-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SX76HHf3+E3EPR53UIZyOK153rsNMnp6XhqId0J8CnkH9iVSqP2TNscV165FNdkZ n1I14GrQxKvIpypkj/rMRg== 0000739421-97-000003.txt : 19970321 0000739421-97-000003.hdr.sgml : 19970321 ACCESSION NUMBER: 0000739421-97-000003 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970320 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: CITIZENS FINANCIAL SERVICES INC CENTRAL INDEX KEY: 0000739421 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 232265045 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-13222 FILM NUMBER: 97559779 BUSINESS ADDRESS: STREET 1: 15 S MAIN ST CITY: MANSFIELD STATE: PA ZIP: 16933 BUSINESS PHONE: 7176622121 MAIL ADDRESS: STREET 1: 15 S MAIN ST CITY: MANSFIELD STATE: PA ZIP: 16933 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1996 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 of other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 15 South Main Street, Mansfield, Pennsylvania 16933 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (717)662-2121 Securities registered pursuant to section 12 (b) of the Act: Title of each class Name of each exchange on which registered NOT APPLICABLE NOT APPLICABLE Securities registered pursuant to section 12 (g) of the Act: Common Stock, par value $1.00 per share. (Title of class) Indicate by checkmark 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_____ The total market value of the voting stock of the Registrant held by non-affiliates (for this purpose, persons or entities other than executive officers, directors, or 5% or more shareholders) of the Registrant, as of March 10, 1997, is estimated to have been approximately $32,000,000. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 or Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ___ The number of shares outstanding of the Registrant's Common Stock, as of March 10, 1997, 1,360,228 shares of Common Stock, par value $1.00. DOCUMENTS INCORPORATED BY REFERENCE Parts I, III and IV - Definitive Proxy Statement for the Annual Meeting of Shareholders to be held April 15, 1997. Parts II and IV - Annual Report to Shareholders for the Year Ended December 31, 1996. Citizens Financial Services, Inc. Form 10-K INDEX Part I Page Item 1-Business 1-8 Item 2-Properties 9 Item 3-Legal Proceedings 9 Item 4-Submission of Matters to a Vote of Shareholders 10 Part II Item 5-Market for Registrant's Common Stock and Related Shareholder Matters 10 Item 6-Selected Financial Data 10 Item 7-Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 8-Financial Statements and Supplementary Data 10 Item 9-Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 11 Part III Item 10-Directors and Executive Officers of the Registrant 11 Item 11-Executive Compensation 11 Item 12-Security Ownership of Certain Beneficial Owners and Management 11 Item 13-Certain Relationships and Related Transactions 11 Part IV Item 14-Exhibits, Financial Statement Schedules, and Reports on Form 8-K 12 Signatures 14 Part I Item 1-Business Citizens Financial Services, Inc. (the "Company") is a Pennsylvania business corporation, incorporated April 30, 1984 for the purpose of forming a bank holding company. On April 30, 1984, First Citizens National Bank (the "Bank") became a wholly-owned subsidiary of the Company by means of a merger in which the shareholders of the Bank became shareholders of the Company. In 1932, First National Bank opened for business in Mansfield, Pennsylvania. In 1970 the First National Bank in Mansfield merged with Citizens National Bank of Blossburg, Pennsylvania to form First Citizens National Bank. In 1971, the Bank expanded into Potter County through the acquisition of the Grange National Bank, which had offices in Ulysses and Genesee, Pennsylvania. On November 16, 1990, the Company acquired Star Savings and Loan Association (the "Association"), originally organized as a Pennsylvania-chartered mutual savings and loan association in 1899 and converted to a Pennsylvania-chartered permanent reserve fund stock savings and loan association on March 27, 1986. On December 31, 1991, the Association merged with the Bank terminating the Association's separate operations as a savings and loan association. On April 20, 1996 the Bank purchased two branch offices of Meridian Bank in Canton and Gillett, Pennsylvania. On October 31, 1996, the Bank opened a branch office in the new Weis supermarket in Wellsboro, Pennsylvania. As of December 31, 1996, the Bank employed 127 full time equivalent employees at its ten banking facilities. The Bank currently engages in the general business of banking throughout its service area of Potter, Tioga and Bradford counties in North Central Pennsylvania and Allegany, Steuben, Chemung and Tioga counties in Southern New York. The Bank maintains its central office in Mansfield, Pennsylvania and presently operates banking facilities in the communities of Mansfield, Blossburg, Ulysses, Genesee, Wellsboro, Troy, Sayre, Canton and Gillett. Automatic teller machines are located in Soldiers and Sailors Memorial Hospital in Wellsboro, Mansfield Wal-Mart and Mansfield University. The Bank's lending and deposit products are offered primarily within the vicinity of its service area. COMPETITION The Company faces strong competition in the communities it serves from other commercial banks, savings banks, and savings and loan associations, some of which are substantially larger institutions than the Company's subsidiary. In addition, personal and corporate trust services are offered by insurance companies, investment counseling firms, and other business firms and individuals. The Company also competes 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 changes to the competitive barriers between bank and non-bank institutions. The Company 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. REGULATION AND SUPERVISION The operations of the Bank are subject to federal and state statutes applicable to banks chartered under the banking laws of the United States, to members of the Federal Reserve System and to banks whose deposits are insured by the Federal Deposit Insurance Corporation ("FDIC"). Bank operations are also subject to regulations of the Comptroller of the Currency ("Comptroller"). The primary supervisory authority of the Bank is the Comptroller, who regularly examines the Bank. The Comptroller has the authority under the Financial Institutions Supervisory Act to prevent a national bank from engaging in unsafe or unsound practice while conducting its business. The Company is subject to regulation under the Bank Holding Company Act of 1956, as amended (the "Act"), and is registered with the Board of Governors of the Federal Reserve System ("Federal Reserve"). Under the Act, bank holding companies are not permitted, with certain exceptions, to acquire direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank and are prohibited from engaging in any business other than that of banking, managing and controlling banks or furnishing services to its subsidiary banks, except that they may, upon application, engage in, and may own shares of companies engaged in, certain businesses found by the Federal Reserve to be so closely related to banking as to be a proper incident thereto (if the Federal Reserve determines that such acquisition will be, on balance, beneficial to the public). The Act does not place territorial restrictions on the activities of non-bank subsidiaries of bank holding companies. The Act requires prior approval by the Federal Reserve of the acquisition by the Company of more than 5% of the voting stock of any additional bank. The Company is required by the Act to file annual reports of its operations with the Federal Reserve and of any additional information that the Federal Reserve may require. The Federal Reserve may also make examinations of the Company and any or all of its subsidiaries. Further, under Section 106 of the 1970 amendments to the Act and the Federal Reserve's regulations, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or provision of credit or provision of any property or service. The so-called "anti-tie-in" provisions state generally that a bank may not extend credit, lease property, sell property or furnish any service to a customer on the condition that the customer provide additional credit or service to the bank, to its bank holding company or to any other subsidiary of its bank holding company or on the condition that the customer not obtain other credit or service from a competitor of the bank, its bank holding company or any subsidiary of its bank holding company. Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the bank holding company or any of its subsidiaries, or investments in the stock or other securities of the bank holding company and on taking of such stock or securities as collateral for loans to any borrower. PERMITTED NON-BANKING ACTIVITIES The Federal Reserve permits bank holding companies to engage in non-banking activities so closely related to banking or managing or controlling banks as to be a proper incident thereto. The Company presently does not engage in any such activities nor does it intend to in the near future. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 is discussed in detail on page 45 of Management's Discussion and Analysis of the 1996 Annual Report to the shareholders, which information is included at Exhibit 13, here of and incorporated berein by reference. Neither the Company nor its subsidiary anticipates that compliance with environmental laws and regulations will have any material effect on capital expenditures, earnings, or on its competitive position. The Company is a legal entity, separate and distinct from the Bank. All of the Company's revenues, including funds available for payment of dividends and for operating expenses, are provided by dividends from the Bank. Certain limitations exist on the availability of the Bank's undistributed net assets for the payment of dividends to its parent without prior approval of the bank regulatory authorities as further described in Footnote 12 of the 1996 Annual Report to the shareholders, which information is included at Exhibit 13, here of and incorporated berein by reference. LEGISLATION AND REGULATORY CHANGES From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial institutions. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies and other financial institutions are frequently made in Congress, and before various bank regulatory agencies. Accurate predictions are difficult to make as to the likelihood of any major changes or the impact such changes might have on the Company and its subsidiary. Certain changes of potential significance to the Company which have been enacted recently and others which are currently under consideration by Congress or various regulatory or professional agencies are discussed below. Risk-Based Capital Guidelines. The Federal Reserve, the FDIC and the Comptroller have issued certain risk-based capital guidelines, which supplement existing capital requirements and have been discussed in the Management Discussion and Analysis section on page 43 and Footnote 12 of the 1996 Annual Report to the shareholders, which information is included at Exhibit 13, here of and incorporated berein by reference. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") enacted December 19,1991, institutions must be classified in one of five defined categories as illustrated below (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized). Total Tier 1 Under a Risk- Risk- Tier I Capital Based Based Leverage Order or Ratio Ratio Ratio Directive CAPITAL CATEGORY Well capitalized >10.0 >6.0 >5.0 No Adequately capitalized > 8.0 >4.0 >4.0* Undercapitalized < 8.0 <4.0 <4.0* Significantly undercapitalized < 6.0 <3.0 <3.0 Critically undercapitalized <2.0 *3.0 for those banks having the highest available regulatory rating. In the event an institution's capital deteriorates to the undercapitalized category or below, FDICIA prescribes an increasing amount of regulatory intervention, including: (1) the implementation by a bank of a capital restoration plan and a guarantee of the plan by a parent institution; and (2) the placement of a hold on increases in assets, number of branches or lines of business. If capital has reached the significantly or critically undercapitalized levels, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management and (in critically undercapitalized situations) appointment of a receiver. For well capitalized institutions, FDICIA provides authority for regulatory intervention where the institution is deemed to be engaging in unsafe or unsound practices or receives a less than satisfactory examination report rating for asset quality, management, earnings or liquidity. All but well capitalized institutions are prohibited from accepting brokered deposits without prior regulatory approval. Under FDICIA, financial institutions are subject to increased regulatory scrutiny and must comply with certain operational, managerial and compensation standards to be developed by Federal Reserve regulations. FDICIA also requires the regulators to issue new rules establishing certain minimum standards to which an institution must adhere including standards requiring a minimum ratio of classified assets to capital, minimum earnings necessary to absorb losses and minimum ratio of market value to book value for publicly held institutions. Additional regulations are required to be developed relating to internal controls, loan documentation, credit underwriting, interest rate exposure, asset growth and excessive compensation, fees and benefits. From time to time, various types of federal and state legislation have been proposed that could result in additional regulation of, and restrictions on, the business of the Company or the Bank. It cannot be predicted whether any such legislation will be adopted or, if adopted, how such legislation would affect the business of the Company or the Bank. As a consequence of the extensive regulation of commercial banking activities in the United States, the Company and the Bank's business is particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business. EFFECT OF GOVERNMENT MONETARY POLICIES The earnings of the Company are and will be affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The monetary policies of the Federal Reserve Board have had and will likely continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The Federal Reserve Board has a major effect upon the levels of bank loans, investments and deposits through its open market operations in United States securities and through its regulation of, among other things, the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature and impact of future changes in monetary and fiscal policies (also see page 45 of Management's Discussion and Analysis of the 1996 Annual Report to the shareholders, which information is included at Exhibit 13, here of and incorporated berein by reference). INVESTMENT PORTFOLIO The investment portfolio is discussed in detail in Footnote 3, page 18 and pages 33 and 34 of Management's Discussion and Analysis of the 1996 Annual Report to the shareholders, which information is included at Exhibit 13, here of and incorporated berein by reference. Investments which have been subject to Moody or Standard and Poor rating changes are reviewed with the investment committee, the board of directors and an independent investment advisor. Particular attention is given to any security whose rating falls below "A" by either rating agency at which time the security is evaluated and a decision is made as to the possible disposition of the investment (if in compliance with the regulation concerning held-to-maturity securities). The investment policy, as described above, has enabled the Company to effectively manage the portfolio for increased profits, satisfy liquidity needs and provide adequate asset/liability management. LOAN PORTFOLIO The loan portfolio is discussed in detail in the Annual Report, page 19 and 20 Footnote 4, and pages 35 and 36 of Management's Discussion and Analysis. Authorized lending limits are assigned to each of the Bank's loan officers based on experience and performance. In addition, all commercial loans are reviewed by the loan committee (established by the board of directors) and loans with aggregate loan relationships over $100,000 are reviewed and approved by the full board of directors. Loans which do not meet the Bank's lending policies but which have merit may be made with U. S. Small Business Administration or Farmer's Home Administration guarantee. The Bank, as part of its commitment to the local communities, makes loans to the municipalities and political subdivisions in its area of service. These loans are for local services such as education, water, sewer, solid waste, and health services. The Bank, prior to the Tax Reform Act of 1986, was also active in local business activity bonds through the local industrial development authority although at present there is little demand for this type of loan. Local municipal loans are made on their individual merits and based on each municipality's financial strength and capacity to service its debt. It is the Bank's policy that when a borrower fails to make a required payment on a loan, the Bank attempts to cure the deficiency by contacting the borrower and seeking payment. A late charge is assessed after 15 days. Notice is sent to the borrower after a payment is 7 to 15 days past due, depending on the type of loan. Contact by telephone or in person is made between 15 and 59 days delinquent. Once the loan is 60 days delinquent and cannot be cured through normal collection procedures, the Bank will institute measures to remedy the default, including commencement of foreclosure action, accepting from the mortgagor a voluntary deed of security in lieu of foreclosure or repossession of collateral in the case of consumer loans. If foreclosure is effected, the property is sold at public auction in which the Bank may participate as a bidder. If the Bank is the successful bidder the acquired asset is then included in the Bank's "foreclosed assets held for sale" account until it is sold. When property is acquired it is recorded at the lower of the loan balance or market value at the date of acquisition and any write-down resulting therefrom is charged to the allowance for loan losses. Interest accrual, if any, ceases on the date of acquisition and all costs incurred in maintaining the related property from the date of acquisition forward are expended. Management believes the Bank's lending policies have been very successful over the past five years and plans to continue these practices, giving due consideration to any future economic changes. The Bank's lending policy is to make loans to individuals with a proven credit history, and minimum of one year at their present employment, and, for installment and credit line loans, a monthly debt payment to gross income ratio of less than 40%. Consumer loans are made primarily on a secured basis, which collateral normally consists of motor vehicles and liens on real property. Unsecured loans are made on a limited basis and in amounts of usually less than $5,000. The Bank is an active originator of guaranteed student loans in conjunction with the Pennsylvania Higher Education Assistance Agency. It is the Bank's policy to sell these loans to the Student Loan Marketing Association. The total guaranteed student loans outstanding as of December 31, 1996 was $2,786,000. Adjustable rate mortgages are fully indexed when originated. The yearly cap for the one-year adjustable rate mortgage is 2.0% on any change date and a maximum of 5.0% over the life of the loan. The yearly cap on the five-year adjustable rate mortgage is 3.0% on any change date and 5.0% over the life of the loan. The Bank also has a bi-weekly mortgage payment plan available. The Bank's commercial and agricultural loans consist of real estate, equipment, and inventory/accounts receivable/working capital loans. Real estate, equipment and working capital loans are made for terms of 15, 7, and 5 years, respectively. These loans are primarily tied to the Bank's prime rate and are adjusted at least annually. Commercial and agricultural lending consists of loans to sole proprietors, partnerships and closely held corporations typically with sales of less than $2,000,000 annually. In underwriting these loans, consideration is given to the quality of management, profitability, cash flow, secondary sources of repayment in the form of owner's capital and collateral and micro- and macro-economic conditions. Other consumer loans granted by the Bank consist of single payment, personal lines of credit, installment loans to finance vehicles, home improvements and other personal property loans. The Bank is not dependent for deposits or exposed by loan concentration to a single customer or to a single industry the loss of any one or more of which would have a materially adverse effect on the financial condition of the Bank. RISK ELEMENTS IN LOAN PORTFOLIO Business loans are generally placed on nonaccrual status when principal and interest payments are past due 90 days or more unless well-secured and in the process of collection. Loans to individuals that are secured by first or second liens on residential real estate are placed on nonaccrual status if past due 90 days or more and a current appraisal indicates that the value of the collateral is less than the loan balance. Consumer installment loans are generally charged-off when they become 90 - 120 days delinquent and collection efforts have failed to prompt payment and/or the security has been repossessed. The risk elements of the loan portfolio are discussed in detail in the Annual Report, page 19 and 20 Footnote 4, and pages 35 and 36 of Management's Discussion and Analysis. ALLOWANCE AND PROVISION FOR POSSIBLE LOAN LOSSES The provision for loan losses is used to increase the allowance for possible loan losses and is influenced by the growth and quality of loans. In each accounting period, the allowance for possible loan losses is adjusted to the amount deemed necessary to maintain the allowance at adequate levels. In determining the adequacy of the allowance for possible loan losses, management considers the financial strength of borrowers, past loan loss experience, loan collateral, changes in volume and composition of the loan portfolio and current and projected economic conditions. The Company regularly monitors the creditworthiness and financial condition of its larger borrowers. See further discussion in the annual report, page 19 and 20, footnote 4, and pages 40 through 43 of Management's Discussion and Analysis. The following table gives a five year comparison of the allowance for loan losses and the percentage of total loans in each category: Allocation of the Allowance for Loan Losses December 31, By percent of loans in each category to total loans 1996 1995 1994 1993 1992 Amount % Amount % Amount % Amount % Amount % Real estate - residential $ 143 59.4 $ 165 59.6 $ 185 62.0 $ 181 64.2 $ 193 64.5 Real estate - commercial, agricultural 325 18.5 328 19.9 323 18.5 253 16.9 147 15.9 Real estate - construction 0 2.3 0 0.6 0 0.8 0 0.8 0 0.6 Loans to individuals for family and other purchases 164 8.0 181 8.2 140 7.6 174 8.2 159 9.6 Commercial and other 108 6.3 110 6.5 114 6.5 94 6.3 63 6.7 State and political subdivision loans 3 5.5 3 5.2 2 4.6 2 3.6 1 2.7 Unallocated 1,252 N/A 1,046 N/A 957 N/A 812 N/A 638 N/A Total loans $1,995 100.0 $1,833 100.0 $1,721 100.0 $1,516 100.0 $1,201 100.0
