10-Q for first quarter 2007
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q



[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2007

Or

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from_____________________ to ___________________

Commission file number 0-13222

CITIZENS FINANCIAL SERVICES, INC.
(Exact name of registrant as specified in its charter)

 PENNSYLVANIA 23-2265045
 (State or other jurisdiction of incorporation or organization)  (I.R.S. Employer Identification No.)


15 South Main Street
Mansfield, Pennsylvania 16933
(Address of principal executive offices)(Zip Code)

Registrant's telephone number, including area code: (570) 662-2121

Indicate by check mark whether the registrant (1) has filed all reports to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __X__ No_____

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. (See definition of “accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act) Check one:

Large Accelerated File ____ Accelerated Filer ____ Non-accelerated Filer __X__


Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes____ No __X__

The number of shares outstanding of the Registrant's Common Stock, as of May 1, 2007, was 2,819,692 shares of Common Stock, par value $1.00.



 
Citizens Financial Services, Inc.
Form 10-Q

INDEX
 
   
PAGE
Part I 
FINANCIAL INFORMATION
 
Item 1.
Financial Statements (unaudited):
 
 
Consolidated Balance Sheet as of March 31, 2007 and
December 31, 2006
1
 
Consolidated Statement of Income for the
Three Months Ended March 31, 2007 and 2006
2
 
Consolidated Statement of Comprehensive Income for the
Three Months Ended March 31, 2007 and 2006
3
 
Consolidated Statement of Cash Flows for the
Three Months Ended March 31, 2007 and 2006
4
 
Notes to Consolidated Financial Statements
5-7
Item 2.
Management’s Discussion and Analysis of Financial
Condition and Results of Operations
7-20
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
20
Item 4.
Controls and Procedures
21
     
Part II 
OTHER INFORMATION
 
Item 1.
Legal Proceedings
22
Item 1A.
Risk Factors
22
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
22
Item 3.
Defaults upon Senior Securities
22
Item 4.
Submission of Matters to a Vote of Security Holders
23
Item 5.
Other Information
23
Item 6.
Exhibits
24-25
 
Signatures
26



CITIZENS FINANCIAL SERVICES, INC.
 
 
 
 
 
CONSOLIDATED BALANCE SHEET
 
 
 
 
 
(UNAUDITED)
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31
 
December 31
 
(in thousands except share data)
 
2007
 
2006
 
ASSETS:
 
 
 
 
 
Cash and due from banks:
 
 
 
 
 
  Noninterest-bearing
 
$
7,491
 
$
10,007
 
  Interest-bearing
   
2
   
8
 
Total cash and cash equivalents
   
7,493
   
10,015
 
 
         
Available-for-sale securities
   
109,320
   
109,743
 
 
         
Loans (net of allowance for loan losses:
         
  2007, $3,972 and 2006, $3,876)
   
408,285
   
410,897
 
 
         
Premises and equipment
   
12,898
   
12,892
 
Accrued interest receivable
   
2,577
   
2,458
 
Goodwill
   
8,605
   
8,605
 
Bank owned life insurance
   
8,126
   
8,047
 
Other assets
   
9,064
   
9,511
 
 
         
TOTAL ASSETS
 
$
566,368
 
$
572,168
 
 
         
LIABILITIES:
         
Deposits:
         
  Noninterest-bearing
 
$
50,865
 
$
48,509
 
  Interest-bearing
   
406,183
   
398,006
 
Total deposits
   
457,048
   
446,515
 
Borrowed funds
   
58,686
   
75,775
 
Accrued interest payable
   
2,167
   
2,287
 
Other liabilities
   
4,081
   
4,091
 
TOTAL LIABILITIES
   
521,982
   
528,668
 
STOCKHOLDERS' EQUITY:
         
Common Stock
         
  $1.00 par value; authorized 10,000,000 shares;
         
  issued 2,992,896 shares in 2007 and 2006, respectively
   
2,993
   
2,993
 
Additional paid-in capital
   
11,933
   
11,933
 
Retained earnings
   
34,767
   
34,007
 
Accumulated other comprehensive loss
   
(1,605
)
 
(1,737
)
Treasury Stock, at cost: 173,204 shares for
         
  2007, and 172,954 shares for 2006
   
(3,702
)
 
(3,696
)
TOTAL STOCKHOLDERS' EQUITY
   
44,386
   
43,500
 
TOTAL LIABILITIES AND
         
  STOCKHOLDERS' EQUITY
 
$
566,368
 
$
572,168
 
 
         
The accompanying notes are an integral part of these unaudited consolidated financial statements.
   


1






CITIZENS FINANCIAL SERVICES, INC.
 
 
 
 
 
CONSOLIDATED STATEMENT OF INCOME
 
 
 
 
 
(UNAUDITED)
 
 
 
 
 
 
 
Three Months Ended
 
 
 
March 31,
 
(in thousands, except per share data)
 
2007
 
2006
 
INTEREST INCOME:
 
 
 
 
 
Interest and fees on loans
 
$
7,357
 
$
6,519
 
Investment securities:
         
  Taxable
   
1,014
   
819
 
  Nontaxable
   
224
   
226
 
  Dividends
   
91
   
67
 
TOTAL INTEREST INCOME
   
8,686
   
7,631
 
INTEREST EXPENSE:
         
Deposits
   
3,309
   
2,601
 
Borrowed funds
   
926
   
663
 
TOTAL INTEREST EXPENSE
   
4,235
   
3,264
 
NET INTEREST INCOME
   
4,451
   
4,367
 
Provision for loan losses
   
120
   
60
 
NET INTEREST INCOME AFTER
         
  PROVISION FOR LOAN LOSSES
   
4,331
   
4,307
 
NON-INTEREST INCOME:
         
Service charges
   
748
   
706
 
Trust
   
138
   
129
 
Brokerage
   
15
   
58
 
Insurance
   
4
   
36
 
Investment securities losses, net
   
-
   
(6
)
Earnings on bank owned life insurance
   
79
   
72
 
Other
   
143
   
137
 
TOTAL NON-INTEREST INCOME
   
1,127
   
1,132
 
NON-INTEREST EXPENSES:
         
