UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2007
COMMISSION FILE NUMBER 000-23777
PENSECO FINANCIAL SERVICES CORPORATION
SCRANTON, PENNSYLVANIA
COMMONWEALTH OF PENNSYLVANIA
I.R.S. EMPLOYER IDENTIFICATION NUMBER 23-2939222
150 NORTH WASHINGTON AVENUE
SCRANTON, PENNSYLVANIA 18503-1848
TELEPHONE NUMBER 570-346-7741
SECURITIES REGISTERED UNDER
SECTION 12(g) OF THE ACT
Common Stock, Par Value $ .01 per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes |_| No |X|
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes |_| No |X|
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No|_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. |_|
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a small reporting company. See
definition of "large accelerated filer", "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer |_| Accelerated filer |X|
Non-accelerated filer |_| Small reporting company |_|
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes |_| No |X|
The aggregate market value of the Company's voting stock held by non-affiliates
of the registrant on June 30, 2007, based on the closing price of such stock on
that date, equals approximately $69,985,208.
The number of shares of common stock outstanding as of February 8, 2008 equals
2,148,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Corporation's definitive proxy statement relating to the 2008
Annual Meeting of Stockholders, to be held on May 6, 2008, are incorporated by
reference in Part III.
PENSECO FINANCIAL SERVICES CORPORATION
PART I
------
ITEM 1 BUSINESS
GENERAL
PENSECO FINANCIAL SERVICES CORPORATION, (the "Company"), which is headquartered
in Scranton, Pennsylvania, was formed under the general corporation laws of the
State of Pennsylvania in 1997 and is registered as a financial holding company.
The Company became a holding company upon the acquisition of all of the
outstanding shares of Penn Security Bank and Trust Company (the "Bank"), a
state-chartered bank, on December 31, 1997. The Company is subject to
supervision by the Federal Reserve Board. The Bank, as a state-chartered
financial institution, is subject to supervision, regulation and examination by
the Federal Deposit Insurance Corporation and the Pennsylvania Department of
Banking.
The Company's principal banking office is located at 150 North Washington
Avenue, Scranton, Pennsylvania, containing trust, investor services, marketing,
audit, credit card, human resources, executive, data processing, central loan
processing and central bookkeeping offices. There are eight additional offices.
Through its banking subsidiary, the Company generates interest income from its
outstanding loans receivable and its investment portfolio. Other income is
generated primarily from merchant transaction fees, trust fees and service
charges on deposit accounts. The Company's primary costs are interest paid on
deposits and borrowings and general operating expenses. The Bank provides a
variety of commercial and retail banking services to business and professional
customers, as well as retail customers, on a personalized basis. The Bank's
primary lending products are real estate, commercial and consumer loans. The
Bank also offers ATM access, credit cards, active investment accounts, trust
department services and other various lending, depository and related financial
services. The Bank's primary deposit products are savings and demand deposit
accounts and certificates of deposit. The Company also offers collateralized
repurchase agreements that have a one day maturity, as an alternative deposit
option for its customers.
The Bank has a third party marketing agreement with National Financial Services
that allows the Bank to offer a full range of securities, brokerage and annuity
sales to its customers. The Investor Services division is located in the
headquarters building and the services are offered throughout the entire branch
system.
The Company is not dependent upon a single customer, or a few customers, the
loss of one or more of which would have a material adverse effect on its
operations. The operations and earnings of the Corporation are not materially
affected by seasonal changes or by Federal, state or local environmental laws or
regulations.
FORWARD LOOKING INFORMATION
This Annual Report on Form 10-K contains forward-looking statements that are
based on assumptions and may describe future plans, strategies and expectations
of Penseco Financial Services Corporation. These forward-looking statements are
generally identified by use of the words "believe," "expect," "intend,"
"anticipate," "estimate," "project" or similar expressions. Penseco Financial
Services Corporation's ability to predict results or the actual effect of future
plans or strategies is inherently uncertain. Factors which could have a material
adverse effect on the operations of Penseco Financial Services Corporation and
its subsidiary include, but are not limited to, changes in interest rates,
national and regional economic conditions, legislative and regulatory changes,
monetary and fiscal policies of the U.S. government, including policies of the
U.S. Treasury and the Federal Reserve Board, the quality and composition of the
loan or investment portfolios, demand for loan products, deposit flows,
competition, demand for financial services in Penseco Financial Services
Corporation's market area, changes in real estate market values in Penseco
Financial Services Corporation's market area, changes in relevant accounting
principles and guidelines and inability of third party service providers to
perform. Additional factors that may affect our results are discussed in Item 1
A to this Annual Report on Form 10-K titled "Risk Factors" below.
These risks and uncertainties should be considered in evaluating forward-looking
statements and undue reliance should not be placed on such statements. Except as
required by applicable law or regulation, Penseco Financial Services Corporation
does not undertake, and specifically disclaims any obligation, to release
publicly the result of any revisions that may be made to any forward-looking
statements to reflect events or circumstances after the date of the statements
or to reflect the occurrence of anticipated or unanticipated events.
Unless the context indicates otherwise, all references in this Annual Report to
"Company," "we," "us" and "our" refer to Penseco Financial Services Corporation
and its subsidiary.
2
ITEM 1A RISK FACTORS
RISKS RELATED TO OUR BUSINESS
CREDIT RISK
CHANGES IN THE CREDIT QUALITY OF OUR LOAN PORTFOLIO MAY IMPACT THE LEVEL OF OUR
ALLOWANCE FOR LOAN LOSSES.
We make various judgments about the collectibility of our loans, including the
creditworthiness of our borrowers and the value of the real estate and other
assets serving as collateral for our loans. In determining the amount of the
allowance for loan losses, we review our loans and our loan loss and delinquency
experience, and we evaluate economic conditions. If our judgments are incorrect,
our allowance for loan losses may not be sufficient to cover future losses,
which will result in additions to our allowance through increased provisions for
loan losses. In addition, bank regulators periodically review our allowance for
loan losses and may require us to increase our provision for loan losses or
recognize further loan charge-offs. Increased provisions for loan losses would
increase our expenses and reduce our profits.
Nonetheless, to the best of management's knowledge, there are also no particular
risk elements in the local economy that put a group or category of loans at
increased risk. The Company does not engage in any sub-prime or Alt-A credit
lending. Therefore, the Company is not subject to any credit risks associated
with such loans.
MARKET RISK
CHANGES IN INTEREST RATES COULD AFFECT OUR INVESTMENT VALUES AND NET INTEREST
INCOME WHICH COULD HURT OUR PROFITS.
At December 31, 2007, the Company owned approximately $77.3 million of
marketable securities available for sale. These securities are carried at fair
value on the consolidated balance sheets. Unrealized gains or losses on these
securities, that is, the difference between the fair value and the amortized
cost of these securities, is reflected in stockholders' equity, net of deferred
taxes. As of December 31, 2007, the Company's available for sale marketable
securities portfolio had a net unrealized gain, net of taxes, of $954 thousand.
The fair value of the Company's available for sale marketable securities is
subject to interest rate change, which would not affect recorded earnings, but
would increase or decrease comprehensive income and stockholders' equity.
The principal component of the Company's earnings is net interest income, which
is the difference between interest and fees earned on interest-earning assets
and interest paid on deposits and other borrowings. The most significant impact
on net interest income between periods is derived from the interaction of
changes in the volume of and rates earned or paid on interest-earning assets and
interest-bearing liabilities. The volume of earning dollars in loans and
investments, compared to the volume of interest-bearing liabilities represented
by deposits and borrowings, combined with the spread, produces the changes in
net interest income between periods.
The Company continually monitors the relationship of its interest rate sensitive
assets and liabilities through its Asset/Liability Committee.
STRONG COMPETITION WITHIN OUR MARKET COULD HURT OUR PROFITS AND INHIBIT GROWTH.
The Bank operates in a competitive environment in which it must share its market
with many local independent banks as well as several banks which are affiliates
or branches of very large regional holding companies. The Bank encounters
competition from diversified financial institutions, ranging in size from small
banks to the nationwide banks operating in its region. The competition includes
commercial banks, savings and loan associations, credit unions, other lending
institutions and mortgage originators.
The principal competitive factors among the Company's competitors can be grouped
into two categories: pricing and services. In the Company's primary service
area, interest rates on deposits, especially time deposits, and interest rates
and fees charged to customers on loans are very competitive. From a service
perspective, the Bank competes in areas such as convenience of location, types
of services, service costs and banking hours. Our profitability depends on our
continued ability to compete successfully in our market area.
3
COMPLIANCE
WE OPERATE IN A HIGHLY REGULATED ENVIRONMENT AND MAY BE ADVERSELY AFFECTED BY
CHANGES IN LAWS AND REGULATIONS.
The Company is registered as a financial holding company under the Bank Holding
Company Act of 1956, as amended, and, as such, is subject to supervision and
regulation by the Board of Governors of the Federal Reserve System ("FRB"). The
Company is required to file quarterly reports of its operations with the FRB.
As a financial holding company, the Company is permitted to engage in
banking-related activities as authorized by the FRB, directly or through
subsidiaries or by acquiring companies already established in such activities
subject to the FRB regulations relating to those activities.
Our banking subsidiary, Penn Security Bank and Trust Company, as a Pennsylvania
state-chartered financial institution, is subject to supervision, regulation and
examination by the Commonwealth of Pennsylvania Department of Banking and by the
Federal Deposit Insurance Corporation (the "FDIC"), which insures the Bank's
deposits to the maximum extent permitted by law.
Any change in such regulation and oversight, whether in the form of regulatory
policy, regulations, legislation or supervisory actions, may have a material
impact on our operations.
OPERATIONAL RISK
THE COMPANY NEEDS TO CONTINUALLY ATTRACT AND RETAIN QUALIFIED PERSONNEL FOR ITS
OPERATIONS.
High quality customer service, as well as efficient and profitable operations,
are dependent on the Company's ability to attract and retain qualified
individuals for key positions within the organization. The Company has
successfully recruited several individuals for management positions in recent
years. As of December 31, 2007, the Company employed 165 full-time equivalent
employees. The employees of the Company are not represented by any collective
bargaining group. Management of the Company considers relations with its
employees to be good.
OUR OPERATIONS COULD BE AFFECTED IF WE DO NOT HAVE ACCESS TO MODERN AND RELIABLE
TECHNOLOGY.
The Company operates in a highly-automated environment, wherein almost all
transactions are processed by computer software to produce results. To remain
competitive, the Company must continually evaluate the adequacy of its data
processing capabilities and make revisions as needed.
The Company regularly tests its ability to restore data capabilities in the
event of a natural disaster, sustained power failure or other inability to
utilize its primary systems.
LIQUIDITY RISK
INCREASED NEEDS FOR DISBURSEMENT OF FUNDS ON LOANS AND DEPOSITS CAN AFFECT OUR
LIQUIDITY.
The objective of liquidity management is to maintain a balance between sources
and uses of funds in such a way that the cash requirements of customers for
loans and deposit withdrawals are met in the most economical manner. Management
monitors its liquidity position continuously in relation to trends of loans and
deposits for short-term as well as long-term requirements. Liquid assets are
monitored on a daily basis to assure maximum utilization. Management also
manages its liquidity requirements by maintaining an adequate level of readily
marketable assets and access to short-term funding sources. Management does not
foresee any adverse trends in liquidity.
OUR FUTURE PENSION PLAN COSTS AND CONTRIBUTIONS COULD BE UNFAVORABLY IMPACTED BY
THE FACTORS THAT ARE USED IN THE ACTUARIAL CALCULATIONS.
Our costs of providing non-contributory defined benefit pension plans are
dependent upon a number of factors, such as the rates of return on plan assets,
discount rates, the level of interest rates used to measure the required minimum
funding levels of the plans, future government regulation and our required or
voluntary contributions made to the plans. Without sustained growth in the
pension investments over time to increase the value of our plan assets and
depending upon the other factors impacting our costs as listed above, we could
be required to fund our plans with higher amounts of cash than are anticipated
by our actuaries. Such increased funding obligations could have a material
impact on our liquidity by reducing our cash flows.
4
ITEM 1B UNRESOLVED STAFF COMMENTS
None
ITEM 2 PROPERTIES
There are nine offices positioned throughout the greater Northeastern
Pennsylvania region. They are located in the South Scranton, East Scranton,
Green Ridge, and Central City sections of Scranton, the Borough of Moscow, the
Town of Gouldsboro, South Abington Township, the Borough of Mount Pocono and the
Borough of East Stroudsburg at Eagle Valley Corners. Through these offices, the
Company provides a full range of banking and trust services primarily to
Lackawanna, Wayne, Monroe and the surrounding counties. All offices are owned by
the Bank or through a wholly owned subsidiary of the Bank, Penseco Realty, Inc.,
with the exception of the Mount Pocono Office, which is owned by the Bank but is
located on land occupied under a long-term lease. The Company also owns property
in the Borough of Dalton, Lackawanna County, to use for potential future
expansion.
The principal office, located at the corner of North Washington Avenue and
Spruce Street in the "Central City" of Scranton's business district, houses the
operations, trust, investor services, marketing, credit card and audit
departments as well as the Company's executive offices. Several remote ATM
locations are leased by the Bank, which are located throughout Northeastern
Pennsylvania. All branches and ATM locations are equipped with closed circuit
television monitoring.
ITEM 3 LEGAL PROCEEDINGS
There are no material pending legal proceedings, other than ordinary routine
litigation incidental to the business of the Company and its subsidiary, as to
which the Company or subsidiary is a party or of which any of their property is
subject.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted by the Company to its shareholders through the
solicitation of proxies or otherwise during the fourth quarter of the fiscal
year covered by this report.
PART II
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ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
This Form 10-K is the Company's annual disclosure statement as required under
Section 13 or 15(d) of the Securities Exchange Act of 1934. Questions may be
directed to any branch location of the Company or by contacting the Controller's
office at:
Patrick Scanlon, Senior Vice President, Controller
Penseco Financial Services Corporation
150 North Washington Avenue
Scranton, Pennsylvania 18503-1848
1-800-327-0394
Management of the Company is aware of the following securities dealers who make
a market in the Company stock:
Boenning & Scattergood, Inc. Jefferies & Company, Inc.
Ferris, Baker, Watts, Inc. Knight Equity Markets, LP
Hill Thompson Magid & Company, Inc. Monroe Securities, Inc.
Hudson Securities, Inc. Stifel, Nicolaus & Company, Inc.
Janney Montgomery Scott, LLC
5
The Company's capital stock is traded on the "Over-the-Counter" BULLETIN BOARD
under the symbol "PFNS". The following table sets forth the price range together
with dividends paid for each of the past two years. These quotations do not
necessarily reflect the value of actual transactions.
Dividends Dividends
Paid Paid
2007 High Low Per Share 2006 High Low Per Share
- ----------------------------------------- --------------------------------------------
First Quarter $ 43 $ 38 $ .37 First Quarter $ 46 $ 41 $ .35
Second Quarter 40 37 .37 Second Quarter 45 42 .35
Third Quarter 38 36 .37 Third Quarter 43 41 .35
Fourth Quarter 40 34 .47 Fourth Quarter 44 41 .45
------ -------
$ 1.58 $ 1.50
====== =======
As of February 8, 2008 there were approximately 874 stockholders of the Company
based on the number of holders of record. Reference should be made to the
information about the Company's dividend policy and regulatory guidelines on
pages 18 and 44.
TRANSFER AGENT
Penn Security Bank and Trust Company, Trust Department, 150 North Washington
Avenue, Scranton, Pennsylvania 18503-1848. Stockholders' questions should be
directed to the Bank's Trust Department at 570-346-7741.
6
PENSECO FINANCIAL SERVICES CORPORATION
The following line graph sets forth comparative information regarding the
Company's cumulative shareholder return on its Common Stock over the last five
fiscal years. Total shareholder return is measured by dividing total dividends
(assuming dividend reinvestment) plus share price change for a period by the
share price at the beginning of the investment period. The Company's cumulative
shareholder return based on an investment of $100 at the beginning of the
five-year period beginning December 31, 2002 is compared to the cumulative total
return of the Russell 2000 Index ("Russell 2000") and the SNL Securities
Northeast Quadrant Pink Sheet Banks Index ("Pink Banks"), which more closely
reflects the Company's peer group. The yearly points marked on the horizontal
axis of the graph correspond to December 31st of that year.
