Citizens Financial Services Inc: Form 10-Q for the period ended Mar 31, 2026

Forward-Looking Statements

We have made forward-looking statements in this document, and in documents that we may incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or expected future results of operations of Citizens Financial Services, Inc., First Citizens Community Bank, First Citizens Insurance Agency, Inc. or the combined Company. When we use words such as “believes,” “expects,” “anticipates,” or similar expressions, we are making forward-looking statements. For a variety of reasons, actual results could differ materially from those contained in or implied by forward-looking statements. The Company cautions readers that the following important factors, among others, could in the future affect the Company’s actual results and could cause the Company’s actual results for subsequent periods to differ materially from those expressed in any forward-looking statement:

• Interest rates could change more rapidly or more significantly than we expect or the yield curve could remain inverted for a longer period than anticipated.
• The economy could change significantly in an unexpected way, which would cause the demand for new loans and the ability of borrowers to repay outstanding loans to change in ways that our models do not anticipate.
• The financial markets could suffer a significant disruption, which may have a negative effect on our financial condition and that of our borrowers, and on our ability to raise money by issuing new securities.
• It could take us longer than we anticipate implementing strategic initiatives, including expansions, designed to increase revenues or manage expenses, or we may be unable to implement those initiatives at all.
• Acquisitions and dispositions of assets and companies could affect us in ways that management has not anticipated.
• We may become subject to new legal obligations or the resolution of litigation may have a negative effect on our financial condition or operating results.
• We may become subject to new and unanticipated accounting, tax, regulatory or compliance practices or requirements. Failure to comply with any one or more of these requirements could have an adverse effect on our operations.
• We could experience greater loan delinquencies than anticipated, adversely affecting our earnings and financial condition.
• We could experience greater losses than expected due to the ever-increasing volume of information theft and fraudulent scams impacting our customers and the banking industry.
• We could lose the services of some or all of our key personnel, which would negatively impact our business because of their business development skills, financial expertise, lending experience, technical expertise and market area knowledge.
• The agricultural economy is subject to extreme swings in both the costs of resources and the prices received from the sale of products as a result of weather, government regulations, international trade agreements and tariffs and consumer tastes, which could negatively impact certain of our customers.
• Loan concentrations in certain industries could negatively impact our results, if financial results or economic conditions deteriorate.
• A budget impasse in the Commonwealth of Pennsylvania or a Federal Government shutdown could impact our asset values, liquidity and profitability as a result of either delayed or reduced funding to school districts and municipalities who are customers of the Bank, as well as individuals who receive state and federal benefits.
• Companies providing support services related to the exploration and drilling of the natural gas reserves in our market area may be affected by federal, state and local laws and regulations such as restrictions on production, permitting, changes in taxes and environmental protection, which could negatively impact our customers and, as a result, negatively impact our loan and deposit volume and loan quality. Additionally, the activities the companies providing support services related to the exploration and drilling of the natural gas reserves may be dependent on the market price of natural gas. As a result, decreases in the market price of natural gas could also negatively impact these companies, our customers.

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Additional factors that may affect our results are discussed under “Part II – Item 1A – Risk Factors” in this report and in the Company’s 2025 Annual Report on Form 10-K under “Item 1.A/ Risk Factors.” Except as required by applicable law and regulation, we assume no obligation to update or revise any forward-looking statements after the date on which they are made.

Introduction

The following is management's discussion and analysis of the Company’s consolidated financial condition and results of operations at the dates and for the periods presented in the accompanying consolidated financial statements for the Company. Our consolidated financial condition and results of operations consist almost entirely of the Bank’s financial condition and results of operations. Management’s discussion and analysis should be read in conjunction with the preceding financial statements presented under Part I and the Company’s audited consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2025. The results of operations for the three months ended March 31, 2026 are not necessarily indicative of the results you may expect for the full year.

The Company engages in the general business of banking throughout our service area of Potter, Tioga, Clinton, Lycoming, Bradford and Centre counties in north central Pennsylvania, Lebanon, Berks, Schuylkill, Lancaster and Chester counties in south central Pennsylvania and Allegany County in southern New York, and the Cities of Wilmington and Dover, Delaware. We also have limited branch offices in Union county, Pennsylvania and Georgetown Delaware, which primarily serve agricultural and commercial customers in those markets. With the HVBC acquisition in 2023, we expanded further into southeast Pennsylvania, including Montgomery, Bucks and Philadelphia Counties as well as Burlington County, New Jersey through the acquisition of five full service branches, four mortgage centers and one business banking facility. We maintain our central office in Mansfield, Pennsylvania. Presently we operate 47 banking facilities, 37 of which operate as bank branches. In Pennsylvania, the Company has full service offices located in Mansfield, Blossburg, Ulysses, Genesee, Wellsboro, Troy, Sayre, Canton, Gillett, Millerton, LeRaysville, Towanda, Rome, the Mansfield Wal-Mart Super Center, Mill Hall, Schuylkill Haven, Friedensburg, Mt. Aetna, Fredericksburg, Mount Joy, Ephrata, Fivepointville, State College, Kennett Square, Warrington, Williamsport, Plumsteadville, Philadelphia, two branches near the city of Lebanon and two branches in Huntington Valley. The Company has limited branch offices located in Winfield, Pennsylvania and Georgetown, Delaware. In New York, our office is in Wellsville. In Delaware, we have three branches in Wilmington and one in Dover. The mortgage centers acquired as part of the acquisition are located in Huntington Valley, PA, Philadelphia, PA and Mount Laurel, NJ. The business banking facility is located in Philadelphia, PA. During the first quarter of 2026, the Williamsport branch moved to a new location and we have received regulatory approval to move the business banking facility located in Philadelphia to a new location.