Salaries and employee benefits
   
2,093
   
2,036
 
Occupancy
   
301
   
308
 
Furniture and equipment
   
128
   
152
 
Professional fees
   
165
   
140
 
Amortization
   
36
   
144
 
Other
   
1,055
   
1,111
 
TOTAL NON-INTEREST EXPENSES
   
3,778
   
3,891
 
Income before provision for income taxes
   
1,680
   
1,548
 
Provision for income taxes
   
300
   
272
 
NET INCOME
 
$
1,380
 
$
1,276
 
 
         
Earnings Per Share
 
$
0.49
 
$
0.44
 
Cash Dividends Paid
 
$
0.22
 
$
0.21
 
 
         
Weighted average number of shares outstanding
   
2,819,775
   
2,867,964
 
 
         
The accompanying notes are an integral part of these unaudited consolidated financial statements.


2



CITIZENS FINANCIAL SERVICES, INC.
 
 
 
 
 
 
 
 
 
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
 
 
 
 
 
 
 
 
 
(UNAUDITED)
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended
 
 
 
March 31
 
(in thousands)
 
 
 
2007
 
 
 
2006
 
Net income
     
$
1,380
     
$
1,276
 
Other comprehensive income (loss):
                 
Unrealized gains (losses) on available for sale securities
   
200
       
(614
)
   
Less: Reclassification adjustment for loss included in net income
   
   -
          
6
        
Other comprehensive income (loss), before tax
       
200
       
(608
)
Income tax expense (benefit) related to other comprehensive loss
       
68
       
(207
)
Other comprehensive income (loss), net of tax
          
132
             
(401
)
Comprehensive income
        
$
1,512
        
$
875
 
 
                 
The accompanying notes are an integral part of these unaudited consolidated financial statements.
       


3




CITIZENS FINANCIAL SERVICES, INC.
 
 
 
 
 
CONSOLIDATED STATEMENT OF CASH FLOWS
 
 
 
 
 
(UNAUDITED)
 
Three Months Ended
 
 
 
March 31,
 
(in thousands)
 
2007
 
2006
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
 
Net income
 
$
1,380
 
$
1,276
 
Adjustments to reconcile net income to net
         
cash provided by operating activities:
         
  Provision for loan losses
   
120
   
60
 
  Depreciation and amortization
   
194
   
382
 
  Amortization and accretion of investment securities
   
52
   
138
 
  Deferred income taxes
   
13
   
(82
)
  Investment securities losses, net
   
-
   
6
 
  Earnings on bank owned life insurance
   
(79
)
 
(72
)
  Originations of loans held for sale
   
(1,377
)
 
(589
)
  Proceeds from sales of loans held for sale
   
1,395
   
595
 
  Gain on sale of foreclosed assets held for sale
   
(23
)
 
(13
)
  Increase in accrued interest receivable
   
(119
)
 
(152
)
  Decrease in accrued interest payable
   
(120
)
 
(205
)
  Other, net
   
(151
)
 
(90
)
   Net cash provided by operating activities
   
1,285
   
1,254
 
 
         
CASH FLOWS FROM INVESTING ACTIVITIES:
         
Available-for-sale securities:
         
  Proceeds from sales of available-for-sale securities
   
-
   
3,793
 
  Proceeds from maturity and principal repayments of securities
   
2,653
   
3,878
 
  Purchase of securities
   
(2,082
)
 
(11,792
)
Proceeds from redemption of Regulatory Stock
   
473
   
683
 
Purchase of Regulatory Stock
   
(80
)
 
(1,269
)
Net decrease (increase) in loans
   
2,519
   
(6,174
)
Purchase of premises and equipment
   
(188
)
 
(81
)
Proceeds from sale of foreclosed assets held for sale
   
80
   
50
 
     Net cash provided by (used in) investing activities
   
3,375
   
(10,912
)
 
         
CASH FLOWS FROM FINANCING ACTIVITIES:
         
Net increase (decrease) in deposits
   
10,533
   
(2,352
)
Proceeds from long-term borrowings
   
5,706
   
288
 
Repayments of long-term borrowings
   
(3,000
)
 
(71
)
Net (decrease) increase in short-term borrowed funds
   
(19,795
)
 
14,151
 
Purchase of Treasury Stock
   
(6
)
 
(567
)
Dividends paid
   
(620
)
 
(598
)
     Net cash (used in) provided by financing activities
   
(7,182
)
 
10,851
 
 
         
       Net (decrease) increase in cash and cash equivalents
   
(2,522
)
 
1,193
 
 
         
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
   
10,015
   
8,609
 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
 
$
7,493
 
$
9,802
 
 
         
Supplemental Disclosures of Cash Flow Information:
         
    Interest paid
 
$
4,355
 
$
3,459
 
 
         
    Income taxes paid
 
$
-
 
$
150
 
               
    Loans transferred to foreclosed property
 
$
-
 
$
103
 
 
         
The accompanying notes are an integral part of these unaudited consolidated financial statements.


4




CITIZENS FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Note 1 - Basis of Presentation

Citizens Financial Service, Inc., (individually and collectively with its direct and indirect subsidiaries, the “Company”) is a Pennsylvania corporation organized as the holding company of its wholly owned subsidiary, First Citizens National Bank (the “Bank”), and its subsidiary, First Citizens Insurance Agency, Inc. All material inter-company balances and transactions have been eliminated in consolidation.

The accompanying consolidated financial statements have been prepared pursuant to rules and regulations of the Securities and Exchange Commission (SEC) and in conformity with U.S. generally accepted accounting principles. Because this report is based on an interim period, certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted.

In the opinion of Management of the registrant, the accompanying interim financial statements for the quarters ended March 31, 2007 and 2006 include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the financial condition and the results of operations for the period. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. The financial performance reported for the Company for the three-month period ended March 31, 2007 is not necessarily indicative of the results to be expected for the full year. This information should be read in conjunction with the Company’s Annual Report to shareholders and Form 10-K for the period ended December 31, 2006.