LIQUIDITY AND ASSET/LIABILITY MANAGEMENT Management in any financial institution is required to ensure that liquidity is adequate to satisfy contractual liabilities, meet withdrawal requirements of depositors, fund operations and provide for customers' credit needs. The adequacy of such liquidity is measured by examining the balance sheet components of the Company's statement of condition. Asset liquidity is provided through receipt of loan payments and the conversion of investments and similar assets into cash. Liability liquidity results from the ability to attract funds from diversified funding sources at reasonable costs. While providing for liquidity, however, management must be aware of the need to monitor the rate sensitivity of interest-earning assets and interest-bearing liabilities which will provide for continued profitability in changing interest rate environments. See further discussion in the Annual Report pages 43 and 44 of Management's Discussion and Analysis. The Asset/Liability Management ("ALM") Committee of the Company manages rate sensitivity to enhance net interest income and margin while maintaining an asset/liability mix balances liquidity needs and interest rate risk and is discussed in further detail on pages 37 through 39 in the Management's Discussion and Analysis section of the 1996 Annual Report. The ALM Committee endeavors to control interest rate risk through management of rate sensitive assets and rate sensitive liabilities and by balancing the maturity and pricing of the Company's loan and deposit products. Interest rate risk arises when an interest-earning asset or interest-bearing liability matures at different intervals or its interest rate changes during a different time frame. The difference between assets subject to rate change over a specific period and liabilities subject to change over the same period is referred to as the interest rate sensitivity gap. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to result in increased net interest income. Based on the ALM Committee's perception as to the trend of interest rates, it may adjust the maturities and pricing of the Company's loan and deposit products in order to achieve or maintain a desired level of net interest revenue. The level of interest rate risk which the ALM Committee determines is acceptable may change periodically in an effort to attain a consistent level of profits while remaining within the Company's loan and investment policy guidelines. It has been management's policy to maintain a conservative gap interest rate sensitivity position (i.e., an interest rate sensitivity ratio in the range of positive 1.25 to negative .75). This is because assets and liabilities with similar contractual repricing characteristics or with out stated maturities may not reprice at the same time or to the same degree. In particular the repricing of the non-maturity core deposits represented by NOW, savings, and money market investor accounts, have characteristics that are difficult to measure using gap analysis. In addition to gap analysis, management now simulates the potential effects of changing interest rates through computer modeling. The Company is better able to implement strategies which would include an acceleration of interest rates and the effect on non-maturity deposits. Some of the key assumptions of this model, as established by the history are that: since the non-maturity core deposits are tiered they do not reprice immediately, except for the top tier money (over $100,000) money market investor funds, which are priced at current market rates; non-maturity core deposits will decay based on industry experience (also used for gap analysis); 65% of IRA certificates of deposit (most are 5 year maturities) reprice within one year if the new rate is higher but do not reprice if the new rate is lower (65% of the IRA customers are over 59 and one-half years of age); prepayment speeds are established within the model that are adjusted to reflect the degree of change in interest rates and the impact on loans and certificates of deposit. Computer model simulations have been generated using 200 basis point parallel shocks to the yield curve (up and down) over one year and simulations using a step up of interest rates over a two year period (300 basis points). No simulations to date have indicated a major impact to the earnings or the market value of portfolio equity. However, management and the board of director are currently evaluating these simulations, and others to establish appropriate guidelines and procedures to implement when earnings or equity value appear to be at risk. Analysis of the Consolidated Statement of Cash Flows (refer to annual report to shareholders) indicates funds from operating activities continues to be a stable source of funds. Even after deducting for dividends, there are adequate funds being added to equity capital (consistent with asset growth). This is further discussed on pages 43 through 45 of Management's Discussion and Analysis section of the 1996 Annual Report to the shareholders, which information is included at Exhibit 13, here of and incorporated berein by reference. CAPITAL ADEQUACY A description of the Company's capital adequacy is presented on page 25, Footnote 12 and on page 43 of the Management's Discussion and Analysis section of the 1996 Annual Report to the shareholders, which information is included at Exhibit 13, here of and incorporated berein by reference. Item 2-Properties The headquarters of the Company is located in Mansfield, Pennsylvania. The building contains the central offices of the Company and the Bank. The Bank also owns six other banking facilities. All buildings are owned by the Bank in fee and are free of any liens or encumbrances. PROPERTIES Current Building Construction Date Main office: 15 South Main St. Mansfield, PA 16933 1971 Branch offices: 320 Main St. Blossburg, PA 16912 1988 502 Main St. Ulysses, PA 16948 1977 Main St. Genesee, PA 16923 1985 306 West Lockhart St. Sayre, PA 18840 1989 99 Main St. Wellsboro, PA 16901 1979 103 West Main St. Troy, PA 16947 1988 29 West Main St. Canton, PA 17724 1974 Main St. Gillett, PA 16925 1970 The net book value for the above properties as of December 31, 1996 was $3,256,000. The properties are adequate to meet the needs of the employees and customers. The Mansfield office includes the corporate headquarters and is in need of expansion which is currently being reviewed by management and the board of directors as discussed further in Management's Discussion and Analysis on page 44 of the 1996 Annual Report to the shareholders, which information is included at Exhibit 13, here of and incorporated berein by reference. Additionally, the Canton and Gillett offices are expected to receive approximately $150,000 in improvements during 1997. All of the facilities are equipped with current technological improvements for data and word processing. Inflation has impact on the Company's operating costs, however, unlike many industrial companies, substantially all of the Company's assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on the Company's performance than the general level of inflation. Over short periods of time, interest rates may not necessarily move in the same direction or in the same magnitude as prices of goods and services. Item 3-Legal Proceedings Management is not aware of any litigation that would have a material adverse effect on the consolidated financial position of the Company. There are no proceedings pending other than ordinary, routine litigation incidental to the business of the Company and its subsidiary. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Company and its subsidiary by government authorities. Item 4-Submission of Matters to a Vote of Shareholders There were no matters submitted to a vote of security holders in the fourth quarter of 1996. Part II Item 5-Market for the Registrant's Common Stock and Related Shareholder Matters The Company's common stock is traded by local brokerage firms and is not listed on any stock exchange. Market and dividend information is incorporated by reference to pages 31 and 48 of the Company's 1996 Annual Report to the Shareholders which pages are included in Exhibit 13 hereto. The Company has paid dividends since, April 30, 1984, the effective date of its formation as a bank holding company. The Company's Board of Directors intends to continue the dividend payment policy; however, future dividends necessarily depend upon earnings, financial condition, appropriate legal restrictions and other factors as in existence at the time the Board of Directors considers dividend policy. Cash available for dividend distributions to shareholders of the Company comes from dividends paid to the Company by the Bank. Therefore, restrictions on the ability of the Bank to make dividend payments are directly applicable to the Company. Under the Pennsylvania Business Corporation Law of 1988, the Company may pay dividends only if, after payment, the Company would be able to pay its debts as they become due in the usual course of its business and it's total assets are greater than the sum of its total liabilities. As of March 10, 1997, the Company has approximately 1,408 shareholders of record. Item 6-Selected Financial Data The information required by this item is incorporated by reference to page 31 of the 1996 Annual Report to the shareholders, which information is included at Exhibit 13, here of and incorporated berein by reference. Item 7-Management's Discussion and Analysis of Financial Condition and Results of Operations The information required by this item is incorporated by reference to pages 33 - 45 of the 1996 Annual Report to the shareholders, which information is included at Exhibit 13, here of and incorporated berein by reference. Item 8-Financial Statements and Supplementary Data The information required by this item is incorporated by reference to pages 11 - 29 and 32 of the 1996 Annual Report to the shareholders, which information is included at Exhibit 13, here of and incorporated berein by reference. Financial Statements: Consolidated Balance Sheet as of December 31, 1996 and 1995 Consolidated Statement of Income for the Years Ended December 31, 1996, 1995 and 1994 Consolidated Statement of Changes in Shareholders' Equity for the Years Ended December 31, 1996, 1995 and 1994 Consolidated Statement of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994 Notes to Consolidated Financial Statements Report of Independent Certified Public Accountants Item 9-Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None Part III Item 10-Directors and Executive Officers of the Registrant Information appearing in the definitive Proxy Statement under the caption "Information as to Nominees, Directors and Executive Officers" and "Principal Officers" to the Annual Meeting of Shareholders to be held April 15, 1997, is incorporated herein by reference in response to this item. Item 11-Executive Compensation Information appearing in the definitive Proxy Statement under the caption "Remuneration of Officers and Directors" related to the Annual Meeting of Shareholders to be held April 15, 1997, is incorporated herein by reference in response to this item. Item 12-Security Ownership of Certain Beneficial Owners and Management Information appearing in the definitive Proxy Statement at under the caption "Principal Beneficial Owners of the Corporation's Stock" related to the Annual Meeting of Shareholders to be held April 15, 1997, is incorporated herein by reference in response to this item. Item 13-Certain Relationships and Related Transactions Information appearing in the definitive Proxy Statement under the caption "Certain Transactions" related to the Annual Meeting of Shareholders to be held April 15, 1997, is incorporated herein by reference in response to this item. Part IV Item 14-Exhibits, Financial Statement Schedules and Reports on Form 8-K Documents Filed as Part of this Report: 14(a)1-Financial Statements. The following consolidated financial statements of Citizens Financial Services, Inc. and subsidiary included in the 1996 Annual Report are incorporated by reference in Item 8: Consolidated Balance Sheet as of December 31, 1996 and 1995 Consolidated Statement of Income for the Years Ended December 31, 1996, 1995 and 1994 Consolidated Statement of Changes in Shareholders' Equity for the Years Ended December 31, 1996, 1995 and 1994 Consolidated Statement of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994 Notes to Consolidated Financial Statements Report of Independent Certified Public Accountants 14(a)2-Financial Statement Schedules. Financial Statement Schedules are omitted because the required information is either not applicable, not required or is shown in the respective financial statement or in the notes thereto. 14(a)3-Exhibits: (3)(i) - Articles of Incorporation of the Corporation, as amended incorporated by reverence to Exhibit (3)(i) to the Annual Report of Form 10-K for the fiscal year ended December 31, 1995, as filed with the Commission on March 26, 1996. (3)(ii)- By-laws of the Corporation, as amended incorporated by reverence to Exhibit (3)(ii) to the Annual Report of Form 10-K for the fiscal year ended December 31, 1995, as filed with the Commission on March 26, 1996. (4) - Instruments Defining the Rights of Shareholders as filed in the registration statement on Form S-14 are incorporated herein by reference thereto. (Incorporated by reference to the Registrant's Registration Statement No.2-89103 on Form S-14, as filed with the Commission on February 17, 1984.) (10) - Material Contracts. Employment Agreement between the Company and Richard E. Wilber. (11) - Computation of Earnings Per Share. In the 1996 Annual Report to the shareholders, which information is included at page 17, Exhibit 13, here of and incorporated berein by reference. (13) - Annual Report to Shareholders for the year ended December 31, 1996. (21) - Subsidiaries of Citizens Financial Services, Inc. (27) - Financial Data Schedule 14(b)-No current report on Form 8-K was filed by the Registrant during the fourth quarter of the 1996 fiscal year. 14(c)-The exhibits required by this Item are listed under Item 14(a) above. 14(d)-Not applicable. SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, there unto duly authorized. Citizens Financial Services, Inc. (Registrant) /s/ Richard E. Wilber /s/ Thomas C. Lyman By: Richard E. Wilber By: Thomas C. Lyman President, Chief Executive Officer Treasurer (Principal Executive Officer) (Principal Financial & Accounting Officer) Date: March 18, 1997 Date: March 18, 1997 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signature and Capacity Date /s/ Richard E. Wilber March 18, 1997 Richard E. Wilber, President, Chief Executive Officer, Director (Principal Executive Officer) _________________________ Robert E. Dalton, Director /s/ Carol J. Tama March 18, 1997 Carol J. Tama, Director /s/ Lowell Coolidge March 18, 1997 Lowell Coolidge, Director /s/ Rudolph J. van der Hiel March 18, 1997 Rudolph J. van der Hiel, Director /s/ John Novak March 18, 1997 John Novak, Director /s/ Bruce L. Adams March 18, 1997 Bruce L. Adams, Director /s/ William D. Van Ettan March 18, 1997 William D. Van Ettan, Director /s/ Larry Croft March 18, 1997 Larry Croft, Director /s/ Thomas C. Lyman March 18, 1997 Thomas C. Lyman, Treasurer (Principal Financial and Accounting Officer) EXHIBITS INDEX (3)(i) - Articles of Incorporation of the Corporation, as amended incorporated by reverence to Exhibit (3)(i) to the Annual Report of Form 10-K for the fiscal year ended December 31, 1995, as filed with the Commission on March 26, 1996. (3)(ii)- By-laws of the Corporation, as amended incorporated by reverence to Exhibit (3)(ii) to the Annual Report of Form 10-K for the fiscal year ended December 31, 1995, as filed with the Commission on March 26, 1996. (4) - Instruments Defining the Rights of Shareholders as filed in the registration statement on Form S-14 are incorporated herein by reference thereto. (Incorporated by reference to the Registrant's Registration Statement No.2-89103 on Form S-14, as filed with the Commission on February 17, 1984.) (10) - Material Contracts. Employment Agreement between the Company and Richard E. Wilber. (11) - Computation of Earnings Per Share. In the 1996 Annual Report To the shareholders, which information is included at page 17, Exhibit 13, here of and incorporated berein by reference. (13) - Annual Report to Shareholders for the year ended December 31, 1996. (21) - Subsidiaries of Citizens Financial Services, Inc. (27) - Financial Data Schedule EX-10 2 EMPLOYMENT AGREEMENT AGREEMENT ("Agreement"), dated April 16, 1996 by and between CITIZENS FINANCIAL SERVICES, INC. (the "Corporation"), and Richard E. Wilber ("Executive"). WITNESSETH THAT: WHEREAS, Executive presently is the duly elected and acting President of the Corporation and First Citizens National Bank (the "Bank"); and WHEREAS, the Corporation recognizes the valuable services that Executive has rendered and desires to be assured that Executive will continue his active participation in the business of the Corporation and the Bank; and WHEREAS, the Corporation and Executive desire to set forth the benefits to which Executive would be entitled in the event that Executive's employment by the Corporation is terminated, as outlined herein; NOW THEREFORE, in consideration of the premises and the mutual agreements herein contained, the Corporation and Executive hereby agree as follows: 1. Termination. The Executive's employment hereunder may be terminated without any breach of the Agreement only under the following circumstances. (a) Death. The Executive's employment shall be terminated upon his death. (b) Retirement. Corporation may terminate the Executive's employment upon his retirement in accordance with the Corporation's retirement policies, including early retirement, generally applicable to its salaried employees, provided, however, that after Executive attains the age of sixty-five (65) this Agreement may be extended annually on a year-to-year basis by written consent of both parties. (c) Cause. Termination by the Corporation of Executive's employment for "Cause" shall mean termination because of misconduct, breach of fiduciary duty involving personal profit, intentional failure to perform stated duties, willful violation of any law, rule, or regulation (other than traffic violations or similar offenses), or final cease-and-desist order, or material breach of any provision of any employment contract between the Corporation and the Executive, including this Agreement, the willful engaging of the Executive in misconduct injurious to Corporation, monetarily or otherwise, or the commission of any act involving moral turpitude or other conduct on the part of Executive which brings public discredit to Corporation or Bank. For purposes of this paragraph, no act or failure to act, on Executive's part shall be considered "willful" unless done, or omitted to be done, by Executive not in good faith and without reasonable belief that Executive's action or omission was in the best interest of the Corporation. Notwithstanding the foregoing, Executive shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to Executive a copy of a Notice of Termination, after reasonable notice to Executive and an opportunity for Executive, together with Executive's counsel, to be heard before the Board of Directors of the Corporation, and a finding that in the good faith opinion of such Board, Executive was guilty of conduct set forth above in the first sentence of this Section 1 (c), such finding specifying the particulars thereof in detail. (d) Termination by Executive for Good Reason. Termination by Executive of his employment for "Good Reason" shall mean termination by Executive based on a change in control of the Corporation. For purposes of the Agreement, a "change in control" of Corporation shall mean a change in control of the nature that would be required to be reported in response to item 6(e) of Schedule 14A promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act') or any successor thereto; provided that, without limitation, such a change in control shall be deemed to have occurred if any person (as such term is used in Sections 13(d) and 14(d) of the Exchange Act), other than a person or persons who are directors or offices of the Corporation or the Bank, is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Corporation representing twenty-five percent (25%) or more of the combined voting power of Corporation's then outstanding securities; or during any period of two (2) or more consecutive years, individuals who at the beginning of such period constitute the Board of Directors of Corporation cease for any reason to constitute at least a majority thereof unless the election, or the nomination for election by Corporation's stockholders, or each new director was approved by a vote of at least two-thirds (2/3) of the directors then still in office who were directors at the beginning of the period. (i) Executive may terminate his employment with Corporation within twenty four (24) months of a change in control of Corporation if the Corporation assigns to Executive, without Executive's express written consent, any duties inconsistent with Executive's positions, duties, responsibilities and status with the Corporation immediately prior to a change in control, or changes the Executive's reporting responsibilities, titles or offices as in effect immediately prior to a change in control, or removes the Executive from or fails to re-elect Executive to any such positions, titles, or offices, except in connection with the termination of Executive's employment for Cause, Disability or Retirement or as a result of Executive's death or by Executive other than for Good Reason. (ii) Executive may terminate his employment with Corporation within twenty four (24) months of a change in control of Corporation, if the Corporation reduces the Executive's base salary as in effect on the date of the change in control or as the same may be increased from time to time thereafter. (iii) Executive may terminate his employment with the Corporation within twenty four (24) months of a change in control of Corporation, if the Corporation fails to continue in effect any benefit or compensation plan, stock ownership plan, stock purchase plan, stock option plan, life insurance plan, health-and-accident plan, disability plan or any other benefit plan in which Executive is participating at the time of a change in control of Corporation, the Corporation takes any action which would adversely affect Executive's participation in or materially reduce Executive's benefits under any of such plan or the Corporation deprives Executive of any material fringe benefit enjoyed by Executive at the time of a change in control of Corporation. (iv) Subsequent to a change in control of Corporation or Bank, any purported termination of Executive's employment which is not effected pursuant to a Notice of Termination satisfying the requirements of paragraph (2) below (and, if applicable, paragraph 1(c) above); and for purposes of this Agreement, no such purported termination shall be effective. (e) Disability. The Executive's employment may be terminated by the Executive upon his disability as defined herein, provided that the Executive shall provide prior written notice, if reasonably possible, of such disability termination at least fourteen (14) days in advance of the planned termination date and, if requested by the Corporation, shall furnish Corporation with a written statement from a qualified doctor to such effect and provided, further, that at Corporation's request, the Executive shall have concurred with the conclusion of the Executive's doctor with respect to the disability. The Executive's employment may be terminated by the Corporation upon Executive's disability, as set forth below. "Disability" shall mean the Executive's inability to perform the essential functions of his job with or without a reasonable accommodation for a period longer than the following: (1) after Executive has exhausted all accumulated sick leave days as a result of Executive's absence from his duties due to physical or mental illness, unless within thirty (30) days after Notice of Termination (as hereinafter defined) is given following such absence, Executive shall have returned to the full time performance of his duties; or (2) after Executive's absence from his duties on a full time basis for ninety (90) consecutive business days with such absence being due to Executive's incapacity as a result of physical or mental illness; unless within thirty (30) days after Notice of Termination (as hereinafter defined) is given following such absence, Executive shall have returned to the full time performance of his duties. 2. Notice of Termination. Any purported termination by the Corporation to paragraphs 1(b), (c) or (e) above or by Executive pursuant to paragraph (d) above shall be communicated by a written "Notice of Termination" to the other party hereto. For purposes of this Agreement, a "Notice of Termination" shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Executive's employment under the provision so indicated. (a) Date of Termination. "Date of Termination" shall mean: (i) if Executive's employment is terminated for Disability, thirty (30) days after Notice of Termination is given provided that Executive shall not have returned to the performance of Executive's duties on a full-time basis during such thirty (30) day period' (ii) if Executive's employment is terminated pursuant to paragraph (c) above, the date specified in the Notice of Termination; and (iii) if Executive's employment is terminated for any other reason, the date on which a Notice of Termination is given or as specified in such Notice; provided such date shall not be less than thirty (30) days nor more than ninety (90) days after such Notice of Termination is given. 