Executive Summary / Key Takeaways

• Citizens Financial Services (CZFS) is a regional bank successfully expanding its footprint through strategic acquisitions, notably the recent HVBC deal, which has broadened its reach into key markets in southeast Pennsylvania and New Jersey.
• The company demonstrated solid core banking performance in Q1 2025, with Net Interest Income increasing 9.75% year-over-year and Net Interest Margin expanding to 3.30%, primarily driven by lower funding costs in a changing rate environment.
• CZFS maintains a significant concentration in commercial real estate (CRE) loans (non-owner-occupied CRE at 306.50% of risk-based capital), which management actively monitors with heightened risk management procedures and believes is adequately reserved for based on current information and historical performance.
• While non-interest income saw a year-over-year decline in Q1 2025 due to non-recurring gains in the prior year and a challenging mortgage rate environment impacting loan sales, the company is focused on growing fee income through its Trust and Brokerage/Insurance services, particularly in newer markets.
• CZFS operates in a highly competitive landscape, facing pressure from larger regional banks with greater scale and technological capabilities, as well as agile fintechs, necessitating continued focus on its community-oriented approach and niche expertise to maintain market position and drive future growth.

A Regional Story of Expansion and Adaptation

Citizens Financial Services, Inc. (CZFS) is more than just a bank; it's a growing financial services provider deeply rooted in the communities it serves across Pennsylvania, southern New York, and Delaware. With its central office in Mansfield, PA, CZFS operates primarily through its subsidiary, First Citizens Community Bank, offering a traditional suite of banking products including deposits and a diverse loan portfolio spanning residential, commercial, agricultural, and construction sectors. Over time, the company has strategically expanded its geographic reach and service offerings, adding trust administration, investment management, and insurance services, positioning itself as a comprehensive financial partner for its customers.

The company's history is marked by deliberate expansion, moving beyond its north central Pennsylvania origins. Notable acquisitions, such as the MidCoast acquisition extending its presence into Delaware and the more recent HVBC acquisition in June 2023, have been pivotal in this growth story. The HVBC deal significantly broadened CZFS's footprint into the more densely populated southeast Pennsylvania region, including Montgomery, Bucks, and Philadelphia Counties, and even into Burlington County, New Jersey, adding branches, mortgage centers, and a business banking facility. This strategic inorganic growth is complemented by organic efforts, like the opening of a new branch in Williamsport, PA, in late 2023, aimed at strengthening its position in central Pennsylvania. These expansions are critical to CZFS's strategy, allowing it to tap into new customer bases and diversify its market exposure.

However, this expansion places CZFS squarely in a highly competitive arena. The banking industry across its service areas is intensely competitive for both loans and deposits. CZFS faces direct competition from a wide array of institutions, including larger regional banks like First Horizon Corp (FHN), Fifth Third Bancorp (FITB), and Truist Financial Corporation (TFC), as well as smaller regional peers like Franklin Financial Services Corporation (FRAF). Competition also comes from non-bank financial service providers, including consumer finance companies, credit unions, investment firms, and increasingly, agile fintech and blockchain entities offering digital-first solutions.

In this competitive landscape, CZFS leverages its community-focused model and niche expertise, particularly in agricultural lending and services related to the natural gas industry in its traditional markets. This local presence often translates into stronger customer relationships and potentially higher customer loyalty compared to larger, more distant institutions. For instance, its specialized agricultural loans are tailored to local needs, and its oil and gas leasing assistance caters to a specific regional demand. This local knowledge and relationship-based approach are key differentiators.

Despite these strengths, CZFS faces inherent disadvantages compared to larger competitors, primarily related to scale and technological investment. Larger banks often benefit from economies of scale, potentially leading to lower operating costs per unit. While the company does not appear to detail specific technological moats or significant R&D initiatives, it acknowledges the competitive pressure from fintechs. The competitive analysis suggests that larger peers like FITB and FHN are investing heavily in digital capabilities and AI, potentially offering faster processing speeds and lower costs, areas where CZFS may lag. CZFS's strategic response appears to involve targeted geographic expansion and deepening relationships within its communities and niche sectors, rather than competing head-to-head on broad technological innovation or scale with the largest players.

Financial Performance: Navigating Rate Shifts and Non-Recurring Items

CZFS's financial performance in the first quarter of 2025 reflects the impact of the current interest rate environment and strategic adjustments. Net income for the three months ended March 31, 2025, increased 8.5% to $7.621 million, or $1.60 per basic share, compared to $7.024 million, or $1.48 per basic share, in the same period of 2024. This improvement was primarily driven by a significant increase in net interest income, partially offset by a decrease in non-interest income and a higher provision for income taxes.

