-----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, VRPj/14oAwgZsbBjDi9HGBjH0L/XmbHbbJhKqTnBTAbChtJNcP6ShnKw0CNdDOEa g7xzq4yds/VMb5J/1tTf4A== 0000739421-99-000003.txt : 19990318 0000739421-99-000003.hdr.sgml : 19990318 ACCESSION NUMBER: 0000739421-99-000003 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990317 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: 99566758 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, 1998 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 our 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 stockholders) of the Registrant, as of March 5, 1999, is estimated to have been approximately $52,660,000. 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, 1999, 2,773,434 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 Stockholders to be held April 20, 1999. Certain information required by Parts II and IV are incorporated by reference to Registrant's Annual Report to Stockholders for the Year Ended December 31, 1998. Citizens Financial Services, Inc. Form 10-K INDEX Part I Page Item 1-Business 1-4 Item 2-Properties 5 Item 3-Legal Proceedings 6 Item 4-Submission of Matters to a Vote of Stockholders 6 Part II Item 5-Market for Registrant's Common Stock and Related Shareholder Matters 7 Item 6-Selected Financial Data 7 Item 7-Management's Discussion and Analysis of Financial Condition and Results of Operations 7 Item 7A-Quantitative and Qualitative Disclosure About Market Risk 8 Item 8-Financial Statements and Supplementary Data 8 Item 9-Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 8 Part III Item 10-Directors and Executive Officers of the Registrant 8 Item 11-Executive Compensation 8 Item 12-Security Ownership of Certain Beneficial Owners and Management 8 Item 13-Certain Relationships and Related Transactions 8 Part IV Item 14-Exhibits, Financial Statement Schedules, and Reports on Form 8-K 9 Signatures 10 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 our Company by means of a merger in which the stockholders of our Bank became stockholders of our 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, our 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 our Bank terminating the Association's separate operations as a savings and loan. On April 20, 1996 our Bank purchased two branch offices of Meridian Bank in Canton and Gillett, Pennsylvania. On October 31, 1996, our Bank opened a branch office in the new Weis supermarket in Wellsboro, Pennsylvania. As of December 31, 1998, our Bank employed 128 full time equivalent employees at our ten banking facilities. We are not dependent upon a few customers, which would cause a material impact on us if their business were lost. We are dependent geographically upon the economic conditions in north central Pennsylvania and western New York. Additional information related to our business and the competition is detailed in the Management's Discussion and Analysis of the 1998 Annual Report to the Stockholders, which information is included at Exhibit 13, hereof and incorporated herein by reference. 1 REGULATION AND SUPERVISION The operations of our Bank are subject to federal and state statutes applicable to banks chartered under our 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 Office of the Comptroller of the Currency ("Comptroller"). The primary supervisory authority of our Bank is the Comptroller, who regularly examines our 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 our business. Our Company is subject to regulation under our Bank Holding Company Act of 1956, as amended (the "Act"), and is registered with the Board of Governors of the Federal Reserve System (AFederal 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 our 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 our Company of more than 5% of the voting stock of any additional bank. Our Company is required by the Act to file annual reports of our operations with the Federal Reserve and of any additional information that the Federal Reserve may require. The Federal Reserve may also make examinations of our Company and any or all of our subsidiaries. Further, under Section 106 of the 1970 amendments to the Act and the Federal Reserve's regulations, a bank holding company and our 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 our Bank, to our bank holding company or to any other subsidiary of our bank holding company. Our Company can not require a condition that the customer not obtain other credit or service from a competitor of ours. Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to our bank holding company or any of our subsidiaries, or investments in the stock or other securities of our bank holding company and on taking of such stock or securities as collateral for loans to any borrower. 2 PERMITTED NON-BANKING ACTIVITIES The Federal Reserve permits our 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. Our Company presently does not engage in any such activities nor does it intend to in the near future. Neither our Company nor our subsidiary anticipates that compliance with environmental laws and regulations will have any material effect on capital expenditures, earnings, or on our competitive position. Our Company is a legal entity, separate and distinct from our Bank. Most of our Company's revenues, including funds available for payment of dividends and for operating expenses, are provided by dividends from our Bank. Certain limitations exist on the availability of our Bank's undistributed net assets for the payment of dividends to our parent without prior approval of our Bank regulatory authorities as further described in Footnote 14 of the 1998 Annual Report to the stockholders, which information is included at Exhibit 13, hereof and incorporated herein by reference. LEGISLATION AND REGULATORY CHANGES 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 our Company and our Bank. Congress has proposed a modernization of the financial services industry. This proposed modernization will have the effect of deregulating and expanding the business activities of financial institutions. These additional activities may include broader insurance powers, securities underwriting activities and equity investments by commercial banks. We cannot predict whether such legislation will be adopted or, if adopted, how such legislation would affect the business of our Company or our Bank. As a consequence of the extensive regulation of commercial banking activities in the United States, the Company's and Bank's business is particularly susceptible to being affected by federal legislation and regulations that may increase the cost of doing business. 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 Footnote 14 of the 1998 Annual Report to the stockholders, which information is included at Exhibit 13, hereof and incorporated herein by reference. We are not aware of any other current specific recommendations by regulatory authorities or proposed legislation, which if it were adopted, would have a material adverse effect upon the liquidity, capital resources, or results of operations, although the general cost of compliance with numerous federal and state laws and regulations does have, and in the future may have, a negative impact on our Company's results of operations. 3 Futher, the business of our Company is also affected by the state of the financial services industry in general. As a result of legal and industry changes, we believe that the industry will continue to experience an increase in consolidations and mergers as the financial services industry strives for greater cost efficiencies and market share. We believe that such consolidations and mergers may enhance our competitive position as a community bank. EFFECT OF GOVERNMENT MONETARY POLICIES The earnings of our Company are and will be affected by domestic economic conditions and the monetary and fiscal policies of the United States government and our 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 our 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 our open market operations in United States securities and through our 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 53 of Management's Discussion and Analysis of the 1998 Annual Report to the Stockholders, which information is included at Exhibit 13, hereof and incorporated herein by reference). 4 Item 2-Properties The headquarters of our Company is located in Mansfield, Pennsylvania. The building contains the central offices of the Company and our Bank. Our Bank also owns eight other banking facilities. All buildings are owned by our 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 Canton, PA 17724 1974 (1997) Main St. Gillett, PA 16925 1970 (1997) The net book value for these properties, as of December 31, 1998 was $5,606,000. 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 50 of the 1998 Annual Report to the Stockholders, 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 our Company's operating costs, however, unlike many industrial companies, substantially all of our Company's assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our 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. 5 Item 3-Legal Proceedings We are not aware of any litigation that would have a material adverse effect on the consolidated financial position of our Company. There are no proceedings pending other than ordinary, routine litigation incidental to the business of the Company and our subsidiary. In addition, no material proceedings are pending or are known to be threatened or contemplated against our Company and our subsidiary by government authorities. Item 4-Submission of Matters to a Vote of Stockholders There were no matters submitted to a vote of security holders in the fourth quarter of 1998. Part II Item 5-Market for the Registrant's Common Stock and Related Shareholder Matters Our 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 21, 35, and 56 of our Company's 1998 Annual Report to the Stockholders which are included in Exhibit 13 hereto. Our Company has paid dividends since, April 30, 1984, the effective date of our formation as a bank holding company. Our 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 stockholders of our Company comes from dividends paid to our Company by our Bank. Therefore, restrictions on the ability of our Bank to make dividend payments are directly applicable to our Company. Under the Pennsylvania Business Corporation Law of 1988, our Company may pay dividends only if, after payment, our Company would be able to pay our debts as they become due in the usual course of our business and its total assets are greater than the sum of our total liabilities. As of March 5, 1999, our Company has approximately 1,479 stockholders of record. Item 6-Selected Financial Data The information required by this item is incorporated by reference to page 35 of the 1998 Annual Report to the Stockholders, 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 - 53 of the 1998 Annual Report to the Stockholders, which information is included at Exhibit 13, hereof and incorporated herein by reference. 6 Item 7A-Quantitative and Qualitative Disclosures About Market Rate Risk The information required by this item 7A is incorporated by reference to pages 50 - 53 of the 1998 Annual Report to the Stockholders, which information is included at Exhibit 13, hereof and incorporated herein by reference. 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 1998 Annual Report to the Stockholders, which information is included at Exhibit 13, hereof and incorporated herein by reference. Financial Statements: Consolidated Balance Sheet as of December 31, 1998 and 1997 Consolidated Statement of Income for the Years Ended December 31, 1998, 1997 and 1996 Consolidated Statement of Changes in Stockholders' Equity for the Years Ended December 31, 1998, 1997 and 1996 Consolidated Statement of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996 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 Stockholders to be held April 20, 1999, 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 Stockholders to be held April 20, 1999, 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 Stockholders to be held April 20, 1999, 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 Stockholders to be held April 20, 1999, is incorporated herein by reference in response to this item. 7 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 1998 Annual Report: Consolidated Balance Sheet as of December 31, 1998 and 1997 Consolidated Statement of Income for the Years Ended December 31, 1998, 1997 and 1996 Consolidated Statement of Changes in Stockholders' Equity for the Years Ended December 31, 1998, 1997 and 1996 Consolidated Statement of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996 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. (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 Stockholders. (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. (i) Employment Agreement between the Company and Richard E. Wilber. (Incorporated by Reference to Exhibit (10) to the Annual Report of Form 10-K for the fiscal year ended December 31, 1998, as filed with the Commission on March 17, 1998.) (ii) Directors Deferred (11) - Computation of Earnings Per Share. (Incorporated by Reference to the 1998 Annual Report to Stockholders, which is included at page 20 of Exhibit 13, hereof and incorporated berein by reference. (13) - Annual Report to Stockholders for the year ended December 31, 1998. (21) - Subsidiaries of Citizens Financial Services, Inc. (27) - Financial Data Schedule 8 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 1998 fiscal year. 9 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 our 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 16, 1999 Date: March 16, 1999 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 16, 1999 Richard E. Wilber, President, Chief Executive Officer, Director (Principal Executive Officer) /s/ Carol J. Tama March 16, 1999 Carol J. Tama, Director /s/ R. Lowell Coolidge March 16, 1999 R. Lowell Coolidge, Director /s/ Rudolph J. van der Hiel March 16, 1999 Rudolph J. van der Hiel, Director /s/ John E. Novak March 16, 1999 John E. Novak, Director /s/ Bruce L. Adams March 16, 1999 Bruce L. Adams, Director /s/ William D. VanEttan March 16, 1999 William D. VanEttan, Director /s/ Larry J. Croft March 16, 1999 Larry J. Croft, Director /s/ John M. Thomas, MD March 16, 1999 John M. Thomas, MD, Director /s/ Mark L. Dalton March 16, 1999 Mark L. Dalton, Director /s/ Thomas C. Lyman March 16, 1999 Thomas C. Lyman, Treasurer (Principal Financial and Accounting Officer) 10 EXHIBIT INDEX (3)(i) - Articles of Incorporation of the Corporation, as amended. (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 Stockholders. (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. (i) Employment Agreement between our Company and Richard E. Wilber. (Incorporated by Reference to Exhibit (10) to the Annual Report of Form 10-K for the fiscal year ended December 31, 1998, as filed with the Commission on March 17, 1998.) (ii) Directors Deferred (11) - Computation of Earnings Per Share. (Incorporated by Reference to the 1998 Annual Report to Stockholders, which is included at page 20 of Exhibit 13, hereof and incorporated berein by reference. (13) - Annual Report to Stockholders for the year ended December 31, 1998. (21) - Subsidiaries of Citizens Financial Services, Inc. (27) - Financial Data Schedule 11 EX-3 2 EXHIBIT 3 (i) AMENDED AND RESTATED ARTICLES OF INCORPORATION CITIZENS FINANCIAL SERVICES, INC. FIRST. The name of Corporation is Citizens Financial Services, Inc. SECOND. The address of the Corporation's registered office in the Commonwealth of Pennsylvania is: 15 South Main Street Mansfield, Pennsylvania 16933 THIRD. The corporation was incorporated on April 30, 1984, under the provisions of the Business Corporation Law of the Commonwealth of Pennsylvania (Act of May 5, 1933, P.L. 364, as amended). The purpose of the Corporation is and it shall have unlimited power to engage in and do any lawful act concerning any or all lawful business for which corporations may be incorporated under the provisions of the Business Corporation Law of the Commonwealth of Pennsylvania. FOURTH. The aggregate number of shares, classes of shares and par value of shares that the Corporation has authority to issue is 10,000,000 shares of common stock, par value $1.00 per share. FIFTH. The term of the Corporation's existence is perpetual. SIXTH. [Intentionally omitted.] SEVENTH. Cumulative voting rights shall not exist with respect to the election of directors. EIGHTH. A. The Board of Directors may, if it deems it advisable, oppose a tender, or other offer for the Corporation's securities, whether the offer is in cash or in securities of a corporation or otherwise. When considering whether to oppose an offer, the Board of Directors may, but it is not legally obligated to, consider any pertinent issues; by way of illustration, but not of limitation, the Board of Directors may, but shall not be legally obligated to, consider any and all of the following: (1) Whether the offer price is acceptable based on the historical and present operating results or financial condition of the Corporation. (2) Whether a more favorable price could be obtained for the Corporation's securities in the future. (3) The impact which an acquisition of the Corporation would have on its employees, depositors and customers of the Corporation and its subsidiaries in the community which they serve. (4) The reputation and business practices of the offeror and its management and affiliates as they would affect the employees, depositors and customers of the Corporation and its subsidiaries and the future value of the Corporation's stock. (5) The value of the securities, if any, which the offeror is offering in exchange for the Corporation's securities, based on an analysis of the worth of the Corporation as compared to the corporation or other entity whose securities are being offered. (6) Any antitrust or other legal and regulatory issues that are raised by the offer. B. If the Board of Directors determines that an offer should be rejected, it may take any lawful action to accomplish its purpose including, but not limited to, any and all of the following: advising shareholders not to accept the offer; litigation against the offeror; filing complaints with all governmental and regulatory authorities; acquiring the authorized but unissued securities or treasury stock or granting options with respect thereto; acquiring a company to create an antitrust or other regulatory problem for the offeror; and obtaining a more favorable offer from another individual or entity. NINTH. The Directors shall be divided into three (3) classes, as nearly equal in number as possible, known as Class 1, consisting of not more than eight (8) Directors; Class 2, consisting of not more than eight (8) Directors; and Class 3, consisting of not more than nine (9) Directors. The initial Directors of Class 1 shall serve until the third (3rd) annual meeting of shareholders. At the third (3rd) annual meeting of the shareholders, the Directors of Class 1 shall be elected for a term of three (3) years and, after expiration of such term, shall thereafter be elected every three (3) years for three (3) year terms. The initial Directors of Class 2 shall serve until the second (2nd) annual meeting of shareholders. At the second annual meeting of the shareholders, the Directors of Class 2 shall be elected for a term of three (3) years and, after the expiration of such term, shall thereafter be elected every three (3) years for three (3) terms. The initial Directors of Class 3 shall serve until the first (1st) annual meeting of shareholders. At the first (1st) annual meeting of the shareholders the Directors of Class 3 shall be elected for a term of three (3) years and, after the expiration of such term, shall thereafter be elected every three (3) years for three (3) year terms. Each director shall serve until his/her successor shall have been elected and shall qualify, even though his/her term of office as herein provided has otherwise expired, except in the event of his/her earlier resignation, removal or disqualification. 