2003 annual report to shareholders
 
 

 


 
 cover page    

 
2 0 0 3
A N N U A L   R E P O R T

1 FINANCIAL HIGHLIGHTS


3 MESSAGE TO SHAREHOLDERS


5 CONSOLIDATED BALANCE SHEET


6 CONSOLIDATED STATEMENT OF INCOME


7 CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY


8 CONSOLIDATED STATEMENT OF CASH FLOWS


9 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


33 REPORT OF INDEPENDENT AUDITORS


34 SELECTED FINANCIAL DATA


36 MANAGEMENT’S DISCUSSION AND ANALYSIS


56 DIRECTORS, OFFICERS AND COMMUNITY OFFICES
 
 inside cover    

 
 

 


 
     

 

CONSOLIDATED FINANCIAL HIGHLIGHTS

 

(dollars in thousands, except per share data)
   
2003
   
2002
 
BALANCE SHEET
   
 
   
 
 



 
Assets
 
$
463,878
 
$
432,658
 
Deposits
   
385,691
   
373,051
 
Net Loans
   
314,037
   
294,836
 
Investments
   
106,587
   
100,725
 
Stockholders' Equity
   
38,529
   
38,406
 
 
   
 
   
 
 
STATEMENT OF INCOME
   
 
   
 
 



 
Interest Income
   
25,615
   
27,377
 
Interest Expense
   
8,826
   
10,404
 
Net Interest Income
   
16,789
   
16,973
 
Net Income
   
4,879
   
5,595
 
 
   
 
   
 
 
PER SHARE DATA
   
 
   
 
 



 
Net Income
   
1.72
   
1.96
 
Cash Dividends
   
0.74
   
0.68
 
 
   
 
   
 
 
TRUST DEPARTMENT
   
 
   
 
 



 
Trust Assets Managed
   
70,384
   
65,171
 
 
 CITIZENS FINANCIAL SERVICES, INC.          2   2003 ANNUAL REPORT 

 
 
MESSAGE TO SHAREHOLDERS

 
   
To Our Shareholders, Customers and Friends,
 
The year 2003 was one in which significant changes occurred at Citizens Financial Services, Inc. After serving 22 years as President, Richard E. Wilber announced his retirement. He presided over years of growth and prosperity, and the excellent condition of the Company is testament to his leadership. As Interim President I am pleased to report that the Company is continuing to prosper, this in great part due to the able staff Dick had in place at the time of his retirement.
 
A change in leadership can often lead to other changes, such as the loss of key management team members or even something more significant such as a change in ownership. In our case, however, neither occurred. The Board of Directors immediately decided that Citizens Financial Services, Inc. will remain independent. To date, key individuals remain on-board and committed to the success of the Company. We believe our reputation as a quality financial services provider in the three counties we serve will provide a solid foundation for continued growth. The search for the next President is well underway. Needless to say, the process is moving forward carefully and deliberately to ensure we select an individual who is well suited to effectively lead a growing, rural community bank. The shareholders and public will be notified soon after the appointment is made.
 

 

   
These are interesting and unusual economic times. The long period of low interest rates is having considerable impact on the performance of the First Citizens National Bank (the "Bank"), the wholly owned subsidiary of Citizens Financial Services, Inc. In such an environment, the lower rates paid on deposit accounts result in reduced interest expense to the Bank. For the same reason, loan demand increases, especially home mortgages. In fact, in 2003, the Bank originated a record number of loans making us again the number one mortgage lender in the Northern Tier. However, lower interest rates also fuel refinancing which leads to less than expected interest income. These issues challenge banks to effectively manage their net interest income margin in order to continue to experience positive growth in net interest income. I am pleased to report that we succeeded in this challenge by maintaining a net interest margin above peers for the second consecutive year. The low interest rate environment inevitably challenges the Bank’s management of its investment portfolio. During 2003 we continued to experience significant cash flow from our mortgage backed securities monthly principal repayments, the proceeds of which were used to support our continued loan growth. Thus it is not surprising the income from the portfolio was less than in 2002.
 
 
 CITIZENS FINANCIAL SERVICES, INC.  3 2003 ANNUAL REPORT 

 

MESSAGE TO SHAREHOLDERS

Despite the challenges, the Company continued to make good progress. Assets grew to $463.9 million or 7.2% and deposits to $385.7 million or 3.4%. We
experienced 6.5% loan growth or $19.2 million. In addition, $22 million in mortgages were originated and sold, compared to $11.9 million in 2002, thereby reducing the Bank’s future exposure to the effects of increasing interest rates. Earnings per share were $1.72 compared with $1.96 in 2002. However, it should be noted for comparison purposes that without the non-recurring charge for Dick Wilber’s retirement package, the earnings would have been $1.91. The average value of Citizens Financial stock was $24.00 a share, an increase of 13% over 2002 and 71% over the past two years. Cash dividends of $.74 were paid in 2003 compared to $.68 in 2002.
The Bank’s non-interest expense and efficiency ratio are still higher than that of our peers. The Bank continues to identify areas that can be addressed in order to achieve an efficiency ratio more in line with the peer group.
We also recognize the growing need for the effective delivery of Financial Planning and Wealth Management services. We have made significant strides in further developing the relationships of existing customers through the sale of other financial services. We must however, recognize greater efficiencies in this area. A plan to produce higher returns through increased sales and restructuring of costs is near completion.
As I stated earlier, the Board of Directors has made it clear that Citizens Financial Services, Inc. will remain independent and that modest growth is not an option. Therefore, we shall continue to identify opportunities to increase assets that may include the establishment or acquisition of new branches. To ensure sufficient capital is available for such activities, the Board decided in December 2003 to participate in a Trust Preferred transaction. Using Trust Preferred Pooled securities, the Company borrowed $7.5 million at favorable rates and re-invested the proceeds to cover the cost of the borrowing until such time as when the funds may be needed for potential acquisition activities. The year 2004 promises to be an exciting year for Citizens Financial Services, Inc., its shareholders, customers and employees.
In these days of mega bank mergers, we believe that a bank such as ours plays a vital role in contributing to the success of the communities and customers we serve. Citizens Financial Services, Inc. continues to invest both time and money in various organizations that make our towns and villages flourish. We are committed to continuing this support.
It is my pleasure to present this report to you, our shareholders, friends, and employees and thank the Directors for the privilege of serving as Interim President.
 
 Sincerely,
 
 John M. Thomas
 Interim President
 
 
 CITIZENS FINANCIAL SERVICES, INC.  4 2003 ANNUAL REPORT 

 

CONSOLIDATED BALANCE SHEET


 
 
December 31,
(in thousands)
 
2003
2002
ASSETS:
 
 
 
Cash and due from banks:
 
 
 
Noninterest-bearing
 
$
9,624
 
$
11,173
 
Interest-bearing
   
327
   
421
 


 
 
Total cash and cash equivalents
   
9,951
   
11,594
 
Available-for-sale securities
   
106,587
   
100,725
 
Loans (net of allowance for loan losses
   
 
   
 
 
2003, $3,620; 2002, $3,621)
   
314,037
   
294,836
 
Premises and equipment
   
10,645
   
11,245
 
Accrued interest receivable
   
1,703
   
1,976
 
Goodwill
   
6,905
   
6,905
 
Core deposit intangible
   
978
   
1,413
 
Bank owned life insurance
   
7,142
   
-
 
Other assets
   
5,930
   
3,964
 

 
 
 
TOTAL ASSETS
 
$
463,878
 
$
432,658
 

 
 
 
LIABILITIES:
   
 
   
 
 
Deposits:
   
 
   
 
 
Noninterest-bearing
 
$
46,820
 
$
40,143
 
Interest-bearing
   
338,871
   
332,908
 

 
 
 
Total deposits
   
385,691
   
373,051
 
Borrowed funds
   
27,796
   
17,027
 
Notes payable
   
7,500
   
-
 
Accrued interest payable
   
1,888
   
2,077
 
Other liabilities
   
2,474
   
2,097
 

 
 
 
TOTAL LIABILITIES
   
425,349
   
394,252
 

 
 
 
STOCKHOLDERS' EQUITY:
   
 
   
 
 
Common Stock
   
 
   
 
 
$1.00 par value; authorized 10,000,000 shares;
   
 
   
 
 
issued 2,909,849 and 2,882,070
   
 
   
 
 
shares in 2003 and 2002, respectively
   
2,910
   
2,882
 
Additional paid-in capital
   
10,213
   
9,473
 
Retained earnings
   
26,455
   
24,447
 

 
 
 
TOTAL
   
39,578
   
36,802
 
Accumulated other comprehensive income
   
956
   
2,553
 
Less: Treasury stock, at cost
   
 
   
 
 
96,962 and 55,162 shares for 2003 and 2002, respectively
   
(2,005
)
 
(949
)
TOTAL STOCKHOLDERS' EQUITY
   
38,529
   
38,406
 

 
 
 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
 
$
463,878
 
$
432,658
 

 
 
 
See accompanying notes to consolidated financial statements.
   
 
   
 
 
 
 CITIZENS FINANCIAL SERVICES, INC. 2003 ANNUAL REPORT 

 
 
CONSOLIDATED STATEMENT OF INCOME


 
 
Year Ended December 31,
(in thousands, except per share data)
   
2003
   
2002
   
2001
 

 
 
 
 
INTEREST INCOME:
   
 
   
 
   
 
 
Interest and fees on loans
 
$
21,593
 
$
21,600
 
$
22,163
 
Interest-bearing deposits with banks
   
29
   
65
   
547
 
Investment securities:
   
 
   
 
   
 
 
Taxable
   
3,222
   
4,711
   
4,969
 
Nontaxable
   
457
   
634
   
853
 
Dividends
   
314
   
367
   
493
 

 
 
 
 
TOTAL INTEREST INCOME
   
25,615
   
27,377
   
29,025
 

 
 
 
 
INTEREST EXPENSE:
   
 
   
 
   
 
 
Deposits
   
8,501
   
10,012
   
13,839
 
Borrowed funds
   
325
   
392
   
467
 

 
 
 
 
TOTAL INTEREST EXPENSE
   
8,826
   
10,404
   
14,306
 

 
 
 
 
NET INTEREST INCOME
   
16,789
   
16,973
   
14,719
 
Provision for loan losses
   
435
   
435
   
445
 

 
 
 
 
NET INTEREST INCOME AFTER PROVISION FOR
   
 
   
 
   
 
 
LOAN LOSSES
   
16,354
   
16,538
   
14,274
 

 
 
 
 
NON-INTEREST INCOME:
   
 
   
 
   
 
 
Service charges
   
3,018
   
3,130
   
2,527
 
Trust
   
622
   
562
   
578
 
Gains on loans sold
   
349
   
185
   
31
 
Realized securities gains, net
   
553
   
254
   
657
 
Other
   
770
   
915
   
496
 
TOTAL NON-INTEREST INCOME
   
5,312
   
5,046
   
4,289
 

 
 
 
 
NON-INTEREST EXPENSES:
   
 
   
 
   
 
 
Salaries and employee benefits
   
8,304
   
7,120
   
6,597
 
Occupancy
   
1,025
   
998
   
992
 
Furniture and equipment
   
713
   
881
   
966
 
Professional fees
   
694
   
667
   
494
 
Amortization of intangibles
   
435
   
457
   
1,015
 
Other
   
4,330
   
4,103
   
3,977
 

 
 
 
 
TOTAL NON-INTEREST EXPENSES
   
15,501
   
14,226
   
14,041
 

 
 
 
 
Income before provision for income taxes
   
6,165
   
7,358
   
4,522
 
Provision for income taxes
   
1,286
   
1,763
   
765
 

 
 
 
 
NET INCOME
 
$
4,879
 
$
5,595
 
$
3,757
 

 
 
 
 
NET INCOME - EARNINGS PER SHARE
 
$
1.72
 
$
1.96
 
$
1.32
 

 
 
 
 
CASH DIVIDENDS PER SHARE
 
$
0.74
 
$
0.68
 
$
0.64
 

 
 
 
 
See accompanying notes to consolidated financial statements.
   