3. Benefits Upon Termination. (a) If Executive's employment by the Corporation shall be terminated by the Corporation for any reason other than the Executive's Retirement, Disability or Death as described in paragraph 1(a), (b) or (e) or for cause as described in paragraph 1(c), the Executive or his designee as defined in Section 7(b) shall be entitled to receive from Corporation, within thirty (30) business days of the Date of Termination, a lump-sum payment in cash in an amount equal to one hundred percent (100%) of the Base Amount (as defined herein) of the Executive. In addition, the Executive shall be entitled to remain a participant in any health and accident, disability and life insurance plan of Corporation or Bank in which Executive was a participant at the Date of Termination, provided such continued participation does not violate the provisions or conditions of such plan or policies or does not violate any state or federal law, rule or regulation. If Executive's participation in such plans amounts to a violation of the plans or policies or of state or federal laws or regulations, the Corporation shall pay the Executive on a monthly basis those sums equal to premiums which the Corporation would have paid on behalf of the Executive if he had been permitted to continue participating in the applicable health and accident, disability and/or life insurance plan. These payments shall terminate on the twelve-month anniversary of the date of Termination, or the first date of employment by the Executive in a full-time position with any other company, whichever occurs first. Executive shall be entitled to only those pension and profit sharing benefits as shall have accrued prior to the Date of Termination. In addition to the amounts listed above, if a Change in Control occurs as defined in paragraph 1(d) above within twelve months of the termination of the Executive, the Corporation shall pay to Executive an additional lump-sum cash payment of seventy-five percent (75%) of the Base Amount. This sum shall be paid within thirty (30) days of the Change in Control. (b) If Executive's employment by the Corporation shall be terminated due to a Change in Control of the Corporation or if Executive terminates his employment for Good Reason as defined in 1(d), then Executive will receive within 30 business days of the Date of Termination, a lump-sum benefit in cash equal to one hundred seventy-five percent (175%) of the Base Amount. In addition, Executive shall be entitled to remain a participant in any health and accident, disability and life insurance plan of employer in which Executive was a participant at the Date of Termination provided such continuation as a plan participant does not violate provisions or conditions of such plan or policies or does not violate any federal or state law, rule or regulation. If Executive's participation in such plans amounts to violation of the plans or policies or of state or federal laws or regulations, the Corporation shall pay Executive, on a monthly basis, those sums equal to premiums which the Corporation would have paid on behalf of the Executive if he had been permitted to continue participating in the applicable health and accident, disability and/or life insurance plan. These payments shall terminate on the twelve-month anniversary of the date of termination, or the first date of employment by the Executive in a full-time position for any other company, whichever occurs first. (c) In the event the lump-sum severance payment made pursuant to this Section 3 hereof, either alone or together with other payments which the Executive has the right to receive from Corporation, would constitute a Parachute Payment, such lump-sum severance payment shall be reduced to the largest amount as will result in no portion of the lump-sum severance payment under Section 3 hereof being subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1954, as amended (the "Code"). The determination of any reduction in the lump-sum severance payment under Section 3 hereof pursuant to the foregoing provision shall be made independent counsel to the Corporation in consultation with the Independent Certified Public Accountants of the Corporation. (d) The Corporation and the Executive recognize that this Agreement may have to be amended in order to reflect any future regulations promulgated under Section 280G of the Code to assure that no Excess Parachute Payments would be paid to the Executive by the Corporation upon termination of employment pursuant to the Section 3, and hereby agree in good faith negotiate such an amendment and to not unreasonably withhold consent thereto upon the promulgation of any such regulations. 4. Base Amount, Parachute Payments and Present Value. "Base Amount", "Parachute Payments", "Excess Parachute Payments", and "Present Value" shall each have the meanings attributed to them under the Code and any regulations which may be promulgated after the date hereof as necessary or appropriate to carry out the purposes of this section. 5. Relocation Expenses. In the event Executive is transferred by or at the request of Corporation at any time during the term of this Agreement to a new principle place of work, Corporation shall reimburse Executive: (a) All reasonable expenses paid or incurred for the moving of the personal effects and household goods of Executive and Executive's family to Executive's new residence. (b) Any reasonable loss incurred by Executive in the sale of Executive's residence at Executive's home in Mansfield, which loss shall be determined by the long term capital loss incurred by Executive in the sale of his residence for federal income tax purposes under the Code. 6. Mitigation. Executive shall not be required to mitigate the amount of any payment provided for in Section 3 hereof by seeking other employment or otherwise, nor, with the exception of those limitations regarding payments for health and accident disability life insurance policies found in Section 3(a) and (b) above, shall the amount of any payment provided for in Section 3 be reduced by any compensation earned by Executive as a result of employment by another employer after the Date of Termination, or otherwise. 7. Successors; Binding Agreement. (a) The Corporation will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Corporation, by agreement in form and substance satisfactory to Executive, to expressly assume and agree to perform this Agreement in the same manner and to the same extent that Corporation would be required to perform it if no such succession had taken place. Failure of the Corporation to obtain such agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle Executive to compensation from the Corporation in the same amount and on the same terms as Executive would be entitled hereunder if Executive terminated his employment for Good Reason, except that for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the Date of Termination. As used in the Agreement, "Corporation" shall mean the Corporation as hereinbefore defined and any successor to its business and/or assets as aforesaid which executes and delivers the Agreement provided for in this paragraph 7 or which otherwise becomes bound by all other terms and provisions of this Agreement by operation of law. (b) This Agreement shall inure to the benefit of and be enforceable by Executive's personal and legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If Executive should die while any amount would still be payable to Executive hereunder if Executive had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to Executive's devisee, legatee or other designee or, if there be no such person, to Executive's estate. 8. Notice. For purposes of this Agreement, notices and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by Unites States certified or registered mail, return receipt requested, postage prepaid, addressed to the respective addresses set forth below: To Corporation: Chairman of the Board Citizens Financial Services, Inc. 15 South Main Street Mansfield, PA 16933 To Executive: Richard E. Wilber 20 Wakefield Terrace Mansfield, PA 16933 9. Miscellaneous. No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing signed by Executive and such officer as may be specifically designated by the Board of Directors of the Corporation to sign on behalf of the Corporation. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior to, or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by any party which are not expressly set forth in the Agreement; provided, however, that this Agreement shall not supersede or in any way limit the rights, duties or obligations the Executive may have under any other written agreement with the Corporation. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the Commonwealth of Pennsylvania. 10. Validity. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or unenforceability of any other provision of this Agreement, which shall remain in full force and effect. 11. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. 12. Arbitration. Any dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration in Mansfield, Pennsylvania, or at any other mutually acceptable location in accordance with the rules of the American Arbitration Association then in effect. Judgement may be entered on the arbitrator's award in any court having jurisdiction. 13. Regulatory and Other Proceedings. The provisions of this Section 13 shall control as to the continuing rights and obligations under this Agreement for as long as they are required to be included in employment contracts for officers of an institution insured by the Federal Deposit Insurance Corporation ("FDIC"), and so long as the Bank is an insured institution. (a) The Executive is suspended and/or temporarily prohibited from participating in the conduct of the Bank's affairs by a Notice served under 12 U.S.C.S. 1818(e)(4) and (g)(1)[the Federal Deposit Insurance Act of September 21, 1950, Chapter 967], the Corporation's obligations under this Agreement shall be suspended as of the date of service, unless stayed by appropriate proceedings. If the charges in the notice are dismissed, the Corporation shall pay the Executive all of the compensation withheld while its obligations hereunder were suspended and reinstate its obligations. (b) If the Executive is removed and/or permanently prohibited from participating in the conduct of the Bank's affairs by any order issued under 12 U.S.C.S. 1818(e)(1)(2)(3) and (g)(1)[the Federal Deposit Insurance Act of September 21, 1950, Chapter 967] all obligations of the Corporation under this Agreement shall terminate as of the effective date of the order, provided that vested rights of the contracting parties shall not be affected. (c) If the Bank becomes in default (as defined in Section 401 (d) of the National Housing Act), or any other similar United States Statute regulating national banks, all obligations under this Agreement shall terminate as of the date of default, provided that this paragraph shall not affect any vested rights of the contracting parties. (d) All obligations under this Agreement shall be terminated, except to the extent determined that continuation thereof is necessary for the continued operation of the Bank, by the FDIC at the time the FDIC enters into an agreement to provide assistance to or on behalf of the Bank, under the authority of any United States Statue or regulations adopted pursuant thereto, at the time such Board of its principal supervisory agent approves a supervisory merger to resolve problems related to the operation of Bank or when Bank is determined by the Board to be in an unsafe or unsound condition, provided that any rights of the parties that have already vested shall not be affected by such action. IN WITNESS WHEREOF, this Agreement has been executed as of the date first above written. ATTEST: CITIZENS FINANCIAL SERVICES, INC. /s/ Terry B. Osborne By /s/ Robert Dalton Secretary Robert Dalton, Chairman of the Board of Directors WITNESS: /s/ William Van Etten By /s/ Richard E. Wilber Richard E. Wilber, President EXHIBIT "A" [Presently, First Citizens does not have a policy regarding termination of employment for employees with long-term disabilities; however, one is being considered. Any termination provision will incorporate FMLA requirements if applicable, and First Citizens short and long-term disability plans. Decisions need to be made regarding employment return to work cutoff as it relates to disability, benefits accrual during disability and whether benefits will also terminate if employment is terminated due to long-term disability. Disability "retirement" should be considered. The absolute minimum time frame should be six months. Many employers use six months to one year as the cutoff. To my knowledge, none have extended the cutoff beyond two years.] EX-13 3 CITIZENS FINANCIAL SERVICES INCORPORATED ANNUAL REPORT 1996 _________________________________________________________________ [GRAPHIC OMITTED: Colonial rider on horseback, middle of the page, approximately two inches square] _________________________________________________________________ _________________________________________________________________ [GRAPHIC OMITTED: Watermark of colonial rider on horseback] _________________________________________________________________ To our Shareholders, Customers and Employees: As you review this 1996 annual report, you will quickly become aware of the tremendous success we enjoyed this past year. It is a pleasure to issue this report because it represents another year of record achievement. The directors and employees deserve recognition for their enthusiastic pursuit of many new strategic initiatives undertaken this year. You would be proud of their superb dedication in stepping up to these challenges. The end result whether measured in asset growth, customer and community service, or earnings and return on shareholder investment is continued success! Allow me to summarize some of this year's highlights. new community offices On April 20, 1996, we welcomed two more communities to our corporation. The Canton and Gillett offices were acquired from Meridian Bancorp, Inc. (subsequently purchased by CoreStates). As a result of this transaction, we added $17.1 million in deposits and $3.7 million in loans. More importantly, we had the opportunity to bring our "community banking" philosophy back to these customers and communities. Supermarket banking has recently become a significant national trend, however this trend had not reached our area until now! On October 31, 1996, we were delighted to open our first supermarket office, a 660 square-foot section within the Weis Market "superstore" just east of the borough of Wellsboro. At this facility, we offer 62 hours of service weekly (including Saturday and Sunday hours). The public reception of the new Weis Market has been tremendous and we are pleased with the deposit and loan growth in the early stages. financial performance During 1996 we saw total assets grow $35.7 million (14.5%) from $247.1 million to $282.8 million. Deposits and loans grew $26.9 million (12.6%) and $20.6 million (12.9%), respectively. A considerable portion of the deposit growth occurred because of the Canton and Gillett office acquisition as mentioned above. Loan demand in 1996 was very strong as evidenced by the $75 million of credit extended as compared to $50 million in 1995. The quality of our loan portfolio remains very high. Net loan charge-offs in 1996 were $43 thousand as compared to $51 thousand in 1995. The allowance for possible loan losses was $2 million at year-end 1996, representing 1.1% of gross loans nearly the same relationship as the 1995 allowance to gross loans. Loans not accruing interest totaled $1.3 million versus $1.5 million at year-end 1996 and 1995, respectively. The largest loans among this group are secured by mortgage liens and we therefore expect minimal loss exposure. <2> _________________________________________________________________ [GRAPHIC OMITTED: Photograph of employees of the Corporation being recognized for years of service, bottom left of page, approximately 3.5 inches by 2 inches] _________________________________________________________________ First Citizens National Bank employees were recognized for five-year intervals of service. Shown from left are: Judy Wetzel (10), Allan Reed (15), Gina Boor (5), Dick Wilber (15), Lynett Myers (10), Bill Austin (5) and Pam King (10). Not shown: Kathy Brooks (5), Wendy Southard (5), Katie Brown (10), Deb Scott (15), Gail Gunther (15), and Bob Wrisley (20). _________________________________________________________________ [GRAPHIC OMITTED: Photograph of the Corporation's President presenting a plaque to an employee of the Corporation, center top of page, approximately 2.5 inches by 3 inches] _________________________________________________________________ Shari L. Johnson, Customer Service Counselor and Terry B. Osborne, Executive Vice President, receive Employee of the Year awards from Richard E. Wilber, President. Shari joined First Citizens in 1992 and Terry in 1975. They were honored at this year's annual Christmas party for their outstanding professional contributions. _________________________________________________________________ Net income grew 6% to a record $3 million. In the third quarter we incurred a one-time assessment of $274 thousand for Federal Deposit Insurance Corporation (FDIC) premiums as a result of congressional action to rescue the ailing Savings Association Insurance Fund. This special assessment was applied to deposits we obtained in the 1989 acquisition of Star Savings and Loan Association. Had it not been for this one-time assessment, net income would have approximated $3.2 million for an annual increase of 12%. Total stockholders' equity grew to $22.9 million or 7.5% over the $21.3 million at year-end 1995. Stockholders' equity now represents 8.1% of year-end assets well in excess of ratios defined as "well capitalized" by regulatory agencies. Earnings per share was $2.21 compared to $2.08 for 1995. Had it not been for the one-time FDIC assessment, 1996 earnings per share would have been $2.33. Dividends declared in 1996 were 89 cents or 4.7% over the 85 cents; in 1995. At year-end, our common shares carried an average bid/ask price of $26.38 or 7.7% greater than $24.50 one year ago. operating and strategic initiatives Aside from the significant efforts that went into the acquisition of Canton and Gillett offices and the creation of the Weis supermarket office, we were very busy with a number of other important strategies. We saw continued success in controlling costs as we had the full - -year benefit of check imaging technology (implemented in mid 1995). Furthermore, as a result of this technology, we incurred very minor incremental costs for processing Canton and Gillett account activity and statement preparation. In addition, "computer output to laser disc" technology reduced our computer paper cost by 50%! These technology investments have proved even more beneficial than initially expected. Although growth in assets and the number of community offices are important, our overriding commitment is to assure we do not diminish the high-quality, personal service that has been our hallmark. Toward this end, management support was increased in order to keep up with customers' increasing product and service expectations. human resources With the addition of the Canton and Gillett offices, we were fortunate to welcome many dedicated and customer-sensitive employees. These employees were instrumental in easing the transitional inconvenience that many customers experience in this situation. Furthermore, consistent with our philosophy in other community offices, we were fortunate to add very competent local board members with a diversity of experience in Gillett, Forest "Woody" Oldroyd (owner of Woody's Country Store) and in Canton, David Wright (dairy and veal farmer), Marilyn Scott (contracted school bus driver and Borough Council president), Roger Graham (self-employed excavating contractor) and Lester Hilfiger (Canton Borough Authority manager). A new local board member was also added in Wellsboro James Stager (president and operator of Joker's Coal and Morris Block). We continue to be blessed with employees committed to enhancing their professional skills. Evidence of this is the fact that 82 employees attended some form of education or training during 1996. the future We are about to embark on a future that appears extremely challenging yet promising. Although our industry changed greatly during the past decade, it is expected that the next decade will experience accelerated evolution. The consolidation trend continues unabated (keep in mind that over the past ten years, the number of commercial banks declined over 30% to less than 10,000). This should continue as full interstate banking and branching is avail able effective September 1997 (regardless of differing state banking rules). The uncertainties regarding Federal Deposit Insurance Corporation reserve levels are now behind us. Future premium costs will return to the more modest levels that we last recall from the 70's. Recent decisions by our regulatory agencies along with decisions of the Supreme Court have laid the foundation for expanded products and services. Of great significance was the provision allowing national banks to offer a full range of insurance products and that such services be offered "from a place with a population not exceeding 5,000." <3> _________________________________________________________________ GRAPHIC OMITTED: Photograph of the Corporation's President presenting a plaque to an employee of the Corporation, top left of page, approximately 3.5 inches by 2.5 inches] _________________________________________________________________ [GRAPHIC OMITTED: Photograph of the Corporation's President, approximately 10 inches in length by 3.5 inches width on right side of page] _________________________________________________________________ A Message from the President _________________________________________________________________ In a separate yet critically important decision by the Supreme Court, restrictions have been imposed on credit union expansion. This decision will soon be subject to a re-hearing by the Court and could create more meaningful restrictions reducing or eliminating the unfair competitive advantages that credit unions enjoy. Various members of Congress are now touting legislation whereby banks may be allowed to enter a host of non-traditional areas currently prohibited by the Glass-Steagall Act. The dialogue in Washington now is for "financial modernization" but we must remember that we've anxiously awaited such modernization for many years. Will this be the year? With this being the landscape for our industry, the question is how it affects (and how soon) the direction of our bank. Our focus during 1997 and into 1998 will be the following: Further utilization of technology to both enhance customer service and restrain the growth of our cost structure. Expand the variety and appeal of products and services (especially as it relates to mortgage loan programs). Sustain a strong marketing, promotions, and business development program to continue our strong growth. Finalize the headquarters and Mansfield community office building plans which have been contemplated for many years. Convert to a new hardware and software system that will enhance and improve customer service, as well as expand the delivery methods available to customers. We recognize this is an aggressive set of plans which will require us to be extremely focused. I am very pleased with our preparation thus far and believe your board of directors and employees are poised to meet these challenges head-on. We are working very hard to sustain the success we have enjoyed and prepare ourselves for the year 2000 and beyond. /s/ Richard E. Wilber Richard E. Wilber President <4> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, one inch square] _________________________________________________________________ First Citizens' Scrap Book _________________________________________________________________ [GRAPHIC OMITTED: Photograph of Allan K. Reed, left side of page, approximately 2 inches by 2.5 inches] _________________________________________________________________ Allan K. Reed _________________________________________________________________ [GRAPHIC OMITTED: Photograph of Chester L. Reed, next to photograph of Allan K. Reed, approximately 2 inches by 2.5 inches] _________________________________________________________________ Chester L. Reed _________________________________________________________________ [GRAPHIC OMITTED: Photograph of William A. Richetti, next to photograph of Chester L. Reed, approximately 2 inches by 2.5 inches] _________________________________________________________________ William R. Richetti _________________________________________________________________ [GRAPHIC OMITTED: Photograph of Christopher S. Landis, next to photograph of William A. Richetti, approximately 2 inches by 2.5 inches] _________________________________________________________________ Christopher S. Landis _________________________________________________________________ Allan K. Reed In November, Allan Reed was promoted to Branch Administrator. Allan was previously office manager of the Mansfield community office. In his new position, Allan is responsible for the operation and profitability of eight community offices in order to meet the financial and credit services needs of their customers. Allan and his family attend the Covington Baptist church. He is active with the Boy Scouts of America, AWANA, Greater Mansfield Area Chamber of Commerce, Mansfield Men's Chorus, Kiwanis Club of Mansfield, Human Service Providers, and Lambs Creek Sportsmen's Club. Chester L. Reed Allan's replacement as Mansfield community office manager was Chet Reed. Chet was most recently office manager of the Sayre community office. Chet has many diplomas from the PBA School of Banking and the Central Atlantic School of Banking. Chet and his family are looking forward to becoming active residents of the Mansfield Area. William A. Richetti Chet's replacement in the Sayre community office is Bill Richetti. Bill most recently was branch manager of the Horseheads office of First Federal Savings and Loan Association of Rochester. As branch manager, Bill earned several honors including 1990, 1992 and 1993 Branch of the Year! Bill, who has been in banking for 19 years, is a graduate of Jamestown Community College and has attended many professional educational seminars. He and his family look forward to becoming active residents of the Sayre area. Christopher S. Landis Introducing Chris Landis, office manager of the Canton community office. A resident of Mansfield, Chris most recently was a loan officer at Northeastern Farm Credit, ACA, in Wellsboro. Chris is a graduate of Lycoming College and has attended several credit-related professional educational seminars. Chris is currently the Youth Director at the New Life Church in Canton. He is looking forward to moving back to the Canton area and becoming an active resident of the community. <5> _________________________________________________________________ [GRAPHIC OMITTED: Photograph of Jennifer L. Snyder, top left side of page, approximately 2 inches by 2.5 inches] _________________________________________________________________ [GRAPHIC OMITTED: Photograph of Helen Kay Shedden, middle center of page, approximately 2 inches by 2.5 inches _________________________________________________________________ [GRAPHIC OMITTED: Photograph of employees of the Corporation donating food to local food banks] _________________________________________________________________ From left: Ruth Wilkinson, Tammy Goodreau, Gina Boor, Abbie Lerch, Cindy Pazzaglia, and Sara Roupp. _________________________________________________________________ Jennifer L. Snyder In October 