-----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, DwCgnFj7Xv5ql92+vlCx+wdPv/KN1/hfkwemK14McWg1e/6t84JnC4i3F+QfqScW Q/Fi1rv87fnuNGt5saBpBA== 0000739421-98-000003.txt : 19980318 0000739421-98-000003.hdr.sgml : 19980318 ACCESSION NUMBER: 0000739421-98-000003 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980317 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: SEC FILE NUMBER: 000-13222 FILM NUMBER: 98567499 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, 1997 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 5, 1998, is estimated to have been approximately $60,500,000. 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 5, 1998, 2,746,564 shares of Common Stock, par value $1.00. DOCUMENTS INCORPORATED BY REFERENCE Certain information required by Parts I, III and IV are incorporated by reference to Registrant's Definitive Proxy Statement for the Annual Meeting of Shareholders to be held April 21, 1998. Certain information required by Parts II and IV are incorporated by reference to Registrant's Annual Report to Shareholders for the Year Ended December 31, 1997. 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 7A-Quantitative and Qualitative Disclosure About Market Risk 10 Item 8-Financial Statements and Supplementary Data 11 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 13 Part I Item 1-Business Citizens Financial Services, Inc. (the "Company") is a Pennsylvania business corporation, incorporated April 30, 1984 to form 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, 1997, the Bank employed 128 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. 1 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. 2 The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 is discussed in detail on page 51 of Management's Discussion and Analysis of the 1997 Annual Report to the shareholders, which information is included at Exhibit 13, hereof and incorporated herein 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 14 of the 1997 Annual Report to the shareholders, which information is included at Exhibit 13, hereof and incorporated herein 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 14of the 1997 Annual Report to the shareholders, which information is included at Exhibit 13, hereof and incorporated herein by reference. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), 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 3 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 51 of Management's Discussion and Analysis of the 1997 Annual Report to the Shareholders, which information is included at Exhibit 13, hereof and incorporated herein by reference). INVESTMENT PORTFOLIO The investment portfolio is discussed in detail in Footnote 4, pages 21 and 22, and pages 37 through 39 of Management's Discussion and Analysis of the 1997 Annual Report to the Shareholders, which information is included at Exhibit 13, hereof and incorporated herein 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 4 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, pages 22 through 24 Footnote 5, and pages 39 and 40 of Management's Discussion and Analysis of the 1997 Annual Report to the Shareholders, which information is included at Exhibit 13, hereof and incorporated herein by reference. 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 for some portion of the loan balance. 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. 5 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, 1997 was $2,589,000. 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 6.0% 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, pages 22 through 24 Footnote 5, and pages 41 through 43 of Management's Discussion and Analysis of the 1997 Annual Report to the Shareholders, which information is included at Exhibit 13, hereof and incorporated herein by reference. ALLOWANCE AND PROVISION FOR LOAN LOSSES The provision for loan losses is used to increase the allowance for loan losses and is influenced by the growth and quality of loans. In each accounting period, the allowance for loan losses is adjusted to the amount deemed necessary to maintain the allowance at adequate levels. In determining the adequacy of the allowance for 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, pages 22 through 24, footnote 5, and page 43 of Management's Discussion and Analysis of the 1997 Annual Report to the Shareholders, which information is included at Exhibit 13, hereof and incorporated herein by reference. 6 LIQUIDITY 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 49 and 50 of Management's Discussion and Analysis. INTEREST RATE AND MARKET VALUE RISK MANAGEMENT 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 which liquidity needs and interest rate risk and is discussed in further detail on pages 49 through 51 in the Management's Discussion and Analysis section of the 1997 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 without 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 and NOW accounts, 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 7 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 ½ 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. 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 continue to evaluate these simulations, and others to reaffirm and 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 49 through 50 of Management's Discussion and Analysis section of the 1997 Annual Report to the Shareholders, which information is included at Exhibit 13, hereof and incorporated herein by reference. CAPITAL ADEQUACY A description of the Company's capital adequacy is presented on page 29, Footnote 14 and on pages 48 and 49 of the Management's Discussion and Analysis section of the 1997 Annual Report to the Shareholders, which information is included at Exhibit 13, hereof and incorporated herein by reference. YEAR 2000 COMPLIANCE A description of the Company's evaluations of our compliance efforts and the cost of compliance is presented on page 52, of the Management's Discussion and Analysis section of the 1997 Annual Report to the Shareholders, which information is included at Exhibit 13, hereof and incorporated herein by reference. 8 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 eight other banking facilities. All buildings are owned by the Bank and are free of any liens or encumbrances. PROPERTIES Current Building Construction Date (Renovation 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 (1997) Main St. Gillett, PA 16925 1970 (1997) The net book value for the above properties as of December 31, 1997 was $5,754,000. The properties are adequate to meet the needs of the employees and customers. The Mansfield office includes the corporate headquarters (currently occupying rental facilities) 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 pages 49 and 50 of the 1997 Annual Report to the Shareholders, which information is included at Exhibit 13, hereof and incorporated herein by reference. All of the facilities are equipped with current technological improvements for data and word processing. Inflation has an 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. 9 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 1997. 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 35, 45 and 49 of the Company's 1997 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 5, 1998, the Company has approximately 1,417 shareholders of record. Item 6-Selected Financial Data The information required by this item is incorporated by reference to page 35 of the 1997 Annual Report to the Shareholders, which information is included at Exhibit 13, hereof and incorporated herein 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 37 - 52 of the 1997 Annual Report to the Shareholders, which information is included at Exhibit 13, hereof and incorporated herein by reference. Item 7A-Quantitative and Qualitative Disclosures About Market Rate Risk The information required by this item 7A is incorporated by reference to pages 50 and 51 of the 1997 Annual Report to the Shareholders, which information is included at Exhibit 13, hereof and incorporated herein by reference. 10 Item 8-Financial Statements and Supplementary Data The information required by this item is incorporated by reference to pages 13 - 33 and 36 of the 1997 Annual Report to the Shareholders, which information is included at Exhibit 13, hereof and incorporated herein by reference. Financial Statements: Consolidated Balance Sheet as of December 31, 1997 and 1996 Consolidated Statement of Income for the Years Ended December 31, 1997, 1996 and 1995 Consolidated Statement of Changes in Shareholders' Equity for the Years Ended December 31, 1997, 1996 and 1995 Consolidated Statement of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995 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 21, 1998, 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 21, 1998, 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 under the caption "Principal Beneficial Owners of the Corporation's Stock" related to the Annual Meeting of Shareholders to be held April 21, 1998, 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 21, 1998, is incorporated herein by reference in response to this item. 11 Part IV Item 14-Exhibits, Financial Statement Schedules and Reports on Form 8-K. a(1)-Financial Statements. The following consolidated financial statements of Citizens Financial Services, Inc. and subsidiary are incorporated by reference to the 1997 Annual Report: Consolidated Balance Sheet as of December 31, 1997 and 1996 Consolidated Statement of Income for the Years Ended December 31, 1997, 1996 and 1995 Consolidated Statement of Changes in Shareholders' Equity for the Years Ended December 31, 1997, 1996 and 1995 Consolidated Statement of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995 Notes to Consolidated Financial Statements Report of Independent Certified Public Accountants (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. (3)-Exhibits: (3)(i) - Articles of Incorporation of the Corporation, as amended. (Incorporated by Reference 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 Reference 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. (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. (Incorporated by Reference to the 1997 Annual Report to Shareholders, which is included at page 17 of Exhibit 13, hereof and incorporated berein by reference. (13) - Annual Report to Shareholders for the year ended December 31, 1997. (21) - Subsidiaries of Citizens Financial Services, Inc. (27) - Financial Data Schedule 14(b)Reports on Form 8-K. No current report on Form 8-K was filed by the Registrant during the fourth quarter of the 1997 fiscal year. 12 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 17, 1998 Date: March 17, 1998 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 17, 1998 Richard E. Wilber, President, Chief Executive Officer, Director (Principal Executive Officer) /s/ Carol J. Tama March 17, 1998 Carol J. Tama, Director /s/ R. Lowell Coolidge March 17, 1998 R. Lowell Coolidge, Director /s/ Rudolph J. van der Hiel March 17, 1998 Rudolph J. van der Hiel, Director /s/ John E. Novak March 17, 1998 John E. Novak, Director /s/ Bruce L. Adams March 17, 1998 Bruce L. Adams, Director /s/ William D. VanEttan March 17, 1998 William D. VanEttan, Director /s/ Larry J. Croft March 17, 1998 Larry J. Croft, Director /s/ John M. Thomas, MD March 17, 1998 John M. Thomas, MD /s/ Thomas C. Lyman March 17, 1998 Thomas C. Lyman, Treasurer (Principal Financial and Accounting Officer) EXHIBITS INDEX (3)(i) - Articles of Incorporation of the Corporation, as amended. (Incorporated by Reference 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 Reference 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. (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. (Incorporated by Reference to the 1997 Annual Report to Shareholders, which is included at page 17 of Exhibit 13, hereof and incorporated berein by reference. (13) - Annual Report to Shareholders for the year ended December 31, 1997. (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 our bank... our community... our 1997 annual report ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of a building being constructed, including trees, grass, landscape, the cover ___________________________________________________________________________ <1> ___________________________________________________________________________ [GRAPHIC OMITTED: Watermark of colonial rider on horseback] ___________________________________________________________________________ To our Shareholders, Customers and Employees: 1997 was another year of tremendous achievement, which makes it a pleasure to deliver this report. We built on the previous year's expansion, firmly grounding our presence in new market spaces. We renewed our technology infrastructure to streamline operations and enhance customer service, providing key capabilities for competitive advantage. Our strategy of growth through a community bank environment continues to ring loud and clear over the noise of industry consolidation. Whether you measure our financial performance, our human capital, our processes and technology, or our high regard in the community, the outcomes underscore our continued success. Let me share with you some of 1997's highlights. financial performance We are very pleased to report on another record-setting year as 1997 total assets grew $12 million (4.2%) to $295 million. This growth was more modest than the 14.5% achieved in 1996, however the acquisition of our Canton and Gillett offices accounted for a large portion of that spectacular growth. Deposits and loans increased $16.6 million and $9.5 million respectively in 1997. The strong deposit growth allowed us to reduce "borrowed funds" by $9 million. Loan demand continued to be very strong as evidenced by the $69 million of credit extended in 1997 as compared to $75 million in 1996 and $50 million in 1995. Even while loan growth has been so strong, the quality of our loan portfolio is exceptional. Our 1997 net charge-offs were only $67 thousand as compared to $43 thousand in 1996 and $50 thousand in 1995. Total non-performing loans at year end were $2 million or 1.04% of total outstanding loans, as compared to $2.1 million or 1.18% for the prior year end. The reserve for possible loan losses grew $143 thousand and stands at 1.11% of gross loans as compared to 1.09% at year end 1996. Net income for 1997 was $3.8 million or 27.6% over the $3.0 million in 1996. As previously reported to you, this exceptional earnings growth was influenced by a $994,000 one-time arbitration award. Had it not been for this award, our net income would have been $3.2 million or 8% greater than 1996. Total