2 TENTH. The Board shall consist of not less than five nor more than twenty-five shareholders, the exact number within such minimum and maximum limits to be fixed and determined from time to time by resolution of a majority of the full Board or by resolution of the shareholders at any meeting thereof; provided, however, that a majority of the full Board of Directors may not increase the number of directors to a number which; (i) exceeds by more than two, the number of directors last elected by shareholder, (ii) in no event shall the number of directors exceed twenty-five. ELEVENTH. Any directorship to be filled by reason of an increase in the number of directors may be filled by the Board of Directors. The Board of Directors shall specify the class in which a director so elected shall serve. Any director elected by the Board of Directors shall hold office only until the next annual meeting of the shareholders and until his successor shall have been elected and qualified, notwithstanding that the term of office of the other directors in the class of which he is a member does not expire at the time of such meeting. His successor shall be elected by the shareholders to a term of office which shall expire at the same time as the term of office of the other directors in the class to which he is elected. TWELFTH. Commencing with the annual meeting of shareholders of 1984, no person shall be eligible to be newly elected or appointed as a Director as he/she shall have attained the age of sixty-eight (68) years on or prior to December 31 of the year prior to the date of his/her election. THIRTEENTH. No shareholder of this Corporation shall be entitled to preemptive rights and preemptive rights shall not exist with respect to shares or securities of this Corporation. FOURTEENTH. The Corporation shall have authority to borrow money and the Board of Directors, without the approval of the shareholders and acting within their sole discretion, shall have the authority to issue debt instruments of the Corporation upon such terms and conditions and with such limitation as the Board of Directors deems advisable. The authority of the Board of Directors shall include, but not be limited to, the power to issue convertible debentures. FIFTEENTH. A. To the extent permitted by Section 410 of the Pennsylvania Business Corporation Law, and any amendments thereto, and sections relating thereto, including the Directors' Liability Act, subject to Federal regulatory restrictions, the Board of Directors of the Corporation shall cause the Corporation to indemnify any person who was or is threatened to be made a party to any threatened, pending, or completed actions, suit, or proceeding, whether civil, criminal, administrative, or investigative by reason of the fact that he or she is or was a director, officer, employee or agent of the Corporation against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him or her in connection with such action, suit, or proceeding, including any amount paid to the institution itself as a result of an action or suit by or in the right of the Corporation. 3 To the extent permitted by law, the Board of Directors of the Corporation shall cause the Corporation to purchase and maintain insurance on behalf of any person who is or was against any liability asserted against him or her and incurred by him or her in any such capacity, and arising out of his or her status as such. B. A director of the Corporation shall not be personally liable for monetary damages as such for any action taken, or any failure to take any action, unless: (1) the director has breached or failed to perform the duties of his or her office under Section 8363 of the Directors' Liability Act (relating to standard of care and justifiable reliance); and (2) the breach or failure to perform constitutes self-dealing, willful misconduct or recklessness. Exception The provisions of this section shall not apply to: (1) the responsibility or liability of a director pursuant to any criminal statute; or (2) the liability of a director for the payment of taxes pursuant to local, State or Federal law. SIXTEENTH. No merger, consolidation, liquidation or dissolution of the Corporation nor any action that would result in the sale of other disposition of all or substantially all of the assets of the Corporation shall be valid unless first approved by the affirmative vote of the holders of at least sixty-six and two-thirds percent (66 2/3%) of the outstanding shares of Common Stock. This Article may not be amended unless first approved by the affirmative vote of the holders of at least sixty-six and two-thirds percent (66 2/3%) of the outstanding shares of Common Stock. 4 EX-10 3 EXHIBIT 10 (ii) CITIZENS FINANCIAL SERVICES, INC. DIRECTORS' DEFERRED COMPENSATION PLAN CITIZENS FINANCIAL SERVICES, INC. DIRECTORS' DEFERRED COMPENSATION PLAN ARTICLE I DEFINITIONS 1.01 Administrator: The administrator appointed to administer the Plan. 1.02 Board: The Board of Directors of Citizens Financial Services, Inc. 1.03 Code: The Internal Revenue Code of 1986, as amended, or as it may be amended from time to time. 1.04 Compensation: All of a Participant's fees, earnings or compensation which is actually paid to him/her during the Plan Year. 1.05 Director: An individual who is a member of the Board of Directors of First Citizens National Bank, as elected in accordance with the bylaws of the Bank, Citizens Financial Services, Inc. or any subsidiary and/or affiliated corporation. 1.06 Effective Date: January 1, 1991. 1.07 Employer: First Citizens National Bank, Citizens Financial Services, Inc. and any subsidiary and/or affiliated corporation 1.08 Participant: A Director participating in the Plan. 1 1.09 Plan: The Citizens Financial Services, Inc. Directors' Deferred Compensation Plan. 1.10 Plan Year: The twelve (12) consecutive month period beginning each January 1 and ending on December 31. 1.11 Retirement Date: As designated in the Articles of Association or By-Laws of Citizens Financial Services and affiliated corporations. 1.12 Valuation Date: The last day of each Plan Year. 2 ARTICLE II ELIGIBILITY 2.01 Only those Directors, as defined in section 1.05, shall be eligible to participate in this Plan. Those Directors deemed eligible to participate shall be so notified. A Director electing to participate in this Plan shall notify the Board by filing a written notice with the Board, in the form so prescribed by the Board. Such Director shall become a Participant on the first day of the Plan Year (each January 1) following his/her election to participate. 2.02 In addition, any individuals who are on the Board of Directors of an institution or corporation which is absorbed or acquired by the Employer sponsoring this Plan shall also become Participants in this Plan on the day that such acquisition becomes effective, subject to approval by the Board. 3 ARTICLE III CONTRIBUTIONS 3.01 The Plan and the benefits thereunder shall be unfunded at all times. A bookkeeping account shall be established and maintained for each Participant to which will be credited the fee amounts that each Participant elects to defer. The benefits payable under the Plan shall be paid by the Employer, when due under the terms of the Plan, out of its general assets. 3.02 A limit on the amount of deferrals may be established by the Board and shall be subject to the sole discretion of the Board. Deferrals shall be limited such that when aggregated with Compensation paid to any one Participant the generally accepted rules of "reasonableness of compensation" will be observed. Thus the amount of Compensation paid during the Plan Year shall not exceed the value of services performed. In determining whether Compensation is "reasonable" the value of the services rendered in earlier years shall be taken into consideration. The test of reasonableness shall be whether the total payments in the current Plan Year plus all Compensation paid in earlier years represents a reasonable allowance for all services rendered up to the end of the current Plan Year. 3.03 The Employer shall pay all the administrative expenses of the Plan so long as the Plan remains in effect. 3.04 A Participant may elect to deter all or a portion of his/her future monthly Director's fees. Such election must be in writing and filed with the Administrator prior to the first day of the Plan Year for Directors in office and prior to the date their term begins for Directors elected to fill vacancies and who were not Directors on the preceding December 31. 3.05 An election to defer Director's fees shall continue from year to year unless the Participant terminates it in accordance with section 3.06. 3.06 An election by a Director to defer fees may be terminated by written request to the Administrator. In the event of such termination the amount already deferred by the Participant shall not be paid to such Participant until the occurrence of one of the events enumerated in section 4.03. 4 ARTICLE lV BENEFITS 4.01 The amount of the benefit payable under the Plan shall be equal to that benefit which can be purchased with the funds in the Participant's account. 4.02 The benefit payable to or on behalf of a Participant as determined under section 4.01 shall be paid in the form as decided upon by the Board, in its sole discretion, upon the occurrence of one of the events enumerated in Section 4.03. Under no circumstances shall a benefit payout period exceed the life expectancy of the Participant or the Participant and his or her spouse. 4.03 Benefits due under the Plan shall be distributed upon the occurrence of one of the following events: (a) the Participant's attainment of his/her Retirement Date; (b) the disability of the Participant; (c) the death of the Participant; (d) the "hostile" acquisition of the Employer by another institution; or (e) the termination of the Participant as a Director. 4.04 Benefits payable under the Plan shall be paid by the Employer from the general assets of the Employer and charged against the Account maintained with respect to the benefits of such Participant. No payment shall be made to or with respect to a Participant to the extent that such payment would exceed the balance then remaining in the Account maintained with respect to the benefits of such Participant. 4.05 A Participant has the right to designate a Beneficiary to receive any benefits under the Plan because of the death of the Participant before retirement and to change that designation from time to time. 4.06 The Plan shall provide a death benefit to the Beneficiary of a Participant who dies before reaching his/her Retirement Date. Such benefit shall be equal to the benefit thus accrued under the Plan for such Participant at the time of death. 4.07 In the event that a Participant incurs a long-term disability, as defined below, he/she Shall be entitled to a benefit equal to the benefit thus accrued under the Plan. Disability means the inability to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that can be expected to last for a continuous period of not less than twelve (12) months. The permanence and degree of such impairment shall be supported by medical evidence. 5 ARTICLE V ADMINISTRATION 5.01 The Administrator shall have such powers and duties as are necessary for the proper administration of the Plan, including, but not limited to, the power to make decisions with respect to the application and interpretation of the Plan. 5.02 The Administrator shall be entitled to rely on the advice or opinion of any consultant, accountant or attorney and such persons may also act in their respective professional capacities as advisors to the Employer. 5.03 Subject to the limitations contained in the Plan, the Administrator shall be empowered from time to time, at its discretion, to establish rules for the transaction of its business and for the administration of the Plan. 5.04 The Administrator shall be responsible for filing any returns, reports or documents with the various government agencies, such as the Internal Revenue Service, as required by law or the regulations. In addition, the Administrator shall also be responsible for providing communication to Participants as required by law or the regulations. 5.05 On each Valuation Date, or as soon as practicable thereafter, the Administrator shall furnish to each Participant and retired Participant a statement reflecting the status of his/her account, including interest credited thereto, as of the end of such Plan Year. 5.06 Upon the occurrence of one of the events enumerated in section 4.03 of the Plan, the Administrator shall begin payment of benefits to such Participant, or such Participant's Beneficiary, from the Employer's general assets in the form prescribed in section 4.02 until such Participant's account is exhausted. 5.07 Claims: The Administrator shall make each claim determination in a uniform and non-discriminatory manner. Within 90 days after the receipt of the claim by the Administrator, the Administrator shall either grant the claim, deny the claim or notify the Participant, former Participant, or Beneficiary (hereafter "Claimant") that special circumstances have required an extension of time for the processing of the claim; such extension not to exceed 180 days from the original notice. 6 Within 30 days after denial of any benefit under the Plan, the Administrator shall give to the Claimant written notice by certified mail, directed to his or her last address of record with the Administrator, of the denial of claim for benefits. The notice shall set forth the specific reason for such denial, shall make specific reference to Plan provisions upon which the denial is based, shall describe any additional material or information necessary for the Claimant to perfect his or her claim and why such material is necessary, and shall advise the Claimant that he or she may file a written appeal of the determination with the Administrator within 60 days after receipt of such notice. In connection with such appeal, the Claimant or his or her duly authorized representative may review pertinent documents and submit issues and comments in writing. Failure of the Claimant to file a written appeal with the Administrator within the allowable 60-day period shall constitute an irrevocable consent by the Claimant to the Administrator's decision denying the benefit claimed, and the Administrator's written notice shall so state. Within 60 days after the filing of the appeal, the Administrator shall notify the Claimant either as to the decision on the appeal or that special circumstances require an extension of time for processing; such extension not to exceed 120 days from the date of the filing of the appeal. If neither the decision nor a notice of extension is furnished within the 60-day period, the claim shall be deemed to be denied on appeal. All notices under this section shall be written in a manner calculated to be understood by Claimant. 7 ARTICLE VI AMENDMENT AND TERMINATION 6.01 While it is the intention of the Employer that this Plan should be permanent and continue to operate, the Employer reserves the right to terminate the Plan, at any time, at its discretion, subject to the approval and consent of the Board. 6.02 The Employer reserves the right to amend the Plan agreement at any time, and from time to time, by appropriate action of the Board and delivery of a certified copy of the amendment to the Administrator. 8 ARTICLE VII MISCELLANEOUS 7.01 Nothing contained in this Plan shall create, or be construed or interpreted to create, any new or additional obligations on the part of the Employer to retain any person in its employ or interfere in any way with the right of the Employer or the Board to discharge any Director. 7.02 Should any provision of this Plan be determined by a court of competent jurisdiction to be unlawful or unenforceable, such determination shall not adversely affect the remaining provisions of this Plan, unless it shall make impossible the maintenance or operation of the Plan for its intended purpose. To the extent any provision of this Plan is determined to be unlawful or unenforceable, this Plan shall be construed to be carried out to the fullest 7.03 This Plan may be executed in any number of counterparts, each of which shall be considered an original and said counterparts shall constitute by one and the same instrument, 7.04 The Plan at all times shall be entirely unfunded and no provision shall at any time be made with respect to segregating any assets of the Employer for payment of benefits hereunder. No Participant, Beneficiary or any other person shall have any interest in any particular assets of the Employer by reason of the right to receive a benefit under the Plan and any such Participant, Beneficiary or other person shall have only the rights of a general creditor of the Employer with respect to any rights under the Plan. Nothing contained in the Plan shall constitute a guarantee by the Employer or any other entity or person that the assets of the Employer will be sufficient to pay any benefit hereunder. 7.05 No benefit payable under the Plan shall be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance or charge prior to actual receipt thereof by the payee. Any attempt to do so shall be void and the Employer shall not be liable for or subject to the debts, contract, liabilities or torts of any person entitled to any benefit under the Plan. 7.06 In the event a Participant ceases to be a Director and becomes a director, proprietor, officer, partner, employee or otherwise becomes affiliated with any business that is in competition with the Employer, the entire balance of such Participant's account, including interest, if directed by the Board, and in its sole discretion, shall be subject to forfeiture. 9 Furthermore, a Participant will achieve a nonforfeitable interest in his or her benefit only as such benefit becomes payable as determined by the form of payment designated by the Board (section 4.02). If a terminated Participant should become a director, proprietor, officer, partner, employee or otherwise becomes affiliated with any business that is in competition with the Employer, the balance of such Participant's benefit not yet paid out shall be subject to forfeiture at the discretion of the Board. 7.07 The benefits of individuals (Directors) who are Participants in the Directors' Deferred Compensation Plan of First citizens National Bank or the Deferred Compensation Plan - Directors' Fees of Star Savings and Loan Association on or before December 31, 1990, shall in no way be subject to reduction or attachment due to a change in the ownership or ownership makeup of First Citizens National Bank or Star Savings and Loan Association which is effective on or after December 31, 1990. IN WITNESS WHEREOF, the individuals have hereunto set their hands and have caused this instrument to be executed by the Employer. CITIZENS FINANCIAL SERVICES, INC. Employer December 17, 1991 /s/ Richard E. Wilber Date Richard E. Wilber 10 EX-13 4 EXHIBIT 13 ANNUAL REPORT OF SHAREHOLDERS CITIZENS FINANCIAL SERVICES INCORPORTAED - -------------------------------------------------------------------------------- [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, bottom center of page, approximately 1 inch length by 1.5 inches wide] - -------------------------------------------------------------------------------- Relationships... Shareholders Customers Community Employees our building blocks for the future 1998 Annual Report <1> ________________________________________________________________________________ [GRAPHIC OMITTED: Watermark silhouette of colonial rider on horseback] - -------------------------------------------------------------------------------- [GRAPIC OMITTED: Design of building blocks with the words, shareholders, customers, community and employees printed in some of the blocks, across middle of page] ________________________________________________________________________________ To our Shareholders, Customers and Employees: Vision - it is essential for survival. It is spawned by faith, sustained by hope, sparked by imagination, and strengthened by enthusiasm. It is greater than sight, deeper than a dream, broader than an idea. Vision encompasses vast vistas outside the realm of the predictable, the safe, the expected.