Note 2 - Earnings per Share

The following table sets forth the computation of earnings per share. Earnings per share calculations give retroactive effect to stock dividends declared by the Company. The Company has no dilutive securities.

 
 
 
Three months ended
 
 
 
March 31,
 
 
 
2007
 
2006
 
 
         
Net income applicable to common stock
 
$
1,380,000
 
$
1,276,000
 
Weighted average common shares outstanding
   
2,819,775
   
2,867,964
 
               
Earnings per share
 
$
0.49
 
$
0.44
 
 

5


Note 3 - Income Tax Expense

Income tax expense is less than the amount calculated using the statutory tax rate, primarily the result of tax-exempt income earned from state and municipal securities and loans and investments in tax credits.


Note 4 - Employee Benefit Plans

For a detailed disclosure on the Company's pension and employee benefits plans, please refer to Note 10 of the Company's Consolidated Financial Statements included in the 2006 Annual Report on Form 10-K.

Defined Benefit Plan

The following sets forth the components of net periodic benefit costs of the noncontributory defined benefit plan for the three months ended March 31, 2007 and 2006, respectively (in thousands):

   
Pension Benefits
 
           
   
2007
 
2006
 
Service cost
 
$
104
 
$
91
 
Interest cost
   
99
   
82
 
Expected return on plan assets
   
(107
)
 
(95
)
Net amortization and deferral
   
24
   
15
 
               
Net periodic benefit cost
 
$
120
 
$
93
 


The Company expects to contribute $450,540 to its noncontributory defined benefit pension plan in 2007. As of March 31, 2007, the Company has contributed $112,635.

Defined Contribution Plan

The Company also sponsors a defined contribution, 401(k) plan covering substantially all of its employees. The Company contributes three percent of applicable salaries into the plan. Contributions totaled $53,500 and $49,900 for the three months ended March 31, 2007 and 2006, respectively.


Note 5 - Recent Accounting Pronouncements

 
    In February 2007, the FASB issued FAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115, which provides all entities with an option to report selected financial assets and liabilities at fair value. The objective of the FAS No. 159 is to improve financial reporting by providing entities with the opportunity to mitigate volatility in earnings caused by measuring related assets and liabilities differently without having to apply the complex provisions of hedge accounting. FAS No. 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007 provided the entity also elects to apply the provisions of FAS No. 157, Fair Value Measurements. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.
 
 
In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”), Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements, providing guidance on quantifying financial statement misstatement and implementation when first applying this guidance. Under SAB No. 108, companies should evaluate a misstatement based on its impact on the current year income statement, as well as the cumulative effect of correcting such misstatements that existed in prior years existing in the current year's ending balance sheet. SAB 108 is effective for fiscal years ending after November 15, 2006. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s results of operations.
 
6


In March 2007, the FASB ratified Emerging Issues Task Force Issue No. 06-10 (“EITF 06-10”), Accounting for Collateral Assignment Split-Dollar Life Insurance Agreements. EITF 06-10 provides guidance for determining a liability for the postretirement benefit obligation as well as recognition and measurement of the associated asset on the basis of the terms of the collateral assignment agreement. EITF 06-10 is effective for fiscal years beginning after December 15, 2007. The Company is currently evaluating the impact the adoption of the EITF will have on the Company’s results of operations or financial condition. 


ITEM 2. 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. The Company would like to caution readers that the following important factors, among others, may have affected and could in the future affect the Company’s actual results and could cause the Company’s actual results for subsequent periods to differ materially from those expressed in any forward looking statement:
 
·  
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 implementing 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, regulations or requirements, including the costs of compliance with such changes.
·  
We could experience greater loan delinquencies than anticipated, adversely affecting our earnings and financial condition. We could also experience greater losses than expected due to the ever increasing volume of information theft and fraudulent scams impacting our customers and the banking industry.
·  
We could lose the services of some or all of our key personnel, which would negatively impact our business because of their business development skills, financial expertise, lending experience, technical expertise and market area knowledge.
 
Except as required by applicable law and regulation, we assume no obligation to update or revise any forward-looking statements after the date on which they are made.

7

 
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 Service, 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 preceding March 31, 2007 financial information. The results of operations for the three months ended March 31, 2007 and 2006 are not necessarily indicative of the results you may expect for the full year.

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 16 banking facilities. In Pennsylvania, these offices are located 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. In New York, we have a new recently constructed branch office in Wellsville.

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, liquidity and regulatory 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.

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, among other things, contingent funding alternatives.

Regulatory risk represents the possibility that a change in law, regulations or regulatory policy may have a material effect on the business of the Company and its subsidiary. We can not predict what legislation might be enacted or what regulations might be adopted, or if adopted, the effect thereof on our operations.

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 Annual Report for the year ended December 31, 2006, filed by our Company and any current reports on Form 8-K filed by us.

We face strong competition in the communities that 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. The financial services industry continues to experience tremendous change to competitive barriers between bank and non-bank institutions. We must compete not only with traditional financial institutions, but in addition, with other business corporations that have begun to deliver competing financial services, and banking services that are easily accessible through the internet. Competition for banking services is based on price, nature of product, quality of service, and in the case of certain activities, convenience of location.

8


Trust and Investment Services

Our Investment and Trust Services Department is committed to helping our customers meet their financial goals. The Trust Department offers professional trust administration, investment management services, estate planning and administration, and custody of securities. We also help the members of our communities prepare for retirement by providing retirement plans for local employers and by managing individual IRA accounts. Assets held by the Company 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 Company. As of March 31, 2007 and December 31, 2006, the Trust Department had $87.2 million and $82.6 million of assets under management, respectively.

Our Investment Representatives offer full service brokerage services throughout the Bank’s market area, and appointments can be made at any First Citizens National Bank branch. The Investment Representatives provide financial planning and help our customers achieve their financial goals with their choice of mutual funds, annuities, health and life insurance. These products are made available through our insurance subsidiary, First Citizens Insurance Agency, Inc.