Risk Management

Risk identification and management are essential elements for the successful management of the Company. In the normal course of business, the Company is subject to various types of risk, including interest rate risk, credit risk, liquidity risk and regulatory and compliance risk.

Interest rate risk is the sensitivity of net interest income and the market value of financial instruments to the direction, frequency and magnitude of changes in market interest rates. Interest rate risk results from various re-pricing frequencies and the maturity structure of the financial instruments owned by the Company. The Company uses its asset/liability and funds management policy to control and manage interest rate risk.

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Credit risk represents the possibility that a customer may not perform in accordance with contractual terms. Credit risk results from loans with customers and the purchase of securities from an issuer. The Company’s primary credit risk is in the loan portfolio. The Company manages credit risk by adhering to an established credit policy and through a disciplined evaluation of the adequacy of the allowance for credit losses. Also, the investment policy limits the amount of credit risk that may be taken in the investment portfolio.

Liquidity risk represents the inability to generate or otherwise obtain funds at reasonable rates to satisfy commitments to borrowers and obligations to depositors. The Company has established guidelines within its asset/liability and funds management policy to manage liquidity risk. These guidelines include, among other things, contingent funding alternatives.

Operational risk arises from the potential that inadequate information systems, operational problems, breaches in internal controls, fraud, or unforeseen catastrophes will result in unexpected losses. We expend significant resources on our operational systems and any breach or malfunction in operational systems could adversely impact our business and customers and our financial condition and earnings.

Regulatory and compliance risk represents the possibility that a change in law, regulations or regulatory policy may have a material effect on the business of the Company. We cannot predict what legislation might be enacted or what regulations might be adopted, or if adopted, the effect thereof on our operations.

Competition

The banking industry in the Bank’s service areas continue to be extremely competitive for loans and deposits, both among commercial banks and with other financial service providers such as consumer finance companies, thrifts, investment firms, mutual funds, insurance companies, credit unions, agricultural cooperatives and internet entities. Competition in our north central Pennsylvania market has increased as a result of other financial institutions expanding or looking to expand into new markets. With larger population centers in our central, south central and south east Pennsylvania markets, as well as in our Delaware market, we experience more competition to gather deposits and to make loans. Mortgage banking firms, financial companies, financial affiliates of industrial companies, brokerage firms, retirement fund management firms and even government agencies provide additional competition for loans, deposits and other financial services. Fintech and blockchain entities offering crypto services are also increasing competition for the Company’s financial services. The Bank is generally competitive with all competing financial institutions in its service areas with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans.

Trust and Investment Services; Oil and Gas Lease Services

Our Investment and Trust Services Division offers professional trust administration, investment management services, estate planning and administration, and custody of securities. In addition to traditional trust and investment services offered, we assist our customers through various oil and gas specific leasing matters from lease negotiations to establishing a successful approach to personal wealth management. Assets held by the Company in a fiduciary or agency capacity for its customers are not included in the Consolidated Balance Sheets since such items are not assets of the Company. Revenues and fees of the Trust Department are reflected in trust income in the Consolidated Statement of Income. As of March 31, 2026 and December 31, 2025, the Trust Department had $191.6 million and $194.8 million of assets under management, respectively.

Our Investment Representatives offer full service brokerage services and financial planning throughout the Bank’s market area. Products such as mutual funds, annuities, health and life insurance are made available through our insurance subsidiary, First Citizens Insurance Agency, Inc. The assets associated with these products are not included in the Consolidated Balance Sheets since such assets are not assets of the Company. Assets owned and invested by customers of the Bank through the Bank’s Investment Representatives increased from $317.9 million at December 31, 2025 to $319.5 million at March 31, 2026 with the increase due to an increase in market values. Fee income from the sale of these products is reflected in brokerage and insurance income in the Consolidated Statement of Income. Management believes that there are opportunities to increase non-interest income through these products and services, especially in our central, south central and south eastern Pennsylvania and Delaware markets.

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Results of Operations

Overview of the Income Statement

The Company had net income of $10,376,000 for the first three months of 2026 compared to $7,621,000 for last year’s comparable period, an increase of $2,755,000, or 36.2%, primarily due to an increase in net interest income after the provision for credit losses of $3,236,000. Basic earnings per share for the first three months of 2026 was $2.16, compared to $1.59 for last year’s comparable period, representing a 35.9% increase. Annualized return on assets and return on equity for the three months of 2026 were 1.34% and 12.03%, respectively, compared with 1.00% and 10.00% for last year’s comparable period.

Net Interest Income

Net interest income, the most significant component of the Company’s earnings, is the amount by which interest income generated from interest-earning assets exceeds interest expense paid on interest-bearing liabilities.

Net interest income for the first three months of 2026 was $26,113,000, an increase of $3,111,000, or 13.5%, compared to the same period in 2025. For the first three months of 2026 the provision for credit losses was $500,000. The provision for the first three months of 2025 was $625,000. Consequently, net interest income after the provision for credit losses was $25,613,000 in the first three months of 2026 compared to $22,377,000 during the first three months of 2025.

The following table sets forth the average balances of, and the interest earned or incurred on, for each principal category of assets, liabilities and stockholders’ equity, the related rates, net interest income and interest rate spread created for the three months ended March 31, 2026 and 2025 on a tax equivalent basis (dollars in thousands):

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(dollars in thousands)

(1) Averages are based on daily averages.