[GRAPH APPEARS HERE]
PERIOD ENDING
- ----------------------------------------------------------------------------------------------------------------------------
INDEX 12/31/02 12/31/03 12/31/04 12/31/05 12/31/06 12/31/07
- ----------------------------------------------------------------------------------------------------------------------------
Penseco Financial Services
Corporation $ 100.00 $ 121.32 $ 128.72 $ 133.18 $ 140.38 $ 135.19
Russell 2000 100.00 147.25 174.24 182.18 215.64 212.26
SNL Northeast OTC-BB and
Pink Banks 100.00 145.85 169.92 169.40 175.06 170.48
7
ITEM 6 SELECTED FINANCIAL DATA
(in thousands, except per share amounts)
RESULTS OF OPERATIONS:
2007 2006 2005 2004 2003
- -----------------------------------------------------------------------------------------------------------------------------
Interest Income $ 34,329 $ 31,922 $ 28,170 $ 25,385 $ 26,014
Interest Expense 12,739 11,054 8,580 7,579 8,228
- -----------------------------------------------------------------------------------------------------------------------------
Net Interest Income 21,590 20,868 19,590 17,806 17,786
Provision for Loan Losses 657 433 263 144 476
- -----------------------------------------------------------------------------------------------------------------------------
Net Interest Income
after Provision for
Loan Losses 20,933 20,435 19,327 17,662 17,310
Other Income 8,720 8,205 8,874 9,594 10,743
Other Expenses 21,331 21,037 20,719 20,584 20,454
Income Taxes 1,624 1,595 1,613 1,071 1,628
- -----------------------------------------------------------------------------------------------------------------------------
Net Income $ 6,698 $ 6,008 $ 5,869 $ 5,601 $ 5,971
=============================================================================================================================
BALANCE SHEET AMOUNTS:
Assets $ 580,793 $ 569,821 $ 575,688 $ 563,708 $ 584,590
Investment Securities $ 145,448 $ 166,080 $ 229,957 $ 262,678 $ 293,125
Net Loans $ 399,939 $ 365,722 $ 317,562 $ 276,576 $ 236,882
Deposits $ 416,533 $ 413,800 $ 397,867 $ 395,301 $ 407,944
Long-Term Borrowings $ 55,966 $ 65,853 $ 75,401 $ 84,620 $ 93,523
Stockholders' Equity $ 69,715 $ 66,571 $ 63,799 $ 62,376 $ 60,807
PER SHARE AMOUNTS:
Earnings per Share $ 3.12 $ 2.80 $ 2.73 $ 2.61 $ 2.78
Dividends per Share $ 1.58 $ 1.50 $ 1.44 $ 1.35 $ 1.35
Book Value per Share $ 32.45 $ 30.99 $ 29.70 $ 29.04 $ 28.31
Common Shares
Outstanding 2,148,000 2,148,000 2,148,000 2,148,000 2,148,000
FINANCIAL RATIOS:
Net Interest Margin 3.92% 3.89% 3.57% 3.18% 3.24%
Return on Average Assets 1.15% 1.07% 1.03% .96% 1.05%
Return on Average Equity 9.75% 9.15% 9.23% 9.11% 9.87%
Average Equity to
Average Asset 11.81% 11.68% 11.19% 10.57% 10.59%
Dividend Payout Ratio 50.64% 53.57% 52.75% 51.72% 48.56%
8
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion is intended to provide information to facilitate the
understanding and assessment of significant changes and trends related to the
financial condition of the Company and the results of its operations. This
discussion and analysis should be read in conjunction with the Company's audited
consolidated financial statements and notes thereto. All information is
presented in thousands of dollars, except as indicated.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Provision (allowance) for possible loan losses - The provision for loan losses
is based on past loan loss experience, management's evaluation of the potential
loss in the current loan portfolio under current economic conditions and such
other factors as, in management's best judgment, deserve current recognition in
estimating loan losses. The annual provision for loan losses charged to
operating expense is that amount which is sufficient to bring the balance of the
allowance for possible loan losses to an adequate level to absorb anticipated
losses.
Actuarial assumptions associated with pension, post-retirement and other
employee benefit plans - These assumptions include discount rate, rate of future
compensation increases and expected return on plan assets.
Provision for income taxes - Management believes that the assumptions and
judgments used to record tax related assets or liabilities have been
appropriate.
Fair value of certain investment securities - Fair value of investment
securities are based on quoted market prices.
Loan servicing rights - Mortgage servicing rights are evaluated for impairment
based on the fair value of those rights. Fair values are estimated using
discounted cash flows based on current market rates of interest and current
expected future prepayment rates. For purposes of measuring impairment, the
rights must be stratified by one or more predominant risk characteristics of the
underlying loans. The Company stratifies its capitalized mortgage servicing
rights based on the product type, interest rate and term of the underlying
loans. The amount of impairment recognized is the amount, if any, by which the
amortized cost of the rights for each stratum exceed the fair value.
Premium amortization - The amortization of premiums on mortgage-backed
securities is done based on management's estimate of the lives of the
securities, adjusted, when necessary, for advanced prepayments in excess of
those estimates.
SUMMARY
Net earnings for 2007 totaled $6,698, an increase of $690 or 11.5% from the
$6,008 earned in 2006, which was an increase of $139 or 2.4% from the $5,869
earned in 2005. Net earnings per share were $3.12 in 2007, compared with $2.80
in 2006 and $2.73 in 2005. Earnings for 2007 were impacted by a fourth quarter
charge, related to lawsuits against VISA Inc., which VISA member banks must
recognize as a contingent liability to indemnify VISA Inc. as described further
herein. Currently, the Company holds 78,122 shares of VISA class USA common
stock. The Company recorded a total expense of $497, which is $328 net of tax,
or $0.15 per share. Upon successful completion of an anticipated public offering
by VISA Inc. in 2008, the Company expects the value on its converted shares to
exceed the aggregate amount of these charges. Net earnings for 2007 increased
from 2006 mainly due to higher interest income from strong loan demand
experienced during 2007. This was offset by a higher provision for loan losses,
as well as, increased operating expenses. Income taxes were slightly higher than
year ago levels. Net income for 2006 increased $139 or 2.4% compared with 2005.
Net earnings for 2006 increased from 2005 mainly due to higher interest income
from strong loan demand experienced during 2006. This was offset by a higher
provision for loan losses and lower non-interest income. Income taxes were lower
largely from increased tax free income. During 2006, the Company recorded a
Voluntary Early Retirement Initiative (VERI) charge of $1,119, which was
partially offset by securities gains of $319. These items reduced net income in
2006 by $528, net of tax, or $0.25 per share.
9
The Company's return on average assets was 1.15% in 2007 compared to 1.07% in
2006 and 1.03% in 2005. Return on average equity was 9.75%, 9.15% and 9.23% in
2007, 2006 and 2005, respectively.
RESULTS OF OPERATIONS
NET INTEREST INCOME
The principal component of the Company's earnings is net interest income, which
is the difference between interest and fees earned on interest-earning assets
and interest paid on deposits and other borrowings.
Net interest income increased $.7 million or 3.3% to $21.6 million for 2007
compared to $20.9 million for 2006. Loan interest income was higher overall for
2007 due to increases in the volume of new loans. Investment income decreased
due in part to the return of principal on the Mortgage-Backed Securities
portfolio and maturities of U.S. Agency Securities. The proceeds were used to
fund loan demand. Interest expense for 2007 increased $1.6 million or 14.4% to
$12.7 million for 2007 compared to $11.1 million in 2006. The increase is
primarily due to competitive market pressures to pay higher rates.
Net interest income increased $1.3 million or 6.6% to $20.9 million for 2006
compared to $19.6 million for 2005. Loan interest income was higher overall for
2006 due to increases in the volume of new loans and interest rates. Investment
income decreased due in part to the return of principal on the Mortgage-Backed
Securities portfolio and maturities of U.S. Agency Securities. The proceeds were
used to fund loan demand. Interest expense for 2006 increased $2.5 million or
29.1% to $11.1 million for 2006 compared to $8.6 million in 2005. The increase
is primarily due to increases in interest rates through 2006.
Net interest income, when expressed as a percentage of average interest-earning
assets, is referred to as net interest margin. The Company's net interest margin
for the year ended December 31, 2007 was 3.92% compared with 3.89% for the year
ended December 31, 2006 and 3.57% for the year ended December 31, 2005.
Interest income in 2007 totaled $34.3 million, compared to $31.9 million in
2006, an increase of $2.4 million or 7.5%. The tax equivalent yield on average
interest-earning assets increased to 6.50% in 2007, compared to 6.20% in 2006.
Average interest-earning assets increased in 2007 to $551.3 million from $536.9
million in 2006. Average loans, which are typically the Company's highest
yielding earning assets, increased $46.0 million or 13.5% in 2007. Average loans
represented 70.0% of 2007 average interest-earning assets, compared to 63.3% in
2006. Income on loans increased $3.0 million or 12.8% in 2007, compared to an
increase in loan income of $4.8 million or 25.8% during 2006. Investment
securities decreased on average by $44.7 million or 23.0% to $149.4 million
compared to $194.1 million in 2006. Income on investments declined $1.3 million
or 15.5% to $7.1 million in 2007, from $8.4 million in 2006. Average earning
assets, including BOLI, increased to 96.0% of average total assets for 2007
compared to 95.7% for the year ago period.
The average rate paid on interest-bearing liabilities increased during 2007 to
2.94%, compared to 2.63% in 2006.
Interest income in 2006 totalled $31.9 million, compared to $28.2 million in
2005, an increase of $3.7 million or 13.1%. The tax equivalent yield on average
interest-earning assets increased to 6.20% in 2006, compared to 5.38% in 2005.
Average interest-earning assets decreased in 2006 to $536.9 million from $548.2
million in 2005. Average loans, which are typically the Company's highest
yielding earning assets, increased $42.0 million or 14.1% in 2006. Average loans
represented 63.3% of 2006 average interest-earning assets, compared to 54.3% in
2005. Income on loans increased $4.8 million or 25.8% in 2006, compared to an
increase in loan income of $5.0 million or 36.8% during 2005. Investment
securities decreased on average by $43.0 million or 18.1% to $194.1 million
compared to $237.1 million in 2005. Income on investments declined $.8 million
or 8.7% to $8.4 million in 2006, from $9.2 million in 2005.
The average rate paid on interest-bearing liabilities during 2006 was 2.63%,
compared to 2.06% in 2005.
The most significant impact on net interest income between periods is derived
from the interaction of changes in the volume of and rates earned or paid on
interest-earning assets and interest-bearing liabilities. The volume of earning
dollars in loans and investments, compared to the volume of interest-bearing
liabilities represented by deposits and borrowings, combined with the spread,
produces the changes in net interest income between periods.
10
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY/INTEREST RATES AND INTEREST DIFFERENTIAL
The table below presents average weekly balances, interest income on a fully taxable equivalent basis and interest expense, as well
as average rates earned and paid on the company's major asset and liability items for the year 2007, 2006 and 2005.
- ------------------------------------------------------------------------------------------------------------------------------------
2007 2006 2005
ASSETS Average Revenue Yield/ Average Revenue Yield/ Average Revenue Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
- ------------------------------------------------------------------------------------------------------------------------------------
Investment Securities:
Available-for-Sale
U.S. Treasury securities $ - $ - -% $ - $ - -% $ 1,849 $ 127 6.87%
U.S. Agency obligations 38,992 1,824 4.68 83,355 3,186 3.82 116,429 3,650 3.13
States & political
subdivision 31,098 1,385 6.75 24,851 1,114 6.79 23,873 1,006 6.38
Federal Home Loan Bank stock 3,948 248 6.28 4,738 232 4.90 4,907 143 2.91
Other 4,208 156 3.71 3,119 108 3.46 1,765 47 2.66
Held to Maturity:
U.S. Agency obligations 41,866 1,907 4.56 48,801 2,174 4.45 59,036 2,631 4.46
States & political
subdivisions 29,246 1,559 8.08 29,221 1,574 8.16 29,250 1,610 8.34
Loans, net of unearned income:
Real estate mortgages 246,504 15,825 6.42 202,709 13,578 6.70 158,733 9,855 6.21
Commercial real estate 76,132 5,637 7.40 67,736 4,881 7.21 59,209 3,541 5.98
Commercial 23,036 1,928 8.37 31,690 2,131 6.72 42,820 2,782 6.50
Consumer and other 40,141 3,039 7.57 37,679 2,784 7.39 37,037 2,391 6.46
Federal funds sold 8,795 456 5.18 - - - 6,011 176 2.93
Interest on balances with banks 7,288 365 5.01 3,047 160 5.25 7,302 211 2.89
- ------------------------------------------------------------------------------------------------------------------------------------
Total Interest Earning Assets/
Total Interest Income 551,254 $ 34,329 6.50% 536,946 $31,922 6.20% 548,221 $ 28,170 5.38%
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and due from banks 10,575 10,534 8,961
Bank premises and equipment 9,609 9,427 9,184
Accrued interest receivable 3,338 3,035 2,967
Cash surrender value life insurance 7,199 1,125 -
Other assets 4,067 5,118 2,663
Less: Allowance for loan losses 4,328 3,895 3,686
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 581,714 $ 562,290 $ 568,310
- ------------------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest Bearing $ 55,803 $ 570 1.02% $ 49,753 $ 347 .70% $ 32,821 $ 190 .58%
Savings 81,096 880 1.09 82,687 767 .93 88,823 566 .64
Money markets 93,089 2,851 3.06 83,349 2,225 2.67 84,115 1,246 1.48
Time-Over $100 41,146 2,010 4.89 32,692 1,408 4.31 26,088 808 3.10
Time-Other 74,923 3,064 4.09 77,551 2,865 3.69 77,434 2,210 2.85
Repurchase agreements 25,842 839 3.25 19,457 455 2.34 27,546 415 1.51
Short-term borrowings 1,254 62 4.94 3,466 189 5.45 378 19 5.03
Long-term borrowings 60,867 2,463 4.05 70,592 2,798 3.96 79,919 3,126 3.91
- ------------------------------------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 434,020 $ 12,739 2.94% 419,547 $11,054 2.63% 417,124 $ 8,580 2.06%
- ------------------------------------------------------------------------------------------------------------------------------------
Demand-Non-interest bearing 74,195 72,950 86,302
All other liabilities 4,818 4,141 1,270
Stockholders' equity 68,681 65,652 63,614
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 581,714 $ 562,290 $568,310
- ------------------------------------------------------------------------------------------------------------------------------------
Interest Spread 3.56% 3.57% 3.32%
- ------------------------------------------------------------------------------------------------------------------------------------
Net Interest Income $ 21,590 $20,868 $ 19,590
- ------------------------------------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Net interest margin 3.92% 3.89% 3.57%
Return on average assets 1.15% 1.07% 1.03%
Return on average equity 9.75% 9.15% 9.23%
Average equity to average assets 11.81% 11.68% 11.19%
Dividend payout ratio 50.64% 53.57% 52.75%
11
DOLLAR AMOUNT OF CHANGE IN INTEREST INCOME AND INTEREST EXPENSE
DOLLAR AMOUNT CHANGE IN CHANGE IN CHANGE IN RATE-
2007 COMPARED TO 2006 OF CHANGE VOLUME RATE VOLUME
--------------------------------------------------------------------------------------------------------
EARNING Investment Securities:
ASSETS Available-for-Sale
U.S. Agency obligations $ (1,362) $ (1,695) $ 717 $ (384)
States & political subdivision 271 280 (7) (2)
Equity securities 64 (1) 73 (8)
Held to Maturity:
U.S. Agency obligations (267) (309) 54 (12)
States & political subdivisions (15) 2 (17) -
Loans, net of unearned income:
Real estate mortgages 3,003 3,565 (487) (75)
Commercial (203) (582) 523 (144)
Consumer and other 255 182 68 5
Federal funds sold 456 - - 456
Interest bearing balances with banks 205 223 (7) (11)
--------------------------------------------------------------------------------------------------------
Total Interest Income 2,407 1,665 917 (175)
--------------------------------------------------------------------------------------------------------
INTEREST Deposits:
BEARING Demand-Interest Bearing 223 42 159 22
LIABILITIES Savings 632 33 530 69
Money markets 626 260 325 41
Time-Over $100 602 364 190 48
Time-Other (320) (523) 239 (36)
Repurchase agreements 384 149 177 58
Short-term borrowings (127) (121) 18 (24)
Long-term borrowings (335) (385) 64 (14)
--------------------------------------------------------------------------------------------------------
Total Interest Expense 1,685 (181) 1,702 164
--------------------------------------------------------------------------------------------------------
NET INTEREST INCOME $ 722 $ 1,846 $ (785) $ (339)
========================================================================================================
============================================================================================================================
2006 COMPARED TO 2005
--------------------------------------------------------------------------------------------------------
EARNING Investment Securities:
ASSETS Available-for-Sale
U.S. Treasury securities $ (127) $ (127) $ (127) $ 127
U.S. Agency obligations (464) (1,035) 803 (232)
States & political subdivision 108 33 64 11
Equity securities 150 34 99 17
Held to Maturity:
U.S. Agency obligations (457) (456) (6) 5
States & political subdivisions (36) (2) (34) -
Loans, net of unearned income:
Real estate mortgages 5,063 3,229 1,482 352
Commercial (651) (723) 94 (22)
Consumer and other 393 41 344 8
Federal funds sold (176) (176) (176) 176
Interest bearing balances with banks (51) (123) 172 (100)
--------------------------------------------------------------------------------------------------------
Total Interest Income 3,752 695 2,715 342
--------------------------------------------------------------------------------------------------------
INTEREST Deposits:
BEARING Demand-Interest Bearing 157 98 39 20
LIABILITIES Savings (27) (27) - -
Money markets 979 (11) 1,001 (11)
Time-Over $100 600 205 316 79
Time-Other 883 46 822 15
Repurchase agreements 40 (122) 229 (67)
Short-term borrowings 170 155 2 13
Long-term borrowings (328) (365) 40 (3)
--------------------------------------------------------------------------------------------------------
Total Interest Expense 2,474 (21) 2,449 46
--------------------------------------------------------------------------------------------------------
NET INTEREST INCOME $ 1,278 $ 716 $ 266 $ 296
========================================================================================================
12
PROVISION FOR LOAN LOSSES
The provision for loan losses represents management's determination of the
amount necessary to bring the allowance for loan losses to a level that
management considers adequate to reflect the risk of future losses inherent in
the Company's loan portfolio.
The provision for loan losses was $657 in 2007, an increase of 51.7% compared to
$433 for 2006. The increase in the provision was due to the Company's increased
loan portfolio, as well management's viewpoint in valuing the loan portfolio for
loan losses as the economy appears to be slowing down.
The Company believes that the judgments used in establishing the allowance for
loan losses are based on reliable information. In assessing the sufficiency of
the allowance for loan losses, management considers, how well prior estimates
have related to actual experience. The Company continually monitors the risk
elements, historical rates and other data used in establishing the allowance on
a periodic basis. The Company has not found it necessary to change the allowance
by material amounts, which would call into question the reliability of the
judgments used in its calculation.
There are also no particular risk elements in the local economy that put a group
or category of loans at increased risk, however the Company has increased its
portfolio of commercial loans, which typically bear a higher risk. These loans
are typically secured by real estate to minimize this risk.
The process of determining the adequacy of the allowance is necessarily
judgmental and subject to changes in external conditions. Accordingly, there can
be no assurance that existing levels of the allowance will ultimately prove
adequate to cover actual loan losses.