Results of Operations

Overview of the Income Statement

    The Company had net income of $1,380,000 for the first three months of 2007 compared with earnings of $1,276,000 for last year’s comparable period, an increase of $104,000 or 8.2%. Earnings per share for the first three months of 2007 were $0.49, compared to $.44 last year representing an 11.4% increase. Annualized return on assets and return on equity for the three months of 2007 was .96% and 12.10%, respectively, compared with .96% and 11.84% for last year’s comparable period. Details of the reasons for this change are discussed on the following pages.

Net Interest Income

Net interest income, the most significant component of earnings, is the amount by which interest income generated from interest-earning assets exceeds interest expense on interest-bearing liabilities.

Net interest income, for the first quarter of 2007, was $4,451,000, an increase of $84,000, compared to the same period in 2006. For the first three months of 2007, the provision for loan losses totaled $120,000 compared to $60,000 for the first three months of 2006. Consequently, net interest income after the provision for loan losses was $4,331,000, an increase of $24,000 over the first three months of 2006.

The following table sets forth the average balances of, and the interest earned or incurred on, each principal category of assets, liabilities and stockholders’ equity, the related rates, net interest income and rate “spread” created:


9


 
 
     
Analysis of Average Balances and Interest Rates (1)
   
                     
 
March 31, 2007
March 31, 2006
March 31, 2005
 
 
Average
 
Average
Average
 
Average
Average
 
Average
 
 
Balance (1)
Interest
Rate
Balance (1)
Interest
Rate
Balance (1)
Interest
Rate
 
(dollars in thousands)
$
$
%
$
$
%
$
$
%
 
ASSETS
                   
Short-term investments:
                   
  Interest-bearing deposits at banks
4
-
4.75
8
-
4.36
10
-
2.43
 
Total short-term investments
4
-
4.75
8
-
4.36
10
-
2.43
 
Investment securities:
                   
  Taxable
92,595
1,116
4.82
84,313
898
4.26
89,605
854
3.81
 
  Tax-exempt (3)
22,584
339
6.00
23,117
342
5.92
11,223
177
6.31
 
  Total investment securities
115,179
1,455
5.05
107,430
1,240
4.62
100,828
1,031
4.09
 
Loans:
                   
  Residential mortgage loans
212,381
3,835
7.32
203,365
3,481
6.94
197,447
3,321
6.82
 
  Commercial & farm loans
145,065
2,791
7.80
125,974
2,325
7.49
115,222
1,950
6.86
 
  Loans to state & political subdivisions
45,021
671
6.04
43,318
640
5.99
37,965
564
6.02
 
  Other loans
12,138
276
9.22
12,932
280
8.78
12,367
270
8.85
 
  Loans, net of discount (2)(3)(4)
414,605
7,573
7.41
385,589
6,726
7.07
363,001
6,105
6.82
 
Total interest-earning assets
529,788
9,028
6.91
493,027
7,966
6.55
463,839
7,136
6.24
 
Cash and due from banks
9,096
   
8,606
   
8,372
     
Bank premises and equipment
12,953
   
12,276
   
11,769
     
Other assets
19,147
 
 
18,532
 
 
18,789
 
 
 
Total non-interest earning assets
41,196
   
39,414
   
38,930
     
Total assets
570,984
 
 
532,441
 
 
502,769
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
                 
Interest-bearing liabilities:
                   
  NOW accounts
85,225
424
2.02
80,617
319
1.60
68,324
114
0.68
 
  Savings accounts
37,948
32
0.34
38,899
29
0.30
40,327
28
0.28
 
  Money market accounts
48,372
436
3.66
45,358
309
2.76
43,880
157
1.45
 
  Certificates of deposit
233,551
2,417
4.20
212,394
1,944
3.71
214,609
1,869
3.53
 
Total interest-bearing deposits
405,096
3,309
3.31
377,268
2,601
2.80
367,140
2,168
2.39
 
Other borrowed funds
67,594
926
5.56
57,313
663
4.69
46,137
378
3.32
 
Total interest-bearing liabilities
472,690
4,235
3.63
434,581
3,264
3.05
413,277
2,546
2.50
 
Demand deposits
47,580
   
48,203
   
44,128
     
Other liabilities
6,216
   
6,529
   
4,513
     
Total non-interest-bearing liabilities
53,796
 
 
54,732
 
 
48,641
 
 
 
Stockholders' equity
44,498
   
43,128
   
40,851
     
Total liabilities & stockholders' equity
570,984
 
 
532,441
 
 
502,769
 
 
 
Net interest income
 
4,793
 
 
4,702
 
 
4,590
 
 
Net interest spread (5)
   
3.28%
   
3.50%
   
3.74%
 
Net interest income as a percentage
                   
of average interest-earning assets
   
3.67%
   
3.87%
   
4.01%
 
Ratio of interest-earning assets
                   
to interest-bearing liabilities
   
1.12
   
1.13
   
1.12
 
                     
(1) Averages are based on daily averages.
                 
(2) Includes loan origination and commitment fees.
                 
(3) Tax exempt interest revenue is shown on a tax equivalent basis for proper comparison using
       
       a statutory federal income tax rate of 34%.
             
(4) Income on non-accrual loans is accounted for on a cash basis, and the loan balances are included in interest-earning assets.
 
(5) Interest rate spread represents the difference between the average rate earned on interest-earning assets
     
      and the average rate paid on interest-bearing liabilities.
               
                     
 
 
10

 
Tax exempt revenue is shown on a tax-equivalent basis for proper comparison using a statutory, federal income tax rate of 34%. For purposes of the comparison, as well as the discussion that follows, this presentation facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Company’s 34% Federal statutory rate. The following table represents the adjustment to convert net interest income to net interest income on a fully taxable equivalent basis for the periods ending March 31, 2007, 2006 and 2005:
 
 

 
   
For the Three Months
 
   
Ended March 31,
 
In thousands:
 
2007
 
2006
 
2005
 
               
Total interest income
 
$
8,686
 
$
7,631
 
$
6,879
 
Total interest expense
   
4,235
   
3,264
   
2,546
 
                     
Net interest income
   
4,451
   
4,367
   
4,333
 
Tax equivalent adjustment
   
342
   
335
   
257
 
                     
Net interest income (fully taxable equivalent)
 
$
4,793
 
$
4,702
 
$
4,590
 


  The following table shows the tax-equivalent effect of changes in volume and rate on interest income and expense.

