wellsboro Amy B. Wherley Assistant Cashier/Branch Manager Knoxville Brenda B. Whiteley Assistant Cashier/Loan Officer Dushore Diane K. Wilson Assistant Cashier and Branch Manager Mansfield
page ---- FIFTEEN annual highlights 2004 citizens & northern bank board of DIRECTORS [PICTURE] Our 2005 Board of Directors, seated, left to right: Karl W. Kroeck, Jan E. Fisher, Ann M. Tyler, Edward L. Learn, Leonard Simpson, J. Robert Bower and Leo F. Lambert; standing, left to right: F. David Pennypacker, R. Robert DeCamp, R. Bruce Haner, Susan E. Hartley, Dennis F. Beardslee, Craig G. Litchfield, James E. Towner and Edward H. Owlett III. BOARD OF DIRECTORS: Leo F. Lambert, President and General Ann M. Tyler, Certified Public Accountant, Dennis F. Beardslee, Owner, Terrace Lanes Manager, Fitzpatrick & Lambert, Inc. Ann M. Tyler CPA, PC Bowling Center Edward L. Learn, former owner, Learn DIRECTORS EMERITI R. Robert DeCamp, President, Patterson Hardware and Building Supply J. Robert Bower, Pharmacist Lumber Co., Inc. Craig G. Litchfield, Chairman of the Board, F. David Pennypacker, Retired, formerly Jan E. Fisher, Executive Director for President and Chief Executive Officer Certified Public Accountant, Pennypacker Healthcare Services, Laurel Health System & Gooch, PC Edward H. Owlett, III, President and CEO R. Bruce Haner, auto buyer for new car of Putnam Company Lawrence F. Mase, Retired, formerly dealers president of Mase's, Inc. Susan E. Hartley, Attorney at Law Leonard Simpson, Attorney at Law Donald E. Treat, Retired, former owner James E. Towner, Publisher of the Daily of Treat Hardware Karl W. Kroeck, farmer and Sunday Review
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