OTHER INCOME
The following table sets forth information by category of other income for the
Company for the past three years:
Years Ended December 31, 2007 2006 2005
- --------------------------------------------------------------------------------
Trust department income $ 1,535 $ 1,483 $ 1,479
Service charges on deposit accounts 1,014 860 940
Merchant transaction income 4,256 3,947 4,521
Other fee income 1,472 1,423 1,575
Bank owned life insurance 314 54 -
Other operating income 80 119 372
Realized gains (losses) on
securities, net 49 319 (13)
- --------------------------------------------------------------------------------
Total Other Income $ 8,720 $ 8,205 $ 8,874
- --------------------------------------------------------------------------------
Other income increased $515 or 6.3% to $8,720 during 2007, from $8,205 for the
same period of 2006. Service charges on deposit accounts increased $154 or
17.9%, primarily due to increased service charge collections during 2007.
Merchant transaction income increased $309 or 7.8%, mainly due to increased
transaction volume and new business. Income from Bank owned life insurance,
which was purchased in the fourth quarter of 2006, increased $260 to $314 in
2007 from $54 in 2006.
Other income declined $669 or 7.5% to $8,205 during 2006, from $8,874 for the
same period of 2005. Service charges on deposit accounts decreased $80 or 8.5%,
largely due to the implementation of the free checking program and
accommodations to customers during the period of our software conversion during
the first quarter of 2006. Merchant transaction income decreased $574 or 12.7%,
mainly due to lower transaction volume. Other fee income declined $152 or 9.7%,
including reduced brokerage income of $98 or 26.6%. Bank owned life insurance,
purchased in the fourth quarter of 2006, generated $54 of income. Other
operating income decreased $253, mainly due to Sunny Day income of $143 recorded
in 2005. The Sunny Day income rebate program was discontinued in 2005. The
Company realized a gain on the sale of securities of $319 which was used to
partly offset the cost associated with the VERI program discussed earlier.
13
OTHER EXPENSES
VISA CONTINGENCY
In October 2007, Penn Security Bank & Trust Company, as a member of VISA U.S.A.
Inc. received shares of restricted stock in VISA, Inc. (VISA) as a result of a
global restructuring of VISA in preparation for an initial public offering in
2008.
In connection with this, VISA member banks are required to recognize a
contingent obligation to indemnify VISA under its revised bylaws for potential
losses arising from certain antitrust litigation, at the estimated fair value of
such obligation, in accordance with FASB Interpretation No. 45. the Company
recorded a $497 charge or $328, net of tax, in the fourth quarter of 2007. The
Company will continue to monitor these litigation matters and record any change
in the liability upon additional information becoming available. Upon successful
completion of the anticipated public offering in 2008, VISA will establish an
escrow account for the litigation, funded by a partial redemption of member
shares for cash (limited to the amount of the obligation recorded). The Company
expects that the value it will receive on these converted shares will exceed the
aggregate amount of its fourth quarter charge.
The following table sets forth information by category of other expenses for the
Company for the past three years:
Years Ended December 31, 2007 2006 2005
- --------------------------------------------------------------------------------
Salaries and employee benefits $ 9,118 $ 10,315 $ 9,261
Expense of premises and
equipment, net 2,586 2,397 2,455
Merchant transaction expenses 3,358 3,141 3,646
Other operating expenses 6,269 5,184 5,357
- --------------------------------------------------------------------------------
Total Other Expenses $21,331 $ 21,037 $20,719
- --------------------------------------------------------------------------------
Total other expenses increased $294 or 1.4% to $21,331 during 2007 compared with
$21,037 for the same period of 2006. Salaries and employee benefits decreased
$1,197 or 11.6%, primarily due to a one time charge of $1,119 recorded in the
fourth quarter of 2006 in connection with the VERI program. Merchant transaction
expenses increased $217 or 6.9 %, due to increased transaction volume. Other
operating expenses increased $1,085 or 20.9%, largely due to increases in
advertising expense of $233 and contributions of $100, in addition to the $497
liability recorded for the VISA lawsuits discussed above, which is expected to
be a one time charge.
Total other expenses increased $318 or 1.5% to $21,037 during 2006 compared with
$20,719 for the same period of 2005. Salaries and employee benefits increased
$1,054 or 11.4%, primarily due to the $1,119 expense recorded in the fourth
quarter of 2006 in connection with the VERI program. Merchant transaction
expenses decreased $505 or 13.9%, due to lower transaction volume. Other
operating expenses decreased $173 or 3.2%, mostly from lower professional fees
and general operating expenses.
INCOME TAXES
Federal income tax expense increased $29 or 1.8% to $1,624 in 2007 compared to
$1,595 in 2006, due to increased operating income partly offset by higher
tax-free income.
Federal income tax expense decreased $18 or 1.1% to $1,595 in 2006 compared to
$1,613 in 2005, due to increased operating income offset by higher tax-free
income.
The Company's effective income tax rate for 2007, 2006 and 2005 was 19.5%, 21.0%
and 21.6%, respectively.
The Company uses the asset and liability method of accounting for deferred
income taxes. If current available information raises doubt as to the
realization of deferred tax assets, a valuation allowance is established. The
Company evaluates the recoverability of deferred tax assets based on its ability
to generate future profits. The Company employs budgeting and periodic reporting
processes to continually monitor its progress. Historically, the Company has had
sufficient profits for recovery of deferred tax benefits.
For further discussion pertaining to Federal income taxes, see Note 15 to the
Consolidated Financial Statements.
14
FINANCIAL CONDITION
Total assets increased $11.0 million or 1.9% during 2007 to $580.8 million at
December 31, 2007 compared to $569.8 million at December 31, 2006. For the year
ended December 31, 2006, total assets decreased $5.9 million or 1.0% to $569.8
million compared to $575.7 million at December 31, 2005.
INVESTMENT PORTFOLIO
The Company maintains a portfolio of investment securities to provide income and
serve as a source of liquidity for its ongoing operations.
The following table presents the carrying value, by security type, for the
Company's investment portfolio:
Years Ended December 31, 2007 2006 2005
- --------------------------------------------------------------------------------
U.S. Agency obligations $ 69,516 $ 99,247 $ 171,308
States & political subdivisions 68,714 59,471 50,887
Equity securities 7,218 7,362 7,762
- --------------------------------------------------------------------------------
Total Investment Securities $ 145,448 $ 166,080 $ 229,957
- --------------------------------------------------------------------------------
LOAN PORTFOLIO
Details regarding the Company's loan portfolio for the past five years are as
follows:
December 31, 2007 2006 2005 2004 2003
- ---------------------------------------------------------------------------------------------------------
Real estate - construction
and land development $ 25,858 $ 23,714 $ 13,132 $ 6,805 $ 3,078
Real estate mortgages 318,437 284,323 227,853 196,149 172,964
Commercial 24,505 26,265 42,894 41,560 30,056
Credit card and related plans 3,324 3,282 3,152 2,872 2,403
Installment 26,542 25,532 26,293 25,679 25,855
Obligations of states &
political subdivisions 5,973 6,806 8,038 7,111 6,026
- ---------------------------------------------------------------------------------------------------------
Loans, net of unearned income 404,639 369,922 321,362 280,176 240,382
Less: Allowance for loan losses 4,700 4,200 3,800 3,600 3,500
- ---------------------------------------------------------------------------------------------------------
Loans, net $ 399,939 $ 365,722 $ 317,562 $ 276,576 $ 236,882
=========================================================================================================
LOANS
Total net loans increased $34.2 million or 9.4% to $399.9 million at December
31, 2007 from $365.7 million at December 31, 2006. This increase is mainly due
to strong loan demand with a mix of fixed and variable rate loans backed by real
estate.
Total net loans increased $48.1 million or 15.1% to $365.7 million at December
31, 2006 from $317.6 million at December 31, 2005. This increase is mainly due
to strong loan demand with a mix of fixed and variable rate loans backed by real
estate.
LOAN QUALITY
The lending activities of the Company are guided by the comprehensive lending
policy established by the Board of Directors. Loans must meet criteria which
include consideration of the character, capacity and capital of the borrower,
collateral provided for the loan, and prevailing economic conditions.
Regardless of credit standards, there is risk of loss inherent in every loan
portfolio. The allowance for loan losses is an amount that management believes
will be adequate to absorb possible losses on existing loans that may become
uncollectible, based on evaluations of the collectibility of the loans. The
evaluations take into consideration such factors as change in the nature and
volume of the loan portfolio, overall portfolio quality, review of specific
problem loans, industry experience, collateral value and current economic
conditions that may affect the borrower's ability to pay. Management believes
that the allowance for loan losses is adequate. While management uses available
information to recognize losses on loans, future additions to the allowance may
be necessary based on changes in economic conditions. In addition, various
15
regulatory agencies, as an integral part of their examination process,
periodically review the Company's allowance for loan losses. Such agencies may
require the Company to recognize additions to the allowance based on their
judgment of information available to them at the time of their examination.
The allowance for loan losses is increased by periodic charges against earnings
as a provision for loan losses, and decreased periodically by charge-offs of
loans (or parts of loans) management has determined to be uncollectible, net of
actual recoveries on loans previously charged-off.
NON-PERFORMING ASSETS
Non-performing assets consist of non-accrual loans, loans past due 90 days or
more and still accruing interest and other real estate owned. The following
table sets forth information regarding non-performing assets as of the dates
indicated:
December 31, 2007 2006 2005 2004 2003
- ---------------------------------------------------------------------------------------------------------
Non-accrual loans $ 1,610 $ 3,180 $ 1,627 $ 1,991 $ 1,533
Loans past due 90 days
or more and accruing
Guaranteed student loans 408 251 152 253 169
Consumer loans 12 - - - -
Secured by real estate 57 177 - - -
Credit card loans 2 6 21 13 3
- ---------------------------------------------------------------------------------------------------------
Total non-performing loans 2,089 3,614 1,800 2,257 1,705
Other real estate owned - - 91 176 121
- ---------------------------------------------------------------------------------------------------------
Total non-performing assets $ 2,089 $ 3,614 $ 1,891 $ 2,433 $ 1,826
- ---------------------------------------------------------------------------------------------------------
Loans are generally placed on a non-accrual status when principal or interest is
past due 90 days or when payment in full is not anticipated. When a loan is
placed on non-accrual status, all interest previously accrued but not collected
is charged against current income. Loans are returned to accrual status when
past due interest is collected and the collection of principal is probable.
Loans on which the accrual of interest has been discontinued or reduced amounted
to $1,610, $3,180, and $1,627 at December 31, 2007, 2006 and 2005, respectively.
The decrease in 2007 was primarily due to the resolution of a single borrower
relationship outstanding in 2006. If interest on those loans had been accrued,
such income would have been $153, $209 and $264 for 2007, 2006 and 2005,
respectively. Interest income on those loans, which is recorded only when
received, amounted to $17, $10 and $27 for 2007, 2006 and 2005, respectively.
There are no commitments to lend additional funds to borrowers whose loans are
on non-accrual status.
The management process for evaluating the adequacy of the allowance for loan
losses includes reviewing each month's loan committee reports which list all
loans that do not meet certain internally developed criteria as to collateral
adequacy, payment performance, economic conditions and overall credit risk.
These reports also address the current status and actions in process on each
listed loan. From this information, adjustments are made to the allowance for
loan losses. Such adjustments include both specific loss allocation amounts and
general provisions by loan category based on present and past collection
experience, nature and volume of the loan portfolio, overall portfolio quality,
and current economic conditions that may affect the borrower's ability to pay.
As of December 31, 2007, there are no significant loans as to which management
has serious doubt about their collectibility.
At December 31, 2007, 2006 and 2005, the Company did not have any loans
specifically classified as impaired.
Most of the Company's lending activity is with customers located in the
Company's geographic market area and repayment thereof is affected by economic
conditions in this market area.
The Company does not engage in any sub-prime or ALT-A credit lending. Therefore,
the Company is not subject to any credit risks associated with such loans.
16
LOAN LOSS EXPERIENCE
The following tables present the Company's loan loss experience during the
periods indicated:
Years Ended December 31, 2007 2006 2005 2004 2003
- ----------------------------------------------------------------------------------------------------------
Balance at beginning of year $ 4,200 $ 3,800 $ 3,600 $ 3,500 $ 3,347
- ----------------------------------------------------------------------------------------------------------
Charge-offs:
Real estate mortgages 84 74 31 - 11
Commercial and all others 10 18 - 12 289
Credit card and related plans 66 49 68 34 51
Installment loans 5 26 14 7 4
- ----------------------------------------------------------------------------------------------------------
Total charge-offs 165 167 113 53 355
- ----------------------------------------------------------------------------------------------------------
Recoveries:
Real estate mortgages 5 - 46 3 24
Commercial and all others 1 131 - - 6
Credit card and related plans 1 3 3 2 2
Installment loans 1 - 1 4 -
- ----------------------------------------------------------------------------------------------------------
Total recoveries 8 134 50 9 32
- ----------------------------------------------------------------------------------------------------------
Net charge-offs 157 33 63 44 323
- ----------------------------------------------------------------------------------------------------------
Provision charged to operations 657 433 263 144 476
- ----------------------------------------------------------------------------------------------------------
Balance at End of Year $ 4,700 $ 4,200 $ 3,800 $ 3,600 $ 3,500
==========================================================================================================
Ratio of net charge-offs
to average loans outstanding 0.04% 0.01% 0.02% 0.02% 0.12%
==========================================================================================================
THE ALLOWANCE FOR LOAN LOSSES IS ALLOCATED AS FOLLOWS:
December 31, 2007 2006 2005 2004 2003
- -------------------------------------------------------------------------------------------------------------------------------
Amount %(1) Amount %(1) Amount %(1) Amount %(1) Amount %(1)
- -------------------------------------------------------------------------------------------------------------------------------
Real estate mortgages $ 1,200 85% $ 1,200 83% $ 1,200 75% $ 1,100 72% $ 1,100 73%
Commercial
and all others 2,900 7 2,500 9 2,190 16 2,070 18 1,970 15
Credit card and
related plans 300 1 250 1 185 1 180 1 180 1
Personal installment loans 300 7 250 7 225 8 250 9 250 11
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 4,700 100% $ 4,200 100% $ 3,800 100% $ 3,600 100% $ 3,500 100%
===============================================================================================================================
(1) - Percent of loans in each category to total loans
DEPOSITS
The primary source of funds to support the Company's operations is its deposit
base. Company deposits increased $2.7 million to $416.5 million at December 31,
2007 from $413.8 million at December 31, 2006. Largely, the Company experienced
growth in transaction accounts due to increased marketing efforts along with
higher interest rates, offset by a decline in time deposits. Company deposits
increased $15.9 million to $413.8 million at December 31, 2006 from $397.9
million at December 31, 2005. The Company experienced growth in money market
accounts as well as time deposits.
The maturities of time deposits of $100,000 or more are as follows:
Three months or less $ 11,826
Over three months through six months 8,750
Over six months through twelve months 7,792
Over twelve months 12,027
----------
Total $ 40,395
==========
17
DIVIDEND POLICY
Payment of future dividends will be subject to the discretion of the Board of
Directors and will depend upon the earnings of the Company, its financial
condition, its capital requirements, its need for funds and other matters as the
Board deems appropriate.
Dividends on the Company common stock, if approved by the Board of Directors,
are customarily paid on or about March 15, June 15, September 15 and December
15.
ASSET/LIABILITY MANAGEMENT
The Company's policy is to match its level of rate-sensitive assets and
rate-sensitive liabilities within a limited range, thereby reducing its exposure
to interest rate fluctuations. While no single measure can completely identify
the impact of changes in interest rates on net interest income, one gauge of
interest rate-sensitivity is to measure, over a variety of time periods, the
differences in the amounts of the Company's rate-sensitive assets and
rate-sensitive liabilities. These differences, or "gaps", provide an indication
of the extent to which net interest income may be affected by future changes in
interest rates. A positive gap exists when rate-sensitive assets exceed
rate-sensitive liabilities and indicates that a greater volume of assets than
liabilities will reprise during a given period. This mismatch may enhance
earnings in a rising interest rate environment and may inhibit earnings when
interest rates decline. Conversely, when rate-sensitive liabilities exceed
rate-sensitive assets, referred to as a negative gap, it indicates that a
greater volume of liabilities than assets may reprise during the period. In this
case, a rising interest rate environment may inhibit earnings and declining
interest rates may enhance earnings. However, because interest rates for
different asset and liability products offered by financial institutions respond
differently, the gap is only a general indicator of interest rate sensitivity.
LIQUIDITY
The objective of liquidity management is to maintain a balance between sources
and uses of funds in such a way that the cash requirements of customers for
loans and deposit withdrawals are met in the most economical manner. Management
monitors its liquidity position continuously in relation to trends of loans and
deposits for short-term as well as long-term requirements. Liquid assets are
monitored on a daily basis to assure maximum utilization. Management also
manages its liquidity requirements by maintaining an adequate level of readily
marketable assets and access to short-term funding sources. Management does not
foresee any adverse trends in liquidity.
The Company remains in a highly liquid condition both in the short and long
term. Sources of liquidity include the Company's U.S. Agency bond portfolios,
additional deposits, and earnings, overnight loans to and from other companies
(Federal Funds) and lines of credit at the Federal Reserve Bank and the Federal
Home Loan Bank (FHLB). The Company is not a party to any commitments, guarantees
or obligations that could materially affect its liquidity.
The Company offers collateralized repurchase agreements, which have a one day
maturity, as an alternative deposit option for its customers. The Company also
has long-term debt outstanding to the FHLB, which was used to purchase a Freddie
Mac pool of residential mortgages, as described earlier in this report. At
December 31, 2007, the Company had $178,490 of available borrowing capacity with
the FHLB.
Subsequent to the Balance Sheet date, the Company purchased $25 million, 5%
mortgage-backed securities using the proceeds from a series of long-term
borrowings from the FHLB. The securities are expected to yield 5.16% based on
average life expectancy for similar securities. The borrowings have maturities
and rates ranging from 1 to 7 years and 2.61%-3.44%, respectively.