 
2007 vs. 2006 (1)
2006 vs. 2005 (1)
 
Change in
Change
Total
Change in
Change
Total
 
Volume
in Rate
Change
Volume
in Rate
Change
Interest Income:
           
Short-term investments:
           
  Interest-bearing deposits at banks
$ -
$ -
$ -
$ -
$ -
$ -
Investment securities:
           
  Taxable
54
164
218
(52)
96
44
  Tax-exempt
(8)
5
(3)
177
(12)
165
Total investments
46
169
215
125
84
209
Loans:
           
  Residential mortgage loans
119
235
354
104
56
160
  Commercial & farm loans
373
93
466
736
(361)
375
  Loans to state & political subdivisions
25
6
31
79
(3)
76
  Other loans
(18)
14
(4)
12
(2)
10
Total loans, net of discount
499
348
847
931
(310)
621
Total Interest Income
545
517
1,062
1,056
(226)
830
Interest Expense:
           
Interest-bearing deposits:
           
  NOW accounts
17
88
105
16
189
205
  Savings accounts
(1)
4
3
(1)
2
1
  Money Market accounts
19
108
127
5
147
152
  Certificates of deposit
112
361
473
(19)
94
75
Total interest-bearing deposits
147
561
708
1
432
433
Other borrowed funds
(695)
958
263
38
247
285
Total interest expense
(548)
1,519
971
39
679
718
Net interest income
$ 1,093
$ (1,002)
$ 91
$ 1,017
$ (905)
$ 112
             
(1) The portion of the total change attributable to both volume and rate changes during the year has been allocated
       to volume and rate components based upon the absolute dollar amount of the change in each component prior to allocation.
 

11

 
 
As can be seen from the preceding tables, we continue to experience a compression of our net interest margin. Due to the inversion of the yield curve, the net interest spread has decreased from 3.50% for the first three months of 2006 to 3.28% for the first three months of 2007. While short-term interest rates have increased nearly 425 basis points since June 2004, long-term rates have remained within a much more narrow trading range. As such, our cost of funds (interest paid on deposits and borrowings) has increased while the rates earned on interest bearing assets have not increased accordingly. Our interest margin will improve when the normal steepness of the yield curve returns. We continue to review various pricing and investment strategies in an attempt to maintain or improve upon the current interest margin. Low cost deposits remain the focus and are key in improving the interest margin.
 
 
Tax equivalent net interest income rose from $4,590,000 in 2005 to $4,702,000 in 2006, and increased to $4,793,000, in 2007. In the period ending March 31, 2007, net interest income increased $91,000 on a tax equivalent basis over the same period in 2006. The increase in interest-earning assets of $36.8 million generated an increase in interest income of $1,062,000, with $545,000 due to volume and $517,000 due to rate while increasing the yield 36 basis points from 6.55% to 6.91%. Interest-bearing liabilities increased $38.1 million resulting in an increase of $971,000 of interest expense mostly attributable to a change in rate. Comparing the first quarter of 2007 with 2006, the average interest rate on interest-bearing liabilities increased 58 basis points, from 3.05% to 3.63%.
 

Provision For Loan Losses

       For the three-month period ending March 31, 2007, we provided $120,000 to the provision as a result of our quarterly review of the allowance for loan losses. Management's quarterly review of the allowance for loan losses is based on the following information: migration analysis of delinquent and non-accrual loans, estimated future losses on loans, recent review of large problem credits, local and national economic conditions, historical loss experience, OCC qualitative adjustments and peer comparisons (see also “Financial Condition - Allowance for Loan Losses).

Non-interest Income
 
Non-interest income as detailed below decreased $5,000 or .4%, for the first three months of 2007 when compared to the same period in 2006. Service charge income increased by $42,000 as it continues to be the primary source of non-interest income. For the first three months, account service charges totaled $748,000 compared to $706,000 last year. Most of this is attributable to the increase in NSF fees of $30,000 and an increase of $17,000 in fee income derived from customers’ usage of their debit cards. Brokerage and insurance income is down $43,000 and $32,000 respectively as we have transitioned over the last several months to a new broker-dealer. We continue to emphasize the successful transition to the new broker-dealer and intend to increase revenues during the remainder of 2007. Trust income is also up $9,000 or 7.0% due to our ongoing success in growing our trust assets under management.

The following table shows the breakdown of non-interest income for the three months ended March 31, 2007 and 2006:

   
Three months ended
         
   
March 31,
 
Change
 
(dollars in thousands)
 
2007
 
2006
 
Amount
   %  
Service charges
 
$
748
 
$
706
 
$
42
   
5.9
 
Trust
   
138
   
129
   
9
   
7.0
 
Brokerage
   
15
   
58
   
(43
)
 
(74.1
)
Insurance
   
4
   
36
   
(32
)
 
(88.9
)
Investment securities losses, net
   
-
   
(6
)
 
6
   
-
 
Earnings on bank owned life insurance
   
79
   
72
   
7
   
9.7
 
Other
   
143
   
137
   
6
   
4.4
 
Total
 
$
1,127
 
$
1,132
 
$
(5
)
 
(0.4
)
 
 
12

    
    We continue to evaluate means of increasing non-interest income. Our approach is to apply service charges on business transaction accounts by charging fees on transaction activity, reduced by earnings credit based on customers' balances, to more equitably recover costs. Additionally, we are focused on the continued growth of our Trust and brokerage areas as a means to service all of our customers financial needs and increasing non-interest income.
 
Non-interest Expense
 
    Total non-interest expense, as detailed below, decreased $113,000 or 2.9%, for the first three months of 2007, compared to the same period in 2006. The increase in salaries and employee benefits of $57,000 is due mainly to merit increases and higher pension costs. Furniture and equipment costs are down due to decreased depreciation expense from assets becoming fully depreciated. Other professional fees have increased $28,000 over last year due to various consulting arrangements including our pension plan and employee incentive plan. Amortization expense is down $108,000 due to a core deposit intangible from a previous acquisition that became fully amortized in March 2006. There has been an overall decrease in other operating expenses of $56,000 as well over the first three months of 2007.

