2008 Message to Shareholders
Shareholder Information / 5 Year Financial Summary / Message to Shareholders

To our Shareholders:

It is amazing how quickly the world has changed. In last year’s letter we reported to you that 2007 was the most profitable year in five. Our efforts in diversifying our markets, taking advantage of size efficiencies, and adapting to a changing marketplace were bearing fruit and were reflected in our earnings and growth.

At that time, no one could predict the events of 2008. During the past year, we experienced plummeting property values, the onset of a significant economic recession, historic losses of value in the stock market, a dramatic drop in interest rates, and the continuation of a shift in jobs from higher paying manufacturing positions to lesser paying service positions. And we are now seeing crushing layoffs and slowdowns.

Considering the issues of 2008, we are pleased to report cash earnings and the payment of dividends. Many banks in Ohio and the nation are unable to say this.

Earnings
After writing off $43,291,000 in goodwill, our net loss for the year was a negative $5.06 per share. As we previously communicated, this does not affect cash, cash earnings, regulatory capital, or dividends. Again, the goodwill was accumulated as a result of the many acquisitions we have made since 1990. Based on our annual review, we, like many other companies, felt it was appropriate to reduce its value on our books.

Net income before the goodwill adjustment was $.56 per share. While this was a good performance for this environment, the economy caused increases in our problem loans and in our expenses for collecting these loans. As a result, additions to our loan loss reserves and collection expenses reduced our earnings by approximately $.62 per share. If we add back the additional reserves, expenses, and goodwill adjustment, the adjusted earnings would have been $1.18 per share for 2008 versus $1.24 per share in 2007.

This is not to dismiss the net loss or the decrease in adjusted earnings. However, while the current market and recession have had a temporary impact on net earnings, it has not materially impacted our ability to generate very respectable gross revenue. Our net interest income before loan loss provision was $5.24 per share in 2008 and $5.37 per share in 2007. The Federal Reserve comparative statistics on Citizens Bank show a 2008 interest margin of 4.48% compared to a peer number of 3.68%. Non-interest income for the bank compares reasonably at .82% of assets to peer banks’ .86% of assets.

Stock Performance
There is no need to point out the dreadful performance of financial stocks in general and Ohio financial stocks in particular. We are no exception. Below is an alternative performance chart, not comparing us to national market statistics, but to publicly traded Ohio financial stocks from year end 2004 to year end 2008. This removes our distortion of the 2003 Russell Index and faces the reality that publicly traded Ohio financials have not performed to any national index.



Source: Bloomberg, SNL Securities

Dividends
For years we have differentiated ourselves as a dividend stock. Over the last five years we have paid a total of $5.35 per share in dividends. Over the last 10 years we have paid a total of $11.58 per share in dividends. This is a strong dividend payout. We understand our shareholders’ interest in dividends. Our goal is to continue a strong dividend program – but our dividend payments are going to be impacted by our earnings, and our earnings are going to be impacted by the dollars that we need to add to our loan loss reserve. The dollars needed for the loan loss reserve are going to be affected by the breadth and depth of this recession.

The Treasury’s Capital Purchase Program does place a $.15 per share per quarter limit on dividends for three years. In view of the economic climate, we will be happy if earnings increase to the extent that we could ask for special permission to exceed $.15 during the three year limitation period.

Staying With The Fundamentals
Banks throughout Ohio have had to adapt to the changes in the state’s economy. Over the last several years we have seen decreased employment opportunities, shifts away from manufacturing, population shifts, etc. Many Ohio banks decided to deploy their capital into new markets outside of the state. Many established offices in other parts of the country, such as Florida, Georgia, and Arizona. Many banks looked at sub-prime mortgages, 120% financing mortgages, negative amortization mortgages, and a variety of non-conventional products. Many banks saw the attractive 8% return on Fannie Mae and Freddie Mac stock and invested heavily in them.

We had the opportunity to invest our capital and resources into these types of alternatives. If we had, you would have seen and been very pleased with the short-term boost to earnings. I can assure you that you would not be pleased today. We were uncomfortable with heated markets outside of areas that we know. We believe that customers should make down payments and have the ability to make their loan payments. And investments that look too good to be true usually are.

We believe that the fundamentals of gathering deposits and making loans in markets we know and developing personal customer relationships continue to prevail. By sticking with the fundamentals, we have avoided the systemic problems plaguing many banks. The issues we confront today are marketplace issues and not issues with our business model.