(2) Includes loan origination and commitment fees.

(3) Tax exempt interest revenue is shown on a tax equivalent basis for proper comparison using a statutory federal income tax rate of 21%.

(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.

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Tax exempt revenue is shown on a tax-equivalent basis (non-GAAP) for proper comparison using a federal statutory income tax rate of 21% for the three months ended March 31, 2026 and 2025. For purposes of the comparison, as well as the discussion that follows, this presentation facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Company’s Federal statutory rate during the corresponding period. The following table represents the adjustment to convert net interest income to net interest income on a fully taxable equivalent basis for the periods ended March 31, 2026 and 2025 (in thousands):

The following table shows the tax-equivalent effect of changes in volume and rate on interest income and expense (in thousands):

(1) The portion of the total change attributable to both volume and rate changes, which cannot be separated, has been allocated proportionally to the change due to volume and the change due to rate prior to allocation.

Tax equivalent net interest income increased from $23,250,000 for the three month period ended March 31, 2025 to $26,483,000 for the three month period ended March 31, 2026, an increase of $3,233,000. This increase was primarily due to rate. Asset yields increased 14 basis points (bps), increasing interest income $1,187,000, while the cost of interest bearing liabilities decreased from 2.80% to 2.46%, resulting in a decrease in interest expense of $2,138,000. The tax equivalent net interest margin increased from 3.30% for the first three months of 2025 to 3.72% for the comparable period in 2026.

Total tax equivalent interest income for the 2026 three month period increased $1,385,000 as compared to the 2025 three month period. This increase was a result of an increase of $1,187,000 due to an increase in the yield on interest earning assets from 5.57% to 5.71%. Average interest earning assets increased $26,386,000 resulting in an increase in interest income due to volume of $198,000.

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Tax equivalent investment income for the three months ended March 31, 2026 increased $584,000 over the same period last year. The primary cause of the increase was due to the increase in yield on investment securities of 50 basis points to 3.35%.

• The average balance of taxable securities decreased $24,317,000, which resulted in a decrease in investment income of $158,000. The yield on taxable securities increased 38 basis points from 2.89% to 3.27% as a result of lower yielding securities maturing and purchases made in a higher market interest rate environment. This resulted in an increase in investment income of $323,000.
• The average balance of tax-exempt securities increased $22,036,000, which resulted in an increase in investment income of $167,000. The yield on taxable securities increased 87 basis points from 2.69% to 3.56%. This resulted in an increase in investment income of $252,000. For a discussion of the Company’s current investment strategy, see “Financial Condition – Investments”.

Total loan interest income increased $841,000 for the three months ended March 31, 2026 compared to the same period last year.

• Interest income on residential mortgage loans decreased $158,000. The change due to rate was an increase of $44,000 as the average yield on residential mortgages increased from 5.87% to 5.92%. The average balance of residential mortgage loans decreased $13,721,000. This resulted in a decrease of $202,000 on total interest income due to volume.
• The average balance of construction loans decreased $73,609,000 as a result of projects in our Delaware market and the southeast Pennsylvania market being completed and the related construction loans either transferring to other portfolios or being paid off. This resulted in a decrease of $1,257,000 on total interest income due to volume. The change due to rate was a decrease of $139,000 as the average yield on construction loans decreased from 7.25% to 6.89% as a result of a decrease in market interest rates in 2025 and the first quarter of 2026.
• The average balance of commercial loans increased $140,301,000 from a year ago. The growth was primarily attributable to completed construction projects converting to permanent financing and growth in our Delaware and south central Pennsylvania markets. This had a positive impact of $2,122,000 on total interest income due to volume. The yield decreased 0.13% to 6.16%, which decreased loan interest income $396,000.
• Interest income on agricultural loans increased $1,534,000 from 2025 to 2026. The yield increased 138 bps to 6.75% as a result of lower yielding loans maturing and repricing at higher rates and the pay-off of a loan relationship that was previously on non-accrual status, which increased loan interest income $1,269,000. The average balance of agricultural loans increased $19,197,000 from a year ago, resulting in an increase in interest income of $265,000.
• The average balance of other loans decreased $47,673,000 as a result of a decrease in outstanding student loans. This resulted in a decrease of $795,000 on total interest income due to volume. The average yield of other loans decreased 67 basis points to 6.62% as a result of a decrease in market interest rates in 2025 and the first quarter of 2026 resulting in a decrease in income of $225,000.

Total interest expense decreased $1,848,000 for the three months ended March 31, 2026 compared with the comparative period last year as a result of a decrease in rate on interest-bearing liabilities. Interest expense increased $290,000 due to volume as a result of an increase in interest bearing liabilities of $8,109,000. The average rate paid on interest-bearing liabilities decreased from 2.80% to 2.46%. The decrease was driven by the Federal Reserve interest rate cuts in the second half of 2025, which caused interest expense to decrease $2,138,000.

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• The average balance of interest bearing deposits increased $50,381,000 from March 31, 2025 to March 31, 2026. The increase was due to organic growth across all regions of the Company’s market areas as well as an increase in brokered deposits of $17,402,000. The effect of these volume changes was an increase in interest expense of $718,000. The average rate paid on interest bearing deposits was 2.26% for the first three months of 2026 and 2.52% for the comparable period in 2025. This resulted in a decrease in interest expense of $1,707,000. The decrease was due to the Federal Reserve decreasing interest rates during the second half of 2025.
• The average balance of other borrowed funds decreased $42,272,000. This resulted in a decrease in interest expense of $428,000. There was a decrease in the average rate paid on other borrowed funds from 4.35% to 3.81% due to the interest rate decreases by the Federal Reserve in the second half of 2025 that decreased borrowings costs resulting in a decrease in interest expense of $431,000.