The following tables reflect the breakdown of non-interest expense and professional fees as of March 31, 2007 and 2006:

   
Three months ended
         
   
March 31,
 
Change
 
(in thousands)
 
2007
 
2006
 
Amount
   %  
Salaries and employee benefits
 
$
2,093
 
$
2,036
 
$
57
   
2.8
 
Occupancy
   
301
   
308
   
(7
)
 
(2.3
)
Furniture and equipment
   
128
   
152
   
(24
)
 
(15.8
)
Professional fees
   
165
   
140
   
25
   
17.9
 
Amortization
   
36
   
144
   
(108
)
 
(75.0
)
Other
   
1,055
   
1,111
   
(56
)
 
(5.0
)
Total
 
$
3,778
 
$
3,891
 
$
(113
)
 
(2.9
)
 
                 
 
                 
 
 
Three months ended 
           
 
March 31, 
Change
(in thousands)
   
2007
   
2006
   
Amount
 
 
% 
 
Other professional fees
 
$
116
 
$
88
 
$
28
   
31.8
 
Legal fees
   
13
   
18
   
(5
)
 
(27.8
)
Examinations and audits
   
36
   
34
   
2
   
5.9
 
Total
 
$
165
 
$
140
 
$
25
   
17.9
 

Provision For Income Taxes

The provision for income taxes was $300,000 for the three-month period ended March 31, 2007 compared to $272,000 for the same period in 2006. Through management of our municipal loan and bond portfolios, we have maintained our effective tax rate at 17.8% for the first three months this year versus 17.5% for the first three months of 2006.

We are involved in three limited partnership agreements that established low-income housing projects in our market areas. As a result of these agreements, for tax purposes we have recognized $594,000 out of a total $913,000 of tax credits from one project in the Towanda area that began in October of 2000. We have recognized $202,000 out of a total $385,000 of tax credits on the second project in the Wellsboro market which was completed in November 2001. In 2005, we entered into a third limited liability partnership for a low-income housing project for senior citizens in our Sayre market area. Beginning in 2007, we have recognized $14,000 out of a total $574,000 of tax credits. We anticipate recognizing $1,062,000 of tax credits over the next ten years.
 
13

 
Financial Condition

Total assets (shown in the Consolidated Balance Sheet) of $566.4 million have decreased 1.0% since year-end 2006’s balance of $572.2 million. Net loans decreased .6% to $408.3 million and investment securities decreased .4% to $109.3 million since year-end 2006. Total deposits increased $10.5 million or 2.4% to $457.0 million since year-end 2006. Borrowed funds have decreased $17.1 million to $58.7 million compared with $75.8 million at year-end. Explanations of variances will be described within the following appropriate sections.

Cash and Cash Equivalents

Cash and cash equivalents totaled $7,493,000 at March 31, 2007 compared to $10,015,000 on December 31, 2006. Noninterest-bearing cash decreased $2,516,000 since year-end 2006, while interest-bearing cash decreased $6,000 during that same period. We believe the liquidity needs of the Company are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources, and the portion of the investment and loan portfolios that mature within one year. These sources of funds will enable the Company to meet cash obligations and off-balance sheet commitments as they come due.

Investments

As shown in the table below, our investment portfolio decreased by $423,000 or .4% from December 31, 2006 to March 31, 2007. During the first quarter of 2007 we purchased approximately $2.0 million of mortgage-backed securities helping to offset the $2.7 million of principal repayments that have occurred during the same time period. We continue to receive monthly principal repayments allowing us to purchase at current market yields. The overall market value of our investment portfolio has also increased approximately $.2 million due to decreases in interest rates since year end. Our investment portfolio is currently yielding 5.05% compared to 4.62% a year ago.
 
Estimated Fair Market Value of Investment Portfolio
 
 
 
March 31,
 
December 31,
 
 
 
2007
 
2006
 
(dollars in thousands)
 
Amount
 
% 
 
Amount
 
% 
 
Available-for-sale:
                 
  U. S. Agency securities
 
$
16,709
   
15.3
 
$
16,651
   
15.2
 
  Obligations of state & political
                         
    subdivisions
   
22,599
   
20.7
   
22,562
   
20.5
 
  Corporate obligations
   
7,970
   
7.3
   
7,997
   
7.3
 
  Mortgage-backed securities
   
59,377
   
54.3
   
59,875
   
54.6
 
  Equity securities
   
2,665
   
2.4
   
2,658
   
2.4
 
Total
 
$
109,320
   
100.0
 
$
109,743
   
100.0
 
 
 
         
 
 
March 31, 2007/
 
 
 
December 31, 2006
 
 
 
Change
 
(dollars in thousands)
 
Amount
 
% 
 
Available-for-sale:
         
  U. S. Agency securities
 
$
58
   
0.3
 
  Obligations of state & political
             
    subdivisions
   
37
   
0.2
 
  Corporate obligations
   
(27
)
 
(0.3
)
  Mortgage-backed securities
   
(498
)
 
(0.8
)
  Equity securities
   
7
   
0.3
 
Total
 
$
(423
)
 
(0.4
)

14


Management continues to monitor the earnings performance and the effectiveness of the liquidity of the investment portfolio on a regular basis. Through active balance sheet management and analysis of the securities portfolio, the Company maintains sufficient liquidity to satisfy depositor requirements and various credit needs of its customers.

Loans

The Company’s lending is focused in the north central Pennsylvania market and the southern tier of New York. The composition of our loan portfolio consists principally of retail lending, which includes single-family residential mortgages and other consumer lending, and commercial lending primarily to locally owned small businesses. New loans are generated primarily from direct loans to our existing customer base, with new customers generated by referrals from real estate brokers, building contractors, attorneys, accountants and existing customers.