The Recession
Our short-term goal is to come through this recession with the least negative impact to the corporation. Paraphrasing a comment from a former United States Comptroller of Currency, banks in this economic climate need “a fortress balance sheet with deep wells of liquidity”. This is at the heart of the Capital Purchase Program. It is also the basis for our efforts to gather the liquidity of deposits, our programs and communications to maintain the confidence of our communities, our investments of additional resources in loan credit analysis with the goal of limiting loan losses, and our regular communications to you. Steps taken include:

• Capital Purchase Program - In January we received shareholder approval to issue preferred stock. With this approval we sold $23,184,000 in preferred stock and warrants to purchase 469,312 shares of common stock to the U.S. Treasury. This program was offered to strengthen healthy banks. This program increased our regulatory capital from approximately $61,000,000 to approximately $84,000,000. Your board and management believe this strengthened-capital position is important in these uncertain economic times. As we stated previously, this additional capital will provide support if we experience a long and sustained economic downturn with increased loan losses. If our economy recovers quickly, we can repurchase this preferred stock at par after three years.
  
  Much publicized restrictions of the Capital Purchase Program involve executive compensation. We can report to you that our compensation structure does not come close to any of these restrictions. Our executive compensation is typically at the 50th percentile for companies of our size, we do not have executive bonus or incentive programs, we do not provide personal automobiles or the trips and perks highlighted in news reports. For 2009 there has been a freeze on executive salaries and most salaries of other company employees.
  
  
• Working With Customer Loan Issues - While the large national and regional banks seem to have little flexibility in working with customers that are impacted by the recession, we are dealing with our customers on an individual basis. If our customer has not abandoned their home or business, we want to work with them. When possible, we are renegotiating and modifying loan terms to help the customer through the recession. We believe this is a better alternative than repossession or foreclosure. A short-term cash flow reduction is preferable to attempting to sell repossessed property in a depressed market. Sometimes this is not possible. When this is the case we assess the situation, assess the collateral involved, and make a decision. Sometimes we sell the property for whatever it brings, and we move on. Sometimes we believe there is long-term potential, and we will hold the property to wait for the market to turn around.
  
  
• Customer Confidence – We have participated in the Transaction Account Guarantee Program which provides unlimited deposit insurance on non-interest bearing checking accounts and the CDARS program which can provide upwards of $50,000,000 in deposit insurance for customers with multiple Certificate of Deposit accounts. Through January 2009, the CDARS program has brought in over $23,000,000 in new deposit dollars. Coupled with the temporary increase of the FDIC insurance to $250,000, we can provide our customers with a high level of safety and soundness for their accounts. Deposits and deposit customers are our raw material.
  
  
• Shareholder Communications – A commitment for 2008 was to provide you with timely and candid information. We have attempted through letters and website postings to provide information on how your company is doing. When shares are held at a broker, we cannot control the timely forwarding of information to you. If your shares are held at a broker and you would like to be on our direct mailing list, complete and return to us the card attached to the annual report.

2009 and Beyond

2009 is going to be a challenging year - perhaps more so than 2008. The current rate environment will place pressure on our interest margin. We are going to see additional loan losses. We will see additional related expenses whether they are expenses to modify loans, repossession expenses, or the estimated $2,600,000 increase in our FDIC premium for 2009, which includes the recently approved one-time emergency special assessment. During these trying times we must keep a balanced perspective. Yes, we do have many customers experiencing significant problems that will take the company’s time, resources, and loan loss reserve dollars to work through, but 95% of our customers are current with their payments. Yes we are seeing unemployment rising in our markets to levels of 10% to 13% - but that means 87% to 90% of our neighbors in the workforce are working.

Our pledge remains to take the steps we deem necessary to get through the recession with the least negative impact to the company. Short-term actions must be taken but it is also a good time for companies to assess where they are at, where they are going, and to be prepared for the turnaround. We are doing exactly that. We are looking at our offices and office needs, staffing, education and training, customer product offerings, marketing efforts, and technology changes. We are focusing on desirable customers currently being ignored by the large banking institutions. We are also focused on our deposit gathering, giving us the raw material needed as the economy turns. And just as it has in the past, it will turn and should offer us the opportunity to prosper.

Very truly yours,

James O. Miller
President & CEO

 

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