1996, First Citizens opened its first supermarket branch at Weis Market in Wellsboro. Selected to be Sales Manager was Jennifer L. Snyder of Mansfield. Jennifer's most recent position was as Assistant Manager of the Lewisburg WalMart. Jennifer is a graduate of Pennsylvania State University, where she received a B.S. degree in Management and International Business. In 1997, Jennifer looks forward to the challenge of making First Citizens' first supermarket office a success. With the team effort used by Jennifer and the rest of the Weis office staff, First Citizens can look forward to a successful 1997. Helen Kay Shedden Helen Kay Shedden, office manager of the Gillett community office, joined the First Citizens family when the Gillett office was purchased from Meridian Bancorp in April of 1996. Helen Kay has been manager of the Gillett community office since 1983. She is active with the Gillett Baptist Church, South Creek Ambulance Association, and the South Creek Lions Club. In October, a committee of First Citizens' employees organized a health fair for all employees. The event, which took place on Columbus Day, was attended by: Project Concern from Soldiers and Sailors Memorial Hospital, Mansfield Fire Company, American Cancer Society, Criss Natural Foods, representatives from Charles Cole Memorial Hospital, MARS Fitness Service, Employee Services, Inc., a certified massage therapist, Blue Cross of Northeastern Pennsylvania, and AFLAC. With the help of these organizations, employees were able to have a wellness check, a stress test, and a massage, as well as receiving nutritional information, diet information, exercise information, and insurance information. Attendees also had the option of learning about adult and infant CPR, Carpal Tunnel Syndrome, and Lite Cooking. As part of this event, each employee brought two nonperishable food items. These items were donated to local food pantries in each of First Citizens' market areas. Pictured above with these items are the committee members. <6> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of two sets of hands holding the globe] _________________________________________________________________ VOLUNTEERISM _________________________________________________________________ [GRAPHIC OMITTED: Photograph of the new clock installed in front of the Wellsboro office, middle center of page, approximately 3 inches by 4.5 inches] _________________________________________________________________ Shown above is the new clock which was installed in front of the Wellsboro office. The clock was designed to match Wellsboro's existing gaslight image of a time gone by. _________________________________________________________________ Community banking means more than just having a bank located within your community; it means having a bank which makes a contribution to the community, is active in local organizations and works to make the area a better place to live. First Citizens National Bank is doing just that. It has always been and will continue to be a concerned, active corporate citizen here in the Twin Tiers. Recently, President Clinton asked retired General Colin Powell to head a committee to promote volunteerism in America. First Citizens is proud to say that this concept isn't new to us. Rather, it's a legacy that has existed since the bank began operations in 1932. As you can see, the theme of our annual report is volunteerism. As you read this report, you will agree that we have reason to be proud of our people and the many ways in which they commit themselves to improving our communities. In 1996, the bank demonstrated its commitment to the communities it serves by donating more than $60,000 to many worthwhile causes. To the people of First Citizens National Bank, reinvesting in the community means more than just providing capital to growing businesses and families. It entails a much deeper, personal commitment. In 1996, First Citizens employees and directors not only lived up to the exemplary standards of the model volunteer, they redefined them. The commitment of which we speak is a commitment of time, money, knowledge and labor. During 1996, the employees and directors donated more than 13,000 hours to all levels of community service. We have forged a partnership with our communities by making this commitment. The result of this partnership is an accomplishment of various goals that would be unachievable alone. In a recent employee survey, we found there were many volunteers among the organization. In fact, many are active in their churches as committee members, Sunday School teachers and organizers of various outreach programs. Many are devoted to the youth in the Twin Tiers through organizations such as Little League, Junior Bowling, AYSO Soccer, Boy Scouts and Girl Scouts of America, just to name a few. We are also proud of two women who are actively involved in efforts of the American Cancer Society. These women have battled the disease themselves and have chosen to share their experience with others in hopes of saving lives. They are to be commended for their courage and selflessness, not only in beating this disease, but in donating their time, knowledge and experiences to help others. Not only do they help support women who have been diagnosed with cancer, they also teach women the importance of self exams and early diagnosis. These women are Judy Wetzel, TeleServices Representative and Dot Rakoski, Customer Service Representative, Blossburg. They have earned our admiration and respect and we are very proud of the job they do. Several other individuals should be commended for the remarkable amount of time and energy they donate to many different organizations. As you read the following, you will agree that these individuals are indeed special. The definition of volunteer is "one who offers service of his own free will." That accurately describes the following individuals: <7> _________________________________________________________________ [GRAPHIC OMITTED: Photograph of a bank employee at Dickens of a Christmas, middle top of page, approximately 5 inches by 3 inches] _________________________________________________________________ Karen, dressed in Victorian costume, is shown at the Community Concert information booth at an annual Dickens of a Christmas celebration in Wellsboro. _________________________________________________________________ Karen is President of the Community Concert Association dedicated to promoting the Arts. _________________________________________________________________ [GRAPHIC OMITTED: Photograph of two bank employees presenting an award to the winner of the Laurel Festival 10-K Race, bottom right side of page 2.5 inches by 3 inches] _________________________________________________________________ Tim is proud of his association with the Laurel Festival 10-K race. Shown above are Rob Carleton (left), also a Wellsboro local board member, and Debbie Callahan, Wellsboro Customer Service Counselor, during a 10-K winners' awards presentation. _________________________________________________________________ Tim has devoted some of his most valuable time to children. _________________________________________________________________ Karen Jacobson Karen Jacobson, a 27-year veteran of First Citizens, is our Assistant Auditor and Security Officer. Karen continually demonstrates the spirit of volunteerism in several of our communities. Karen is on the Financial Advisory Board of Martha Lloyd Community Services. Martha Lloyd provides care and training for mentally challenged women and men. As past treasurer of the main board, Karen still works to ensure quality of care and financial strength for Martha Lloyd so its programs will be available in Troy for a long time to come. For the past 26 years Karen has been Mansfield University chapter advisor for Delta Zeta Sorority, and has also served on the national level. Delta Zeta provides an opportunity for young women to assume leadership roles and participate in philanthropic activities while emphasizing academic excellence and the social skills necessary to be successful. The Wellsboro Presbyterian Church, of which Karen is a member, provides for the spiritual well-being of members of the Wellsboro and surrounding communities through many programs. Karen's involvement also includes Bell Choir, Chancel Choir, Lay Reader, and Member Care & Outreach "Fellowship Friend". Last, but not least, Karen is also involved in the musical arena. She is president of the Community Concert Association, a 49-year-old local organization dedicated to promoting the arts in the Potter-Tioga-Bradford area. She is an officer of and plays in the Wellsboro Town Band, an organization for area musicians of all ages from all over the Twin Tiers. They join together for six weeks each summer to provide a bit of small-town Americana for their audience. Timothy J. Gooch, CPA Tim has been a board member for the Wellsboro community office of First Citizens since 1995. He is also a stockholder in the certified public accounting firm, Pennypacker and Zeigler, P.C. Through his involvement, Tim continually exhibits his concern for the continued growth of the Wellsboro area and its residents. The Wellsboro area Chamber of Commerce unites its 260 business and individual members for the betterment of the Wellsboro area business community. Tim serves as vice president of the Chamber as well as serving on several committees. His work with the committees includes organizing efforts to increase the membership of the Chamber, assisting in the preparation and monitoring of the annual budget and working with the area businesses for the development and enhancement of the Wellsboro community. Tim also volunteers in various Chamber activities including Homecoming Harvest, Winterfest '97, Dickens of a Christmas, and the Laurel Classic Bicycle Race. Tim has devoted some of his most valuable time to children. He serves on the board of directors of the Wellsboro Area Little League, which in 1996 enrolled 596 youngsters age 5-18 on 46 teams. In 1996, through the Wellsboro Area Little League program, Tim helped develop a new tee-ball league for five-olds, in which 29 players participated. Continuing with his sports enthusiasm, Tim has been the Race Director for the PA State Laurel Festival 10K Race since 1987. As race director, Tim is responsible for organizing the event in its entirety. From mapping out the course and designing tee-shirts to arranging the prizes and the corporate sponsor, Tim volunteers the time necessary to make this a successful event each year. <8> _________________________________________________________________ [GRAPHIC OMITTED: Photograph of Carol J. Tama, Corporate Board member, top right side of page, approximately 2.5 inches by 3.5 inches] _________________________________________________________________ Carol is proud of her involvement with organizations whose mission is to better the life of local children. _________________________________________________________________ [GRAPHIC OMITTED: Photograph of Phillip D. Vaughn, bottom right of page, approximately 2.5 inches by 3.5 inches] _________________________________________________________________ Phil helps guide the church regarding community outreach and missions. _________________________________________________________________ Carol J. Tama Carol has been a director on the Corporate Board of First Citizens National Bank since 1984 and Citizens Financial Services, Inc. since 1986. Carol donates her time to many worthy organizations. As a trustee for the First United Methodist Church in Blossburg, Carol helps to oversee the regular maintenance of the building and grounds as well as various improvement projects. The most recent projects included the restoration of the stained glass windows and the restoration of the sanctuary. The Blossburg Public Library is open to the residents of the Blossburg borough and surrounding communities. As treasurer, Carol oversees the $60,000 budget of the library, $10,000 of which is used each year to purchase new books. Carol also donates time to North Penn Comprehensive Health Services. NPCHS was founded because the community wanted to keep medical care available in Blossburg after the hospital closed in 1972. Many valuable programs which fall under the NPCHS umbrella include Headstart, Northern Tier Youth Services, Home Health, and Home and Center. All of these programs offer a valuable service to the community. Carol also serves on the Laurel Health Services Board of Directors which is comprised of board members from NPCHS, Soldiers & Sailors Memorial Hospital, and the Green Home. This board strives to ensure that the mission of each separate entity is being followed while also following the mission of Laurel Health Services. Carol also serves as a trustee for Mansfield University. The trustees meet quarterly to review the state of the university and to ensure the university's philosophies are being followed in order to maintain the respectable reputation it has earned as an education facility. Carol is proud of her involvement with organizations whose mission is to better the life of local children. She does this through the Blossburg Area Swimming Association and the Jones Foundation. The swimming association controls the funds which are used to maintain the community pool at Island Park. Although another organization sees to the day-to-day running of the pool, this association sees that funds are available for maintenance and improvements. In 1997, a $60,000 renovation is planned to make the bath house and pool handicapped accessible. The Jones Foundation donates approximately $35,000 each year to North Penn student activities including sending kids to camps, assembly programs, various Boy Scout and Girl Scout groups, and summer programs at Island Park. Phillip D. Vaughn Phil, who has been office manager of the Ulysses community office since 1990, is very involved with his local church as well as several community improvement committees and outreach programs. As Elder and a Sunday School teacher with the Zion Christian Assembly, Phil helps guide the church regarding community outreach and missions, as well as budget and building maintenance. He is also a licensed minister who often speaks at his own church as well as other churches throughout the area. His community improvement efforts include serving on the boards of the Potter County Housing Authority and the Redevelopment Authority. The Housing Authority is the local channel for HUD-subsidized housing, which helps approved renters with the rental fee of HUD-approved housing. It also owns several housing units including those for low-income families and for retired persons. The Redevelopment Authority focuses on the development of industry in Potter County including industrial parks and incubator projects. These efforts include building property to the customer's specifications and then selling the property to these businesses as well as providing space for new businesses until they are secure enough to locate their own facilities. As a member of the Charles Cole Memorial Hospital Auxiliary, Phil helps his wife, Jessie, who is the gift shop manager. He also serves on the Funds Development Council, which was designed to get feedback from the community regarding what the hospital could do to better provide for their needs. Ultimately, the focus is then on raising funds to implement new programs which would serve those needs. Phil is also part of the Potter County Habitat for Humanity. In 1996, after becoming a Habitat affiliate, the Potter County organization selected a site for their first house to be constructed. A family for the house is soon to be selected and building is slated to begin this summer. <9> _________________________________________________________________ [GRAPHIC OMITTED: Photograph of Jim Wagner, Ulysses Local Board member, top right of page, approximately 2.5 inches by 3 inches] _________________________________________________________________ Jim is proud of his involvement in the improvement of the sewer and water systems, as these improvements help ensure the future growth and vitality of the community. _________________________________________________________________ [GRAPHIC OMITTED: Photograph of bank employee, Claudia Steadman, bottom right of page, approximately 2.5 inches by 3 inches] _________________________________________________________________ Claudia is always eager to help her community. _________________________________________________________________ Jim Wagner Jim is a local board member of the Ulysses community office. For the past 18 years, he has served on the Ulysses Municipal Authority and is its Chairman. The Municipal Authority owns the water and sewer systems in Ulysses. During his term, the authority has changed from dumping raw sewage directly into the streams to treating the sewage prior to discharge. They are currently working on a $500,000 project which will further treat the sewage to lower the high concentration of ammonia nitrates. Jim is proud of his involvement in the improvement of the sewer and water systems, as these improvements help ensure the future growth and vitality of the community. Jim is also a director for the Northeast Potter County Industrial Development Corporation. His service to this organization includes aiding in the development of an industrial park. This park now has sewer and water access, and efforts are being made to bring new industry to the park. This, of course, would result in increased revenue and jobs in the Potter County area. Jim is a trustee and choir member of the First Baptist Church. Trustees of the church handle the funding and decision making regarding the church building and property. As a choir member, Jim enjoys singing each Sunday as well as performing during special events, both at the church and elsewhere. He feels especially blessed when he, his wife Carol, and their three sons are able to present special music together for their church. Jim also serves as a board member of Human Service Providers, Inc. Human Service Providers is a non-profit organization which sells its services to county governments in Potter, Tioga and Bradford counties. As a board member, Jim ensures that programs are in place and working to fulfill the mission of the organization. This mission is to strengthen and improve the lives of mentally challenged individuals. Claudia Steadman Claudia, a Senior Customer Service Representative in our Genesee community office, is the area representative for the Salvation Army. As such, she organizes ways in which families in the area are provided with food and clothing when there is a loss from a fire or other natural disaster. She has served as liaison between Potter County and the Salvation Army headquarters in Philadelphia for four years. She is also a member of the Genesee United Methodist Church, where she is a choir member and a Pastor/Parish Relations Committee member. She enjoys singing in the choir and has done so for the past 25 years. In her role with the Pastor/Parish Relations Committee, Claudia acts as a liaison between the congregation and the minister. Claudia also serves as bookkeeper for the Genesee Township Water Authority. She en joys this position as it allows her to serve the community, but also because as bookkeeper, she works with her husband who is the treasurer. Together, they handle the accounting procedures for the Authority. Claudia is always eager to help her community. When asked to donate money or items for many different community fundraisers, she is quick to respond. This is a characteristic which she shares with many of First Citizens employees and directors. With individuals like these, our communities are much richer, not necessarily in a monetary way, but because of the invaluable knowledge, energy and experiences which the communities receive from them. First Citizens has a diverse group of employees who are active in all areas of their communities, serving in every imaginable capacity, from giving blood to working with children to raising funds for the needy. We are very proud to have these individuals as part of our family. <10> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left had corner of page .5 inches square] _________________________________________________________________ FINANCIAL HIGHLIGHTS _________________________________________________________________ Citizens Financial Services, Inc. _________________________________________________________________ in thousands, except per share data 1996 1995 BALANCE SHEET Assets $282,810 $247,094 Deposits 240,177 213,316 Net Loans 180,418 159,794 Investments 86,057 73,715 Stockholders' Equity 22,904 21,297 STATEMENT OF INCOME Interest Income 21,341 19,422 Interest Expense 10,867 9,851 Net Interest Income 10,474 9,571 Net Income 3,003 2,834 PER SHARE DATA Net Income 2.21 2.08 Cash Dividends 0.89 0.85 TRUST AND INVESTMENT SERVICES Trust Assets Managed 43,311 41,172 _________________________________________________________________ [GRAPHICS OMITTED: Seven bar charts depicting 1. total assets, 2. net income, 3. stockholders' equity, 4. deposits, 5. net loans, 6. cash dividends declared, and 7. investments, each from 1992 to 1996 (except for investments which are presented from 1993 to 1996). Tabular representation of those graphs are set forth as follows: TOTAL ASSETS: (Dollars in Thousands) 1992 1993 1994 1995 1996 $202,155 $216,237 $232,537 $247,094 $282,810 NET INCOME (Dollars in Thousands) 1992 1993 1994 1995 1996 $2,248 $2,424 $2,625 $2,834 $3,003 STOCKHOLDERS' EQUITY (Dollars in Thousands) 1992 1993 1994 1995 1996 $16,329 $18,340 $18,903 $21,297 $22,904 DEPOSITS (Dollars in Thousands) 1992 1993 1994 1995 1996 $178,033 $191,013 $194,478 $213,316 $240,177 NET LOANS (Dollars in Thousands) 1992 1993 1994 1995 1996 $128,326 $140,391 $154,848 $159,794 $180,418 CASH DIVIDENDS DECLARED (Dollars in Thousands) 1992 1993 1994 1995 1996 $960 $1,023 $1,088 $1,153 $1,219 INVESTMENTS (Dollars in Thousands) 1993 1994 1995 1996 $62,645 $64,257 $73,715 $86,057 _________________________________________________________________ <11> _________________________________________________________________ CONSOLIDATED BALANCE SHEET December 31, 1996 and 1995 _________________________________________________________________ Nineteen hundred ninety-six Annual Report _________________________________________________________________ (in thousands) 1996 1995 ASSETS: Cash and due from banks: Noninterest-bearing $ 6,407 $ 5,536 Interest-bearing 52 37 Total cash and cash equivalents 6,459 5,573 Available-for-sale securities 28,736 21,444 Held-to-maturity securities (estimated market value 1996, $57,587; 1995, $53,589) 57,321 52,271 Loans (net of allowance for possible loan losses 1996, $1,995; 1995, $1,833) 180,418 159,794 Foreclosed assets held for sale 164 208 Premises and equipment 4,345 4,175 Accrued interest receivable 2,930 2,607 Other assets 2,437 1,022 TOTAL ASSETS $282,810 $247,094 LIABILITIES: Deposits: Noninterest-bearing $ 17,924 $ 15,140 Interest-bearing 222,253 198,176 Total deposits 240,177 213,316 Borrowed funds 15,817 8,855 Accrued interest payable 2,293 2,106 Dividends payable 612 579 Other liabilities 1,007 941 TOTAL LIABILITIES 259,906 225,797 STOCKHOLDERS' EQUITY: Common Stock $1.00 par value; authorized 5,000,000 shares; issued and outstanding 1,360,228 and 1,347,323 shares in 1996 and 1995, respectively 1,360 1,347 Additional paid-in capital 6,828 6,512 Retained earnings 14,544 13,089 TOTAL 22,732 20,948 Unrealized holding gains on available-for-sale securities 172 349 TOTAL STOCKHOLDERS' EQUITY 22,904 21,297 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $282,810 $247,094 See notes to consolidated financial statements. <12> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of a colonial rider horseback, upper left hand corner of page .5 inches square] _________________________________________________________________ CONSOLIDATED STATEMENT OF INCOME Years Ended December 31, 1996, 1995 and 1994 _________________________________________________________________ Citizens Financial Services, Inc. _________________________________________________________________ (in thousands, except per share data) 1996 1995 1994 INTEREST INCOME: Interest and fees on loans $15,817 $14,799 $12,918 Interest-bearing deposits with banks 148 135 25 Investment Securities: Taxable 5,238 4,233 4,046 Nontaxable 66 179 281 Dividends 72 76 66 TOTAL INTEREST INCOME 21,341 19,422 17,336 INTEREST EXPENSE: Deposits 10,276 9,340 7,521 Borrowed funds 591 511 423 TOTAL INTEREST EXPENSE 10,867 9,851 7,944 NET INTEREST INCOME 10,474 9,571 9,392 Provision for possible loan losses 205 163 255 NET INTEREST INCOME AFTER PROVISION FOR POSSIBLE LOAN LOSSES 10,269 9,408 9,137 OTHER OPERATING INCOME: Service charges 844 732 707 Trust 270 255 204 Realized securities gains, net 19 10 63 Other 258 255 162 TOTAL OTHER OPERATING INCOME 1,391 1,252 1,136 OTHER OPERATING EXPENSES: Salaries and employee benefits 3,418 3,150 3,088 Occupancy 466 413 391 Furniture and equipment 599 574 599 Federal deposit insurance premiums 372 289 406 Other 2,495 2,239 2,006 TOTAL OTHER OPERATING EXPENSES 7,350 6,665 6,490 Income before provision for income taxes 4,310 3,995 3,783 Provision for income taxes 1,307 1,161 1,158 NET INCOME $ 3,003 $ 2,834 $ 2,625 EARNINGS PER SHARE $ 2.21 $ 2.08 $ 1.93