* *As quoted by Zig Ziglar in Breaking Through to the Next Level, page 62, Honor Books, copyright 1998. First Citizens National Bank is embracing the new millennium. Unlike dreamers who talk of grandiose plans of what they will do tomorrow or the next day with no foundation on which to build, First Citizens National Bank's foundation is firm and our vision is clear. Our relationships with each of you are our building blocks. Technology, information and our intense desire to serve our customers is the cement that holds these relationships together. Our vision for the new millennium addresses the needs of each of you - our customers, our community, our employees and our shareholders. <2> ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of the Corporation's President, top left side of page, approximately 5 inches length by 3 inches wide] ___________________________________________________________________________ "1998 brought exciting changes..." ___________________________________________________________________________ financial performance Before discussing the future in more detail, I would like to report on the accomplishments of 1998, and highlight our record setting performance. Our total assets surpassed $300 million to reach a new high of $313.6 million - - representing growth of $18.8 million or 6.4%. Total deposits grew $17.4 million (6.8%), while loans increased $13.7 million (7.2%). Of particular importance, loans totaling $90 million were granted in 1998 as compared to $69 million, $75 million, and $50 million in 1997, 1996 and 1995 respectively. Even though loan demand stood at an all time high, non-performing assets (non-accrual loans, loans past due 90 days or more and foreclosed assets held for sale) were $2.4 million at year end 1998 versus $2.0 million one year prior. Our high quality loan portfolio is also reflected by the fact that net loan charge-offs were $64 thousand in 1998 compared to $67 thousand in 1997. Our reserve for possible loan losses grew 7.2% to $2.3 million and represents 1.11% of total loans (the same percentage as year-end 1997). Net income for 1998 totaled $3.5 million, compared to $3.8 million in 1997. These years are difficult to compare because of some very unusual revenues and expenses. In 1997, as you know, we benefited significantly by an arbitration award. Had it not been for this non-recurring revenue, our net income would have approximated $3.2 million. During 1998, we also experienced unusual revenues and expenses, most notably $457 thousand in securities gains. This was offset somewhat by a $213 thousand prepayment charge to extinguish long-term borrowings from the Federal Home Loan Bank in Pittsburgh. Had it not been for these, our 1998 net income would have approximated $3.3 million. Total stockholders' equity grew $2.7 million (10.3%) to $28.6 million. Cash dividends declared in the fourth quarter 1998 were 13.5 cents (a 54 cents annualized rate) versus 12.5 cents (a 50 cents annualized rate) in the comparable quarter of 1997 - an 8% increase. operating and strategic initiatives The year 1998 brought exciting challenges as we introduced our debit card program, saw a significant increase in usage of our automated voice response system and installed a 24-hour ATM in Wellsboro. In addition, considerable resources were devoted to the Year 2000 (Y2K) challenge. Among our efforts was the engagement of Blair Technology Group to oversee our comprehensive Y2K program. In addition, our Jack Henry software system and the IBM AS/400 hardware was successfully tested in November 1998. Other important ancillary systems were also identified and became the next focus of attention to assure our readiness for January 1, 2000. We believe we have this challenge well in-hand and do not expect to encounter any significant disruptions. Another major step forward was the engagement of Dearden, Maguire, Weaver and Barrett as the professional investment advisory source for our Trust and Investment department. This partnership has been very beneficial both in terms of enhancing the professional research and investment evaluation underlying our asset management, as well as proving to be cost effective. We are optimistic that significant growth can be achieved through continued customer awareness of this program. As we look toward the next decade, we see continued changes occurring due to the increased expectations of our customers, employees, communities and shareholders. As a result, we have established objectives to fulfill the expectations and to strengthen our relationships with each of these four groups. In setting strategies for 1999 and beyond, we must constantly ask whether we have what it takes to continue our successes. In mid-1998, we launched a new effort to strengthen our capabilities. One of the first efforts was to enhance our knowledge of the marketplace we serve and to identify the changing desires of our customers. As a result, we are streamlining the processes in our community offices so employees can use their sales skills to build customer relationships. <3> ___________________________________________________________________________ "There is a great sense of fulfillment as we capitalize on opportunities..." ___________________________________________________________________________ Strengthening leadership skills at all levels in our organization, we are drawing upon the talents of a very supportive and committed team of employees. We are working with our employees to ensure that each is aligned with the strategic goals of our corporation and we are providing incentives to employees for the successful achievement of such goals. Of great importance, too, is for us to be viewed as being more sensitive to our communities than other financial services providers, as well as being the customer's "provider of choice" for all financial needs. We are well underway toward implementing these efforts and expect full implementation by the third quarter of 2000. Employees have been very supportive and seem eager to "step up" to this challenge. I have great optimism as we prepare to meet these new challenges head on. human resources While long term success is dependent on many variables, clearly one variable is highly dedicated and skilled people. We are very fortunate to have this at all levels of our corporation - employees and local board members, as well as corporate board members. Let me highlight just a few examples of the commitment by employees. During 1998, 69 employees attended 151 seminars, schools or conferences. In addition, 71 employees utilized a weekly video tape service to enhance their skills and knowledge of banking issues. Two employees, Paula Bellows and Gina Boor, were specially recognized because they viewed every video, requiring a commitment of nearly 110 hours of their personal time. Although no changes occurred in corporate board members, we were pleased to welcome two new local board members. Michael Yanuzzi, part owner and operator of his family business, Yanuzzi Restaurant in South Waverly, New York, joined the Sayre local board. William Watkins, who owns Hess Farm Equipment with his wife Barb, joined the Canton local board. Both bring a real sense of community and business knowledge to their respective local boards, and will assist us greatly in serving our customers and the needs of each marketplace. building program In recent weeks, we were fortunate to acquire a two-acre parcel of land adjacent to the Wal-Mart store south of Mansfield. This parcel houses a relatively new and nicely constructed 6,000 square foot building facility. Use of the building will allow us to eliminate the two rented facilities currently housing 18 employees. Furthermore, it will afford us plenty of room to locate employees by workgroups, improving efficiency and reducing disruptions caused by distance. We expect to add to this facility to accommodate our data processing and operations departments. Tentative plans call for the main office building in the center of Mansfield to undergo some much needed renovation. The exterior will undergo changes to make it appear more aesthetically pleasing. The changes will improve energy efficiency and reduce maintenance cost. The interior will change dramatically - - not only due to the "facelift" but also because we will enhance customer service, offer opportunities to demonstrate new services and significantly improve the area where lending, trust and investment and banking services are available. We are excited about the recent developments on this project and will have much more information to share with you in our first quarter financial report for 1999 and our annual meeting in April. conclusion Each year seems to be characterized by noticeable successes, as well as unique challenges. Your board of directors with the support of each local board and all employees are committed to finding opportunities within the never-ending challenges. There is a great sense of fulfillment when capitalizing on such opportunities extends the successful record we have enjoyed over the years. As a final thought, I have found shareholders to be great ambassadors of this corporation. Such shareholder loyalty and support are instrumental to our success. Please continue to encourage others to utilize First Citizens National Bank whenever the opportunity arises. Sincerely, /s/ Richard E. Wilber Richard E. Wilber President <4> ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of First Citizens National Bank's MasterMoney Card, left middle of page, approximately 2 inches length by 3.25" wide] ___________________________________________________________________________ [GRAPHIC OMITTED: personal computer address line in which the location reads http://www.firstcitizensbank.com/, near bottom right of page, approximately one-half inch length by 5 inches wide] ___________________________________________________________________________ "First Citizens completed internal Year 2000 testing of its systems in November 1998..." ___________________________________________________________________________ Our Relationship with our Customers Builds Trust and Confidence First Citizens National Bank is not passively waiting for the future to dictate the materials used to build our customers' trust and confidence. Aggressively implementing new ideas and technologies, the bank's leaders are meeting the changing habits and needs of First Citizens' customers. With the increased pace of life and all the new technologies available, our customers needed more immediate access to our banking options. Early in 1998, First Citizens customers began to actively use our new Bank-by-Phone service. Our customers are able to access their accounts 24 hours a day by dialing 1-888-HLP-FCNB. Regardless of a customer's schedule, information on their accounts is available when they need it. Because customers want more convenient, yet secure, ways to access their accounts, First Citizens also launched its MasterMoney card. Our customers use this combination ATM/debit card in place of cash or checks at over 14 million locations worldwide where the MasterCard logo is displayed. As of the end of 1998, nearly 2,500 First Citizens customers carried the MasterMoney card. This enthusiastic response translated into an average of 3,633 transactions per month. Another service First Citizens implemented to meet the individual needs of our customers was to premiere Phase I of the First Citizens website. This informational site is just the beginning of our vision for an interactive, community centered resource. Currently, our website offers financial news, lending rates, a mortgage calculator and a variety of links to financial organizations such as the IRS, the FDIC and the Pennsylvania Bankers Association. Embracing the growth in Internet use, First Citizens plans to pursue the incorporation of PC banking as part of our website offerings. With an estimated increase in on-line banking usage to 21% by the year 2000, PC banking is one way to reach more customers and increase our service offerings to our existing customers. We anticipate that our account holders will be able to view their accounts, make transfers between eligible First Citizens accounts, request copies of statements and more. Our web vision extends past the predictable as we endeavor to incorporate other community addresses to create a one-stop local site that feeds all of the information needs of our customers. Links to local Chamber of Commerce and borough sites would include areas for community events, church schedules, births, news, banking services, sporting events, shopping, advertising, school closings, etc. Watch for our progress at our address above. <5> ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of the Philip Prough, Trust and Investment Services Officer with customer Maurice Harman, bottom right third of page, approximately 3.5 inches length by 5 inches wide] ___________________________________________________________________________ Customer Maurice Harman reviews investment information with Trust and Investment Services Officer Philip Prough ___________________________________________________________________________ "I wanted something local" Maurice Harman served as controller at Ward Manufacturing in Blossburg for 24 years. He wanted to be sure that after his retirement, he had easy access to his investments. So, he set up a self-directed IRA at First Citizens. "I felt I wanted something in the area - something local," said Herman, who began dealing with the First Citizens' Trust and Investment Services Department in the 1980s. "If I want money transferred, I can just make a local phone call and I'm in business." Harman describes the staff of the Trust and Investment Services Department as "very good, very accommodating." On more than one occasion, they have "come up with suggestions" that helped him get the most out of his investment. ___________________________________________________________________________ Serving our customers has never been more important than with the approach of the Year 2000 (Y2K). Helping our customers become more aware of the Y2K programming issue, First Citizens has been advising our business customers to plan and prepare for the millennium date change. By providing loan assistance, preparation checklists and referral services to our commercial clients, First Citizens is once again branching outside the predictable services offered by a banking institution. Our definition of helping our customers to be successful includes reaching out a helping hand to combat the millennium bug. While assisting our customers to plan and prepare for the millennium change, First Citizens has been conducting its own internal testing for the past two years. In 1997, First Citizens installed Year 2000 compliant core operating software from Jack Henry and Associates (JHA) and hardware systems from IBM. The JHA Silverlake System Software was certified by the Information Technology Association of America (ITAA) on March 16, 1998 while the IBM AS/400 unit received the first-ever Year 2000 certification by ITAA. First Citizens successfully completed internal testing and validation of those primary mission critical systems in November 1998. First Citizens' Trust and Investment Services Division is also a demonstration of our effort to meet the financial needs of our customers. While investment firms are singularly focused, First Citizens' Trust and Investment Services Division cares for our customers' entire financial situation. The volume of financial information now available via the Internet and other sources has the potential to be overwhelming. To use this information to the best advantage, information often needs interpretation and the benefit of experience. In a 1996 Dalbar survey, 83% of investors ranked education as the primary expectation of their financial advisor. Without education and good advice, the financial investments of our customers and our community could be in jeopardy. With Trust, Estate planning, individual and corporate investing services, First Citizens' Trust and Investment Services Division was created as much to inform and educate as to serve our customers. First Citizens feels that solid personal and corporate investing provides the solid foundation on which our community builds and grows. <6> ___________________________________________________________________________ [GRAPHIC OMITTED: photograph of Jim Wagner, Ulysses local board member, bottom left side of page, approximately 3.5 inches length by 3 inches wide] ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of Wagner True Value, a business owned by Jim Wagner, bottom right of page, approximately 1.5 inches by 2.5 inches wide] ___________________________________________________________________________ Jim Wagner pictured (left) in his Coudersport True Value Store, has been a local director for the Ulysses community office for twelve years. Phil Vaughn, Ulysses community office manager, states, "Jim is an excellent representative of First Citizens and is very helpful with customer development. His presence now in Coudersport is a real asset to our community office and its business development effort." Carrying on an 85-year-old business previously owned by his grandfather and father, Jim expanded the Wagner True Value business in Ulysses (below) with the purchase of Frederick True Value Hardware in Coudersport. Jim also finds time for many community activities. He is chairman of the Ulysses Municipal Authority, member of the Allegheny Good Time Singers and he and his wife, Carolyn, are Deacons and choir members of the Ulysses First Baptist Church. ___________________________________________________________________________ "Our commitment to our customers and our community enables us to rise above the competition of larger banks..." ___________________________________________________________________________ Our Relationship with Our Community Builds a Better Place for Everyone to Live Our reputation as a community-driven, hometown bank is the cornerstone of our foundation. In today's climate of mergers and acquisitions, First Citizens continues to solidify its commitment to remain a key community support. Our commitment, along with the active support of our community, allows us to grow and mature as a financial institution, enabling us to rise above the competition of larger corporate banks. As members of the communities we serve, it is First Citizens' responsibility to help our customers succeed through personal and business lending. First Citizens is a flexible lender who does not exclusively use a strict formula to make a lending decision. A one-size-fits-all method of lending would not serve our customers. A First Citizens loan officer looks at alternative methods to make a loan work and to say "yes" to our customers' loan needs. As the new millennium approaches and the information age continues, First Citizens is taking a proactive approach to shoring up its foundation for a strong financial community. Our visioning team embraces the evolution of banking into a broader, customer-driven, financial center. Statistics show that consumers get their financial information from a diverse group of resources such as TV/radio, finance magazines, investment advisors, Internet/on-line services, libraries, reference books and newspapers. Welcome to the First Citizens of the new millennium where we will be a one-stop financial resource. We envision Internet access, a financial library, a meeting place for local business people to gather and plan for the benefit of the entire community. Shared knowledge is the most valuable resource of the new millennium. We encourage and support this principle and want to actively participate by providing a place to encourage the sharing of knowledge. <7> ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of Tim Gooch, Wellsboro local board member, right hand side of page, approximately 4.25 inches length by 2.75 inches wide] ___________________________________________________________________________ Tim Gooch (right) has been a board member for the Wellsboro community office since 1995. Wellsboro office manager, Jeff Wilson, states, "Tim's involvement with the community and its businesses has been a driving force in the business development efforts of the Wellsboro office. His referrals, forward thinking and accounting expertise are an important asset in the continued growth of First Citizens." A certified public accountant and stockholder at the accounting firm, Pennypacker and Gooch, P.C. in Wellsboro, Tim enjoys being involved with First Citizens. "If we can not only become involved but see a chance to improve, we have to seize the opportunity to make ourselves and the bank better," says Tim. "We, as a bank, have to be prepared to be more responsive, more creative, and better prepared to meet our existing and potential customers' needs. Satisfied customers are better than any sales force we can possibly hire at any cost." Tim and his wife, Rhonda, along with their two children are very involved with community events including Tim's service as President of the Wellsboro Area Chamber of Commerce. ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of Don White, Troy local board member, center, left side of page, approximately 3.5 inches by 3 inches wide] ___________________________________________________________________________ Don White (left) has been a local board member for the Troy community office since 1991. Kip Carlson, Troy office manager, says, "Don has been a member of our community for a long time and his reputation as a well respected businessman is unquestioned. We are very fortunate that Don is always prepared to help us in our efforts to grow First Citizens. In fact, I would guess that we receive more referrals for commercial business from Don than from any other source." An accountant, Don has owned and operated his own business since 1979 providing accounting, tax and payroll services to a wide variety of businesses. Don views his involvement with First Citizens as an extension of his business services. "Recommending First Citizens is easy because I know they will do their best to meet the needs of those that I send their way. " Together with his wife, Barbara, Don resides in Troy and is active in numerous community and professional organizations. ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of John Hyslip, Genesee local board member and his son, Jeff, bottom right hand side of page, approximately 2.75 inches length by 3.5 inches wide] ___________________________________________________________________________ John "Jack" Hyslip has been a local board member for the Genesee community office for nearly six years. Bill Austin, Genesee community office manager, states, "Jack is very aggressive in making referrals to First Citizens because he knows that First Citizens is indeed a community bank where customer service is our biggest priority. Jack stops in the office a couple of times a week just to see if there is anything that he can help with. A large deposit and loan customer stated that it was the integrity of Jack Hyslip which brought him to do business with First Citizens." Jack believes and will tell others that at First Citizens, the customer is not a number but an individual. He believes it is this customer service and attention to the customer's individual needs, in a friendly and personal manner, which will continue to bring residents from north of the border to the Genesee office. Jack owns and operates five car washes located in Wellsville, Portville and Olean. He is also active in the wholesaling of used cars. Jack and his wife, Marilyn, reside in Wellsville. He is pictured here with co-owner and son, Jeff. <8> ___________________________________________________________________________ "Our employees take satisfaction in seeing their work play an important part in the success of the community in which they live..." ___________________________________________________________________________ First Citizens' Degrees Earned - American Financial Skylink Education Program Guy Abell, Associates Degree, Paula Bellows, Associates, Bachelors, Masters, 2 Doctorate Degrees, Gina Boor, Associates, Bachelors, Masters, 2 Doctorate Degrees, Irene Douglass, Associates Degree, Paula Johnson, Associates and Bachelor Degrees, Deb Kjellander, Associates Degree, Connie Mattison, Associates Degree, Chris Miller, Associates Degree, Nancy Oldroyd, Associates Degree, Cindy Pazzaglia, Associates and Bachelor Degrees, H. Kay Shedden, Associates Degree ____________________________________________________________________________ Our Relationship with Our Employees is the Foundation on Which We Build Residents of a productive rural area understand that the key to building a better community is the interdependence of its neighbors, its businesses, and its financial institution. Helping to draw all of these players together are the employees of First Citizens National Bank. First Citizens' account managers have a stake in the ongoing financial success of their customers. Our neighbors, our friends, our community leaders are the customers we serve. In an effort to empower our employees to better serve our customers, First Citizens continues to invest in educational opportunities. In 1998, 69 employees attended a combined total of 151 seminars, schools and American Institute of Banking classes. First Citizens also continues to participate in the American Financial Skylink education program. Skylink is presented on video by top professionals in the banking field. Owned and operated by and for bankers, it is the first network of its kind providing the latest and most up-to-date banking information available. To earn various Skylink degrees, employees volunteer their time from 15 to 110 hours to increase their skills in areas such as management, trust, security and risk, lending, human resources, and marketing. It is our employees' professional duty not to tell our customers why it can't be done, but how it can. Every piece of their work, no matter how big or small, is important; they are proud of their work. They want the satisfaction of seeing their work play an important part in our customers' success and the success of the community in which we live. Fifty percent of our employees have been with us for over five years. These experienced employees have a keen understanding of the bank, its services, the community and the customers they serve, providing a solid foundation for our growth. <9> ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of First Citizens National Bank employees being recognized for years of service at the Company's Christmas party, top left and center of page, approximately 3 inches length by 4.5 inches wide] ___________________________________________________________________________ Employees Recognized for Years of Service First row shown from left are: Cindy Estep (15 years), Roxy LeBlanc (20 years), Nancy Stanton (20 years), and Agnes Worden (35 years). Second row: Kristina Payne (10 years), Kim Chaapel (5 years), Mary Brooks (15 years), Cindy Pazzaglia (15 years), and Eileen Page (5 years). Third row: Pam Baldwin (5 years), Jan Pinkney (5 years), Mary Brook (5 years), Chet Reed (10 years), Tom Lyman (10 years), and Guy Abell (5 years). Not pictured are: Paula Bellows (5 years), Randy Black (5 years), Laurie Copas (5 years), Alan Hoover (5 years), Ruth Wilkinson (5 years), Sandy Baker (10 years), Chris Miller (10 years), Bonney Welch (10 years), Shirley Whipple (15 years) and Sherry Cornell (20 years). ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of the Corporation's President presenting a plaque to an employee of the Corporation, left side of page, approximately, 2.5 inches square] ___________________________________________________________________________ Valerie S. Davis - 1998 Employee of the Year. Hired in 1989, Valerie has consistently shown a willingness to work while maintaining her cheerful disposition. As an Assistant Credit Services Manager, Valerie is shown here accepting her plaque from President Dick Wilber, who comments that "Valerie handles all customer contacts with an air of professionalism yet all the while projecting understanding and concern." ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of the Corporation's President presenting a plaque to an employee of the Corporation, center of page, approximately 2.5 inches square] ___________________________________________________________________________ Katie E. Brown - 1998 Employee of the Year. As a Customer Service Counselor I, Katie exhibits outstanding dedication and concern for her customers. She is shown here accepting her plaque from President Dick Wilber, who describes her as have a "desire to serve customers to the fullest." ___________________________________________________________________________ [GRAPHIC OMITTED: Photograph of Jerald Rumsey, Senior Vice President, top right of page, approximately 2 inches square] ___________________________________________________________________________ Senior Vice President Retiring in '99. Jerald J. Rumsey began working for First Citizens' predecessor, the former First National Bank of Mansfield, when he was 23 years old and fresh out of the Marine Corps. He started as a bookkeeper but took on new roles as opportunities arose: head bookkeeper, assistant cashier, and assistant loan officer. When the bank became First Citizens in 1970, Rumsey was named Mansfield branch manager and Assistant Vice President. Rumsey will retire this year at the age of 62, vacating his current position as Senior Vice President and Credit Service Manager. First Citizens total assets are now more than 60 times the size of the holdings of the bank where he began his career. "I've always enjoyed most everything I did." Rumsey says. "The nice part is meeting a lot of people, making a lot of friends." Many changes have swept through the banking industry in the past several decades - compliance and regulatory changes, adjustable rate mortgages, information technology. But Rumsey points to relationships with customers and bank employees as highlights of his career, and he will leave the bank with a high regard for its directors. "Over the years, we've had an excellent board of directors," he says. "Their goal is what it has always been - for the bank to remain independent." Typically, he says, the board has made decisions based on the long-term good of the bank, its customers and employees, rather than trying to turn a quick, short-term profit. ___________________________________________________________________________ <10> Our Relationship with Our Shareholders Builds Security for Our Customers, Our Community and Our Employees First Citizens' financial partners share and support our vision for the future by providing the investment we need to embrace the challenges and opportunities of the new millennium. We currently have 1,477 shareholders and 2,773,434 shares outstanding. Nearly 80% of our shareholders live in the market area served by First Citizens. Our shareholders benefit from direct communication with our directors and employees as well as from our upgraded shareholder service programs. For example, since offering direct deposit for the quarterly cash dividend disbursements in October 1997, over 370 shareholders have participated to date. Also in 1997, First Citizens converted our shareholder accounting process to a new software system allowing more efficient processing and incorporating many new features. Upholding our service ethic, First Citizens also continues to act as its own transfer agent to assure that our shareholders have quick access to answers about their stock holdings. First Citizens' commitment to keeping our bank financially strong is the key to sustaining shareholder confidence and averting the threat of a corporate merger. The success of our financial commitment to our shareholders is reflected by the compound annual return as shown below (the return incorporates all cash dividends and stock dividends over the respective time periods). 20 Years 16.71% 10 Years 16.01% 5 Years 27.63% As always, First Citizens remains alert for new opportunities that may arise within a very challenging financial services business. The relationships we have and continue to build with our customers, our communities, our employees and our shareholders allows us to confidently embrace the new millennium; building upon our solid foundation to create a better and more secure place for all of us to live and work. <11> ___________________________________________________________________________ [GRAPHIC OMITTED: Watermark silhouette of colonial rider on horseback ___________________________________________________________________________ 1998 Annual Report Financial Highlights in thousands, except per share data 1998 1997 Balance Sheet Assets $313,564 $294,811 Deposits 274,193 256,783 Net Loans 203,583 189,910 Investments 93,082 88,562 Stockholders' Equity 28,598 25,923 Statement of Income Interest Income 23,088 22,779 Interest Expense 11,920 11,610 Net Interest Income 11,168 11,169 Net Income 3,489 3,832 Per Share Data Net Income 1.26 1.38 Cash Dividends .520 .355 Trust and Investment Services Trust Assets Managed 69,095 66,104 <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 1994 to 1998. Tabular representation of those graphs are set forth as follows: TOTAL ASSETS (Dollars in Thousands) 1994 1995 1996 1997 1998 $232,537 $247,094 $282,810 $294,811 $313,564 NET INCOME (Dollars in Thousands) 1994 1995 1996 1997 1998 $2,625 $2,834 $3,003 $3,832 $3,489 STOCKHOLDERS' EQUITY (Dollars in Thousands) 1994 1995 1996 1997 1998 $18,903 $21,297 $22,904 $25,923 $28,598 DEPOSITS (Dollars in Thousands) 1994 1995 1996 1997 1998 $194,478 $213,316 $240,177 $256,783 $274,193 NET LOANS (Dollars in Thousands) 1994 1995 1996 1997 1998 $154,848 $159,794 $180,418 $189,910 $203,583 CASH DIVIDENDS PAID (Dollars in Thousands) 1994 1995 1996 1997 1998 $1,056 $1,121 $1,187 $1,596 $1,449] ___________________________________________________________________________ <13> ___________________________________________________________________________ CONSOLIDATED BALANCE SHEET December 31, 1998 and 1997 ___________________________________________________________________________ Nineteen hundred ninety-eight Annual Report ___________________________________________________________________________ (in thousands) 1998 1997 ASSETS: Cash and due from banks: Noninterest-bearing $ 7,175 $ 6,100 Interest-bearing deposits with banks 130 243 Total cash and cash equivalents 7,305 6,343 Available-for-sale securities 93,082 24,827 Held-to-maturity securities (estimated market value 1997,$64,490) - 63,735 Loans (net of allowance for loan losses 1998, $2,292; 1997, $2,138) 203,583 189,910 Foreclosed assets held for sale 529 238 Premises and equipment 5,606 5,754 Accrued interest receivable 2,188 2,426 Other assets 1,271 1,578 TOTAL ASSETS $313,564 $294,811 LIABILITIES: Deposits: Noninterest-bearing $ 20,978 $ 19,016 Interest-bearing 253,215 237,767 Total deposits 274,193 256,783 Borrowed funds 7,334 6,864 Accrued interest payable 2,363 2,331 Commitment to purchase investment securities - 1,981 Other liabilities 1,076 929 TOTAL LIABILITIES 284,966 268,888 STOCKHOLDERS' EQUITY: Common Stock $1.00 par value; authorized 10,000,000 shares in 1998 and 5,000,000 shares in 1997; issued and outstanding 2,773,434 and 2,746,564 shares in 1998 and 1997, respectively 2,773 2,746 Additional paid-in capital 7,913 7,181 Retained earnings 16,934 15,653 TOTAL 27,620 25,580 Accumulated other comprehensive income 978 343 TOTAL STOCKHOLDERS' EQUITY 28,598 25,923 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $313,564 $294,811 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, 1998, 1997 and 1996 ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ (in thousands, except per share data) 1998 1997 1996 INTEREST INCOME: Interest and fees on loans $17,652 $17,174 $15,817 Interest-bearing deposits with banks 290 221 148 Investment securities: Taxable 4,550 5,250 5,238 Nontaxable 492 52 66 Dividends 104 82 72 TOTAL INTEREST INCOME 23,088 22,779 21,341 INTEREST EXPENSE: Deposits 11,482 11,107 10,276 Borrowed funds 438 503 591 TOTAL INTEREST EXPENSE 11,920 11,610 10,867 NET INTEREST INCOME 11,168 11,169 10,474 Provision for loan losses 218 210 205 NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 10,950 10,959 10,269 OTHER OPERATING INCOME: Service charges 1,060 848 844 Trust 362 339 270 Realized securities gains, net 457 25 19 Other 304 246 258 Arbitration settlement 112 994 - TOTAL OTHER OPERATING INCOME 2,295 2,452 1,391 OTHER OPERATING EXPENSES: Salaries and employee benefits 3,848 3,882 3,418 Occupancy 522 519 466 Furniture and equipment 713 706 599 Professional fees 401 219 198 Federal deposit insurance premiums 56 56 372 Other 2,674 2,524 2,297 TOTAL OTHER OPERATING EXPENSES 8,214 7,906 7,350 Income before provision for income taxes and extraordinary item 5,031 5,505 4,310 Provision for income taxes 1,401 1,673 1,307 Income before extraordinary item 3,630 3,832 3,003 Extraordinary item: Loss on extinguishment of debt, net of related taxes of $72 141 - - NET INCOME $ 3,489 $ 3,832 $ 3,003 EARNINGS PER SHARE BEFORE EXTRAORDINARY ITEM $ 1.31 $ 1.38 $ 1.08 EARNINGS PER SHARE $ 1.26 $ 1.38 $ 1.08
See notes to consolidated financial statements. <15> ___________________________________________________________________________ CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 1998, 1997 and 1996 ___________________________________________________________________________ Nineteen hundred ninety-eight Annual Report ___________________________________________________________________________ Accumulated Additional Other (in thousands, Common Stock Paid-in Retained Comprehensive except per share data) Shares Amount Capital Earnings Income Total Balance, December 31, 1995 1,347,323 $1,347 $6,512 $13,089 $349 $21,297 Comprehensive income: Net income 3,003 3,003 Change in net unrealized gain (loss) on securities available-for-sale, net of taxes of $(91) (177) (177) Total comprehensive income 2,826 Stock dividend 12,905 13 316 (329) Cash dividends, $.44 per share (1,219) (1,219) ($.445 per share on a historical basis) Balance, December 31, 1996 1,360,228 1,360 6,828 14,544 172 22,904 Comprehensive income: Net income 3,832 3,832 Change in net unrealized gain (loss) on securities available-for-sale, net of taxes of $88 171 171 Total comprehensive income 4,003 Stock dividend 13,054 13 353 (366) Stock split in the form of a dividend 1,373,282 1,373 (1,373) - Cash dividends, $.355 per share (984) (984) ($.355 per share on a historical basis) Balance, December 31, 1997 2,746,564 2,746 7,181 15,653 343 25,923 Comprehensive income: Net income 3,489 3,489 Change in net unrealized gain (loss) on securities available-for-sale, net of taxes of $327 635 635 Total comprehensive income 4,124 Stock dividend 26,870 27 732 (759) Cash dividends, $.52 per share (1,449) (1,449) Balance, December 31, 1998 2,773,434 $2,773 $7,913 $16,934 $978 $28,598