stockholders' equity grew $3 million or 13.2% and now represents 8.8% of total assets as compared to 8.1% at year-end 1996. Cash dividends paid in 1997 totaled $1,596,000 as compared to $1,187,000 in 1996. In October 1997, we initiated quarterly cash dividend payments (previously we paid dividends semi-annually). <2> ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of the Weis Market branch employees dressed up for Dickens of a Christmas, left center of page, approximately 3.5 inches by 2.5 inches] ___________________________________________________________________________ Dickens of a Christmas at Weis Market ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of the Corporation's Chairman, Robert E. Dalton of the Board and his son, lower right side of page, approximately 2 inches by 2.5 inches] ___________________________________________________________________________ Robert E. Dalton and son Mark ___________________________________________________________________________ follow-up on 1996 community office expansion In April 1996, we acquired the Canton and Gillett offices from Meridian Bancorp, Inc. I am delighted to report that, since joining our corporation, total deposits in these two offices have grown $4.4 million or 25.6%. Additionally, although the only loans we acquired in that transaction were of Gillett customers (totaling $3.7 million), total loans in the two offices now exceed $10.6 million-a 290% increase! Needless to say, we are pleased that customer acceptance of our bank has been so strong. I'm very appreciative of the support and commitment of the fine employees in these offices-typical of employees throughout this corporation. Our supermarket location at the Weis Market "superstore" in Wellsboro continues its progress. Deposits and loans at year end surpassed $1.3 million and $350 thousand respectively. In a recent survey, we discovered that every customer surveyed not only knew a bank was located in the store, but also knew it was First Citizens! This recognition is the basis for our continued optimism that growth opportunities exist at Weis Market. operating and strategic initiatives Each year, it seems, is marked by a major "distinguishable" event. In 1996, as mentioned, was the acquisition of Canton and Gillett offices and the opening of our supermarket office at Weis Market. During 1997, we had a distinguishable event-a complete computer hardware and software conversion. In April, we signed contracts for the new data processing system and six months later, we were converted! This technology transition was, by far, one of the most challenging actions we have ever undertaken. Because we changed both hardware and software, every employee had to adjust to new systems, procedures and internal reports, as well as understand new customer statements, notices and other information. I was so proud of how every employee embraced the challenges of this project and worked so hard to minimize customer disruption. The new data processing system allows us to continue enhancing customer service by creating and delivering new products and services. In October, we introduced a 24-hour "voice response" service whereby customers use their touch-tone telephone to access account information, transfer funds between accounts, obtain information on our current interest rates, etc. Evidence of customer appeal for this service was clear by the nearly 3,200 telephone calls handled by the system in December. In March 1998, we are introducing our "debit card" product whereby customers present a card (which looks like a charge card) to the merchant in payment for goods and services knowing that such payment reduces their checking account balance. The customer greatly appreciates the convenience and speed of this new payment option. We expect to build upon this new technology investment as we evaluate new services and new operating methods that enhance efficiency. We believe we have a technology partner that is committed to providing advanced capabilities and we're very excited about using this tool for improving our competitive success. In addition to the product and service initiatives, we demolished the "old A&P" building in Mansfield in preparation for our new building project, modified our investment portfolio to enhance overall portfolio yield, and revised service fees for commercial checking accounts (implementation is scheduled for March 1998). Of particular significance, too, was our expansion and renovation of the Gillett office facility which included the addition of a 24-hour drive-up ATM. The customer response to this "investment" in Gillett has been very favorable. human resources This corporation continues to be blessed with outstanding directors (corporate as well as local board members) and employees. We were all saddened by the announced retirement of Robert E. Dalton (effective April 1998) who has been chairman of Citizens Financial Services, Inc. (since 1994) and First Citizens National Bank (since 1985). We will greatly miss the leadership that has been so instrumental to the success of this corporation. Joining the board of directors of First Citizens National Bank is Mark L. Dalton. Mark is owner of Robert E. Dalton General Insurance and has been principal in this company for 12 years. Mark served on the Blossburg local board for 12 years (the last five years as chairman) and is also very active in the Blossburg community-currently president of the Blossburg Swimming Pool Association. Mrs. Susan Signor and Mr. William Zwicharowski recently joined our Blossburg local board and Mr. Jerry McCaslin was <3> ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of the Corporation's President, lower right one-third of page, approximately 5.5 inches by 4 inches] ___________________________________________________________________________ added to the Ulysses local board. Mrs. Signor is employed by the family owned and operated business, Signor Brothers. She is a graduate of North Penn High School and Mansfield University (she graduated Summa Cum Laude with a Bachelor of Science Degree in Secondary Education). She is a member of the Arnot Sportsmen's Club and is a volunteer for the American Heart Association. Mr. Zwicharowski owns and operates William Zwicharowski Funeral Home in Blossburg. His community activities include: Blossburg Area Catholic Churches, Knights of Columbus, Kiwanis Club, Morris Run Legion and North Williamson Cable Company. He is also on the board of directors for North Penn Comprehensive Health Services and a trustee at the Arnot Sportsman's Club. Mr. McCaslin was born and raised in Ulysses. In 1973, after attending college, he began working with his father at Ulysses Motors. In 1988, upon his father's retirement, Jerry assumed control of the family business. He is an active resident of Ulysses and is president of the Borough Council, president of Northeastern Potter Economic Development Association, member of the Ulysses United Methodist Church, member of Charles Cole Memorial Hospital and board member of the Northern Tier Children's Home. In terms of professional development for employees, this past year was, as usual, a busy one. One hundred and six employees attended some form of education or training. We recently implemented an additional resource for employee education - a weekly video tape service covering eight topics of current interest. Employee response has been very positive and this promises to be a very convenient method to enhance our knowledge and skills. future In many respects, the future of banking is very bright. The strength of our industry is very sound. Most of us don't even remember that banks and thrift institutions were failing in the early 1990s and there was even concern over the solvency of the FDIC fund. In recent years, our industry has experienced record profits while bank failures are now unheard of. Also positive are the opportunities banks possess to expand into new lines of business. The U.S. Supreme Court is expected to make an important decision regarding the unfair competitive advantage that credit unions have over banks. The court is expected to address the credit union's blatant circumvention of the "common bond." Prior court rulings have sided with our industry and we hope the Supreme Court will as well. First Citizens should benefit by the continuing industry consolidation (as evidenced by the First Union announcement to acquire CoreStates). We expect new customers will join our bank in pursuit of a true community bank environment. Customers are expected to increase the demand for new services and delivery methods (such as enhanced cash management services for businesses, "call centers" where products and services can be obtained nearly 24 hours per day, etc.). A great deal of attention is being focused on "the year 2000" concern, which centers on the belief that many computerized systems were not programmed to distinguish the year 2000 from the year 1900. We must devote resources to assure that our bank and customers are not significantly impacted by this technological challenge. We are quickly moving along on plans for a major building project here in Mansfield. Architects are formulating plans and preliminary cost estimates on alternative concepts, and we expect key decisions will be made over the next few months. As always, we will continue to pursue growth strategies. Successful achievement will require a continued business development commitment by all employees and directors which will be supported by the expanded computer capabilities. Yes, there is a lot to be done, but we are looking forward to meeting these challenges and sustaining the success we've enjoyed. I am so proud of the commitment and dedication of our directors and employees and derive a great deal of optimism from them. Sincerely, /s/ Richard E. Wilber Richard E. Wilber President <4> ___________________________________________________________________________ our bank... ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of employees of the Corporation being recognized for years of service, top left one-third of page, approximately 5 inches by 3.5 inches] ___________________________________________________________________________ Shown from left are: Jim Hepp, Renee Davis, Shari Johnson, Jackie Hataloski, Michele Litzelman, Katina Garrison, Sara Roupp, Jeff Wilson, and Claudia Steadman. ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of the Corporation's President presenting a plaque to an employee of the Corporation, bottem right of page, approximately 3 inches by 4 inches] ___________________________________________________________________________ Receiving her plaque from President Richard E. Wilber (right) is Phyllis Estep (left) for First Citizens' Employee of the Year. ___________________________________________________________________________ First Citizens National Bank employees were recognized for five year intervals of service recently and received awards of Citizens Financial Services, Inc. stock. Recognized for five years of service were Renee Davis and Jackie Hataloski, Operations Department and Jim Hepp, Shari Johnson, and Judy Kingston from the Mansfield community office. Recognized for ten years of service were: Katina Garrison, Canton community office; Michele Litzelman, Blossburg community office; Sara Roupp, Trust and Investment Services; and Jeff Wilson, Wellsboro community office. Recognized for twenty years of service were Diane Anderson, Loan Central; Claudia Steadman, Genesee community office; and Margie Wesneski, Blossburg community office. Phyllis B. Estep was nominated as our 1997 Employee of the Year. Phyllis's outstanding dedication, professional attitude and concern for her customers and fellow employees have earned her this honor. Since July 1964, Phyllis has done an outstanding job serving her customers over the years in a fashion that clearly distinguishes us. When honored with a plaque at the Christmas party, Richard E. Wilber, President, stated "Phyllis is a person I can talk to about how to improve service for customers and I can be sure she will offer great insight. Her desire to serve customers to the fullest is very evident." Thank you Phyllis for representing First Citizens so well! <5> ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of the Corporation's President presenting a plaque to an employee of the Corporation, top left side of page, approximately 3 inches by 4 inches] ___________________________________________________________________________ [GRAPIC OMITTED: Photograph of Philip Prough, Trust and Investment Services Officer, bottem right side of page, approximately 3 inches by 4 inches] ___________________________________________________________________________ With sincere appreciation for 32 years of service, First Citizens National Bank wishes Jane McGee all the best upon her retirement. Jane began with the bank in 1959 as a teller and held various positions in the Trust and Proof departments. At retirement, Jane held the position of General Ledger Bookkeeper and added support services to Accounts Payable. At a dinner where Jane was recognized, Richard E. Wilber, President of First Citizens, stated "Throughout her years of service, Jane distinguished herself through exemplary dedication to co-workers, customers and shareholders of this corporation." We, at First Citizens, extend our wishes for continued success! Philip Prough was appointed as Trust and Investment Services Officer this year. Philip currently owns Prough Insurance Agency in Wellsboro and has six years experience in the financial arena. Philip will be serving the investment and trust needs of First Citizens' customers by visiting homes and businesses in the area. Prior to owning his own insurance business, Philip was the district agent for the Harvest Life Insurance Company and an accountant at the Wilkes-Barre based accounting firm of Parente, Randolph, Orlando, Carey and Associates. An honors graduate from Lycoming College, Philip obtained a Bachelor of Arts Degree in accounting and is now licensed as an Annuity, Life and Health Insurance agent. Together with his wife, Sherri, and their son, Dylan, the Prough's are active members of the Wellsboro community. Please join us in welcoming Philip. <6> ___________________________________________________________________________ our community... ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of the outside of the recently expanded Gillett branch, top left side of page, approximately 4 inches by 2.5 inches ___________________________________________________________________________ ...a community bank, by definition, is one which involves itself through active participation in the interests of its local area ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of the teller line in the recently expanded Gillett branch, center right side of page, approximately 4 inches by 2.5 inches ___________________________________________________________________________ ...we believe in reinvesting in the community ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of the new accounts area in the recently expanded Gillett branch, bottom left side of page, approximately 4 inches by 2.5 inches ___________________________________________________________________________ ...we all work together as a community every day ___________________________________________________________________________ <7> ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of the outside of the recently expanded Gillett branch, top left center of page, approximately 4 inches by 2.5 inches ___________________________________________________________________________ The definition of community is "an interacting and participating group sharing a common history, interests and/or geography". Therefore, a community bank, by definition, is one which involves itself through active participation in the interests of its local area. First Citizens National Bank epitomizes that definition. We "live" here-we reside here, work here, send our children to school here, we recreate here, shop here, and offer support to groups intent on bettering our environment and quality of life here. First Citizens National Bank participates with the community in several ways. We are actively involved in economic development which creates new jobs - the result being enhanced household income and achieving a higher standard of living. We are a participant with neighbors, friends and colleagues in a fellowship aimed at fostering the best lifestyle we can for future generations. We help others faced with various challenges and those less fortunate through organizations such as Santa's Gift Bag and the Food Pantry. We do these things because we believe in our communities just as we believe we are a part of these communities. During the second half of 1997, First Citizens demonstrated such a belief in one of these communities by conducting some major renovations to the Gillett community office. The remodeling included increasing the size of the building, which allowed for more private office space to handle customers' financial matters confidentially. We also added a 24-hour automated teller machine (ATM), which enables our customers to do their banking when it is convenient for them. Customers can now withdraw cash, transfer money between accounts, conduct balance inquiries, and make loan payments and deposits 24 hours a day. In addition, we made the facility handicapped accessible by installing a ramp to the front entrance, making the doorways wider, and adding a wheelchair-accessible restroom and check counter. This remodeling occurred on the heels of the previous institution wanting to shut the doors of the Gillett bank. However, we believed in the potential of the Gillett community and not only wanted the bank to remain open, we wanted to see it grow! <8> ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of the Troy Fire Hall being constructed, top right side of page, approximately 4 inches by 2.5 inches] ___________________________________________________________________________ Work in process Troy Fire Hall, Troy Pennsylvania ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of the completed Troy Fire Hall, center right side of page, approximately 4 inches by 2.5 inches] ___________________________________________________________________________ Completed Troy Fire Hall, Troy Pennsylvania ___________________________________________________________________________ In addition to reinvesting in our communities through the remodeling of local offices, we believe in reinvesting in the community by supporting volunteer organizations which everyone relies on in a crisis. We have practiced this belief by providing funding and low-interest loans to these organizations. In 1997, First Citizens donated $5,000 to the Troy Volunteer Fire Department for their new facility. Not only did we make this donation, we also provided a low-interest loan to make the new building a reality. We have provided similar services for many of the volunteer organizations throughout Bradford, Tioga and Potter counties. We do this because we recognize their importance in offering aid to the families who live here. It is our responsibility to support these organizations and ensure they are available to help all of us when needed. Unfortunately, in 1997 several First Citizens customers lost their homes to fire. We have witnessed the best in interaction between the fire company, the insurance company, the family, the contractor and the bank. Each play a vital role in helping the family begin rebuilding their dreams. One example demonstrates the part we play: A Mansfield home caught fire on a Saturday afternoon; within minutes the home was completely engulfed. Luckily, no lives were lost, although they lost most of their possessions. First Citizens worked closely with their insurance agent and contractor in the rebuilding process. We wrote a new mortgage for the customer and provided the line of credit for the contractor. Everyone worked hand-in-hand in the best interest of the family. If any business member hadn't fulfilled its duty, the rebuilding process would have been delayed. Because First Citizens is locally operated, there were no lengthy delays in assuring that finances were in place. There were no delays due to decisions being be made by strangers - because we make decisions locally, the rebuilding process proceeded in a timely fashion. We provided peace of mind to the family as their home was rebuilt. During this period, many acts of kindness were witnessed, as is usually the case among small communities. Neighbors, churches and organizations donated food, clothing and money to fulfill the immediate needs of this family. Their acts of kindness were quick and generous. Our hats are off to everyone who has ever helped someone in need. After all, isn't that what any business is about, fulfilling a need? Sometimes that need is most often felt by the youth organizations in our area. <9> ___________________________________________________________________________ [GRAPHIC OMITTED: Front side of Mike McCoy's football card, top left side of page, approximately 2.5 inches by 3.5 inches] ___________________________________________________________________________ [GRAPHIC OMITTED: Back side of Mike McCoy's football card, center right side of page, approximately 2.5 inches by 3.5 inches] ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of the Minutemen, a bank sponsored soccer team, wearing First Citizens National Bank logo shirts, center left of page, approximately 4 inches by 3 inches] ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of the Patriots, a bank sponsored soccert team, wearing First Citizens National Bank logo shirts, botter left of page, approximately 4 inches by 3 inches] ___________________________________________________________________________ First Citizens National Bank makes annual donations of money, uniforms and facilities to many local youth organizations. Each community office of First Citizens sponsors at least one little league team, if not more. The sponsorship usually includes a monetary donation toward the program with extra money for uniforms. Often, First Citizens' employees participate by being a coach, a team parent, a referee or a snack bar worker. Besides Little League, First Citizens sponsors several AYSO (Area Youth Soccer Organization) teams, contributes to the Boy Scouts of America, the Girl Scouts of America and many others. One event which First Citizens was proud to sponsor in 1997 was the Champions for Today program. This program was held in the Southern Tioga School District to help young people make positive choices in their lives. Each Champions For Today (CFT) Pro is a former NFL player who is specifically trained to address life's issues. The Pro for the local program was Mike McCoy, retired defensive tackle for the Green Bay Packers. CFT Pro's have spoken to thousands of students in schools across America. The Pro can help students make changes: from dropping out to academic leadership, from peer pressure to positive personal values, from alcohol and drug abuse to freedom from the chemical culture. They also encourage those students who have made positive choices. Isn't this reinvestment in our youth the epitome of giving something back? Aren't our youth also our future? First Citizens feels this is a most worthwhile investment. After all, our youth are our future leaders of tomorrow. They are our doctors and nurses, our farmers, our lawyers, our principals and teachers, our politicians and maybe even our future presidents! Without them, we can reasonably say we have no future. <10> ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of Terry Asalone, Blossburg Office Manager, presenting a donation to the Football Gridiron Club, bottom left side of page, approximately 3 inches by 4 inches] ___________________________________________________________________________ First Citizens is proud to support our community youth by giving a $5,000 donation to the Football Gridiron Club. Students from Liberty High School, North Penn High School and Mansfield Jr. and Sr. High Schools participate in this football program. The club worked diligently to raise funs for the installation of lights at the Panther Football field at Island Park and accomplished their goal by playing their first night game this past August. ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of Phillip Vaughn, Ulysses Office Manager, purchasing a market steer at a county fair, bottom right side of page, approximately 3 inches by 2 inches] ___________________________________________________________________________ Potter County 1997 JR Livestock Sale - Shown is Phil Vaughn - Ulysses FCNB Community Office Manager, Stacey Hamilton and Amanda Barker - daughter of Richard and Karmen Barker. Amanda - 10, won second place in her division with her market steer. First Citizens won the bid to purchase the steer ___________________________________________________________________________ When you consider all these scenarios together, you realize we all work together as a community every day. Whether it's neighbor helping neighbor or many people coming together to reach a larger goal, it is moments such as these when you realize that community works. This is also why a community bank like First Citizens National Bank works in the Twin Tiers. When First Citizens develops or enhances products or services, we do so with the needs of our customers and the community in mind. How do we know what is important to the customer? We simply ask them. Then, we use their feedback in making decisions about our products and services. During 1997, we added the 24-hour Bank-By-Phone service. This service has been very well received, with 3,200 callers being serviced in December alone. Early in 1998, we will be offering another new service, a MasterMoney Debit Card. This is an enhanced ATM card which looks like a MasterCard. This service will enable our customers to shop with peace of mind at over 14 million locations worldwide. We are very excited about the growth we expect to experience in 1998 through the addition of other products and services. We look forward to continuing our interaction with the communities in the Twin Tiers--contributing to each other's success! <11> ___________________________________________________________________________ [GRAPHIC OMITTED: Watermark of colonial rider on horseback] ___________________________________________________________________________ our 1997 Annual Report... Financial Highlights in thousands, except per share data 1997 1998 Balance Sheet Assets $294,811 $282,810 Deposits 256,783 240,177 Net Loans 189,910 180,418 Investments 88,562 86,057 Stockholders' Equity 25,923 22,904 Statement of Income Interest Income 22,779 21,341 Interest Expense 11,610 10,867 Net Interest Income 11,169 10,474 Net Income 3,832 3,003 Per Share Data Net Income 1.40 1.09 Cash Dividends .355 .445 Trust and Investment Services Trust Assets Managed 50,510 43,311 <12> ___________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ FINANCIAL HIGHLIGHTS ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ [GRAPHICS OMITTED: Six bar charts depicting 1. total assets, 2. net income, 3.. stockholders' equity, 4. deposits, 5. net loans, and 6. cash dividends paid, each from 1993 to 1997. Tabular representation of those graphs are set forth as follows: TOTAL ASSETS: (Dollars in Thousands) 1993 1994 1995 1996 1997 $216,237 $232,537 $247,094 $282,810 $294,811 NET INCOME: (Dollars in Thousands) 1993 1994 1995 1996 1997 $2,424 $2,625 $2,834 $3,003 $3,832 STOCKHOLDERS' EQUITY: (Dollars in Thousands) 1993 1994 1995 1996 1997 $18,340 $18,903 $21,297 $22,904 $25,923 DEPOSITS: (Dollars in Thousands) 1993 1994 1995 1996 1997 $191,013 $194,478 $213,316 $240,177 $256,783 NET LOANS: (Dollars in Thousands) 1993 1994 1995 1996 1997 $140,391 $154,848 $159,794 $180,418 $189,910 CASH DIVIDENDS DECLARED: (Dollars in Thousands) 1993 1994 1995 1996 1997 $1,023 $1,088 $1,153 $1,219 $984 ___________________________________________________________________________ <13> ___________________________________________________________________________ CONSOLIDATED BALANCE SHEET December 31, 1997 and 1996 ___________________________________________________________________________ Nineteen hundred ninety-seven Annual Report ___________________________________________________________________________ (in thousands) 1997 1996 ASSETS: Cash and due from banks: Noninterest-bearing $ 6,100 $ 6,407 Interest-bearing 243 52 Total cash and cash equivalents 6,343 6,459 Available-for-sale securities 24,827 28,736 Held-to-maturity securities (estimated market value 1997, $64,490; 1996, $57,587) 63,735 57,321 Loans (net of allowance for loan losses 1997, $2,138; 1996, $1,995) 189,910 180,418 Foreclosed assets held for sale 238 164 Premises and equipment 5,754 4,345 Accrued interest receivable 2,426 2,930 Other assets 1,578 2,437 TOTAL ASSETS $294,811 $282,810 LIABILITIES: Deposits: Noninterest-bearing $ 19,016 $ 17,924 Interest-bearing 237,767 222,253 Total deposits 256,783 240,177 Borrowed funds 6,864 15,817 Accrued interest payable 2,331 2,293 Dividends payable - 612 Commitment to purchase investment securities 1,981 - Other liabilities 929 1,007 TOTAL LIABILITIES 268,888 259,906 STOCKHOLDERS' EQUITY: Common Stock $1.00 par value; authorized 5,000,000 shares; issued and outstanding 2,746,564 and 1,360,228 shares in 1997 and 1996, respectively 2,746 1,360 Additional paid-in capital 7,181 6,828 Retained