See notes to consolidated financial statements. <13> _________________________________________________________________ CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 1996, 1995, and 1994 _________________________________________________________________ Nineteen hundred ninety-six Annual Report _________________________________________________________________ Unrealized Additional Holding (in thousands, except per share data) Common Stock Paid-in Retained Gains/(Losses) Shares Amount Capital Earnings on Securities Total Balance, December 31, 1993 1,321,887 $1,321 $5,976 $10,433 $610 $18,340 Net income 2,625 2,625 Stock dividend 12,656 13 248 (261) Cash dividends, $.80 per share (1,088) (1,088) ($.81 per share on a historical basis) Unrealized losses on available-for-sale securities (974) (974) Balance, December 31, 1994 1,334,543 1,334 6,224 11,709 (364) 18,903 Net income 2,834 2,834 Stock dividend 12,780 13 288 (301) Cash dividends, $.85 per share (1,153) (1,153) ($.85 per share on a historical basis) Unrealized gains on available-for-sale securities 713 713 Balance, December 31, 1995 1,347,323 1,347 6,512 13,089 349 21,297 Net income 3,003 3,003 Stock dividend 12,905 13 316 (329) Cash dividends, $.89 per share (1,219) (1,219) Unrealized losses on available-for-sale securities (177) (177) Balance, December 31, 1996 1,360,228 $1,360 $6,828 $14,544 $172 $22,904
See notes to consolidated financial statements. <14> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of a colonial rider horseback, upper left hand corner of page .5 inches square] _________________________________________________________________ CONSOLIDATED STATEMENT OF CASH FLOWS Years Ended December 31, 1996, 1995 and 1994 _________________________________________________________________ Citizens Financial Services, Inc. _________________________________________________________________ (in thousands) 1996 1995 1994 Cash Flows from Operating Activities: Net income $ 3,003 $ 2,834 $ 2,625 Adjustments to reconcile net income to net cash provided by operating activities: Provision for possible loan losses 205 163 255 Provision for depreciation and amortization 442 412 440 Amortization and accretion on investment securities 362 248 190 Deferred income taxes 36 25 20 Realized gains on securities (19) (10) (63) Realized gains on loans sold (23) (37) (12) Gain on sales or disposals of premises and equipment - - (2) Gain on sales of foreclosed assets held for sale (50) (45) (24) (Increase) decrease in accrued interest receivable and other assets (487) (393) 247 Increase in accrued interest payable and other liabilities 253 468 82 Net cash provided by operating activities 3,722 3,665 3,758 Cash Flows from Investing Activities: Available-for-sale securities: Proceeds from sales of securities 16 - 3,063 Proceeds from maturities of securities 2,000 1,000 - Purchases of securities (9,682) (6,797) (3,003) Held-to-maturity securities: Proceeds from maturities and principal repayments of securities 8,108 5,556 3,203 Purchases of securities (13,395) (8,375) (6,478) Net increase in loans (17,338) (5,250) (14,713) Purchase of loans (3,659) - - Capital expenditures (539) (463) (602) Proceeds from sale of premises and equipment - - 4 Proceeds from sale of foreclosed assets held for sale 285 184 100 Property purchased for future expansion (250) - - Deposit acquisition premium (1,018) - - Net cash used in investing activities (35,472) (14,145) (18,426) Cash Flows from Financing Activities: Net increase in deposits 9,731 18,838 3,465 Proceeds from long-term borrowings 1,166 1,844 2,844 Repayments of long-term borrowings (1,050) (186) (390) Net increase (decrease) in short-term borrowed funds 6,846 (8,833) 9,704 Dividends paid (1,187) (1,121) (1,056) Deposits of acquired branches 17,130 - - Net cash provided by financing activities 32,636 10,542 14,567 Net increase (decrease) in cash and cash equivalents 886 62 (101) Cash and Cash Equivalents at Beginning of Year 5,573 5,511 5,612 Cash and Cash Equivalents at End of Year $ 6,459 $ 5,573 $ 5,511 Supplemental Disclosures of Cash Flow Information: Interest paid $10,680 $ 9,437 $ 7,970 Income taxes paid $ 1,310 $ 1,135 $ 1,097 Noncash activities: Real estate acquired in settlement of loans $ 191 $ 179 $ 13
See notes to consolidated financial statements. <15> _________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS _________________________________________________________________ Nineteen hundred ninety-six Annual Report _________________________________________________________________ 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Citizens Financial Services, Inc. (individually and collectively, the "Company") is a Pennsylvania corporation organized as the holding company of its wholly-owned subsidiary, First Citizens National Bank (the "Bank"). The Bank is a national banking association headquartered in Mansfield, Pennsylvania and operating ten full-service banking offices in Potter, Tioga and Bradford counties. The Bank provides a comprehensive range of services including consumer loans, residential real estate loans, commercial loans, and loans to various state and municipal entities. Deposit pro grams encompass the full range of consumer as well as commercial checking and savings accounts. Deposit products also include certificates of deposit and individual retirement accounts. A comprehensive menu of trust and investment services are also available. The Company's principal sources of revenue are derived from its loan and investment portfolios. 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 accounting policies followed by the Company and the methods of applying these principles conform with generally accepted accounting principles and with general practice within the banking industry. All material intercompany balances and transactions have been eliminated in consolidation. 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. Actual results could differ significantly from those estimates. INVESTMENT SECURITIES Investment securities 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. 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, 1996 and 1995. 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 approximates the effective interest method. Gains and losses on the sale of investment securities are computed on the basis of specific identification of the adjusted cost of each security. 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 restricted equity securities held-to-maturity. 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. <16> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of a colonial rider horseback, upper left hand corner of page .5 inches square] _________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENT - continued _________________________________________________________________ Citizens Financial Services, Inc. _________________________________________________________________ LOANS Interest on installment loans originated after 1992 is recognized on the accrual basis based upon the principal amount outstanding. Interest on installment loans originated before 1993 is recognized on the accrual basis using a method which approximates the interest method. Interest income on all other 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. 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 Effective January 1, 1995, the Company adopted Statement of Financial Accounting Standards No. 114 ("SFAS No. 114"), "Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118. Under this Standard, the Company estimates credit losses on impaired loans based on the present value of expected cash flows or fair value of the underlying collateral if the loan repayment is expected to come from the sale or operation of such collateral. Prior to 1995, the credit losses related to these loans were estimated based on undiscounted cash flows or the fair value of the underlying collateral. SFAS No. 118 amends SFAS No. 114 to permit a creditor to use existing methods for recognizing interest income on impaired loans, eliminating the income recognition provisions of SFAS No. 114. The adoption of these statements did not have a material effect on the Company's financial position or results of operations. 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. The allowance for loan losses represents the amount which management estimates is adequate to provide for potential losses 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. 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. <17> _________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENT - continued _________________________________________________________________ Nineteen hundred ninety-six Annual Report _________________________________________________________________ PREMISES AND EQUIPMENT Premises and equipment are stated at cost, less accumulated depreciation. 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. Depreciation expense is computed on the straight-line and accelerated methods over the estimated useful lives of the assets. OTHER ASSETS Goodwill is the excess of the purchase price over the fair value of net assets of companies acquired through business combinations accounted for as purchases. Included in other assets is $581,000 of goodwill that is being amortized using the straight-line method over 15 years. Core deposit intangibles are a measure of the value of consumer demand and savings deposits acquired in business combinations accounted for as purchases. Included in other assets is $364,000 of core deposit intangibles which are being amortized on a straight-line basis over 6 years. 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. INCOME TAXES The Company and its subsidiary 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 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's net periodic pension cost is based on the provisions of Statement of Financial Accounting Standards No. 87. The Company also has a profit-sharing plan which provides tax-deferred salary savings to plan participants. 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 the demand deposit portion of 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. Trust income is reported on a cash basis, which is not materially different from the accrual basis. EARNINGS PER SHARE Earnings per share calculations give retroactive effect to the issuances of stock dividends declared by the Company. The number of shares used in the earnings per share and dividends per share calculation was 1,360,228 for 1996, 1995, and 1994. RECLASSIFICATION Certain of the 1995 and 1994 amounts have been reclassified to conform with the 1996 presentation. Such reclassifications had no effect on net income. 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 $1,262,000 and $937,000 at December 31, 1996 and 1995, 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. <18> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of a colonial rider horseback, upper left hand corner of page .5 inches square] _________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENT - continued _________________________________________________________________ Citizens Financial Services, Inc. _________________________________________________________________ 3. INVESTMENT SECURITIES The amortized cost and estimated fair value of investment securities at December 31, 1996 and 1995, were as follows (in thousands): Gross Gross Estimated Amortized Unrealized Unrealized Fair December 31, 1996 Cost Gains Losses Value Held-to-Maturity Securities: U.S. Treasury securities $49,169 $449 $(179) $49,439 Obligations of state and political subdivisions 606 14 - 620 Corporate obligations 4,694 22 (4) 4,712 Mortgage-backed securities 1,724 1 (37) 1,688 Total debt securities 56,193 486 (220) 56,459 Restricted equity securities 1,128 - - 1,128 Total Held-to-Maturity $57,321 $486 $ (220) $57,587 Available-for-Sale Securities: U.S. Treasury securities $21,239 $238 $ (71) $21,406 Corporate obligations 7,235 21 (3) 7,253 Equity securities 3 74 77 Total Available-for-Sale $28,477 $333 $ (74) $28,736 Gross Gross Estimated Amortized Unrealized Unrealized Fair December 31, 1995 Cost Gains Losses Value Held-to-Maturity Securities: U.S. Treasury securities $42,700 $1,209 $ (4) $43,905 Obligations of state and political subdivisions 1,311 37 - 1,348 Corporate obligations 4,744 103 (2) 4,845 Mortgage-backed securities 2,377 2 (27) 2,352 Total debt securities 51,132 1,351 (33) 52,450 Restricted equity securities 1,139 - - 1,139 Total Held-to-Maturity $52,271 $1,351 $(33) $53,589 Available-for-Sale Securities: U.S. Treasury securities $15,201 $390 $ - $15,591 Corporate obligations 5,711 67 - 5,778 Equity securities 4 71 - 75 Total Available-for-Sale $20,916 $528 $ - $21,444
There were no sales of debt securities in 1996 and 1995. Proceeds from the sale of available-for-sale debt securities during 1994 amounted to $3,063,000, with a gain of $59,000 realized on sales. In 1996, 1995, and 1994 gains of $4,000, $10,000 and $4,000, respectively, resulted from early calls of debt securities. Net realized gains of $15,000 on sales of equity securities were recorded in 1996. There were no sales of equity securities in 1995 and 1994. <19> _________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENT - continued _________________________________________________________________ Nineteen hundred ninety-six Annual Report _________________________________________________________________ Investment securities with an approximate carrying value of $48,103,000 and $40,615,000 at December 31, 1996 and 1995, were pledged to secure public funds and certain other deposits as provided by law. The amortized cost and estimated carrying value of debt securities at December 31, 1996, by contractual maturity, are shown below (in thousands). 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. Estimated Amortized Cost Fair Value Held-to-Maturity Securities: Due in one year or less $ 5,767 $ 5,785 Due after one year through five years 44,109 44,324 Due after five years through ten years 4,594 4,663 Due after ten years 1,723 1,687 Total $56,193 $56,459 Estimated Amortized Cost Fair Value Available-for-Sale Securities: Due in one year or less $ 5,927 $ 5,959 Due after one year through five years 17,024 17,062 Due after five years through ten years 5,523 5,638 Total $28,474 $28,659
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, a substantial portion of its debtors' ability to honor their contracts is dependent on the economic conditions within this region. Major classifications of loans are as follows (in thousands): December 31, 1996 1995 Real estate loans: Residential $108,416 $ 96,594 Commercial 27,670 24,167 Agricultural 6,134 8,027 Construction 4,262 1,018 Loans to individuals for household, family and other purchases 14,465 13,198 Commercial and other loans 11,529 10,535 State and political subdivision loans 10,105 8,347 182,581 161,886 Less unearned income on loans 168 259 Less allowance for possible loan losses 1,995 1,833 Loans, net $180,418 $159,794
<20> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of a colonial rider horseback, upper left hand corner of page .5 inches square] _________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENT - continued _________________________________________________________________ Citizens Financial Services, Inc. _________________________________________________________________ At December 31, 1996 and 1995, net unamortized loan fees and costs of $874,000 and $850,000, respectively, have been deducted from the carrying value of loans. At December 31, 1996 and 1995, the recorded investment in loans that are considered to be impaired in accordance with SFAS No.114 was $414,000, and $696,000, respectively, all of which were on a nonaccrual basis. At December 31, 1996 and 1995, all of the $414,000 and $696,000, respectively, of impaired loans do not have an allowance for loan losses allocated as a result of the loans being collateral dependent and the value of the collateral exceeding the recorded investment in the loan. The average recorded investment in impaired loans during the year ended December 31, 1996 and 1995, was approximately $696,000. For the year ended December 31, 1996 and 1995, the Company recognized interest income on impaired loans of $2,000 and $3,000, respectively, all of which was recognized using the cash basis method of income recognition. Loans on which the accrual of interest has been discontinued or reduced amounted to $1,258,000 and $1,459,000 (which included the impaired loans in accordance with SFAS No. 114) at December 31, 1996 and 1995, respectively. If interest had been recorded at the original rate on those loans, such income would have approximated $127,000, $147,000, and $131,000 for the years ended December 31, 1996, 1995, and 1994, respectively. Interest income on such loans, which is recorded as received, amounted to approximately $40,000, $58,000, and $40,000 for the years ended December 31, 1996, 1995, and 1994, respectively. Transactions in the allowance for possible loan losses were as follows (in thousands): Years Ended December 31, 1996 1995 1994 Balance, beginning of year $1,833 $1,721 $1,516 Provisions charged to income 205 163 255 Recoveries on loans previously charged against the allowance 21 18 18 2,059 1,902 1,789 Loans charged against the allowance (64) (69) (68) Balance, end of year $1,995 $1,833 $1,721 The following is a summary of the past due and nonaccrual loans as of December 31, 1996 and 1995 (in thousands):
December 31, 1996 Past Due Past Due 30-89 days 90 days ormore Nonaccrual Real estate loans $2,283 $716 $1,229 Installment loans 12 - - Credit cards and related loans 26 1 - Commercial and all other loans 356 6 29 Total $2,677 $723 $1,258 December 31, 1995 Past Due Past Due 30-89 days 90 days ormore Nonaccrual Real estate loans $1,875 $622 $1,442 Installment loans 13 19 - Credit cards and related loans 35 4 - Commercial and all other loans 430 44 17 Total $2,353 $689 $1,459
<21> _________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENT - continued _________________________________________________________________ Nineteen hundred ninety-six Annual Report _________________________________________________________________ 5. PREMISES & EQUIPMENT Premises and equipment are summarized as follows (in thousands): December 31, 1996 1995 Land $ 907 $ 897 Buildings 3,926 3,694 Furniture, fixtures and equipment 3,914 3,624 8,747 8,215 Less accumulated depreciation 4,402 4,040 Premises and equipment, net $4,345 $4,175 Depreciation expense amounted to $370,000, $412,000, and $440,000 for 1996, 1995, and 1994, respectively. 6. DEPOSITS Certificates of deposit of $100,000 or more amounted to $19,280,000 and $18,542,000 at December 31, 1996 and 1995, respectively. Interest expense on certificates of deposit of $100,000 or more amounted to $1,172,000, $1,089,000, and $861,000 for the years ended December 31, 1996, 1995, and 1994, respectively. Following are maturities of certficates of deposit as of December 31, 1996 (in thousands): 1997 $ 72,182 1998 21,566 1999 11,447 2000 21,395 2001 9,972 Thereafter 672 Total certificates of deposit $137,234 7. BORROWED FUNDS Securities Sold Under Other Total Agreements to FHLB Borrowed Borrowed (dollars in thousands) Repurchase(a) Advances(b) Funds(c) Funds 1996 Balance at December 31 $ 5,018 $ 8,925 $ 1,874 $15,817 Highest balance at any month-end 5,367 9,800 1,874 17,041 Average balance 5,263 2,599 1,874 9,736 Weighted average interest rate: Paid during year 5.80% 5.54% 7.56% 6.07% As of year-end 5.90 6.76 7.56 6.58 1995 Balance at December 31 $ 5,331 $ 1,650 $ 1,874 $ 8,855 Highest balance at any month-end 5,331 10,400 1,874 17,605 Average balance 4,257 1,900 1,874 8,031 Weighted average interest rate: Paid during year 5.91% 6.20% 7.56% 6.36% As of year-end 5.91 6.05 7.56 6.29 1994 Balance at December 31 $4,756 $ 9,400 $ 1,874 $16,030 Highest balance at any month-end 5,224 9,400 1,874 16,498 Average balance 4,964 2,629 847 8,440 Weighted average interest rate: Paid during year 4.47% 5.18% 7.61% 5.01% As of year-end 5.28 6.61 7.61 6.33
<22> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of a colonial rider horseback, upper left hand corner of page .5 inches square] _________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENT - continued _________________________________________________________________ Citizens Financial Services, Inc. _________________________________________________________________ (a) Securities sold under agreements to repurchase mature within one to five years. The Company has pledged U.S. Treasury securities with a carrying value at December 31, 1996 and 1995, of $6,494,000 and $6,615,000, respectively. The respective market values were $6,513,000 and $6,786,000. (b) FHLB Advances are comprised of two types of borrowings 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 $20,000,000, exclusive of any outstanding advances. As of December 31, 1996, total FHLB advances were comprised of Open RepoPlus borrowings. The Company also has an avail able line of credit with the FHLB ("Flexline"), with a borrowing limit of approximately $8,500,000. Flexline advances also mature within one year and bear a variable rate of interest that adjusts daily. There are no prepayment penalties for these borrowings. As of December 31, 1995 and 1994, total FHLB advances were comprised of Flexline borrowings. There were no outstanding borrowings on this line of credit as of December 31, 1996. Although no specific collateral is required to be pledged for Open RepoPlus or Flexline 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. (c) Other borrowed funds consist of separate loans with the Federal Home Loan Bank of Pittsburgh as follows (in thousands): December 31, Fixed Rate Maturity 1996 1995 7.25% May 15, 2000 $ 166 $ 166 7.40% May 15, 2001 245 245 7.52% May 15, 2002 229 229 7.60% May 15, 2003 216 216 7.56% May 17, 2004 201 201 7.61% May 16, 2005 188 188 7.65% May 15, 2006 175 175 7.68% May 15, 2007 163 163 7.72% May 15, 2008 151 151 7.76% May 15, 2009 140 140 Total borrowed funds $1,874 $1,874 Following are maturities of borrowed funds as of December 31, 1996 (in thousands): 1997 $12,557 1998 822 1999 288 2000 442 2001 245 Thereafter 1,463 Total borrowed funds $15,817 8. LEASES The Company is committed under two noncancellable operating leases for facilities with initial or remaining terms in excess of one year. The minimum annual rental commitments under these leases at December 31, 1996, are as follows (in thousands): 1997 $ 50 1998 50 1999 35 2000 30 2001 30 Thereafter 56 Total minimum lease payments $251 Total rental expense for all operating leases for 1996, 1995, and 1994 amounted to $52,000, $31,000, and $28,000, respectively. <23> _________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENT - continued _________________________________________________________________ Nineteen hundred ninety-six Annual Report _________________________________________________________________ 9. EMPLOYEE BENEFIT PLANS The Company has a noncontributory, defined-benefit pension plan (the "Plan") for all employees meeting certain age and length of service requirements. Benefits are based primarily on years of service and the average annual compensation during the highest five consecutive years within the final ten years of employment. The Company's funding policies are consistent with the funding requirements of federal law and regulations. Plan assets are comprised of common stock, U.S. government and corporate debt securities. Plan assets included 5,905 and 4,936 shares of the Company's common stock at December 31, 1996 and 1995, respectively. Pension cost for 1996, 1995, and 1994 include the following components (in thousands): Years Ended December 31, 1996 1995 1994 Service cost benefits earned during the period $101 $ 85 $ 70 Interest cost on projected benefit obligation 111 104 83 Return on assets (229) (331) (26) Net amortization and deferral 54 189 (117) Net pension cost $ 37 $ 47 $ 10
As of December 31, 1996, the Plan's total accumulated benefit obligation was $1,235,000, including vested benefits of $1,196,000. The funded status of the Plan and amount recognized in the Company's consolidated balance sheet are summarized as follows (in thousands): December 31, 1996 1995 Projected benefit obligation $(1,782) $(1,699) Plan assets at fair value 2,242 1,937 Excess of assets over projected benefit obligation 460 238 Prior service costs (69) (76) Unrecognized net (loss) gain from past experience different from that assumed and effects of changes in assumptions (74) 92 Unrecognized net transition gain (129) (144) Prepaid pension cost $ 188 $ 110
The projected benefit obligation for the Plan at December 31, 1996, 1995, and 1994, were determined using an assumed discount rate of 7%, 7%, and 8%, respectively, and an assumed long-term rate of compensation increase of 4.0%, 4.5%, and 5%, respectively. The assumed long-term rate of return on Plan assets was 8% at December 31, 1996, 1995, and 1994. The Company also has a profit-sharing plan, covering substantially all employees, which provides tax-deferred salary savings to plan participants. The Company's contributions to the profit-sharing plan are allocated to the participants based upon a percentage of their compensation. The Company's profit-sharing contribution is determined by the board of directors on a discretionary basis. The Company's contributions for 1996, 1995, and 1994 were $131,000, $86,000, and $120,000, respectively. 10. INCOME TAXES The provision for income taxes consists of the following (in thousands): Years Ended December 31, 1996 1995 1994 Currently payable $1,271 $1,136 $1,138 Deferred liability 36 25 20 Provision for income taxes $1,307 $1,161 $1,158 <24> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of a colonial rider horseback, upper left hand corner of page .5 inches square] _________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENT - continued _________________________________________________________________ Citizens Financial Services, Inc. _________________________________________________________________ The following temporary differences gave rise to the net deferred tax asset at December 31, 1996 and 1995 (in thousands): 1996 1995 Deferred tax assets: Allowance for loan losses $495 $440 Deferred compensation 194 184 Loan fees and costs 53 99 Goodwill and core deposit intangibles 9 - Capital loss carryforward - 5 Total 751 728 Deferred tax liabilities: Unrealized gains on available-for-sale securities (88) (180) Premises and equipment (147) (108) Bond accretion (67) (74) Prepaid pension cost (64) (37) Total (366) (399) Deferred tax asset, net $385 $329 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, 1996 1995 1994 Provision at statutory rates on pre-tax income $1,465 $1,358 $1,286 Effect of tax-exempt income (198) (188) (170) Nondeductible interest 27 23 19 Other items 13 32 23 Provision for income taxes $1,307 $1,161 $1,158 Statutory tax rates 34% 34% 34% Effective tax rates 30.3% 29.1% 30.6%