Provision for Credit Losses

For the three month period ended March 31, 2026, we recorded a provision for credit losses of $500,000, which represents a decrease of $125,000 from the $625,000 provision recorded in the corresponding three months of last year. The decrease in the provision is due to the updated loss driver analysis completed in the first quarter of 2026 and the Iran war that started in the first quarter of 2026. (see “Financial Condition – Allowance for Credit Losses and Credit Quality Risk”).

Non-interest Income

The following table shows the breakdown of non-interest income for the three months ended March 31, 2026 and 2025 (dollars in thousands):

Non-interest income for the three months ended March 31, 2026 totaled $3,690,000, an increase of $263,000 when compared to the same period in 2025. During the first three months of 2026, net equity security gains amounted to $19,000 as a result of market gains associated with general banking stock gains compared with an $11,000 loss in the comparable 2025 period associated with market conditions for that period. There were no sales of available for sale securities during the first three months of 2026 or 2025.

The increase in earnings on bank owned life insurance is due to purchasing $22.0 million of additional insurance in January of 2026. The decrease in brokerage and insurance commissions was due to the resignation of a broker in the third quarter of 2025.

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Non-interest Expense

The following tables reflect the breakdown of non-interest expense for the three months ended March 31, 2026 and 2025 (dollars in thousands):

Non-interest expenses increased $223,000 for the three months ended March 31, 2026 compared to the same period in 2025. Salaries and employee benefits decreased $13,000 or 0.1%. Full time equivalent employees (FTE) increased 6.7 or 1.8% when comparing 2026 to 2025. This increase in headcount in addition to merit increases resulted in payroll and payroll taxes increasing by $120,000. Due to actuarial assumptions, post retirement benefits decreased $50,000. As a result of the decrease in brokerage and insurance commissions due to the resignation of a broker in the third quarter of 2025, commission expense decreased $96,000.

Provision for Income Taxes

The provision for income taxes was $2,326,000 for the three month period ended March 31, 2026 compared to $1,805,000 for the same period in 2025. The increase is primarily attributable to the increase in income before the provision for income taxes of $3,276,000 for the comparable periods due to an increase in net interest income after the provision for credit losses. Through management of our municipal loan and bond portfolios, management is focused on minimizing our effective tax rate. Our effective tax rate was 18.3% and 19.2% for the first three months of 2026 and 2025, respectively, compared to the federal statutory rate of 21%.

We are invested in seven limited partnerships that have established low-income housing projects in our market areas, with our most recent investments made in the second half of 2022. We are currently recognizing credits on three projects. The remaining four partnership credits are fully utilized as of December 31, 2024. We anticipate recognizing an aggregate of $6.6 million of tax credits over the next 11 years.

Financial Condition

Total assets were $3.03 billion at March 31, 2026, a decrease of $38.1 million from $3.06 billion at December 31, 2025, due primarily to a decrease in outstanding student loans. Cash and cash equivalents decreased $1.2 million to $33.1 million. Available for sale securities increased $3.5 million. Total loans decreased $52.5 million, while loans held for sale decreased $3.5 million. Total deposits increased $64.2 million to $2.44 billion since year-end 2025, while borrowed funds decreased $110.7 million to $198.7 million.

Cash and Cash Equivalents

Cash and cash equivalents totaled $33.1 million at March 31, 2026 compared to $34.3 million at December 31, 2025. The decrease is due to a decrease in the cash held at the Federal Reserve. Management actively measures and evaluates the Company’s liquidity position through our Asset–Liability Committee and believes the Company’s liquidity needs are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources including the Bank’s core deposits, Federal Home Loan Bank financing, federal funds lines with correspondent banks, brokered certificates of deposit and the portion of the investment and loan portfolios that mature within one year. Management expects that these sources of funds will permit us to meet cash obligations and off-balance sheet commitments as they come due.

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Investments

The following table shows the composition of the investment portfolio (including debt and equity securities) as of March 31, 2026 and December 31, 2025 (dollars in thousands):

Our investment portfolio increased by $3.6 million, or 0.8%, from December 31, 2025 to March 31, 2026. During 2026, we purchased $13.9 million of mortgage-backed securities in U.S government sponsored entities and $12.3 million of state and political subdivision bonds. We experienced $8.3 million of principal repayments and $11.5 million of calls and maturities. As a result of increases in market interest rates, the unrealized loss on available for sale investment portfolio increased $2.8 million. Excluding our short-term investments consisting of monies held primarily at the Federal Reserve for liquidity purposes, our investment portfolio for the three month period ended March 31, 2026 yielded 3.35%, compared to 2.85% in the comparable period in 2025, on a tax equivalent basis.

The investment strategy for 2026 has been to utilize cashflows from the investment portfolio to repurchase investments primarily in mortgage backed and municipal securities. We continually monitor interest rate trading ranges and seek to time investment security purchases when rates are in the top third of the trading range. The Company believes its investment strategy has appropriately mitigated its interest rate risk exposure for various rate environments, including a rising rate environment, while providing sufficient cashflows to meet liquidity needs.

Management continues to monitor the earnings performance and the liquidity of the investment portfolio on a regular basis. Through active balance sheet management and analysis of the investment portfolio, the Company believes it maintains sufficient liquidity to satisfy depositor withdrawal requirements and various credit needs of its customers.