1998 1997 1996 Components of comprehensive income: Change in net unrealized gain on investment securities available-for-sale $937 $188 $(164) Realized gains included in net income, net of tax (302) (17) (13) Balance, end of year $635 $171 $(177) 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, 1998, 1997 and 1996 ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ (in thousands) 1998 1997 1996 Cash Flows from Operating Activities: Net income $ 3,489 $ 3,832 $ 3,003 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 218 210 205 Provision for depreciation and amortization 761 588 442 Amortization and accretion on investment securities 358 368 362 Deferred income taxes (4) 59 36 Realized gains on securities (475) (25) (19) Realized gains on loans sold (63) (19) (23) Originations of loans held for sale (3,817) (1,152) (1,639) Proceeds from sales of loans held for sale 3,880 1,171 1,662 Gain on sales or disposals of premises and equipment (1) - - Losses (Gains) on sales of foreclosed assets held for sale 2 (10) (50) Decrease (increase) in accrued interest receivable and other assets 436 859 (487) (Decrease) increase in accrued interest payable and other liabilities (147) (40) 253 Net cash provided by operating activities 4,637 5,841 3,745 Cash Flows from Investing Activities: Available-for-sale securities: Proceeds from sales of securities 23,243 5,588 16 Proceeds from maturities of securities 8,786 5,900 2,000 Purchases of securities (35,444) (7,503) (9,682) Held-to-maturity securities: Proceeds from maturities and principal repayments of securities 7,440 7,716 8,108 Purchases of securities (9,445) (12,311) (13,395) Net increase in loans (14,242) (9,914) (17,361) Purchase of loans - - (3,659) Capital expenditures (504) (1,638) (539) Proceeds from sale of premises and equipment 1 - - Proceeds from sale of foreclosed assets held for sale 59 148 285 Property purchased for future expansion - - (250) Deposit acquisition premium - - (1,018) Net cash used in investing activities (20,106) (12,014) (35,495) Cash Flows from Financing Activities: Net increase in deposits 17,410 16,606 9,731 Proceeds from long-term borrowings 956 2,056 1,166 Repayments of long-term borrowings (2,850) (2,146) (1,050) Net increase (decrease) in short-term borrowed funds 2,364 (8,863) 6,846 Dividends paid (1,449) (1,596) (1,187) Deposits of acquired branches - - 17,130 Net cash provided by financing activities 16,431 6,057 32,636 Net increase (decrease) in cash and cash equivalents 962 (116) 886 Cash and Cash Equivalents at Beginning of Year 6,343 6,459 5,573 Cash and Cash Equivalents at End of Year $ 7,305 $ 6,343 $ 6,459 Supplemental Disclosures of Cash Flow Information: Interest paid $11,889 $11,572 $10,680 Income taxes paid $ 1,380 $ 1,645 $ 1,310 Noncash activities: Real estate acquired in settlement of loans $ 351 $ 212 $ 191
See notes to consolidated financial statements. <17> ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ___________________________________________________________________________ Nineteen hundred ninety-eight 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, 1998 and 1997. 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 available-for-sale. 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 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. 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. 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. <19> ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Nineteen hundred ninety-eight Annual Report ___________________________________________________________________________ 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, 1998 and 1997 is $500,000 and $541,000, 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, 1998 and 1997 is $227,000 and $295,000, 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 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. COMPREHENSIVE INCOME Effective January 1, 1998, the Company adopted the Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income". In adopting Statement No. 130, the Company is required to present comprehensive income and its components in a full set of general purpose financial statements. The Company has elected to report the effects of Statement No. 130 as part of the Consolidated Statement of Changes in Stockholders' Equity. NEW ACCOUNTING STANDARDS Employer's Disclosures About Pension and Other Post Retirement Benefits In February 1998, the Financial Accounting Standards Board issued SFAS No. 132 "Employer's Disclosures About Pensions and Other Post Retirement Benefits." This Statement revises employers' disclosures about pension and other post-retirement benefit plans. It does not change the measurement or recognition of those plans. It standardizes the disclosure requirements for pensions and other post-retirement benefits to the extent practicable, requires additional information on changes in the benefit obligations and fair values of plan assets that will facilitate financial analysis, and eliminates certain disclosures that are no longer useful as they were when "FASB Statements No. 87, Employers' Accounting <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. ___________________________________________________________________________ for Pensions, No. 88, Employers' Accounting for Settlement s and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, and No. 106, Employers' Account for Post-Retirement Benefits Other Than Pensions," were issued. This statement requires changes in disclosures and would not affect the financial condition, equity or operating results of the Company. This Statem ent is effective for the fiscal years beginning after December 15, 1997. Accounting for Derivative Instrument and Hedging Activities In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of certain foreign currency exposures. This statement becomes effective for fiscal years beginning after December 15, 1998. Earlier adoption is permitted. The Company adopted SFAS 133 in its fourth fiscal quarter of 1998, including its provision for the potential reclassification of investments, resulting in a $63,585,000 transfer of securities from held-to-maturity to available-for-sale and an increase of $1,152,000 of unrealized gains, net of taxes, on securities available-for-sale. The adoption of this statement did not affect operating results of the Company. PENDING ACCOUNTING STANDARDS Accounting for the Costs of Computer Software Developed or Obtained for Internal Use In March 1998, the Accounting Standards Executive Committee issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." This SOP, which is effective for fiscal years beginning after December 15, 1998, provides guidance on accounting for the costs of computer software developed or obtained for internal use and provides guidance for determining whether computer software is for internal use. The Company will adopt SOP 98-1 in the first quarter of 1999 and does not believe the effect of adoption will be material. 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 2,773,434 for 1998, 1997, and 1996. RECLASSIFICATION Certain of the 1997 and 1996 amounts have been reclassified to conform with the 1998 presentation. Such reclassifications had no effect on net income. <21> ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Nineteen hundred ninety-eight Annual Report ___________________________________________________________________________ 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 prior years have been restated to reflect the stock split. 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 $1,845,000 and $1,314,000 at December 31, 1998 and 1997, 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, 1998 and 1997, were as follows (in thousands): Gross Gross Unrealized Unrealized Estimated Amortized Holding Holding Fair December 31, 1998 Cost Gains Losses Value Available-for-sale securities: U.S. Treasury securities $31,763 $1,000 $ - $32,763 Obligations of state and political subdivisions 18,289 247 (84) 18,452 Corporate obligations 14,818 75 (4) 14,889 Mortgage-backed securities 23,112 67 (66) 23,113 Equity securities 2,271 413 (167) 2,517 Restricted equity securities 1,348 - - 1,348 Total available-for-sale $91,601 $1,802 $ (321) $93,082 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
<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. ___________________________________________________________________________ Proceeds from the sale of securities available-for-sale during 1998, 1997 and 1996 were $23,243,000, $5,588,000 and $16,000, respectively. Gross gains and gross losses were realized on those sales as follows (in thousands): 1998 1997 1996 Gross Gains $475 $34 $19 Gross Losses 18 9 - Net Gains $457 $25 $19 Investment securities with an approximate carrying value of $43,695,000 and $47,457,000 at December 31, 1998 and 1997, 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, 1998, by contractual maturity, are shown below (in thousands). Estimated Amortized Cost Fair Value Available-for-sale securities: Due in one year or less $13,518 $13,639 Due after one year through five years 41,716 42,723 Due after five years through ten years 14,540 14,537 Due after ten years 18,208 18,318 Total $87,982 $89,217 On October 1, 1998, the Company transferred certain held-to-maturity securities to the available-for-sale investment portfolio. The amortized cost of the securities was approximately $63,585,000, gain net of taxes of approximately $1,152,000. This transfer was in accordance with a special reassessment provision contained within Statement of Financial Accounting Standard No. 133, "Accounting for Derivative Instruments and Hedging Activities," which was adopted by the Company on October 1, 1998. 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, 1998 1997 Real estate loans: Residential $127,053 $120,019 Commercial 27,164 27,480 Agricultural 9,266 8,769 Construction 5,234 3,035 Loans to individuals for household, family and other purchases 14,489 13,905 Commercial and other loans 12,457 9,485 State and political subdivision loans 10,272 9,457 205,935 192,150 Less unearned income on loans 60 102 Less allowance for loan losses 2,292 2,138 Loans, net $203,583 $189,910 <23> ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Nineteen hundred ninety-eight Annual Report ___________________________________________________________________________ At December 31, 1998 and 1997, net unamortized loan fees and costs of $818,000 and $856,000, respectively, have been deducted from the carrying value of loans. At December 31, 1998 and 1997, the recorded investment in loans that are considered to be impaired was $859,000, and $382,000, respectively, all of which were on a nonaccrual basis. At December 31, 1998 and 1997, the Company had an impaired loan of $336,000 and $382,000 with an allocation of $60,000 and $40,000 of the allowance for loan losses, respectively. The average recorded investment in impaired loans during the year ended December 31, 1998 and 1997, was approximately $621,000 and $398,000, respectively. For the years ended December 31, 1998 and 1996, the Company recognized interest income on impaired loans of $10,000 and $2,000, respectively, all of which was recognized using the cash basis method of income recognition. For the year ended December 31, 1997, there was no interest income recognized on impaired loans. Loans on which the accrual of interest has been discontinued or reduced amounted to $1,877,000 and $1,551,000 (which included impaired loans) at December 31, 1998 and 1997, respectively. If interest had been recorded at the original rate on those loans, such income would have approximated $298,000, $229,000, and $127,000 for the years ended December 31, 1998, 1997, and 1996, respectively. Interest income on such loans, which is recorded as received, amounted to approximately $89,000, $72,000, and $40,000 for the years ended December 31, 1998, 1997, and 1996, respectively. Transactions in the allowance for loan losses were as follows (in thousands): Years Ended December 31, 1998 1997 1996 Balance, beginning of year $2,138 $1,995 $1,833 Provisions charged to income 218 210 205 Recoveries on loans previously charged against the allowance 48 16 21 2,404 2,221 2,059 Loans charged against the allowance (112) (83) (64) Balance, end of year $2,292 $2,138 $1,995 The following is a summary of the past due and nonaccrual loans as of December 31, 1998 and 1997 (in thousands): December 31, 1998 Past Due Past Due 30-89 days 90 days or more Nonaccrual Real estate loans $1,593 $12 $1,821 Installment loans 203 2 - Credit cards and related loans 22 1 - Commercial and all other loans 32 - 56 Total $1,850 $15 $1,877 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 <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. ___________________________________________________________________________ 6. PREMISES & EQUIPMENT Premises and equipment are summarized as follows (in thousands): December 31, 1998 1997 Land $ 1,198 $ 1,198 Buildings 4,353 4,164 Furniture, fixtures and equipment 5,056 5,263 10,607 10,625 Less accumulated depreciation 5,001 4,871 Premises and equipment, net $ 5,606 $ 5,754 Depreciation expense amounted to $652,000, $479,000, and $370,000 for 1998, 1997, and 1996, respectively. 7. DEPOSITS Certificates of deposit of $100,000 or more amounted to $24,658,000 and $23,960,000 at December 31, 1998 and 1997, respectively. Interest expense on certificates of deposit of $100,000 or more amounted to $1,504,000, $1,420,000, and $1,172,000 for the years ended December 31, 1998, 1997, and 1996, respectively. Following are maturities of certificates of deposit as of December 31, 1998 (in thousands): 1999 $ 66,633 2000 40,244 2001 22,240 2002 12,759 2003 7,944 Thereafter 277 Total certificates of deposit $150,097 8. BORROWED FUNDS Securities Sold Under Other Capital Total Agreements to FHLB Borrowed Lease Borrowed (dollars in thousands) Repurchase(a) Advances(b) Funds(c) Obligations Funds 1998 Balance at December 31 $3,966 $3,208 $ - $ 160 $ 7,334 Highest balance at any month-end 5,217 3,208 1,874 198 10,497 Average balance 4,903 269 1,746 182 7,100 Weighted average interest rate: Paid during year 5.76% 5.47% 7.56% 4.91% 6.17% As of year-end 5.48 4.96 - 4.90 4.23 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 14,923 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
<25> ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Nineteen hundred ninety-eight Annual Report ___________________________________________________________________________ (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, 1998 and 1997, of $5,170,000 and $5,921,000, respectively. (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. 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, 1998 and 1997, approximate carrying value of collateral was $48,722,000 and $18,944,000, respectively. (c) Other borrowed funds consist of separate loans with the FHLB as follows (in thousands): Fixed Rate Maturity December 31, 1997 7.25% May 15, 2000 $ 166 7.40% May 15, 2001 245 7.52% May 15, 2002 229 7.60% May 15, 2003 216 7.56% May 17, 2004 201 7.61% May 16, 2005 188 7.65% May 15, 2006 175 7.68% May 15, 2007 163 7.72% May 15, 2008 151 7.76% May 15, 2009 140 Total borrowed funds $1,874 During 1998, the Company retired these loans with the FHLB prior to their stated maturity. The retirement resulted in the Company incurring a prepayment penalty of $141,000, net of income tax of $72,000, which is reported as an extraordinary item in the Consolidated Statement of Income. Following are maturities of borrowed funds as of December 31, 1998 (in thousands): 1999 $5,348 2000 641 2001 787 2002 558 Total borrowed funds $7,334 <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. ___________________________________________________________________________ 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, 1998, are as follows (in thousands): 1999 $ 35 2000 30 2001 30 2002 30 2003 25 Total minimum lease payments $150 Total rental expense for all operating leases for 1998, 1997, and 1996 amounted to $50,000, $50,000, and $52,000, 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 10,100 and 11,928 shares of the Company's common stock at December 31, 1998 and 1997, respectively. The following table sets forth the change in plan assets and benefit obligation at December 31 (in thousands): 1998 1997 Plan assets at fair value, beginning of year $2,681 $2,243 Actual return on plan assets 433 478 Amendments 1 - Employer contribution - - Benefits paid (51) (40) Plan assets at fair value, end of year 3,064 2,681 Benefit obligation, beginning of year 2,226 1,782 Service cost 144 110 Interest cost 146 126 Amendments 48 248 Benefits paid (51) (40) Benefit obligation, end of year 2,513 2,226 Funded Status 551 455 Transition adjustment (99) (114) Prior service cost (57) (63) Unrecognized net gain from past experience different from that assumed (298) (125) Benefit asset, end of year $ 97 $ 153 <27> ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Nineteen hundred ninety-eight Annual Report ___________________________________________________________________________ Assumptions used in determining net periodic pension cost are as follows: 1998 1997 1996 Discount rate 6.50% 6.50% 7.00% Expected return on plan assets 8.00% 8.00% 8.00% Rate of compensation increase 4.00% 4.00% 4.00% Net periodic pension cost includes the following components (in thousands): 1998 1997 1996 Service cost of the current period $144 $110 $101 Interest cost on projected benefit obligation 146 126 111 Actual return on plan assets (433) (478) (229) Net amortization and deferral 199 277 54 Unrealized gain - - - Net periodic pension cost $ 56 $ 35 $ 37 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 1998, 1997, and 1996 were $128,000, $187,000, and $131,000, 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, 1998 and 1997 there was $112,000 and $110,000, respectively, of credits applied for current expenditures. At December 31, 1998, the Bank had $28,000 in remaining credits. 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, 1998 1997 1996 Currently payable $1,333 $1,614 $1,271 Deferred (benefit) liability (4) 59 36 Provision for income taxes $1,329 $1,673 $1,307 <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 (liability) at December 31, 1998 and 1997 (in thousands): 1998 1997 Deferred tax assets: Allowance for loan losses $596 $544 Deferred compensation 211 201 Loan fees and costs 3 29 Core deposit intangible 37 23 Investment security loss 7 - Total 854 797 Deferred tax liabilities: Unrealized gains on available-for-sale Securities (504) (177) Premises and equipment (298) (235) Bond accretion (94) (86) Prepaid pension cost (33) (52) Foreclosed assets held for sale (11) (10) Total (940) (560) Deferred tax (liability) asset, net $ (86) $ 237 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, 1998 1997 1996 Provision at statutory rates on pre-tax income $1,638 $1,872 $1,465 Effect of tax-exempt income (364) (211) (198) Nondeductible interest 56 27 27 Other items (1) (15) 13 Provision for income taxes $1,329 $1,673 $1,307 Statutory tax rates 34% 34% 34% Effective tax rates 27.6% 30.4% 30.3% Income taxes applicable to realized security gains at December 31, 1998, 1997, and 1996, were $155,000, $9,000, and $1,000, 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 1998 $1,172 $1,753 $ 335 $2,590 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-eight 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 1999 without approval of the Comptroller of the Currency of approximately $2,501,000, plus the Bank's net income for 1999. Loans: The Bank is subject to regulatory restrictions which limit its ability to loan funds to the Company. At December 31, 1998, the regulatory lending limit amounted to approximately $2,843,000. 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, 1998, 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, 1998, 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 capital ratios at December 31 (in thousands): 1998 1997 Amount Ratio Amount Ratio Total capital (to risk-weighted assets) Company $29,296 14.99% $26,867 15.83% For capital adequacy purposes 15,632 8.00% 13,589 8.00% To be well capitalized 19,540 10.00% 16,986 10.00% Tier I capital (to risk-weighted assets) Company $26,893 13.76% $24,744 14.58% For capital adequacy purposes 7,816 4.00% 6,794 4.00% To be well capitalized 11,724 6.00% 10,192 6.00% Tier I capital (to average assets) Company $26,893 8.66% $24,744 8.47% For capital adequacy purposes 12,423 4.00% 11,691 4.00% To be well capitalized 15,529 5.00% 14,613 5.00%