earnings 15,653 14,544 TOTAL 25,580 22,732 Net unrealized holding gains on available-for-sale securities 343 172 TOTAL STOCKHOLDERS' EQUITY 25,923 22,904 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $294,811 $282,810 See notes to consolidated financial statements. <14> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ CONSOLIDATED STATEMENT OF INCOME Years Ended December 31, 1997, 1996 and 1995 ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ (in thousands, except per share data) 1997 1996 1995 [S] [C] [C] [C] INTEREST INCOME: Interest and fees on loans $17,174 $15,817 $14,799 Interest-bearing deposits with banks 221 148 135 Investment securities: Taxable 5,250 5,238 4,233 Nontaxable 52 66 179 Dividends 82 72 76 TOTAL INTEREST INCOME 22,779 21,341 19,422 INTEREST EXPENSE: Deposits 11,107 10,276 9,340 Borrowed funds 503 591 511 TOTAL INTEREST EXPENSE 11,610 10,867 9,851 NET INTEREST INCOME 11,169 10,474 9,571 Provision for loan losses 210 205 163 NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 10,959 10,269 9,408 OTHER OPERATING INCOME: Service charges 848 844 732 Trust 339 270 255 Realized securities gains, net 25 19 10 Other 246 258 255 Arbitration settlement 994 - - TOTAL OTHER OPERATING INCOME 2,452 1,391 1,252 OTHER OPERATING EXPENSES: Salaries and employee benefits 3,882 3,418 3,150 Occupancy 519 466 413 Furniture and equipment 706 599 574 Federal deposit insurance premiums 56 372 289 Other 2,743 2,495 2,239 TOTAL OTHER OPERATING EXPENSES 7,906 7,350 6,665 Income before provision for income taxes 5,505 4,310 3,995 Provision for income taxes 1,673 1,307 1,161 NET INCOME $ 3,832 $ 3,003 $ 2,834 EARNINGS PER SHARE $ 1.40 $ 1.09 $ 1.03 See notes to consolidated financial statements. <15> ___________________________________________________________________________ CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 1997, 1996 and 1995 ___________________________________________________________________________ Nineteen hundred ninety-seven Annual Report ___________________________________________________________________________ Net Unrealized Additional Holdings (in thousand) Common Stock Paid-in Retained Gains/(Losses) except per share data) Shares Amount Capital Earnings on Securities Total 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, $.42 per share (1,153) (1,153) ($.425 per share on a historical basis) Net 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, $.44 per share (1,219) (1,219) ($.445 per share on a historical basis) Net 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 Net income 3,832 3,832 Stock dividend 13,054 13 353 (366) Stock split in form of a div 1,373,282 1,373 (1,373) Cash dividends, $.355 per share (984) (984) Net unrealized gains on available-for-sale securities (171) (171) Balance, December 31, 1997 2,746,564 $2,746 $7,181 $15,653 $343 $25,923
See notes to consolidated financial statements. <16> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ CONSOLIDATED STATEMENT OF CASH FLOWS Years Ended December 31, 1997, 1996 and 1995 ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ (in thousands) 1997 1996 1995 Cash Flows from Operating Activities: Net income $ 3,832 $ 3,003 $ 2,834 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 210 205 163 Provision for depreciation and amortization 588 442 412 Amortization and accretion on investment securities 368 362 248 Deferred income taxes 59 36 25 Realized gains on securities (25) (19) (10) Realized gains on loans sold (19) (23) (37) Originations of loans held for sale (1,152) (1,639) (1,737) Proceeds from sales of loans held for sale 1,171 1,662 1,760 Gain on sales of foreclosed assets held for sale (10) (50) (45) Decrease (increase) in accrued interest receivable and other assets 859 (487) (393) Decrease) increase in accrued interest payable and other liabilities (40) 253 468 Net cash provided by operating activities 5,841 3,745 3,688 Cash Flows from Investing Activities: Available-for-sale securities: Proceeds from sales of securities 5,588 16 - Proceeds from maturities of securities 5,900 2,000 1,000 Purchases of securities (7,503) (9,682) (6,797) Held-to-maturity securities: Proceeds from maturities and principal repayments of securities 7,716 8,108 5,556 Purchases of securities (12,311) (13,395) (8,375) Net increase in loans (9,914) (17,361) (5,273) Purchase of loans (3,659) Capital expenditures (1,638) (539) (463) Proceeds from sale of foreclosed assets held for sale 148 285 184 Property purchased for future expansion - (250) - Deposit acquisition premium - (1,018) - Net cash used in investing activities (12,014) (35,495) (14,168) Cash Flows from Financing Activities: Net increase in deposits 16,606 9,731 18,838 Proceeds from long-term borrowings 2,056 1,166 1,844 Repayments of long-term borrowings (2,146) (1,050) (186) Net (decrease) increase in short-term borrowed funds (8,863) 6,846 (8,833) Dividends paid (1,596) (1,187) (1,121) Deposits of acquired branches - 17,130 - Net cash provided by financing activities 6,057 32,636 10,542 Net (dec) increase in cash and cash equivalents (116) 886 62 Cash and Cash Equivalents at Beginning of Year 6,459 5,573 5,511 Cash and Cash Equivalents at End of Year $ 6,343 $ 6,459 $ 5,573 Supplemental Disclosures of Cash Flow Information: Interest paid $11,572 $10,680 $9,437 Income taxes paid $ 1,645 $ 1,310 $1,135 Noncash activities: Real estate acquired in settlement of loans $ 212 $ 191 $ 179
See notes to consolidated financial statements. <17> ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ___________________________________________________________________________ Nineteen hundred ninety-seven 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 programs 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, 1997 and 1996. 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. <18> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 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. <19> ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Nineteen hundred ninety-seven Annual Report ___________________________________________________________________________ FORECLOSED ASSETS HELD FOR SALE Foreclosed assets acquired in settlement of foreclosed loans are carried at the lower of fair value minus estimated costs to sell or cost. Prior to foreclosure, the value of the underlying loan is written down to fair market value of the real estate or other assets to be acquired by a charge to the allowance for loan losses, if necessary. Any subsequent write-downs are charged against operating expenses. Operating expenses of such properties, net of related income and losses on disposition, are included in other expenses and gains are included in other income. PREMISES AND EQUIPMENT Premises and equipment are stated at cost, less accumulated depreciation. 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 at December 31, 1997 and 1996 is $541,000 and $581,000, respectively, 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 at December 31, 1997 and 1996 is $295,000 and $364,000, respectively, 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 the Bank file a consolidated federal income tax return. Deferred tax assets and liabilities are computed based on the difference between the financial statement and income tax basis of assets and liabilities using the enacted marginal tax rates. Deferred income tax expenses or benefits are based on the changes in the net deferred tax asset or liability from period to period. EMPLOYEE BENEFIT PLANS The Company has a noncontributory 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. MORTGAGE SERVICING RIGHTS (MSR's) The Company has loan agreements for the express purpose of selling these loans in the secondary market. The Company maintains all servicing rights for these loans. The loans are carried at cost. Originated MSR's are to be recorded by allocating total costs incurred between the loan and servicing rights based on their relative fair values. MSR's are amortized in proportion to the estimated servicing income over the estimated life of the servicing portfolio. <20> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ NEW ACCOUNTING STANDARDS Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities In June 1996, the FASB issued Statement No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." The Statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings based on a control-oriented "financial-components" approach. Under this approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and liabilities it has incurred, derecognizes financial assets when control has been surrendered and derecognizes liabilities when extinguished. The provisions of Statement No. 125 are effective for transactions occurring after December 31, 1996, except those provisions relating to repurchase agreements, securities lending, and other similar transactions and pledged collateral, which have been delayed until after December 31, 1997, by Statement No. 127, "Deferral of the Effective Date of Certain Provisions of Statement No. 125, an amendment of Statement No.125." The adoption of the provisions of Statement No. 127 is not expected to have a material impact on financial position or results of operations. Reporting Comprehensive Income In June 1997, the FASB issued Statement No. 130, "Reporting Comprehensive Income." This Statement establishes standards for the reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. Statement No. 130 requires that all items that are required to be recognized as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. This Statement does not require a specific format for that financial statement, but requires that an enterprise display an amount representing total comprehensive income for the period in that financial statement. Statement No. 130 is effective for fiscal years beginning after December 15, 1997. The impact of this Statement on the Company would be to require additional disclosures in the Company's financial statements. CASH FLOWS The Company utilizes the net reporting of cash receipts and cash payments for deposit and lending activities. The Company considers amounts due from banks and interest-bearing deposits in banks as cash equivalents. TRUST ASSETS AND INCOME Assets held by the Bank in a fiduciary or agency capacity for its customers are not included in the consolidated financial statements since such items are not assets of the Bank. Trust income is reported on a cash basis, which is not materially different from the accrual basis. EARNINGS PER SHARE In February 1997, the FASB issued Statement No. 128, "Earnings Per Share" effective in the fourth quarter of 1997. Statement No. 128 is designed to simplify the computation of earnings per share and requires disclosure of "basic earnings per share" and, if applicable, "diluted 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 2,746,564 for 1997, 1996, and 1995. RECLASSIFICATION Certain of the 1996 and 1995 amounts have been reclassified to conform with the 1997 presentation. Such reclassifications had no effect on net income. 2. COMMON STOCK SPLIT On August 19, 1997, the Board of Directors approved a two-for-one stock split. The additional shares resulting from the split were effected in the form of a 100% stock dividend. All references to the number of average common shares and per share amounts for 1996 and 1995 have been restated to reflect the stock split. <21> ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Nineteen hundred ninety-seven Annual Report ___________________________________________________________________________ 3. 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 $1,314,000 and $1,262,000 at December 31, 1997 and 1996, 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. 4. INVESTMENT SECURITIES The amortized cost and estimated fair value of investment securities at December 31, 1997 and 1996, were as follows (in thousands): Gross Gross Unrealized Unrealized Estimated Amortized Holding Holding Fair December 31, 1997 Cost Gains Losses Value Held-to-maturity securities: U.S. Treasury securities $46,922 $668 $ (24) $47,566 Obligations of state and political subdivisions 5,533 78 - 5,611 Corporate obligations 3,160 16 (1) 3,175 Mortgage-backed securities 6,838 20 (2) 6,856 Total debt securities 62,453 782 (27) 63,208 Restricted equity securities 1,282 - - 1,282 Total held-to-maturity $63,735 $782 $ (27) $64,490 Available-for-sale securities: U.S. Treasury securities $14,599 $355 $ (6) $14,948 Corporate obligations 6,837 17 (5) 6,849 Mortgage-backed securities 2,758 13 - 2,771 Equity securities 113 146 - 259 Total available-for-sale $24,307 $531 $ (11) $24,827 Gross Gross Unrealized Unrealized Estimated Amortized Holding Holding 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
