<Page>1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------
FORM 10-Q
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/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2008
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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Commission file number 000-23777
PENSECO FINANCIAL SERVICES CORPORATION
Incorporated pursuant to the laws of Pennsylvania
------------------
Internal Revenue Service -- Employer Identification No. 23-2939222
150 North Washington Avenue, Scranton, Pennsylvania 18503-1848
(570) 346-7741
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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 checkmark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions 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 /_/
Smaller reporting company /_/
(Do not check if a smaller reporting company)
Indicate by checkmark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes /_/ No /X/|
The total number of shares of the registrant's Common Stock, $0.01 par value,
outstanding on April 25, 2008 was 2,148,000.
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PENSECO FINANCIAL SERVICES CORPORATION
Page
PART I -- FINANCIAL INFORMATION
Item 1. Unaudited Financial Statements - Consolidated
Balance Sheets:
March 31, 2008............................................ 3
December 31, 2007......................................... 3
Statements of Income:
Three Months Ended March 31, 2008......................... 4
Three Months Ended March 31, 2007......................... 4
Statements of Cash Flows:
Three Months Ended March 31, 2008........................ 5
Three Months Ended March 31, 2007........................ 5
Notes to Unaudited Consolidated Financial Statements........ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk..... 23
Item 4. Controls and Procedures........................................ 23
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings............................................. 24
Item 1A. Risk Factors.................................................. 24
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds... 26
Item 3. Defaults Upon Senior Securities............................... 26
Item 4. Submission of Matters to a Vote of Security Holders........... 26
Item 5. Other Information............................................. 26
Item 6. Exhibits...................................................... 26
Signatures................................................................. 27
<Page>3
PART I. FINANCIAL INFORMATION, ITEM 1 -- FINANCIAL STATEMENTS
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<Table>
<Caption>
March 31, December 31,
2008 2007
-------- -----------
ASSETS
Cash and due from banks $ 21,095 $ 10,677
Interest bearing balances with banks 6,345 967
Federal funds sold - -
-------- --------
Cash and Cash Equivalents 27,440 11,644
Investment securities:
Available-for-sale, at fair value 96,888 77,328
Held-to-maturity (fair value of $68,662
and $69,491, respectively) 66,623 68,120
-------- --------
Total Investment Securities 163,511 145,448
Loans, net of unearned income 408,975 404,639
Less: Allowance for loan losses 4,925 4,700
-------- --------
Loans, Net 404,050 399,939
Bank premises and equipment 9,200 9,323
Other real estate owned - -
Accrued interest receivable 3,335 3,558
Cash surrender value of life insurance 7,446 7,368
Other assets 3,107 3,513
-------- --------
Total Assets $ 618,089 $580,793
======== ========
LIABILITIES
Deposits:
Non-interest bearing $ 78,668 $ 73,926
Interest bearing 342,646 342,607
-------- --------
Total Deposits 421,314 416,533
Other borrowed funds:
Repurchase agreements 40,520 20,492
Short-term borrowings 203 13,201
Long-term borrowings 79,310 55,966
Accrued interest payable 1,550 1,498
Other liabilities 2,995 3,388
-------- --------
Total Liabilities 545,892 511,078
-------- --------
STOCKHOLDERS' EQUITY
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 61,773 59,697
Accumulated other comprehensive income (416) (822)
-------- --------
Total Stockholders' Equity 72,197 69,715
-------- --------
Total Liabilities and Stockholders' Equity $618,089 $580,793
======== ========
</Table>
(See accompanying Notes to Unaudited Consolidated Financial Statements)
<Page>4
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<Table>
<Caption>
Three Months Three Months
Ended Ended
March 31, 2008 March 31, 2007
----------------- -----------------
INTEREST INCOME
Interest and fees on loans $ 6,661 $ 6,293
Interest and dividends on investments:
U.S. Treasury securities and U.S.