Loans Held for Sale

Loans held for sale decreased $3.5 million to $5.9 million as of March 31, 2026 from December 31, 2025 due to the first quarter typically being the slowest quarter for residential home sales. For loans sold on the secondary market, the Company recognizes fee income for servicing certain sold loans, which is included in non-interest income.

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Loans

The following table shows the composition of the loan portfolio as of March 31, 2026 and December 31, 2025 (dollars in thousands):

Lending efforts have historically been focused in north central Pennsylvania, the south central Pennsylvania counties of Lebanon, Schuylkill, Berks and Lancaster, the central Pennsylvania counties of Lycoming, Clinton and Centre, and southern New York. In Delaware, our activity is centered around the cities of Wilmington and Dover, Delaware. We have a limited service branch office in Union County that is staffed by a lending team to primarily support agricultural opportunities in central Pennsylvania and a loan production office in Georgetown, Delaware to also support our agricultural initiative. In June 2023, we completed the HVBC acquisition, which expanded our markets into south east Pennsylvania, including the counties of Montgomery, Bucks and Philadelphia. It also includes a Mortgage production office in Mount Laurel, New Jersey. We originate loans primarily through direct loans to our existing customer base, with new customers generated through the strong relationships our lending teams have with their customers and our lenders expertise in certain areas, as well as by referrals from real estate brokers, building contractors, attorneys, accountants, corporate and advisory board members, existing customers and the Bank’s website. The Bank offers a variety of loans although historically most of our lending has focused on real estate loans including residential, commercial, agricultural, and construction loans. All lending is governed by a lending policy that is developed and administered by management and approved by the Board of Directors.

Loan activity remained steady in the first months of 2026 with growth experienced across most markets even after a large pay-offs in our Delaware market. The decrease in consumer loans was driven by the seasonality of that portfolio with the expected pay-offs in the first or second quarter of a year.

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The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending. Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions which have (1) total reported loans for construction, land development and other land acquisitions which represent 100% or more of an institution’s total risk-based capital; or (2) total commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the institution’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios and may be required to hold higher levels of capital. The Company, like many community banks, has a concentration in commercial real estate loans, and the Company has experienced growth in its commercial real estate portfolio in recent years. As of March 31, 2026, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represented 294.7% of consolidated risk based capital. Construction, land and land development loans represented 27.2% of consolidated risk based capital as of March 31, 2026. Management has extensive experience in commercial real estate lending and has implemented and continues to maintain heightened risk management procedures and strong underwriting criteria with respect to its commercial real estate portfolio. We may be required to maintain higher levels of capital as a result of our commercial real estate concentrations, which could require us to obtain additional capital and may adversely affect shareholder returns. The Company has an extensive Capital Policy and Capital Plan, which includes pro-forma projections including stress testing within which the Board of Directors has established internal minimum targets for regulatory capital ratios that are in excess of well capitalized ratios. The Company continues to refine information reviewed related to commercial real estate and to implement additional monitoring and testing of commercial real estate loans. As of March 31, 2026, management believes that it has implemented appropriate risk management practices, including risk assessments, board-approved underwriting policies and related procedures, which include monitoring loan portfolio performance and stressing of the commercial real estate portfolio under adverse economic conditions.

Given the significance of commercial real estate (“CRE”) loans to our total loan portfolio, the following table further disaggregates these loans by owner occupied status and by non-owner occupied status as of March 31, 2026 and December 31, 2025 (dollars in thousands):

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The following table provides a breakdown of our construction loan portfolio by collateral type as of March 31, 2026 and December 31, 2025 (dollars in thousands):

The Company obtains an independent appraisal of the real estate collateral securing a CRE loan prior to originating the loan. The appraised value is used to calculate the ratio of the outstanding loan balance to the value of the real estate collateral, or loan-to-value ratio (“LTV”). The original appraisal is used to monitor the LTVs within the CRE portfolio unless an updated appraisal is received, which may happen for a variety of reasons, including but not limited to payment delinquency, additional loan requests using the same collateral, and loan modifications. The following table presents the ranges in the LTVs of our CRE loans at March 31, 2026 and December 31, 2025(dollars in thousands):

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While the Company lends to companies that service companies that explore for natural gas in our market area, the Company has not originated any loans to companies performing the actual drilling and exploration activities. Loans made by the Company are to service industry customers which include trucking companies, stone quarries and other support businesses, favoring customers that have had a relationship with the Company prior to supporting the exploration for natural gas. We also have originated loans to businesses and individuals for restaurants, hotels and apartment rentals that have been developed and expanded to meet the housing and living needs of the gas industry workers. Due to our understanding of the industry and its cyclical nature, the loans made for natural gas-related activities have been originated in accordance with specific policies and procedures for lending to these entities, which include more stringent loan to value thresholds, shortened amortization periods, and expansion of our monitoring of loan concentrations associated with this activity.

Allowance for Credit Losses - Loans

The allowance for credit losses - loans is maintained at a level which, in management’s judgment, is adequate to absorb losses in the loan portfolio. The provision for credit losses - loans is charged against current income. Loans deemed not collectable are charged-off against the allowance while subsequent recoveries increase the allowance. The allowance for credit losses - loans was $22,894,000 or 1.00% of total loans as of March 31, 2026 as compared to $22,806,000 or 0.97% of loans as of December 31, 2025. The $88,000 increase is a result of a $144,000 provision for credit losses – loans less net charge-offs of $56,000. The following table shows the distribution of the allowance for credit losses - loans and the percentage of loans compared to total loans by loan category as of March 31 30, 2026 and December 31, 2025 (dollars in thousands):

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The following table provides information related to credit loss experience and loan quality for the three months ended March 31, 2026 and the year ended December 31, 2025 (dollars in thousands).