 
   
 
   
 
 
 
 
 CITIZENS FINANCIAL SERVICES, INC. 2003 ANNUAL REPORT 

 
 
 
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY


 
 
 
 
 
 
Accumulated
 
 
 
 
 
 
Additional
 
Other
 
 
 
 
Common Stock
 
Paid-in
Retained
Comprehensive
Treasury
 
(in thousands, except share data)
 
Shares
Amount
Capital
Earnings
Income(Loss)
Stock
Total
 






Balance, December 31, 2000
 
2,827,409
$ 2,827
$ 8,670
$ 19,657
$ 344
$ (949)
$ 30,549
 
 
 
 
 
 
 
 
 
Comprehensive income:
 
 
 
 
 
 
 
 
Net income
 
 
 
 
3,757
 
 
3,757
Change in net unrealized gain on securities
 
 
 
 
 
 
 
 
available-for-sale, net of taxes of $448
 
 
 
 
 
869
 
869
   
Total comprehensive income
 
 
 
 
 
 
 
4,626
Stock dividend
 
27,173
28
347
(375)
 
 
Cash dividends, $.64 per share
 
 
 
 
(1,786)
 
 
(1,786)

 






Balance, December 31, 2001
 
2,854,582
2,855
9,017
21,253
1,213
(949)
33,389
 
 
 
 
 
 
 
 
 
Comprehensive income:
 
 
 
 
 
 
 
 
Net income
 
 
 
 
5,595
 
 
5,595
Change in net unrealized gain on securities
 
 
 
 
 
 
 
 
available-for-sale, net of taxes of $690
 
 
 
 
 
1,340
 
1,340
   
Total comprehensive income
 
 
 
 
 
 
 
6,935
Stock dividend
 
27,488
27
456
(483)
 
 
Cash dividends, $.68 per share
 
 
 
 
(1,918)
 
 
(1,918)

 






Balance, December 31, 2002
 
2,882,070
2,882
9,473
24,447
2,553
(949)
38,406
 
 
 
 
 
 
 
 
 
Comprehensive income:
 
 
 
 
 
 
 
 
Net income
 
 
 
 
4,879
 
 
4,879
Change in net unrealized loss on securities
 
 
 
 
 
 
 
 
available-for-sale, net of tax benefit of $823
 
 
 
 
 
(1,597)
 
(1,597)
   
Total comprehensive income
 
 
 
 
 
 
 
3,282
Stock dividend
 
27,779
28
740
(768)
 
 
Purchase of treasury stock (41,800 shares)
 
 
 
 
 
 
(1,056)
(1,056)
Cash dividends, $.74 per share
 
 
 
 
(2,103)
 
 
(2,103)

 






Balance, December 31, 2003
 
2,909,849
$ 2,910
$ 10,213
$ 26,455
$ 956
$ (2,005)
$ 38,529

 







 
 
2003
2002
2001

 


Components of comprehensive income (loss):
 
 
 
 
Change in net unrealized gain (loss) on investment
 
 
 
 
securities available-for-sale
 
$
(1,232
)
$
1,508
 
$
1,303
 
Realized gains included in net income, net
   
 
   
 
   
 
 
of taxes of $188, $86 and $223
   
(365
)
 
(168
)
 
(434
)

 
 
 
 
Total
 
$
(1,597
)
$
1,340
 
$
869
 

 
 
 
 
See accompanying notes to consolidated financial statements.
   
 
   
 
   
 
 

 
 CITIZENS FINANCIAL SERVICES, INC.  2003 ANNUAL REPORT 

 
 
CONSOLIDATED STATEMENT OF CASH FLOWS


 
 
Year Ended December 31,

 


(in thousands)
 
2003
2002
2001

 


Cash Flows from Operating Activities:
 
 
 
 
Net income
 
$
4,879
 
$
5,595
 
$
3,757
 
Adjustments to reconcile net income to net
   
 
   
 
   
 
 
cash provided by operating activities:
   
 
   
 
   
 
 
Provision for loan losses
   
435
   
435
   
445
 
Depreciation and amortization
   
1,358
   
1,447
   
1,968
 
Amortization and accretion on investment securities
   
1,129
   
690
   
199
 
Deferred income taxes
   
(141
)
 
116
   
(279
)
Realized gains on securities
   
(553
)
 
(254
)
 
(657
)
Increase in cash value of bank owned life insurance
   
(142
)
 
-
   
-
 
Realized gains on loans sold
   
(349
)
 
(185
)
 
(31
)
Originations of loans held for sale
   
(22,435
)
 
(11,857
)
 
(3,839
)
Proceeds from sales of loans held for sale
   
23,749
   
13,119
   
2,103
 
Loss (gain) on sales or disposals of premises and equipment
   
-
   
(30
)
 
36
 
Decrease in accrued interest receivable
   
273
   
10
   
332
 
Increase in other assets and intangibles
   
(216
)
 
(429
)
 
(615
)
Decrease in accrued interest payable
   
(189
)
 
(208
)
 
(335
)
Increase (decrease) in other liabilities
   
831
   
(8
)
 
478
 

 
 
 
 
Net cash provided by operating activities
   
8,629
   
8,441
   
3,562
 

 
 
 
 
Cash Flows from Investing Activities:
   
 
   
 
   
 
 
Available-for-sale securities:
   
 
   
 
   
 
 
Proceeds from sale of securities
   
12,108
   
13,927
   
35,529
 
Proceeds from maturity of securities
   
49,343
   
34,090
   
13,841
 
Purchase of securities
   
(71,320
)
 
(32,899
)
 
(63,216
)
Net increase in loans
   
(20,819
)
 
(28,045
)
 
(7,218
)
Purchase of bank owned life insurance
   
(7,000
)
 
-
   
-
 
Acquisition of premises and equipment
   
(490
)
 
(473
)
 
(2,086
)
Proceeds from sale of premises and equipment
   
-
   
275
   
16
 
Proceeds from sale of foreclosed assets held for sale
   
155
   
422
   
425
 

 
 
 
 
Net cash used in investing activities
   
(38,023
)
 
(12,703
)
 
(22,709
)

 
 
 
 
Cash Flows from Financing Activities:
   
 
   
 
   
 
 
Net increase in deposits
   
12,641
   
2,577
   
2,688
 
Proceeds from long-term borrowings
   
10,702
   
1,268
   
1,993
 
Repayments of long-term borrowings
   
(2,569
)
 
(949
)
 
(1,720
)
Net increase in short-term borrowed funds
   
2,636
   
3,398
   
1,834
 
Proceeds from notes payable
   
7,500
   
-
   
-
 
Dividends paid
   
(2,103
)
 
(1,918
)
 
(1,786
)
Acquisition of treasury stock
   
(1,056
)
 
-
   
-
 

 
 
 
 
Net cash provided by financing activities
   
27,751
   
4,376
   
3,009
 

 
 
 
 
 
   
 
   
 
   
 
 
Net increase (decrease) in cash and cash equivalents
   
(1,643
)
 
114
   
(16,138
)
 
   
 
   
 
   
 
 
Cash and Cash Equivalents at Beginning of Year
   
11,594
   
11,480
   
27,618
 

 
 
 
 
Cash and Cash Equivalents at End of Year
 
$
9,951
 
$
11,594
 
$
11,480
 
Supplemental Disclosures of Cash Flow Information:
   
 
   
 
   
 
 

 
 
 
 
Interest paid
 
$
9,015
 
$
10,612
 
$
14,641
 

 
 
 
 
Income taxes paid
 
$
1,265
 
$
1,755
 
$
915
 

 
 
 
 
Noncash activities:
   
 
   
 
   
 
 
Real estate acquired in settlement of loans
 
$
218
 
$
162
 
$
284
 

 
 
 
 
See accompanying notes to consolidated financial statements.
   
 
   
 
   
 
 

 
 CITIZENS FINACIAL SERVICES, INC.  8 2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS AND ORGANIZATION
Citizens Financial Services, Inc. (individually and collectively, the "Company"), is headquartered in Mansfield, Pennsylvania, and provides a full range of banking and related services through its wholly owned subsidiary, First Citizens National Bank (the "Bank"). The Bank is a national banking association and operates fifteen full-service banking offices in Potter, Tioga and Bradford counties. The Bank also provides trust services, including the administration of trusts and estates, retirement plans, and other employee benefit plans, along with a comprehensive menu of investment services. The Bank serves individual and corporate customers and is subject to competition from other financial institutions and intermediaries with respect to these services. The Company is supervised by the Board of Governors of the Federal Reserve System, while the Bank is subject to regulation and supervision by the Office of the Comptroller of the Currency.
A summary of significant accounting and reporting policies applied in the presentation of the accompanying financial statements follows:
BASIS OF PRESENTATION
The financial statements are consolidated to include the accounts of the Company and its subsidiary, First Citizens National Bank, and its subsidiary, First Citizens Insurance Agency, Inc. These statements have been prepared in accordance with accounting principles generally accepted in the United States of America. All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements.
In preparing the financial statements, management makes estimates and assumptions that affect the reported amounts of assets and liabilities as of the balance sheet date and revenues and expenses for the period. Actual results could differ significantly from those estimates.
OPERATING SEGMENTS
Statement of Financial Accounting Standards (FAS) No. 131 requires disclosures about an enterprise’s operating segments in financial reports issued to shareholders. The Statement defines an operating segment as a component of an enterprise that engages in business activities that generates revenue and incurs expense, and the operating results of which are reviewed by the chief operating decision maker in the determination of resource allocation and performance. While the Company’s chief decision makers monitor the revenue streams of the various Company’s products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, the Company’s business activities are currently confined to one segment which is community banking.
INVESTMENT SECURITIES
Investment securities at the time of purchase are classified as one of the three following types:
Held-to-Maturity Securities - includes securities that the Company has the positive intent and ability to hold to maturity. These securities are reported at amortized cost. The Company had no held-to-maturity securities as of December 31, 2003 and 2002.
Trading Securities - includes debt and equity securities bought and held principally for the purpose of selling them in the near term. Such securities are reported at fair value with unrealized holding gains and losses included in earnings. The Company had no trading securities as of December 31, 2003 and 2002.
Available-for-Sale Securities - includes debt and equity securities not classified as held-to-maturity or trading securities. Such securities are reported at fair value, with unrealized holding gains and losses excluded from earnings and reported as a separate component of stockholders’ equity, net of estimated income tax effect.
The amortized cost of investment in debt securities is adjusted for amortization of premiums and accretion of discounts, computed by a method that results in a level yield. Gains and losses on the sale of investment securities are computed on the basis of specific identification of the adjusted cost of each security.
 
 CITIZENS FINANCIAL SERVICES, INC. 2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Common stock of the Federal Reserve Bank and Federal Home Loan Bank represents ownership in institutions which are wholly owned by other financial institutions. These equity securities are accounted for at cost and are classified as other assets.
The fair value of investments, except certain state and municipal securities, is estimated based on bid prices published in financial newspapers or bid quotations received from securities dealers. The fair value of certain state and municipal securities is not readily available through market sources other than dealer quotations, so fair value estimates are based on quoted market prices of similar instruments, adjusted for differences between the quoted instruments and the instruments being valued.
LOANS
Interest on all loans is recognized on the accrual basis based upon the principal amount outstanding. The accrual of interest income on loans is discontinued when, in the opinion of management, there exists doubt as to the ability to collect such interest. Payments received on nonaccrual loans are applied to the outstanding principal balance or recorded as interest income, depending upon our assessment of our ultimate ability to collect principal and interest. Loans are returned to the accrual status when factors indicating doubtful collectibility cease to exist.
The Company recognizes nonrefundable loan origination fees and certain direct loan origination costs over the life of the related loan as an adjustment of loan yield using the interest method.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses represents the amount which management estimates is adequate to provide for probable losses inherent in its loan portfolio. The allowance method is used in providing for loan losses. Accordingly, all loan losses are charged to the allowance and all recoveries are credited to it. The allowance for loan losses is established through a provision for loan losses which is charged to operations. The provision is based upon management’s periodic evaluation of individual loans, the overall risk characteristics of the various portfolio segments, past experience with losses, the impact of economic conditions on borrowers, and other relevant factors. The estimates used in determining the adequacy of the allowance for loan losses are particularly susceptible to significant change in the near term.
Impaired loans are commercial and commercial real estate loans for which it is probable that the Company will not be able to collect all amounts due according to the contractual terms of the loan agreement. The Company individually evaluates such loans for impairment and does not aggregate loans by major risk classifications. The definition of "impaired loans" is not the same as the definition of "nonaccrual loans," although the two categories overlap. The Company may choose to place a loan on nonaccrual status due to payment delinquency or uncertain collectibility, while not classifying the loan as impaired if the loan is not a commercial or commercial real estate loan. Factors considered by management in determining impairment include payment status and collateral value. The amount of impairment for these types of impaired loans is determined by the difference between the present value of the expected cash flows related to the loan, using the original interest rate, and its recorded value; or, as a practical expedient in the case of collateralized loans, the difference between the fair value of the collateral and the recorded amount of the loans. When foreclosure is probable, impairment is measured based on the fair value of the collateral.
Mortgage loans on one- to four-family properties and all consumer loans are large groups of smaller balance homogeneous loans and are measured for impairment collectively. Loans that experience insignificant payment delays, which is defined as 90 days or less, generally are not classified as impaired. Management determines the significance of payment delays on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the borrower’s prior payment record, and the amount of shortfall in relation to the principal and interest owed.
 