Agency obligations 905 1,011
States & political subdivisions 836 721
Other securities 74 141
Interest on Federal funds sold - 85
Interest on balances with banks 11 91
------------- -------------
Total Interest Income 8,487 8,342
------------- -------------
INTEREST EXPENSE
Interest on time deposits of $100,000
or more 451 509
Interest on other deposits 1,533 1,812
Interest on other borrowed funds 926 776
------------- -------------
Total Interest Expense 2,910 3,097
------------- -------------
Net Interest Income 5,577 5,245
Provision for loan losses 235 96
------------- -------------
Net Interest Income After Provision
for Loan Losses 5,342 5,149
------------- -------------
OTHER INCOME
Trust department income 365 372
Service charges on deposit accounts 263 251
Merchant transaction income 1,184 1,047
Other fee income 479 281
Bank-owned life insurance income 78 78
Other operating income 36 16
VISA mandatory share redemption 1,213 -
Realized gains (losses) on securities, net - 51
------------- -------------
Total Other Income 3,618 2,096
------------- -------------
OTHER EXPENSES
Salaries and employee benefits 2,415 2,375
Expense of premises and fixed assets 768 625
Merchant transaction expenses 902 824
Other operating expenses 973 1,408
------------- -------------
Total Other Expenses 5,058 5,232
------------- -------------
Income before income taxes 3,902 2,013
Applicable income taxes 945 343
------------- -------------
Net Income 2,957 1,670
Other comprehensive income, net of taxes:
Unrealized securities gains (losses) 406 22
------------- -------------
Comprehensive Income $ 3,363 $ 1,692
============= =============
Earnings per Common Share
(Based on 2,148,000 shares
outstanding) $ 1.38 $ 0.78
Cash Dividends Declared Per Common Share $ 0.41 $ 0.37
</Table>
(See accompanying Notes to Unaudited Consolidated Financial Statements)
<Page>5
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<Table>
<Caption>
Three Months Three Months
Ended Ended
March 31, 2008 March 31, 2007
----------------- -----------------
OPERATING ACTIVITIES
Net Income $ 2,957 $ 1,670
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation 214 194
Provision for loan losses 225 96
Deferred income tax provision (benefit) 6 2
Amortization of securities, (net of accretion) 79 112
Gain on VISA mandatory share redemption (1,213) -
Net realized (gains) losses on securities - (51)
(Gain) loss on other real estate - -
Decrease (increase) in interest receivable 223 318
(Increase) decrease in cash surrender value of life
insurance (78) (78)
Decrease (increase) in other assets 400 (311)
Increase (decrease) in income taxes payable 605 341
Increase (decrease) in interest payable 52 184
(Decrease) increase in other liabilities (1,208) 150
----------------- -----------------
Net cash (used) provided by operating activities 2,262 2,627
----------------- -----------------
INVESTING ACTIVITIES
Purchase of investment securities available-for-sale (27,214) (10,823)
Proceeds from sales and maturities of investment
securities available-for-sale 6,451 12,617
Purchase of investment securities to be
held-to-maturity - -
Proceeds from repayments of investment securities
available-for-sale 3,036 2,754
Proceeds from repayments of investment securities
held-to-maturity 1,414 1,505
Net loans (originated) repaid (4,336) (4,719)
Proceeds from other real estate - -
Investment in premises and equipment (91) (558)
----------------- -----------------
Net cash (used) provided by investing activities (20,740) 776
----------------- -----------------
FINANCING ACTIVITIES
Net increase (decrease) in demand and savings
deposits 1,407 2,134
Net proceeds (payments) on time deposits 3,374 8,654
Increase (decrease) in federal funds purchased - -
Increase (decrease) in repurchase agreements 20,028 7,982
Net (decrease) increase in short-term borrowings (12,998) (5,004)
Increase in long-term borrowings 26,000 -
Repayments of long-term borrowings (2,656) (2,439)
Cash dividends paid (881) (795)
----------------- -----------------
Net cash provided (used) by financing activities 34,274 10,532
----------------- -----------------
Net increase (decrease) in cash and cash
equivalents 15,796 13,935
Cash and cash equivalents at January 1 11,644 14,778
----------------- -----------------
Cash and cash equivalents at March 31 $ 27,440 $ 28,713
================= =================
</Table>
The Company paid interest and income taxes of $2,858 and $172 and $2,913 and $0,
for the three month period ended March 31, 2008 and 2007, respectively.
