Citizens & Northern: Time To Jump Back In On This Bank

Summary

• Citizens is down from a high of $29.24 to the current price of $22.66, a 22.5% drop.
• Citizens acquired Monument Bancorp, Inc., pushing them over $1.6 billion in total assets.
• Citizens recorded record earnings, excluding merger expenses, through 6 months 2019.

Who exactly is Citizens & Northern (NASDAQ:CZNC) ? They are a $1.6 billion total asset sized bank, based in Wellsboro, PA. They provide traditional banking services - taking in deposits and originating loans. Further, they also have a significant investment and insurance business, with almost $950 million in assets under management on the investment service side.

This may sound plain Jane, but they are an exceptional community bank. In fact, in the last year, Citizens & Northern has gone through a vast change. First, they are currently rebranding their image. Their logo has changed, their culture is changing, and that's partly because of the next big item.

Citizens & Northern, in April 2019, closed on their merger of Monument Bancorp in a deal that cost ~$43 million. Monument had $348 million in total assets that was added right to CZNC's balance sheet after the close.

As I am always eager to add an undervalued community bank to my portfolio, I wanted to re-look at CZNC, as I've owned them in the past, and with the new acquisition, I wanted to see how business was performing and if the dividend metrics look ripe for an add to the current position.

Citizen & Northern's Q2 2019 Performance Review

Where shall we begin? I would say the income statement is a great place to start, as we will have to dissect it slightly, due to the merger we discussed earlier.

Through the first 6 months of 2019, CZNC earned $30.2 in interest income and dividend revenue. Comparatively to last year, this is better by $6 million, as June 30, 2018 produced $24.2 million. That is a massive 25% increase from prior year. Non-interest income remained relatively flat, with a modest 3.4% growth from 6 months 2019 compared to 6 months 2018. The driver of the increase in interest income is primarily related to the merger, as loans increased by over 30%, which in turn drives up loan interest income.

Now, most financial institutions have experienced a large up-tick in interest expense this year, due to the war on deposits. Not to mention, interest rates "were" rising in the earlier part of the year, which caused deposit savings rates to also increase, as well as certificates of deposits. However, we are starting to see rates decrease again, after the Fed cut the interest rate by 0.25 points at the end of July. Therefore, interest expense increased from $1 million in 2018 through 6 months, to $2.9 million. The cost almost tripled year, over, year. This is due to higher rates being offered, as expected, as well as deposits increasing over 20%, primarily due to the merger.

Net income through 6 months was $8.7 million, but this included $3.6 million of merger costs, that we will add back to perform a true comparison. This equates to $12.3 million net income for year-to-date 2019. For 2018, through 6 months, net income was $10.7 million. Therefore, 2019 has displayed a growth rate of 15% versus 2018! As mentioned previously, primary cause is the merger, plus organic growth. These are very positive results and should be a baseline for expectations going forward.

Luckily, their balance sheet change is going to stick out, as well, due to the merger. Their total assets have increased $320, due to the merger, since December 31, 2018. Loans, the blood-line of a bank, have increased by almost $300 million as well, which proves out why loan interest income increased so much this year vs. last year. In addition, deposits are $250 million higher, but the liabilities increasing does not stop there. Short and long term advances/borrowings have also increased $16.9 million from the prior year. This is needed, occasionally, to continue to fuel loan growth, if deposit growth is not sufficient.

Nothing on the balance sheet really scares me. They now have $7 million of subordinated debt, which was assumed through the merger. However, nothing "exciting" on the balance sheet that should cause of concern nor strikes the curiosity.

Overall, CZNC shows strong financial performance, both from top line and bottom-line. The top line has grown faster than the bottom-line and one would have to predict that costs synergies should come throughout the remainder of the year and into 2020 from the merger. Though the financial performance and statement of condition/balance is highly important, it's time to look at their dividend metrics and to see if more fits in my portfolio.

CZNC Dividend Analysis

Stock Price*	Dividend	Forward EPS^	Dividend Yield	Payout Ratio	3-Year Growth Rate	5-Year Growth Rate	P/E Ratio
$22.66	$1.08	$1.90	4.77%	57%	1.28%	1%	11.93

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*Based on 8/23/19 close price^Based on Annualizing YTD 6/30/19 figures and adding back merger expenses

I would want to see a payout ratio below 60, a price-to-earnings (P/E) ratio below 13 (lower due to historically lower P/E ratios in the industry, and the market has pushed downward), a yield above 4.00% (i.e., higher than the market and most community-based bank yields), and a dividend growth rate of 6.00% (given strength in desired yield).

1.) Payout Ratio - After adding back the merger related expenses of $3.6 million, I re-calculated EPS by annualizing those earnings, to calculate $1.90 in earnings per share. Therefore, at a dividend of $1.08 from CZNC, this equates to 57%. That's a higher payout ratio and is on that upper range of 60 that I typically want/like to see.

2.) Price-to-Earnings (P/E) - This metric is used to see if the company is undervalued. According to my source, the S&P 500 P/E ratio is 21.20. Therefore, CZNC's 11.93 ratio is definitely below the 13 desired, and is also consistent with what I've seen in the industry, but slightly on the higher side.

3.) Dividend Yield - The current dividend of $1.08 equates to a monster yield of 4.77% on the share price of $22.66. That's a very high yield and is very appealing. However, as well know, it's not all about the higher yield, as that may risk a cut, and the growth rate may be low-to-non-existent. We need to find these details out. If $1,000 was invested, this equates to $47.70 on a go-forward basis.

4.) Dividend Growth Rate - Ouch. Here is the pain point for CZNC. Sad to say, they do not really make the cut here. They increased to $0.27 in 2018 and also gave a special dividend of $0.10 in 2019, which helps the shareholders with the years of limited to no growth.

Conclusion

CZNC is a tough bank to crack here. They are growing. I love that they are one of few banks still acquiring, which is nice to see. In addition, they are getting closer and closer to the $2 billion total asset mark, which was always a treasured milestone within the last 10 years for community banks. It definitely is one thing when a bank crosses the $1 billion threshold, but to double that size, it is quite a feat.

Then, their performance has been rock solid. Earnings are strong/growing by a double digit mark, and their balance sheet is not sophisticated, that could increase risk with lack of understanding. Charge offs are almost half of what they were in 2018, which has been consistent within the financial institution industry. The banking arena has gone through leaps of high credit quality and CZNC also fits on that boat.

However, there are downsides. Their dividend metrics are OK, for the most part, but there is one black eye. The dividend growth rate. It's hard seeing an OK payout ratio, a great yield and decent price to earnings ratio become now as appealing when the dividend growth rate is brought in. As a dividend growth investor, you "kind of" need that growth part to the equation. Now, they did pay a $0.10 special dividend this year to shareholders. This would have made up for a plethora of dividend increases, but still it just does not taste the same.

I will continue to monitor CZNC and if they approach closer to 5% yield or drop to the $21.60 range, I will add then. However, at current prices, I am willing to hold and to not add to my position.

Please share your thoughts and feedback on the analysis and conclusion above. I would love to hear from everyone and look forward to the comments. As always, good luck and happy investing!

Disclosure: I am/we are long CZNC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.