 CITIZENS FINANCIAL SERVICES, INC.  10 2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FORECLOSED ASSETS HELD FOR SALE
Foreclosed assets acquired in settlement of foreclosed loans are carried at the lower of fair value minus estimated costs to sell or cost. Prior to foreclosure, the value of the underlying loan is written down to fair market value of the real estate or other assets to be acquired by a charge to the allowance for loan losses, if necessary. Any subsequent write-downs are charged against operating expenses. Operating expenses of such properties, net of related income and losses on disposition, are included in other expenses and gains are included in other income.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost, less accumulated depreciation. Depreciation expense is computed on straight line and accelerated methods over the estimated useful lives of the assets, which range from 3 to 15 years for furniture, fixtures and equipment and 5 to 39 1/2 years for building premises. Repair and maintenance expenditures which extend the useful life of an asset are capitalized and other repair expenditures are expensed as incurred.
When premises or equipment are retired or sold, the remaining cost and accumulated depreciation are removed from the accounts and any gain or loss is credited or charged to income.
INTANGIBLE ASSETS
Intangible assets include core deposit intangibles, which are a measure of the value of consumer demand and savings deposits acquired in business combinations accounted for as purchases. The core deposit intangibles are being amortized to expense over a 5 1/2 to 6-year life on a straight-line basis. The recoverability of the carrying value of intangible assets is evaluated on an ongoing basis, and permanent declines in value, if any, are charged to expense.
GOODWILL
Goodwill is the excess of the purchase price over the fair value of assets acquired of companies in connection with business acquisitions accounted for as purchases and was being amortized on the straight-line method over 15 years, prior to January 1, 2002. On January 1, 2002, the Company adopted FAS No. 142, Goodwill and Other Intangible Assets , which changed the accounting for goodwill from an amortization method to an impairment-only approach. This statement eliminates the regularly scheduled amortization of goodwill and replaces this method with a two-step process for testing the impairment of goodwill on at least an annual basis. This approach could cause more volatility in the Company’s reported net income because impairment losses, if any, could occur irregularly and in varying amounts. The Company, upon adoption of this Statement, stopped amortizing existing goodwill of $6.9 million. Based on the fair value of the reporting unit, estimated using the expected present value of future cash flows, no impairment of goodwill was recognized in 2003 and 2002.
BANK OWNED LIFE INSURANCE
The Company has purchased life insurance policies on certain officers. Bank owned life insurance is recorded at its cash surrender value, or the amount that can be realized.
INCOME TAXES
The Company and the Bank file a consolidated federal income tax return. Deferred tax assets and liabilities are computed based on the difference between the financial statement, and income tax basis of assets and liabilities using the enacted marginal tax rates. Deferred income tax expenses or benefits are based on the changes in the net deferred tax asset or liability from period to period.
EMPLOYEE BENEFIT PLANS
The Company has a noncontributory defined benefit pension plan covering substantially all employees. It is the Company’s policy to fund pension costs on a current basis to the extent deductible under existing tax regulations. Such contributions are intended to provide not only for benefits attributed to service to date, but also for those expected to be earned in the future.
The Company also has a profit-sharing plan which provides tax-deferred salary savings to plan participants.
 
 CITIZENS FINANCIAL SERVICES, INC.  11 2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

MORTGAGE SERVICING RIGHTS (MSR’S)
The Company originates certain loans for the express purpose of selling such loans in the secondary market. The Company maintains all servicing rights for these loans. The loans are carried at lower of cost or market. Originated MSR’s are recorded by allocating total costs incurred between the loan and servicing rights based on their relative fair values. MSR’s are amortized in proportion to the estimated servicing income over the estimated life of the servicing portfolio.
COMPREHENSIVE INCOME
The Company is required to present comprehensive income in a full set of general purpose financial statements for all periods presented. Other comprehensive income is comprised exclusively of unrealized holding gains (losses) on the available-for-sale securities portfolio. The Company has elected to report the effects of other comprehensive income as part of the Consolidated Statement of Changes in Stockholders’ Equity.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2003, the Financial Accounting Standards Board ("FASB") revised Statement of Financial Accounting Standards ("FAS") No. 132, Employers’ Disclosures about Pension and Other Postretirement Benefit. This statement retains the disclosures required by FAS No. 132, which standardized the disclosure requirements for pensions and other postretirement benefits to the extent practicable and requires additional information on changes in the benefit obligations and fair value of plan assets. Additional disclosures include information describing the types of plan assets, investment strategy, measurement date(s), plan obligations, cash flows, and components of net periodic benefit cost recognized during interim periods. This statement retains reduced disclosure requirements for nonpublic entities from FAS No. 132, and it includes reduced disclosure for certain of the new requirements. This statement is effective for financial statements with fiscal years ending after December 15, 2003. The interim disclosures required by this statement are effective for interim periods beginning after December 15, 2003. The adoption of this statement did not have a material effect on the Company’s disclosure requirements.
In August 2001, the FASB issued FAS No. 143, Accounting for Asset Retirement Obligations , which requires that the fair value of a liability be recognized when incurred for the retirement of a long-lived asset and the value of the asset be increased by that amount. The statement also requires that the liability be maintained at its present value in subsequent periods and outlines certain disclosures for such obligations. The adoption of this statement, which was effective January 1, 2003, did not have a material effect on the Company’s financial position or results of operations.
In July 2002, the FASB issued FAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities , which requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. This statement replaces EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring) . The new statement is effective for exit or disposal activities initiated after December 31, 2002. The adoption of this statement did not have a material effect on the Company’s financial position or results of operations.
On December 31, 2002, the FASB issued FAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, which amends FAS No. 123, Accounting for Stock-Based Compensation . FAS No. 148 amends the disclosure requirements of FAS No. 123 to require more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. Under the provisions of FAS No. 123, companies that adopted the preferable, fair value based method were required to apply that method prospectively for new stock option awards. This contributed to a "ramp-up" effect on stock-based compensation expense in the first few years following adoption, which caused concern for companies and investors because of the lack of consistency in reported results. To address that concern, FAS No. 148 provides two additional methods of transition that reflect an entity’s full complement of stock-based compensation expense immediately upon adoption, thereby eliminating the ramp-up effect. FAS No. 148 also improves the clarity and prominence of disclosures about the pro forma effects of using the fair value based method of accounting for stock-based compensation for all companies—regardless of the accounting method used—by requiring that the data be presented more prominently and in a more user-friendly format in the footnotes to the financial statements. In addition, the statement improves the timeliness of those disclosures by requiring that this information be included in interim as well as annual financial statements. The transition guidance and annual disclosure provisions of FAS No. 148 are effective for fiscal years ending after December 15, 2002, with earlier application permitted in certain circumstances. The interim disclosure provisions are effective for financial reports containing financial statements for interim periods beginning after December 15, 2002. The adoption of this statement did not have a material effect on the Company’s disclosure requirements.
 
 CITIZENS FINANCIAL SERVICES, INC.  12 2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

In April, 2003, the FASB issued FAS No. 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 FAS No. 133. The amendments set forth in FAS No. 149 improve financial reporting by requiring 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 FAS No. 133. In addition, it clarifies when a derivative contains a financing component that warrants special reporting in the statement of cash flows. FAS No.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 is effective for contracts entered into or modified after September 30, 2003, except as stated below and for hedging relationships designated after September 30, 2003. The guidance should be applied prospectively. The provisions of this statement that relate to FAS No. 133 Implementation Issues that have been effective for fiscal quarters that began prior to September 15, 2003, should continue to be applied in accordance with their respective effective dates. In addition, certain provisions relating to forward purchases or sales of when-issued securities or other securities that do not yet exist, should be applied to existing contracts as well as new contracts entered into after September 30, 2003. The adoption of this statement did not have a material effect on the Company’s financial position or results of operations.
In May 2003, the FASB issued FAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity . This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Such instruments may have been previously classified as equity. This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after September 15, 2003. The adoption of this statement did not have a material effect on the Company’s reported equity.
In November, 2002, the FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others . This interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. This interpretation clarifies that a guarantor is required to disclose (a) the nature of the guarantee, including the approximate term of the guarantee, how the guarantee arose, and the events or circumstances that would require the guarantor to perform under the guarantee; (b) the maximum potential amount of future payments under the guarantee; (c) the carrying amount of the liability, if any, for the guarantor’s obligations under the guarantee; and (d) the nature and extent of any recourse provisions or available collateral that would enable the guarantor to recover the amounts paid under the guarantee. This interpretation also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the obligations it has undertaken in issuing the guarantee, including its ongoing obligation to stand ready to perform over the term of the guarantee in the event that the specified triggering events or conditions occur. The objective of the initial measurement of that liability is the fair value of the guarantee at its inception. The initial recognition and initial measurement provisions of this interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. The disclosure requirements in this interpretation are effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of this interpretation did not have a material effect on the Company’s financial position or results of operations.
 
 CITIZENS FINANCIAL SERVICES, INC. 13  2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

In January, 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, in an effort 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. The objective of this interpretation is not to restrict the use of variable interest entities but to improve financial reporting by companies involved with variable interest entities. Until now, one company generally has included another entity in its consolidated financial statements only if it controlled the entity through voting interests. This interpretation 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. The consolidation requirements of this interpretation apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. In October, 2003, the FASB decided to defer to the fourth quarter from the third quarter the implementation date for Interpretation No. 46. This deferral only applies to variable interest entities that existed prior to February 1, 2003. The adoption of this interpretation has not and is not expected to have a material effect on the Company’s financial position or results of operations.
TREASURY STOCK
The purchase of the Company’s common stock is recorded at cost. At the date of subsequent reissue, the treasury stock account is reduced by the cost of such stock on a last-in-first-out basis.
CASH FLOWS
The Company utilizes the net reporting of cash receipts and cash payments for deposit and lending activities. The Company considers amounts due from banks and interest-bearing deposits in banks as cash equivalents.
TRUST ASSETS AND INCOME
Assets held by the Bank in a fiduciary or agency capacity for its customers are not included in the consolidated financial statements since such items are not assets of the Bank.
EARNINGS PER SHARE
Earnings per share calculations give retroactive effect to stock dividends declared by the Company. The number of shares used in the earnings per share computations presented was 2,841,633, 2,854,688 and 2,854,688 for 2003, 2002 and 2001, respectively. The Company has no dilutive securities.
RECLASSIFICATION
Certain of the prior year amounts have been reclassified to conform with the current year presentation. Such reclassifications had no effect on net income or stockholders’ equity.
2. RESTRICTIONS ON CASH AND DUE FROM BANKS
The Bank is required to maintain reserves, in the form of cash and balances with the Federal Reserve Bank, against its deposit liabilities. The amount of such reserves was $554,000 and $546,000 at December 31, 2003 and 2002, respectively.
Deposits with one financial institution are insured up to $100,000. The Company maintains cash and cash equivalents with other financial institutions in excess of the insured amount.
 