(See accompanying Notes to Unaudited Consolidated Financial Statements)
<Page>6
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE QUARTER ENDED MARCH 31, 2008
(UNAUDITED)
These Notes to Unaudited Consolidated Financial Statements reflect events
subsequent to December 31, 2007, the date of the most recent Report of
Independent Registered Public Accounting Firm, through the date of this
Quarterly Report on Form 10-Q. These Notes to Unaudited Consolidated Financial
Statements should be read in conjunction with Parts I and II of this Report, in
particular, (1) Part I, Item 2, Management's Discussion and Analysis of
Financial Condition and Results of Operations for the three months ended March
31, 2008 and March 31, 2007, with respect to the Company's net interest income,
capital requirements and liquidity, (2) Part II, Item 6, Exhibits and (3) the
Company's Annual Report on Form 10-K for the year ended December 31, 2007, which
was filed with the Securities and Exchange Commission on March 17, 2008 and is
incorporated herein by reference.
FORWARD LOOKING INFORMATION
This Quarterly Report on Form 10-Q 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 1A
to this Quarterly Report on Form 10-Q titled "Risk Factors".
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 Quarterly Report
to "Company," "we," "us" and "our" refer to Penseco Financial Services
Corporation and its subsidiary.
NOTE 1 -- PRINCIPLES OF CONSOLIDATION
Penseco Financial Services Corporation is a financial holding company
incorporated under the laws of Pennsylvania. It is the parent company of Penn
Security Bank and Trust Company (Bank), a Pennsylvania state chartered bank.
Intercompany transactions have been eliminated in preparing the consolidated
financial statements.
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.
NOTE 2 -- BASIS OF PRESENTATION
The unaudited consolidated financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information.
In the opinion of management, all adjustments that are of a normal recurring
nature and are considered necessary for a fair presentation have been included.
They are not, however, necessarily indicative of the results of consolidated
operations for a full year.
All information is presented in thousands of dollars, except per share amounts.
For further information, refer to the consolidated financial statements and
accompanying notes included in the Company's Annual Report on Form 10-K for the
year ended December 31, 2007.
<Page>7
NOTE 3 -- 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.
NOTE 4 -- 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.
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.
Realized 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. Unrealized gains
and losses are included as a separate item in computing comprehensive income.
The amortized cost and fair value of investment securities at March 31, 2008 and
December 31, 2007 are as follows:
AVAILABLE-FOR-SALE
<Table>
<Caption>
Gross Gross
Amortized Unrealized Unrealized Fair
March 31, 2008 Cost Gains Losses Value
- ---------------------------------------------------------------------------------------
U.S. Agency securities $ 9,986 $ 276 $ - $ 10,262
Mortgage-backed securities 37,150 229 - 37,379
States & political subdivisions 39,894 1,205 8 41,091
- ---------------------------------------------------------------------------------------
Total Debt Securities 87,030 1,710 8 88,732
Equity securities 7,798 928 570 8,156
- ---------------------------------------------------------------------------------------
Total Available-for-Sale $ 94,828 $ 2,638 $ 578 $ 96,888
- ---------------------------------------------------------------------------------------
</Table>
AVAILABLE-FOR-SALE
<Table>
<Caption>
Gross Gross
Amortized Unrealized Unrealized Fair
March 31, 2008 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
- ---------------------------------------------------------------------------------------
</Table>
<Page>8
HELD-TO-MATURITY
<Table>
<Caption>
Gross Gross
Amortized Unrealized Unrealized Fair
March 31, 2008 Cost Gains Losses Value
- ---------------------------------------------------------------------------------------
Mortgage-backed securities $ 37,385 $ 230 $ 1 $ 37,614
States & political subdivisions 29,238 1,810 - 31,048
- ---------------------------------------------------------------------------------------
Total Held-to-Maturity $ 66,623 $ 2,040 $ 1 $ 68,662
- ---------------------------------------------------------------------------------------
</Table>
HELD-TO-MATURITY
<Table>
<Caption>
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 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
- ---------------------------------------------------------------------------------------
</Table>
The amortized cost and fair value of debt securities at March 31, 2008 by
contractual maturity are shown below. 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.