The most recent notification from the Office of the Comptroller of the Currency categorized the Bank as well capitalized under the regulatory framework for corrective action. At <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. ___________________________________________________________________________ December 31, 1998, the Bank's Total capital and Tier I ratios were 13.91% and 12.68%, respectively, and Tier I capital to average assets was 8.16%. At December 31, 1997, the Bank's Total capital and Tier I ratios were 15.75% and 14.50%, respectively, and Tier I capital to average assets was 8.54%. This annual report has not been reviewed, or confirmed for accuracy or relevance, by the Federal Deposit Insurance Corporation. 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, 1998 and 1997, are as follows (in thousands): 1998 1997 Commitments to extend credit $33,039 $21,871 Standby letters of credit 898 548 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, 1998 CARRYING ESTIMATED AMOUNT FAIR VALUE Financial assets: Cash and due from banks $ 7,305 $ 7,305 Available-for-sale securities 93,082 93,082 Net loans 203,583 206,935 Accrued interest receivable 2,188 2,188 Total financial assets $306,158 $309,510 Financial liabilities Deposits $274,193 $276,639 Securities sold under agreements to repurchase 3,966 4,024 Other borrowed funds 3,368 3,159 Accrued interest payable 2,363 2,363 Total financial liabilities $283,890 $286,185 <31> ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Nineteen hundred ninety-eight Annual Report ___________________________________________________________________________ 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 Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions can significantly affect the estimates. Estimated fair values have been determined by the Company using historical data, as generally provided in the Company's regulatory reports, and an estimation methodology suitable for each category of financial instruments. The Company's fair value estimates, methods and assumptions are set forth below for the Company's other financial instruments. Cash and Due From Banks: The carrying amounts for cash and due from banks approximate fair value because they mature in 90 days or less and do not present unanticipated credit concerns. Investment Securities: The fair values of investments are based on quoted market prices as of the balance sheet date. For certain instruments, fair value is estimated by obtaining quotes from independent dealers. Loans: Fair values are estimated for portfolios of loans with similar financial characteristics. The fair value of performing loans has been estimated by discounting expected future cash flows. The discount rate used in these calculations is derived from the Treasury yield curve adjusted for credit quality, operating expense and prepayment option price, and is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Company's historical experience with repayments for each loan classification, modified as required by an estimate of the effect of current economic and lending conditions. <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, 1998 and 1997 (in thousands) 1998 1997 Assets: Cash $ 135 $ 46 Investment in subsidiary, First Citizens National Bank 26,134 25,771 Available-for-sale securities 2,336 141 Other assets 9 1 Total assets $28,614 $25,959 Liabilities: Other liabilities $ - $ 26 Deferred tax liability 16 10 Total liabilities $ 16 $ 36 Stockholders' equity 28,598 25,923 Total liabilities and stockholders' equity $28,614 $25,959 <33> ___________________________________________________________________________ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued ___________________________________________________________________________ Nineteen hundred ninety-eight Annual Report ___________________________________________________________________________ CITIZENS FINANCIAL SERVICES, INC. CONDENSED STATEMENT OF INCOME Years Ended December 31, 1998, 1997, and 1996 (in thousands) 1998 1997 1996 Dividends from: Bank subsidiary $3,801 $1,179 $1,265 Available-for-sale securities 17 1 - Interest-bearing deposits with banks 12 - - Total income 3,830 1,180 1,265 Realized securities losses (18) - - Expenses 75 97 62 Income before equity in undistributed earnings of subsidiary 3,737 1,083 1,203 Equity in undistributed earnings - First Citizens National Bank (248) 2,749 1,800 Net income $3,489 $3,832 $3,003 CITIZENS FINANCIAL SERVICES, INC. CONDENSED STATEMENT OF CASH FLOWS Years Ended December 31, 1998, 1997, and 1996 (in thousands) 1998 1997 1996 Cash flows from operating activities: Net income $ 3,489 $ 3,832 $ 3,003 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed earnings of subsidiary 248 (2,749) (1,800) Deferred income taxes (6) - - Realized gains on securities (1) - - (Increase) decrease in other assets (8) 611 (32) (Decrease) increase in other liabilities (26) 26 - Net cash provided by operating activities 3,696 1,720 1,171 Cash flows from investing activities: Purchase of available-for-sale securities (2,333) (111) - Proceeds from the sale of available-for-sale Securities 175 - - Net cash used in investing activities (2,158) (111) - Cash flows used in financing activities: Cash dividends paid (1,449) (1,596) (1,187) Net increase (decrease) in cash 89 13 (16) Cash at beginning of year 46 33 49 Cash at end of year $ 135 $ 46 $ 33 <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 ___________________________________________________________________________ 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, 1998 and 1997, 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, 1998. 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, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. /s/ S. R. Snodgrass, A.C. Wexford, PA February 5, 1999 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-eight Annual Report ___________________________________________________________________________ (dollar amounts in thousands) 1998 1997 1996 1995 1994 Interest income $ 23,088 $ 22,779 $ 21,341 $ 19,422 $ 17,336 Interest expense 11,920 11,610 10,867 9,851 7,944 Net interest income 11,168 11,169 10,474 9,571 9,392 Provision for loan losses 218 210 205 163 255 Net interest income after provision for loan losses 10,950 10,959 10,269 9,408 9,137 Other operating income 1,838 2,427 1,372 1,242 1,073 Realized securities gains, net 457 25 19 10 63 Other operating expenses 8,427 7,906 7,350 6,665 6,490 Income before provision for income taxes and extraordinary item 5,031 5,505 4,310 3,995 3,783 Provision for income taxes 1,401 1,673 1,307 1,161 1,158 Income before extraordinary item 3,630 3,832 3,003 2,834 2,625 Extraordinary item 141 - - - - Net income $ 3,489 $ 3,832 $ 3,003 $ 2,834 $ 2,625 Per share data: Income before extraordinary item (1) $ 1.31 $ 1.38 $ 1.08 $ 1.02 $ .95 Net income (1) 1.26 1.38 1.08 1.02 .95 Cash dividends (1) .52 .355 .445 .425 .405 Book value (1) 10.31 9.35 8.26 7.68 6.82 Total investments $ 93,082 $ 88,562 $ 86,057 $ 73,715 $ 64,257 Loans, net 203,583 189,910 180,418 159,794 154,848 Total assets 313,564 294,811 282,810 247,094 232,537 Total deposits 274,193 256,783 240,177 213,316 194,478 Stockholders' equity 28,598 25,923 22,904 21,297 18,903
(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 quarterly basis and the effects of stock dividends have been stated retroactively in the table below (also see dividend restrictions in Note 14). Dividends Dividends 1998 declared 1997 declared High Low per share High Low per share First quarter $24.75 $18.75 $ 0.125 First quarter (1) $13.31 $12.94 Second quarter 27.75 24.75 $ 0.130 Second quarter (1) 14.00 13.31 $ .230 Third quarter 27.75 26.50 $ 0.130 Third quarter 16.38 14.00 Fourth quarter 26.50 24.00 $ 0.135 Fourth quarter 18.75 17.00 $ .125
(1) 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 1998 March 31 June 30 Sept 30 Dec 31 Interest income $5,659 $5,700 $5,857 $5,872 Interest expense 2,915 2,957 3,034 3,014 Net interest income 2,744 2,743 2,823 2,858 Provision for loan losses 53 52 53 60 Other operating income 425 480 446 487 Realized securities gains, net 95 78 202 82 Other operating expenses 2,021 1,973 2,075 2,358 Income before provision for income taxes and extraordinary item 1,190 1,276 1,343 1,222 Provision for income taxes 343 361 375 322 Income before extraordinary item 847 915 968 900 Extraordinary item - - - 141 Net income $ 847 $ 915 $ 968 $ 759 Earnings Per Share $ .31 $ .33 $ .35 $ .27 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 $ .44 $ .31 $ .32 $ .31
TRUST AND INVESTMENT SERVICES FUNDS UNDER MANAGEMENT (market value) 1998 1997 INVESTMENTS: Bonds $12,385 $15,384 Stock 34,270 28,060 Savings and money market funds 11,875 13,350 Mutual funds 9,557 8,414 Mortgages 302 374 Real estate 549 298 Miscellaneous 202 56 Cash (45) 168 TOTAL $69,095 $66,104 ACCOUNTS: Estates $ 578 $ 833 Trusts 35,099 33,881 Guardianships 395 345 Pension/profit sharing 12,564 12,601 Investment management 14,921 16,071 Custodial 5,538 2,373 TOTAL $69,095 $66,104 The following graph shows personal trust asset growth over the past five years. ___________________________________________________________________________ [GRAPHIC OMITTED: A bar chart depicting personal trust assets from 1994 to 1998. A tabular presentation of the graph is set forth as follows: PERSONAL TRUST ASSETS (Dollars in Thousands) 1994 1995 1996 1997 1998 $27,781 $31,786 $39,776 $41,643 $46,654] ___________________________________________________________________________ <37> ___________________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ___________________________________________________________________________ Nineteen hundred ninety-eight Annual Report ___________________________________________________________________________ [GRAPHIC OMITTED: A bar chart depicting investments from 1994 to 1998. A tabular presentation of the graph is set forth as follows: INVESTMENTS (Dollars in Thousands) 1994 1995 1996 1997 1998 Available for Sale $14,640 $21,444 $28,736 $24,827 $93,082 Held to Maturity $49,617 $52,271 $57,321 $63,735 $ 0 Total $64,257 $73,715 $86,057 $88,562 $93,082 ___________________________________________________________________________ Introduction The following is management's discussion and analysis of the significant changes in the results of operations, capital resources and liquidity presented in its accompanying consolidated financial statements for Citizens Financial Service, Inc., a bank holding company and its subsidiary (the Company). Our Company's consolidated financial condition and results of operations consist almost entirely of our wholly owned subsidiary's (First Citizens National Bank) financial conditions and results of operations. Our discussion should be read in conjunction with the 1998 Annual Report. Current performance does not guarantee, assure or indicate similar performance in the future. Forward-looking statements may prove inaccurate. We have made forward-looking statements in this document, and in documents that we incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include the information concerning possible or assumed future results of operations of Citizens Financial Services, Inc., First Citizens National Bank or the combined company. When we use such words as "believes", "expects", "anticipates", or similar expressions, we are making forward-looking statements. You should note that many factors, some of which are discussed elsewhere in this document and in the documents we incorporate by reference, could affect the future financial results. These factors include, but are not limited to, the following: *operating, legal and regulatory risks; *economic, political and competitive forces affecting our banking, securities, asset management and credit services; *risk that our analysis of these risks and forces could be incorrect and/or the strategies developed to address them could be unsuccessful. Readers should carefully review the risk factors described in other documents our Company files from time to time with the Securities and Exchange Commission, including the quarterly reports on Form 10-Q to be filed by our Company and any current reports on Form 8-K filed by our Company. Our Company currently engages in the general business of banking throughout our service area of Potter, Tioga and Bradford counties in North Central Pennsylvania and Allegany, Steuben, Chemung and Tioga counties in Southern New York. We maintain our central office in Mansfield, Pennsylvania. Presently we operate banking facilities in Mansfield, Blossburg, Ulysses, Genesee, Wellsboro, Troy, Sayre, Canton, Gillett and the Wellsboro Weis Market store. Additionally, we have automatic teller machines (ATMs) located in Soldiers and Sailors Memorial Hospital in Wellsboro and at Mansfield University. Our Company's lending and deposit products and investment services are offered primarily within the vicinity of the service area. Our 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 our subsidiary. In addition, personal and corporate trust services are offered by insurance companies, investment counseling firms, and other business firms and individuals. We also compete with credit unions, issuers of money market funds, securities brokerage firms, consumer finance companies, mortgage brokers and insurance companies. These entities are strong competitors for virtually all types of financial services. In recent years, the financial services industry has experienced tremendous change to competitive barriers between bank and non-bank institutions. We not only must compete with traditional financial institutions, but also with other business corporations that have begun to deliver competing financial services. Competition for banking services is based on price, nature of product, quality of service, and in the case of certain activities, convenience of location. <38> ___________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ Trust and Investment Services Our Company offers the following trust and investment services: *Investment management accounts that assume managerial duties for investment accounts. *Custody services for safekeeping and preservation of assets. *Mutual funds that provide an asset allocation program. *Personal trust services that include stand-by, living and testamentary trusts. *Estate planning and administration to provide financial planning. *Retirement plan services for individuals and businesses. Financial Condition The following table presents the growth (dollars in millions) during the past two years: 1997/1998 1996/1997 $ % $ % Total assets 18.8 6.4 12.0 4.2 Total deposits 17.4 6.8 16.6 6.9 Total loans 13.7 7.2 9.5 5.3 Total investments (including available-for-sale and held-to-maturity) 4.5 5.1 2.5 2.9 Total stockholders' equity 2.7 10.3 3.0 13.2 Investments The investment portfolio, including available-for-sale (and held-to-maturity securities in 1997), increased by $4.5 million or 5.1% in 1998 as compared to growth of $2.5 million in 1997. From 1990 through 1996, the concentration of our Company's investment portfolio shifted to U.S. Treasury securities and, until last year, no new investments had been made in state and political subdivisions. During 1997 and 1998, we have been selling U.S. Treasury notes to restructure the investment portfolio. We then reinvest the proceeds by purchasing AAA municipal bonds, investment grade corporate bonds and U S agency mortgage backed securities. The following table shows the year-end composition of the investment portfolio for the five years ended December 31, 1998: Estimated Fair Market Value at December 31, 1998 % of 1997 % of 1996 % of 1995 % of 1994 % of Total Total Total Total Total Held-to-maturity: U.S. Treasury securities $ - - $47,566 53.2 $49,439 57.2 $43,905 58.5 $34,381 54.9 Federal agency obligations - - - - - - - - 506 0.8 Obligations of state & political Subdivisions - - 5,611 6.3 620 0.7 1,348 1.8 2,832 4.5 Corporate obligations - - 3,175 3.6 4,712 5.5 4,845 6.5 6,787 10.9 Mortgage-backed securities - - 6,856 7.7 1,688 2.0 2,352 3.1 2,293 3.7 Available-for-sale: U.S. Treasury securities 32,763 35.3 14,948 16.7 21,406 24.8 15,591 20.8 14,594 23.3 Obligations of state & political Subdivisions 18,452 19.8 - - - - - - - - Corporate obligations 14,889 16.0 6,849 7.7 7,253 8.4 5,778 7.7 - - Mortgage-backed securities 23,113 24.8 2,771 3.1 - - - - - - Equity securities 2,517 2.7 259 0.3 77 0.1 75 0.1 46 0.1 Restricted equity securities 1,348 1.4 1,282 1.4 1,128 1.3 1,139 1.5 1,098 1.8 Total $93,082 100.0 $89,317 100.0 $86,323 100.0 $75,033 100.0 $62,537 100.0
<39> ___________________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Nineteen hundred ninety-eight Annual Report ___________________________________________________________________________ In addition, we adopted SFAS 133 discussed in Footnote 1 of the Consolidated Financial Statements in the fourth quarter of 1998. This change in accounting procedure allows us, over time, to continue to restructure our investments to target mix shown in the following table. % of Target Mix Total U. S. Treasury securities 12.5 Obligations of state and political subdivisions 25.0 Corporate obligations 25.0 Mortgage-backed securities 33.5 Other equity securities 2.5 Restricted equity securities 1.5 Total 100.0 The expected principal repayments (amortized cost) and average weighted yields for the above investment portfolio as of December 31, 1998, are shown below. Expected maturities are significantly different than the contractual maturities detailed in Footnote 4 of the Consolidated Financial Statements. Yields on tax-exempt securities are presented on a fully-taxable equivalent basis assuming a 34% tax rate. Within One- Five- After Amortized Estimated One Yield Five Yield Ten Yield Ten Yield Cost Yield Fair Year (%) Years % Years (%) Years (%) Total (%) Value Available-for-sale securities: U.S. Treasury 8,533 8.69 23,230 6.47 - - - - 31,763 7.07 $32,763 State and political subdivisions, 2 8.33 11,603 6.94 5,921 6.79 423 6.86 17,949 6.89 18,110 general obligation State and political subdivisions, 340 9.85 - - - - - - 340 9.85 342 revenue Corporate obligations 4,644 6.54 10,174 5.86 - - - - 14,818 6.07 14,889 Mortgage-backed securities 4,982 6.65 18,130 6.65 - - - - 23,112 6.65 23,113 Equity securities - - - - - - 2,271 2.30 2,271 2.30 2,517 Restricted equity securities - - - - - - 1,348 6.00 1,348 6.00 1,348 Total available-for-sale 18,501 7.62 63,137 6.51 5,921 6.79 4,042 4.01 91,601 6.64 93,082