 CITIZENS FINANCIAL SERVICES, INC.  14 2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

3. INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities at December 31, 2003 and 2002, were as follows ( in thousands ):

 
 
 
Gross
Gross
 
 
 
 
Unrealized
Unrealized
Estimated
 
 
Amortized
Holding
Holding
Fair
December 31, 2003
 
Cost
Gains
Losses
Value

 



Available-for-sale securities:
   
 
   
 
   
 
   
 
 
U.S. Agency securities
 
$
1,005
 
$
28
 
$
-
 
$
1,033
 
Obligations of state and
   
 
   
 
   
 
   
 
 
political subdivisions
   
8,011
   
292
   
-
   
8,303
 
Corporate obligations
   
13,656
   
1,018
   
-
   
14,674
 
Mortgage-backed securities
   
78,080
   
671
   
(375
)
 
78,376
 
Equity securities
   
4,387
   
35
   
(221
)
 
4,201
 

 
 
 
 
 
Total available-for-sale
 
$
105,139
 
$
2,044
 
$
(596
)
$
106,587
 

 
 
 
 
 
 

 
 
 
Gross
Gross
 
 
 
 
Unrealized
Unrealized
Estimated
 
 
Amortized
Holding
Holding
Fair
December 31, 2002
 
Cost
Gains
Losses
Value

 



Available-for-sale securities:
 
 
 
 
 
U.S. Agency securities
 
$
1,008
 
$
44
 
$
-
 
$
1,052
 
Obligations of state and
   
 
   
 
   
 
   
 
 
political subdivisions
   
12,424
   
307
   
-
   
12,731
 
Corporate obligations
   
19,845
   
1,311
   
-
   
21,156
 
Mortgage-backed securities
   
58,913
   
1,888
   
-
   
60,801
 
Equity securities
   
4,667
   
318
   
-
   
4,985
 

 
 
 
 
 
Total available-for-sale
 
$
96,857
 
$
3,868
 
$
-
 
$
100,725
 

 
 
 
 
 
The following table shows the Company's gross unrealized losses and fair value, aggregated by investment category and length of time, that the individual securities have been in a continuous unrealized loss position, at December 31, 2003 (in thousands):

 
 
Less than Twelve Months
Twelve Months or Greater
Total
   





 
 
Approx
Gross
Approx
Gross
Approx
Gross
 

 

Market
Unrealized
Market
Unrealized
Market
Unrealized
 

 

Value
Losses
Value
Losses
Value
Losses
   





Mortgage-backed securities
 
$
47,391
 
$
375
 
$
-
 
$
-
 
$
47,391
 
$
375
 
Equity securities
   
4,166
   
221
   
-
   
-
   
4,166
   
221
 

 
 
 
 
 
 
 
Total
 
$
51,557
 
$
596
 
$
-
 
$
-
 
$
51,557
 
$
596
 
                                       

 
 CITIZENS FINANCIAL SERVICES, INC.  15 2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The Company's investment securities portfolio contains unrealized losses of mortgage-related instruments issued or backed by the full faith and credit of the United States government or are generally viewed as having the implied guarantee of the U.S. government, and equity securities.
On a monthly basis the Company evaluates the severity and duration of impairment for its investment securities portfolio unless the Company has the ability to hold the security to maturity without incurring a loss. Generally, impairment is considered other than temporary when an investment security has sustained a decline of ten percent or more for six months.
The Company has concluded that any impairment of its investment securities portfolio is not permanent, but rather, temporary, and is the result of interest rate changes, sector credit rating changes, or company-specific rating changes that are not expected to result in the noncollection of principal and interest during the period.
Proceeds from sales of securities available-for-sale during 2003, 2002, and 2001 were $12,108,000, $13,927,000 and $35,529,000 respectively. Gross gains and gross losses were realized on those sales as follows ( in thousands ):

 
 
2003
2002
2001

 
 
 
 
Gross gains
 
$
553
 
$
287
 
$
817
 
Gross losses
   
-
   
33
   
160
 

 
 
 
 
Net gains (losses)
 
$
553
 
$
254
 
$
657
 

 
 
 
 
Investment securities with an approximate carrying value of $64,788,000 and $50,733,000 at December 31, 2003 and 2002, respectively, were pledged to secure public funds and certain other deposits as provided by law.
Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The amortized cost and estimated carrying value of debt securities at December 31, 2003, by contractual maturity, are shown below ( in thousands ):

 
 
Amortized
Estimated
 
 
Cost
Fair Value

 

Available-for-sale securities:
   
 
   
 
 
Due in one year or less
 
$
2
 
$
2
 
Due after one year through five years
   
14,725
   
15,494
 
Due after five years through ten years
   
63,790
   
64,126
 
Due after ten years
   
22,235
   
22,764
 

 
 
 
Total
 
$
100,752
 
$
102,386
 

 
 
 
4. LOANS
The Company grants commercial, industrial, residential, and consumer loans primarily to customers throughout Northcentral Pennsylvania and Southern New York. Although the Company has a diversified loan portfolio at December 31, 2003 and 2002, a substantial portion of its debtors’ ability to honor their contracts is dependent on the economic conditions within this region.
 
 CITIZENS FINANCIAL SERVICES, INC. 16  2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Major classifications of loans are as follows ( in thousands ):

 
 
December 31,
 
 
2003
2002

 

Real estate loans:
 
 
 
Residential
 
$
180,333
 
$
175,323
 
Commercial
   
57,370
   
47,210
 
Agricultural
   
7,594
   
9,844
 
Construction
   
5,784
   
5,009
 
Loans to individuals for household,
   
 
   
 
 
family and other purchases
   
13,145
   
13,915
 
Commercial and other loans
   
16,219
   
18,564
 
State and political subdivision loans
   
37,212
   
28,592
 

 
 
 
 
   
317,657
   
298,457
 
Less allowance for loan losses
   
3,620
   
3,621
 

 
 
 
Loans, net
 
$
314,037
 
$
294,836
 

 
 
 
Real estate loans serviced for Freddie Mac, which are not included in the consolidated balance sheet, totaled $35,643,000 and $20,087,000, at December 31, 2003 and 2002, respectively.
At December 31, 2003 and 2002, net unamortized loan fees and costs of $784,000 and $767,000, respectively, have been deducted from the carrying value of loans.
The Company had nonaccrual loans, inclusive of impaired loans, of $2,504,000 and $2,980,000 at December 31, 2003 and 2002, respectively. Interest income on loans would have increased by approximately $49,000, $84,000 and $105,000 during 2003, 2002 and 2001, respectively, if these loans had performed in accordance with their original terms.
Information with respect to impaired loans as of and for the years ended December 31, is as follows ( in thousands ):

 
 
2003
2002
2001

 


Impaired loans without related allowance for loan losses
 
$
1,197
 
$
-
 
$
-
 
Impaired loans with related allowance for loan losses
   
729
   
1,916
   
1,077
 
Related allowance for loan losses
   
35
   
327
   
325
 
Average recorded balance of impaired loans
   
1,772
   
1,967
   
1,078
 
Interest income recognized on impaired loans
   
35
   
-
   
26
 
Transactions in the allowance for loan losses were as follows ( in thousands ):

 
 
Years Ended December 31,
 

 

2003
2002
2001

 


Balance, beginning of year
 
$
3,621
 
$
3,250
 
$
2,777
 
Provision charged to income
   
435
   
435
   
445
 
Recoveries on loans previously
   
 
   
 
   
 
 
charged against the allowance
   
116
   
115
   
175
 

 
 
 
 
 
   
4,172
   
3,800
   
3,397
 
Loans charged against the allowance
   
(552
)
 
(179
)
 
(147
)

 
 
 
 
Balance, end of year
 
$
3,620
 
$
3,621
 
$
3,250
 

 
 
 
 

 
 CITIZENS FINANCIAL SERVICES, INC.  17 2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The following is a summary of the past due and nonaccrual loans as of December 31, 2003 and 2002 ( in thousands ):

 
 
December 31, 2003
 
 
Past Due
Past Due
 
 
 
30 - 89 days
90 days or more
Nonaccrual

 


Real estate loans
 
$
1,420
 
$
170
 
$
2,491
 
Installment loans
   
167
   
12
   
13
 
Credit cards and related loans
   
27
   
-
   
-
 
Commercial and all other loans
   
38
   
3
   
-
 

 
 
 
 
Total
 
$
1,652
 
$
185
 
$
2,504
 

 
 
 
 
 

       December 31, 2002

   
Past Due  

 

 

Past Due

 

 

 

 

 

 

 

30 - 89 days  

 

 

90 days or more

 

 

Nonaccrual
 

 
 
 
 
Real estate loans
 
$
1,744
 
$
-
 
$
2,980
 
Installment loans
   
307
   
29
   
-
 
Credit cards and related loans
   
36
   
3
   
-
 
Commercial and all other loans
   
145
   
7
   
-
 

 
 
 
 
Total
 
$
2,232
 
$
39
 
$
2,980
 

 
 
 
 
5. PREMISES & EQUIPMENT
Premises and equipment are summarized as follows ( in thousands ):

 
 
December 31,
 
 
2003
2002

 

Land
 
$
1,867
 
$
1,867
 
Buildings
   
9,723
   
9,681
 
Furniture, fixtures and equipment
   
6,598
   
6,476
 
Construction in process
   
32
   
21
 

 
 
 
 
   
18,220
   
18,045
 
Less accumulated depreciation
   
7,575
   
6,800
 

 
 
 
Premises and equipment, net
 
$
10,645
 
$
11,245
 

 
 
 
Depreciation expense amounted to $836,000, $990,000, and $953,000 for 2003, 2002, and 2001, respectively.

6. DEPOSITS
Certificates of deposit of $100,000 or more amounted to $41,362,000 and $35,671,000 at December 31, 2003 and 2002, respectively. Interest expense on certificates of deposit of $100,000 or more amounted to $1,618,000, $1,654,000, and $1,976,000 for the years ended December 31, 2003, 2002, and 2001, respectively.
 
 CITIZENS FINANCIAL SERVICES, INC.  18 2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Following are maturities of certificates of deposit as of December 31, 2003 ( in thousands ):

 
2004
 
$ 79,182
 
2005
 
44,453
 
2006
 
30,384
 
2007
 
29,691
 
2008
 
15,356
 
Thereafter
 
2,493
 
Total certificates of deposit
 
$ 201,559
7. BORROWED FUNDS

 
 
Securities
 
 
 
 
 
 
 
Sold Under
 
 
 
Capital
Total
 
 
Agreements to
TT&L
FHLB
Term
Lease
Borrowed
(dollars in thousands)
 
Repurchase(a)
Borrowings(b)
Advances(c)
Loans(d)
Obligations
Funds

 





2003
 
 
 
 
 
 
 
Balance at December 31
 
$
8,495
 
$
2,203
 
$
1,160
 
$
15,938
 
$
-
 
$
27,796
 
Highest balance at any month-end
   
14,460
   
4,602
   
8,670
   
15,938
   
-
   
43,670
 
Average balance
   
10,019
   
461
   
2,322
   
1,167
   
-
   
13,969
 
Weighted average interest rate:
   
 
   
 
   
 
   
 
   
 
   
 
 
Paid during the year
   
2.44
%
 
2.08
%
 
1.29
%
 
2.46
%
 
0.00
%
 
2.24
%
As of year-end
   
2.50
%
 
0.94
%
 
1.03
%
 
2.05
%
 
0.00
%
 
2.05
%

 
 
 
 
 
 
 
2002
   
 
   
 
   
 
   
 
   
 
   
 
 
Balance at December 31
 
$
7,647
 
$
-
 
$
7,380
 
$
2,000
 
$
-
 
$
17,027
 
Highest balance at any month-end
   
14,897
   
-
   
7,380
   
2,000
   
20
   
24,297
 
Average balance
   
11,096
   
-
   
1,208
   
2,000
   
6
   
14,310
 
Weighted average interest rate:
   
 
   
 
   
 
   
 
   
 
   
 
 
Paid during the year
   
2.69
%
 
-
   
1.59
%
 
3.64
%
 
4.93
%
 
2.73
%
As of year-end
   
2.94
%
 
-
   
1.31
%
 
3.13
%
 
0.00
%
 
2.25
%

 
 
 
 
 
 
 
2001
   
 
   
 
   
 
   
 
   
 
   
 
 
Balance at December 31
 
$
8,322
 
$
-
 
$
2,965
 
$
2,000
 
$
24
 
$
13,311
 
Highest balance at any month-end
   
10,758
   
-
   
2,965
   
2,000
   
67
   
15,790
 
Average balance
   
8,752
   
-
   
47
   
2,000
   
49
   
10,848
 
Weighted average interest rate:
   
 
   
 
   
 
   
 
   
 
   
 
 
Paid during the year
   
4.31
%
 
-
   
2.00
%
 
5.94
%
 
4.93
%
 
4.60
%
As of year-end
   
3.20
%
 
-
   
1.88
%
 
3.61
%
 
4.90
%
 
2.97
%

 
 
 
 
 
 
 
(a)  Securities sold under agreements to repurchase mature within one to five years. The carrying value of the underlying securities at December 31, 2003 and 2002 was $14,923,000 and $16,936,000, respectively.
(b)  TT&L borrowings consist of notes issued under the U.S. Treasury Department's program of investing the treasury tax and loan account balances in interest-bearing demand notes insured by depository institutions. These notes bear interest at a rate of .25 percent less than the average Federal funds rate as computed by the Federal Reserve Bank.
(c)  FHLB Advances consist of an "Open RepoPlus" agreement with the Federal Home Loan Bank of Pittsburgh. FHLB "Open RepoPlus" advances are short-term borrowings maturing within one year, bear a fixed rate of interest and are subject to prepayment penalty. The Company has a borrowing limit of $177,390,000, exclusive of any outstanding advances. Although no specific collateral is required to be pledged for the "Open RepoPlus" borrowings, FHLB advances are secured by a blanket security agreement that includes the Company's FHLB stock, as well as investment and mortgage-backed securities held in safekeeping at the FHLB and certain residential mortgage loans. At December 31, 2003 and 2002, the approximate carrying value of the securities collateral was $69,162,000 and $58,722,000, respectively.
 