The transaction resulted in increases in the total assets and total liabilities
of the Company from December 31, 2007 of approximately 4.3% and 4.9%,
respectively.
COMMITMENTS AND CONTINGENT LIABILITIES
In the normal course of business, there are outstanding commitments and
contingent liabilities, created under prevailing terms and collateral
requirements such as commitments to extend credit, financial guarantees and
letters of credit, which are not reflected in the accompanying Financial
Statements. The Company does not anticipate any losses as a result of these
transactions. These instruments involve, to varying degrees, elements of credit
and interest rate risk in excess of the amount recognized in the Balance Sheets.
The contract or notional amounts of those instruments reflect the extent of
involvement the Company has in particular classes of financial instruments.
18
Financial instruments whose contract amounts represent credit risk at December
31, 2007 and 2006 are as follows:
2007 2006
- ------------------------------------------------------------------
Commitments to extend credit:
Fixed rate $ 40,105 $ 37,692
Variable rate $ 78,868 $ 74,577
Standby letters of credit $ 13,104 $ 15,061
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have expiration dates of one year or less or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Standby letters of credit are conditional commitments issued to guarantee the
performance of a customer to a third party. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending loan
facilities to customers.
RELATED PARTIES
The Company does not have any material transactions involving related persons or
entities, other than traditional banking transactions, which are made on the
same terms and conditions as those prevailing at the time for comparable
transactions with unrelated parties. At December 31, 2007, the Bank has issued
standby letters of credit for the accounts of related parties in the amount of
$8,093.
CAPITAL RESOURCES
A strong capital position is important to the continued profitability of the
Company and promotes depositor and investor confidence. The Company's capital
provides a basis for future growth and expansion and also provides additional
protection against unexpected losses.
Additional sources of capital would come from retained earnings from the
operations of the Company and from the sale of additional shares of common
stock. Management has no plans to offer additional shares of common stock at
this time.
The Company's total risk-based capital ratio was 19.89% at December 31, 2007.
The Company's risk-based capital ratio is more than the 10.00% ratio that
Federal regulators use as the "well capitalized" threshold. This is the current
criteria which the FDIC uses in determining the lowest insurance rate for
deposit insurance. The Company's risk-based capital ratio is more than double
the 8.00% limit which determines whether a company is "adequately capitalized".
Under these rules, the Company could significantly increase its assets and still
comply with these capital requirements without the necessity of increasing its
equity capital.
The following table presents Stockholders' Equity of the Company for the past
two years:
Year Ended December 31, 2007 2007 2006
- ----------------------------------------------------------------------------
Balance at beginning of year $ 66,571 $ 63,799
Net income 6,698 6,008
Other comprehensive income (160) 1,659
Cash dividends declared (3,394) (3,222)
Adjustments to initially apply
FASB Statement No. 158 net of tax - (1,673)
- ----------------------------------------------------------------------------
Total Stockholders' Equity $ 69,715 $ 66,571
============================================================================
ITEM 7A QUANTATIVE AND QUALATIVE DISCLOSURES ABOUT MARKET RISK
The Company currently does not enter into derivative financial instruments,
which include futures, forwards, interest rate swaps, option contracts and other
financial instruments with similar characteristics. However, the Company is
party to traditional financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit, financial guarantees
and letters of credit. These traditional instruments involve to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the Consolidated Balance Sheets.
19
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Standby letters of credit are conditional commitments
issued to guarantee the performance of a customer to a third party up to a
stipulated amount and with specified terms and conditions.
Commitments to extend credit and standby letters of credit are not recorded as
an asset or liability by the Company until the instrument is exercised.
The Company's exposure to market risk is reviewed on a regular basis by the
Asset/Liability Committee. Interest rate risk is the potential of economic
losses due to future interest rate changes. These economic losses can be
reflected as a loss of future net interest income and/or a loss of current fair
market values. The objective is to measure the effect on net interest income and
to adjust the balance sheet to minimize the inherent risk while at the same time
maximizing income. Management realizes certain risks are inherent and that the
goal is to identify and minimize the risks. Tools used by management include the
standard GAP report and an interest rate shock simulation report. The Company
has no market risk sensitive instruments held for trading purposes. It appears
the Company's market risk is reasonable at this time.
The following table provides information about the Company's market rate
sensitive instruments used for purposes other than trading that are sensitive to
changes in interest rates. For loans, securities, and liabilities with
contractual maturities, the table presents principal cash flows and related
weighted-average interest rates by contractual maturities as well as the
Company's historical experience of the impact of interest rate fluctuations on
the prepayment of residential and home equity loans and mortgage-backed
securities. For core deposits (e.g., DDA, interest checking, savings and money
market deposits) that have no contractual maturity, the table presents principal
cash flows and, as applicable, related weighted-average interest rates based on
the Company's historical experience, management's judgment, and statistical
analysis, as applicable, concerning their most likely withdrawal behaviors.
20
MATURITIES AND SENSITIVITY OF MARKET RISK AS OF DECEMBER 31, 2007
The table below presents States and political subdivisions securities on a fully
taxable equivalent basis.
NON-RATE FAIR
2008 2009 2010 2011 2012 THEREAFTER SENSITIVE TOTAL VALUE
====================================================================================================================================
ASSETS
Fixed interest rate securities:
U.S. Agency obligations $ 20,703 $ 11,584 $ 4,553 $ 3,344 $ 2,564 $ 10,952 $ - $53,700 $ 53,358
YIELD 5.03% 5.08% 5.03% 5.03% 5.03% 5.03% - 5.04% -
State & political subdivisions - 7,196 8,975 13,050 7,333 32,160 - 68,714 70,423
YIELD - 8.47% 8.51% 7.55% 7.60% 6.69% - 7.44% -
Variable interest rate securities:
U.S. Agency obligations 15,816 - - - - - - 15,816 15,820
YIELD 5.77% - - - - - - 5.77% -
Federal Home Loan Bank stock 4,389 - - - - - - 4,389 4,389
YIELD 6.25% - - - - - - 6.25% -
Other - - - - - 2,829 - 2,829 2,829
YIELD - - - - - 4.82% - 4.82% -
Fixed interest rate loans:
Real estate mortgages 66,448 41,623 27,655 19,561 13,314 25,054 - 193,655 194,643
YIELD 6.37% 6.29% 6.35% 6.35% 6.36% 6.59% - 6.37% -
Commercial 1,286 1,148 4.24 298 436 1,507 - 5,099 5,079
YIELD 6.63% 5.91% 6.88% 7.14% 7.17% 7.51% - 6.83% -
Consumer and other 5,894 1,553 956 562 452 7,080 - 16,497 16,460
YIELD 5.73% 7.5% 7.56% 7.37% 7.29% 6.32% - 6.36% -
Variable interest rate loans:
Real estate mortgages 134,308 2,656 6,495 4,156 2,921 104 - 150,640 151,409
YIELD 6.71% 7.22% 7.05% 6.47% 7.11% 7.55% - 6.72% -
Commercial 14,730 61 383 4,232 - - - 19,406 19,330
YIELD 7.12% 7.35% 7.27% 6.71% - - - 7.03% -
Consumer and other 16,465 93 98 103 2,583 - - 19,342 19,298
YIELD 8.16% 8.03% 8.03% 8.03% 8.03% - - 8.15% -
Less: Allowance for loan losses - - - - - 4,700 - 4,700 -
Interest bearing balances with banks 967 - - - - - - 967 967
YIELD 3.25% - - - - - - 3.25% -
Cash surrender life insurance 7,368 - - - - - - 7,368 7,368
YIELD 4.75% - - - - - - 4.75% -
Cash and due from banks - - - - - - 10,677 10,677 10,677
Other assets - - - - - - 16,394 16,394 -
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 288,374 $ 65,914 $ 49,539 $ 45,306 $ 29,603 $ 74,896 $ 27,071 $ 580,793 $ 572,050
====================================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Variable interest rate deposits:
Demand-Interest bearing $ 6,276 $ - $ - $ - $ - $ 48,543 $ - $ 54,819 $ 54,819
YIELD 4.16% - - - - .67% - 1.07% -
Savings 15,543 - - - - 64,511 - 80,054 80,054
YIELD 3.45% - - - - .35% - .95% -
Money markets 103,294 - - - - - - 103,924 103,924
YIELD 2.8% - - - - - - 2.80% -
Fixed interest rate deposits:
Time-Over $100,000 28,368 5,626 5,456 318 424 203 - 40,395 40,528
YIELD 4.42% 4.94% 5.14% 5.41 % 4.43% 5.63% - 4.61% -
Time-Other 40,689 13,007 5,453 1,961 1,744 561 - 63,415 63,625
YIELD 3.93% 4.27% 4.33% 4.61% 4.79% 5.46% - 4.09% -
Demand-Non interest bearing - - - - - - 73,926 73,926 73,926
Repurchase agreements 20,492 - - - - - - 20,492 20,453
YIELD 2.92% - - - - - - 2.92% -
Short-term borrowings 13,201 - - - - - - 13,201 13,201
YIELD 3.38% - - - - - - 3.38% -
Long-term borrowings 8,780 8,612 6,634 6,116 6,361 19,463 - 55,966 56,028
YIELD 3.69% 3.74% 3.90% 3.98% 3.98% 4.63% - 4.08% -
Other liabilities - - - - - - 4,886 4,886 -
Stockholders' equity - - - - - - 69,715 69,715 -
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 237,273 $ 27,245 $ 17,543 $ 8,395 $ 8,529 $ 133,281 $ 148,527 $ 580,793 $ 506,558
====================================================================================================================================
EXCESS OF ASSETS (LIABILITIES)
SUBJECT TO INTEREST RATE CHANGE $ 51,101 $ 38,669 $ 31,996 $ 36,911 $ 21,074 $ 58,295 $(121,456) $ - -
====================================================================================================================================
21
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2007 2006
- ---------------------------------------------------------------------------------------------------
Cash and due from banks $ 10,677 $ 12,999
Interest bearing balances with banks 967 1,779
- ---------------------------------------------------------------------------------------------------
Cash and Cash Equivalents 11,644 14,778
Investment securities:
Available-for-sale, at fair value 77,328 91,705
Held-to-maturity (fair value of $69,491
and $75,120, respectively) 68,120 74,375
- ---------------------------------------------------------------------------------------------------
Total Investment Securities 145,448 166,080
Loans, net of unearned income 404,639 369,922
Less: Allowance for loan losses 4,700 4,200
- ---------------------------------------------------------------------------------------------------
Loans, Net 399,939 365,722
Bank premises and equipment 9,323 9,471
Other real estate owned - -
Accrued interest receivable 3,558 3,632
Cash surrender value of life insurance 7,368 7,054
Other assets 3,513 3,084
- ---------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 580,793 $ 569,821
===================================================================================================
Deposits:
Non-interest bearing $ 73,926 $ 71,585
Interest bearing 342,607 342,215
- ---------------------------------------------------------------------------------------------------
Total Deposits 416,533 413,800
Other borrowed funds:
Repurchase agreements 20,492 13,441
Short-term borrowings 13,201 5,486
Long-term borrowings 55,966 65,853
Accrued interest payable 1,498 1,472
Other liabilities 3,388 3,198
- ---------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 511,078 503,250
===================================================================================================
Common stock, $.01 par value, 15,000,000 shares
authorized, 2,148,000 shares issued and outstanding 21 21
Surplus 10,819 10,819
Retained earnings 59,697 56,393
Accumulated other comprehensive income (822) (662)
- ---------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 69,715 66,571
- ---------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 580,793 $ 569,821
===================================================================================================
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
22
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2007 2006 2005
- -------------------------------------------------------------------------------------------------------------------
Interest and fees on loans $ 26,429 $ 23,374 $ 18,569
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency obligations 3,731 5,360 6,408
States & political subdivisions 2,944 2,688 2,616
Other securities 404 340 190
Interest on Federal funds sold 456 - 176
Interest on balances with banks 365 160 211
- -------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST INCOME 34,329 31,922 28,170
- -------------------------------------------------------------------------------------------------------------------
Interest on time deposits of $100,000 or more 2,010 1,408 808
Interest on other deposits 7,365 6,204 4,212
Interest on other borrowed funds 3,364 3,442 3,560
- -------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST EXPENSE 12,739 11,054 8,580
- -------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 21,590 20,868 19,590
Provision for loan losses 657 433 263
- -------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 20,933 20,435 19,327
- -------------------------------------------------------------------------------------------------------------------
Trust department income 1,535 1,483 1,479
Service charges on deposit accounts 1,014 860 940
Merchant transaction income 4,256 3,947 4,521
Other fee income 1,472 1,423 1,575
Bank-owned life insurance 314 54 -
Other operating income 80 119 372
Realized gains (losses) on securities, net 49 319 (13)
- -------------------------------------------------------------------------------------------------------------------
TOTAL OTHER INCOME 8,720 8,205 8,874
- -------------------------------------------------------------------------------------------------------------------
Salaries and employee benefits 9,118 10,315 9,261
Expense of premises and equipment, net 2,586 2,397 2,455
Merchant transaction expenses 3,358 3,141 3,646
Other operating expenses 6,269 5,184 5,357
- -------------------------------------------------------------------------------------------------------------------
TOTAL OTHER EXPENSES 21,331 21,037 20,719
- -------------------------------------------------------------------------------------------------------------------
Income before income taxes 8,322 7,603 7,482
Applicable income taxes 1,624 1,595 1,613
- -------------------------------------------------------------------------------------------------------------------
NET INCOME $ 6,698 $ 6,008 $ 5,869
===================================================================================================================
EARNINGS PER SHARE $ 3.12 $ 2.80 $ 2.73
===================================================================================================================
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
23
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005
- --------------------------------------------
ACCUMULATED
OTHER TOTAL
COMMON RETAINED COMPREHENSIVE STOCKHOLDERS'
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) STOCK SURPLUS EARNINGS INCOME EQUITY
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2004 $ 21 $ 10,819 $ 50,832 $ 704 $ 62,376
Comprehensive income:
Net income, 2005 - - 5,869 - 5,869
Other comprehensive income, net of tax
Unrealized losses on securities,
net of reclassification adjustment - - - (341) (341)
Minimum pension liability adjustment - - - (1,011) (1,011)
---------- -----------
Other comprehensive income (1,352) (1,352)
-----------
Comprehensive income 4,517
Cash dividends declared ($1.44 per share) - - (3,094) - (3,094)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2005 21 10,819 53,607 (648) 63,799
Comprehensive income:
Net income, 2006 - - 6,008 - 6,008
Other comprehensive income, net of tax
Unrealized gains on securities,
net of reclassification adjustment - - - 648 648
Minimum pension liability adjustment - - - 1,011 1,011
---------- -----------
Other comprehensive income 1,659 1,659
-----------
Comprehensive income 7,667
Cash dividends declared ($1.50 per share) - - (3,222) - (3,222)
Adjustment to initially apply FASB Statement
No. 158, net of tax - - - (1,673) (1,673)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2006 21 10,819 56,393 (662) 66,571
Comprehensive income:
Net income, 2007 - - 6,698 - 6,698
Other comprehensive income, net of tax
Unrealized losses on securities,
net of reclassification adjustment - - - (57) (57)
Unrealized losses on employee benefit plans, net - - - (103) (103)
---------- -----------
Other comprehensive income (160) (160)
-----------
Comprehensive income 6,538
Cash dividends declared ($1.58 per share) - - (3,394) - (3,394)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2007 $ 21 $ 10,819 $ 59,697 $ (822) $ 69,715
====================================================================================================================================
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
24
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31, 2007 2006 2005
- --------------------------------------------------------------------------------------------------------------------
Net Income $ 6,698 $ 6,008 $ 5,869
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation 861 723 704
Provision for loan losses 657 433 263
Deferred income tax (benefit) provision (344) (254) 166
Amortization of securities (net of accretion) 366 419 1,379
Increase in cash surrender value of life insurance (314) (54) -
Net realized (gains) losses on securities (49) (319) 13
(Gain) loss on other real estate (19) 10 (46)
Gain on disposition of fixed assets - - (5)
Decrease (increase) in interest receivable 74 (159) (67)
(Increase) decrease in other assets (36) (304) 313
Decrease in income taxes payable (14) (4) (442)
Increase in interest payable 26 211 375
Increase (decrease) in other liabilities 82 940 (29)
- --------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 7,988 7,650 8,493
- --------------------------------------------------------------------------------------------------------------------
Purchase of investment securities available-for-sale (21,412) (25,770) (47,526)
Proceeds from sales and maturities of investment
securities available-for-sale 21,962 68,287 46,451
Proceeds from repayments of investment
securities available-for-sale 13,779 15,028 19,140
Proceeds from repayments of investment
securities to be held-to-maturity 5,899 7,213 12,746
Net loans originated (34,950) (48,676) (41,550)
Proceeds from other real estate 95 164 432
Proceeds from sale of fixed assets - - 10
Investment in premises and equipment (713) (741) (929)
Purchase of life insurance policies - (7,000) -
- --------------------------------------------------------------------------------------------------------------------
NET CASH (USED) PROVIDED BY INVESTING ACTIVITIES (15,340) 8,505 (11,226)
- --------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in demand and savings deposits 17,781 (1,374) (3,984)
Net (payments) proceeds on time deposits (15,048) 17,307 6,550
Increase (decrease) in repurchase agreements 7,051 (16,973) 12,016
Net increase in short-term borrowings 7,715 860 3,740
Payments on long-term borrowings (9,887) (9,548) (9,219)
Cash dividends paid (3,394) (3,222) (3,094)
- --------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES 4,218 (12,950) 6,009
- --------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (3,134) 3,205 3,276
Cash and cash equivalents at January 1 14,778 11,573 8,297
- --------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT DECEMBER 31 $ 11,644 $ 14,778 $ 11,573
====================================================================================================================
The accompanying Notes are an integral part of these Consolidated Financial
Statements.