Income taxes applicable to realized security gains at December 31, 1996, 1995, and 1994, were $1,000, $3,000, and $21,000, respectively. 11. 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): Beginning Ending Balance Additions Repayments Balance 1996 $1,379 $ 156 $ 261 $1,274 1995 1,501 181 303 1,379 1994 1,541 618 658 1,501
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. <25> _________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENT - continued _________________________________________________________________ Nineteen hundred ninety-six Annual Report _________________________________________________________________ 12. 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 1997 without approval of the Comptroller of the Currency of approximately $3,463,000, plus the Bank's net income for 1997. Loans: The Bank is subject to regulatory restrictions which limit its ability to loan funds to the Company. At December 31, 1996, the regulatory lending limit amounted to approximately $2,487,000. Regulatory Capital Requirements: The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by the regulators that, if undertaken, could have a direct material effect on the Company's and Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabili ties, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's and Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by the regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of Total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as de fined). Management believes, as of December 31, 1996, that the Company and the Bank meet all capital adequacy requirements to which they (the Company and the Bank) are subject. As of December 31, 1996, the most recent notifications from the Federal Reserve Board and the Office of the Comptroller of the Currency categorized the Company and the Bank as well capital ized under the regulatory framework for prompt corrective action. To be categorized as well capi talized they must maintain minimum Total risk-based, Tier I risk-based and Tier I leverage ratios at least 100 to 200 basis points above those ratios set forth in the table. There have been no conditions or events since that notification that management believes have changed the Company's or the Bank's category. The following table reflects the Company's and the Bank's capital ratios at December 31 (in thousands): 1996 1995 Amount Ratio Amount Ratio Total capital (to risk-weighted assets) Company $23,764 15.03% $22,666 16.52% Bank 23,731 15.01 22,616 16.48 For capital adequacy purposes 12,649 8.00 10,979 8.00 To be well capitalized 15,811 10.00 13,724 10.00 Tier I capital (to risk-weighted assets) Company $21,787 13.78% $20,949 15.26% Bank 21,754 13.76 20,899 15.23 For capital adequacy purposes 6,324 4.00 5,490 4.00 To be well capitalized 9,486 6.00 8,234 6.00 Tier I capital (to average assets) Company $21,787 7.76% $20,949 8.54% Bank 21,754 7.75 20,899 8.52 For capital adequacy purposes 8,424 3.00 7,359 3.00 To be well capitalized 14,041 5.00 12,265 5.00
This annual report has not been reviewed, or confirmed for accuracy or relevance, by the Federal Deposit Insurance Corporation. <26> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of a colonial rider horseback, upper left hand corner of page .5 inches square] _________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENT - continued _________________________________________________________________ Citizens Financial Services, Inc. _________________________________________________________________ 13. 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. 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, 1996 and 1995, are as follows (in thousands): 1996 1995 Commitments to extend credit $16,740 $13,228 Standby letters of credit $ 660 $ 863 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 guaranteeing performance by a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending normal loan commitments to customers. The Company generally holds collateral supporting standby letters of credit. 14. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards (SFAS) No. 107, "Disclosures about Fair Value of Financial Instruments," requires that the Company disclose estimated fair values for its financial instruments. 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. Also, it is the Company's general practice and interest to hold its financial instruments to maturity and not to engage in trading or sales activities. 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 deter mined 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 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. <27> _________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENT - continued _________________________________________________________________ Nineteen hundred ninety-six Annual Report _________________________________________________________________ In accordance with SFAS No. 115, available-for-sale securities are marked to-market for financial reporting purposes and therefore already approximate fair value (in thousands): DECEMBER 31, 1996 DECEMBER 31, 1995 BOOK ESTIMATED BOOK ESTIMATED VALUE FAIR VALUE VALUE FAIR VALUE Available-for-sale securities $28,736 $28,736 $21,444 $21,444 Held-to-maturity securities 57,321 57,587 52,271 53,589 Total investment securities $86,057 $86,323 $73,715 $75,033
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. The following table presents information for loans (in thousands): DECEMBER 31, 1996 DECEMBER 31, 1995 BOOK ESTIMATED BOOK ESTIMATED VALUE FAIR VALUE VALUE FAIR VALUE Net loans $180,418 $180,586 $159,794 $160,681
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 as of December 31, 1996 and 1995. 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 (in thousands). DECEMBER 31, 1996 DECEMBER 31, 1995 BOOK ESTIMATED BOOK ESTIMATED VALUE FAIR VALUE VALUE FAIR VALUE Noninterest-bearing demand $ 17,924 $17,924 $ 15,140 $ 15,140 Interest-bearing deposits: Savings and NOW 59,168 59,168 48,998 48,998 Money market investors 25,851 25,851 24,096 24,096 Certificates of deposit less than $100,000 117,954 119,504 106,540 107,929 Certificates of deposit more than $100,000 19,280 19,388 18,542 18,636
<28> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of a colonial rider horseback, upper left hand corner of page .5 inches square] _________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENT - continued _________________________________________________________________ Citizens Financial Services, Inc. _________________________________________________________________ The fair value estimates above 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 (in thousands): DECEMBER 31, 1996 DECEMBER 31, 1995 BOOK ESTIMATED BOOK ESTIMATED VALUE FAIR VALUE VALUE FAIR VALUE Securities sold under agreements to repurchase $5,018 $5,018 $5,331 $5,331 FHLB Advances 8,925 8,925 1,650 1,650 Other borrowed funds 1,874 1,975 1,874 1,976
Commitments to Extend Credit and Standby Letters of Credit: There is no material difference between the notional amount and the estimated fair value of off-balance-sheet items which are primarily comprised of unfunded loan commitments which are generally priced at market at the time of funding (see Note 13). 15. BRANCH ACQUISITIONS On April 20, 1996, the Bank completed the acquisition of the Canton and Gillett, Pennsylvania banking offices of Meridian Bank of Pennsylvania with total assets of $3,845,000 and retail core deposits of $17,130,000. The transaction was accounted for under the purchase method and the Bank received approximately $12,270,000 in cash. 16. SUBSEQUENT EVENT On February 24, 1997, the Bank reached an arbitration settlement with a vendor. The settlement was for legal remedies associated with relationships with this vendor. The Bank received $884,000 in cash and $250,000 in credits to be applied to future expenditures, which if unused will expire within two years. The amount received by the Bank is net of fees associated with the arbitration. <29> _________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENT - continued _________________________________________________________________ Nineteen hundred ninety-six Annual Report _________________________________________________________________ 17. CONDENSED FINANCIAL INFORMATION PARENT COMPANY ONLY CITIZENS FINANCIAL SERVICES, INC. CONDENSED BALANCE SHEET December 31, 1996 and 1995 (in thousands) 1996 1995 Assets Cash $ 33 $ 49 Dividends receivable - subsidiary 612 579 Investment in subsidiary, First Citizens National Bank 22,871 21,248 Total assets $23,516 $21,876 Liabilities & stockholders' equity Dividends payable $ 612 $ 579 Stockholders' equity 22,904 21,297 Total liabilities and stockholders' equity $23,516 $21,876
CITIZENS FINANCIAL SERVICES, INC. CONDENSED STATEMENT OF INCOME Years Ended December 31, 1996, 1995, and 1994 (in thousands) 1996 1995 1994 Dividend income $1,265 $1,235 $1,136 Expenses 62 64 65 Income before equity in undistributed earnings of subsidiary 1,203 1,171 1,071 Equity in undistributed earnings - First Citizens National Bank 1,800 1,663 1,554 Net income $3,003 $2,834 $2,625 CITIZENS FINANCIAL SERVICES, INC. CONDENSED STATEMENT OF CASH FLOWS Years Ended December 31, 1996, 1995, and 1994 (in thousands) 1996 1995 1994 Cash Flows from operating activities: Net income $3,003 $2,834 $2,625 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed earnings of subsidiary (1,800) (1,663) (1,554) Increase in other assets (32) (32) (19) Net cash provided by operating activities 1,171 1,139 1,052 Cash flows used in financing activities: Cash dividends paid (1,187) (1,121) (1,056) Net (decrease) increase in cash (16) 18 (4) Cash at beginning of year 49 31 35 Cash at end of year $ 33 $ 49 $ 31
<30> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of a colonial rider horseback, upper left hand corner of page .5 inches square] _________________________________________________________________ REPORT OF INDEPENDENT AUDITORS _________________________________________________________________ Citizens Financial Services, Inc. _________________________________________________________________ SNODGRASS Certified Public Accountants [LOGO OMITTED] 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, 1996 and 1995, 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, 1996. 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 generally accepted auditing standards. 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, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. As discussed in the notes to the consolidated financial statements, effective January 1, 1995, the Company changed its method of accounting for impairment of loans and related allowance for loan losses. /s/ S.R. Snodgrass, A.C. Wexford, PA February 28, 1997 S.R. Snodgrass, A.C. 101 Bradford Road Wexford, PA 15090-6909 Phone: 412-934-0344 Faxsimile: 412-934-0345 <31> _________________________________________________________________ SELECTED FINANCIAL DATA FIVE YEARS SUMMARY OF OPERATIONS _________________________________________________________________ Nineteen hundred ninety-six Annual Report _________________________________________________________________ (dollar amounts in thousands) 1996 1995 1994 1993 1992 Interest income $ 21,341 $ 19,422 $ 17,336 $ 16,551 $ 16,684 Interest expense 10,867 9,851 7,944 7,853 8,895 Net interest income 10,474 9,571 9,392 8,698 7,789 Provision for possible loan losses 205 163 255 315 324 Net interest income after provision for possible loan losses 10,269 9,408 9,137 8,383 7,465 Other operating income 1,372 1,242 1,073 1,016 991 Realized securities gains (losses), net 19 10 63 50 35 Other operating expenses 7,350 6,665 6,490 6,117 5,423 Income before provision for income taxes 4,310 3,995 3,783 3,332 3,068 Provision for income taxes 1,307 1,161 1,158 908 820 Net income $ 3,003 $ 2,834 $ 2,625 $ 2,424 $ 2,248 Per share data: Net income $ 2.21 $ 2.08 $ 1.93 $ 1.78 $ 1.65 Cash dividends .89 .85 .81 .77 .73 Book value 16.84 15.66 13.90 13.48 12.00 Total investments $ 86,057 $ 73,715 $ 64,257 $ 62,645 $ 59,742 Loans, net 180,418 159,794 154,848 140,391 128,326 Total assets 282,810 247,094 232,537 216,237 202,155 Total deposits 240,177 213,316 194,478 191,013 178,033 Stockholders' equity 22,904 21,297 18,903 18,340 16,329
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 semiannual basis and the effects of stock dividends have been stated retroactively in the table below (also see dividend restrictions in Note 12). Dividends Dividends 1996 declared 1995 declared High Low per share High Low per share First quarter $25.88 $25.88 First quarter $23.00 $20.50 Second quarter 25.25 24.75 $ .44 Second quarter 23.00 20.50 $ .42 Third quarter 25.50 25.00 Third quarter 22.75 22.50 Fourth quarter 25.88 25.50 $ .45 Fourth quarter 23.50 21.50 $ .43
<32> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of a colonial rider horseback, upper left hand corner of page .5 inches square] _________________________________________________________________ CONSOLIDATED QUARTERLY DATA TRUST AND INVESTMENT SERVICES STATEMENT OF CONDITION _________________________________________________________________ Citizens Financial Services, Inc. _________________________________________________________________ CONSOLIDATED QUARTERLY DATA (dollar amounts in thousands) Three Months Ended 1996 March 31 June 30 Sept 30 Dec 31 Interest income $5,005 $5,302 $5,512 $5,522 Interest expense 2,528 2,687 2,816 2,836 Net interest income 2,477 2,615 2,696 2,686 Provision for possible loan losses 48 53 52 52 Other operating income 302 333 374 363 Realized securities gains, net 19 - - - Other operating expenses 1,673 1,754 2,024 1,899 Income before provision for income taxes 1,077 1,141 994 1,098 Provision for income taxes 352 332 284 339 Net income $ 725 $ 809 $ 710 $ 759 Earnings Per Share $ 0.53 $ 0.59 $ 0.52 $ 0.56 Three Months Ended 1995 March 31 June 30 Sept 30 Dec 31 Interest income $4,628 $4,783 $4,964 $5,047 Interest expense 2,313 2,436 2,515 2,587 Net interest income 2,315 2,347 2,449 2,460 Provision for possible loan losses 50 38 38 37 Other operating income 287 335 291 329 Realized securities gains, net 5 - 5 - Other operating expenses 1,709 1,740 1,582 1,634 Income before provision for income taxes 848 904 1,125 1,118 Provision for income taxes 240 257 324 340 Net income $ 608 $ 647 $ 801 $ 778 Earnings Per Share $ 0.45 $ 0.47 $ 0.59 $ 0.57
TRUST AND INVESTMENT SERVICES STATEMENT OF CONDITION The following graph shows personal trust asset growth over the past five years. 1996 1995 INVESTMENTS: Bonds $14,770 $19,161 Stock 10,284 8,713 Savings and money market funds 10,554 8,666 Mutual funds 6,756 3,556 Mortgages 491 578 Real estate 285 236 Miscellaneous 127 96 Cash 44 166 TOTAL $43,311 $41,172 ACCOUNTS: Estates $ 413 $ 314 Trusts 25,458 20,751 Guardianships 197 116 Pension/profit sharing 8,611 7,412 Investment management 4,911 3,884 Custodial 3,721 8,695 TOTAL $43,311 $41,172 [GRAPH OMITTED: One bar chart depicting personal trust assets from 1992 to 1996. Tabular representation of those graphs are set forth as follows: PERSONAL TRUST ASSETS (Dollars in Thousands) 1992 1993 1994 1995 1996 $23,706 $26,085 $27,781 $31,786 $39,776 _________________________________________________________________ <33> _________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS _________________________________________________________________ Nineteen hundred ninety-six Annual Report _________________________________________________________________ This narrative is provided to assist in the understanding and evaluation of the financial condition and results of operations of Citizens Financial Services, Inc. and its subsidiary (the "Company") and should be read in conjunction with the preceding consolidated financial statements and related footnotes. Such financial condition and results of operations are not intended to be indicative of future performance. Except as noted, tabular information is presented in thousands of dollars. In addition to historical information, this report contains forward-looking statements. The statements contained herein are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Important factors that might cause such a material difference include, but are not limited to, those discussed in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations." Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date thereof. The Company undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date hereof. Readers should carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including the quarterly reports on Form 10-Q to be filed by the Company and any current reports on Form 8-K filed by the Company. Financial Condition The following table presents the growth (dollars in millions) during the past two years: Growth in: 1996 1995 $ % $ % Total assets 35.7 14.5 14.5 6.3 Total deposits 26.9 12.6 18.8 9.7 Total loans 20.6 12.9 4.9 3.2 Total investments (including available-for-sale and held-to-maturity) 12.3 16.7 9.5 14.7 Total stockholders' equity 1.6 7.5 2.4 12.7 Investments The investment portfolio, including available-for-sale and held-to-maturity securities, increased by $12.3 million or 16.7% in 1996 as compared to growth of $9.5 million in 1995. The primary growth in the investment portfolio occurred in U.S. Treasury securities, with a $12.3 million or a 21.1% increase as compared to an increase of $7.7 million in 1995. Corporate obligations increased by $1.4 million during 1996. The 1996 growth in the investment portfolio was the result of strong deposit growth and the addition of the banking offices described later in this Management's Discussion and Analysis section and in Footnote 15 of the Consolidated Financial Statements. The funds that are not used to fund loans are placed in investments which are of less risk and, therefore, lower yield. The impact on net interest income is discussed later in the Net Interest Income section. The following table shows the year-end composition of the investment portfolio for the five years ended December 31, 1996: <34> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of a colonial rider horseback, upper left hand corner of page .5 inches square] _________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued _________________________________________________________________ Citizens Financial Services, Inc. _________________________________________________________________ Book Value at December 31, % of % of % of % of % of 1996 Total 1995 Total 1994 Total 1993 Total 1992 Total Available-for-sale: U.S. Treasury securities $21,406 24.9 $15,591 21.2 $14,594 22.7 $16,126 25.7 Corporate obligations 7,253 8.4 5,778 7.8 - - - - Equity securities 77 .1 75 .1 46 .1 45 .1 Held-to-maturity: U.S. Treasury securities 49,169 57.1 42,700 57.9 36,042 56.1 30,686 49.0 $38,942 65.2 Federal agency obligations - - - - 500 .8 502 .8 1,000 1.7 Obligations of state & political subdivisions 606 .7 1,311 1.8 2,735 4.3 3,498 5.6 4,106 6.9 Corporate obligations 4,694 5.5 4,744 6.4 6,729 10.4 7,715 12.3 10,108 16.9 Mortgage-backed securities 1,724 2.0 2,377 3.2 2,513 3.9 3,066 4.9 4,606 7.7 Restricted equity securities 1,128 1.3 1,139 1.6 1,098 1.7 1,007 1.6 980 1.6 Total $86,057 100.0 $73,715 100.0 $64,257 100.0 $62,645 100.0 $59,742 100.0
Maturities and Average Weighted Yields of Investment Securities The expected maturities and average weighted yields for the above investment portfolio as of December 31, 1996, as shown below. Yields on tax-exempt securities are presented on a fully-taxable equivalent basis assuming a 34% tax rate: Within One- Five- After One Yield Five Yield Ten Yield Ten Yield Yield Year (%) Years (%) Years (%) Years (%) Total (%) Held-to-maturity securities: U.S. Treasury $ 4,014 6.28 $43,187 6.33 $1,968 6.72 $ - - $49,169 6.34 State & political subdivisions, general obligation 2 8.33 9 8.33 4 8.33 - - 15 8.33 State & political subdivisions, revenue 251 13.18 340 12.31 - - - - 591 12.68 Corporate obligations 1,500 9.16 3,194 6.53 - - - - 4,694 7.37 Mortgage-backed securities 1,065 5.73 659 5.68 - - - - 1,724 5.71 Restricted equity securities - - - - - - 1,128 6.00 1,128 6.00 Total held-to-maturity $ 6,832 7.08 $47,389 6.38 $1,972 6.72 $ 1,128 6.00 $57,321 6.47 Available-for-sale securities: U.S. Treasury $ 3,030 7.61 $12,738 6.19 $5,638 6.55 $ - - $21,406 6.49 Corporate obligations 2,929 6.11 4,324 6.43 - - - - 7,253 6.30 Equity securities - - - - - - 77 1.50 77 1.50 Total available-for-sale $ 5,959 6.87 $17,062 6.25 $5,638 6.55 $ 77 1.50 $28,736 6.43
During 1990 through 1996, the concentration of the Company's investment portfolio has shifted dramatically as U.S. Treasury securities now comprise 82% of the total portfolio. No new investments have been made in state and political subdivisions since 1985. In 1996, the Company invested $4.8 million in corporate obligations (investment-grade securities). This investment strategy reflects management's conservative investment philosophy and its reluctance to pursue other types of securities that carry more interest rate and credit risk but offer only a marginally higher rate of return. Approximately 86% of the amortized cost of debt securities are expected to mature within five years or less (average expected maturity 3.2 years), as evidenced in Footnote 3 of the Consolidated Financial Statements. It is management's intention to hold substantially all debt securities purchased to maturity. Further, the Company expects that earnings from operations, the high liquidity level of the securities, growth of deposits and the availability of borrowings from the Federal Home Loan Bank are sufficient to meet future liquidity needs, and management does not anticipate selling securities for liquidity requirements. Accordingly, the majority of the securities portfolio is classified as held-to-maturity. The Company has no securities from a single issuer representing more than 10% of stockholders' equity. <35> _________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued _________________________________________________________________ Nineteen hundred ninety-six Annual Report _________________________________________________________________ Loans Historically, loans have been originated by the Company to customers in North Central Pennsylvania and the Southern Tier of New York. Loans have been originated 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. The Company also does a limited amount of indirect loans through new and used car dealers in the primary lending area. All lending is governed by a lending policy which is developed and maintained by management and approved by the board of directors. The Company's lending policy regarding real estate loans is that generally the maximum mortgage granted on owner-occupied residential property is 80% of the appraised value or purchase price (whichever is lower) 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 15 years for commercial and vacation property. As shown in the following table, total loans grew by $20.7 million in 1996, or 12.8%, a strong increase from the 3.0% increase during 1995. The residential mortgage loan portfolio increased 12.2% as a result of higher demand during 1996. In addition, $1.6 million in conforming mortgage loans were originated and sold on the secondary market through the Federal Home Loan Mortgage Corporation, providing over $23,000 of income in origination fees and premiums on loans sold, compared to $1.7 million in loans originated and $37,000 of income in 1995. Residential mortgage lending is a principal business activity and one the Company expects to continue by providing a full complement of conforming, nonconforming and home equity mortgages priced competitively. Total commercial real estate increased by $3.5 million or 14.5% (up from the 10.5% gain in 1995). Commercial lending activity is primarily focused on small businesses and the Company's commercial lending officers have been very successful in attracting new business loans. Loans to individuals increased $1.3 million or 9.6% during 1996 compared to an increase of $1.3 million in 1995. State and political subdivision loans increased $1.8 million or 21.1% compared to an increase of $1.0 million in 1995. Over the last few years, management has been successful in obtaining tax-exempt loans from local municipalities and school districts to replace the maturing tax-exempt securities in the investment portfolio. The acquisition of the offices at Canton and Gillett accounted for $3.7 million of the loan growth. (See Footnote 15 of the Consolidated Financial Statements and discussion to follow.) The majority of lending activity has been mortgage loans secured by one- to four-family residential property. The Company does offer a 25-year fixed-rate mortgage product; however, since 1987 the growth in the mortgage portfolio has been in the area of one- to five-year adjustable rate mortgages. As of December 31, 1996, residential real estate and real estate construction loans made up 61.7% of the Company's total loan portfolio. Continuing in 1997, the Company's primary goal is to be the premier mortgage lender in its market area, with its large menu of conforming mortgages (including "jumbo" and low- to moderate-income home buyer mortgages) through Farmers Home Administration (FmHA) and Pennsylvania Housing Finance Agency (PHFA). Continued training of branch office personnel and the focus on flexibility and fast "turn around time" will aid in meeting this goal. (Also see the discussion in Footnote 4.) Five Year Breakdown of Loans by Type December 31, 1996 1995 1994 1993 1992 Amount % Amount % Amount % Amount % Amount % Real estate: Residential $ 108,416 59.4 $ 96,594 59.7 $ 97,359 62.0 $ 92,149 64.3 $ 85,196 64.5 Commercial 27,670 15.2 24,167 14.9 21,915 13.9 19,926 13.9 15,994 12.1 Agricultural 6,134 3.4 8,027 5.0 7,125 4.5 4,216 2.9 5,011 3.8 Construction 4,262 2.3 1,018 0.6 1,271 0.8 1,102 0.8 803 0.6 Loans to individuals for family and other purchases 14,465 7.9 13,198 8.1 11,886 7.7 11,696 8.2 12,637 9.6 Commercial and other 11,529 6.3 10,535 6.5 10,285 6.5 8,959 6.3 8,811 6.7 State and political subdivision loans 10,105 5.5 8,347 5.2 7,303 4.6 5,170 3.6 3,581 2.7 Total loans 182,581 100.0 161,886 100.0 157,144 100.0 143,218 100.0 132,033 100.0 Unearned income 168 259 575 1,311 2,506 Allowance for possible loan losses 1,995 1,833 1,721 1,516 1,201 Net loans $ 180,418 $159,794 $154,848 $140,391 $128,326