 CITIZENS FINANCIAL SERVICES, INC.  19 2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(d)     Term Loans consist of separate loans with a third party bank and the Federal Home Loan Bank of Pittsburgh as follows ( in thousands ):

 
 
 
December 31,
December 31,
Interest Rate
 
Maturity
2003
2002

 


Variable:
 
 
 
 
(e)
 
August 31, 2004
$ 938
$ 2,000
Fixed:
 
 
 
 
1.28%
 
January 20, 2004
5,000
 
1.81%
 
June 17, 2005
3,000
 
2.45%
 
June 19, 2006
4,000
 
2.76%
 
December 18, 2006
3,000
 

 


Total term loans
   
 
 
$
15,938
 
$
2,000
 

 
 
 
 
(e)     Interest rate floats monthly based on the 1 month LIBOR +1.75%, the interest rate was 2.92% and 3.19% at December 31, 2003 and 2002, respectively.
Notes Payable:
In December 2003, the Company formed a special purpose entity ("Entity") to issue $7,500,000 of floating rate obligated mandatory redeemable securities as part of a pooled offering. The rate is determined quarterly and floats based on the 3 month LIBOR plus 2.80%. At December 31, 2003, the rate was 3.97%. The Entity may redeem them, in whole or in part, at face value after December 17, 2008. The Company borrowed the proceeds of the issuance from the Entity in December 2003 in the form of a $7,500,000 note payable, which is included in the liabilities section of the Company’s balance sheet. Debt issue costs of $75,000 have been capitalized and are being amortized through the first call date.
Under current accounting rules, the Company’s minority interest in the Entity was recorded at the initial investment amount and is included in the other assets section of the balance sheet. The Entity is not consolidated as part of the Company’s consolidated financial statements.
Following are maturities of borrowed funds and notes payable as of December 31, 2003 ( in thousands ):

2004
 
$
15,445
 
2005
   
420
 
2006
   
11,215
 
2007
   
716
 
2008
   
7,500
 

 
 
Total borrowed funds
 
$
35,296
 

 
 
8. EMPLOYEE BENEFIT PLANS
The Bank sponsors a trusteed, noncontributory defined benefit pension plan covering substantially all employees and officers. The plan calls for benefits to be paid to eligible employees at retirement based primarily upon years of service with the Bank and compensation rates near retirement. The Bank's funding policy is to make annual contributions, if needed, based upon the funding formula developed by the plan's actuary.
 
 CITIZENS FINANCIAL SERVICES, INC.  20 2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Obligations and Funded Status
At December 31 ( in thousands ):

 
 
Pension Benefits

 

 
 
2003
2002
Change in benefit obligation
   
 
   
 
 
Benefit obligation at beginning of year
 
$
3,926
 
$
3,342
 
Service cost
   
340
   
269
 
Interest cost
   
267
   
229
 
Amendments
   
222
   
74
 
Assumption change
   
117
   
96
 
Benefits paid
   
(87
)
 
(84
)

 
 
 
Benefit obligation at end of year
   
4,785
   
3,926
 

 
 
 
Change in plan assets
   
 
   
 
 
Fair value of plan assets at beginning of year
   
3,117
   
3,181
 
Actual return on plan assets
   
530
   
(371
)
Employer contribution
   
454
   
391
 
Benefits paid
   
(87
)
 
(84
)

 
 
 
Fair value of plan assets at end of year
   
4,014
   
3,117
 
   
 
 
Funded status
   
(771
)
 
(809
)
Transition adjustment
   
(25
)
 
(39
)
Unrecognized prior service cost (benefit)
   
23
   
21
 
Unrecognized net gain from past experience
   
 
   
 
 
different from that assumed
   
1,007
   
1,010
 

 
 
 
Prepaid benefit cost
 
$
234
 
$
183
 

 
 
 
The accumulated benefit obligation for all defined benefit pension plans was $3,638,000 and $2,960,000 at December 31, 2003 and 2002, respectively.
Components of Net Periodic Benefit Cost ( in thousands ):

 
 
Pension Benefits

 

 
 
2003
2002
Service cost
 
$
340
 
$
269
 
Interest cost
   
267
   
229
 
Return on plan assets
   
(530
)
 
371
 
Net amortization and deferral
   
325
   
(646
)

 
 
 
Net periodic benefit cost
 
$
402
 
$
223
 

 
 
 
 
 CITIZENS FINANCIAL SERVICES, INC.  21 2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Assumptions
Weighted-average assumptions used to determine benefit obligations at December 31:

 
 
 
 
 
 
 
Pension Benefits











 
 
 
 
 
 
 
2003
 
2002
 
Discount rate
 
 
 
 
 
6.25
%
6.50
%
Rate of compensation increase
 
 
 
 
 
3.25
 
3.50
 
Weighted-average assumptions used to determine net periodic benefit cost for the years ended December 31:

 
 
 
 
 
 
 
Pension Benefits











 
 
 
 
 
 
 
2003
 
2002
 
Discount rate
 
 
 
 
 
6.25
%
6.50
%
Expected long-term return on plan assets
 
 
 
 
 
8.00
 
8.00
 
Rate of compensation increase
 
 
 
 
 
3.25
 
3.50
 
The long-term rate of return on plan assets gives consideration to returns currently being earned on plan assets as well as future rates expected to be earned.

Plan Assets
The Bank's pension plan weighted-average asset allocations at December 31, 2003 and 2002, by asset category are as follows:

 
 
 
 
 
 
 
Plan Assets
 
 
 
 
 
 
 
at December 31
 
 
 
 
 
 
 
2003
 
2002
 











Equity securities
 
 
 
 
 
67.4
%
55.2
%
Debt securities
 
 
 
 
 
30.3
 
29.0
 
Other
 
 
 
 
 
2.3
 
15.8
 











Total
 
 
 
 
 
100.0
%
100.0
%
Equity securities include the Bank's common stock in the amounts of $253,000 (6.3% of total plan assets) and $210,000 (6.7% of total plan assets) at December 31, 2003 and 2002, respectively.
The Bank expects to contribute $459,000 to its pension plan in 2004.
 
 CITIZENS FINANCIAL SERVICES, INC.  22 2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

9. INCOME TAXES
The provision for income taxes consists of the following ( in thousands ):

 
 
Years Ended December 31,
 
 
2003
2002
2001

 


Currently payable
 
$
1,427
 
$
1,647
 
$
1,044
 
Deferred liability (benefit)
   
(141
)
 
116
   
(279
)

 
 
 
 
Provision for income taxes
 
$
1,286
 
$
1,763
 
$
765
 

 
 
 
 
The following temporary differences gave rise to the net deferred tax assets (liabilities) at December 31, 2003 and 2002 ( in thousands ):

 
 
2003
2002

 

Deferred tax assets:
 
 
 
Allowance for loan losses
 
$
1,038
 
$
1,038
 
Deferred compensation
   
546
   
243
 
Goodwill and core deposit intangibles
   
19
   
108
 
Merger & acquisition costs
   
24
   
34
 
Foreclosed assets held for sale
   
3
   
-
 

 
 
 
Total
   
1,630
   
1,423
 

 
 
 
 
   
 
   
 
 
Deferred tax liabilities:
   
 
   
 
 
Unrealized gains on available-for-sale securities
   
(492
)
 
(1,315
)
Depreciation and amortization
   
(301
)
 
(259
)
Bond accretion
   
(81
)
 
(126
)
Pension expense
   
(80
)
 
(62
)
Loan fees and costs
   
(77
)
 
(69
)
Mortgage servicing rights
   
(88
)
 
(45
)

 
 
 
Total
   
(1,119
)
 
(1,876
)

 
 
 
Deferred tax asset (liability), net
 
$
511
 
$
(453
)

 
 
 
No valuation allowance was established at December 31, 2002 in view of certain tax strategies coupled with the anticipated future taxable income as evidenced by the Company's earnings potential.
 
 CITIZENS FINANCIAL SERVICES, INC.  23 2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The total provision for income taxes is different from that computed at the statutory rates due to the following items ( in thousands ):

 
 
Years Ended December 31,
 
 
2003
2002
2001

 


Provision at statutory rates on
 
 
 
 
pre-tax income
 
$
2,096
 
$
2,502
 
$
1,537
 
Effect of tax-exempt income
   
(710
)
 
(693
)
 
(764
)
Tax credits
   
(130
)
 
(130
)
 
(113
)
Bank owned life insurance
   
(48
)
 
-
   
-
 
Nondeductible interest
   
62
   
67
   
97
 
State income taxes
   
-
   
9
   
-
 
Other items
   
16
   
8
   
8
 

 
 
 
 
Provision for income taxes
 
$
1,286
 
$
1,763
 
$
765
 
Statutory tax rates
   
34
%
 
34
%
 
34
%
Effective tax rates
   
20.9
%
 
24.0
%
 
16.9
%
10. RELATED PARTY TRANSACTIONS
Certain executive officers, corporate directors or companies in which they have 10 percent or more beneficial ownership were indebted to the Bank.
A summary of loan activity with officers, directors, stockholders and associates of such persons is listed below ( in thousands ):

 
 
Years Ended December 31,
 
 
2003
2002
2001

 


Balance, beginning of year
 
$
3,678
 
$
3,972
 
$
2,814
 
New loans
   
1,243
   
847
   
2,341
 
Repayments
   
(1,576
)
 
(1,141
)
 
(1,183
)

 
 
 
 
Balance, end of year
 
$
3,345
 
$
3,678
 
$
3,972
 

 
 
 
 
Such loans were made in the ordinary course of business at the Bank’s normal credit terms and do not present more than a normal risk of collection.
11. REGULATORY MATTERS
DIVIDEND RESTRICTIONS:
The approval of the Comptroller of the Currency is required for a national bank to pay dividends up to the Company if the total of all dividends declared in any calendar year exceeds the Bank’s net income (as defined) for that year combined with its retained net income for the preceding two calendar years. Under this formula, the Bank can declare dividends in 2004 without approval of the Comptroller of the Currency of approximately $4,901,000, plus the Bank’s net income for 2004.
LOANS:
The Bank is subject to regulatory restrictions which limit its ability to loan funds to the Company. At December 31, 2003, the regulatory lending limit amounted to approximately $4,286,000.
 