<Table>
<Caption>
March 31, 2008 Available-for-Sale Held-to-Maturity
- -------------------------------------------------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
- -------------------------------------------------------------------------------------------------
Due in one year or less:
U.S. Agency securities $ 4,980 $ 5,050 $ - $ -
After one year through five years:
U.S. Agency securities 5,006 5,212 - -
After five year through ten years:
States & political subdivisions 460 491 1,795 1,901
After ten years:
States & political subdivisions 39,434 40,600 27,443 29,147
- -------------------------------------------------------------------------------------------------
Subtotal 49,880 51,353 29,238 31,048
Mortgage-backed securities 37,150 37,379 37,385 37,614
- -------------------------------------------------------------------------------------------------
Total Debt Securities 87,030 88,732 66,623 68,662
- -------------------------------------------------------------------------------------------------
</Table>
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 March 31, 2008 and
December 31, 2007 are as follows:
<Table>
<Caption>
Less than twelve Twelve months or
months more Totals
--------------------- --------------------- ---------------------
Fair Unrealized Fair Unrealized Fair Unrealized
March 31, 2008 Value Losses Value Losses Value Losses
- ---------------------------------------------------------- --------------------- ---------------------
Mortgage-backed securities $ 242 $ 1 $ - $ - $ 242 $ 1
States & political subdivisions 1,637 8 - - 1,637 8
Equities 217 119 1,144 451 1,361 570
--------------------- --------------------- ---------------------
Total $ 2,096 $ 128 $ 1,144 $ 451 $ 3,240 $ 579
===================== ===================== =====================
</Table>
The table above at March 31, 2008, includes thirteen (13) securities that have
unrealized losses for less than twelve months and eleven (11) securities that
have been in an unrealized loss position for twelve or more months.
<Page>9
<Table>
<Caption>
Less than twelve Twelve months or
months more Totals
--------------------- --------------------- ---------------------
Fair Unrealized Fair Unrealized Fair Unrealized
December 31, 2008 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
===================== ===================== =====================
</Table>
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 March 31, 2008.
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 a recovery of fair value, which may be maturity, the Company
does not consider these investments to be other-than-temporarily impaired at
March 31, 2008.
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 March 31, 2008.
NOTE 5 -- LOAN PORTFOLIO
Details regarding the Company's loan portfolio:
<Table>
<Caption>
March 31, December 31,
As of: 2008 2007
- --------------------------------------------------------------------------------
Real estate - construction and land development $ 22,545 $ 25,858
Real estate mortgages 326,017 318,437
Commercial 23,837 24,505
Credit card and related plans 3,113 3,324
Installment and other 27,611 26,542
Obligations of states & political subdivisions 5,852 5,973
- --------------------------------------------------------------------------------
Loans, net of unearned income 408,975 404,639
Less: Allowance for loan losses 4,925 4,700
- --------------------------------------------------------------------------------
Loans, net $404,050 $399,939
- --------------------------------------------------------------------------------
</Table>
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.
<Page>10
NOTE 6 -- 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 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.
NOTE 7 -- LONG-TERM DEBT
A summary of the long-term debt at March 31, 2008 is as follows:
<Table>
<Caption>
Monthly Fixed Maturity
Installment Rate Date Balance
--------------------------------------------------------
Amortizing loans
$ 253 3.22% 08/30/10 $ 5,872
90 3.10% 02/28/13 4,923
430 3.74% 03/13/13 23,501
13 3.48% 03/31/15 1,000
67 3.44% 03/02/15 4,947
186 4.69% 03/13/23 24,067
--------------------------------------------------------
Total amortizing 64,310
--------------------------------------------------------
Non-amortizing loans
2.61% 03/02/09 1,000
2.62% 08/31/09 1,000
2.61% 03/01/10 1,000
3.48% 03/15/10 1,000
2.88% 02/28/11 2,000
3.27% 02/29/12 2,000
3.485% 02/28/13 7,000
--------------------------------------------------------
Total non-amortizing 15,000
--------------------------------------------------------
Total long term debt $79,310
--------------------------------------------------------
</Table>
The loans are secured by a general collateral pledge of the Company.
The Company has agreed to maintain sufficient qualifying collateral to fully
secure the above borrowings.
Aggregate maturities of long-term debt at March 31, 2008 are as follows:
<Table>
<Caption>
March 31, Principal
----------- ------------
2009 $ 11,091
2010 12,463
2011 10,768
2012 10,066
2013 15,287
Thereafter 19,635
------------
$ 79,031
============
</Table>
<Page>11>
NOTE 8 -- EMPLOYEE BENEFIT PLANS
The Company provides a defined benefit pension plan for eligible employees.