Approximately 93% of the amortized cost of debt securities are expected to mature within five years or less (average expected maturity 5 years). Our Company expects that earnings from operations, the high liquidity level of the available-for-sale securities, growth of deposits and the availability of borrowings from the Federal Home Loan Bank will be sufficient to meet future liquidity needs. Our Company has no securities from a single issuer representing more than 10% of stockholders' equity. Loans Historically, loans have been originated by our 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. We also do 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 us and approved by the Board of Directors. Our 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. <40> ___________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ As shown in the following table, total loans grew by $13.7 million in 1998, or 7.2% the result of continued demand and attractive interest rates. In addition, $3.8 million in conforming mortgage loans were originated and sold on the secondary market through the Federal Home Loan Mortgage Corporation, providing over $63,000 of income in origination fees and premiums on loans sold, compared to $1.2 million in loans originated and $19,000 of income in 1997. Residential mortgage lending is a principal business activity and one our Company expects to continue by providing a full complement of competitively priced conforming, nonconforming and home equity mortgages. Commercial lending activity is primarily focused on small businesses and our Company's commercial lending officers have been successful in attracting new business loans. We expect loans to state and political subdivisions will continue to 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, 1998, residential real estate and real estate construction loans made up 64.3% of our Company's total loan portfolio. Continuing in 1998, our Company's primary goal is to be the premier mortgage lender in our market area, with our 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 of the Consolidated Financial Statements.) Five Year Breakdown of Loans by Type December 31, 1998 1997 1996 1995 1994 Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent Real estate: Residential 127,053 61.8 120,019 62.5 108,416 59.4 96,594 59.7 97,359 62.0 Commercial 27,164 13.2 27,480 14.3 27,670 15.2 24,167 14.9 21,915 13.9 Agricultural 9,266 4.5 8,769 4.6 6,134 3.4 8,027 5.0 7,125 4.5 Construction 5,234 2.5 3,035 1.6 4,262 2.3 1,018 0.6 1,271 0.8 Loans to individuals for household, family and other 14,489 7.0 13,905 7.2 14,465 7.9 13,198 8.2 11,886 7.6 purchases Commercial and other loans 12,457 6.0 9,485 4.9 11,529 6.3 10,535 6.5 10,285 6.5 State and political 10,272 5.0 9,457 4.9 10,105 5.5 8,347 5.2 7,303 4.6 subdivision loans Total loans 205,935 100.0 192,150 100.0 182,581 100.0 161,886 100.0 157,144 100.0 Unearned income 60 102 168 259 575 Allowance for loan losses 2,292 2,138 1,995 1,833 1,721 Net loans 203,583 189,910 180,418 159,794 154,848
1998/1997 1997/1996 Change Change $ % $ % Real estate: Residential 7,034 5.9 11,603 10.7 Commercial (316) (1.1) (190) (0.7) Agricultural 497 5.7 2,635 43.0 Construction 2,199 72.5 (1,227) (28.8) Loans to individuals for household, family and other purchases 584 4.2 (560) (3.9) Commercial and other loans 2,972 31.3 (2,044) (17.7) State and political subdivision loan 815 8.6 (648) (6.4) Total loans 13,785 7.2 9,569 5.2 <41> ___________________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Nineteen hundred ninety-eight Annual Report ___________________________________________________________________________ The predominant source of earning assets is from the loan portfolio. The following table shows the maturity of state and political subdivision loans, commercial and agricultural loans and commercial loans secured by real estate as of December 31, 1998, classified according to the sensitivity to changes in interest rates within various time intervals: Commercial, financial, Real estate Maturity of loans: agricultural construction Total One year or less 4,791 0 4,791 Over one year but less than five years 15,402 0 15,402 Over five years 38,966 5,234 44,200 Total 59,159 5,234 64,393 Sensitivity of loans to changes in interest rates - loans due after one year: Predetermined interest rate 18,719 923 19,642 Floating or adjustable interest rate 35,649 4,311 39,960 Total 54,368 5,234 59,602
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. A separate collections department was established to focus on the collection and workout of problem loans. We 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: December 31, 1998 1997 1996 1995 1994 Nonperforming loans: Nonaccruing loans 1,018 1,169 844 762 1,557 Impaired loans 859 382 414 697 Accrual loans - 90 days or more past due 15 170 723 689 267 Total non-performing loans 1,892 1,721 1,981 2,148 1,824 Foreclosed assets held for sale 529 238 164 208 168 Total non-performing assets 2,421 1,959 2,145 2,356 1,992 Nonperforming loans as a percent of loans net of unearned income 0.92 0.90 1.09 1.33 1.17 Nonperforming assets as a percent of loans net of unearned income 1.18 1.02 1.18 1.46 1.27
<42> ___________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ Another way to view the credit quality exposure of the loan portfolio is by reviewing the "watch list" categories used by us (and as required by the regulatory agencies). This monitoring process is reviewed and reported monthly to identify problems or potential problems. 1998 1997 1996 Special mention $ 532 $ - $ 216 Substandard 6,193 4,625 3,740 Doubtful 98 121 23 Total $6,823 $4,746 $3,979 Percent of total loans, net of unearned income 3.31% 2.47% 2.18% We do not believe there are any loans classified for regulatory purposes as loss, doubtful, substandard, special mention or otherwise which will result in losses or to have a material impact on future operations, liquidity or capital reserves. We are not aware of any other information that causes us 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 Experiance 1998 1997 1996 1995 1994 Balance at beginning of period 2,138 1,995 1,833 1,721 1,516 Charge-offs: Real estate-construction - - - - - Real estate-mortgage - 10 8 23 31 Loans to individuals for household, family and other purchases 105 32 56 42 28 Commercial and other loans 7 41 - 4 9 Total loans charged-off 112 83 64 69 68 Recoveries: Real estate-construction - - - - - Real estate-mortgage 2 3 1 - - Loans to individuals for household, family and other purchases 37 11 19 15 14 Commercial and other loans 9 2 1 3 4 Total loans recovered 48 16 21 18 18 Net loans charged-off 64 67 43 51 50 Provision charged to expense 218 210 205 163 255 Balance at end of year $2,292 $2,138 $1,995 $1,833 $1,721 Loans outstanding at end of year $205,875 $192,048 $182,413 $161,627 $156,569 Average loans outstanding, net $196,281 $186,425 $170,104 $156,754 $146,894 Net charge-offs to average loans 0.03% 0.04% 0.03% 0.03% 0.03% Year-end allowance to total loans 1.11% 1.11% 1.09% 1.13% 1.10% Year-end allowance to total 121.14% 124.23% 100.71% 85.34% 94.35% non-performing loans
<43> ___________________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Nineteen hundred ninety-eight Annual Report ___________________________________________________________________________ As detailed in Footnote 5 of the Consolidated Financial Statements and the above tables, total past due (90 days or more) and nonperforming loans increased 9.9% from December 31, 1997 to December 31, 1998. The majority of the loan volume is well-collateralized by real estate. Total charge-offs for 1999 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. Provisions charged to operating expense and reduced by net charge-offs increase the allowance. Management's basis for the level of the allowance and the annual provision is as follows: *Our evaluation of the loan portfolio, *Current and projected economic conditions, *Historical loan loss experience, *Present and prospective financial condition of the borrowers, *The level of nonperforming assets, *Other relevant factors. While we evaluate 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 our Company's allowance for loan losses. These agencies may require us to recognize additions to the allowance based on their evaluation of information available to them. We believe that the current allowance is adequate to offset any exposure that may exist for under secured or loans that might not be collectable. We do not accrue interest income on seriously past due loans. Subsequent cash payments received are applied to the outstanding principal balance or recorded as interest income, depending upon our assessment of our ultimate ability to collect principal and interest. 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 that includes a percentage comparison to total loans: 1998 1997 1996 1995 1994 $ % $ % $ % $ % $ % Real estate: Residential 140 61.8 140 62.5 143 59.4 165 59.6 185 62.0 Commercial, agricultural 927 17.7 577 18.9 325 18.5 328 19.9 323 18.5 Construction 0 2.5 0 1.6 0 2.3 0 0.6 0 0.8 Loans to individuals for household, family and other 365 7.0 321 7.2 164 8.0 181 8.2 140 7.6 purchases Commercial and other loans 265 6.0 323 4.9 108 6.3 110 6.5 114 6.5 State and political 4 5.0 4 4.9 3 5.5 3 5.2 2 4.6 subdivision loans Unallocated 591 N/A 773 N/A 1,252 N/A 1,047 N/A 957 N/A Total loans 2,292 100.0 2,138 100.0 1,995 100.0 1,834 100.0 1,721 100.0
Deposits Our Company tiers interest-bearing transaction and savings accounts by deposit size (larger balances receive higher rates). We have been offering a wide variety of deposit instruments, as have our competitors. <44> ___________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ Some of the deposit product variations are: *Money Market Investor accounts (limited transaction deposit accounts with interest rates that vary as often as daily), *NOW accounts (unlimited transaction interest-bearing accounts), *Premier 50 and Premier 50 Plus (interest-bearing transactions accounts for senior customers), *Gold Club accounts (a package of services combined with a checking account), *Individual retirement accounts (certificates of deposit), *Longer-term certificates of deposit (generally of five-year maturity), *Promotional 30-month, 66-month and Roll-Up certificates of deposit. Our Company also offers a wide variety of IRA products including the new Roth and Educational IRA's. Deposit growth in 1998 was $17.4 million or 6.8%. The following table shows the composition of deposit accounts over the last three years as of December 31: Deposits by Major Classification 1998 1997 1996 Amount Percent Amount Percent Amount Percent Noninterest-bearing deposits $ 20,978 7.7 $ 19,016 7.4 $ 17,924 7.5 NOW accounts 37,113 13.5 32,794 12.8 31,836 13.2 Savings deposits 26,421 9.6 26,523 10.3 27,332 11.4 Money market deposit accounts 39,584 14.4 34,357 13.4 25,851 10.8 Certificates of deposit 150,097 54.7 144,093 56.1 137,234 57.1 Total $274,193 100.0 $256,783 100.0 $240,177 100.0
1998/1997 1997/1996 Change Change $ % $ % Noninterest-bearing deposits 1,962 10.3 1,092 6.1 NOW accounts 4,319 13.2 958 3.0 Savings deposits (102) (.4) (809) (3.0) Money market deposit accounts 5,227 15.2 8,506 32.9 Certificates of deposit 6,004 4.2 6,859 5.0 Total 17,410 6.8 16,606 6.9 Remaining maturities of certificates of deposit of $100,000 or more 1998 1997 1996 3 months or less $ 1,295 $ 1,658 $ 1,962 3 through 6 months 2,409 6,929 2,788 6 through 12 months 6,788 10,263 6,051 Over 12 months 14,166 5,110 8,479 Total $24,658 $23,960 $19,280 As a percent of total certificates 16.43% 16.63% 14.05% of deposits <45> ___________________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Nineteen hundred ninety-eight Annual Report ___________________________________________________________________________ Deposits by Type of Depositor 1998 1997 1996 Amount Percent Amount Percent Amount Percent Individual, partnerships and $240,466 87.7 $226,306 88.1 $212,398 88.4 corporation United States government 22 - 20 - 148 .1 State and political subdivisions 32,374 11.8 28,721 11.2 25,794 10.7 Other 1,351 .5 1,736 .7 1,837 .8 Total $274,193 100.0 $256,783 100.0 $240,177 100.0
The methods used by our Company to attract and retain deposits (in addition to competitive interest rates) have been by increased marketing and business development efforts, continuous emphasis on quality personal service, and expanded trust and investment management services. 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. We currently provide ten MAC automated teller machines, which are part of the MAC regional and PLUS national network. We also implemented a MasterMoney debit card program in 1998. In addition to the above, continuing an effort to add value to products, we 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 1998 was $3.5 million (net income per share of $1.26), a decrease of $343,000 or 9% less than the $3.8 million reported in 1997 (net income per share of $1.38). The following table sets forth certain performance ratios of our Company for the periods indicated (net of the arbitration settlement discussed in Footnote 11 of the Consolidated Financial Statements): 1998 1997 1996 Return on Assets (net income to average total assets) 1.13% 1.10% 1.11% Return on Equity (net income to average total equity) 12.75% 13.11% 13.59% Dividend Payout Ratio (dividends declared divided by net income) 41.53% 25.68% 40.59% Equity to Asset Ratio (average equity to average total assets) 8.86% 8.38% 8.18% 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. 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-earning assets exceeds interest expense on interest-bearing liabilities. Factors which influence net interest income are changes in volume of interest-earning assets and liabilities as well as changes in the associated interest rates. The following tables set forth our 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] ___________________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ Analysis of Average Balances and Interest Rates (1) December 31 December 31 December 31 1998 1997 1996 Average Average Average Average Average Average Balance Interest Rate Balance Interest Rate Balance Interest Rate $ $ % $ $ % $ $ % Assets Short-term investments: Interest-bearing deposits at banks 5,403 290 5.37% 4,042 221 5.47% 2,782 147 5.28% Total short-term investments 5,403 290 5.37% 4,042 221 5.47% 2,782 147 5.28% Investment securities: Taxable 75,722 4,654 6.15% 83,686 5,332 6.37% 82,163 5,310 6.46% Tax-exempt (3) 10,428 745 7.14% 714 79 11.06% 792 100 12.63% Total investment securities 86,150 5,399 6.27% 84,400 5,411 6.41% 82,955 5,410 6.52% Loans: Residential mortgage loans 126,683 11,254 8.88% 119,083 10,952 9.20% 104,176 9,699 9.31% Commercial and farm loans 45,371 4,272 9.42% 43,790 4,263 9.74% 41,896 4,121 9.84% Loans to state and political 10,299 885 8.59% 9,652 875 9.07% 9,631 829 8.61% subdivisions Other loans 13,928 1,542 11.07% 13,900 1,378 9.91% 14,401 1,435 9.96% Loans, net of discount (2)(3)(4) 196,281 17,953 9.15% 186,425 17,468 9.37% 170,104 16,084 9.46% Total interest-earning assets 287,834 23,642 8.21% 274,867 23,100 8.40% 255,841 21,641 8.46% Cash and due from banks 6,663 6,417 5,920 Bank premises and equipment 5,697 5,140 4,311 FASB 115 adjustment 499 170 218 Other assets 1,449 2,342 3,828 Total non-interest bearing assets 14,308 14,069 14,277 Total assets 302,142 288,936 270,118 LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: NOW accounts 33,411 693 2.07% 32,644 786 2.41% 29,752 688 2.31% Savings accounts 26,670 580 2.17% 27,736 614 2.21% 27,541 612 2.22% Money market accounts 37,682 1,801 4.78% 29,420 1,349 4.59% 27,189 1,192 4.38% Certificates of deposit 146,630 8,408 5.73% 143,837 8,358 5.81% 133,071 7,784 5.85% Other borrowed funds 7,100 438 6.17% 8,129 503 6.19% 9,730 591 6.07% Total interest-bearing liabilities 251,493 11,920 4.74% 241,766 11,610 4.80% 227,283 10,867 4.78% Demand deposits 19,924 19,141 17,550 Other liabilities 3,950 3,804 3,184 Total non-interest-bearing 23,874 22,945 20,734 liabilities Stockholders' equity 26,775 24,225 22,101 Total liabilities and stockholders' equity 302,142 288,936 270,118 Net interest income 11,722 11,490 10,774 Net interest spread (5) 3.47% 3.60% 3.68% Net interest income as a percentage of average interest-earning assets 4.07% 4.18% 4.21% Ratio of interest-earning assets to interest-bearing liabilities 1.14 1.14 1.13
(1) Averages are based on daily averages. (2) Includes loan origination and commitment fees of $187, $141 and $155 for 1998, 1997 and 1996, 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 non-accrual loans is accounted for on a cash basis, and the loan balances are included in interest-earning assets. (5) Interest rate spread represents the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities. <47> ___________________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Nineteen hundred ninety-eight Annual Report ___________________________________________________________________________ As described above, we have experienced a narrowing interest margin percentage during 1998. The current flat yield curve has limited our Company's opportunity to increase margin with new business as the existing investments and loans mature or repay. We continue to review various pricing and investment strategies to enhance deposit growth while maintaining or expanding the current interest margin. 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 changes 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 1998 vs. 1997 1997 vs. 1996 Change in Change in Total Change in Change in Total Volume Rate Change Volume Rate Change Interest Income: Short-term investments: Interest-bearing deposits at banks $ 73 $ (4) $ 69 $ 69 $ 5 $ 74 Investment securities: Taxable (494) (184) (678) 92 (70) 22 Tax-exempt 684 (18) 666 (9) (12) (21) Total investment securities 190 (202) (12) 83 (82) 1 Loans: Residential mortgage loans 648 (346) 302 1,369 (116) 1,253 Commercial and farm loans 98 (89) 9 184 (42) 142 Loans to state and political 45 (35) 10 2 44 46 subdivisions Other loans 3 161 164 (50) (7) (57) Loans, net of discount 794 (309) 485 1,505 (121) 1,384 Total Interest Income 1,057 (515) 542 1,657 (198) 1,459 Interest Expense: Interest-bearing deposits: NOW accounts 19 (112) (93) 69 29 98 Savings accounts (23) (11) (34) 4 (2) 2 Money Market accounts 393 59 452 101 56 157 Certificates of deposit 155 (105) 50 625 (51) 574 Total interest-bearing deposits 544 (169) 375 799 32 831 Other borrowed funds (63) (2) (65) (99) 11 (88) Total interest expense 481 (171) 310 700 43 743 Net interest income $ 576 $ (344) $ 232 $ 957 $ (241) $ 716