The credit loss expense for the first three months of 2026 was driven by the economic forecast and the annual update of the loss driver analysis, as well as the Iran war. This update includes revising prepayment and curtailment speeds. In addition, loss rates are updated to include the most recent completed year of 2025.

The Company believes it utilizes a disciplined and thorough loan review process based upon its internal loan policy approved by the Company’s Board of Directors. The purpose of the review is to assess credit quality, analyze delinquencies, identify problem loans, evaluate potential charge-offs and recoveries, and assess general overall economic conditions in the markets served. An external independent loan review is performed on our commercial portfolio at least semi-annually for the Company. The external consultant is engaged to 1) review a minimum of 50% of the dollar volume of the commercial loan portfolio on an annual basis, 2) a large sample of relationships in aggregate over $1,000,000, 3) selected loan relationships over $750,000 which are over 30 days past due, or classified Special Mention, Substandard, Doubtful, or Loss, and 4) such other loans which management or the consultant deems appropriate. As part of this review, our underwriting process and loan grading system is evaluated.

Management believes it uses the best information available to make such determinations and that the allowance for credit losses - loans is adequate as of March 31, 2026. However, future adjustments could be required if circumstances differ substantially from assumptions and estimates used in making the initial determination. A prolonged downturn in the economy, changes in the economies of various segments of our agricultural and commercial portfolios, high unemployment rates, significant changes in the value of collateral and delays in receiving financial information from borrowers could result in increased levels of non-performing assets, charge-offs, credit loss provisions and reduction in income. Additionally, bank regulatory agencies periodically examine the Bank’s allowance for credit losses. The banking agencies could require the recognition of additions to the allowance for credit losses - loans based upon their judgment of information available to them at the time of their examination.

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On a monthly basis, problem loans are identified and updated primarily using internally prepared past due reports. Based on data surrounding the collection process of each identified loan, the loan may be added or deleted from the monthly watch list. The watch list includes loans graded special mention, substandard, doubtful, and loss, as well as additional loans that management may choose to include. Watch list loans are continually monitored going forward until satisfactory conditions exist that allow management to upgrade and remove the loan from the watchlist. In certain cases, loans may be placed on non-accrual status or charged-off based upon management’s evaluation of the borrower’s ability to pay. All commercial loans, which include commercial real estate, agricultural real estate, state and political subdivision loans, other commercial loans and other agricultural loans, on non-accrual are evaluated quarterly for impairment.

See also “Note 5 – Loans and Related Allowance for Credit Losses - Loans” to the consolidated financial statements.

The following table is a summary of our non-performing assets as of March 31, 2026 and December 31, 2025.

(dollars in thousands)

The following table identifies amounts of loans contractually past due 30 to 90 days and non-performing loans by loan category, as well as the change from December 31, 2025 to March 31, 2026 in non-performing loans (in thousands). Non-performing loans include accruing loans that are contractually past due 90 days or more and non-accrual loans. Interest does not accrue on non-accrual loans. Subsequent cash payments received are applied to the outstanding principal balance or recorded as interest income, depending upon management’s assessment of its ultimate ability to collect principal and interest.

(in thousands)

46

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(in thousands)

Nonperforming loans increased $10.9 million during the first three months of 2026. During the first three months of 2026, four commercial real estate relationships with a cumulative balance as of March 31, 2026 of $11.7 million were placed on non-accrual status, which accounts for the majority of the increase in non-performing loans. All non-performing commercial, agricultural and construction loans are reviewed on an individual basis to determine the need for a specific reserve at quarter end. In addition, non-performing residential loans with a balance in excess of $150,000 are individually evaluated. The specific reserves for these non-performing loans as of March 31, 2026 and December 31, 2025 was $940,000 and $1,039,000, respectively. In addition, the Bank policy is to reserve 100% of all non-performing student loans. The reserve for these loans was $920,000 and $770,000 as of March 31, 2026 and December 31, 2025, respectively.

Management believes that the allowance for credit losses - loans March 31, 2026 was adequate at that date, which was based on the following factors:

• Specific reserves for non-performing loans total $1,860,000.
• The Company has a history of low charge-offs, which were 0.01% of average loans on an annualized basis for 2026 and 0.03% for 2025.

Bank Owned Life Insurance

The Company owns bank owned life insurance policies to offset future employee benefit costs. These policies provide the Bank with an asset that generates earnings to partially offset the current costs of benefits, and eventually (at the death of the insureds) provide partial recovery of cash outflows associated with the benefits. As of March 31, 2026, and December 31, 2025, the cash surrender value of the life insurance was $74.1 million and $51.5 million, respectively. The change in cash surrender value, net of purchases and amounts acquired through acquisitions, is recognized in the results of operations. The amounts recorded as non-interest income totaled $570,000 and $346,000 for the three month periods ended March 31, 2026 and 2025, respectively. During the first quarter of 2026, the Bank purchased $22.0 million of additional bank owned life insurance policies. During the first three months of 2025, the Company received proceeds of $108,000 upon the passing of a former director of the First National Bank of Fredericksburg. There were no proceeds received in 2026. The Company evaluates annually the risks associated with the life insurance policies, including limits on the amount of coverage and an evaluation of the various carriers’ credit ratings.