25
GENERAL NOTES TO FINANCIAL STATEMENTS
NOTE 1 -- NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Penseco Financial Services Corporation (Company) is a financial holding company,
incorporated in 1997 under the laws of Pennsylvania. It is the parent company of
Penn Security Bank and Trust Company (Bank), a state chartered bank.
The Company operates from nine banking offices under a state bank charter and
provides full banking services, including trust services, to individual and
corporate customers primarily in Northeastern Pennsylvania. The Company's
primary deposit products are savings and demand deposit accounts and
certificates of deposit. Its primary lending products are real estate,
commercial and consumer loans.
The Company's revenues are attributable to a single reportable segment,
therefore segment information is not presented.
The accounting policies of the Company conform with accounting principles
generally accepted in the United States of America and with general practices
within the banking industry.
BASIS OF PRESENTATION
The Financial Statements of the Company have been consolidated with those of its
wholly-owned subsidiary, Penn Security Bank and Trust Company, eliminating all
intercompany items and transactions.
The Statements are presented on the accrual basis of accounting.
All information is presented in thousands of dollars, except per share amounts.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for losses on loans and the
valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In connection with the determination of the allowances
for losses on loans and foreclosed real estate, management obtains independent
appraisals for significant properties.
EMERGING ACCOUNTING STANDARDS
In February 2006, the Financial Accounting Standards Board (FASB) issued
Statement No. 155, ACCOUNTING FOR CERTAIN HYBRID FINANCIAL INSTRUMENTS - AN
AMENDMENT OF FASB STATEMENTS NO. 133 AND 140. Statement No. 155 eliminated the
exception from applying Statement 133 to interests in securitized financial
assets so that similar instruments are accounted for similarly regardless of the
form of the instruments. The Statement was effective for all financial
instruments acquired or issued after the beginning of the first fiscal year that
began after September 15, 2006.
The adoption of Statement No. 155 did not have a significant effect on the
Company's financial statements.
In March 2006, FASB issued Statement No. 156, ACCOUNTING FOR SERVICING OF
FINANCIAL INSTRUMENTS - AN AMENDMENT OF FASB STATEMENT NO. 140. Statement No.
156 requires the recognition of the fair value of a servicing asset or servicing
liability each time an obligation to service a financial asset by entering into
a servicing contract is undertaken, if practicable. It also allows the entity to
subsequently measure the asset or liability under an amortization or fair value
method. The Statement was effective for all financial instruments acquired or
issued after the beginning of the first fiscal year that began after September
15, 2006.
The adoption of Statement No. 156 did not have a significant effect on the
Company's financial statements.
In July 2006, FASB issued FASB Interpretation No. 48, ACCOUNTING FOR UNCERTAINTY
IN INCOME TAXES - AN INTERPRETATION OF FASB STATEMENT NO. 109. Interpretation
No. 48 clarifies the application of Statement No. 109 by establishing a
threshold condition that a tax position must meet for any part of that position
to be recognized in the financial statements. In addition to recognition, the
Interpretation provides guidance on the measurement, derecognition,
classification and disclosure of tax positions. The Interpretation was effective
for fiscal years beginning after December 15, 2006.
The adoption of Interpretation No. 48 did not have a significant effect on the
Company's financial statements.
26
In September 2006, FASB issued Statement No. 157, FAIR VALUE MEASUREMENTS.
Statement No. 157 defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles (GAAP), and expands
disclosures about fair value measurement. The Statement is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years.
The adoption of this Statement is not expected to have a material impact on the
Company's financial position, results of operations or cash flows.
In September 2006, the FASB ratified Emerging Issues Task Force (EITF) issue No.
06-4, ACCOUNTING FOR DEFERRED COMPENSATION AND POSTRETIREMENT BENEFIT ASPECTS OF
ENDORSEMENT SPLIT-DOLLAR LIFE INSURANCE ARRANGEMENTS (EITF 06-4), and in March
2007, the FASB ratified EITF Issue No. 06-10, ACCOUNTING FOR COLLATERAL
ASSIGNMENT SPLIT-DOLLAR LIFE INSURANCE ARRANGEMENTS (EITF 06-10). EITF 06-4
requires deferred compensation or postretirement benefit aspects of an
endorsement-type split-dollar life insurance arrangement to be recognized as a
liability by the employer and states the obligation is not effectively settled
by the purchase of a life insurance policy. The liability for future benefits
should be recognized based on the substantive agreement with the employee, which
may be either to provide a future death benefit or to pay for the future cost of
the life insurance. EITF 06-10 provides recognition guidance for postretirement
benefit liabilitied related to collateral assignment split-dollar life insurance
arrangements, as well as recognition and measurement of the associated asset on
the basis of the terms of the collateral assignment split-dollar life insurance
arrangement. EITF 06-4 and EITF 06-10 are effective for fiscal years beginning
after December 15, 2007.
The Company is currently evaluating the impact of the adoption of EITF 06-4 and
06-10 on its financial condition, results of operations and cash flows.
In February 2007, FASB issued Statement No. 159, THE FAIR VALUE OPTION FOR
FINANCIAL ASSETS AND FINANCIAL LIABILITIES. Statement No. 159 permits companies
to elect to follow fair value accounting for certain financial assets and
liabilities in an effort to mitigate volatility in earnings without having to
apply complex hedge accounting provisions. The standard also establishes
presentation and disclosure requirements designed to facilitate comparison
between entities that choose different measurement attributes for similar types
of assets and liabilities. The Statement is effective for fiscal years beginning
after November 15, 2007.
The adoption of this Statement is not expected to have a material impact on the
Company's financial position, results of operations or cash flows.
In November 2007, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 109 (SAB 109), WRITTEN LOAN COMMITMENTS RECORDED AT FAIR
VALUE THROUGH EARNINGS. SAB 109 supersedes SAB 105, APPLICATION OF ACCOUNTING
PRINCIPLES TO LOAN COMMITMENTS and indicates that the expected net future cash
flows related to the associated servicing of the loan should be included in the
measurement of all written loan commitments that are accounted for at fair value
through earnings. The guidance in SAB 109 should be applied on a prospective
basis to derivative loan commitments issued or modified in fiscal quarters
beginning after December 15, 2007.
The adoption of this guidance is not expected to have a material impact on the
Company's financial position, results of operations or cash flows.
In December 2007, FASB issued Statement No. 141R, BUSINESS COMBINATIONS and
Statement No. 160, NONCONTROLLING INTERESTS IN CONSOLIDATED FINANCIAL
STATEMENTS, AND AMENDMENT OF ARB NO. 51. These new standards significantly
change the accounting for and reporting of business combination transactions and
noncontrolling interests (previously referred to as minority interests) in
consolidated financial statements. Both standards are effective for fiscal years
beginning on or after December 15, 2008, with early adoption prohibited.
The Company is currently evaluating the provisions of Statements No. 141(R) and
160.
INVESTMENT SECURITIES
Investments in securities are classified in two categories and accounted for as
follows:
Securities Held-to-Maturity Bonds, notes, debentures and mortgage-backed
- ---------------------------
securities for which the Company has the positive intent and ability to hold to
maturity are reported at cost, adjusted for amortization of premiums and
accretion of discounts computed on the straight-line basis, which approximates
the interest method, over the remaining period to maturity.
27
Securities Available-for-Sale Bonds, notes, debentures, mortgage-backed
- -----------------------------
securities and certain equity securities not classified as securities to be held
to maturity are carried at fair value with unrealized holding gains and losses,
net of tax, reported as a net amount in a separate component of stockholders'
equity until realized.
The amortization of premiums on mortgage-backed securities is done based on
management's estimate of the lives of the securities, adjusted, when necessary,
for advanced prepayments in excess of those estimates.
Gains and losses on the sale of securities available-for-sale are determined
using the specific identification method and are reported as a separate
component of other income in the Statements of Income.
LOANS AND PROVISION (ALLOWANCE) FOR POSSIBLE LOAN LOSSES
Loans are stated at the principal amount outstanding, net of any unearned
income, deferred loan fees and the allowance for loan losses. Interest is
accrued daily on the outstanding balances.
Loans are generally placed on a non-accrual status when principal or interest is
past due 90 days or when payment in full is not anticipated. When a loan is
placed on non-accrual status, all interest previously accrued but not collected
is charged against current income. Loans are returned to accrual status when
past due interest is collected and the collection of principal is probable.
The provision for loan losses is based on past loan loss experience,
management's evaluation of the potential loss in the current loan portfolio
under current economic conditions and such other factors as, in management's
best judgement, deserve current recognition in estimating loan losses. The
annual provision for loan losses charged to operating expense is that amount
which is sufficient to bring the balance of the allowance for possible loan
losses to an adequate level to absorb anticipated losses.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation.
Provision for depreciation and amortization, computed principally on the
straight-line method, is charged to operating expenses over the estimated useful
lives of the assets. Maintenance and repairs are charged to current expense as
incurred.
LOAN SERVICING
The Company generally retains the right to service mortgage loans sold to
others. The cost allocated to the mortgage servicing rights retained has been
recognized as a separate asset and is being amortized in proportion to and over
the period of estimated net servicing income.
Mortgage servicing rights are evaluated for impairment based on the fair value
of those rights. Fair values are estimated using discounted cash flows based on
current market rates of interest and current expected future prepayment rates.
For purposes of measuring impairment, the rights must be stratified by one or
more predominant risk characteristics of the underlying loans. The Company
stratifies its capitalized mortgage servicing rights based on the product type,
interest rate and term of the underlying loans. The amount of impairment
recognized is the amount, if any, by which the amortized cost of the rights for
each stratum exceed the fair value.
ADVERTISING EXPENSES
Advertising costs are expensed as incurred. Advertising expenses for the years
ended December 31, 2007, 2006 and 2005, amounted to $612, $379 and $472,
respectively.
INCOME TAXES
Provisions for income taxes are based on taxes payable or refundable for the
current year (after exclusion of non-taxable income such as interest on state
and municipal securities) as well as deferred taxes on temporary differences,
between the amount of taxable income and pre-tax financial income and between
the tax bases of assets and liabilities and their reported amounts in the
Financial Statements. Deferred tax assets and liabilities are included in the
Financial Statements at currently enacted income tax rates applicable to the
period in which the deferred tax assets and liabilities are expected to be
realized or settled as prescribed in Statement of Financial Accounting Standards
No. 109, ACCOUNTING FOR INCOME TAXES (SFAS 109). As changes in tax laws or rates
are enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes.
28
PENSION EXPENSE
Pension expense has been determined in accordance with Statement of Financial
Accounting Standards No. 87, EMPLOYERS ACCOUNTING FOR PENSIONS (SFAS 87).
STOCK APPRECIATION RIGHTS EXPENSE
The Company records its obligation under its stock appreciation rights plan in
accordance with Statement of Financial Accounting Standards No. 123R, ACCOUNTING
FOR STOCK BASED COMPENSATION (SFAS 123R).
POSTRETIREMENT BENEFITS EXPENSE
Postretirement benefits expense has been determined in accordance with Statement
of Financial Accounting Standards No. 106, EMPLOYERS ACCOUNTING FOR
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS (SFAS 106).
CASH FLOWS
For purposes of the Statements of Cash Flows, cash and cash equivalents include
cash on hand, due from banks, interest bearing balances with banks and Federal
funds sold for a one-day period.
The Company paid interest and income taxes during the years ended December 31,
2007, 2006 and 2005 as follows:
2007 2006 2005
- -----------------------------------------------------------------
Income taxes paid $ 1,730 $ 1,752 $ 1,886
Interest paid $ 12,713 $ 10,843 $ 8,205
Non-cash transactions during the years ended December 31, 2007, 2006 and 2005,
comprised entirely of the net acquisition of real estate in the settlement of
loans, amounted to $76, $83 and $301, respectively.
LONG-LIVED ASSETS
The Company reviews the carrying value of long-lived assets for impairment
whenever events or changes in circumstances indicate that carrying amounts of
the assets might not be recoverable, as prescribed in Statement of Financial
Accounting Standards No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF
LONG-LIVED ASSETS (SFAS 144).
TRUST ASSETS AND INCOME
Assets held by the Company in a fiduciary or agency capacity for its customers
are not included in the Financial Statements since such items are not assets of
the Company. Trust income is reported on the accrual basis of accounting.
EARNINGS PER SHARE
Basic earnings per share is computed on the weighted average number of common
shares outstanding during each year (2,148,000) as prescribed in Statement of
Financial Accounting Standards No. 128, EARNINGS PER SHARE (SFAS 128). A
calculation of diluted earnings per share is not applicable to the Company.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current year
presentation.
NOTE 2 -- CASH AND DUE FROM BANKS
Cash and due from banks are summarized as follows:
December 31, 2007 2006
- --------------------------------------------------------------------
Cash items in process of collection $ 8 $ 31
Non-interest bearing balances 6,603 9,102
Cash on hand 4,066 3,866
- --------------------------------------------------------------------
Total $ 10,677 $ 12,999
- --------------------------------------------------------------------
The Company may, from time to time, maintain bank balances with other financial
institutions in excess of $100,000 each. Management is not aware of any evidence
that would indicate that such deposits are at risk.
29
NOTE 3 -- INVESTMENT SECURITIES
The amortized cost and fair value of investment securities at December 31, 2007
and 2006 are as follows:
AVAILABLE-FOR-SALE
Gross Gross
Amortized Unrealized Unrealized Fair
2007 Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------
U.S. Agency securities $ 14,929 $ 144 $ - $ 15,073
Mortgage-backed securities 15,402 161 - 15,563
States & political subdivisions 38,740 830 96 39,474
- ----------------------------------------------------------------------------------------------
Total Debt Securities 69,071 1,135 96 70,110
Equity securities 6,812 921 515 7,218
- ----------------------------------------------------------------------------------------------
Total Available-for-Sale $ 75,883 $ 2,056 $ 611 $ 77,328
==============================================================================================
Gross Gross
Amortized Unrealized Unrealized Fair
2006 Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------
U.S. Agency securities $ 24,897 $ 9 $ 23 $ 24,883
Mortgage-backed securities 29,231 91 82 29,240
States & political subdivisions 29,281 939 - 30,220
- ----------------------------------------------------------------------------------------------
Total Debt Securities 83,409 1,039 105 84,343
Equity securities 6,764 628 30 7,362
- ----------------------------------------------------------------------------------------------
Total Available-for-Sale $ 90,173 $ 1,667 $ 135 $ 91,705
==============================================================================================
Equity securities at December 31, 2007 and 2006, consisted primarily of other
financial institutions' stock and Federal Home Loan Bank (FHLB) stock, which is
a required investment in order to participate in an available line of credit
program. The FHLB stock is stated at par value as there is no readily
determinable fair value.
A summary of transactions involving available-for-sale debt securities in 2007,
2006 and 2005 are as follows:
December 31, 2007 2006 2005
- -----------------------------------------------------------------------
Proceeds from sales $ - $ - $ 10,250
Gross realized gains - - 51
Gross realized losses - - 64
30
HELD-TO-MATURITY
Gross Gross
Amortized Unrealized Unrealized Fair
2007 Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------
Mortgage-backed securities $ 38,880 $ 3 $ 341 $ 38,542
States & political subdivisions 29,240 1,709 - 30,949
- ----------------------------------------------------------------------------------------------
Total Held-to-Maturity $ 68,120 $ 1,712 $ 341 $ 69,491
==============================================================================================
Gross Gross
Amortized Unrealized Unrealized Fair
2006 Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------
Mortgage-backed securities $ 45,124 $ 4 $ 1,074 $ 44,054
States & political subdivisions 29,251 1,815 - 31,066
- ----------------------------------------------------------------------------------------------
Total Held-to-Maturity $ 74,375 $ 1,819 $ 1,074 $ 75,120
==============================================================================================
Investment securities with amortized costs and fair values of $128,682 and
$131,134, respectively, at December 31, 2007 and $98,949 and $99,898,
respectively, at December 31, 2006, were pledged to secure trust funds, public
deposits and for other purposes as required by law.
The amortized cost and fair value of debt securities at December 31, 2007 by
contractual maturity, are shown in the following table. Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
Available-for-Sale Held-to-Maturity
- -----------------------------------------------------------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
- -----------------------------------------------------------------------------------------------------------
Due in one year or less:
U.S. Agency securities $ 9,920 $ 9,951 $ - $ -
After one year through five years:
U.S. Agency securities 5,009 5,122 - -
After five years through ten years:
States & political subdivisions 460 496 1,794 1,902
After ten years:
States & political subdivisions 38,280 38,978 27,446 29,047
- -----------------------------------------------------------------------------------------------------------
Subtotal 53,669 54,547 29,240 30,949
Mortgage-backed securities 15,402 15,563 38,880 38,542
- -----------------------------------------------------------------------------------------------------------
Total Debt Securities $ 69,071 $ 70,110 $ 68,120 $ 69,491
===========================================================================================================
31
The gross fair value and unrealized losses of the Company's investments,
aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, at December 31, 2007 and
2006 are as follows:
Less than twelve months Twelve months or more Totals
----------------------------------------------------------------------------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
December 31, 2007 Value Losses Value Losses Value Losses
---------------------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities $ - $ - $ 38,285 $ 341 $ 38,285 $ 341
States & political subdivisions 8,817 96 - - 8,817 96
Equities 1,075 285 464 230 1,539 515
---------------------------------------------------------------------------------------------------------------------------------
Total $ 9,892 $ 381 $ 38,749 $ 571 $ 48,641 $ 952
==================================================================================================================================
Less than twelve months Twelve months or more Totals
----------------------------------------------------------------------------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
December 31, 2006 Value Losses Value Losses Value Losses
---------------------------------------------------------------------------------------------------------------------------------
U.S. Agency securities $ 9,868 $ 9 $ 9,985 $ 14 $ 19,853 $ 23
Mortgage-backed securities - - 50,379 1,156 50,379 1,156
Equities 160 1 541 29 701 30
---------------------------------------------------------------------------------------------------------------------------------
Total $ 10,028 $ 10 $ 60,905 $ 1,199 $ 70,933 $ 1,209
==================================================================================================================================
The table above at December 31, 2007, includes twenty-five (25) securities that
have unrealized losses for less than twelve months and seven (7) securities that
have been in an unrealized loss position for twelve or more months.