 CITIZENS FINANCIAL SERVICES, INC. 24  2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

REGULATORY CAPITAL REQUIREMENTS:
Federal regulations require the Company and the Bank to maintain minimum amounts of capital. Specifically, each is required to maintain certain minimum dollar amounts and ratios of Total and Tier I capital to risk-weighted assets and of Tier I capital to average total assets.
In addition to the capital requirements, the Federal Deposit Insurance Corporation Improvement Act (FDICIA) established five capital categories ranging from "well capitalized" to "critically undercapitalized." Should any institution fail to meet the requirements to be considered "adequately capitalized", it would become subject to a series of increasingly restrictive regulatory actions.
As of December 31, 2003 and 2002, the Federal Reserve Board and the Office of the Comptroller of the Currency categorized the Company and the Bank as well capitalized, under the regulatory framework for prompt corrective action. To be categorized as a well capitalized financial institution, Total risk-based, Tier I risk-based and Tier I leverage capital ratios must be at least 10%, 6% and 5%, respectively.
The following table reflects the Company’s capital ratios at December 31 ( in thousands ):

 
 
2003
2002
 
 
Amount
Ratio
Amount
Ratio
Total capital (to risk weighted assets)
 
 
 
 
 

 



Company
 
$
40,655
   
14.07
%
$
31,036
   
11.52
%
For capital adequacy purposes
   
23,115
   
8.00
%
 
21,552
   
8.00
%
To be well capitalized
   
28,894
   
10.00
%
 
26,939
   
10.00
%
 
   
 
   
 
   
 
   
 
 
Tier I capital (to risk weighted assets)
   
 
   
 
   
 
   
 
 

 
 
 
 
 
 
   
 
   
 
   
 
   
 
 
Company
 
$
37,042
   
12.82
%
$
27,522
   
10.22
%
For capital adequacy purposes
   
11,557
   
4.00
%
 
10,776
   
4.00
%
To be well capitalized
   
17,336
   
6.00
%
 
16,164
   
6.00
%
 
   
 
   
 
   
 
   
 
 
Tier I capital (to average assets)
   
 
   
 
   
 
   
 
 

 
 
 
 
 
 
   
 
   
 
   
 
   
 
 
Company
 
$
37,042
   
8.50
%
$
27,522
   
6.48
%
For capital adequacy purposes
   
17,437
   
4.00
%
 
16,978
   
4.00
%
To be well capitalized
   
21,796
   
5.00
%
 
21,223
   
5.00
%
At December 31, 2003, the Bank’s Total capital and Tier I ratios were 11.73% and 10.48%, respectively, and Tier I capital to average assets was 7.03%. At December 31, 2002, the Bank’s Total capital and Tier I ratios were 12.13% and 10.85%, respectively, and Tier I capital to average assets was 7.00%.
This annual report has not been reviewed, or confirmed for accuracy or relevance, by the Federal Deposit Insurance Corporation.

12. OFF-BALANCE-SHEET RISK
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate or liquidity risk in excess of the amount recognized in the consolidated balance sheet.
 
 CITIZENS FINANCIAL SERVICES, INC.  25 2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

 
The Company’s exposure to credit loss from nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Company 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, 2003 and 2002, are as follows ( in thousands ):

   

 2003 

 2002


 
 
 
 Commitments to extend credit   $ 41,094   $ 33,946  
 Standby letters of credit      1,404      1,143  
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 Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Company on extension of credit is based on management’s credit assessment of the counter party.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Performance letters of credit represent conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. These instruments are issued primarily to support bid or performance related contracts. The coverage period for these instruments is typically a one-year period with an annual renewal option subject to prior approval by management. Fees earned from the issuance of these letters are recognized over the coverage period. For secured letters of credit, the collateral is typically Bank deposit instruments or customer business assets.
13. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company’s financial instruments are as follows ( in thousands ):

December 31, 2003

 

 
 
Carrying
Estimated
 
 
Amount
Fair Value

 

Financial assets:
 
 
 
Cash and due from banks
 
$
9,951
 
$
9,951
 
Available-for-sale securities
   
106,587
   
106,587
 
Net loans
   
314,037
   
322,813
 
Bank owned life insurance
   
7,142
   
7,142
 
Regulatory stock
   
2,540
   
2,540
 
Accrued interest receivable
   
1,703
   
1,703
 

 
 
 
Financial liabilities:
   
 
   
 
 
Deposits
 
$
385,691
 
$
391,282
 
Borrowed funds
   
27,796
   
27,998
 
Notes payable
   
7,500
   
7,500
 
Accrued interest payable
   
1,888
   
1,888
 

 
 
 
 
 CITIZENS FINANCIAL SERVICES, INC. 26  2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


December 31, 2002

 

 
 
Carrying
Estimated
 
 
Amount
Fair Value

 

Financial assets:
 
 
 
Cash and due from banks
 
$
11,594
 
$
11,594
 
Available-for-sale securities
   
100,725
   
100,725
 
Net loans
   
294,836
   
297,913
 
Regulatory stock
   
1,529
   
1,529
 
Accrued interest receivable
   
1,976
   
1,976
 

 
 
 
Financial liabilities:
   
 
   
 
 
Deposits
 
$
373,051
 
$
375,007
 
Borrowed funds
   
17,028
   
17,080
 
Accrued interest payable
   
2,077
   
2,077
 

 
 
 
      Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions can significantly affect the estimates.
Estimated fair values have been determined by the Company using historical data, as generally provided in the Company’s regulatory reports, and an estimation methodology suitable for each category of financial instruments. The Company’s fair value estimates, methods and assumptions are set forth below for the Company’s other financial instruments.

CASH AND DUE FROM BANKS:
The carrying amounts for cash and due from banks approximate fair value because they mature in 90 days or less and do not present unanticipated credit concerns.

INVESTMENT SECURITIES:
The fair values of investments are based on quoted market prices as of the balance sheet date. For certain instruments, fair value is estimated by obtaining quotes from independent dealers.
LOANS:
Fair values are estimated for portfolios of loans with similar financial characteristics.
The fair value of performing loans has been estimated by discounting expected future cash flows. The discount rate used in these calculations is derived from the Treasury yield curve adjusted for credit quality, operating expense and prepayment option price, and 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 loan. The estimate of maturity is based on the Company’s historical experience with repayments for each loan classification, modified as required by an estimate of the effect of current economic and lending conditions.
Fair value for significant nonperforming loans is based on recent external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discount rates are judgmentally determined using available market information and specific borrower information.
 
 CITIZENS FINANCIAL SERVICES, INC.  27  2003 ANNUAL REPORT

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

BANK OWNED LIFE INSURANCE:
The carrying value of bank owned life insurance approximates fair value based on applicable redemption provisions.

REGULATORY STOCK:
The carrying value of regulatory stock approximates fair value based on applicable redemption provisions.

DEPOSITS:
The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings and NOW accounts, and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit 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 deposits’ fair value estimates do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market, commonly referred to as the core deposit intangible.

BORROWED FUNDS:
Rates available to the Company for borrowed funds with similar terms and remaining maturities are used to estimate the fair value of borrowed funds.

14. GOODWILL - ADOPTION OF STATEMENT 142
A summary of goodwill is as follows ( in thousands ):

 
 
December 31,
 
 
2003
2002
2001

 


Gross carrying amount
 
$
7,685
 
$
7,685
 
$
7,685
 
Less accumulated amortization
   
780
   
780
   
780
 

 
 
 
 
Net carrying amount
 
$
6,905
 
$
6,905
 
$
6,905
 

 
 
 
 
Amortization expense amounted to $512,000 for 2001.
The gross carrying amount of goodwill is tested for impairment in the fourth quarter, after the annual forecasting process. Due to an increase in overall earning asset growth, operating profits and cashflows were greater than expected. Based on the fair value of the reporting unit, estimated using the expected present value of future cashflows, no goodwill impairment loss was recognized in the current year.
 
 CITIZENS FINANCIAL SERVICES, INC.  28 2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The following table sets forth a comparison of net income and basic earnings per share adjusted for the adoption of SFAS No. 142, "Goodwill and Other Intangible Assets":
(in thousands, except per share data)

 
 
For the Year Ended
 
 
December 31,
 
 
2003
2002
2001

 


Goodwill amortization
 
$
-
 
$
-
 
$
512
 
Net Income
   
4,879
   
5,595
   
3,757
 
Addback: Goodwill amortization (net of tax)
   
-
   
-
   
338
 

 
 
 
 
Adjusted net income
 
$
4,879
 
$
5,595
 
$
4,095
 

 
 
 
 
Basic earnings per share:
   
 
   
 
   
 
 
Net income
 
$
1.72
 
$
1.96
 
$
1.32
 
Goodwill amortization
   
-
   
-
   
0.12
 

 
 
 
 
Adjusted basic earnings per share
 
$
1.72
 
$
1.96
 
$
1.44
 

 
 
 
 
15. CORE DEPOSIT INTANGIBLE ASSETS
A summary of core deposit intangible assets is as follows (in thousands) :

 
 
December 31,
 
 
2003
2002
2001

 


Gross carrying amount
 
$
2,763
 
$
2,763
 
$
2,763
 
Less accumulated amortization
   
1,785
   
1,350
   
893
 

 
 
 
 
Net carrying amount
 
$
978
 
$
1,413
 
$
1,870
 

 
 
 
 
Amortization expense amounted to $435,000, $457,000 and $503,000 for 2003, 2002 and 2001, respectively.

The estimated amortization expense of intangible assets for each of the five succeeding fiscal years is as follows:
(in thousands) :

 
Core deposit
 
intangibles


For the year ended December 31, 2004
$ 435
For the year ended December 31, 2005
435
For the year ended December 31, 2006
108
For the year ended December 31, 2007
-
For the year ended December 31, 2008
-
 
 CITIZENS FINANCIAL SERVICES, INC. 29  2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

16. CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY
CITIZENS FINANCIAL SERVICES, INC.
CONDENSED BALANCE SHEET

 
 
December 31,
(in thousands)
 
2003
2002

 

Assets:
 
 
 
Cash
 
$
7,680
 
$
68
 
Investment in subsidiary,
   
 
   
 
 
First Citizens National Bank
   
39,241
   
39,978
 
Available-for-sale securities
   
-
   
416
 
Other assets
   
306
   
13
 

 
 
 
Total assets
 
$
47,227
 
$
40,475
 
 
   
 
   
 
 
Liabilities:
   
 
   
 
 
Other liabilities
 
$
260
 
$
23
 
Deferred tax liability
   
-
   
46
 
Notes payable
   
7,500
   
-
 
Borrowed funds
   
938
   
2,000
 

 
 
 
Total liabilities
 
$
8,698
 
$
2,069
 
Stockholders' equity
   
38,529
   
38,406
 

 
 
 
Total liabilities and stockholders' equity
 
$
47,227
 
$
40,475
 

 
 
 
CITIZENS FINANCIAL SERVICES, INC.
CONDENSED STATEMENT OF INCOME

 
 
Year Ended December 31,
(in thousands)
 
2003
2002
2001

 


Dividends from:
 
 
 
 
Bank subsidiary
 
$
4,142
 
$
1,478
 
$
481
 
Available-for-sale securities
   
3
   
19
   
44
 
Interest-bearing deposits with banks
   
-
   
2
   
22
 

 
 
 
 
Total income
   
4,145
   
1,499
   
547
 
Realized securities gains, net
   
150
   
178
   
189
 
Expenses
   
186
   
213
   
264
 

 
 
 
 
Income before equity
   
 
   
 
   
 
 
in undistributed earnings
   
 
   
 
   
 
 
of subsidiary
   
4,109
   
1,464
   
472
 
Equity in undistributed
   
 
   
 
   
 
 
earnings - First Citizens National Bank
   
770
   
4,131
   
3,285
 

 
 
 
 
Net income
 
$
4,879
 
$
5,595
 
$
3,757
 

 
 
 
 
 
 
 CITIZENS FINANCIAL SERVICES, INC.  30 2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

CITIZENS FINANCIAL SERVICES, INC.
STATEMENT OF CASH FLOWS

 
 
Year Ended December 31,
(in thousands)
 
2003
2002
2001

 


Cash flows from operating activities:
 
 
 
 
Net income
 
$
4,879
 
$
5,595
 
$
3,757
 
Adjustments to reconcile net income to net
   
 
   
 
   
 
 
cash provided by operating activities:
   
 
   
 
   
 
 
Equity in undistributed earnings of subsidiaries
   
(770
)
 
(4,131
)
 
(3,285
)
Deferred income taxes
   
-
   
-
   
3
 
Realized gains on securities
   
(150
)
 
(178
)
 
(189
)
Decrease (increase) in other assets
   
(293
)
 
11
   
35
 
Increase (decrease) in other liabilities
   
238
   
1
   
(4
)

 
 
 
 
Net cash provided by operating activities
   
3,904
   
1,298
   
317
 

 
 
 
 
Cash flows from investing activities:
   
 
   
 
   
 
 
Purchase of available-for-sale securities
   
-
   
-
   
(418
)
Proceeds from the sale of available-for-sale securities
   
429
   
621
   
2,283
 
Additional contribution in subsidiaries
   
-
   
-
   
(500
)

 
 
 
 
Net cash provided by investing activities
   
429
   
621
   
1,365
 

 
 
 
 
Cash flows from financing activities:
   
 
   
 
   
 
 
Cash dividends paid
   
(2,103
)
 
(1,918
)
 
(1,786
)
Advances of borrowed funds
   
1,055
   
-
   
-
 
Repayments of borrowed funds
   
(2,117
)
 
-
   
-
 
Acquisition of treasury stock
   
(1,056
)
 