As shown in the tables below (dollars in thousands), total loans decreased approximately $2.5 million or .6% during the first quarter of 2007. Residential, consumer and municipal loans have decreased $1.0 million, $.4 million, and $.5 million, respectively. Also decreasing by $.7 million was construction loans.

There has been a decrease in loan demand due to several economic factors. As seen in previous years, loan growth has been slow during the first quarter and is less than what we normally experience throughout the rest of the year. Residential mortgage lending continues to be a principal business activity and one our Company expects to continue by providing a full complement of competitively priced conforming, nonconforming and home equity mortgages. The Company is continuing its focus on commercial lending as a means to increase loan growth as well as deposits from farmers and small businesses throughout our market area. Lenders have worked diligently on improving organic loan growth while deepening relationships with the goal to better serve customers within our market. We continue to emphasize branch office personnel training and the focus on flexibility and fast “turn around time” that will aid in growing our loan portfolio. Finally, the Company has a strong team of dedicated, experienced professionals that enable us to meet the needs of commercial and agricultural customers within our service area.
 
   
March 31,
 
December 31,
 
   
2007
 
2006
 
(in thousands)
 
Amount
 
% 
 
Amount
 
% 
 
Real estate:
                 
  Residential
 
$
205,059
   
49.7
 
$
206,059
   
49.7
 
  Commercial
   
94,245
   
22.9
   
94,122
   
22.7
 
  Agricultural
   
17,202
   
4.2
   
17,054
   
4.1
 
  Construction
   
6,286
   
1.5
   
7,027
   
1.7
 
Loans to individuals
                         
  for household, family and other purchases
   
12,054
   
2.9
   
12,482
   
3.0
 
Commercial and other loans
   
32,615
   
7.9
   
32,766
   
7.9
 
State & political subdivision loans
   
44,796
   
10.9
   
45,263
   
10.9
 
Total loans
   
412,257
   
100.0
   
414,773
   
100.0
 
Less allowance for loan losses
   
3,972
            
3,876
          
Net loans
 
$
408,285
        
$
410,897
        
 
 
 
 
 
 
 
   
March 31, 2007/
 
   
December 31, 2006
 
   
Change
 
(in thousands)
 
Amount
 
% 
 
Real estate:
         
  Residential
 
$
(1,000
)
 
(0.5
)
  Commercial
   
123
   
0.1
 
  Agricultural
   
148
   
0.9
 
  Construction
   
(741
)
 
(10.5
)
Loans to individuals
             
  for household, family and other purchases
   
(428
)
 
(3.4
)
Commercial and other loans
   
(151
)
 
(0.5
)
State & political subdivision loans
   
(467
)
 
(1.0
)
Total loans
 
$
(2,516
)
 
(0.6
)
 

15

Allowance For Loan Losses

As shown in the table below, the Allowance for Loan Losses as a percentage of loans increased from .93% at December 31, 2006 to .96% at March 31, 2007. The dollar amount of the reserve increased $96,000 since year-end 2006. The increase is a result of a $120,000 provision for the first quarter less net charge-offs. Gross charge-offs for the first three months of 2007 were $34,000, while recoveries were $10,000.



   
March 31,
 
December 31,
 
(in thousands)
 
2007
 
2006
 
2005
 
2004
 
2003
 
Balance, at beginning of period
 
$
3,876
 
$
3,664
 
$
3,919
 
$
3,620
 
$
3,621
 
  Provision charged to income
   
120
   
330
   
60
   
-
   
435
 
  Increase related to acquisition
   
-
   
-
   
-
   
290
   
-
 
  Recoveries on loans previously
                               
    charged against the allowance
   
10
   
172
   
57
   
324
   
116
 
     
4,006
   
4,166
   
4,036
   
4,234
   
4,172
 
  Loans charged against the allowance
   
(34
)
 
(290
)
 
(372
)
 
(315
)
 
(552
)
Balance, at end of year
 
$
3,972
 
$
3,876
 
$
3,664
 
$
3,919
 
$
3,620
 
                                 
Allowance for loan losses as a percent
                               
  of total loans
   
0.96
%
 
0.93
%
 
0.96
%
 
1.09
%
 
1.14
%
 
                     
Allowance for loan losses as a percent
                     
  of non-performing loans
   
176.85
%
 
115.43
%
 
163.94
%
 
176.53
%
 
134.62
%


The adequacy of the allowance for loan losses is subject to a formal analysis by management of the Company. Management deems the allowance to be adequate to absorb inherent losses probable in the portfolio, as of March 31, 2007. The Company has disclosed in its annual report on Form 10-K for the year ended December 31, 2006 the process and methodology supporting the loan loss provision.

Credit Quality Risk

The following table identifies amounts of loan losses and non-performing loans. Past due loans are those that were contractually past due 90 days or more as to interest or principal payments (dollars in thousands).

 
 
March 31,
 
December 31,
 
(dollars in thousands)
 
2007
 
2006
 
2005
 
2004
 
2003
 
Non-performing loans:
                     
  Non-accruing loans
 
$
519
 
$
478
 
$
867
 
$
722
 
$
578
 
  Impaired loans
   
1,543
   
1,190
   
1,031
   
1,061
   
1,926
 
  Accrual loans - 90 days or
                               
    more past due
   
184
   
1,690
   
337
   
437
   
185
 
Total non-performing loans
   
2,246
   
3,358
   
2,235
   
2,220
   
2,689
 
Foreclosed assets held for sale
   
700
   
758
   
619
   
712
   
305
 
Total non-performing assets
 
$
2,946
 
$
4,116
 
$
2,854
 
$
2,932
 
$
2,994
 
Non-performing loans as a percent of loans
                       
  net of unearned income
   
0.54
%
 
0.81
%
 
0.58
%
 
0.62
%
 
0.85
%
Non-performing assets as a percent of loans
                       
  net of unearned income
   
0.71
%
 
0.99
%
 
0.75
%
 
0.82
%
 
0.94
%
 
                     

16



Interest does not accrue on non-accrual loans. Subsequent cash payments received are applied to the outstanding principal balance or recorded as interest income, depending upon management's assessment of its ultimate ability to collect principal and interest. The decrease in accrual loans - 90 days or more past due for the first quarter is primarily due to a temporary delay in payment from one large commercial customer.