<36> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of a colonial rider horseback, upper left hand corner of page .5 inches square] _________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued _________________________________________________________________ Citizens Financial Services, Inc. _________________________________________________________________ The predominant source of earning assets is from the loan portfolio. The following table shows the maturity of commercial and agricultural loans and commercial loans secured by real estate as of December 31, 1996, classified according to the sensitivity to changes in interest rates within various time intervals: Commercial, financial, Real estate agricultural construction Total Maturity of loans: One year or less $ 6,761 $ - $ 6,761 Over one year but less than five years 10,871 - 10,871 Over five years 37,806 4,262 42,068 Total $55,438 $4,262 $59,700 Sensitivity of loans to changes in interest rates - loans due after one year: Predetermined interest rate $16,217 $2,547 $18,764 Floating or adjustable interest rate 32,460 1,715 34,175 Total $48,677 $4,262 $52,939
Deposits Over the last several years the Company, responding to the demand for new competitive products in the market area, began to tier interest-bearing transaction and savings accounts by deposit size (larger balances receive higher rates). The Company has been offering a wide variety of deposit instruments, as have its competitors. Some of the deposit product variations were limited transaction deposit accounts with interest rates that vary as often as daily, unlimited transaction interest-bearing accounts, Premier 50, Premier 50 Plus, Gold Club, individual retirement accounts, longer-term certificates of deposit (generally of five-year maturity), promotional 30-month, 66-month and Roll-Up certificates of deposit (which allows the customer to adjust the interest rate up once during the term by a maximum of 100 basis points). During 1996, the Company moved to expand and consolidate its market share by the acquisition of two offices and the start of its first supermarket office at Weis Market in Wellsboro. Deposit growth of $26.9 million or 12.6% was the result of the acquisition of the offices at Canton and Gillett ($17.1 million) and the competitive pricing of certificates of deposit. Deposit growth in 1995 was an increase of $18.8 million or 9.7%. Transaction accounts (noninterest-bearing and interest-bearing) increased $10.9 million or 20% in 1996, while total certificates of deposit increased $12 million or 9.7%. Certificates of deposit growth in 1995 was $16 million or 14.6%. During 1996, the interest cost of certificates of deposit remained high while the interest rate paid on Money Market Investors and savings accounts declined. This rate environment (high rates for certificates of deposit and lower rates for interest-bearing transaction and savings accounts) resulted in substantial growth in certificates of deposit. Money market deposit accounts (which are paid a higher interest rate than savings and NOW accounts) had growth of $1.8 million or 7.3%. The following table shows the composition of deposit accounts over the last three years as of December 31: Deposits by Major Classification 1996 1995 1994 Amount % Amount % Amount % Noninterest-bearing deposits $ 17,924 7.5 $15,140 7.1 $ 14,495 7.5 NOW accounts 31,836 13.2 23,681 11.1 23,963 12.3 Savings deposits 27,332 11.4 25,317 11.9 26,102 13.4 Money market deposit accounts 25,851 10.8 24,096 11.3 20,799 10.7 Certificates of deposit 137,234 57.1 125,082 58.6 109,119 56.1 Total deposits $240,177 100.0 $213,316 100.0 $194,478 100.0
<37> _________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued _________________________________________________________________ Nineteen hundred ninety-six Annual Report _________________________________________________________________ Remaining maturities of certificates of deposit of $100,000 or more: 1996 1995 1994 3 months or less $ 1,962 $2,708 $ 4,339 3 through 6 months 2,788 2,474 3,813 6 through 12 months 6,051 4,538 2,323 Over 12 months 8,479 8,822 5,903 Total $19,280 $18,542 $16,378 As a percent of total certificates of deposit 14.05% 14.82% 15.01%
Deposits by Type of Depositor 1996 1995 1994 Amount % Amount % Amount % Individual, partnerships & corporations $212,398 88.4 $188,471 88.4 $173,879 89.4 United States government 148 .1 132 .1 214 .1 State & political subdivisions 25,794 10.7 23,279 10.9 18,868 9.7 Other 1,837 .8 1,434 .6 1,517 .8 Total deposits $240,177 100.0 $213,316 100.0 $194,478 100.0
The methods used by the Company to attract and retain deposits (in addition to competitive interest rates) have been increased marketing and business development efforts, continuous emphasis on quality personal service, expanded trust and investment management services and more convenient hours. In all of our community offices, lobby and drive-up hours now include Wednesday afternoons (when they were traditionally closed) as well as Saturday hours. The supermarket office is open seven days a week with extended hours on weekdays. The Company currently provides nine MAC automated teller machines, which are part of the MAC regional and PLUS national network. Results of Operations Net income during 1996 increased to $3 million (net income per share of $2.21), an increase of $169,000 or 6% over the $2.8 million reported in 1995 (net income per share of $2.08). The following table sets forth certain performance ratios of the Company for the periods indicated: 1996 1995 1994 Return on assets (net income to average total assets) 1.11% 1.18% 1.17% Return on equity (net income to average total equity) 13.59% 14.10% 14.06% Dividend payout ratio (dividends declared divided by net income) 40.12% 40.22% 41.45% Equity to asset ratio (average equity to average total assets) 8.18% 8.45% 8.33%
Net income is influenced by five key elements: net interest income, other operating income, other operating expenses, provision for income taxes and the provision for possible loan losses. A discussion of these five elements follows. Net Interest Income The most significant source of revenue is net interest income, the amount by which interest earned on interest-bearing assets exceeds interest expense on interest-bearing liabilities. Net interest income (tax adjusted) in 1996 was $10.8 million (an increase of $ .9 million or 9.4%) as compared to $9.9 million in 1995 and $9.7 million in 1994. Factors which influence net interest income are changes in volume of interest-bearing assets and liabilities as well as changes in the associated interest rates. The following tables set forth the Company's 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: <38> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of a colonial rider horseback, upper left hand corner of page .5 inches square] _________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued _________________________________________________________________ Citizens Financial Services, Inc. _________________________________________________________________ Analysis of Average Balances and Interest Rates (1) 1996 1995 Average Average Average Average Balance Interest Rate Balance Interest Rate $ $ % $ $ % Assets Short-term investments: Interest-bearing deposits at banks 2,782 147 5.28 2,334 135 5.78 Total short-term investments 2,782 147 5.28 2,334 135 5.78 Investment securities: Taxable 82,163 5,310 6.46 64,990 4,309 6.63 Tax-exempt (3) 792 100 12.63 2,150 271 12.61 Total investment securities 82,955 5,410 6.52 67,140 4,580 6.82 Loans: Residential mortgage loans 104,176 9,699 9.31 96,998 9,018 9.30 Commercial & farm loans 41,896 4,121 9.84 38,615 3,829 9.92 Loans to state & political subdivisions 9,631 829 8.61 7,152 644 9.00 Other loans 14,401 1,435 9.96 13,989 1,501 10.73 Loans, net of discount (2)(3)(4) 170,104 16,084 9.46 156,754 14,992 9.56 Total interest-earning assets 255,841 21,641 8.46 226,228 19,707 8.71 Cash and due from banks 5,920 4,737 Bank premises and equipment 4,311 4,128 FASB 115 adjustment 218 46 Other assets 3,828 2,653 Total noninterest-bearing assets 14,277 11,564 Total assets 270,118 237,792 Liabilities and Stockholders' Equity Interest-bearing deposits: NOW accounts 29,752 688 2.31 24,152 556 2.30 Savings accounts 27,541 612 2.22 25,722 628 2.44 Money market accounts 27,189 1,192 4.38 23,003 1,089 4.73 Certificates of deposit 133,071 7,784 5.85 119,260 7,067 5.93 Total interest-bearing deposits 217,553 10,276 4.72 192,137 9,340 4.86 Other borrowed funds 9,730 591 6.07 8,031 511 6.36 Total interest-bearing liabilities 227,283 10,867 4.78 200,168 9,851 4.92 Demand deposits 17,550 14,647 Other liabilities 3,184 2,837 Total noninterest-bearing liabilities 20,734 17,484 Stockholders' equity 22,101 20,140 Total liabilities&stockholders' equity 270,118 237,792 Net interest income 10,774 9,856 Net interest spread (5) 3.68% 3.79% Net interest income as a percentage of average interest-earning assets 4.21% 4.36% Ratio of interest-earning assets to interest-bearing liabilities 1.13 1.13
Analysis of Average Balances and Interest Rates (1) - continued 1994 Average Average Balance Interest Rate $ $ % Assets Short-term investments: Interest-bearing deposits at bank 605 25 4.13 Total short-term investments 605 25 4.13 Investment securities: Taxable 61,215 4,111 6.72 Tax-exempt (3) 2,997 427 14.26 Total investment securities 64,212 4,538 7.07 Loans: Residential mortgage loans 93,697 8,229 8.78 Commercial & farm loans 32,937 2,887 8.77 Loans to state & political subdivisions 6,427 482 7.50 Other loans 13,833 1,448 10.47 Loans, net of discount (2)(3)(4) 146,894 13,046 8.88 Total interest-earning assets 211,711 17,609 8.32 Cash and due from banks 4,694 Bank premises and equipment 3,999 FASB 115 adjustment 125 Other assets 3,419 Total noninterest-bearing assets 12,237 Total assets 223,948 Liabilities and Stockholders' Equity Interest-bearing deposits: NOW accounts 26,052 593 2.28 Savings accounts 27,388 635 2.32 Money market accounts 21,363 728 3.41 Certificates of deposits 105,455 5,565 5.28 Total interest-bearing deposits 180,258 7,521 4.17 Other borrowed funds 8,440 423 5.01 Total interest-bearing liabilities 188,698 7,944 4.21 Demand deposits 14,318 Other liabilities 18,664 Total noninterest-bearing liabilities 16,586 Stockholder's equity 18,664 Total liabilities & stockholders' equity 223,948 Net interest income 9,665 Net interest spread (5) 4.11% Net interest income as a percentage of average interest-earning assets 4.57% Ratio of interest-earning assets to interest-bearing liabilities 1.12 (1) Averages are based on daily balances. (2) Includes loan origination and commitment fees of $155, $155, and $180 for 1996, 1995, and 1994, respectively. (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 nonaccrual 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. <39> _________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued _________________________________________________________________ Nineteen hundred ninety-six Annual Report _________________________________________________________________ The following table shows the effect of changes in volume and rates on interest income and expense. Rate/Volume variances are allocated to rate and volume variances based upon the absolute change in each. Tax-exempt interest revenue is shown on a tax-equivalent basis for proper comparison using a statutory federal income tax rate of 34%. Analysis of Changes in Net Interest Income on a Tax-Equivalent Basis 1996 vs. 1995 1995 vs. 1994 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 $ 22 $ (10) $ 12 $ 96 $ 14 $ 110 Investment securities: Taxable 1,107 (106) 1,001 250 (52) 198 Tax-exempt (172) 1 (171) (111) (45) (156) Total investments 935 (105) 830 139 (97) 42 Loans: Residential mortgage loans 668 13 681 96 493 789 Commercial and farm loans 323 (31) 292 535 407 942 Loans to state & political subdivisions 212 (27) 185 58 104 162 Other loans 46 (112) (66) 17 36 53 Total loans - net of discount 1,249 (157) 1,092 906 1,040 1,946 Total interest income 2,206 (272) 1,934 1,141 957 2,098 Interest expense: Interest bearing deposits: NOW accounts 129 2 131 (44) 8 (36) Savings accounts 59 (75) (16) (55) 48 (7) Money market accounts 174 (71) 103 60 301 361 Certificates of deposit 807 (90) 717 775 727 1,502 Total interest-bearing deposits 1,169 (234) 935 736 1,084 1,820 Other borrowed funds 102 (21) 81 (19) 106 87 Total interest expense 1,271 (255) 1,016 717 1,190 1,907 Net interest income $ 935 $ (17) $ 918 $ 424 $ 233 $ 191
As can be seen from the preceding tables, tax equivalent net interest income rose from $9,665,000 in 1994 to $9,856,000 in 1995 and increased to $10,774,000 in 1996. In 1996, net interest income increased $918,000 as overall spread decreased from 3.79% to 3.68%. The increased volume of interest-earning assets generated an increase in income of $2,206,000 while increased volume of interest-bearing liabilities produced $1,271,000 of interest expense. The change in volume resulted in an increase of $935,000 in interest income. The net change in rate was $17,000 resulting in a total positive net change of $918,000. The yield on interest-earning assets decreased 25 basis points from 8.71% to 8.46% and the average interest rate on interest-bearing liabilities decreased 14 basis points from 4.92% to 4.78%. Analysis of the Company's current net interest income in 1996 indicates that the effects of recent interest rate changes and the effect of the yield curve remaining relatively level, continued to have a negative effect on interest margin. Management is currently evaluating alter natives to improve the interest spread. Other Operating Income The Company achieved other operating income of $1,391,000 in 1996 which was an increase of $139,000 or 11.1% from $1,252,000 in 1995. An increase of $112,000 occurred in service charges on deposit accounts, primarily the result of additional accounts obtained by the two branches discussed previously. The sale and maturity of securities resulted in $19,000 in gains compared to $10,000 in 1995. Other operating income increased $3,000 in 1996 or 1.2% over that of 1995. Trust income of $270,000 increased 5.9% from the $255,000 earned during 1995, primarily as the result of growth in traditional trust and investment business and estate settlements through a recently instituted employee referral program. In 1997, management plans to continue to expand small business relationships by working with the community offices and commercial lending staff. <40> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of a colonial rider horseback, upper left hand corner of page .5 inches square] _________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued _________________________________________________________________ Citizens Financial Services, Inc. _________________________________________________________________ Other Operating Expenses Salaries and employee benefits, the largest category of noninterest expense, increased $268,000 or 8.5% to $3.4 million in 1996 from $3.2 million in 1995. Occupancy expense increased $53,000 in 1996, or 12.8%, as compared to an increase of $22,000 in 1995. Furniture and equipment expense increased $25,000 or 4.4%. Other expenses increased in 1996 by $256,000 or 11.4% compared to an increase of $233,000 in 1995. All of the above other operating expenses have been impacted by the increased staff, buildings and equipment expenses related to the acquisition of the two offices in the spring of 1996 and the new supermarket office started during the fourth quarter of 1996. On September 30, 1996, the President signed into law the Deposit Insurance Funds Act of 1996 to recapitalize the SAIF administered by the FDIC and to provide repayment of Financial Institution Collateral Obligation ("FICO") Bonds issued by the United States Treasury Department. The FDIC levied a one-time assessment on the SAIF deposits equal to 65.7 cents per $100 of the SAIF-assess able deposit base as of March 31, 1995. During the years 1997, 1998 and 1999, the BIF will pay $322 million of FICO debt service and SAIF will pay $458 million. Qualifying Oakar institutions (BIF-insured banks that have acquired SAIF deposits and continue to pay SAIF assessments on a portion of their deposits) are entitled to reduce their SAIF assessment base by 20% for purposes of calculating this special assessment. The Bank is a qualified Oakar bank because of the acquisition of Star Savings and Loan Association in 1991. During 1997, 1998 and 1999, the average regular annual deposit insurance assessment is estimated to be about 1.29 cents per $100 of deposits for BIF deposits and 6.44 cents per $100 of deposits for SAIF deposits. Individual institutions' assessments will continue to vary according to their capital and management ratings. As always, the FDIC will be able to raise the assessments as necessary to maintain the funds at their target capital ratios provided by law. After 1999, BIF and SAIF will share the FICO costs equally. Under current estimates, BIF and SAIF assessment bases would each be assessed at the rate of approximately 2.43 cents per $100 of deposits. The FICO bonds will mature in 2018-2019, ending the interest payment obligation. The law also provides that BIF and SAIF are to merge to form the Deposit Insurance Fund ("DIF") at the beginning of 1999, provided that there are no SAIF institutions in existence at that time. Merger of the funds will require state laws to be amended in those states authorizing savings associations to eliminate that authorization (state chartered savings banks will not be affected). The provision reflects Congress's apparent intent to merge thrift and commercial bank charters by January 1999; however, no law has yet been enacted to achieve that purpose. Based on projected deposit levels for 1997, Management expects that the FDIC assessment will be approximately $67,000 or $305,000 less than the FDIC expense for 1996. Provision for Income Taxes The provision for income taxes for 1996 increased by $146,000 to $1.3 million, compared to the $3,000 increase in 1995, due to increased earnings adjusted by tax-free interest income. Loan Quality and Provision for Possible Loan Losses As discussed previously, the loan portfolio contains a large portion of real estate secured loans (generally residential home mortgages, mortgages on small business properties, etc.), consumer installment loans and other commercial loans. Footnote 4 of the Consolidated Financial Statements provides further details on the composition of the loan portfolio and is incorporated herein. Management follows quality credit underwriting policies and collection practices and is supplemented by an internal loan review program. In addition, a separate collections department was established to focus on the collection and workout of problem loans. The board of directors and management believe all of these initiatives have led to relatively low levels of nonperforming loans and loan chargeoffs. The following tables indicate the level of nonperforming loans, net chargeoffs and charges against the allowance for losses on real estate owned over the past five years ending December 31: <41> _________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued _________________________________________________________________ Nineteen hundred ninety-six Annual Report _________________________________________________________________ 1996 1995 1994 1993 1992 Nonperforming loans: Nonaccruing loans $ 844 $ 762 $ 1,557 $ 1,566 $ 689 Impaired loans 414 697 - - - Accrual loans - 90 days or more past due 723 689 267 418 439 Total nonperforming loans $ 1,981 $ 2,148 $ 1,824 $ 1,984 $ 1,128 Foreclosed assets held for sale 164 208 168 231 330 Total nonperforming assets $ 2,145 $ 2,356 $ 1,992 $ 2,215 $ 1,458 Total loans $182,581 $161,886 $157,144 $143,218 $132,033 Unearned income 168 259 575 1,311 2,506 Loans, net of unearned income $182,413 $161,627 $156,569 $141,907 $129,527 Nonperforming loans as a percent of loans, net of unearned income 1.09% 1.33% 1.17% 1.40% 0.87% Total nonperforming assets as a percent of loans, net of unearned income 1.18% 1.46% 1.27% 1.56% 1.13%
The composition of nonaccrual loans at December 31, 1996, consists predominately of one- to four-family residential loans where the accrual of interest has been discontinued. Another way to view the credit quality exposure of the loan portfolio is by reviewing the "watch list" categories used by management (and as required by the regulatory agencies). This monitoring process is reviewed and reported monthly to identify problems or potential problems. Loans classified on the "watch list" as of December 31: 1996 1995 1994 Special mention $ 216 $ 232 $1,106 Substandard 3,740 4,093 2,781 Doubtful 23 41 10 Loss - - - Total $3,979 $4,366 $3,897 Percent of total loans, net of unearned income 2.18% 2.70% 2.49% Based upon current information available and upon measures taken to maintain the allowance for loan losses at an appropriate level, management does not believe there are any loans classified for regulatory purposes as loss, doubtful, substandard, special mention or otherwise which will result in losses which would reasonably be expected to have a material impact on future operations, liquidity or capital reserves. At December 31, 1996, there were no loans which were not included as past due, nonaccrual or restructured troubled debt, where known information about possible credit problems of borrowers causes management to have serious doubts as to the ability of such borrowers to comply over the next six months with present loan repayment terms. Management is not aware of any other information which causes it to have serious doubts as to the ability of borrowers in general to comply with repayment terms. <42> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of a colonial rider horseback, upper left hand corner of page .5 inches square] _________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued _________________________________________________________________ Citizens Financial Services, Inc. _________________________________________________________________ The following table presents an analysis of the allowance for possible loan losses for the five years ending December 31: Summary of Loan Loss Experience 1996 1995 1994 1993 1992 Balance at beginning of period $1,833 $1,721 $1,516 $1,201 $ 996 Charge-offs Real estate - construction - - - - - Real estate - mortgage 8 23 31 25 1 Loans to individuals for household, family and other purchases 56 42 28 43 63 Commercial and other loans - 4 9 3 87 Total loans charged-off 64 69 68 71 151 Recoveries Real estate - construction - - - - - Real estate - mortgage 1 - - 3 30 Loans to individuals for household, family and other purchases 19 15 14 60 1 Commercial and other loans 1 3 4 8 1 Total loans recovered 21 18 18 71 32 Net loans charged-off 43 51 50 - 119 Provisions charged to expense 205 163 255 315 324 Balance at end of year $1,995 $1,833 $1,721 $1,516 $1,201 Loans outstanding at end of year $182,413 $161,627 $156,569 $141,907 $129,527 Average loans outstanding, net $170,104 $156,754 $146,894 $136,025 $126,604 Net charge-offs to average loans 0.03% 0.03% 0.03% 0.00% 0.09% Year-end allowance to total loans 1.09% 1.13% 1.10% 1.07% 0.93% Year-end allowance to total nonperforming loans 100.71% 85.34% 94.35% 76.41% 106.47%