MORTGAGE-BACKED SECURITIES
The unrealized losses on the Company's investment in mortgage-backed securities
were caused by interest rate fluctuations. The contractual cash flows of these
investments are guaranteed by an agency of the U.S. government. Accordingly, it
is expected that these securities would not be settled at a price less than the
amortized cost of the Company's investment. Because the decline in market value
is attributable to changes in interest rates and not credit quality and because
the Company has the ability to hold these investments until a recovery of fair
value, which may be maturity, the Company does not consider these investments to
be other-than-temporarily impaired at December 31, 2007.
STATE AND POLITICAL SUBDIVISIONS
The unrealized losses on the Company's investments in these obligations were
caused by interest rate fluctuations. The contractual terms of these investments
do not permit the issuer to settle the securities at price less than the par
value of the investment. Because the Company has the ability to hold these
investments until recovery of fair value, which may be maturity, the Company
does not consider these investments to be other-than-temporarily impaired at
December 31, 2007.
MARKETABLE EQUITY SECURITIES
The unrealized losses on the Company's investment in marketable equity
securities were caused primarily by interest rate fluctuations and other market
conditions. The Company's investments in marketable equity securities consist
primarily of investments in common stock of companies in the financial services
industry. Because the Company has the ability and intent to hold these
investments for a reasonable period of time sufficient for a forecasted recovery
of fair value, the Company does not consider these investments to be
other-than-temporarily impaired at December 31, 2007.
32
NOTE 4 -- LOANS
Major classifications of loans are as follows:
December 31, 2007 2006
- --------------------------------------------------------------------------------
Loans secured by real estate:
Construction and land development $ 25,858 $ 23,714
Secured by 1-4 family residential properties:
Revolving, open-end loans 22,432 17,691
Secured by first liens 184,193 156,944
Secured by junior liens 27,877 30,108
Secured by multi-family properties 3,092 2,870
Secured by non-farm, non-residential properties 80,843 76,710
Commercial and industrial loans to U.S. addressees 24,505 26,265
Loans to individuals for household, family
and other personal expenditures:
Credit card and related plans 3,324 3,282
Other (installment and student loans, etc.) 25,482 24,647
Obligations of states & political subdivisions 5,973 6,806
All other loans 1,060 885
- --------------------------------------------------------------------------------
Gross Loans 404,639 369,922
Less: Unearned income on loans - -
- --------------------------------------------------------------------------------
Loans, Net of Unearned Income $ 404,639 $ 369,922
================================================================================
Loans on which the accrual of interest has been discontinued or reduced amounted
to $1,610, $3,180 and $1,627 at December 31, 2007, 2006 and 2005, respectively.
The decrease in 2007 was primarily due to the resolution of a single borrower
relationship outstanding in 2006. If interest on those loans had been accrued,
such income would have been $153, $209 and $264 for 2007, 2006 and 2005,
respectively. Interest income on those loans, which is recorded only when
received, amounted to $17, $10 and $27 for 2007, 2006 and 2005, respectively.
Also, at December 31, 2007 and 2006, the Bank had loans totaling $479 and $434,
respectively, which were past due 90 days or more and still accruing interest,
primarily guaranteed student loans.
The Company does not engage in any sub-prime or Alt-A credit lending. Therefore,
the Company is not subject to any credit risks associated with such loans.
NOTE 5 -- ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses are as follows:
Years Ended December 31, 2007 2006 2005
- -------------------------------------------------------------------------------
Balance at beginning of year $ 4,200 $ 3,800 $ 3,600
Provision charged to operations 657 433 263
Recoveries credited to allowance 8 134 50
- -------------------------------------------------------------------------------
4,865 4,367 3,913
Losses charged to allowance (165) (167) (113)
- -------------------------------------------------------------------------------
Balance at End of Year $ 4,700 $ 4,200 $ 3,800
===============================================================================
A comparison of the provision for loan losses for Financial Statement purposes
with the allowable bad debt deduction for tax purposes is as follows:
Years Ended December 31, Book Provision Tax Deduction
- ------------------------ -------------- -------------
2007 $ 657 $ 157
2006 $ 433 $ 33
2005 $ 263 $ 63
33
The balance of the reserve for bad debts as reported for Federal income tax
purposes was $0, $0 and $380 at December 31, 2007, 2006 and 2005, respectively.
NOTE 6 -- LOAN SERVICING
The Company services $43,618 in mortgage loans for Freddie Mac which are not
included in the accompanying Consolidated Balance Sheets.
Custodial escrow balances maintained in connection with the foregoing loan
servicing, and included in deposits, were approximately $604 and $595, at
December 31, 2007 and 2006, respectively. The balance of the servicing rights
was $91 and $197 at December 31, 2007 and 2006, respectively, net of
amortization.
The Company has not recorded any new mortgage servicing rights during 2007 or
2006. Amortization expense of $106 and $116 was recorded for the years ended
December 31, 2007 and 2006, respectively.
There was no allowance for impairment recorded at December 31, 2007 or 2006.
NOTE 7 -- BANK PREMISES AND EQUIPMENT
December 31, 2007 2006
- -------------------------------------------------------------------
Land $ 3,117 $ 3,117
Buildings and improvements 14,787 14,752
Furniture and equipment 14,670 14,018
- -------------------------------------------------------------------
32,574 31,887
Less: Accumulated depreciation 23,251 22,416
- -------------------------------------------------------------------
Net Bank Premises and Equipment $ 9,323 $ 9,471
===================================================================
Buildings and improvements are being depreciated over 10 to 39.5 year periods
and equipment over 3 to 10 year periods. Depreciation expense amounted to $861
in 2007, $723 in 2006 and $704 in 2005.
Occupancy expenses were reduced by rental income received in the amount of $64,
$64 and $61 in the years ended December 31, 2007, 2006 and 2005, respectively.
NOTE 8 -- OTHER REAL ESTATE OWNED
Real estate acquired through foreclosure is recorded at the lower of cost or
market at the time of acquisition. Any subsequent write-downs are charged
against operating expenses. The other real estate owned was $0 as of December
31, 2007 and 2006.
NOTE 9 -- INVESTMENT IN AND LOAN TO, INCOME FROM DIVIDENDS AND EQUITY IN
EARNINGS OR LOSSES OF SUBSIDIARY
Penseco Realty, Inc. is a wholly-owned subsidiary of the Bank which owns certain
banking premises. Selected financial information is presented below:
Equity in
Percent underlying Bank's
of voting Total net assets at Amount proportionate
stock investment balance of part of loss for
Year owned and loan sheet date dividends the period
- --------------------------------------------------------------------------------
2007 100% $ 3,250 $ 3,235 None $ -
2006 100% $ 3,250 $ 3,235 None $ -
2005 100% $ 3,250 $ 3,235 None $ -
NOTE 10 -- CASH SURRENDER VALUE OF LIFE INSURANCE
The Company has purchased Bank Owned Life Insurance (BOLI) policies on certain
officers.
The policies are split-dollar life insurance policies which provide for the
Company to receive the cash value of the policy and to split the residual
proceeds with the officer's designated beneficiary upon the death of the
insured, while the officer is employed at the Company. The majority of the
residual proceeds are retained by the Company per the individual agreements with
the insured officers.
34
NOTE 11 -- DEPOSITS
December 31, 2007 2006
- -----------------------------------------------------------------------
Demand - Non-interest bearing $ 73,926 $ 71,585
Demand - Interest bearing 54,819 57,309
Savings 80,054 80,328
Money markets 103,924 85,720
Time - Over $100,000 40,395 39,478
Time - Other 63,415 79,380
- -----------------------------------------------------------------------
Total $ 416,533 $ 413,800
=======================================================================
Scheduled maturities of time deposits are as follows:
2008 $ 69,056
2009 18,648
2010 10,896
2011 2,278
2012 2,168
2013 and thereafter 764
- --------------------------------------------
Total $ 103,810
============================================
NOTE 12 -- OTHER BORROWED FUNDS
At December 31, 2007 and 2006, other borrowed funds consisted of demand notes to
the U.S. Treasury, Federal Home Loan Bank overnight borrowings and repurchase
agreements.
Short-term borrowings generally have original maturity dates of thirty days or
less.
Investment securities with amortized costs and fair values of $49,990 and
$50,009, respectively, at December 31, 2007 and $31,109 and $31,062,
respectively, at December 31, 2006, were pledged to secure repurchase
agreements.
Year Ended December 31, 2007 2006
- ------------------------------------------------------------------------------
Amount outstanding at year end $ 33,693 $ 18,927
Average interest rate at year end 3.27% 2.91%
Maximum amount outstanding at any month end $ 33,920 $ 29,285
Average amount outstanding $ 27,096 $ 22,775
Weighted average interest rate during the year
Federal funds purchased 4.94% 5.28%
Repurchase agreements 3.25% 2.34%
Demand notes to U.S. Treasury 5.76% 4.96%
The Company has an available credit facility with the Federal Reserve Bank in
the amount of $10,000, secured by pledged securities with amortized costs and
fair values of $10,143 and $10,053, respectively, at December 31, 2007 and
$10,202 and $9,958, respectively, at December 31, 2006 and with interest rates
of 4.25% at December 31, 2007 and 5.25% at December 31, 2006. There is no stated
expiration date for the credit facility as long as the Company maintains the
pledged securities at the Federal Reserve Bank. There was no outstanding balance
as of December 31, 2007 and 2006, respectively.
The Company has the availability of a $5,000 overnight Federal funds line of
credit with Wachovia Bank, N.A. Also, the Company has a $16,000 overnight
Federal Funds line with PNC Bank. There was no balance outstanding as of
December 31, 2007 and 2006, respectively.
The Company maintains a collateralized maximum borrowing capacity of $178,490
with the Federal Home Loan Bank of Pittsburgh. There was a balance of $12,575
outstanding as of December 31, 2007.
35
NOTE 13 -- LONG-TERM DEBT
The loans from the Federal Home Loan Bank, which were borrowed to purchase a
mortgage-backed security, are secured by a general collateral pledge of the
Company's assets.
A summary of long-term debt, including amortizing principal Aggregate maturities of long-term debt at
and interest payments, at December 31, 2007 is as follows: December 31, 2007 are as follows:
Monthly Fixed Maturity
Installment Rate Date Balance Amount
- ----------------------------------------------------------- -----------------------------------------------
$ 161 2.73% 03/13/08 $ 480 2008 $ 8,780
253 3.22% 03/13/10 6,579 2009 8,612
430 3.74% 03/13/13 24,565 2010 6,634
186 4.69% 03/13/23 24,342 2011 6,116
- ----------------------------------------------------------- 2012 6,361
Total $ 55,966
=========================================================== 2013 and thereafter 19,463
-----------------------------------------------
Total $ 55,966
===============================================
The Company has agreed to maintain sufficient qualifying collateral to fully
secure the above borrowings.
NOTE 14 -- EMPLOYEE BENEFIT PLANS
The Company provides an Employee Stock Ownership Plan (ESOP), a Retirement
Profit Sharing Plan, an Employees' Pension Plan, an unfunded supplemental
executive pension plan, Postretirement Life Insurance Plan and a stock
appreciation rights plan (SAR), all non-contributory, covering all eligible
employees.
Under the ESOP, amounts voted by the Board of Directors are paid into the ESOP
and each employee is credited with a share in proportion to their annual
compensation. All contributions to the ESOP are invested in or will be invested
primarily in Company stock. Distribution of a participant's ESOP account occurs
upon retirement, death or termination in accordance with the plan provisions.
At December 31, 2007 and 2006, the ESOP held 67,101 and 73,591 shares,
respectively of the Company's stock, all of which were acquired as described
above and allocated to specific participant accounts. These shares are treated
the same for dividend purposes and earnings per share calculations as are any
other outstanding shares of the Company's stock. The Company contributed $70,
$70 and $70 to the plan during the years ended December 31, 2007, 2006 and 2005,
respectively.
Under the Retirement Profit Sharing Plan, amounts voted by the Board of
Directors are paid into a fund and each employee is credited with a share in
proportion to their annual compensation. Upon retirement, death or termination,
each employee is paid the total amount of their credits in the fund in one of a
number of optional ways in accordance with the plan provisions. The Company
contributed $70, $70 and $70 to the plan during the years ended December 31,
2007, 2006 and 2005, respectively.
Under the Pension Plan, amounts computed on an actuarial basis are paid by the
Company into a trust fund. Provision is made for fixed benefits payable for life
upon retirement at the age of 65, based on length of service and compensation
levels as defined in the plan. Plan assets of the trust fund are invested and
administered by the Trust Department of Penn Security Bank and Trust Company.
The unfunded supplemental executive pension plan provides certain officers with
additional retirement benefits to replace benefits lost due to limits imposed on
qualified plans by Federal tax law.
The postretirement life insurance plan is an unfunded, non-vesting defined
benefit plan. The plan is non-contributory and provides for a reducing level of
term life insurance coverage following retirement.
For the unfunded plans above, amounts calculated on an actuarial basis are
recorded as a liability.
The Company granted 10,000 SAR's to an executive on January 3, 2006 at a strike
price of $43.00 per share. The rights vest on a straight line basis over a five
year period and are expected to be settled in cash when exercised. The Company
calculates the value of the vested rights using the Black-Scholes method and
has recorded an expense for 2007 of $19.
36
Obligations and funded status of the plans:
Pension Benefits Other Benefits
------------------------ ---------------------------------------
December 31, 2007 2006 2007 2006
- ------------------------------------------------------------------------------------ ---------------------------------------
Change in benefit obligation:
Benefit obligation, beginning $ 12,600 $ 13,267 $ 299 $ 287
Service cost 438 436 5 6
Interest cost 738 673 18 17
Change in assumptions (154) (1,167) (17) 1
Actuarial (gain) loss 559 (55) 3 -
Benefits paid (623) (554) (16) (12)
- ------------------------------------------------------------------------------------ ---------------------------------------
Benefit obligation, ending 13,558 12,600 292 299
- ------------------------------------------------------------------------------------ ---------------------------------------
Change in plan assets:
Fair value of plan assets, beginning 11,548 9,709 - -
Actual return on plan assets 1,051 954 - -
Employer contribution 279 1,439 - -
Benefits paid (623) (554) - -
- ------------------------------------------------------------------------------------ ---------------------------------------
Fair value of plan assets, ending 12,255 11,548 - -
- ------------------------------------------------------------------------------------ ---------------------------------------
Funded status at end of year $ (1,303) $ (1,052) $ (292) $ (299)
==================================================================================== =======================================
Amounts recognized in the balance sheet consist of:
Pension Benefits Other Benefits
------------------------ ---------------------------------------
December 31, 2007 2006 2007 2006
- ------------------------------------------------------------------------------------ ---------------------------------------
Non Current Assets $ 443 $ 358 $ - $ -
Non Current Liabilities $ 1,303 $ 1,052 $ 292 $ 299
Amounts recognized in the accumulated other comprehensive income consist of:
Pension Benefits Other Benefits
------------------------ ---------------------------------------
December 31, 2007 2006 2007 2006
- ------------------------------------------------------------------------------------ ---------------------------------------
Prior service costs $ 52 $ 52 $ 27 $ 34
Net actuarial loss (gain) 2,656 2,482 (45) (34)
Deferred taxes (921) (861) 6 -
- ------------------------------------------------------------------------------------ ---------------------------------------
Net amount recognized $ 1,787 $ 1,673 $ (12) $ -
- ------------------------------------------------------------------------------------ ---------------------------------------
The accumulated benefit obligation for all defined benefit pension plans was
$11,531 and $10,915 at December 31, 2007 and 2006, respectively.
Information for pension plans with an accumulated benefit obligation in excess
of plan assets is as follows:
Pension Benefits
-----------------------------
2007 2006
-----------------------------
Projected benefit obligation $ 14 $ -
Accumulated benefit obligation 4 -
Fair value of plan assets - -
37
Components of net periodic pension cost and other amounts recognized in other
comprehensive income:
Pension Benefits
----------------
Years Ended December 31, 2007 2006 2005
- ----------------------------------------------------------------------------------------------------
Components of net periodic pension cost:
Service cost $ 438 $ 436 $ 415
Interest cost 738 673 678
Expected return on plan assets (962) (890) (755)
Amortization of prior service cost 1 - -
Amortization of unrecognized net loss 141 166 114
- ----------------------------------------------------------------------------------------------------
Net periodic pension cost $ 356 $ 385 $ 452
- ----------------------------------------------------------------------------------------------------
Other changes in plan assets and benefit obligations recognized in other
comprehensive income:
Net loss $ 175 $ -
Deferred tax (60) -
FASB 158 recognition of deferred cost, net - 1,673
Reverse effect of additional minimum liability - (1,011)
- ----------------------------------------------------------------------------------------------------
Total recognized in other comprehensive
income 115 662
- ----------------------------------------------------------------------------------------------------
Total recognized in net period pension
cost and other comprehensive income $ 471 $ 1,047
- ----------------------------------------------------------------------------------------------------
Other Benefits
--------------
Years Ended December 31, 2007 2006 2005
- ----------------------------------------------------------------------------------------------------
Components of net periodic pension cost:
Service cost $ 5 $ 6 $ 6
Interest cost 18 17 16
Amortization of prior service cost 7 7 7
Amortization of unrecognized net gain - - -
- ----------------------------------------------------------------------------------------------------
Net periodic other benefit cost $ 30 $ 30 $ 29
- ----------------------------------------------------------------------------------------------------
Other changes in plan assets and benefit obligations
recognized in other comprehensive income:
Net gain $ (18) $ -
Deferred taxes 6 -
- ----------------------------------------------------------------------------------------------------
Total recognized in other comprehensive
income (12) -
- ----------------------------------------------------------------------------------------------------
Total recognized in net period pension
cost and other comprehensive income $ 18 $ 30
- ----------------------------------------------------------------------------------------------------
The estimated net loss and prior service cost for the defined benefit pension
plans that will be amortized from accumulated other comprehensive income into
net periodic benefit cost over the next fiscal year are $108 and ($1),
respectively. The estimated prior service cost for the other defined benefit
postretirement plan will be amortized from accumulated other comprehensive
income into net periodic benefit cost over the next fiscal year is $ 7.