Net interest income, the core earnings engine for CZFS, rose by a robust 9.75% to $23.002 million in Q1 2025 from $20.958 million in Q1 2024. On a tax-equivalent basis, the net interest margin expanded from 3.05% to 3.30%. This expansion was largely a result of a decrease in the cost of interest-bearing liabilities, which declined from 2.99% to 2.80%. Management attributed this decrease primarily to lower market interest rates in 2025 compared to 2024, which reduced borrowing costs and the rates paid on interest-bearing deposits, particularly NOW accounts. While average interest-bearing assets increased by $58.7 million, contributing positively to interest income volume, the yield on interest-earning assets saw a more modest increase from 5.48% to 5.57%. This indicates that the benefit from lower funding costs was a more significant driver of NIM expansion than asset yield improvement in the quarter.

The provision for credit losses decreased to $625,000 in Q1 2025 from $785,000 in Q1 2024. This change was influenced by the annual update of the company's loss driver analysis under the CECL methodology. For residential loans, an increase in the historical loss rate combined with slower prepayment speeds led to an increased provision for that segment. Conversely, for other commercial loans, a decreased historical loss rate resulted in a lower provision. The overall decrease in the provision was also attributed to a decrease in specific reserves for non-performing loans when comparing the two periods.

Non-interest income totaled $3.427 million in Q1 2025, a significant decrease of 31.1% from $4.971 million in Q1 2024. This decline was primarily due to two factors: the absence of a $1.102 million gain from the sale of the Braavo division assets in Q1 2024 (a non-recurring event) and a 34.8% decrease in gains on loans sold ($0.272 million vs. $0.417 million). The lower gains on loan sales were attributed to the continued high mortgage rate environment, which has limited both sales volume and refinancing opportunities. Earnings on bank-owned life insurance also decreased by 48.2% ($0.346 million vs. $0.668 million), as the prior year included a death benefit received. Service charges on deposit accounts also saw a slight decrease. Despite the overall decline, brokerage and insurance income saw a modest increase, and management highlighted opportunities to grow non-interest income from Trust and Brokerage/Insurance services, particularly in the newer central, south central, and southeastern Pennsylvania markets.

Non-interest expenses decreased slightly by 1.3% to $16.428 million in Q1 2025 compared to $16.643 million in Q1 2024. Salaries and employee benefits remained relatively flat despite a decrease in full-time equivalent employees, as merit increases and higher profit sharing/retirement expenses offset the headcount reduction. Professional fees decreased significantly due to various legal matters and costs related to the Braavo sale in 2024 that did not recur. FDIC insurance expense also decreased due to an increase in the Bank's leverage ratio. ORE expenses increased, primarily because the prior year included a gain on the sale of an OREO property.

The provision for income taxes increased to $1.755 million in Q1 2025 from $1.477 million in Q1 2024, reflecting the higher pre-tax income. The effective tax rate remained below the statutory rate (18.7% in Q1 2025 vs. 17.4% in Q1 2024), benefiting from the company's investments in municipal loan and bond portfolios and tax credits from low-income housing projects, from which the company anticipates recognizing an aggregate of $7.6 million over the next 11 years.

Financial Health, Asset Quality, and Risk Considerations

As of March 31, 2025, CZFS reported total assets of $3.02 billion, a slight decrease of $9.4 million from December 31, 2024. This change was primarily influenced by decreases in loans held for sale and other assets, partially offset by increases in available-for-sale securities and total loans. Cash and cash equivalents decreased by $5.4 million, attributed to a decrease in cash held at the Federal Reserve.

The loan portfolio saw a modest increase of $2.0 million since year-end 2024, totaling $2.32 billion. Growth was experienced across most loan categories, including commercial, agricultural, and construction loans, despite some large pay-offs. Residential mortgage and consumer loans saw slight decreases.

A key area of focus for CZFS, like many community banks, is its concentration in commercial real estate (CRE) lending. As of March 31, 2025, non-owner-occupied CRE loans (including construction, land, and land development) represented 306.50% of consolidated risk-based capital, while construction, land, and land development loans alone represented 57.80%. Regulatory guidance identifies institutions exceeding certain thresholds as having potential CRE concentration risk, which may require heightened risk management and potentially higher capital levels. CZFS management acknowledges this concentration and states it has extensive experience in CRE lending, implementing heightened risk management procedures, strong underwriting criteria, and ongoing monitoring and stress testing of the portfolio.