The Company policies that were purchased directly from insurance companies and acquired as part of the HVBC acquisition are structured so that any death benefits received from a policy while the insured person is an active employee of the Bank will be split with the beneficiary of the policy. Under these agreements, the employee’s beneficiary will be entitled to receive 50% of the net amount at risk from the proceeds. The net amount at risk is the total death benefit payable less the cash surrender value of the policy as of the date of death. The policies acquired as part of an acquisition in 2015 provide a fixed split-dollar benefit for the beneficiary’s estate, which is dependent on several factors including whether the covered individual was a former Director of First National Bank of Fredericksburg (“FNB”) or a former employee of FNB and their salary level. As of March 31, 2026 and December 31, 2025, included in other liabilities on the Consolidated Balance Sheet was a liability of $533,000 and $529,000, respectively, for the obligation under the split-dollar benefit agreements.

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Premises and Equipment

Premises and equipment decreased $283,000 to $20,715,000 as of March 31, 2026 from December 31, 2025 as a result of depreciation.

Other assets

Other assets decreased $7.8 million to $45.3 million as of March 31, 2026 from December 31, 2025. The primary drivers of the decrease was a reduction in FHLB stock held due to the decrease in outstanding borrowings and a reduction in the right of use asset for leases.

Deposits

The following table shows the composition of deposits as of March 31, 2026 and December 31, 2025 (dollars in thousands):

Deposits increased $64.2 million since December 31, 2025. The increase in deposits was driven by an increase in brokered deposits since year end of $52.8 million that were utilized to offset seasonal municipal deposit outflows and pay-down outstanding borrowings. We continue to see customer funds being transferred to higher-yielding investment alternatives. Brokered deposits totaled $112.8 million and $60.01 million as of March 31, 2026 and December 31, 2025, respectively. At March 31, 2026, the Bank estimates that balances held by customers in excess of the FDIC insurance limit ($250,000 per insured account) totaled $1.17 billion, or 47.9% of the Bank’s total deposits. Included in this balance are balances held through Intrafi, which provides customers with additional FDIC insurance, as well as deposits collateralized by securities or letters of credit (almost exclusively municipal deposits). The total of these items was $593.7 million, or 24.3% of the Bank’s total deposits, as of March 31, 2026.

Borrowed Funds

Borrowed funds were $198.7 million and $309.4 million as of March 31, 2026 and December 31, 2025, respectively. The decrease in borrowed funds was due to the increase in deposit levels through March 31, 2025 due to the increase in brokered deposits and the decrease in outstanding consumer loans.

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The Company’s current strategy for borrowings is to consider terms and structures to manage interest rate risk and liquidity in a declining market interest rate environment. The Company’s daily cash requirements or short-term investments are primarily met by using the financial instruments available through the Federal Home Loan Bank of Pittsburgh.

Stockholders’ Equity

We evaluate stockholders’ equity in relation to total assets and the risks associated with those assets. The greater the capital resource, the more likely a corporation will meet its cash obligations and absorb unforeseen losses. For these reasons, capital adequacy has been, and will continue to be, of paramount importance to the Company. As such, the Company has implemented policies and procedures to ensure that it has adequate capital levels. As part of this process, we routinely stress test our capital levels and identify potential risk and alternative sources of additional capital should the need arise.

Total stockholders’ equity was $343,578,000 at March 31, 2026 compared to $338,051,000 at December 31, 2025, an increase of $5,527,000, or 1.6%. Excluding accumulated other comprehensive loss, stockholders’ equity increased $7,832,000, or 2.2%. The accumulated comprehensive loss increased $2,305,000, which was primarily the result of the decrease in fair value of the Company’s available for sale investment portfolio caused by the increase in longer term market interest rates in the first quarter of 2026. For the first three months of 2026, the Company had net income of $10,376,000 and declared cash dividends of $2,402,000, or $0.50 per share, representing a cash dividend payout ratio of 23.2%.

All of the Company’s debt investment securities are classified as available-for-sale, making this portion of the Company’s balance sheet more sensitive to the changing market value of investments due to changes in market interest rates. As a result of the increase in longer term market interest rates, accumulated other comprehensive loss increased approximately $2,305,000 from December 31, 2025.

The Bank is 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 regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under U.S. GAAP, regulatory reporting requirements, and regulatory capital standards. The 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 regulatory capital standards to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and Tier 1 capital (as defined) to risk-weighted assets (as defined), common equity Tier 1 capital (as defined) to total risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). As permitted by applicable federal regulation, the Bank has opted to use the community bank leverage ratio (the “CBLR”) framework for determining its capital adequacy. Under the CBLR framework a qualifying community bank is considered well-capitalized if its leverage ratio (Tier 1 capital divided by average total consolidated assets) exceeds 9%. There is a two quarter grace period for a qualifying community bank to return to 9% as long as the CBLR is at least 8%. If a qualifying community bank fails to maintain the applicable minimum CBLR during the grace period, or if it is unable to restore compliance with the CBLR within the grace period, then it will revert to the Basel III capital framework and the normal Prompt Corrective Action capital categories will apply. At March 31, 2026 and December 31, 2025, the Bank leverage ratio under the CBLR framework was 9.33% and 9.54%, respectively, which meet the 9.0% requirement to be considered “well-capitalized” under the CBLR.