The components of the net periodic benefit costs are as follows:
<Table>
<Caption>
Pension Benefits Other Benefits
--------------------- --------------------
Three months ended March 31, 2008 2007 2008 2007
- ---------------------------------------------------------------------------------
Service cost $ 101 $ 109 $ 1 $ 1
Interest cost 204 185 5 4
Expected return on plan assets (255) (241) - -
Amortization of prior service cost - - 2 2
Amortization of net loss (gain) 35 36 - -
- ---------------------------------------------------------------------------------
Net periodic pension cost $ 85 $ 89 $ 8 $ 7
- ---------------------------------------------------------------------------------
</Table>
Contributions
- -------------
The Company previously disclosed in its financial statements for the year ended
December 31, 2007 that it expected to contribute $290 to its pension plan and
$14 to its postretirement plan for 2008. The final actuarial calculation for
2008 was revised to $400 and $32, respectively. As of April 15, 2008, $100 has
been contributed to the pension plan for 2008. Readers should refer to the
Annual Report on Form 10-K for further details on the Company's defined benefit
pension plan.
NOTE 9 -- 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's 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 March 31, 2008, that the Company and the
Bank meet all capital adequacy requirements to which they are subject.
As of March 31, 2008, 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.
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 March 31, 2008,
the balances in the capital stock and surplus accounts totaling $10,840 are
unavailable for dividends.
<Page>12
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.
<Table>
<Caption>
Actual Regulatory Requirements
- --------------------------------------------------------------- -----------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
------------------- --------------------
As of March 31, 2008 Amount Ratio Amount Ratio Amount Ratio
- ----------------------------------------------------------------------------------------------------------------
Total Capital (to Risk Weighted Assets)
PFSC (Company) $77,343 20.11% > $ 30,766 > 8.0% > $38,457 > 10.0%
- - - -
PSB (Bank) $74,009 19.30% > $ 30,682 > 8.0% > $38,353 > 10.0%
- - - -
Tier 1 Capital (to Risk Weighted Assets)
PFSC $72,536 18.86% > $ 15,383 > 4.0% > $23,074 > 6.0%
- - - -
PSB $69,215 18.05% > $ 15,341 > 4.0% > $23,012 > 6.0%
- - - -
Tier 1 Capital (to Average Assets)
PFSC $72,536 12.28% > * > * > $29,541 > 5.0%
- - - -
PSB $69,215 11.79% > * > * > $29,346 > 5.0%
- - - -
</Table>
PFSC - *3.0% ($17,725), 4.0% ($23,633) or 5.0% ($29,541) depending on the bank's
CAMELS Rating and other regulatory risk factors.
PSB - *3.0% ($17,608), 4.0% ($23,477) or 5.0% ($29,346) depending on the bank's
CAMELS Rating and other regulatory risk factors.
<Table>
<Caption>
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 $75,145 19.89% > $ 30,222 > 8.0% > $37,777 > 10.0%
- - - -
PSB $71,840 19.11% > $ 30,080 > 8.0% > $37,601 > 10.0%
- - - -
Tier 1 Capital (to Risk Weighted Assets)
PFSC $70,445 18.65% > $ 15,111 > 4.0% > $22,666 > 6.0%
- - - -
PSB $67,140 17.86% > $ 15,040 > 4.0% > $22,561 > 6.0%
- - - -
Tier 1 Capital (to Average Assets)
PFSC $70,445 12.11% > * > * > $29,081 > 5.0%
- - - -
PSB $67,140 11.62% > * > * > $28,900 > 5.0%
- - - -
</Table>
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.
<Page>13
PART 1. FINANCIAL INFORMATION, ITEM 2 --
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following commentary provides an overview of the financial condition and
significant changes in the results of operations of Penseco Financial Services
Corporation and its subsidiary, Penn Security Bank and Trust Company, at March
31, 2008 and for the three months ended March 31, 2008 and March 31, 2007. 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.
NON-GAAP FINANCIAL MEASURES: (VISA TRANSACTION)
Certain financial measures contained in this 10-Q exclude the decrease of the
liability accrual related to VISA's covered litigation provision as well as the
gain from the mandatory redemption of a portion of the Company's class B shares
in VISA. Financial measures which exclude the above-referenced items have not
been determined in accordance with generally accepted accounting principles and
are therefore non-GAAP financial measures. Management of the Company believes
that investors' understanding of the Company's performance is enhanced by
disclosing these non-GAAP financial measures as a reasonable basis for
comparison of the Company's ongoing results of operations. These non-GAAP
measures should not be considered a substitute for GAAP-basis measures and
results. Our non-GAAP measures may not be comparable to non-GAAP measures of
other companies. The attached Non-GAAP Reconciliation Schedule provides a
reconciliation of these non-GAAP financial measures to the most closely
analogous measure determined in accordance with GAAP.