As detailed in Footnote 4 and the above tables, total past due (90 days or more) and nonperforming loans decreased 7% from December 31, 1995, to December 31, 1996. Nonaccrual loans decreased by 14% from 1995. The majority of the loan volume is well-collateralized by real estate. Total charge-offs for 1997 are still expected to approximate the moderate historic levels. Allowance For Possible Loan Losses The allowance is maintained at a level to absorb potential future loan losses. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. Management's basis for the level of the allowance and the annual provision is its evaluation of the loan portfolio, current and projected economic conditions, the historical loan loss experience, present and prospective financial condition of the borrowers, the level of nonperforming assets, and other relevant factors. While management evaluates all of this information, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, various regulatory agencies, as an integral part of their examination process, review the Company's allowance for possible loan losses. Such agencies may require the Company to recognize additions to the allowance based on their evaluation of information available to them at the time of their examination. Based on this process, management believes that the current allowance is adequate to offset any exposure that may exist for under-collateralized or uncollectible loans. The allowance for possible loan losses as a percentage of total loans was 1.10%, 1.13%, and 1.09% as of December 31, 1994, 1995, and 1996, respectively. The 1996 growth in the allowance is the combined result of a $205,000 charge to earnings and $43,000 in net loan losses. The level of charge-offs and recoveries were relatively the same as 1995. <43> _________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued _________________________________________________________________ Nineteen hundred ninety-six Annual Report _________________________________________________________________ Allocation of the Allowance for Possible Loan Losses The following table provides the percentage distribution of the allowance for possible loan losses and the various loan categories: 1996 1995 1994 1993 1992 $ % $ % $ % $ % $ % Real estate loans: Residential 143 7.2 165 9.0 185 10.8 181 11.9 193 16.1 Commercial, agricultural 325 16.3 328 17.9 323 18.8 253 16.7 147 12.2 Construction - - - - - - - - - - Loans to individuals for household, family and other purchases 164 8.2 181 9.9 140 8.1 174 11.5 159 13.2 Commercial and other loans 108 5.4 110 6.0 114 6.6 94 6.2 63 5.3 State and political subdivision loans 3 0.1 3 0.1 2 0.1 2 0.1 1 0.1 Unallocated 1,252 62.8 1,046 57.1 957 55.6 812 53.6 638 53.1 Total Allowance for Possible Loan Losses 1,995 100.0 1,833 100.0 1,721 100.0 1,516 100.0 1,201 100.0
As described in Footnote 1 and Footnote 4, in 1995 the Company implemented SFAS 114 as amended by SFAS 118, which impacted management's method for determining the allowance for loan losses. Management does not believe any material impact on earnings will occur as a result of the implementation of SFAS 114 in the future. Stockholders' Equity Stockholders' equity is evaluated in relation to total assets and the risk associated with those assets. The greater the capital resources, 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. Stockholders' equity has grown by 7.6% in 1996, 12.7% in 1995, and 3.1% in 1994 to the current level of $22.9 million. Adjustments made to equity for gains and losses on available-for-sale securities resulted in a decrease of $177,000 in 1996 compared to an increase of $349,000 in 1995. Total equity was approximately 8.1% of total assets at December 31, 1996, as compared to 8.6% at December 31, 1995. The Company pays cash dividends on a semiannual basis. The dividend rate is determined by the Board of Directors after considering the Company's capital requirements, current and projected net income, and other factors. In 1996 and 1995, 40.1% and 40.2% of net income was paid out in dividends, respectively. The Company paid a one percent stock dividend in July 1996. The one percent stock dividend resulted in 12,905 additional common shares outstanding. For the year ended December 31, 1996, the total number of common shares outstanding was 1,360,228. For comparative purposes, outstanding shares for prior periods were adjusted for the 1996 stock dividend in computing earnings and cash dividends per share. There are currently three federal regulatory measures of capital adequacy. The Company's ratios substantially exceed all federal regulatory standards as detailed in Footnote 12 of the Consolidated Financial Statements. Liquidity Liquidity is a measure of the Company's ability to efficiently meet normal cash flow requirements of both borrowers and depositors. To maintain proper liquidity, the Company uses funds management policies along with its investment policies to assure it can meet its financial obligations to depositors, credit customers and shareholders. Liquidity is needed to meet depositors' withdrawal demands, extend credit to meet borrowers' needs, provide funds for normal operating expenses and cash dividends, and fund other capital expenditures. The Company's historical activity in this area can be seen in the Consolidated Statement of Cash Flows from investing and financing activities. Liquidity management is influenced by cash generated by operating activities, investing activities and financing activities. The most important source of funds is the deposits which are primarily core deposits (deposits from customers with other relationships). In 1996, an additional source of funds was $17.1 million in deposits from acquired offices. Short-term debt from the Federal Home Loan Bank supplements the Company's need for funds. The Company's use of funds is shown in the investing activities where the net increase in loans is detailed. Other significant uses of funds are capital expenditures, purchase of loans and acquisition premiums. Surplus funds are then invested in investment securities. The recent reorganization by the Company's current computer application software vendor has made it necessary for the Company to evaluate new computer software and hardware alternatives. This evaluation process began during 1996 with the actual implementation of the new processing to occur in 1997. The associated costs have yet to be determined but it may adversely impact future short-term earnings. Management anticipates that increased productivity and additional customer services will help mitigate an adverse impact over the long term. <44> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of a colonial rider horseback, upper left hand corner of page .5 inches square] _________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued _________________________________________________________________ Citizens Financial Services, Inc. _________________________________________________________________ In addition, the Company expects to evaluate a number of other strategic technology issues such as a call center, voice response system and computer networking during 1997. It is management's intention that (based upon current expectations and market conditions) none of the proposed strategic technology projects will have a material impact on liquidity of the Company, and capital expenditures will be offset by improved operating efficiency. Capital expenditures of $539,000 in 1996 was more than 1995 by $76,000. In addition to the computer hardware and software purchases discussed above, management expects normal equipment replacements of approximately $250,000 for 1997. These purchases will allow greater operating efficiency and provide the customer with a higher quality product. On July 17, 1996, the Company purchased a building and lot adjacent to the Mansfield office location for future expansion in the amount of $250,000. The Company plans to use this area as part of the new operations/administration center that has been in the early planning stages for more than six years. Management anticipates that the construction will take place in 1997 or early 1998 with a total current estimated cost of approximately $2 million. Management believes that it has sufficient resources to complete these projects from its normal operations and that they will have a long-term positive effect on revenues, efficiency and the capacity for future growth. The deposit acquisition premium represents the cost to acquire the deposits of the Canton and Gillett offices. (See Footnote 1 of the Consolidated Financial Statements.) To assure the maintenance of liquidity reserves, the Company monitors and places various internal constraints on the level of loans relative to core deposits and other stable funding sources; the liquidity characteristics of investments; and the volume and maturity structure of wholesale funding. Asset/Liability Management The objective of interest rate sensitivity management is to maintain an appropriate balance between the stable growth of income and the risks associated with maximizing income through interest sensitivity imbalances. The primary components of interest-sensitive assets include adjustable-rate loans and investments, loan repayments, investment maturities and money market investments. The primary components of interest-sensitive liabilities include maturing certificates of deposit, IRA certificates of deposit (individuals over 59 and one half have the option of changing their interest rate annually) and short-term borrowings. Savings deposits, NOW accounts and money market investor accounts are considered core deposits and are not short-term interest sensitive (except for the top-tier money market investor accounts which are paid current market interest rates). The following table shows the cumulative static GAP for various time intervals: Maturity or Repricing of Company Assets and Liabilities at December 31, 1996 (in thousands) 0-3 months 3-12 months 1-3 years 3-5 years 5-10 years Over 10 years Total Investment securities and interest-bearing deposits $ 3,513 $ 9,456 $ 32,861 $ 29,031 $ 11,248 $ - $ 86,109 Loans, net of unearned income and deferred loan fees 47,678 48,208 38,972 23,557 19,729 4,269 182,413 Total interest-earning assets $ 51,191 $ 57,664 $ 71,833 $ 52,588 $ 30,977 $ 4,269 $268,522 Interest-bearing demand and savings deposits $ 21,998 $ 12,481 $ 26,873 $ 23,667 $ - $ - $ 85,019 Certificates of deposit 25,260 64,593 28,831 17,878 672 - 137,234 Borrowed funds 9,621 2,760 1,110 688 1,009 629 15,817 Total interest-bearing liabilities $ 56,879 $ 79,834 $ 56,814 $ 42,233 $ 1,681 $ 629 $238,245 Excess interest-earning assets (liabilities) $ (5,688) $ (22,170) $ 15,019 $ 10,355 $ 29,296 $ 3,640 Cumulative interest-earning assets $ 51,191 $ 108,855 $ 180,688 $ 233,276 $ 264,253 $268,522 Cumulative interest-bearing liabilities 56,879 136,713 193,527 235,760 237,441 238,070 Cumulative gap $ (5,688) $ (27,858) $ (12,839) $ (2,484) $ 26,812 $ 30,452 Cumulative interest rate sensitivity ratio (1) 0.90 0.80 0.93 0.99 1.11 1.13
(1) Cumulative interest-earning assets divided by interest-bearing liabilities <45> _________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued _________________________________________________________________ Nineteen hundred ninety-six Annual Report _________________________________________________________________ Gap analysis, the method previously used by the Company to analyze interest rate risk, does not necessarily show the precise impact of specific interest rate movements on the Company's net interest income because the repricing of certain assets and liabilities is discretionary and is subject to competitive and other pressures. In addition, assets and liabilities within the same period may, in fact, be repaid at different times and at different rate levels. The Company has not experienced the kind of earnings volatility that might be indicated from gap analysis. The Company currently uses a computer simulation model to better measure the impact of interest rate changes on net interest income. Management uses the model as part of its risk management process that will effectively identify, measure, and monitor the Company's risk exposure. Numerous interest rate simulations using a variety of assumptions are used by management to evaluate its interest rate risk exposure. A shock analysis at December 31, 1996, indicated that a 200 basis point parallel movement in interest rates in either direction would not have a significant adverse impact on the Company's anticipated net interest income over the next twelve months. Community Office Expansion On April 20, 1996, the Bank purchased two branch offices of Meridian Bank (Canton and Gillett), comprising approximately $17.1 million of deposit liabilities and $3.7 million of loans. In consideration for the assumption of the deposit liabilities the Bank paid a premium of approximately $1 million. Loans were priced at fair value plus accrued but unpaid interest. Management believes the acquisition will have a positive impact on future earnings and will consider future acquisitions as the opportunities arise. (See Footnote 15 of the Consolidated Financial Statements.) Supermarket Banking On April 11, 1996, the Bank entered a license agreement with Weis Market, Inc. for exclusive rights to operate a bank office within the new supermarket in Wellsboro, PA. Management is using a consulting firm to provide support in the development of the office that was opened in October 1996. Management will be considering other supermarket office possibilities in the future. General The majority of assets and liabilities of a financial institution are monetary in nature and, therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. However, inflation does have an important impact on the growth of total assets and on noninterest expenses, which tend to rise during periods of general inflation. The level of inflation over the last few years has been declining. The Federal Deposit Insurance Corporation Improvement Act of 1991 (the "Act") was signed into law on December 19, 1991. The Act addresses the recapitalization of the bank insurance fund and is designed to limit risk within the banking industry. Much of the impact of the legislation has taken place and management does not believe that full implementation of the Act will have a material impact on liquidity, capital resources or reported results of operations in future periods. The passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 and the Riegle Community Development and Regulatory Improvement Act may have a significant impact upon the Company. The key provisions pertain to interstate banking and interstate branching as well as a reduction in the regulatory burden on the banking industry. Since September 1995, bank holding companies have been able to acquire banks in other states without regard to state law. In addition, banks can merge with other banks in another state beginning in June 1997. States may adopt laws preventing interstate branching but, if so, no out-of-state bank can establish a branch in such state and no bank in such state may branch outside the state. Pennsylvania amended the provisions of its banking code to authorize full interstate banking and branching under Pennsylvania law and to facilitate the operations of interstate banks in Pennsylvania. Various congressional bills have been passed and other proposals have been made for significant changes to the banking system, including provisions for: limitation on deposit insurance coverage; changing the timing and method financial institutions use to pay for deposit insurance; expanding the power of banks by removing restrictions on bank underwriting activities; tightening the regulation of bank derivatives activities; allowing commercial enterprises to own banks; and permitting bank holding companies or the bank to own or control affiliates that engage in securities, mutual funds and insurance activities. Normal examinations of the Company by the Comptroller of the Currency occurred during 1996. The last Community Reinvestment Act performance evaluation by the same agency during 1996 resulted in a rating of "Satisfactory Record of Meeting Community Credit Needs." Aside from those matters described above, management does not believe that there are any trends, events or uncertainties which would have a material adverse impact on future operating results, liquidity or capital resources, nor is it aware of any current recommendations by the regulatory authorities (except as described herein) which, if they were to be implemented, would have such an effect although the general cost of compliance with numerous and multiple federal and state laws and regulations does have, and in the future may have, a negative impact on the Company's results of operations. Subsequent Event On February 24, 1997, the Bank reached an arbitration settlement with a vendor. The settlement was for legal remedies associated with relationships with this vendor. The Bank received $884,000 in cash and $250,000 in credits to be applied to future expenditures, which if unused will expire within two years. The amount received by the Bank is net of fees associated with the arbitration. The source of income from the settlement is a nonrecurring event which will have a favorable impact on 1997 income. <46> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of a colonial rider horseback, approximately 1 inch square, top left of page] _________________________________________________________________ FIRST CITIZENS NATIONAL BANK _________________________________________________________________ CITIZENS FINANCIAL SERVICES INCORPORATED _________________________________________________________________ 15 SOUTH MAIN STREET 717-662-2121 MANSFIELD, PA 16933 800-326-9486 FAX 717-662-2365 DIRECTORS Robert E. Dalton Chairman of the Board Bruce L. Adams Carol J. Tama R. Lowell Coolidge, Esquire Larry J. Croft John E. Novak John M. Thomas, MD Rudolph J. van der Hiel, Esquire William D. VanEtten Richard E. Wilber President Chief Executive Officer OFFICERS Administrative Services Cynthia T. Pazzaglia Assistant Vice President Administrative Division Manager Human Resources Manager Audit/Compliance V. Guy Abell Auditor Robert D. Wrisley Vice President Loan Compliance and Review Karen R. Jacobson Assistant Auditor/Security Officer Banking Services Terry B. Osborne Executive Vice President Secretary, Citizens Financial Services, Inc. Jerald J. Rumsey Senior Vice President Credit Services Manager Allan K. Reed Assistant Vice President Branch Administrator Robert L. Champion Commercial Services Officer Pamela A. Hazelton Appraiser Wendy L. Southard Marketing Coordinator Finance/Control Thomas C. Lyman Assistant Vice President Treasurer, Citizens Financial Services, Inc. Finance/Control Division Manager Randall E. Black Controller Operations William W. Wilson Vice President Operations Division Manager Robert J. Jackson Data Operations Manager Joanne W. Marvin Banking Operations Manager Trust and Investment Services Deborah E. Scott Vice President Trust and Investment Services Division Manager Jean A. Knapp Trust Administrator Sara J. Roupp Trust Administrator FULL SERVICE COMMUNITY BANKING HOURS MANSFIELD* M,T,W,Th: 8:30 am - 4:30 pm Fri.: 8:30 am - 6:00 pm Sat.:8:30 am - Noon BLOSSBURG* M,T,W,Th: 8:30 am - 4:30 pm Fri.:8:30 am - 6:00 pm Sat.: 8:30 am - Noon ULYSSES* M,T,W,Th: 8:30 am - 4:30 pm Fri.: 8:30 am - 6:00 pm Sat.: 8:30 am - Noon GENESEE* M,T,W,Th: 8:30 am - 4:30 pm Fri.: 8:30 am - 6:00 pm Sat.: 8:30 am - Noon SAYRE* M,T,W,Th: 8:30 am - 4:30 pm Fri.: 8:30 am - 6:00 pm Sat.: 8:30 am - Noon WELLSBORO* M,T,W,Th: 8:30 am - 4:30 pm Fri.: 8:30 am - 6:00 pm Sat.: 8:30 am - Noon TROY* M,T,W,Th: 8:30 am - 4:30 pm Fri.: 8:30 am - 6:00 pm Sat.: 8:30 am - Noon * Drive-up opens at 8:00 am CANTON Lobby Hours: Mon, Tues: 9:00 am - 3:00 pm Wed, Sat:: 9:00 am - Noon Thurs: 9:00 am - 4:30 pm Fri: 9:00 am - 6:00 pm Drive-Up Hours: Mon, Tues, Thurs: 9:00 am - 4:30 pm Wed: 9:00 am - 3:00 pm Fri: 9:00 am - 6:00 pm Sat: 9:00 am - Noon GILLETT Lobby Hours: Mon, Thurs: 10:00 am - 5:00 pm Tues, Wed: 10:00 am - 2:00 pm Fri: 10:00 am - 6:00 pm Sat: 9:00 am - Noon Drive-Up Hours: Mon, Thurs: 9:30 am - 5:00 pm Tues, Wed: 9:30 am - 2:00 pm Fri: 9:30 am - 6:00 pm Sat: 9:00 am - Noon WEIS MARKET, WELLSBORO Mon - Fri: 10:00 am - 8:00 pm Sat & Sun: 10:00 am - 4:00 pm DIRECTORS Robert E. Dalton Chairman of the Board Bruce L. Adams Carol J. Tama R. Lowell Coolidge, Esquire Larry J. Croft John E. Novak John M. Thomas, MD Rudolph J. van der Hiel, Esquire William D. VanEtten Richard E. Wilber DIRECTORS EMERITI Edward Kosa John G. Kuster Robert J. Landy, Esquire Robert G. Messinger Wilber Wagner <47> COMMUNITY OFFICES Toll free to all locations: 800-326-9486 MANSFIELD 717-662-2121 15 South Main Street Mansfield, PA 16933 FAX 717-662-3278 Local Board William J. Waldman Chairman Anthony D. Fiamingo Chester L. Reed Stephen A. Saunders William J. Smith Officers Chester L. Reed Assistant Vice President Office Manager James T. Hepp Assistant Office Manager Shari L. Johnson Customer Service Counselor Kristina M. Payne Customer Service Counselor BLOSSBURG 717-638-2115 300 Main Street Blossburg, PA 16912 FAX 717-638-3178 Local Board Mark L. Dalton Chairman Terrance M. Asalone Harold K. House George D. Lloyd Thomas Phinney Officers Terrance M. Asalone Assistant Vice President Office Manager Michele E. Litzelman Customer Service Counselor ULYSSES 814-848-7572 502 Main Street Ulysses, PA 16948 FAX 814-848-7633 Local Board Ronald G. Bennett Chairman Lloyd R. Dugan D. Thomas Eggler Phillip D. Vaughn James A. Wagner Officers Phillip D. Vaughn Assistant Vice President L. Abbie Lerch Customer Service Counselor WELLSBORO 717-724-2600 99 Main Street Wellsboro, PA 16901 FAX 717-724-4381 Local Board William A. Hebe, Esquire Chairman Robin K. Carleton Timothy J. Gooch, CPA James K. Stager Jeffrey L. Wilson Office Manager Jeffrey L. Wilson Assistant Vice President GENESEE 814-228-3201 RR 1 Box 58 Genesee, PA 16923 Fax 814-228-3395 Local Board Gene E. Kosa Chairman William R. Austin John K. Hyslip Stephen B. Richard Dennis C. Smoker Officers William R. Austin Assistant Vice President Christine M. Miller Customer Service Counselor CANTON 717-673-3103 29 West Main Street Canton, PA 17724 FAX 717-673-4573 Local Board Roger Graham, Jr. Chairman Lester Hilfiger Christopher S. Landis Marilyn Scott Dave Wright Office Manager Christopher S. Landis GILLETT 717-596-2679 P.O. Box 125 Gillett, PA 16925 FAX 717-596-4888 Local Board Forest Oldroyd Office Manager Helen Kay Shedden WEIS MARKET 800-326-9486 99 Main Street Wellsboro, PA 16901 FAX 717-724-1842 Officers Jennifer L. Snyder Sales Manager Carol L. Strong Assistant Sales Manager SAYRE 717-888-6602 306 West Lockhart Street Sayre, PA 18840 FAX 717-888-3198 Local Board Joseph Burkhart Chairman Blaine W. Cobb, MD Robert Elsbree Russel Knight Chester L. Reed Officers William A. Richetti Office Manager Toni Tracy Customer Service Counselor TROY 717-297-4131 303 West Main Street Troy, PA 16947 FAX 717-297-4133 Local Board Lyle A. Haflett Chairman Thomas A. Calkins, III Richard H. Packard David E. Carlson Donald D. White Office Manager David E. Carlson Assistant Vice President _________________________________________________________________ [MAC LOGO OMITTED _________________________________________________________________ MAC Money Access Card _________________________________________________________________ 24 Hour Automated Teller Blossburg Mansfield; Mansfield University Mansfield WalMart, Weis Market Soldiers and Sailors Memorial Hospital Wellsboro; Genesee; Ulysses; Sayre <48> _________________________________________________________________ [GRAPHIC OMITTED: Silhouette of a colonial rider on horseback, approximately two inches square, top left one-third of page] _________________________________________________________________ MISSION STATEMENT We Recognize That Our Customers Are The Reason For Our Existence. Our mission is to be the dominant financial services provider in our marketplace. We will establish ourselves apart from other financial vendors by providing service excellence to our customers through satisfied, motivated, professional employees and a profitable range of financial services to meet the customers' changing needs. It is also our mission to profitably satisfy shareholder performance expectations and to be an active citizen of the communities we serve. _________________________________________________________________ [LOGO OMITTED: F.D.I.C. Equal Housing Lender] _________________________________________________________________ SHAREHOLDER INFORMATION ANNUAL MEETING The Annual Meeting and Luncheon for the shareholders of Citizens Financial Services, Inc. will be held at the Tioga County Fairgrounds Youth Building in Whitneyville, PA on Tuesday, April 15, 1997, at 12:00 noon. FORM 10-K The Annual Report to the Securities and Exchange Commission, Form 10-K, will be made available upon request. Contact: Thomas C. Lyman Treasurer Citizens Financial Services, Inc. 15 South Main Street Mansfield, PA 16933 The Annual Report and other Company reports are also filed electronically through the Electronic Data Gathering, Analysis, and Retrieval System ("EDGAR") which performs automated collection, validation, indexing, acceptance, and forwarding of submissions to the Securities and Exchange Commission (SEC) and is accessible by the public using the Internet at http://www.sec.gov./edgarhp.htm. TRANSFER AGENT Citizens Financial Services, Inc. 15 South Main Street Mansfield, PA 16933 Telephone: 717-662-2121 / 800-326-9486 SHAREHOLDER SERVICES Shareholder inquiries and requests for assistance should be directed to the Transfer Agent listed above. STOCK PURCHASING INFORMATION The stock symbol for Citizens Financial Services, Inc. is "CZFS". Citizens Financial Services, Inc. stock is quoted Over the Counter ("OTC") through the following Market Makers: Market Makers Ferris-Baker-Watts Fahnestock & Co. 6 Bird Cage Walk 1500 Walnut Street Hollidaysburg, PA 16648 Philadelphia, PA 19102 Telephone: 800-343-5149 Telephone: 800-722-2294 Ryan, Beck & Co. Janney Montgomery Scott 80 Main Street 1601 Market Street West Orange, NJ 07052 Philadelphia, PA 19103 Telephone: 800-342-2325 Telephone: 800-JANNEYS Hopper Soliday & Co., Inc. PaineWebber Incorporated 1703 Oregon Pike 10 Park Street, P.O. Box 2636 Lancaster, PA 17601-4201 Concord, NH 03302 Telephone: 800-646-8647 Telephone: 800-678-0619 We invite you to mail any comments or questions to us at our E-Mail address, which is fcnbank@epix.net. EX-21 4 EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT ____________________ First Citizens National Bank of Mansfield, Pennsylvania is the Company's sole subsidiary. EX-27 5
9 YEAR DEC-31-1996 DEC-31-1996 6,407 52 0 0 28,736 57,321 57,587 180,418 1,995 282,810 240,177 12,557 3,912 3,260 0 0 1,360 21,544 282,810 15,817 5,376 148 21,341 10,276 10,867 10,474 205 19 7,350 4,310 3,003 0 0 3,003 2.21 2.21 4.21 1,258 723 0 0 1,833 64 21 1,995 1,995 0 1,252
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