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Off-Balance Sheet Activities

Some financial instruments, such as loan commitments, credit lines, and letters of credit, are issued to meet customer financing needs but are not recorded on the Company’s balance sheet. The contractual amount of financial instruments with off-balance sheet risk was as follows at March 31, 2026 and December 31, 2025 (in thousands):

We also offer limited overdraft protection as a non-contractual courtesy which is available to demand deposit accounts in good standing. Overdraft charges as a result of ATM withdrawals and one-time point of sale (non-recurring) transactions require prior approval of the customer. The non-contractual amount of financial instruments with off-balance sheet risk at March 31, 2026 and December 31, 2025 was $12,212,000 and $12,207,000, respectively. The Company reserves the right to discontinue this service without prior notice.

Liquidity

Liquidity is a measure of the Company’s ability to efficiently meet normal cash flow requirements of both borrowers and depositors. To maintain proper liquidity, we use funds management policies, which include liquidity target ratios, 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 to fund other capital expenditures.

Cash generated by operating activities, investing activities and financing activities influences liquidity management. Our Company’s historical activity in this area can be seen in the Consolidated Statement of Cash Flows. The most important source of funds is core deposits. Repayment of principal on outstanding loans and cash flows created from the investment portfolio are also factors in liquidity management. Other sources of funding include brokered certificates of deposit and the sale of loans or investments, if needed.

The Company’s use of funds is shown in the investing activity section of the Consolidated Statement of Cash Flows, where the net loan activity is presented. Other uses of funds include purchasing stock from the Federal Home Loan Bank (FHLB) of Pittsburgh, as well as capital expenditures. Capital expenditures (including software purchases), during the first three months of 2026 were $125,000 compared to $585,000 during the same time period in 2025.

Short-term debt from the FHLB supplements the Bank’s availability of funds. The Bank achieves liquidity primarily from temporary or short‑term investments in the Federal Reserve and the FHLB. The Bank had a maximum borrowing capacity at the FHLB of approximately $1.14 billion, of which $334.4 million was outstanding, at March 31, 2026. The Bank also has two federal funds lines with third party providers for $34.0 million as of March 31, 2026, which are unsecured and were undrawn upon as of March 31, 2026. The Company also has a borrower in custody line with the Federal Reserve Bank of approximately $11.6 million, which also was not drawn upon as of March 31, 2026. The Company has a $15.0 million line of credit with a New York community bank, which also was not drawn upon as of March 31, 2026. The Company continues to evaluate its liquidity needs and as necessary finds additional sources.

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Citizens Financial Services, Inc. is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, Citizens Financial Services, Inc. is responsible for paying any dividends declared to its shareholders. Citizens Financial also has repurchased shares of its common stock. Citizens Financial Services, Inc.’s primary source of income is dividends received from the Bank. Both federal and state laws impose restrictions on the ability of the Bank to pay dividends. In particular, the Bank may not, as a state-chartered bank which is a member of the Federal Reserve System, declare a dividend without approval of the Federal Reserve, unless the dividend to be declared by the Bank’s Board of Directors does not exceed the total of: (i) the Bank’s net profits for the current year to date, plus (ii) its retained net profits for the preceding two current years, less any required transfers to surplus. The Federal Reserve Board and the FDIC have formal and informal policies which provide that insured banks and bank holding companies should generally pay dividends only out of current operating earnings, with some exceptions. The Prompt Corrective Action Rules, described above, further limit the ability of banks to pay dividends, because banks which are not classified as well capitalized or adequately capitalized may not pay dividends and no dividend may be paid which would make the Bank undercapitalized after the dividend. At March 31, 2026, Citizens Financial Services, Inc. (on an unconsolidated basis) had liquid assets of approximately $16.1 million.

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 or commodity price risk and, because we have no trading portfolio, we are not subject to trading risk. At March 31, 2026, the Company has equity securities that represent only 0.06% of its total assets 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, typically held by local governments, which are paid current market interest rates).

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 re-pricing 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. We have not experienced the kind of earnings volatility that might be indicated from gap analysis.

The Company currently uses a computer simulation model to better measure the impact of interest rate changes on net interest income. We use the model as part of our risk management and asset liability management processes that we believe will effectively identify, measure, and monitor the Company’s risk exposure. In this analysis, the Company examines the results of movements in interest rates with additional assumptions made concerning prepayment speeds on mortgage loans and mortgage securities. Shock scenarios, which assume a parallel shift in interest rates and is instantaneous, typically have the greatest impact on net interest income. The following is a rate shock analysis and the impact on net interest income as of March 31, 2026 (dollars in thousands):

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The model makes estimates, at each level of interest rate change, regarding cash flows from principal repayments on loans and mortgage backed securities, call activity of other investment securities, and deposit selection, re-pricing and maturity structure. Because of these assumptions, actual results could differ significantly from these estimates which would result in significant differences in the calculated projected change on net interest income. Additionally, the changes above do not necessarily represent the level of change under which management would undertake specific measures to realign its portfolio in order to reduce the projected level of change. The changes in net interest income disclosed in the above table are in line with Company policy for interest rate risk.

In the normal course of conducting business activities, the Company is exposed to market risk, principally interest rate risk, through the operations of its banking subsidiary. Interest rate risk arises from market driven fluctuations in interest rates that affect cash flows, income, expense and values of financial instruments and was discussed previously in this Form 10-Q. Management and a committee of the Board of Directors manage interest rate risk (see also “Interest Rate and Market Risk Management”).

(a) Disclosure Controls and Procedures

The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the SEC (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

(b) Changes to Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting during the quarter ended March 31, 2026 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1.A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2025, which could materially affect our business, financial condition or future results. At March 31, 2026, the risk factors of the Company have not changed materially from those reported in our 2025 Annual Report on Form 10-K. However, the risks described in our Annual Report on Form 10-K are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.