Bank Owned Life Insurance

The Company has elected to purchase bank owned life insurance to offset future employee benefit costs. As of March 31, 2007 the cash surrender value of this life insurance is $8,126,000, an increase of $79,000 since year end. The use of life insurance policies provides the bank with an asset that will generate earnings to partially offset the current costs of benefits, and eventually (at the death of the insureds) provide partial recovery of cash outflows associated with the benefits.

Deposits

Traditional deposits continue to be the most significant source of funds for the Company. As shown in the following tables, deposits increased $10,533,000 or 2.4%, since December 31, 2006. As of March 31, 2007, non-interest-bearing deposits increased by $2,356,000, NOW accounts increased by $381,000, savings accounts increased $1,496,000, and money market deposit accounts increased $315,000. Brokered certificates of deposit also increased by $6,067,000, due largely to acquiring short-term brokered deposits at rates consistently lower than the Federal Home Loan Bank.
 

 
 
March 31,
 
December 31,
 
 
 
2007
 
2006
 
(in thousands)
 
Amount
 
% 
 
Amount
 
% 
 
Non-interest-bearing deposits
 
$
50,865
   
11.1
 
$
48,509
   
10.9
 
NOW accounts
   
86,448
   
18.9
   
86,067
   
19.3
 
Savings deposits
   
39,133
   
8.6
   
37,637
   
8.4
 
Money market deposit accounts
   
46,381
   
10.1
   
46,066
   
10.3
 
Brokered certificates of deposit
   
19,920
   
4.4
   
13,853
   
3.1
 
Certificates of deposit
   
214,301
   
46.9
   
214,383
   
48.0
 
Total
 
$
457,048
   
100.0
 
$
446,515
   
100.0
 
 
 
           
 
 
March 31, 2007/ 
 
 
 
December 31, 2006  
 
 
Change 
 
(in thousands)
 
 Amount
 
%  
 
Non-interest-bearing deposits
 
$
2,356
   
4.9
 
NOW accounts
   
381
   
0.4
 
Savings deposits
   
1,496
   
4.0
 
Money market deposit accounts
   
315
   
0.7
 
Brokered certificates of deposit
   
6,067
   
43.8
 
Certificates of deposit
   
(82
)
 
(0.0
)
Total
 
$
10,533
   
2.4
 


Borrowed Funds

    Borrowed funds decreased $17,089,000 during the first three months of 2007. The decrease in cash and loans along with the increase in deposits, as previously mentioned, were all factors in the overall decrease in borrowed funds. The Company's daily cash requirements or short-term investments are primarily met by using the financial instruments available primarily through the Federal Home Loan Bank.
 
17

 
    In December 2003, the Company formed a special purpose entity, Citizens Financial Statutory Trust I (“the 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 March 31, 2007, the rate was 8.15%. 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 within borrowed funds in the liabilities section of the Company’s balance sheet. 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. 

Stockholder’s Equity

We evaluate stockholders’ equity in relation to total assets and the risks associated with those assets. The greater the capital resource, the more likely a corporation is to meet its cash obligations and absorb unforeseen losses. For these reasons, capital adequacy has been, and will continue to be, of paramount importance.

Total Stockholders’ Equity was $44,386,000 at March 31, 2007 compared to $43,500,000, at December 31, 2006, an increase of $886,000 or 2.0%. Excluding accumulated other comprehensive loss, stockholder’s equity increased $754,000, or 1.7%. In the first three months of 2007, the Company had net income of $1,380,000 and paid dividends of $620,000, representing a dividend payout ratio of 44.9%. The Company also purchased 250 shares of treasury stock for $5,625 at a weighted average cost of $22.50 per share.

All of the Company’s investment securities are classified as available-for-sale making this portion of the Company’s balance sheet more sensitive to the changing market value of investments. Accumulated other comprehensive loss decreased $132,000 compared to December 31, 2006 as a result of interest rate movements.

       The Company has also complied with standards of being well capitalized mandated by the banking regulators. The Company’s primary regulators have established “risk-based” capital requirements designed to measure capital adequacy. Risk-based capital ratios reflect the relative risks associated with various assets entities hold in their portfolios. A weight category of 0% (lowest risk assets), 20%, 50%, or 100% (highest risk assets), is assigned to each asset on the balance sheet. The Company’s computed risk-based capital ratios are as follows:

   
March 31,
 
December 31,
 
(dollars in thousand)
 
2007
 
2006
 
Total capital (to risk-weighted assets)
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Company
 
$
48,462
   
12.72
%
$
47,604
   
12.59
%
For capital adequacy purposes
   
30,475
   
8.00
%
 
30,252
   
8.00
%
To be well capitalized
   
38,094
   
10.00
%
 
37,815
   
10.00
%
                           
Tier I capital (to risk-weighted assets)
                             
Company
 
$
44,475
   
11.68
%
$
43,684
   
11.55
%
For capital adequacy purposes
   
15,238
   
4.00
%
 
15,126
   
4.00
%
To be well capitalized
   
22,856
   
6.00
%
 
22,689
   
6.00
%
                           
Tier I capital (to average assets)
                             
Company
 
$
44,475
   
7.90
%
$
43,684
   
7.82
%
For capital adequacy purposes
   
22,511
   
4.00
%
 
22,355
   
4.00
%
To be well capitalized
   
28,138
   
5.00
%
 
27,944
   
5.00
%


18



The Bank’s computed risk-based capital ratios are as follows:

   
March 31,
 
December 31,
 
(dollars in thousand)
 
2007
 
2006
 
Total capital (to risk-weighted assets)
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Bank
 
$
42,095
   
11.06
%
$
41,249
   
10.93
%
For capital adequacy purposes
   
30,439
   
8.00
%
 
30,200
   
8.00
%
To be well capitalized
   
38,049
   
10.00
%
 
37,750
   
10.00
%
                           
Tier I capital (to risk-weighted assets)
                             
Bank
 
$
38,107
   
10.02
%
$
37,330
   
9.89
%
For capital adequacy purposes