Proceeds from the sale of available-for-sale debt securities during 1997 amounted to $5,588,000, with a gain of $25,000 realized on sales. There were no sales of debt securities <22> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ in 1996 and 1995. In 1996 and 1995 gains of $4,000 and $10,000, 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 1997 and 1995. Investment securities with an approximate carrying value of $47,457,000 and $48,103,000 and estimated market value of $48,085,000 and $48,390,000 at December 31, 1997 and 1996, respectively, were pledged to secure public funds and certain other deposits as provided by law. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The amortized cost and estimated carrying value of debt securities at December 31, 1997, by contractual maturity, are shown below (in thousands). Estimated Amortized Cost Fair Value Held-to-maturity securities: Due in one year or less $ 7,010 $ 7,034 Due after one year through five years 45,439 46,086 Due after five years through ten years 6,127 6,167 Due after ten years 3,877 3,921 Total $62,453 $63,208 Estimated Amortized Cost Fair Value Available-for-sale securities: Due in one year or less $ 4,754 $ 4,780 Due after one year through five years 18,057 18,396 Due after five years through ten years 1,383 1,392 Total $24,194 $24,568 5. 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 1997 1996 Real estate loans: Residential $120,019 $108,416 Commercial 27,480 27,670 Agricultural 8,769 6,134 Construction 3,035 4,262 Loans to individuals for household, family and other purchases 13,905 14,465 Commercial and other loans 9,485 11,529 State and political subdivision loans 9,457 10,105 192,150 182,581 Less unearned income on loans 102 168 Less allowance for loan losses 2,138 1,995 Loans, net $189,910 $180,418 <23> ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Nineteen hundred ninety-seven Annual Report ___________________________________________________________________________ At December 31, 1997 and 1996, net unamortized loan fees and costs of $856,000 and $874,000, respectively, have been deducted from the carrying value of loans. At December 31, 1997 and 1996, the recorded investment in loans that are considered to be impaired in accordance with SFAS No.114 was $382,000, and $414,000, respectively, all of which were on a nonaccrual basis. At December 31, 1997, the Company had an impaired loan of $382,000 with an allocation of $40,000 of the allowance for loan losses. At December 31, 1996, all of the $414,000 of impaired loans did 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, 1997 and 1996, was approximately $398,000 and $696,000, respectively. At December 31, 1997, there was no interest income recognized on impaired loans. For the year ended December 31, 1996, the Company recognized interest income on impaired loans of $2,000, 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 $1,551,000 and $1,258,000 (which included the impaired loans in accordance with SFAS No. 114) at December 31, 1997 and 1996, respectively. If interest had been recorded at the original rate on those loans, such income would have approximated $229,000, $127,000, and $147,000 for the years ended December 31, 1997, 1996, and 1995, respectively. Interest income on such loans, which is recorded as received, amounted to approximately $72,000, $40,000, and $58,000 for the years ended December 31, 1997, 1996, and 1995, respectively. Transactions in the allowance for loan losses were as follows (in thousands): Years Ended December 31, 1997 1996 1995 Balance, beginning of year $1,995 $1,833 $1,721 Provisions charged to income 210 205 163 Recoveries on loans previously charged against the allowance 16 21 18 2,221 2,059 1,902 Loans charged against the allowance (83) (64) (69) Balance, end of year $2,138 $1,995 $1,833 <24> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ The following is a summary of the past due and nonaccrual loans as of December 31, 1997 and 1996 (in thousands): December 31, 1997 Past Due Past Due 30-89 days 90 days or more Nonaccrual Real estate loans $2,566 $146 $1,446 Installment loans 227 20 - Credit cards and related loans 20 4 - Commercial and all other loans 106 - 105 Total $2,919 $170 $1,551 December 31, 1996 Past Due Past Due 30-89 days 90 days or more 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 6. PREMISES & EQUIPMENT Premises and equipment are summarized as follows (in thousands): December 31, 1997 1996 Land $ 1,198 $ 907 Buildings 4,164 3,926 Furniture, fixtures and equipment 5,263 3,914 10,625 8,747 Less accumulated depreciation 4,871 4,402 Premises and equipment, net $ 5,754 $4,345 Depreciation expense amounted to $479,000, $370,000, and $412,000 for 1997, 1996, and 1995, respectively. 7. Deposits Certificates of deposit of $100,000 or more amounted to $23,960,000 and $19,280,000 at December 31, 1997 and 1996, respectively. Interest expense on certificates of deposit of $100,000 or more amounted to $1,420,000, $1,172,000, and $1,089,000 for the years ended December 31, 1997, 1996, and 1995, respectively. Following are maturities of certificates of deposit as of December 31, 1997 (in thousands): 1998 $ 63,956 1999 24,016 2000 32,463 2001 10,068 2002 12,630 Thereafter 960 Total certificates of deposit $144,093 <25> ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Nineteen hundred ninety-seven Annual Report ___________________________________________________________________________ 8. BORROWED FUNDS Securities Sold Under Other Capital Total Agreements to FHLB Borrowed Lease Borrowed Repurchase(a) Advances(b) Funds(c) Obligations Funds dollars in thousands) 1997 Balance at December 31 $4,789 $ - $1,874 $ 201 $ 6,864 Highest balance at any month-end 5,202 7,625 1,874 222 16,498 Average balance 5,030 1,117 1,874 108 8,129 Weighted average interest rate: Paid during year 5.85% 5.56% 7.56% 5.16% 6.19% As of year-end 5.78% 5.73% 7.56% 4.90% 6.24% 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%
(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, 1997 and 1996, of $5,921,000 and $6,494,000, respectively. The respective market values were $6,019,000 and $6,513,000. (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. At December 31, 1996, the Company also had an available 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, total FHLB advances were comprised of Flexline borrowings. There were no outstanding borrowings on this line of credit as of December 31, 1997 and 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. At December 31, 1997 and 1996, approximate carrying value of collateral was $18,944,000 and $17,339,000 and estimated market value was $19,213,000 and $17,445,000, respectively. <26> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ (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 1997 1996 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, 1997 (in thousands): 1998 $3,509 1999 358 2000 683 2001 293 2002 787 Thereafter 1,234 Total borrowed funds $6,864 9. 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, 1997, are as follows (in thousands): 1998 $ 50 1999 35 2000 30 2001 30 2002 30 Thereafter 25 Total minimum lease payments $200 Total rental expense for all operating leases for 1997, 1996, and 1995 amounted to $50,000, $52,000, and $31,000, respectively. 10. 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 11,928 and 5,905 shares of the Company's common stock at December 31, 1997 and 1996, respectively. <27> ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Nineteen hundred ninety-seven Annual Report ___________________________________________________________________________ Pension cost for 1997, 1996, and 1995 include the following components (in thousands): Years Ended December 31, 1997 1996 1995 Service cost benefits earned during the period $ 110 $ 101 $ 85 Interest cost on projected benefit obligation 126 (111) 104 Return on assets (478) (229) (331) Net amortization and deferral 277 54 189 Net pension cost $1035 $1037 $ 47 As of December 31, 1997 and 1996, the Plan's total accumulated benefit obligation was $1,524,000 and $1,235,000, including vested benefits of $1,480,000 and $1,196,000, respectively. The funded status of the Plan and amount recognized in the Company's consolidated balance sheet are summarized as follows (in thousands): December 31, 1997 1996 Projected benefit obligation $(2,226) $(1,782) Plan assets at fair value 2,681 2,242 Excess of assets over projected benefit obligation 455 460 Prior service costs (63) (69) Unrecognized net (loss) from past experience different from that assumed and effects of changes in assumptions (125) (74) Unrecognized net transition gain (114) (129) Prepaid pension cost $ 153 $ 188 The projected benefit obligation for the Plan at December 31, 1997, 1996, and 1995, were determined using an assumed discount rate of 61/2%, 7%, and 7%, respectively, and an assumed long-term rate of compensation increase of 4.0%, 4.0%, and 4.5%, respectively. The assumed long-term rate of return on Plan assets was 8% at December 31, 1997, 1996, and 1995. 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 1997, 1996, and 1995 were $187,000, $131,000, and $86,000, respectively. 11. ARBITRATION SETTLEMENT 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. As of December 31, 1997 there was $110,000 of credits applied for current expenditures. The amount received by the Bank is net of fees associated with the arbitration. 12. INCOME TAXES The provision for income taxes consists of the following (in thousands): Years Ended December 31, 1997 1996 1995 Currently payable $1,614 $1,271 $1,136 Deferred liability 59 36 25 Provision for income taxes $1,673 $1,307 $1,161 <28> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ The following temporary differences gave rise to the net deferred tax asset at December 31, 1997 and 1996 (in thousands): 1997 1996 Deferred tax assets: Allowance for loan losses $544 $495 Deferred compensation 201 194 Loan fees and costs 29 53 Core deposit intangible 23 9 Total 797 751 Deferred tax liabilities: Unrealized gains on available-for-sale securities (177) (88) Premises and equipment (235) (147) Bond accretion (86) (67) Prepaid pension cost (52) (64) Foreclosed assets held for sale (10) - Total (560) (366) Deferred tax asset, net $237 $385 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, 1997 1996 1995 Provision at statutory rates on pre-tax income $1,872 $1,465 $1,358 Effect of tax-exempt income (211) (198) (188) Nondeductible interest 27 27 23 Other items (15) 13 (32) Provision for income taxes $1,673 $1,307 $1,161 Statutory tax rates 34% 34% 34% Effective tax rates 30.4% 30.3% 29.1% Income taxes applicable to realized security gains at December 31, 1997, 1996, and 1995, were $9,000, $1,000, and $3,000, respectively. 13. 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 1997 $1,274 $ 778 $ 880 $1,172 1996 1,379 156 261 1,274 1995 1,501 181 303 1,379 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. <29> ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Nineteen hundred ninety-seven Annual Report ___________________________________________________________________________ 14. 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 1998 without approval of the Comptroller of the Currency of approximately $4,549,000, plus the Bank's net income for 1998. Loans: The Bank is subject to regulatory restrictions which limit its ability to loan funds to the Company. At December 31, 1997, the regulatory lending limit amounted to approximately $2,791,000. 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, liabilities, 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 defined). Management believes, as of December 31, 1997, 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, 1997, 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 capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized 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 (which is substantially the same as the Bank's) capital ratios at December 31 (in thousands): 1997 1996 Amount Ratio Amount Ratio Total capital (to risk-weighted assets) Company $26,867 15.83% $23,764 15.03% For capital adequacy purposes 13,589 8.00% 12,649 8.00% To be well capitalized 16,986 10.00% 15,811 10.00% Tier I capital (to risk-weighted assets) Company $24,744 14.58% $21,787 13.78% For capital adequacy purposes 6,794 4.00% 6,324 4.00% To be well capitalized 10,192 6.00% 9,486 6.00% Tier I capital (to average assets) Company $24,744 8.47% $21,787 7.76% For capital adequacy purposes 8,768 3.00% 8,424 3.00% To be well capitalized 14,613 5.00% 14,041 5.00% This annual report has not been reviewed, or confirmed for accuracy or relevance, by the Federal Deposit Insurance Corporation. <30> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ 15. 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, 1997 and 1996, are as follows (in thousands): 1997 1996 Commitments to extend credit $21,871 $16,740 Standby letters of credit 548 660 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. 16. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair values of the Company's financial instruments are as follows (in thousands) December 31, 1997 CARRYING ESTIMATED AMOUNT FAIR VALUE Financial assets: Cash and due from banks $ 6,343 $ 6,343 Available-for-sale securities 24,827 24,827 Held-to-maturity securities 63,735 64,490 Net loans 189,910 191,658 Accrued interest receivable 2,426 2,426 Total financial assets $287,241 $289,744 Financial liabilities Deposits $256,783 $258,829 Securities sold under agreements to repurchase 4,789 4,851 Other borrowed funds 2,075 2,240 Accrued interest payable 2,331 2,331 Total financial liabilities $265,978 $268,251 <31> ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Nineteen hundred ninety-seven Annual Report ___________________________________________________________________________ December 31, 1996 CARRYING ESTIMATED AMOUNT FAIR VALUE Financial assets: Cash and due from banks $ 6,459 $ 6,459 Available-for-sale securities 28,736 28,736 Held-to-maturity securities 57,321 57,587 Net loans 180,418 180,586 Accrued interest receivable 2,930 2,930 Total financial assets $275,864 $276,298 Financial liabilities Deposits $240,177 $241,835 Securities sold under agreements to repurchase 5,018 5,018 FHLB advances 8,925 8,925 Other borrowed funds 1,874 1,975 Accrued interest payable 2,293 2,293 Total financial liabilities $258,287 $260,046 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 determined with precision. Changes in assumptions can significantly affect the estimates. Estimated fair values have been determined by the Company using historical data, as generally provided in the Company's regulatory reports, and an estimation methodology suitable for each category of financial instruments. The Company's fair value estimates, methods and assumptions are set forth below for the Company's other financial instruments. Cash and Due From Banks: The carrying amounts for cash and due from banks approximate fair value because they mature in 90 days or less and do not present unanticipated credit concerns. Investment Securities: The fair values of investments are based on quoted market prices as of the balance sheet date. For certain instruments, fair value is estimated by obtaining quotes from independent dealers. Loans: Fair values are estimated for portfolios of loans with similar financial characteristics. The fair value of performing loans has been estimated by discounting expected future cash flows. The discount rate used in these calculations is derived from the Treasury yield curve adjusted for credit quality, operating expense and prepayment option price, and is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Company's historical experience with repayments for each loan classification, modified as required by an estimate of the effect of current economic and lending conditions. <32> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ 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. Deposits: The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings and NOW accounts, and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. The deposit's fair value estimates do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market, commonly referred to as the core deposit intangible. Borrowed Funds: Rates available to the Company for borrowed funds with similar terms and remaining maturities are used to estimate the fair value of borrowed funds. 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 15). 