Asset quality metrics showed some fluctuations. Non-performing loans decreased by $1.0 million during Q1 2025, totaling $24.938 million. This change was primarily driven by one large construction relationship being placed on non-accrual status, offset by the removal of one large commercial and one large agricultural relationship from non-accrual. The allowance for credit losses - loans stood at $22.081 million, or 0.95% of total loans, at March 31, 2025, compared to $21.699 million, or 0.94%, at December 31, 2024. Management believes the allowance is adequate based on specific reserves for non-performing loans ($1.58 million, including 100% reserve for non-performing student loans), a history of low charge-offs (0.03% annualized in Q1 2025, 0.11% in 2024 including acquired loans), and a disciplined loan review process. However, the company acknowledges that future adjustments could be necessary if economic conditions or portfolio performance deviate significantly from current assumptions.

Deposits decreased by $17.2 million since year-end 2024, totaling $2.36 billion. This decrease was attributed to fluctuations in state and political organization balances related to tax receipts and a decrease in brokered deposits. Management also noted that customers continue to transfer funds to higher-yielding investment alternatives, a common trend in the current rate environment. Borrowed funds increased by $4.3 million to $302.0 million to support asset growth and offset the decrease in deposits. CZFS utilizes various funding sources, including core deposits, FHLB advances, federal funds lines, and brokered CDs, and management believes it maintains sufficient liquidity to meet its obligations. The company also uses interest rate swaps to manage interest rate risk on floating-rate debt.

Capital adequacy remains a focus, particularly given the CRE concentration. The Bank operates under the Community Bank Leverage Ratio (CBLR) framework. At March 31, 2025, the Bank's leverage ratio was 9.06%, meeting the well-capitalized requirement under the CBLR. This is an improvement from December 31, 2024, when the ratio was 8.99%, requiring reporting under the Basel III framework for that date (where the Bank was also well-capitalized). The company has a Capital Policy and Plan that includes stress testing and internal targets exceeding regulatory minimums. Total stockholders equity increased by $8.56 million, or 2.9%, since year-end 2024, reaching $308.3 million. This increase was driven by net income and a decrease in accumulated other comprehensive loss, primarily due to an increase in the fair value of the available-for-sale investment portfolio resulting from lower longer-term interest rates.

Beyond CRE and interest rate risk, CZFS faces other risks, including the general economic environment, potential disruptions in financial markets, challenges in implementing strategic initiatives (including integrating acquisitions), litigation, regulatory changes, cybersecurity threats, reliance on key personnel, and the cyclical nature of the agricultural and natural gas industries in its markets.

Outlook and Competitive Positioning

Looking ahead, CZFS's performance will be influenced by the trajectory of interest rates, the health of the regional economies it serves, and its ability to effectively integrate recent acquisitions and grow its customer base in new markets. While the Q1 2025 results are not necessarily indicative of the full year, they demonstrate core profitability and an ability to manage funding costs in a dynamic rate environment.

Management's investment strategy for 2025 involves utilizing investment portfolio cashflows to repurchase investments, timing purchases when rates are favorable, and managing interest rate risk. Their borrowing strategy is focused on managing interest rate risk and liquidity in a declining rate environment. Analyst projections, such as the Zacks Consensus Estimate for 2025 EPS of $6.54 (as of June 6, 2025 news), suggest expectations for continued earnings growth.

In the competitive landscape, CZFS's ability to compete effectively against larger, more technologically advanced institutions and agile fintechs will be crucial. While it may lack the scale and R&D budgets of national or larger regional players, its strength lies in its community banking model, local expertise, and relationship-driven approach, particularly in niche markets like agriculture and the natural gas service industry. The success of integrating the HVBC acquisition and generating growth in southeast Pennsylvania and New Jersey will be a key indicator of its ability to expand its model into more competitive, populated areas. Growing non-interest income from Trust and Brokerage/Insurance services in these new markets is also a strategic focus to diversify revenue streams.

The company's CRE concentration remains a factor to monitor, although management appears to have robust procedures in place. The adequacy of the allowance for credit losses will continue to be evaluated based on economic conditions and portfolio performance. Deposit stability in a competitive rate environment, particularly managing the outflow of funds to higher-yielding alternatives, will also be important for managing funding costs and liquidity.

Conclusion

Citizens Financial Services presents an investment case centered on a growing regional bank leveraging its community roots and niche expertise while strategically expanding into new, more competitive markets through acquisitions. The recent financial performance, particularly the expansion of net interest income and margin in Q1 2025, demonstrates operational resilience in a shifting rate environment. The company's focus on managing its CRE concentration and maintaining adequate capital levels provides a foundation of stability.

However, investors must weigh these strengths against the challenges posed by intense competition from larger, more technologically sophisticated players and the need to successfully integrate acquired operations and grow deposits in a competitive funding market. The ability of CZFS to translate its community-focused model into sustainable growth and profitability in its expanded footprint, alongside effective risk management in its concentrated loan portfolios, will be key determinants of its long-term success. The outlook suggests continued earnings growth, supported by strategic initiatives and a disciplined approach to managing interest rate and credit risks.