-
   
-
 
Proceeds from notes payable
   
7,500
   
-
   
-
 

 
 
 
 
Net cash provided by (used in) financing activities
   
3,279
   
(1,918
)
 
(1,786
)

 
 
 
 
 
   
 
   
 
   
 
 
Net increase (decrease) in cash
   
7,612
   
1
   
(104
)
 
   
 
   
 
   
 
 
Cash at beginning of year
   
68
   
67
   
171
 

 
 
 
 
Cash at end of year
 
$
7,680
 
$
68
 
$
67
 

 
 
 
 
 
 
 CITIZENS FINANCIAL SERVICES, INC.  31 2003 ANNUAL REPORT 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

17. CONDENSED QUARTERLY DATA
CONSOLIDATED QUARTERLY DATA

(dollar amounts in thousands)
 
Three Months Ended
2003
 
Mar 31
Jun 30
Sep 30
Dec 31

 



Interest income
 
$
6,520
 
$
6,401
 
$
6,329
 
$
6,365
 
Interest expense
   
2,313
   
2,264
   
2,149
   
2,100
 

 
 
 
 
 
Net interest income
   
4,207
   
4,137
   
4,180
   
4,265
 
Provision for loan losses
   
135
   
120
   
120
   
60
 
Non-interest income
   
1,095
   
1,270
   
1,212
   
1,182
 
Realized securities gains, net
   
259
   
141
   
114
   
39
 
Non-interest expenses
   
3,631
   
3,631
   
4,490
   
3,749
 

 
 
 
 
 
Income before provision for income taxes
   
1,795
   
1,797
   
896
   
1,677
 
Provision for income taxes
   
430
   
415
   
90
   
351
 

 
 
 
 
 
Net income
 
$
1,365
 
$
1,382
 
$
806
 
$
1,326
 

 
 
 
 
 
Earnings Per Share
 
$
0.48
 
$
0.48
 
$
0.28
 
$
0.47
 

 
 
 
 
 
 

 
 
Three Months Ended
2002
 
Mar 31
Jun 30
Sep 30
Dec 31

 



Interest income
 
$
6,867
 
$
6,825
 
$
6,894
 
$
6,791
 
Interest expense
   
2,723
   
2,632
   
2,558
   
2,491
 

 
 
 
 
 
Net interest income
   
4,144
   
4,193
   
4,336
   
4,300
 
Provision for loan losses
   
120
   
90
   
90
   
135
 
Non-interest income
   
1,201
   
1,154
   
1,177
   
1,260
 
Realized securities gains, net
   
30
   
186
   
38
   
-
 
Non-interest expenses
   
3,467
   
3,590
   
3,571
   
3,598
 

 
 
 
 
 
Income before provision for income taxes
   
1,788
   
1,853
   
1,890
   
1,827
 
Provision for income taxes
   
428
   
438
   
459
   
438
 

 
 
 
 
 
Net income
 
$
1,360
 
$
1,415
 
$
1,431
 
$
1,389
 

 
 
 
 
 
Earnings Per Share
 
$
0.48
 
$
0.50
 
$
0.50
 
$
0.49
 

 
 
 
 
 
18. SUBSEQUENT EVENT
On February 25, 2004 the Company announced that they have entered into a definitive agreement whereby the Company has purchased two branch locations from Legacy Bank. Under the terms of the agreement, the Company will acquire approximately $24 million in loans and $21 million in deposits, in addition to assuming the lease costs of the branches. This acquisition has been approved by the Company’s board of directors and is expected to close in the second quarter of 2004.
 
 CITIZENS FINANCIAL SERVICES, INC.  32 2003 ANNUAL REPORT 

 
 
REPORT OF INDEPENDENT AUDITORS

 
 
To the Stockholders and Board of Directors of
Citizens Financial Services, Inc.
 
We have audited the consolidated balance sheet of Citizens Financial Services, Inc. and subsidiary as of December 31, 2003 and 2002, 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, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
 
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Citizens Financial Services, Inc. and subsidiary as of December 31, 2003 and 2002, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.
 
 
 
Wexford, PA
January 16, 2004
except for Note 18, as to which the date is February 25, 2004
 
S.R. Snodgrass, A.C.
1000 Stonewood Drive, Suite 200 Wexford, PA 15090-8399 Phone: 724-934-0344 Facsimile: 724-934-0345
 
 CITIZENS FINANCIAL SERVICES, INC. 33  2003 ANNUAL REPORT 

 

SELECTED FINANCIAL DATA

FIVE YEAR SUMMARY OF OPERATIONS

(dollar amounts in thousands)
 
2003
2002
2001
2000
1999

 




Interest income
 
$
25,615
 
$
27,377
 
$
29,025
 
$
26,226
 
$
23,546
 
Interest expense
   
8,826
   
10,404
   
14,306
   
14,238
   
12,066
 

 
 
 
 
 
 
Net interest income
   
16,789
   
16,973
   
14,719
   
11,988
   
11,480
 
Provision for loan losses
   
435
   
435
   
445
   
610
   
475
 

 
 
 
 
 
 
Net interest income after provision
   
 
   
 
   
 
   
 
   
 
 
for loan losses
   
16,354
   
16,538
   
14,274
   
11,378
   
11,005
 
Non-interest income
   
4,759
   
4,792
   
3,632
   
2,670
   
2,345
 
Realized securities gains (losses), net
   
553
   
254
   
657
   
(9
)
 
279
 
Non-interest expenses
   
15,501
   
14,226
   
14,041
   
10,187
   
9,033
 

 
 
 
 
 
 
Income before provision for income taxes and
   
 
   
 
   
 
   
 
   
 
 
extraordinary item
   
6,165
   
7,358
   
4,522
   
3,852
   
4,596
 
Provision for income taxes
   
1,286
   
1,763
   
765
   
644
   
1,043
 

 
 
 
 
 
 
Net income
 
$
4,879
 
$
5,595
 
$
3,757
 
$
3,208
 
$
3,553
 

 
 
 
 
 
 
Per share data:
   
 
   
 
   
 
   
 
   
 
 
Net income (1)
 
$
1.72
 
$
1.96
 
$
1.32
 
$
1.12
 
$
1.22
 
Cash dividends (1)
   
0.740
   
0.680
   
0.640
   
0.600
   
0.560
 
Book value (1)
   
13.70
   
13.45
   
11.70
   
10.69
   
9.33
 
 
   
 
   
 
   
 
   
 
   
 
 
Total investments
 
$
106,587
 
$
100,725
 
$
113,604
 
$
97,984
 
$
90,031
 
Loans, net (2)
   
314,037
   
294,836
   
268,464
   
260,209
   
229,159
 
Total assets (2)
   
463,878
   
432,658
   
421,110
   
413,332
   
340,779
 
Total deposits (2)
   
385,691
   
373,051
   
370,474
   
367,785
   
284,318
 
Stockholders' equity
   
38,529
   
38,406
   
33,389
   
30,549
   
27,082
 

(1) Amounts were adjusted to reflect stock dividends
 
 
(2) Amounts in 2000 reflect the acquisition of branches in the fourth quarter of 2000
 
 
 
 CITIZENS FINANCIAL SERVICES, INC.  34 2003 ANNUAL REPORT 

 

SELECTED FINANCIAL DATA (CONTINUED)

COMMON STOCK
Common stock issued by Citizens Financial Services, Inc. is traded in the local over-the-counter market, primarily in Pennsylvania and New York. Prices presented in the table below are bid/ask prices between broker-dealers published by the National Association of Securities Dealers through the NASD OTC "Bulletin Board", its automated quotation system for non-NASDAQ quoted stocks and the National Quotation Bureau’s "Pink Sheets." The prices do not include retail markups or markdowns or any commission to the broker-dealer. The bid prices do not necessarily reflect prices in actual transactions. Cash dividends are declared on a quarterly basis and the effects of stock dividends have been stated retroactively in the table below (also see dividend restrictions in Note 11).

     

 

Dividends

 

 

 Dividends

 
 
2003
declared
2002
declared
 
 
High
Low
per share
High
Low
per share

 





First quarter
 
$
22.47
 
$
20.30
 
$
0.180
 
$
16.75
 
$
13.50
 
$
0.165
 
Second quarter
   
28.02
   
22.52
   
0.185
   
17.50
   
16.80
   
0.170
 
Third quarter
   
27.40
   
26.98
   
0.185
   
19.35
   
17.00
   
0.170
 
Fourth quarter
   
24.75
   
22.50
   
0.190
   
21.80
   
19.35
   
0.175
 
 
TRUST AND INVESTMENT SERVICES FUNDS UNDER MANAGEMENT (MARKET VALUE)

 
 
2003
2002

 

INVESTMENTS:
 
 
 
Bonds
 
$
11,806
 
$
13,153
 
Stock
   
22,384
   
20,783
 
Savings and Money Market Funds
   
10,837
   
11,168
 
Mutual Funds
   
22,831
   
18,257
 
Mortgages
   
868
   
936
 
Real Estate
   
994
   
816
 
Miscellaneous
   
193
   
29
 
Cash
   
471
   
29
 
TOTAL
 
$
70,384
 
$
65,171
 

 
 
 
ACCOUNTS:
   
 
   
 
 
Estates
 
$
2,377
 
$
1,016
 
Trusts
   
22,908
   
25,134
 
Guardianships
   
106
   
184
 
Employee Benefits
   
22,088
   
19,490
 
Investment Management
   
18,000
   
13,377
 
Custodial
   
4,905
   
5,970
 
TOTAL
 
$
70,384
 
$
65,171
 

 
 
 
 
 
 CITIZENS FINANCIAL SERVICES, INC.  35 2003 ANNUAL REPORT 

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTIONARY STATEMENT
Forward-looking statements may prove inaccurate. We have made forward-looking statements in this document, and in documents that we incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of operations of Citizens Financial Services, Inc., First Citizens National Bank, First Citizens Insurance Agency, Inc. or the combined Company. When we use such words as "believes," "expects," "anticipates," or similar expressions, we are making forward-looking statements. For a variety of reasons, actual results could differ materially from those contained in or implied by forward-looking statements:
·    Interest rates could change more rapidly or more significantly than we expect.
·    The economy could change significantly in an unexpected way, which would cause the demand for new loans and the ability of borrowers to repay outstanding loans to change in ways that our models do not anticipate.
·    The stock and bond markets could suffer a significant disruption, which may have a negative effect on our financial condition and that of our borrowers, and on our ability to raise money by issuing new securities.
·    It could take us longer than we anticipate to implement strategic initiatives designed to increase revenues or manage expenses, or we may be unable to implement those initiatives at all.
·    Acquisitions and dispositions of assets could affect us in ways that management has not anticipated.
·    We may become subject to new legal obligations or the resolution of litigation may have a negative effect on our financial condition.
·    We may become subject to new and unanticipated accounting, tax, or regulatory practices or requirements.
INTRODUCTION
The following is management’s discussion and analysis of the significant changes in the results of operations, capital resources and liquidity presented in its accompanying consolidated financial statements for Citizens Financial Services, Inc., a bank holding company and its subsidiary (the Company). Our Company’s consolidated financial condition and results of operations consist almost entirely of our wholly owned subsidiary’s (First Citizens National Bank) financial conditions and results of operations. Management’s discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes. Except as noted, tabular information is presented in thousands of dollars.
Our Company currently engages in the general business of banking throughout our service area of Potter, Tioga and Bradford counties in North Central Pennsylvania and Allegany, Steuben, Chemung and Tioga counties in Southern New York. We maintain our central office in Mansfield, Pennsylvania. Presently we operate banking facilities in Mansfield, Blossburg, Ulysses, Genesee, Wellsboro, Troy, Sayre, Canton, Gillett, Millerton, LeRaysville, Towanda, the Wellsboro Weis Market store and the Mansfield Wal-Mart Super center. Additionally, we have automatic teller machines (ATMs) located in Soldiers and Sailors Memorial Hospital in Wellsboro and at Mansfield University. Our lending and deposit products and investment services are offered primarily within our service area.
Risk identification and management are essential elements for the successful management of the Company. In the normal course of business, the Company is subject to various types of risk, including interest rate, credit and liquidity risk.
Interest rate risk is the sensitivity of net interest income and the market value of financial instruments to the direction and frequency of changes in interest rates. Interest rate risk results from various re-pricing frequencies and the maturity structure of the financial instruments owned by the Company. The Company uses its asset/liability and funds management policy to control and manage interest rate risk.
 