17. CONDENSED FINANCIAL INFORMATION PARENT COMPANY ONLY CITIZENS FINANCIAL SERVICES, INC. CONDENSED BALANCE SHEET December 31, 1997 and 1996 (in thousands) 1997 1996 Assets: Cash $ 46 $ 33 Dividends receivable - subsidiary - 612 Investment in subsidiary, First Citizens National Bank 25,771 22,871 Available-for-sale securities 141 - Other assets 1 - Total assets $25,959 $23,516 Liabilities: Other liabilities $ 26 $ - Deferred tax liability 10 - Dividends payable - 612 Total liabilities $ 36 $ 612 Stockholders' equity 25,923 22,904 Total liabilities and stockholders' equity $25,959 $23,516 <33> ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Nineteen hundred ninety-seven Annual Report ___________________________________________________________________________ CITIZENS FINANCIAL SERVICES, INC. CONDENSED STATEMENT OF INCOME Years Ended December 31, 1997, 1996, and 1995 (in thousands) 1997 1996 1995 Dividends from: Bank subsidiary $1,179 $1,265 $1,235 Available-for-sale securities 1 - - Total income 1,180 1,265 1,235 Expenses 97 62 64 Income before equity in undistributed earnings of subsidiary 1,083 1,203 1,171 Equity in undistributed earnings - FCNB 2,749 1,800 1,663 CITIZENS FINANCIAL SERVICES, INC. CONDENSED STATEMENT OF CASH FLOWS Years Ended December 31, 1997, 1996, and 1995 (in thousands) 1997 1996 1995 Cash flows from operating activities: Net income $ 3,832 $ 3,003 $2,834 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed earnings of subsidiary 2,749 (1,800) (1,663) Decrease (increase) in other assets 611 (32) (32) Increase in other liabilites 26 - - Net cash provided by operating activities 1,720 1,171 1,139 Cash flows used in investing activities: Purchase of available-for-sale securities (111) - - Cash flows used in financing activities: Cash dividends paid (1,596) (1,187) (1,121) Net increase (decrease) in cash (13) (16) (18) Cash at beginning of year 33 49 31 Cash at end of year $ 46 $ 33 $ 49 <34> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on 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, 1997 and 1996, 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, 1997. 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, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, 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 20, 1998 S.R. Snodgrass, A.C. 101 Bradford Road Wexford, PA 15090-6909 Phone: 724-934-0344 Faxsimile: 724-934-0345 <35> ___________________________________________________________________________ SELECTED FINANCIAL DATA FIVE YEARS SUMMARY OF OPERATIONS ___________________________________________________________________________ Nineteen hundred ninety-seven Annual Report ___________________________________________________________________________ (dollar amounts in thousands) 1997 1996 1995 1994 1993 Interest income $ 22,779 $ 21,341 $ 19,422 $ 17,336 $ 16,551 Interest expense 11,610 10,867 9,851 7,944 7,853 Net interest income 11,169 10,474 9,571 9,392 8,698 Provision for loan losses 210 205 163 255 315 Net interest income after provision for loan losses 10,959 10,269 9,408 9,137 8,383 Other operating income 2,427 1,372 1,242 1,073 1,016 Realized securities gains, net 25 19 10 63 50 Other operating expenses 7,906 7,350 6,665 6,490 6,117 Income before provision for income taxes 5,505 4,310 3,995 3,783 3,332 Provision for income taxes 1,673 1,307 1,161 1,158 908 Net income $ 3,832 $ 3,003 $ 2,834 $ 2,625 $ 2,424 Per share data: Net income (1) $ 1.40 $ 1.09 $ 1.03 $ .96 $ .88 Cash dividends (1) 0.355 0.445 0.425 0.405 0.385 Book value (1) 9.44 8.34 7.75 6.88 6.68 Total investments $888,562 $ 86,057 $ 73,715 $ 64,257 $ 62,645 Loans, net 189,910 180,418 159,794 154,848 140,391 Total assets 294,811 282,810 247,094 232,537 216,237 Total deposits 256,783 240,177 213,316 194,478 191,013 Stockholders' equity 25,923 22,904 21,297 18,903 18,340
(1) Amounts were adjusted to reflect the two-for-one stock split as described in Footnote 2. 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 14). Dividends Dividends 1997 declared 1996 declared High Low per share High Low per share First quarter (1) $13.31 $12.94 First quarter (1) $12.38 $11.63 Second quarter (1) 14.00 13.31 $ 0.230 Second quarter (1) 12.63 12.38 $ 0.210 Third quarter 16.38 14.00 Third quarter (1) 12.75 12.50 Fourth quarter 18.75 17.00 $ 0.125 Fourth quarter (1) 12.94 12.75 $ 0.215
Amounts were adjusted to reflect the two-for-one stock split as described in Footnote 2. <36> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on 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 1997 March 31 June 30 Sept 30 Dec 31 Interest income $5,486 $5,672 $5,847 $5,774 Interest expense 2,809 2,891 2,958 2,952 Net interest income 2,677 2,781 2,889 2,822 Provision for loan losses 53 52 53 52 Other operating income 1,229 356 432 410 Realized securities gains, net - - - 25 Other operating expenses 2,039 1,843 2,032 1,992 Income before provision for income taxes 1,814 1,242 1,236 1,213 Provision for income taxes 599 368 359 347 Net income $1,215 $ 874 $ 877 $ 866 Earnings Per Share $ 0.44 $ 0.32 $ 0.32 $ 0.32 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 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 $ 0.26 $ 0.29 $ 0.26 $ 0.28
TRUST AND INVESTMENT SERVICES STATEMENT OF CONDITION 1997 1996 INVESTMENTS: Bonds $14,115 $14,770 Stock 14,995 10,284 Savings and money market funds 13,350 10,554 Mutual funds 7,100 6,756 Mortgages 374 491 Real estate 298 285 Miscellaneous 110 127 Cash 168 44 TOTAL $50,510 $43,311 ACCOUNTS: Estates $ 827 $ 413 Trusts 24,666 25,458 Guardianships 332 197 Pension/profit sharing 9,871 8,611 Investment management 12,527 4,911 Custodial 2,287 3,721 TOTAL $50,510 $43,311 __________________________________________________________________________ [GRAPHIC OMITTED: One bar chart depicting personal trust assets from 1993 to 1997. Tabular representation of this graph is set forth as follows: PERSONAL TRUST ASSETS: (Dollars in Thousands) 1993 1994 1995 1996 1997 $26,085 $27,781 $31,786 $39,776 $41,643 ___________________________________________________________________________ <37> ___________________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION ___________________________________________________________________________ Nineteen hundred ninety-seven 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: 1997/1996 1996/1995 $ % $ % Total assets 12.0 4.2 35.7 14.5 Total deposits 16.6 6.9 26.9 12.6 Total loans 9.5 5.3 20.6 12.9 Total investments (including available-for-sale and held-to-maturity) 2.5 2.9 12.3 16.7 Total stockholders' equity 3.0 13.2 1.6 7.5 Investments The investment portfolio, including available-for-sale and held-to-maturity securities, increased by $2.5 million or 2.9% in 1997 as compared to growth of $12.3 million in 1996. From 1990 through 1996, the concentration of the Company's investment portfolio shifted to U.S. Treasury securities and, until this year, no new investments had been made in state and political subdivisions since 1985. During 1997, the investment portfolio was restructured by selling $5.6 million U. S. Treasury notes and purchasing $5.2 million AAA insured Pennsylvania municipal bonds. In addition, throughout the year as funds became available from deposits and the maturity of investments, $9.9 million in FNMA and FHLMC mortgage-backed securities and $2.6 million in investment-grade corporate bonds were purchased. The deposits and other liabilities that are not used to fund loans are placed in investments which possess less risk and, therefore, lower yield. The impact on net interest income is discussed later in the Net Interest Income section. __________________________________________________________________________ [GRAPHIC OMITTED: One bar chart depicting investments from 1993 to 1997 for available-for-sale and held to maturity. Tabular representation of this graph is set forth as follows: INVESTMENTS: (Dollars in Thousands) Available-for-Sale 1993 1994 1995 1996 1997 $16,171 $14,640 $21,444 $28,736 $24,827 Held to Maturity 1993 1994 1995 1996 1997 $46,474 $49,617 $52,271 $57,321 $63,735 Total 1993 1994 1995 1996 1997 $62,645 $64,257 $73,715 $86,057 $88,562 ___________________________________________________________________________ <38> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ The following table shows the year-end composition of the investment portfolio for the five years ended December 31, 1997: Book Value at December 31, % of % of % of % of % of 1997 Total 1996 Total 1995 Total 1994 Total 1993 Total Held-to-maturity: U.S. Treasury securities $46,922 53.0 $49,169 57.1 $42,700 57.9 $36,042 56.1 $30,686 49.0 Federal agency obligations - - - - - - 500 0.8 502 0.8 Obligations of state & political subdivisions 5,533 6.2 606 0.7 1,311 1.8 2,735 4.3 3,498 5.6 Corporate obligations 3,160 3.6 4,694 5.5 4,744 6.4 6,729 10.4 7,715 12.3 Mortgage-backed securities 6,838 7.7 1,724 2.0 2,377 3.2 2,513 3.9 3,066 4.9 Restricted equity securities 1,282 1.5 1,128 1.3 1,139 1.6 1,098 1.7 1,007 1.6 Available-for-sale: U.S. Treasury securities 14,948 16.9 21,406 24.9 15,591 21.2 14,594 22.7 16,126 25.7 Corporate obligations 6,849 7.7 7,253 8.4 5,778 7.8 - - - - Mortgage-backed securities 2,771 3.1 - - - - - - - - Equity securities 259 0.3 77 0.1 75 0.1 46 0.1 45 0.1 Total $88,562 100.0 $86,057 100.0 $73,715 100.0 $64,257 100.0 $62,645 100.0
Maturities and Average Weighted Yields of Investment Securities The expected maturities and average weighted yields for the above investment portfolio as of December 31, 1997, are 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 $7,008 6.77 $39,914 6.27 $ - - $ - - $46,922 6.34 State & political subdivisions, general obligation 2 8.33 2,057 7.14 2,377 7.39 757 7.27 5,193 7.27 State & political subdivisions, revenue - - 340 12.31 - - - - 340 12.31 Corporate obligations - - 3,160 6.53 - - - - 3,160 6.53 Mortgage-backed securities 76 7.25 2,240 6.55 4,522 6.86 - - 6,838 6.76 Restricted equity securities - - - - - - 1,282 6.00 1,282 6.00 Total held-to-maturity $7,086 6.78 $47,711 6.38 $6,899 7.04 $2,039 6.47 $63,735 6.50 Available-for-sale securities: U.S. Treasury $2,029 7.13 $12,919 6.54 $ - - $ - - $14,948 6.62 Corporate obligations 2,751 6.11 4,098 6.43 - - - - 6,849 6.30 Mortgage-backed securities - - 2,771 6.46 - - - - 2,771 6.46 Equity securities - - - - - - 259 1.50 259 1.50 Total available-for-sale $4,780 6.54 $19,788 6.51 $ - - $ 259 1.50 $24,827 6.46
<39> ___________________________________________________________________________ MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Nineteen hundred ninety-seven Annual Report ___________________________________________________________________________ Approximately 87% of the amortized cost of debt securities are expected to mature within five years or less (average expected maturity 3.3 years), as evidenced in Footnote 4 of the Consolidated Financial Statements. The Company expects that earnings from operations, the high liquidity level of the available-for-sale securities, growth of deposits and the availability of borrowings from the Federal Home Loan Bank will be sufficient to meet future liquidity needs. 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. 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 20 years for commercial and vacation property. As shown in the following table, total loans grew by $9.6 million in 1997, or 5.2%, a decrease from the strong 12.8% increase during 1996. The residential mortgage loan portfolio increased 10.7% as a result of continued strong demand during 1997. In addition, $1.2 million in conforming mortgage loans were originated and sold on the secondary market through the Federal Home Loan Mortgage Corporation, providing over $19,000 of income in origination fees and premiums on loans sold, compared to $1.6 million in loans originated and $23,000 of income in 1996. Residential mortgage lending is a principal business activity and one the Company expects to continue by providing a full complement of competitively priced conforming, nonconforming and home equity mortgages. Total commercial real estate, agricultural real estate and commercial/other loans increased by $.4 million or 1% (down from the 6% increase in 1996). Commercial lending activity is primarily focused on small businesses and the Company's commercial lending officers have been successful in attracting new business loans. Loans to individuals decreased $.6 million or 4% during 1997 compared to an increase of $1.3 million in 1996. Loan consolidations moved some of these volumes to residential mortgage loans. State and political subdivision loans decreased $.6 million or 6.4% compared to an increase of $1.8 million in 1996. Management expects this type of loan will increase in 1998 as the result of bond refinancing activity in a lower interest rate environment. The majority of lending activity has been mortgage loans secured by one- to four-family residential property. As of December 31, 1997, residential real estate and real estate construction loans made up 64.1% of the Company's total loan portfolio. <40> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ Continuing in 1998, 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 5.) Five Year Breakdown of Loans by Type December 31, 1997 1996 1995 1994 1993 Amount % Amount % Amount % Amount % Amount % Real estate: Residential $120,019 62.5 $108,416 59.4 $ 96,594 59.7 $ 97,359 62.0 $ 92,149 64.3 Commercial 27,480 14.3 27,670 15.2 24,167 14.9 21,915 13.9 19,926 13.9 Agricultural 8,769 4.6 6,134 3.4 8,027 5.0 7,125 4.5 4,216 2.9 Construction 3,035 1.6 4,262 2.3 1,018 0.6 1,271 0.8 1,102 0.8 Loans to individuals for family and other purchases 13,905 7.2 14,465 7.9 13,198 8.1 11,886 7.7 11,696 8.2 Commercial and other 9,485 4.9 11,529 6.3 10,535 6.5 10,285 6.5 8,959 6.3 State and political subdivision loans 9,457 4.9 10,105 5.5 8,347 5.2 7,303 4.6 5,170 3.6 Total loans 192,150 100.0 182,581 100.0 161,886 100.0 157,144 100.0 143,218 100.0 Unearned income 102 168 259 575 1,311 Allow for loan losses 2,138 1,995 1,833 1,721 1,516 Net loans $189,910 $180,418 $159,794 $154,848 $140,391