38
Weighted-average assumptions used to determine benefit obligations were as
follows:
Pension Benefits Other Benefits
---------------- --------------
December 31, 2007 2006 2007 2006
- ---------------------------------------------------------------------------------------------------------------
Discount rate 6.00% 5.75%-6.00% 6.00% 6.00%
Expected long-term return on plan assets 8.50% 8.50% - -
Rate of compensation increase 3.50% 3.00% 3.50% 4.50%
The expected long-term return on plan assets was determined using average
historical returns of the Company's plan assets.
The Company's pension plan weighted-average asset allocations at December 31,
2007 and 2006, by asset category are as follows:
Plan Assets at December 31,
---------------------------
2007 2006
- ----------------------------------------------------------------
Asset Category
- --------------
Equity securities 56.7% 55.9%
Corporate bonds 21.3 20.1
U.S. Government securities 21.1 23.2
Cash and cash equivalents .9 .8
- ----------------------------------------------------------------
100.0% 100.0%
- ----------------------------------------------------------------
The Company investment policies and strategies include:
1.) The Trust and Investment Division's equity philosophy is Large-Cap Core with
a value bias. We invest in individual high-grade common stocks that are selected
from our approved list.
2.) Diversification is maintained by having no more than 20% in any industry
sector and no individual equity representing more than 10% of the portfolio.
3.) The fixed income style is conservative but also responsive to the various
needs of our individual clients. For our "Fixed Income" securities, we buy U.S.
Government bonds and Agencies or high-grade Corporate rated "A" or better. The
Company targets the following allocation percentages: cash equivalents 10%,
fixed income 40% and equities 50%.
There is no Company stock included in equity securities at December 31, 2007 or
2006.
Contributions
- -------------
The Company expects to contribute $ 290, to its pension plan and $14 to its
other postretirement plan in 2008.
Estimated Future Benefit Payments
- ---------------------------------
The following benefit payments, which reflect expected future service, as
appropriate, are expected to be paid in the next five years and in the aggregate
for the five years thereafter:
Pension Benefits Other Benefits
---------------- --------------
2008 $ 521 $ 14
2009 536 14
2010 572 15
2011 607 15
2012 694 17
2013-2017 4,458 96
39
NOTE 15 -- INCOME TAXES
The total income taxes in the Statements of Income are as follows:
Years Ended December 31, 2007 2006 2005
- --------------------------------------------------------------------------------
Currently payable $ 1,968 $ 1,849 $ 1,447
Deferred provision (benefit) (344) (254) 166
- --------------------------------------------------------------------------------
Total $ 1,624 $ 1,595 $ 1,613
- --------------------------------------------------------------------------------
A reconciliation of income taxes at statutory rates to applicable income taxes
reported in the Statements of Income is as follows:
Years Ended December 31, 2007 2006 2005
- --------------------------------------------------------------------------------
Tax at statutory rate $ 2,829 $ 2,585 $ 2,544
Reduction for non-taxable interest (1,301) (1,052) (1,012)
Other additions 96 62 81
- --------------------------------------------------------------------------------
Applicable Income Taxes $ 1,624 $ 1,595 $ 1,613
- --------------------------------------------------------------------------------
The components of the deferred income tax (benefit) provision, which result from
temporary differences, are as follows:
Years Ended December 31, 2007 2006 2005
- --------------------------------------------------------------------------------
Accretion of discount on bonds $ 18 $ (29) $ 18
Accelerated depreciation 21 13 (4)
Supplemental benefit plan - 51 (3)
Allowance for loan losses (192) (243) (165)
Prepaid pension cost (22) (46) 320
Accrued liabilities (169) - -
- --------------------------------------------------------------------------------
Total $ (344) $ (254) $ 166
- --------------------------------------------------------------------------------
The significant components of deferred tax assets and liabilities are as
follows:
December 31, 2007 2006
- --------------------------------------------------------------
Deferred tax assets:
Allowance for loan losses $ 1,598 $ 1,406
Accrued pension costs 443 358
Accumulated depreciation 288 309
Accrued liabilities 169 -
- --------------------------------------------------------------
Total Deferred Tax Assets 2,498 2,073
- --------------------------------------------------------------
Deferred tax liabilities:
Unrealized securities gains 492 522
Accumulated accretion 58 40
Post retirement gains 6 -
- --------------------------------------------------------------
Total Deferred Tax Liabilities 556 562
- --------------------------------------------------------------
Net Deferred Tax Assets $ 1,942 $ 1,511
- --------------------------------------------------------------
In management's opinion, the deferred tax assets are realizable in as much as
there is a history of strong earnings and a carryback potential greater than the
deferred tax assets. Management is not aware of any evidence that would preclude
the realization of the benefit in the future and, accordingly, has not
established a valuation allowance against the deferred tax assets.
40
NOTE 16 -- ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income was ($822), ($662) and ($648) at December
31, 2007, 2006 and 2005, respectively.
OTHER COMPREHENSIVE INCOME
Other comprehensive income (comprehensive income, excluding net income),
beginning with the 2005 period, includes two components, the change in
unrealized holding gains and losses on available for sale securities and the
change in the unfunded pension liability. The components of other comprehensive
income are reported net of related tax effects in the Consolidated Statements of
Changes in Stockholders' Equity.
In 2006, accumulated other comprehensive income includes the initial application
of FASB No. 158 to record the unrecognized components of net periodic pension
cost. As of 2007, changes in these components are shown in other comprehensive
income.
A reconciliation of other comprehensive income for the years ended December 31,
2007, 2006 and 2005 is as follows:
Tax
Before-Tax (Expense) Net-of-Tax
2007 Amount Benefit Amount
- ------------------------------------------------------------------------------------------------------------------
Unrealized losses on available-for-sale securities:
Unrealized losses arising during the year $ (38) $ 13 $ (25)
Less: Reclassification adjustment for gains realized in income 49 (17) 32
----------------------------------------------
Net unrealized losses (87) 30 (57)
Change in funded status of employee benefit plans (157) 54 (103)
- ------------------------------------------------------------------------------------------------------------------
Other Comprehensive Income $ (244) 84 (160)
==================================================================================================================
Tax
Before-Tax (Expense) Net-of-Tax
2006 Amount Benefit Amount
- ------------------------------------------------------------------------------------------------------------------
Unrealized gains on available-for-sale securities:
Unrealized gains arising during the year $ 1,302 $ (443) $ 859
Less: Reclassification adjustment for gains realized in income 319 (108) 211
---------------------------------------------
Net unrealized gains 983 (335) 648
Change in minimum pension liability 1,531 (520) 1,011
- ------------------------------------------------------------------------------------------------------------------
Other Comprehensive Income $ 2,514 $ (855) $ 1,659
==================================================================================================================
Tax
Before-Tax (Expense) Net-of-Tax
2005 Amount Benefit Amount
- ------------------------------------------------------------------------------------------------------------------
Unrealized losses on available-for-sale securities:
Unrealized losses arising during the year $ (531) $ 181 $ (350)
Less: Reclassification adjustment for losses realized in income (13) 4 (9)
---------------------------------------------
Net unrealized losses (518) 177 (341)
Change in minimum pension liability (1,531) 520 (1,011)
- ------------------------------------------------------------------------------------------------------------------
Other Comprehensive Income $ (2,049) $ 697 $ (1,352)
==================================================================================================================
NOTE 17 -- COMMITMENTS AND CONTINGENT LIABILITIES
In the normal course of business, there are outstanding commitments and
contingent liabilities, created under prevailing terms and collateral
requirements such as commitments to extend credit, financial guarantees and
letters of credit, which are not reflected in the accompanying Financial
41
Statements. The Company does not anticipate any losses as a result of these
transactions. These instruments involve, to varying degrees, elements of credit
and interest rate risk in excess of the amount recognized in the Balance Sheets.
The contract or notional amounts of those instruments reflect the extent of
involvement the Company has in particular classes of financial instruments.
Financial instruments whose contract amounts represent credit risk at December
31, 2007 and 2006 are as follows:
2007 2006
- --------------------------------------------------------------
Commitments to extend credit:
Fixed rate $ 40,105 $ 37,692
Variable rate $ 78,868 $ 74,577
Standby letters of credit $ 13,104 $ 15,061
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have expiration dates of one year or less or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Standby letters of credit are conditional commitments issued to guarantee the
performance of a customer to a third party. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending loan
facilities to customers.
Various actions and proceedings are presently pending to which the Company is a
party. Management is of the opinion that the aggregate liabilities, if any,
arising from such actions would not have a material adverse effect on the
financial position of the Company.
NOTE 18 -- FAIR VALUE DISCLOSURE
GENERAL
Statement of Financial Accounting Standards No.107, "DISCLOSURES ABOUT FAIR
VALUE OF FINANCIAL INSTRUMENTS" (SFAS 107), requires the disclosure of the
estimated fair value of on and off-balance sheet financial instruments.
VALUATION METHODS AND ASSUMPTIONS
Estimated fair values have been determined using the best available data, an
estimation methodology suitable for each category of financial instruments. For
those loans and deposits with floating interest rates it is presumed that
estimated fair values generally approximate the carrying amount balances.
Financial instruments actively traded in a secondary market have been valued
using quoted available market prices. Those with stated maturities have been
valued using a present value discounted cash flow with a discount rate
approximating current market for similar assets and liabilities. Those
liabilities with no stated maturities have an estimated fair value equal to both
the amount payable on demand and the carrying amount balance. The net loan
portfolio has been valued using a present value discounted cash flow. The
discount rate used in these calculations is the current loan rate adjusted for
non-interest operating costs, credit loss and assumed prepayment risk. Off
balance sheet carrying amounts and fair value of letters of credit represent the
deferred income fees arising from those unrecognized financial instruments.
Changes in assumptions or estimation methodologies may have a material effect on
these estimated fair values.
All assets and liabilities which are not considered financial instruments have
not been valued differently than has been customary with historical cost
accounting.
42
December 31, 2007 December 31, 2006
- -----------------------------------------------------------------------------------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
- -----------------------------------------------------------------------------------------------------------------------------
Financial Assets:
Cash and due from banks $ 10,677 $ 10,677 $ 12,999 $ 12,999
Interest bearing balances with banks 967 967 1,779 1,779
- -----------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents 11,644 11,644 14,778 14,778
Investment Securities:
Available-for-sale:
U.S. Agency obligations 30,636 30,636 54,123 54,123
States & political subdivisions 39,474 39,474 30,220 30,220
Federal Home Loan Bank stock 4,389 4,389 5,093 5,093
Other securities 2,829 2,829 2,269 2,269
Held-to-maturity:
U.S. Agency obligations 38,880 38,542 45,124 44,054
States & political subdivisions 29,240 30,949 29,251 31,066
- -----------------------------------------------------------------------------------------------------------------------------
Total investment securities 145,448 146,819 166,080 166,825
Loans, net of unearned income:
Real estate mortgages 344,295 346,052 308,037 307,508
Commercial 24,505 24,409 26,265 25,963
Consumer and other 35,839 35,758 35,620 35,492
Less: Allowance for loan losses 4,700 4,200
- -----------------------------------------------------------------------------------------------------------------------------
Loans, net 399,939 406,219 365,722 368,963
Cash surrender value of life insurance 7,368 7,368 7,054 7,054
- -----------------------------------------------------------------------------------------------------------------------------
Total Financial Assets 564,399 $ 572,050 553,634 $ 557,620
========= =========
Other assets 16,394 16,187
- -----------------------------------------------------------------------------------------------------------------------------
Total Assets $ 580,793 $ 569,821
- -----------------------------------------------------------------------------------------------------------------------------
Financial Liabilities:
Demand - Non-interest bearing $ 73,926 $ 73,926 $ 71,585 $ 71,585
Demand - Interest bearing 54,819 54,819 57,309 57,309
Savings 80,054 80,054 80,328 80,328
Money markets 103,924 103,924 85,720 85,720
Time 103,810 104,153 118,858 118,201
- -----------------------------------------------------------------------------------------------------------------------------
Total Deposits 416,533 416,876 413,800 413,143
Repurchase agreements 20,492 20,453 13,441 13,441
Short-term borrowings 13,201 13,201 5,486 5,486
Long-term borrowings 55,966 56,028 65,853 63,306
- -----------------------------------------------------------------------------------------------------------------------------
Total Financial Liabilities 506,192 $ 506,558 498,580 $ 495,376
========= =========
Other Liabilities 4,886 4,670
Stockholders' Equity 69,715 66,571
- -----------------------------------------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 580,793 $ 569,821
- -----------------------------------------------------------------------------------------------------------------------------
Standby Letters of Credit $ (131) $ (131) $ (151) $ (151)
43
NOTE 19 -- OPERATING LEASES
The Company leases the land upon which the Mount Pocono Office was built and the
land upon which a drive-up ATM was built on Meadow Avenue, Scranton. The Company
also leases space at several locations which are being used as remote banking
facilities. Rental expense was $83 in 2007, $90 in 2006 and $94 in 2005. All
leases contain renewal options. The Mount Pocono and the Meadow Avenue leases
contain the right of first refusal for the purchase of the properties and
provisions for annual rent adjustments based upon the Consumer Price Index.
Future minimum rental commitments under these leases at December 31, 2007 are as
follows:
Mount Meadow ATM
Pocono Avenue Sites Total
- -------------------------------------------------------------------------------------------
2008 $ 56 $ 23 $ 9 $ 88
2009 55 22 1 78
2010 55 22 - 77
2011 23 15 - 38
2012 and beyond - - - -
- -------------------------------------------------------------------------------------------
Total minimum payments required $ 189 $ 82 $ 10 $ 281
- -------------------------------------------------------------------------------------------
NOTE 20 -- LOANS TO DIRECTORS, PRINCIPAL OFFICERS AND RELATED PARTIES
The Company has had, and may be expected to have in the future, banking
transactions in the ordinary course of business with directors, principal
officers, their immediate families and affiliated companies in which they are
principal stockholders (commonly referred to as related parties), on the same
terms, including interest rates and collateral, as those prevailing at the time
for comparable transactions with others. A summary of loans to directors,
principal officers and related parties is as follows:
Years Ended December 31, 2007 2006
- ----------------------------------------------------------------
Beginning Balance $ 10,425 $ 10,490
Additions 3,694 1,042
Reclassifications (251) 8
Collections (2,831) (1,115)
- ----------------------------------------------------------------
Ending Balance $ 11,037 $ 10,425
- ----------------------------------------------------------------
In addition to the loan amounts shown above, the Bank has issued standby letters
of credit for the accounts of related parties in the amount of $8,093.
NOTE 21 -- REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital requirements
administered by the Federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory--and possibly additional
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on the Company and the Bank's Consolidated Financial Statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company and the Bank must meet specific capital
guidelines that involve quantitative measures of their assets, liabilities, and
certain off-balance sheet items as calculated under regulatory accounting
practices. The Company and the Bank's capital amounts and classifications are
also subject to qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the Capital Adequacy table on the following page) of Tier I and Total
Capital to risk-weighted assets and of Tier I Capital to average assets
(Leverage ratio). The table also presents the Company's actual capital amounts
and ratios. Management believes, as of December 31, 2007, that the Company and
the Bank meet all capital adequacy requirements to which they are subject.
As of December 31, 2007, the most recent notification from the Federal Deposit
Insurance Corporation (FDIC) categorized the Company as "well capitalized" under
the regulatory framework for prompt corrective action. To be categorized as
"well capitalized", the Company must maintain minimum Tier I Capital, Total
Capital and Leverage ratios as set forth in the Capital Adequacy table. There
are no conditions or events since that notification that management believes
have changed the Company's categorization by the FDIC.
44
The Company and Bank are also subject to minimum capital levels which could
limit the payment of dividends, although the Company and Bank currently have
capital levels which are in excess of minimum capital level ratios required.
The Pennsylvania Banking Code restricts capital funds available for payment of
dividends to the retained earnings of the Bank. Accordingly, at December 31,
2007, the balances in the capital stock and surplus accounts totaling $10,840
are unavailable for dividends.
In addition, the Bank is subject to restrictions imposed by Federal law on
certain transactions with the Company's affiliates. These transactions include
extensions of credit, purchases of or investments in stock issued by the
affiliate, purchases of assets subject to certain exceptions, acceptance of
securities issued by an affiliate as collateral for loans, and the issuance of
guarantees, acceptances, and letters of credit on behalf of affiliates. These
restrictions prevent the Company's affiliates from borrowing from the Bank
unless the loans are secured by obligations of designated amounts. Further, the
aggregate of such transactions by the Bank with a single affiliate is limited in
amount to 10 percent of the Bank's Capital Stock and Surplus, and the aggregate
of such transactions with all affiliates is limited to 20 percent of the Bank's
Capital Stock and Surplus. The Federal Reserve System has interpreted "Capital
Stock and Surplus" to include undivided profits.