 CITIZENS FINANCIAL SERVICES, INC.  36 2003 ANNUAL REPORT 

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Credit risk represents the possibility that a customer may not perform in accordance with contractual terms. Credit risk results from loans with customers and the purchasing of securities. The Company’s primary credit risk is in the loan portfolio. The Company manages credit risk by adhering to an established credit policy and through a disciplined evaluation of the adequacy of the allowance for loan losses. Also, the investment policy limits the amount of credit risk that may be taken in the investment portfolio.
Liquidity risk represents the inability to generate or otherwise obtain funds at reasonable rates to satisfy commitments to borrowers and obligations to depositors. The Company has established guidelines within its asset/liability and funds management policy to manage liquidity risk. These guidelines include contingent funding alternatives.
Readers should carefully review the risk factors described in other documents our Company files from time to time with the Securities and Exchange Commission, including the quarterly reports on Form 10-Q and any current reports on Form 8-K filed by us.
We face strong competition in the communities we serve from other commercial banks, savings banks, and savings and loan associations, some of which are substantially larger institutions than our subsidiary. In addition, insurance companies, investment-counseling firms, and other business firms and individuals offer personal and corporate trust services. We also compete with credit unions, issuers of money market funds, securities brokerage firms, consumer finance companies, mortgage brokers and insurance companies. These entities are strong competitors for virtually all types of financial services.
In recent years, the financial services industry has experienced tremendous change to competitive barriers between bank and non-bank institutions. We not only must compete with traditional financial institutions, but also with other business corporations that have begun to deliver competing financial services. Competition for banking services is based on price, nature of product, quality of service, and in the case of certain activities, convenience of location.
TRUST AND INVESTMENT SERVICES
Our Trust & Investment Department services range from professional estate settlement services through management of complex trust accounts to investment management and custody of securities. Our Investment and Trust Department manages retirement accounts for many area companies and individuals. We also manage many individual IRAs, both rollover and contributory.
The Investment Department offers full service brokerage services in selected locations throughout the Bank’s market area and appointments can be made in any First Citizens National Bank branch.
The Bank offers annuities and life insurance through our insurance subsidiary, First Citizens Insurance Agency, Inc.
FINANCIAL CONDITION
The following table presents ending balances (dollars in millions), growth (reduction) and the percentage change during the past two years:

 
 
2003
Increase

%

2002
Increase

%

2001
 
 
Balance
(Decrease)
Change
Balance
(Decrease)
Change
Balance

 






Total assets
 
$ 463.9
$ 31.2
7.2
$ 432.7
$ 11.6
2.8
$ 421.1
Total loans, net
 
314.0
19.2
6.4
294.8
26.3
9.8
268.5
Total investments
 
106.6
5.9
5.9
100.7
(12.9)
(11.4)
113.6
Total deposits
 
385.7
12.6
3.4
373.1
2.6
0.7
370.5
Total stockholders' equity
 
38.5
0.1
0.3
38.4
5.0
15.0
33.4
 
CASH AND CASH EQUIVALENTS
Cash and cash equivalents totaled $9,951,000 at December 31, 2003 compared to $11,594,000 at December 31, 2002. Non-interest bearing cash decreased $1,549,000 since December 31, 2002, while interest-bearing cash decreased $94,000 during that same time period.
 
 CITIZENS FINANCIAL SERVICES, INC.  37 2003 ANNUAL REPORT 

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

We believe the Company’s liquidity needs are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources, Federal Home Loan Bank financing, and the portion of the investment and loan portfolios that mature within one year. These sources of funds should permit us to meet cash obligations and off-balance sheet commitments as they come due.
INVESTMENTS
Our investment portfolio increased by $5.9 million or 5.9% in 2003 as compared to a decrease of $12.9 million in 2002. Our investment portfolio has increased primarily as a result of a $22 million investment purchase that occurred in December 2003 related to a leveraged transaction. We continued to experience significant cash flow from our mortgage-backed securities monthly principal repayments, which averaged $3,730,000 per month. This, along with the sale of some mortgage-backed securities, and the call of some municipal bonds throughout 2003, allowed excess funds to be used for our continued loan growth.
During 2003 new investments were made primarily in short-term mortgage-backed securities. Our current investment strategy is to reinvest in short-term mortgage-backed securities as funds become available.
The following table shows the year-end composition of the investment portfolio for the five years ending December 31:

Estimated Fair Market Value at December 31,
 
 
2003
% of
2002
% of
2001
% of
2000
% of
1999
% of
 
 
Amount
Total
Amount
Total
Amount
Total
Amount
Total
Amount
Total

 









Available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
U. S. Treasury securities
 
$ -
-
$ -
-
$ -
-
$ 8,655
8.8
$ 13,628
15.1
U. S. Agency securities
 
1,033
1.0
1,052
1.0
-
-
1,531
1.6
-
-
Obligations of state & political
 
 
 
 
 
 
 
 
 
 
 
subdivisions
 
8,303
7.8
12,731
12.6
18,543
16.3
20,592
21.0
19,469
21.6
Corporate obligations
 
14,674
13.8
21,156
21.0
12,200
10.7
19,710
20.1
18,629
20.7
Mortgage-backed securities
 
78,376
73.5
60,801
60.4
77,211
68.0
38,473
39.3
34,045
37.8
Other equity securities
 
4,201
3.9
4,985
4.9
5,650
5.0
9,023
9.2
4,260
4.7

 









Total
 
$ 106,587
100.0
$ 100,725
100.0
$ 113,604
100.0
$ 97,984
100.0
$ 90,031
100.0

 









The expected principal repayments (amortized cost) and average weighted yields for the investment portfolio as of December 31, 2003, are shown below. Expected maturities, which include prepayment speed assumptions for mortgage-back securities, are significantly different than the contractual maturities detailed in Footnote 3 of the Consolidated Financial Statements. Yields on tax-exempt securities are presented on a fully taxable equivalent basis, assuming a 34% tax rate.

 
 
Within
 
One-
 
Five-
 
After
 
Amortized
 
 
 
One
Yield
Five
Yield
Ten
Yield
Ten
Yield
Cost
Yield
 
 
Year
(%)
Years
(%)
Years
(%)
Years
(%)
Total
(%)

 









Available-for-sale securities:
 
 
 
 
 
 
 
 
 
 
 
U.S. Agency securities
 
$ -
 
$ 1,005
4.0
$ -
 
$ -
 
$ 1,005
4.0
Obligations of state & political
 
subdivisions
 
4,035
6.4
3,547
7.0
429
6.4
-
-
8,011
6.7
Corporate obligations
 
-
-
11,705
5.5
1,951
7.2
-
-
13,656
5.8
Mortgage-backed securities
 
1,703
5.3
70,308
4.3
6,069
3.9
-
-
78,080
4.3
Equity securities
 
-
-
4,387
5.9
-
-
-
-
4,387
5.9

 









Total available-for-sale
 
$ 5,738
6.1
$ 90,952
4.6
$ 8,449
4.8
$ -
-
$ 105,139
4.7

 









 
 
 CITIZENS FINANCIAL SERVICES, INC.  38 2003 ANNUAL REPORT 

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Approximately 92% of the amortized cost of debt securities is expected to mature within five years or less.
Our Company expects that earnings from operations, the high liquidity level of the available-for-sale securities, growth of deposits and the availability of borrowings from the Federal Home Loan Bank will be sufficient to meet future liquidity needs.
Our Company has no securities from a single issuer representing more than 10% of stockholders’ equity.
LOANS
Historically, our Company’s loan customers have been located in North Central Pennsylvania and the Southern Tier of New York. We originate loans primarily through direct loans to our existing customer base, with new customers generated by referrals from real estate brokers, building contractors, attorneys, accountants and existing customers. We also do a limited amount of indirect loans through new and used car dealers in our primary lending area.
All lending is governed by a lending policy that is developed and maintained by us and approved by the Board of Directors. Our Company’s real estate loan lending policy generally permits the Bank to lend up to 80% of the appraised value or purchase price (whichever is lower) on owner-occupied residential property, when secured by the first mortgage on the property. Home equity lines of credit or second mortgage loans are generally originated subject to maximum mortgage liens against the property of 80% of the current appraised value. The maximum term for mortgage loans is 25 years for one- to four-family residential property and 20 years for commercial and vacation property.
As shown in the following table, total loans grew by $19.2 million in 2003, or 6.4%. In addition, $22.4 million in conforming mortgage loans were originated and $23.8 million sold in the secondary market through Freddie Mac, providing over $349,000 of income in origination fees and premiums on loans sold, compared to $11.9 million in loans originated and $185,000 of income in 2002. The increased activity in loans sold was primarily a result of the conducive interest rate environment that continued during 2003. Residential mortgage lending is a principal business activity and one we expect to continue.
Our Company focuses its commercial lending activity on small businesses and our commercial lending officers have attracted new business loans, especially loans to state and political subdivisions.
The majority of lending activity has been mortgage loans secured by one- to four-family residential property. As of December 31, 2003, residential real estate and real estate construction loans were 58.6% of our total loan portfolio.
Continuing in 2004, our Company’s primary goal is to be the premier mortgage lender in our market area, with our menu of conforming mortgages (including "jumbo" and low- to moderate-income homebuyer mortgages) through Farmers Home Administration (FmHA). The local economy has started to improve slightly and the average unemployment rate has recently been approximately 5.2% (slightly higher than the state unemployment rate of 4.6%) down from 5.9% in 2002. Loan demand has continued during the last quarter of 2003 for residential mortgages and commercial loans. We believe that our continued emphasis on training branch office personnel and the focus on flexibility and fast "turn around time" will continue to aid in growing our loan portfolio. (Also see the discussion in Footnote 4 of the Consolidated Financial Statements.)
 
 CITIZENS FINANCIAL SERVICES, INC.  39 2003 ANNUAL REPORT 

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


Five Year Breakdown of Loans by Type
December 31,
 
 
 
 
 
 
 
 
 
 
 
 
 
2003
2002
2001
2000

1999

 
 
Amount

%

Amount

%

Amount

%

Amount

%

Amount

%


 









Real estate:
 
 
 
 
 
 
 
 
 
 
 
Residential
 
$ 180,333
56.8
$ 175,323
58.7
$ 160,439
59.0
$ 151,782
57.7
$ 139,518
60.3
Commercial
 
57,370
18.1
47,210
15.8
43,174
15.9
40,044
15.2
32,159
13.9
Agricultural
 
7,594
2.4
9,844
3.3
12,169
4.5
12,075
4.6
9,392
4.1
Construction
 
5,784
1.8
5,009
1.7
3,219
1.2
3,112
1.2
4,359
1.9
Loans to individuals
 
 
 
 
 
 
 
 
 
 
 
for household,
 
 
 
 
 
 
 
 
 
 
 
family and other purchases
 
13,145
4.1
13,915
4.7
14,694
5.4
15,020
5.7
15,540
6.7
Commercial and other loans
 
16,219
5.1
18,564
6.2
15,099
5.6
17,509
6.7
12,313
5.3
State & political subdivision loans
 
37,212
11.7
28,592
9.6
22,920
8.4
23,444
8.9
18,148
7.8

 









 
Total loans
 
317,657
100.0
298,457
100.0
271,714
100.0
262,986
100.0
231,429
100.0
Less allowance for loan losses
 
3,620
 
3,621
 
3,250
 
2,777
 
2,270
 

 









Net loans
 
$ 314,037
 
$ 294,836
 
$ 268,464
 
$ 260,209
 
$ 229,159
 

 









 

 
 
2003/2002
 
2002/2001
 
 
 
Change
 
Change
 
 
 
Amount

 %

Amount

 %


 



Real estate:
 
 
 
 
 
Residential
 
$
5,010
   
2.9
 
$
14,884
   
9.3
 
Commercial
   
10,160
   
21.5
   
4,036
   
9.3
 
Agricultural
   
(2,250
)
 
(22.9
)
 
(2,325
)
 
(19.1
)
Construction
   
775
   
15.5
   
1,790
   
55.6
 
Loans to individuals
   
 
   
 
   
 
   
 
 
for household,
   
 
   
 
   
 
   
 
 
family and other purchases
   
(770
)
 
(5.5
)
 
(779
)
 
(5.3
)
Commercial and other loans
   
(2,345
)
 
(12.6
)
 
3,465
   
22.9
 
State & political subdivision loans
   
8,620
   
30.1
   
5,672
   
24.7
 
Total loans
 
$
19,200
   
6.4