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, 1997, 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 $ 5,365 $ - $ 5,365 Over one year but less than five years 12,143 - 12,143 Over five years 37,683 3,035 40,718 Total $55,191 $3,035 $58,226 Sensitivity of loans to changes in interest rates - loans due after one year: Predetermined interest rate $13,401 $ 102 $13,503 Floating or adjustable interest rate 36,425 2,933 39,358 Total $49,826 $3,035 $52,861 <41> ___________________________________________________________________________ MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Nineteen hundred ninety-seven Annual Report ___________________________________________________________________________ Loan Quality and Provision for 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 5 of the Consolidated Financial Statements provides further details on the composition of the loan portfolio and is incorporated herein. 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 assets over the past five years ending December 31: 1997 1996 1995 1994 1993 Nonperforming loans: Nonaccruing loans $ 1,169 $ 844 $ 762 $ 1,557 $ 1,566 Impaired loans 382 414 697 - - Accrual loans - 90 days or more past due 170 723 689 267 418 Total nonperforming loans $ 1,721 $ 1,981 $ 2,148 $ 1,824 $ 1,984 Foreclosed assets held for sale 238 164 208 168 231 Total nonperforming assets $ 1,959 $ 2,145 $ 2,356 $ 1,992 $ 2,215 Total loans $192,150 $182,581 $161,886 $157,144 $143,218 Unearned income 102 168 259 575 1,311 Loans, net of unearned income $192,048 $182,413 $161,627 $156,569 $141,907 Nonperforming loans as a percent of loans, net of unearned income .90% 1.09% 1.33% 1.17% 1.40% Total nonperforming assets as a percent of loans, net of unearned income 1.02% 1.18% 1.46% 1.27% 1.56% 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. <42> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued __________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ Loans classified on the "watch list" as of December 31: 1997 1996 1995 Special mention $ - $ 216 $ 232 Substandard 4,625 3,740 4,093 Doubtful 121 23 41 Loss - - - Total $4,746 $3,979 $4,366 Percent of total loans, net of unearned income 2.47% 2.18% 2.70% 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, 1997, 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. The following table presents an analysis of the allowance for loan losses for the five years ending December 31: Summary of Loan Loss Experience 1997 1996 1995 1994 1993 Balance at beginning of period $1,995 $1,833 $1,721 $1,516 $1,201 Charge-offs Real estate - construction - - - - - Real estate - mortgage 10 8 23 31 25 Loans to individuals for household, family and other purchases 32 56 42 28 43 Commercial and other loans 41 - 4 9 3 Total loans charged-off 83 64 69 68 71 Recoveries Real estate - construction - - - - - Real estate - mortgage 3 1 - - 3 Loans to individuals for household, family and other purchases 11 19 15 14 60 Commercial and other loans 2 1 3 4 8 Total loans recovered 16 21 18 18 71 Net loans charged-off 67 43 51 50 - Provisions charged to expense 210 205 163 255 315 Balance at end of year $2,138 $1,995 $1,833 $1,721 $1,516 Loans outstanding at end of year $192,048 $182,413 $161,627 $156,569 $141,907 Average loans outstanding, net $186,425 $170,104 $156,754 $146,894 $136,025 Net charge-offs to average loans 0.04% 0.03% 0.03% 0.03% 0.00% Year-end allowance to total loans 1.11% 1.09% 1.13% 1.10% 1.07% Year-end allowance to total nonperforming loans 124.23% 100.71% 85.34% 94.35% 76.41%
<43> ___________________________________________________________________________ MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Nineteen hundred ninety-seven Annual Report ___________________________________________________________________________ As detailed in Footnote 5 and the above tables, total past due (90 days or more) and nonperforming loans decreased 13.1% from December 31, 1996 to December 31, 1997. The majority of the loan volume is well-collateralized by real estate. Total charge-offs for 1998 are still expected to increase moderately from the historic levels (although low in relationship to peers). Allowance For 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 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 loan losses as a percentage of total loans was 1.13%, 1.09%, and 1.11% as of December 31, 1995, 1996, and 1997, respectively. The 1997 growth in the allowance is the combined result of a $210,000 charge to earnings and $67,000 in net loan losses. The level of charge-offs and recoveries were similar to 1996. Allocation of the Allowance for Loan Losses The following table provides the percentage distribution of the allowance for loan losses and the various loan categories: 1997 1996 1995 1994 1993 $ % $ % $ % $ % $ % Real estate loans: Residential 140 62.5 143 59.4 165 59.6 185 62.0 181 64.2 Commercial, agricultural 577 18.9 325 18.5 328 19.9 323 18.5 253 16.9 Construction - 1.6 - 2.3 - .6 - .8 - .8 Loans to individuals for household, family and other purchases 321 7.2 164 8.0 181 8.2 140 7.6 174 8.2 Commercial and other loans 323 4.9 108 6.3 110 6.5 114 6.5 94 6.3 State and political subdivision loans 4 4.9 3 5.5 3 5.2 2 4.6 2 3.6 Unallocated 773 N/A 1,252 N/A 1,046 N/A 957 N/A 812 N/A Total allowance for loan losses 2,138 100.0 1,995 100.0 1,833 100.0 1,721 100.0 1,516 100.0
As described in Footnote 1 and Footnote 5, 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 applying SFAS 114 in the future. <44> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ Deposits The Company tiers 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). The Company also offers a wide variety of IRA products including the new Roth and Educational IRA's. During 1996, the Company moved to expand and consolidate its market share by the acquisition of two offices in Canton and Gillett and the start of its first supermarket office at the Weis Market in Wellsboro. Deposit growth in 1997 was $16.6 million or 6.9%. Deposit growth was higher in 1996 (an increase of $26.9 million or 12.6%) primarily as the result of the acquisition of two offices. Transaction accounts (noninterest-bearing and interest-bearing) increased $2 million or 4% in 1997, while total certificates of deposit increased $6.9 million or 5%. Certificates of deposit growth in 1996 was $12 million or 9.7%. During 1997, the interest cost of certificates of deposit remained high and the interest rate paid on Money Market Investors accounts increased. This rate environment (high rates for certificates of deposit and high balance Money Market Investor accounts) resulted in growth in both types of deposits. Money market deposit accounts (which are paid a higher interest rate than savings and NOW accounts) had growth of $8.5 million or 32.9%. The following table shows the composition of deposit accounts over the last three years as of December 31: Deposits by Major Classification 1997 1996 1995 Amount % Amount % Amount % Noninterest-bearing deposits $ 19,016 7.4 $ 17,924 7.5 $ 15,140 7.1 NOW accounts 32,794 12.8 31,836 13.2 23,681 11.1 Savings deposits 26,523 10.3 27,332 11.4 25,317 11.9 Money market deposit accounts 34,357 13.4 25,851 10.8 24,096 11.3 Certificates of deposit 144,093 56.1 137,234 57.1 125,082 58.6 Total deposits $256,783 100.0 $240,177 100.0 $213,316 100.0 Remaining maturities of certificates of deposit of $100,000 or more: 1997 1996 1995 3 months or less $ 1,658 $ 1,962 $ 2,708 3 through 6 months 6,929 2,788 2,474 6 through 12 months 10,263 6,051 4,538 Over 12 months 5,110 8,479 8,822 Total $23,960 $19,280 $18,542 As a percent of total certificates of deposit 16.63% 14.05% 14.82% <45> ___________________________________________________________________________ MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Nineteen hundred ninety-seven Annual Report ___________________________________________________________________________ Deposits by Type of Depositor 1997 1996 1995 Amount % Amount % Amount % Individual, partnerships & corporations $226,306 88.1 $212,398 88.4 $188,471 88.4 United States government 20 - 148 .1 132 .1 State & political subdivisions 28,721 11.2 25,794 10.7 23,279 10.9 Other 1,736 0.7 1,837 0.8 1,434 0.6 Total deposits $256,783 100.0 $240,177 100.0 $213,316 100.0 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 ten MAC automated teller machines, which are part of the MAC regional and PLUS national network. Management will be implementing a MasterMoney debit card program in the first quarter of 1998. In addition to the above, continuing an effort to add value to products, the Company began a voice response system to provide customers a convenient method of accessing account information and transferring funds 24 hours a day. Results of Operations Net income during 1997 increased to $3.8 million (net income per share of $1.40), an increase of $829,000 or 27.6% over the $3 million reported in 1996 (net income per share of $1.09). The following table sets forth certain performance ratios of the Company for the periods indicated (net of the arbitration settlement discussed on page 48): 1997 1996 1995 Return on assets (net income to average total assets) (1) 1.16% 1.11% 1.18% Return on equity (net income to average total equity) (1) 13.87% 13.59% 14.10% Dividend payout ratio (dividends declared divided by net income) 25.68% 40.59% 40.68% Equity to asset ratio (average equity to average total assets) 8.45% 8.18% 8.45%
(1) Return on average assets and average equity was computed after excluding the nonrecurring after-tax income associated with the arbitration award by a vendor. In 1997, the dividend payout ratio was effected by the Company changing from a semi-annual dividend to a quarterly dividend in October, 1997. 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. 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. Net interest income (tax adjusted) in 1997 was $11.5 million (an increase of $ .7 million or 6.6%) as compared to $10.8 million in 1996 and $9.9 million in 1995. 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: <46> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ Analysis of Average Balances and Interest Rates (1) 1997 1996 1995 Average Average Average Average Average Average Balance Interest Rate Balance Interest Rate Balance Interest Rate $ $ % $ $ % $ $ % Assets Short-term investments: Interest-bearing deposits at banks 4,042 221 5.47 2,782 147 5.28 2,334 135 5.78 Total short-term investments 4,042 221 5.47 2,782 147 5.28 2,334 135 5.78 Investment securities: Taxable 83,686 5,332 6.37 82,163 5,310 6.46 64,990 4,309 6.63 Tax-exempt (3) 714 79 11.06 792 100 12.63 2,150 271 12.61 Total investment securities 84,400 5,411 6.41 82,955 5,410 6.52 67,140 4,580 6.82 Loans: Residential mortgage loans 119,083 10,952 9.20 104,176 9,699 9.31 96,998 9,018 9.30 Commercial & farm loans 43,790 4,263 9.74 41,896 4,121 9.84 38,615 3,829 9.92 Loans to state & political subdivisions 9,652 875 9.07 9,631 829 8.61 7,152 644 9.00 Other loans 13,900 1,378 9.91 14,401 1,435 9.96 13,989 1,501 10.73 Loans, net of discount (2)(3)(4) 186,425 17,468 9.37 170,104 16,084 9.46 156,754 14,992 9.56 Total interest-earning assets 274,867 23,100 8.40 255,841 21,641 8.46 226,228 19,707 8.71 Cash and due from banks 6,417 5,920 4,737 Bank premises and equipment 5,140 4,311 4,128 FASB 115 adjustment 170 218 46 Other assets 2,342 3,828 2,653 Total noninterest-bearing assets 14,069 14,277 11,564 Total assets 288,936 270,118 237,792 Liabilities and Stockholders' Equity Interest-bearing deposits: NOW accounts 32,644 786 2.41 29,752 688 2.31 24,152 556 2.30 Savings accounts 27,736 614 2.21 27,541 612 2.22 25,722 628 2.44 Money market accounts 29,420 1,349 4.59 27,189 1,192 4.38 23,003 1,089 4.73 Certificates of deposit 143,837 8,358 5.81 33,071 7,784 5.85 119,260 7,067 5.93 Total interest-bearing deposits 233,637 11,107 4.75 217,553 10,276 4.72 192,137 9,340 4.86 Other borrowed funds 8,129 503 6.19 9,730 591 6.07 8,031 511 6.36 Total interest-bearing liabilities 241,766 11,610 4.80 227,283 10,867 4.78 200,168 9,851 4.92 Demand deposits 19,141 17,550 14,647 Other liabilities 3,804 3,184 2,837 Total noninterest-bearing liabilities 22,945 20,734 17,484 Stockholders' equity 24,225 22,101 20,140 Total liabilities & stockholders' equity 288,936 270,118 237,792 Net interest income 11,490 10,774 9,856 Net interest spread (5) 3.60% 3.68% 3.79% Net interest income as a percentage of average interest-earning assets 4.18% 4.21% 4.36% Ratio of interest-earning assets to interest-bearing liabilities 1.14 1.13 1.13%
(1) Averages are based on daily balances. (2) Interest includes loan origination and commitment fees of $225, $155, and $155 for 1997, 1996, and 1995, 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. <47> ___________________________________________________________________________ MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Nineteen hundred ninety-seven 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 1997 vs. 1996 1996 vs. 1995 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 $ 69 $ 5 $ 74 $ 22 $ 10 $ 12 Investment securities: Taxable 92 (70) 22 1,107 (106) 1,001 Tax-exempt (9) (12) (21) (172) 1 (171) Total investments 83 (82) 1 935 (105) 830 Loans: Residential mortgage loans 1,369 (116) 1,253 668 13 681 Commercial and farm loans 184 (42) 142 323 (31) 292 Loans to state & political subdivisions 2 44 46 212 (27) 185 Other loans (50) (7) (57) 46 (112) (66) Total loans - net of discount 1,505 (121) 1,384 1,249 (157) 1,092 Total interest income 1,657 (198) 1,459 2,206 (272) 1,934 Interest expense: Interest bearing deposits: NOW accounts 69 29 98 129 2 131 Savings accounts 4 (2) 2 59 (75) (16) Money market accounts 101 56 157 174 (71) 103 Certificates of deposit 625 (51) 574 807 (90) 717 Total interest-bearing deposits 799 32 831 1,169 (234) 935 Other borrowed funds (99) 11 (88) 102 (21) 81 Total interest expense 700 43 743 1,271 (255) 1,016 Net interest income $ 957 $ (241) $ 716 $ 935 $ (17) $ 918