<Page>14
In March 2008, VISA Inc. (VISA) completed its initial public offering. Penn
Security Bank & Trust Company and certain other VISA member banks are
shareholders in VISA. Following the initial public offering, the Company
received $1.2 million in proceeds from the offering, as a mandatory partial
redemption of 28,351 shares, reducing the Company's holding from 73,333 to
44,982 shares of Class B common stock. Using proceeds from this offering, VISA
established a $3.0 billion escrow account to cover the resolution of pending
litigation and related claims. The partial redemption proceeds are reflected in
other non-interest income in the first quarter of 2008.
The remaining unredeemed shares of VISA Class B common stock are restricted and
may not be transferred until the later of (1) three years from the date of the
initial public offering or (2) the period of time necessary to resolve the
covered litigation. A conversion ratio of 0.71429 was established for the
conversion rate of Class B shares into Class A shares. If the funds in the
escrow account are insufficient to settle all the covered litigation, VISA may
sell additional Class A shares, use the proceeds to settle litigation, and
further reduce the conversion ratio. If funds remain in the escrow account after
all litigation is settled, the Class B conversion ratio will be increased to
reflect that surplus. As of March 31, 2008, the value of the Class A shares was
$62.36 per share. The value of unredeemed Class A equivalent shares owned by the
Company was $2.0 million as of March 31, 2008, and has not yet been reflected in
the accompanying financial statements.
In connection with VISA's establishment of the litigation escrow account, the
Company reversed a $497,000 reserve in the first quarter of 2008, reflected as a
reduction of other non-interest expense. This reserve was created in the fourth
quarter of 2007, pending completion of the VISA Inc. initial public offering as
a charge to other non-interest expense.
NON-GAAP RECONCILIATION SCHEDULE
PENSECO FINANCIAL SERVICES CORPORATION
(unaudited)
(in thousands)
The following tables present the reconciliation of non-GAAP financial measures
to reported GAAP financial measures.
<Table>
<Caption>
Three Months Ended
March 31,
2008 2007 Change
------------ ------------ ------------
Net interest income after provision
for loan losses $ 5,342 $ 5,149 $ 193
Non-interest income 3,618 2,096 1,522
Non-interest expense (5,058) (5,232) 174
Income tax provision (945) (343) (602)
------------ ------------ ------------
Net income 2,957 1,670 1,287
Adjustments
- -----------
Non-interest income
Gain on mandatory
redemption of VISA, Inc. class B
common stock (1,213) - (1,213)
Non-interest expense
Covered litigation provision (497) - (497)
------------ ------------ ------------
Total Adjustments pre-tax (1,710) - (1,710)
Income tax provision 581 - 581
------------ ------------ ------------
After tax adjustments to GAAP (1,129) - (1,129)
------------ ------------ ------------
Adjusted net income $ 1,828 $ 1,670 $ 158
============ ============ ============
Return on Average Assets 1.24% 1.16%
Return on Average Equity 10.37% 9.94%
</Table>
<Page>15
Return on average equity (ROE) and return on average assets (ROA) for the
quarter ended March 31, 2008 was 16.77% (10.37% excluding the VISA gain) and
2.00% (1.24% excluding the VISA gain), respectively. ROE was 9.94% and ROA was
1.16% for the same period last year.
EXECUTIVE SUMMARY
Penseco Financial Services Corporation reported an increase in net income of
$1,287 or 77.1% for the three months ended March 31, 2008 to $2,957 or $1.38 per
share compared with $1,670 or $.78 per share from the year ago period. Largely,
the increase in net income was attributed to one time after tax income of $1,129
($.53 per share) related to VISA Inc.'s Initial Public Offering, which consisted
of a gain from the mandatory partial share redemption by VISA and also the
reversal of a litigation liability accrual that had been recorded by the Company
in the fourth quarter of 2007. Excluding this gain, net income increased $158 or
9.5% from the first quarter of 2007 (1). Net interest income increased $332 or
6.3% to $5,577 for the three months ended March 31, 2008 compared to $5,245 for
the same quarter of 2007. The increase resulted from higher interest on loans
due to net loan growth of $30.5 million since March 31, 2007, including $4.1
million from December 31, 2007. Interest on investments declined due to maturing
investments being redeployed to fund future loan demand and total interest
expense declined mainly from lower deposit costs. Net interest income after
provision for loan losses increased $193 or 3.7% as the provision for loan
losses increased $139 from the year ago period. While the Company's asset
quality improved, management felt it prudent to increase the allowance for loan
losses due to the decline of general market economic conditions.