As can be seen from the preceding tables, tax equivalent net interest income rose from $10.7 million in 1996 to $11.5 million in 1997 and increased to $11.7 million in 1998. In 1998, net interest income increased $232,000 while overall spread decreased from 3.60% to 3.47%. The increased volume of interest-earning assets generated an increase in interest income of $1,057,000 while increased volume of interest-bearing liabilities produced $481,000 of interest expense. The change in volume resulted in an increase of $576,000 in net interest income. The net change in rate was a negative $344,000 resulting in a total positive net change of $232,000 when combined with change in volume. The yield on interest-earning assets decreased 19 basis points from 8.40% to 8.21% and the average interest rate on interest-bearing liabilities decreased only 6 basis points from 4.80% to 4.74%. Analysis of our Company's current net interest income in 1999 indicates that the effects of stable interest rates and the effect of the yield curve continuing to be level, has a negative effect on interest margin. We are 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] ___________________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ OTHER OPERATING INCOME: 1998 1997 1996 Service charges $1,060 $ 848 $ 844 Trust 362 339 270 Other 304 246 258 Arbitration settlement 112 994 0 Realized securities gains, net 457 25 19 TOTAL OTHER OPERATING INCOME $2,295 $2,452 $1,391 1998/1997 1997/1996 Change Change $ % $ % Service charges 212 25.0 4 .5 Trust 23 6.8 69 25.6 Other 58 23.6 (12) (4.7) Arbitration settlement (882) (88.7) 994 - Realized securities gains, net 432 1728.0 6 31.6 TOTAL (157) (6.4) 1,061 76.3 Total other operating income decreased $157,000 compared with the same period in 1997 primarily as a result of the reduction of the arbitration settlement during 1998. Service charge income increased as a result of additional business checking account, ATM and MasterMoney Card charges. We continue 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. We expect to use this analysis for our other products in the near future. Investment security gains increased by $432,000 as a result of the restructuring of our investment portfolio as discussed previously. This restructuring was accomplished with out significantly reducing the yield of the portfolio. OTHER OPERATING EXPENSES: 1998 1997 1996 Salaries and employee benefits $3,848 $3,882 $3,418 Occupancy 522 519 466 Furniture and equipment 713 706 599 Professional fees 401 219 198 Federal Deposit Insurance premiums 56 56 372 Other 2,674 2,524 2,297 TOTAL $8,214 $7,906 $7,350 1998/1997 1997/1996 Change Change $ % $ % Salaries and employee benefits (34) (.9) 464 13.6 Occupancy 3 .6 53 11.4 Furniture and equipment 7 1.0 107 17.9 Professional fees 182 83.1 21 10.5 Federal Deposit Insurance premiums - - (316) (85.0) Other 150 5.9 227 9.9 TOTAL 308 3.9 556 7.6 <49> ___________________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Nineteen hundred ninety-eight Annual Report ___________________________________________________________________________ Total other operating expense was $8,214,000 in 1998 reflecting an increase of $308,000 over the 1997 period. Salaries and benefit's expense decreased by $33,000 for the current period reflecting normal merit increases offset by a reduction of profit sharing expense during the same period in 1997 (an accrual to salaries and benefit expense of $154,000 for profit sharing reflecting the additional arbitration income). Professional Fees 1998 1997 1996 Other professional fees $301 $161 $141 Legal fees 59 19 19 Examinations and audits 41 39 38 Total $401 $219 $198 1998/1997 1997/1996 Change Change $ % $ % Other professional fees 140 87.0 20 14.2 Legal fees 40 210.5 - - Examinations and audits 2 5.1 1 2.6 Total 182 83.1 21 10.6 Other expenses increased $331,000 or 11.9% during 1998 one of the major expenses other professional fees increased $141,000 reflect management's efforts to implement future strategic growth strategies. In addition, Y2K expense of $37,000 were included in this category. The extraordinary item represented the prepayment of Federal Home Loan Bank long-term debt resulting in a one-time expense of $213,000 ($141,000 net of taxes) and was done as part of the restructuring of the investment portfolio. Provision for Income Taxes The provision for income taxes before extraordinary item was $1,402,000 during 1998 compared with $1,673,000 during the 1997 related period. Income before taxes decreased $271,000 in the 1998 period over the same period in 1997 reflecting the change in income and increased levels of tax exempt income. 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 our 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 10.3% in 1998, 13.2% in 1997, and 7.6% in 1996 to the current level of $28.6 million. Adjustments made to equity for unrealized holding gains and losses on available-for-sale securities resulted in an increase of $978,000 in 1998 compared to an increase of $343,000 in 1997. Total equity was approximately 9.1% of total assets at December 31, 1998, as compared to 8.8% at December 31, 1997. The dividend rate is determined by the Board of Directors after considering our Company's capital requirements, current and projected net income, and other factors. In 1998 and 1997, 41.5% and 25.7% of net income was paid out in dividends, respectively. For the year ended December 31, 1998, the total number of common shares outstanding was 2,773,434. For comparative purposes, outstanding shares for prior periods were adjusted for the 1998 stock dividend in computing earnings and cash dividends per share. <50> ___________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ There are currently three federal regulatory measures of capital adequacy. Our 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 our Company's ability to efficiently meet normal cash flow requirements of both borrowers and depositors. To maintain proper liquidity, we use funds management policies along with our investment policies to assure we can meet our financial obligations to depositors, credit customers and stockholders. 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. Our Company's historical activity in this area can be seen in the Consolidated Statement of Cash Flows from investing and financing activities. Cash generated by operating activities, investing activities and financing activities influences liquidity management. The most important source of funds is the deposits that are primarily core deposits (deposits from customers with other relationships). Short-term debt from the Federal Home Loan Bank supplements our Company's availability of funds. Our Company's use of funds is shown in the investing activity 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. Capital expenditures were $504,000 in 1998, $1,134,000 less than 1997. Some major capital expenditures in 1998 were: *$213,000 for remodeling branch offices; *$53,000 for ATMs; Some major capital 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. On February 8, 1999, we acquired a property near the Mansfield Wal-Mart consisting of a large office building on 2 acres, to be used as an administration and/or operations facility. We expect the costs of acquisition and remodeling to be approximately $1 million. This building will allow us to discontinue rentals of two other properties. Our calculations show this should result in a net savings. Our Company continues to plan for an approximate $1 million renovation of the Mansfield community office. This effort has been in various stages of planning for more than eight years. We expect renovation to take place in late 1999 or early 2000. We believe our Company has sufficient resources to complete these projects from our 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, our 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 our operations, we are not subject to foreign currency exchange <51> ___________________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Nineteen hundred ninety-eight Annual Report ___________________________________________________________________________ or commodity price risk and, since our Company has no trading portfolio, it is not subject to trading risk. Currently our Company has equity securities that represent only 4% of our 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 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 (at amortized cost) for various time intervals: Maturity or Repricing of Company Assets and Liabilities at December 31, 1998 Over 5 (in thousands) 3 months 12 months 2 years 3 years 5 years years Total Investment securities and interest-bearing deposits $ 3,509 $ 15,181 $ 13,121 $ 16,705 $ 33,217 $ 9,998 $ 91,731 Loans, net of unearned income and deferred loan fees 32,648 65,200 41,200 33,689 26,056 7,142 205,935 Total interest-earning assets $ 36,157 80,381 54,321 $ 50,394 $ 59,273 $ 16,950 $297,476 Interest-bearing demand and savings deposits $ 45,100 $ - $ - $ - $ - $ 58,087 $103,187 Certificates of deposit 18,634 48,001 40,240 22,239 20,706 208 150,028 Borrowed funds 4,400 949 642 784 559 - 7,334 Total interest-bearing liabilities $ 68,134 $ 48,950 $ 40,882 $ 23,023 $ 21,265 $ 58,295 $260,549 Excess interest-earning assets (liabilities) $(31,977) $ 31,431 $ 13,439 $ 27,371 $ 38,008 $(41,345) Cumulative interest-earning assets $ 36,157 $116,538 $170,859 $221,253 $280,526 $297,476 Cumulative interest-bearing liabilities 68,134 117,084 157,966 180,989 202,254 260,549 Cumulative gap $(31,977) $ (546) $ 12,893 $ 40,264 78,272 36,927 Cumulative interest rate sensitivity ratio (1) 0.53 1.00 1.08 1.22 1.39 1.14
(1) Cumulative Interest-earning assets divided by interest-bearing liabilities. The previous table and the simulation models discussed below are presented assuming money market investment accounts and NOW accounts in the top interest rate tier are repriced within the first three months. IRA certificates of deposit represent $36.6 million and are subject to being repriced once per year if the individual is over 59 ½ years of age. We project that 78% of the IRAs are over 59 ½ and would reprice if interest rates moved up 100 basis points or more. However, a recent change in policy would limit this repricing risk to once per contract rather than once per year for any new or renewed IRA CDs. 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 us to analyze interest rate risk, does not necessarily show the precise impact of specific interest rate movements on our 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. Our <52> ___________________________________________________________________________ GRAPHIC OMITTED: Silhouette of colonial rider on horeseback, upper left hand corner of page, .5 inches square] ___________________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued ___________________________________________________________________________ Citizens Financial Services, Inc. ___________________________________________________________________________ Company currently uses a computer simulation model to better measure the impact of interest rate changes on net interest income. We use the model as part of our risk management process that will effectively identify, measure, and monitor our Company's risk exposure. Interest rate simulations using a variety of assumptions are used by us to evaluate our interest rate risk exposure. A shock analysis at December 31, 1998, indicated that a 200 basis point movement in interest rates in either direction would not have a significant adverse impact on our Company's anticipated net interest income or the market value of assets and liabilities over the next twenty four months. Year 2000 Problem * Bank's State of Readiness We are 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). If not corrected, some computer applications could fail or create erroneous results by or at the Year 2000. This could cause entire system failures, miscalculations, and disruptions of normal business operations including, among other things, a temporary inability to process transactions, send statements, or engage in similar day to day business activities. The extent of the potential impact of the Year 2000 Problem in not yet known, and if not timely corrected, it could affect the global economy. We have assessed the extent of vulnerability of our Company's computer systems to the problem. Our Company's conversion, in August 1997, to Jack Henry and Associates (JHA) 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 our exposure to these problems. The JHA Silverlake System software was certified by the Information Technology Association of America (ITAA) on March 16, 1998 while the IBM AS\400 received the first ever Year 2000 certification by that organization. Internal testing and validation for these primary mission critical systems was successfully completed in November, 1998 and we expect that the entire testing process of critical systems will be complete early in 1999. *Risk Assessment of Year 2000 We believe that, with modifications to existing software and conversions to new software, the Year 2000 problem will not pose a significant operational problem for us. However, because most computer systems are, by their very nature, interdependent, it is possible that non-compliant third party computers could impact our Company's computer systems. Additionally, we have taken steps to communicate with the third parties, such as wire transfer systems, telephone systems, electric companies and other utility companies with which it deals to coordinate Year 2000 compliance but could be adversely affected if it or the unrelated third parties are unsuccessful. We are also assessing the impact, if any, the Year 2000 may have on our large loan (credit risk) and deposit customers. *Cost of Year 2000 As described above, our primary systems are Year 2000 compliant, therefore, little programming costs will be incurred. Most of the costs incurred in addressing this problem are related to planning and internal testing and validation which are expected to be expensed as incurred. The financial impact to our Company of Year 2000 compliance was $39,000 in 1998 is not anticipated to be material to our Company's financial position or results of operations for 1999. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those plans. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the replacement of noncompliance of third party vendors, and similar uncertainties. <53> __________________________________________________________________________ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued __________________________________________________________________________ Nineteen hundred ninety-eight Annual Report __________________________________________________________________________ *Contingency Plans We, in conjunction with our Year 2000 and Disaster Recovery consultants, are in the process of modifying our disaster recover plans to include the response to a Year 2000 problem in a most likely worst case scenario. Our Company's preliminary contingency plans involve the use of manual labor to compensate for the temporary loss of certain automated computer systems or third party vendors. 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. 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 our Company to own or control affiliates that engage in securities, mutual funds and insurance activities. Normal examinations of our Company by the Office of Comptroller of the Currency occurred during 1998. The last Community Reinvestment Act performance evaluation by the same agency resulted in a rating of "Satisfactory Record of Meeting Community Credit Needs." Aside from those matters described above, we do 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. We are not 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 our Company's results of operations. <54> CITIZENS FINANCIAL SERVICES INCORPORATED 15 SOUTH MAIN STREET 570-662-2121 MANSFIELD, PA 16933 800-326-9486 FAX 570-662-2365 DIRECTORS R. Lowell Coolidge, Esquire Chairman of the Board Carol J. Tama Vice Chairman of the Board Bruce L. Adams Larry J. Croft Mark L. Dalton John E. Novak John M. Thomas, MD Rudolph J. van der Hiel, Esquire William D. VanEtten Richard E. Wilber DIRECTORS EMERITI Robert E. Dalton Edward Kosa John G. Kuster Robert J. Landy, Esquire Robert G. Messinger Wilber Wagner DIRECTORS R. Lowell Coolidge, Esquire Chairman of the Board Carol J. Tama Vice Chairman of the Board Bruce L. Adams Larry J. Croft Mark L. Dalton John E. Novak John M. Thomas, MD Rudolph J. van der Hiel, Esquire William D. VanEtten Richard E. Wilber President Chief Executive Officer OFFICERS Administrative Services Cynthia T. Pazzaglia Assistant Vice President Administrative Division Manager Human Resources Manager Audit/Compliance V. Guy Abell Auditor 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 Valerie S. Davis Assistant Credit Services Manager Allan K. Reed Assistant Vice President Branch Administrator Chester L. Reed Commercial Services Officer Robert P. Fitzgerald Calling 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 Asst. Treasurer, Citizens Financial Services, Inc. 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> ___________________________________________________________________________ GRAPHIC OMITTED: First Citizens National Bank MasterMoney Card, bottom left of page, approximately 1.5 inches length by 2.5 inches wide] ___________________________________________________________________________ Bank-By-Phone 24 Hour Banking 1-888-HLP-FCNB (1-888-457-3262) or 662-3874 ___________________________________________________________________________ [MAC LOGO OMITTED] ___________________________________________________________________________ 24 Hour Automated Teller Blossburg, Mansfield Mansfield University Weis Market Solders and Sailors Memorial Hospital Wellsboro, Genesee, Ulysses, Sayre Gillett ___________________________________________________________________________ COMMUNITY OFFICES Toll free to all locations: 800-326-9486 MANSFIELD 570-662-2121 15 South Main Street Mansfield, PA 16933 FAX 570-662-3278 Local Board William J. Smith Chairman Anthony D. Fiamingo Shari L. Johnson Stephen A. Saunders William J. Waldman Officers Shari L. Johnson Office Manager Michele E. Litzelman Customer Service Counselor Kristina M. Payne Customer Service Counselor BLOSSBURG 570-638-2115 300 Main Street Blossburg, PA 16912 FAX 570-638-3178 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 Alisha M. Fitch 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 570-888-6602 306 West Lockhart Street Sayre, PA 18840 FAX 570-888-3198 Local Board Joseph P. Burkhart, Jr. Chairman Blaine W. Cobb, MD R. Joseph Landy, Esquire William A. Richetti Michael J. Yanuzzi Officers William A. Richetti Assistant Vice President Office Manager Antoinette G. Tracy Customer Service Counselor TROY 570-297-4131 103 West Main Street Troy, PA 16947 FAX 570-297-4133 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 570-724-2600 99 Main Street Wellsboro, PA 16901 FAX 570-724-4381 Local Board William A. Hebe, Esquire Chairman Timothy J. Gooch, CPA James K. Stager Jeffrey L. Wilson Officers Jeffrey L. Wilson Assistant Vice President Office Manager Marsha B. Jones Customer Service Counselor CANTON 570-673-3103 29 West Main Street Canton, PA 17724 FAX 570-673-4573 Local Board Roger C. Graham, Jr. Chairman William F. Watkins Christopher S. Landis Marilyn I. Scott David L. Wright Office Manager Christopher S. Landis Assistant Vice President Catherine O. Casiello Customer Service Counselor GILLETT 570-596-2679 P.O. Box 125 Gillett, PA 16925 FAX 570-596-4888 Local Board Forrest M. Oldroyd Helen Kay Shedden Office Manager Helen Kay Shedden Assistant Vice President WEIS MARKET 570-724-4644 201 Weis Plaza Wellsboro, PA 16901 FAX 570-724-1842 Officers Carol L. Strong Sales Manager Richard A. Pino, II Assistant Sales Manager <56> ___________________________________________________________________________ [GRAPHIC OMITTED: Silhouette of colonial rider on horseback, left side of page, approximately 2.25 inches by 2 inches wide] ___________________________________________________________________________ [FDIC EQUAL HOUSING LENDER LOGO OMITTED] ___________________________________________________________________________ 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. ___________________________________________________________________________ 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 20, 1999, 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: 570-662-2121 / 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 EX-21 5 EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT ____________________ First Citizens National Bank of Mansfield, Pennsylvania is the Company's sole subsidiary. EX-27 6
9 12-MOS DEC-31-1998 DEC-31-1998 7,175 130 0 0 93,082 0 0 205,875 2,292 313,564 274,193 5,348 3,439 1,986 0 0 2,773 25,825 313,564 17,652 5,146 290 23,088 11,482 11,920 11,168 218 457 8,214 5,031 3,630 141 0 3,489 1.26 1.26 4.07 1,877 15 0 0 2,138 112 48 2,292 1,701 0 591
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