As can be seen from the preceding tables, tax equivalent net interest income rose from $9,856,000 in 1995 to $10,774,000 in 1996 and increased to $11,490,000 in 1997. In 1997, net interest income increased $716,000 while overall spread decreased from 3.68% to 3.60%. The increased volume of interest-earning assets generated an increase in interest income of $1,657,000 while increased volume of interest-bearing liabilities produced $700,000 of interest expense. The change in volume resulted in an increase of $957,000 in net interest income. The net change in rate was a negative $241,000 resulting in a total positive net change of $716,000 when combined with change in volume. The yield on interest-earning assets decreased 6 basis points from 8.46% to 8.40% and the average interest rate on interest-bearing liabilities increased 2 basis points from 4.78% to 4.80%. Analysis of the Company's current net interest income in 1997 indicates that the effects of stable interest rates and the effect of the yield curve continuing to become more level, has a negative effect on interest margin. Management is currently evaluating alternatives to improve the interest spread. <48> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ Other Operating Income The Company achieved other operating income of $2,452,000 in 1997, which was an increase of $1,061,000 or 76.3% from $1,391,000 in 1996. An increase of $4,000 occurred in service charges on deposit accounts. The sale and maturity of securities resulted in $25,000 in gains compared to $19,000 in 1996. Other operating income decreased $12,000, or 4.8%, in 1997. Management continues to evaluate means of increasing other operating income to off-set the loss of net interest income described above. One approach, recently adopted, is to apply service charges on business accounts by charging fees on transaction activity (reduced by earnings credit based on customers' balances) to more equitably recover costs. Management expects to use this analysis for its other products in the near future. Trust income of $339,000 increased 25.6% from the $270,000 earned during 1996, primarily as the result of strong growth in traditional trust and investment business and estate settlements. In 1998, management plans to continue to expand small business and trust relationships by working with the community offices and commercial lending staff. Management recently revised its trust fees to better reflect level of service required to administer the various accounts. 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 income realized during 1997 was $994,000. Management expects the remaining credits ($140,000) to be used during 1998. Other Operating Expenses Salaries and employee benefits, the largest category of noninterest expense, increased $464,000 or 13.6% to $3.9 million in 1997 from $3.4 million in 1996, $154,000 of the increase was the result of profit sharing expense associated with the arbitration settlement. Occupancy expense increased $53,000 in 1997, or 11.4%, as compared to a similar increase of $53,000 in 1996. Furniture and equipment expense increased $107,000 or 17.9% ($25,000 increase in 1996). These increases reflect the addition of three offices and new data processing equipment and software. Changes in the Bank's FDIC assessment rate, caused by the enactment of the Deposit Insurance Funds Act of 1996, resulted in a premium expense decrease in 1997 of $316,000 or 84.9%. Management expects the current level of FDIC premium expense to continue in 1998. Other expenses increased in 1997 by $248,000 or 9.9% compared to an increase of $256,000 in 1996 and generally reflect the expenses resulting from the additional three offices and the conversion to a new application processing system. Provision for Income Taxes The provision for income taxes for 1997 increased by $366,000 to $1.7 million, compared to the $146,000 increase in 1996, due to increased taxable earnings. 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 13.2% in 1997, 7.6% in 1996, and 12.7% in 1995 to the current level of $25.9 million. Adjustments made to equity for unrelized holding gains and losses on available-for-sale securities resulted in an increase of $171,000 in 1997 com- <49> ___________________________________________________________________________ MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Nineteen hundred ninety-seven Annual Report ___________________________________________________________________________ pared to a decrease of $177,000 in 1996. Total equity was approximately 8.8% of total assets at December 31, 1997, as compared to 8.1% at December 31, 1996. 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 1997 and 1996, 25.7% and 40.6% of net income was paid out in dividends, respectively. As detailed in the Consolidated Statement of Changes in Stockholders' Equity and discussed in Footnote 2, the Company had two stock dividends. The Company paid a one percent stock dividend in July, then in September it effected a 100% stock dividend. The one percent stock dividends resulted in 13,054 shares while the stock split increased common shares outstanding by 1,373,282 additional common shares outstanding. For the year ended December 31, 1997, the total number of common shares outstanding was 2,746,564. For comparative purposes, outstanding shares for prior periods were adjusted for the 1997 stock dividends 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 14 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 availability of funds. The Company's use of funds is shown in the investing activities section of the Consolidated Statement of Cash Flows, 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. 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 were $1,638,000 in 1997, $1,099,000 greater than 1996. Major expenditures in 1997 were $450,000 to purchase, renovate and add parking for the Canton office, as well as major improvements to the Gillett, Sayre and Wellsboro offices; $958,000 for the software and hardware needed to implement the new Jack Henry system and associated networking costs ($193,000 for the IBM AS/400 was financed by a capital lease through IBM). These purchases will allow greater operating efficiency and provide the customer with a higher quality product. In 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 and community office that has been in the early planning stages for more than seven years. Management anticipates that the construction will begin in late 1998 with a total current estimated cost of approximately $3.5 million. <50> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ 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. 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. Interest Rate and Market Risk 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 and the market value risk of assets and liabilities. Because of the nature of it's operations, the Company is not subject to foreign currency exchange or commodity price risk and, since the Company has no trading portfolio, it is not subject to trading risk. Currently the Company has equity securities that represent only 1.8% of its investment portfolio and, therefore, equity risk is not significant. 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 1/2 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, 1997 (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 $ 4,653 $ 8,913 $ 33,969 $ 33,901 $ 4,392 $ 2,977 $ 88,805 Loans, net of unearned income and deferred loan fees 30,192 58,048 63,126 21,948 13,382 5,352 192,048 Total interest-earning assets $ 34,845 $ 66,961 $ 97,095 $ 55,849 $ 17,774 $ 8,329 $280,853 Interest-bearing demand and savings deposits $ 38,865 $ 13,527 $ 23,781 $ 17,501 $ - $ - $ 93,674 Certificates of deposit 21,744 42,195 56,427 22,704 1,023 - 144,093 Borrowed funds 976 2,537 908 1,007 943 493 6,864 Total interest-bearing liabilities $ 61,585 $ 58,259 $ 81,116 $ 41,212 $ 1,966 $ 493 $244,631 Excess interest-earning assets (liabilities) $(26,740) $ 8,702 $ 15,979 $ 14,637 $ 15,808 $ 7,836 Cumulative interest-earning assets $ 34,845 $101,806 $198,901 $254,750 $272,524 $280,853 Cumulative interest-bearing liabilities 61,585 119,844 200,960 242,172 244,138 244,631 Cumulative gap $(26,740) $(18,038) $ (2,059) $ 12,578 $ 28,386 $ 36,222 Cumulative interest rate sensitivity ratio (1) 0.57 0.85 0.99 1.05 1.12 1.15
(1) Cumulative interest-earning assets divided by cumulative interest-bearing liabilities. <51> ___________________________________________________________________________ MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Nineteen hundred ninety-seven Annual Report ___________________________________________________________________________ The previous table and the simulation models discussed below are presented assum ing a decay rate of approximately 20% per year for the savings accounts and NOW accounts (not in the top interest rate tier). Money market investment accounts and NOW accounts in the top interest rate tier are primarily repriced within the first three months. IRA certificates of deposit represent $36.2 million and are subject to being repriced once a year if the individual is over 59 1/2 years of age. The Company projects the 65% of the IRAs are over 59 1/2 and would reprice if interest rates moved up 100 basis points or more. The loan amounts reflect the principal balances expected to be repriced as a result of contractual amortization and anticipated early payoffs. Gap analysis, one of the methods 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, 1997, 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 or the market value of assets and liabilities over the next twelve months. 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. <52> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ Management is aware of the possibility of exposure by banks to a computer problem known as the "Year 2000 Problem" or the "Millennium Bug" (the inability of some computer programs to distinguish between the year 1900 and the year 2000). The Company is in the process of assessing the cost and extent of vulnerability of the Company's computer systems to the problem. Modifications or replacements of computer systems to attain Year 2000 compliance have begun, and the Company expects to attain Year 2000 compliance and institute appropriate testing of its modifications and replacements before the Year 2000 change date. The Company's recent conversion to Jack Henry and Associates for core banking application software and the purchase of a new IBM AS/400 hardware system on which to run the core processing software, has greatly minimized the exposure to these problems as both systems are expected to be compliant. The Company believes that, with modifications to existing software and conversions to new software, the Year 2000 problem will not pose a significant operational problem for the Company. However, because most computer systems are, by their very nature, interdependent, it is possible that non-compliant third party computers could effect the Company's computer systems. The Company has taken steps to communicate with the third parties with whom it deals to coordinate Year 2000 compliance but could be adversely affected if it or the unrelated third parties are unsuccessful. Most of the costs incurred in addressing this problem are expected to be expensed as incurred. The financial impact to the Company of Year 2000 compliance has not been and is not anticipated to be material to the Company's financial position or results of operations in any given year. 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 1997. The last Community Reinvestment Act performance evaluation by the same agency during 1998 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. <53> __________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, left side of page, approximately 2 inches by 1.5 inches] ___________________________________________________________________________ FIRST CITIZENS NATIONAL BANK - COMMUNITY BANKING HOURS ___________________________________________________________________________ Nineteen hundred ninety-seven Annual Report ___________________________________________________________________________ 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 CANTON* M,T,W,Th: 8:30 am - 4:30 pm Fri.: 8:30 am - 6:00 pm Sat.:8:30 am - Noon GILLETT 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 WEIS MARKET, WELLSBORO Mon - Fri: 10:00 am - 8:00 pm Sat & Sun: 10:00 am - 4:00 pm * Drive-up opens at 8:00 am <54> ___________________________________________________________________________ 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 DIRECTORS EMERITI Edward Kosa John G. Kuster Robert J. Landy, Esquire Robert G. Messinger Wilber Wagner DIRECTORS Robert E. Dalton Chairman of the Board Bruce L. Adams R. Lowell Coolidge, Esquire Larry J. Croft Mark L. Dalton John E. Novak Carol J. Tama 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 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. Baldwin 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 Joanne W. Marvin Banking Operations Manager Trust and Investment Services Philip A. Prough Trust and Investment Services Officer Jean A. Knapp Trust Administrator Sara J. Roupp Trust Administrator <55> 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. Smith Chairman Anthony D. Fiamingo Chester L. Reed Stephen A. Saunders William J. Waldman Officers Chester L. Reed Assistant Vice President Office Manager Shari L. Johnson Assistant Office Manager Kristina M. Payne Customer Service Counselor BLOSSBURG 717-638-2115 300 Main Street Blossburg, PA 16912 FAX 717-638-3178 Local Board Thomas R. Phinney Chairman Terrance M. Asalone George D. Lloyd Susan M. Signor William D. Zwicharowski 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 D. Thomas Eggler Jerry R. McCaslin Phillip D. Vaughn James A. Wagner Officers Phillip D. Vaughn Assistant Vice President Office Manager L. Abbie Lerch Customer Service Counselor GENESEE 814-228-3201 391 Main Street Genesee, PA 16923 Fax 814-228-3395 Local Board E. Gene Kosa Chairman William R. Austin John K. Hyslip Stephen B. Richard Dennis C. Smoker Officers William R. Austin Assistant Vice President Office Manager Christine M. Miller Customer Service Counselor SAYRE 717-888-6602 306 West Lockhart Street Sayre, PA 18840 FAX 717-888-3198 Local Board Joseph P. Burkhart, Jr. Chairman Blaine W. Cobb, MD J. Robert Elsbree William A. Richetti Officers William A. Richetti Assistant Vice President Office Manager Antoinette G. Tracy Customer Service Counselor TROY 717-297-4131 103 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 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 Officers Jeffrey L. Wilson Assistant Vice President Office Manager Deborah A. Callahan Customer Service Counselor CANTON 717-673-3103 29 West Main Street Canton, PA 17724 FAX 717-673-4573 Local Board Roger C. Graham, Jr. Chairman Lester E. Hilfiger Christopher S. Landis Marilyn I. Scott David L. Wright Office Manager Christopher S. Landis Assistant Vice President GILLETT 717-596-2679 P.O. Box 125 Gillett, PA 16925 FAX 717-596-4888 Local Board Forrest M. Oldroyd Office Manager Helen Kay Shedden Assistant Vice President WEIS MARKET 800-326-9486 201 Weis Plaza Wellsboro, PA 16901 FAX 717-724-1842 Officers Jennifer L. Snyder Assistant Vice President Sales Manager Carol L. Strong Assistant Sales Manager ___________________________________________________________________________ [MAC LOG OMITTED] ___________________________________________________________________________ MAC Money Access Card ___________________________________________________________________________ 24 Hour Automated Teller Blossburg, Mansfield Mansfield University Mansfield WalMart, Weis Market Solders and Sailors Memorial Hospital Wellsboro, Genesee, Ulysses, Sayre Gillett <56> ___________________________________________________________________________ [GRAPHIC OMITTED: Silhoutte 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 21, 1998, 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") on the OTC Bulletin Board 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. Visit our Web Site at www.firstcitizensbank.com. 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-31-1997 DEC-31-1997 6100 243 0 0 24827 63735 64490 189910 2138 294811 256783 3509 5241 3355 0 0 2746 23177 294811 17174 5384 221 22779 11107 11610 11169 210 25 7906 5505 0 0 0 3832 1.40 1.40 4.18 1551 170 0 0 1995 83 16 2138 1365 0 773
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