Other income increased $1,522 to $3,618 for the three months ended March 31,
2008, compared with $2,096 for the similar period of 2007 due primarily to the
gain on the VISA stock redemption of $1,213. Total other expense decreased $174
or 3.3% to $5,058 for the first quarter ended March 31, 2008 compared with
$5,232 for the same period of 2007 primarily due to the reversal of the VISA
litigation accrual of $497 recorded by the Company in the fourth quarter of
2007.
NET INTEREST INCOME AND NET INTEREST MARGIN
Net interest income, the largest contributor to the Company's earnings, is
defined as the difference between interest income on assets and the cost of
funds supporting those assets. Average earning assets are composed primarily of
loans and investments while deposits, short-term and long-term borrowings
represent interest-bearing liabilities. Variations in the volume and mix of
these assets and liabilities, as well as changes in the yields earned and rates
paid, are determinants of changes in net interest income.
Net interest income after provision for loan losses increased $193 or 3.7% to
$5,342 for the three months ended March 31, 2008 compared to $5,149 for the
three months ended March 31, 2007. The average yield on interest earning assets
decreased 5 basis points, largely from the Federal Reserve Bank lowering its
target for the federal funds rate 300 basis points from the fall of 2007 thru
the first quarter of 2008.
The net interest margin represents the Company's net yield on its average
interest earning assets and is calculated as net interest income divided by
average interest earning assets. In the three months ended March 31, 2008, net
interest margin was 4.28% increasing 15 basis points from 4.13% in the same
period of 2007.
Total average interest earning assets and average interest bearing funds
increased in the three months ended March 31, 2008 as compared to 2007. Average
interest earning assets increased $17.4 million or 3.2%, from $543.5 million in
2007 to $560.9 million in 2008 and average interest bearing funds increased
$18.5 million, or 4.3%, from $425.6 million to $444.1 million for the same
period, mainly due to higher loans and increases in money market accounts,
repurchase agreements, and short-term borrowings, offset by lower time-deposits.
Long-term borrowings decreased a net of $1.2 million or 1.9% reflecting new
borrowings during the first quarter of 2008. Average earning assets,
(1) See page 13 for a reconciliation of GAAP net income to net income excluding
the gain related to the VISA, Inc. initial public offering during the three
months ended March 31, 2008.
<Page>16
including Bank-Owned Life Insurance (BOLI), increased to 96.2% for the three
months ended March 31, 2008 from 96.0% for the year ago period.
Changes in the mix of both interest earning assets and funding sources also
impacted net interest income in the three months ended March 31, 2008 and 2007.
Average loans as a percentage of average interest earning assets increased from
67.9% in 2007 to 72.7% in 2008, due in part to the increase of new and
refinanced residential mortgages. Average investments decreased $9.1 million
from 29.6% to 27.0% of interest earning assets. Average short-term investments,
federal funds sold and interest bearing balances with banks decreased $12.4
million to $1.5 million from $13.9 million. Average time deposits decreased
$18.1 million to $107.4 million from $125.5 million, average long-term
borrowings decreased, a net of $1.2 million, while repurchase agreements
increased $6.2 million.
Shifts in the interest rate environment and competitive factors affected the
rates paid for funds as well as the yields earned on assets. The investment
securities tax equivalent yield increased 34 basis points from 5.58% for the
three months ended March 31, 2007 to 5.92% for the three months ended March 31,
2008. Average loan yields decreased 30 basis points, from 6.83% for the three
months ended March 31, 2007 to 6.53% for the three months ended March 31, 2008.
The average time deposit costs decreased 14 basis points from 4.35% for the
three months ended March 31, 2007 to 4.21% for the three months ended March 31,
2008, along with the average cost of money market accounts decreasing 66 basis
points from 3.01% for the three months ended March 31, 2007 to 2.35% for the
three months ended March 31, 2008.