ACTUAL REGULATORY REQUIREMENTS
---------------------------------------------------------------- ------------------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
----------------- ------------------
As of December 31, 2007 Amount Ratio Amount Ratio Amount Ratio
---------------------------------------------------------------------------------------------------------------------------
Total Capital (to Risk Weighted Assets)
PFSC (Company) $ 75,145 19.89% > $ 30,222 > 8.0% > $ 37,777 > 10.0%
- - - -
PSB (Bank) 71,840 19.11% > $ 30,080 > 8.0% > $ 37,601 > 10.0%
- - - -
Tier 1 Capital (to Risk Weighted Assets)
PFSC (Company) $ 70,445 18.65% > $ 15,111 > 4.0% > $ 22,666 > 6.0%
- - - -
PSB (Bank) $ 67,140 17.86% > $ 15,040 > 4.0% > $ 22,561 > 6.0%
- - - -
Tier 1 Capital (to Average Assets)
PFSC (Company) $ 70,445 12.11% > $ * > * > $ 29,081 > 5.0%
- - - -
PSB (Bank) $ 67,140 11.62% > $ * > * > $ 28,900 > 5.0%
- - - -
PFSC - *3.0% ($17,449), 4.0% ($23,265) or 5.0% ($29,081) depending on the bank's CAMELS Rating and other regulatory risk
factors.
PSB - *3.0% ($17,340), 4.0% ($23,120) or 5.0% ($28,900) depending on the bank's CAMELS Rating and other regulatory risk factors.
For Capital To Be
Adequacy Purposes "Well Capitalized"
----------------- ------------------
As of December 31, 2006 Amount Ratio Amount Ratio Amount Ratio
---------------------------------------------------------------------------------------------------------------------------
Total Capital (to Risk Weighted Assets)
PFSC (Company) $ 71,235 19.65% > $ 28,998 > 8.0% > $ 36,248 > 10.0%
- - - -
PSB (Bank) $ 68,029 18.84% > $ 28,882 > 8.0% > $ 36,103 > 10.0%
- - - -
Tier 1 Capital (to Risk Weighted Assets)
PFSC (Company) $ 67,035 18.49% > $ 14,499 > 4.0% > $ 21,749 > 6.0%
- - - -
PSB (Bank) $ 63,829 17.68% > $ 14,441 > 4.0% > $ 21,662 > 6.0%
- - - -
Tier 1 Capital (to Average Assets)
PFSC (Company) $ 67,035 11.93% > $ * > * > $ 28,105 > 5.0%
- - - -
PSB (Bank) $ 63,829 11.36% > $ * > * > $ 28,083 > 5.0%
- - - -
PFSC - *3.0% ($16,863), 4.0% ($22,484) or 5.0% ($28,105) depending on the bank's CAMELS Rating and other regulatory risk
factors.
PSB - *3.0% ($16,850), 4.0% ($22,466) or 5.0% ($28,083) depending on the bank's CAMELS Rating and other regulatory risk factors.
45
NOTE 22 -- PENSECO FINANCIAL SERVICES CORPORATION (PARENT CORPORATION)
The condensed Company-only information follows:
BALANCE SHEETS
DECEMBER 31, 2007 2006
- ---------------------------------------------------------------------
Cash $ 5 $ 1
Interest bearing balances with banks 920 1,554
- ---------------------------------------------------------------------
Cash and Cash Equivalents 925 1,555
Investment in bank subsidiary 66,141 62,970
Equity investments 2,809 2,249
- ---------------------------------------------------------------------
TOTAL ASSETS $ 69,875 $ 66,774
- ---------------------------------------------------------------------
TOTAL LIABILITIES $ 160 $ 203
TOTAL STOCKHOLDERS' EQUITY 69,715 66,571
- ---------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 69,875 $ 66,774
- ---------------------------------------------------------------------
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2007 2006 2005
- --------------------------------------------------------------------------------------------------------------
Dividends from bank subsidiary $ 3,394 $ 3,222 $ 5,594
Dividends on investment securities 99 106 45
Interest on balances with banks 40 5 3
Gain on sale of equities 49 319 -
- --------------------------------------------------------------------------------------------------------------
Total income 3,582 3,652 5,642
Other non-interest expense 88 21 10
- --------------------------------------------------------------------------------------------------------------
Net income before undistributed earnings of bank subsidiary 3,494 3,631 5,632
Undistributed earnings of bank subsidiary 3,204 2,377 237
- --------------------------------------------------------------------------------------------------------------
NET INCOME $ 6,698 $ 6,008 $ 5,869
- --------------------------------------------------------------------------------------------------------------
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2007 2006 2005
- --------------------------------------------------------------------------------------------------------------
Operating Activities:
Net income $ 6,698 $ 6,008 $ 5,869
Adjustments to reconcile net income to net cash
provided by operating activities:
Gain on sale of equities (49) (319) -
Equity in undistributed net income of bank subsidiary (3,204) (2,377) (237)
Increase in other liabilities 23 - -
- --------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 3,468 3,312 5,632
- --------------------------------------------------------------------------------------------------------------
Investing Activities:
Purchase of equity investments (1,055) (160) (2,465)
Proceeds from sales of equity securities 351 1,544 -
- --------------------------------------------------------------------------------------------------------------
NET CASH (USED) PROVIDED BY INVESTING ACTIVITIES (704) 1,384 (2,465)
- --------------------------------------------------------------------------------------------------------------
Financing Activities:
Cash dividends paid (3,394) (3,222) (3,094)
- --------------------------------------------------------------------------------------------------------------
NET CASH USED BY FINANCING ACTIVITIES (3,394) (3,222) (3,094)
- --------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (630) 1,474 73
Cash and cash equivalents at January 1 1,555 81 8
- --------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT DECEMBER 31 $ 925 $ 1,555 $ 81
- --------------------------------------------------------------------------------------------------------------
46
NOTE 23 -- SUBSEQUENT EVENTS
Subsequent to the Balance Sheet date, the Company purchased $25 million, 5%
mortgage-backed securities using the proceeds from a series of long-term
borrowings from the FHLB. The securities are expected to yield 5.16% based on
average life expectancy for similar securities. The borrowings have maturities
and rates ranging from 1 to 7 years and 2.61%-3.44%, respectively.
The transaction resulted in increases in the total assets and total liabilities
of the Company from December 31, 2007 of approximately 4.3% and 4.9%,
respectively.
The Company also awarded an additional 8,500 SARS to the President and CEO. The
SARS have a straight-line vesting period of 5 years and a strike price of $37.50
per share.
NOTE 24 -- SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
First Second Third Fourth
2007 Quarter Quarter Quarter Quarter
- ---------------------------------------------------------------------------------------------------------------
Net Interest Income $ 5,245 $ 5,342 $ 5,530 $ 5,473
Provision for Loan Losses 96 124 308 129
Other Income 2,096 1,980 2,663 1,981
Other Expenses and Taxes 5,575 5,498 5,704 6,178
Net Income 1,670 1,700 2,181 1,147
Earnings Per Share $ .78 $ .79 $ 1.01 $ .54
First Second Third Fourth
2006 Quarter Quarter Quarter Quarter
- ---------------------------------------------------------------------------------------------------------------
Net Interest Income $ 5,171 $ 5,212 $ 5,214 $ 5,271
Provision for Loan Losses 127 27 143 136
Other Income 2,038 1,655 2,452 2,060
Other Expenses and Taxes 5,508 5,279 5,650 6,195
Net Income 1,574 1,561 1,873 1,000
Earnings Per Share $ .73 $ .73 $ .87 $ .47
47
MMQ
Francis J. Merkel, CPA
Joseph J. Quinn, CPA/ABV, CVA
Daniel J. Gerrity, CPA
Mary Ann E. Novak, CPA
McGrail Merkel Quinn & Associates
CERTIFIED PUBLIC ACCOUNTANTS & CONSULTANTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Penseco Financial Services Corporation
We have audited the consolidated balance sheets of Penseco Financial
Services Corporation and subsidiary as of December 31, 2007 and 2006, and
the related consolidated statements of income, stockholders' equity and
cash flows for each of the three years in the period ended December 31,
2007. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Penseco
Financial Services Corporation and subsidiary as of December 31, 2007 and
2006, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 2007, in conformity with
U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), Penseco Financial
Services Corporation and subsidiary's internal control over financial
reporting as of December 31, 2007, based on criteria established in
Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) and our report
dated February 29, 2008 expressed an unqualified opinion on the
effectiveness of Penseco Financial Services Corporation and subsidiary's
internal control over financial reporting.
/s/ McGrail Merkel Quinn & Associates
Scranton, Pennsylvania
February 29, 2008
RSM McGladrey Network
An Independently Owned Member
Clay Avenue Professional Plaza, 1173 Clay Avenue, Scranton, PA 18510
570 961-0345 Fax: 570 961-8650
www.mmq.com
48
MMQ
Francis J. Merkel, CPA
Joseph J. Quinn, CPA/ABV, CVA
Daniel J. Gerrity, CPA
Mary Ann E. Novak, CPA
McGrail Merkel Quinn & Associates
CERTIFIED PUBLIC ACCOUNTANTS & CONSULTANTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Penseco Financial Services Corporation
We have audited Penseco Financial Services Corporation and subsidiary's internal
control over financial reporting as of December 31, 2007, based on criteria
established in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Penseco Financial
Services Corporation and subsidiary's management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting included in the
accompanying Management's Report on Internal Control Over Financial Reporting.
Our responsibility is to express an opinion on the company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, and
testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk. Our audit also included performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
RSM McGladrey Network
An Independently Owned Member
Clay Avenue Professional Plaza, 1173 Clay Avenue, Scranton, PA 18510
570 961-0345 Fax: 570 961-8650
www.mmq.com
49
In our opinion, Penseco Financial Services Corporation and subsidiary
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2007, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial
statements of Penseco Financial Services Corporation and subsidiary and our
report dated February 29, 2008 expressed an unqualified opinion.
/s/ McGrail Merkel Quinn & Associates
Scranton, Pennsylvania
February 29, 2008
50
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There were no changes in or disagreements with accountants on matters of
accounting principles or practices or financial statement disclosures in 2007 or
2006.
ITEM 9A CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including
our Chief Executive Officer and Controller, we conducted an evaluation of our
disclosure controls and procedures, as such term is defined under Rule 13a-15(e)
under the Securities Exchange Act of 1934. Based upon this evaluation, our Chief
Executive Officer and our Controller concluded that our disclosure controls and
procedures were effective as of the end of the period covered by this annual
report. Management's annual report on internal control over financial reporting
is included below.
The Company continually assesses the adequacy of its internal control over
financial reporting and enhances its controls in response to internal control
assessments, and internal and external audit and regulatory recommendations. No
change in internal control over financial reporting during the quarter ended
December 31, 2007, or through the date of this Annual Report on Form 10-K, have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
Management maintains a comprehensive system of controls intended to ensure that
transactions are executed in accordance with management's authorization, assets
are safeguarded, and financial records are reliable. Management also takes steps
to see that information and communication flows are effective and to monitor
performance, including performance of internal control procedures.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate due to changes in conditions, or that the degree of compliance with
the policies or procedures may deteriorate.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Penseco Financial Services Corporation is responsible for
establishing and maintaining adequate internal control over financial reporting.
Penseco Financial Services Corporation's internal control system over financial
reporting was designed to provide reasonable assurance to the Company's
management and Board of Directors regarding the preparation and fair
presentation of published financial statements in accordance with U.S. generally
accepted accounting principles. All internal control systems, no matter how well
designed, have inherent limitations. Therefore, even those systems determined to
be effective can provide only reasonable assurance with respect to financial
statement preparation and presentation.
The Company's management, under the supervision and with the participation of
the Company's Chief Executive Officer and Controller, has evaluated the
effectiveness of the Company's internal control over financial reporting as of
December 31, 2007 based on the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Controls-Integrated
Framework. Based on this assessment, management believes that, as of December
31, 2007, the Company's internal control over financial reporting is effective.
The effectiveness of the Company's internal control over financial reporting as
of December 31, 2007 has been audited by McGrail, Merkel, Quinn & Associates, an
independent registered public accounting firm, as stated in their report
appearing on page 49.
ITEM 9B OTHER INFORMATION
None
51
PART III
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Code of Ethics
--------------
The Company has a Code of Ethics applicable to all employees including the
Company's principal Executive Officer and principal Financial Officer
(Controller). The purpose of the Code is to promote honest and ethical conduct,
full and fair disclosures of financial information, compliance with laws and
regulations and accountability for actions.
A copy of the Code of Ethics may be obtained, without charge, on the web site or
by contacting:
Patrick Scanlon, Senior Vice President, Controller
Penseco Financial Services Corporation
150 North Washington Avenue
Scranton, PA 18503-1848
1-800-327-0394
AUDIT COMMITTEE FINANCIAL EXPERT
--------------------------------
The Sarbanes-Oxley Act of 2002 requires the Company to disclose whether or not
its Audit Committee has, as one of its members, an "Audit Committee Financial
Expert", as that term is defined by the U.S. Securities and Exchange Commission
(SEC).
The Board of Directors has determined that the Audit Committee does not have an
"audit committee financial expert" as that term is defined in the Securities and
Exchange Commission's rules and regulations. However, the Board believes that
each of the members of the Audit Committee has demonstrated that he is capable
of analyzing and evaluating the Company's financial statements and understanding
internal controls and procedures for financial reporting. Because the Board
believes that the current members of the Audit Committee are qualified to carry
out all of the duties and responsibilities of the Company's Audit Committee, the
Board does not believe that it is necessary at this time to actively search for
an outside person to serve on the Board who would qualify as an audit committee
financial expert.
Other information required by this Item as to Directors of the Company contained
under the headings "Voting Securities & Principal Holders Thereof", "Election of
Directors", "Board and Committee Meetings" and "Certain Relationships and
Related Transactions" within the definitive proxy statement relating to the
Company's Annual Meeting of Shareholders, to be held May 6, 2008, is
incorporated herein by reference thereto.
ITEM 11 EXECUTIVE COMPENSATION
The information contained under the headings "Executive Compensation",
"Directors Compensation", "Compensation Discussion and Analysis", "Compensation
Committee Report on Executive Compensation" and "Compensation Committee
Interlocks and Insider Participation" in the definitive proxy statement relating
to the Company's Annual Meeting of stockholders, to be held May 6, 2008, is
incorporated herein by reference thereto.
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information contained under the heading "Voting Securities & Principal
Holders Thereof" in the definitive proxy statement relating to the Company's
Annual Meeting of stockholders, to be held May 6, 2008, is incorporated herein
by reference thereto.
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information contained under the heading "Certain Relationships, Related
Transactions" and "Transactions with Directors and Principal Officers" in the
definitive proxy statement relating to the Company's Annual Meeting of
stockholders, to be held May 6, 2008 is incorporated herein by reference
thereto.
52
ITEM 14 PRINCIPAL ACCOUNTING FEES AND SERVICES
The information contained under the heading "Our Relationship with Our Auditors"
in the definitive proxy statement relating to the Company's Annual Meeting of
stockholders, to be held May 6, 2008 is incorporated herein by reference
thereto.
PART IV
ITEM 15 EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1) Financial Statements - The following financial statements are incorporated by reference in Part II, Item 8 hereof:
Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
General Notes to Financial Statements
Report of Independent Registered Public Accounting Firm
(2) Financial Statement Schedules - The Financial Statement Schedules are incorporated by reference in Part II, Item 8 hereof.
(3) Exhibits
The following exhibits are filed herewith or incorporated by reference as part of this Annual Report.
3(i) Articles of Incorporation (Incorporated herein by reference to Exhibit 3(i) of Registrant's report on Form 10-K
filed with the SEC on March 30, 1998.)
3(ii) By-Laws (Incorporated herein by reference to Exhibit 3(ii) of Registrant's report on Form 10-K filed with the SEC
on March 16, 2006.)
10 Material contracts (Incorporated herein by reference to Exhibit 10 of Registrant's report on Form 10-K filed with
the SEC on March 16, 2006.)
14 Code of Ethics (Incorporated herein by reference to Exhibit 10 of Registrant's report on Form 10-K filed with the
SEC on March 16, 2006.)
21 Subsidiaries of the registrant (Incorporated herein by reference to Exhibit 21 of Registrant's report on Form 10-K
filed with the SEC on March 30, 1998.)
31 Certifications required under Section 302 of the Sarbanes-Oxley Act 2002
32 Certifications required under Section 906 of the Sarbanes-Oxley Act of 2002
(b) A Form 8-K was filed during the fourth quarter of the fiscal year ended December 31, 2007.
(c) The exhibits required to be filed by this Item are listed under Item 15(a)(3), above.
(d) There are no financial statement schedules required to be filed under this item.
53
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Bank has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized on March 5, 2008.
By: /s/ Craig W. Best
--------------------------------------------------
Craig W. Best
President and CEO
By: /s/ Richard E. Grimm
--------------------------------------------------
Richard E. Grimm
Executive Vice-President
By: /s/ Patrick Scanlon
--------------------------------------------------
Patrick Scanlon
Senior Vice President, Controller
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on March 5, 2008.
By: /s/ Craig W. Best By: /s/ Robert W. Naismith, Ph. D.
- -------------------------------------------------- --------------------------------------------------
Craig W. Best Robert W. Naismith, Ph. D.
President and CEO Director
By: /s/ Edwin J. Butler By: /s/ James B. Nicholas
- -------------------------------------------------- --------------------------------------------------
Edwin J. Butler James B. Nicholas
Director Director
By: /s/ Richard E. Grimm By: /s/ Emily S. Perry
- -------------------------------------------------- --------------------------------------------------
Richard E. Grimm Emily S. Perry
Director Director
By: /s/ Russell C. Hazelton By: /s/ Sandra C. Phillips
- -------------------------------------------------- --------------------------------------------------
Russell C. Hazelton Sandra C. Phillips
Director Director
By: /s/ D. William Hume By: /s/ Otto P. Robinson, Jr.
- -------------------------------------------------- --------------------------------------------------
D. William Hume Otto P. Robinson, Jr.
Director, Chairman of The Board Director
By: /s/ James G. Keisling By: /s/ Steven L. Weinberger
- -------------------------------------------------- --------------------------------------------------
James G. Keisling Steven L. Weinberger
Director Director
By: /s/ P. Frank Kozik
- --------------------------------------------------
P. Frank Kozik
Director
54