<Page>17
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY/INTEREST RATES
AND INTEREST DIFFERENTIAL
The table below presents average 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 three months ended
March 31, 2008 and March 31, 2007.
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------------
March 31, 2008 March 31, 2007
ASSETS Average Revenue/ Yield/ Average Revenue/ Yield/
Balance Expense Rate Balance Expense Rate
- -----------------------------------------------------------------------------------------------------
Investment Securities
Available-for-sale:
U.S. Agency obligations $ 35,989 $ 471 5.23% $ 45,812 $ 518 4.52%
States & political subdivisions 40,594 447 6.67% 30,191 334 6.70%
Federal Home Loan Bank stock 4,885 48 3.93% 4,240 69 6.51%
Other 2,736 26 3.80% 7,067 72 4.08%
Held-to-maturity:
U.S. Agency obligations 38,229 434 4.54% 44,281 493 4.45%
States & political subdivisions 29,239 389 8.06% 29,250 387 8.02%
Loans, net of unearned income:
Real estate mortgages 263,008 4,098 6.23% 231,911 3,684 6.35%
Commercial real estate 84,415 1,445 6.85% 73,779 1,371 7.43%
Commercial 23,706 444 7.49% 23,067 489 8.48%
Consumer and other 36,666 674 7.35% 40,021 749 7.49%
Federal funds sold - - - 6,550 85 5.19%
Interest on balances with banks 1,481 11 2.97% 7,310 91 4.98%
- -----------------------------------------------------------------------------------------------------
Total Interest Earning Assets/
Total Interest Income 560,948 $8,487 6.36% 543,479 $8,342 6.41%
- -----------------------------------------------------------------------------------------------------
Cash and due from banks 9,900 10,407
Bank premises and equipment 9,257 9,524
Accrued interest receivable 3,335 3,244
Cash surrender value of life insurance 7,396 7,081
Other assets 4,770 4,092
Less: Allowance for loan losses 4,704 4,191
- -----------------------------------------------------------------------------------------------------
TOTAL ASSETS $590,902 $573,636
- -----------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 52,436 $ 112 0.85% $ 51,295 $ 94 0.73%
Savings 77,803 131 0.67% 79,848 214 1.07%
Money markets 103,638 610 2.35% 86,311 650 3.01%
Time - Over $100 40,131 451 4.50% 41,001 509 4.97%
Time - Other 67,220 680 4.05% 84,469 854 4.04%
Federal funds purchased - - - - - -
Repurchase agreements 23,655 154 2.60% 17,494 117 2.68%
Short-term borrowings 15,835 140 3.54% 635 8 5.04%
Long-term borrowings 63,411 632 3.99% 64,581 651 4.03%
- -----------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 444,129 $2,910 2.62% 425,634 $3,097 2.91%
- -----------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 70,848 75,678
All other liabilities 5,413 5,093
Stockholders' equity 70,512 67,231
- -----------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $590,902 $573,636
- -----------------------------------------------------------------------------------------------------
Interest Spread 3.74% 3.50%
- -----------------------------------------------------------------------------------------------------
Net Interest Income $5,577 $5,245
- -----------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Net interest margin 4.28% 4.13%
Return on average assets 2.00% 1.16%
Return on average equity 16.77% 9.94%
Average equity to average assets 11.93% 11.72%
Dividend payout ratio 29.71% 47.44%
- -----------------------------------------------------------------------------------------------------
</Table>
<Page>18
INVESTMENTS
The Company's investment portfolio consists primarily of two functions: To
provide liquidity and to contribute to earnings. To provide liquidity the
Company may invest in short-term securities such as Federal funds sold, interest
bearing deposits with banks, U.S. Treasury securities and U.S. Agency securities
all with maturities of one year or less. These funds are invested short-term to
ensure the availability of funds to meet customer demand for credit needs. The
Company enhances interest income by securing long-term investments within its
investment portfolio, by means of U.S. Treasury securities, U.S. Agency
securities, municipal securities and mortgage-backed securities generally with
maturities greater than one year. The Company's mortgage-backed securities
portfolio does not contain any sub-prime or Alt-A credits.
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.
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.
Realized 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. Unrealized gains
and losses are included as a separate item in computing comprehensive income.
DEPOSITS
The Company is largely dependent on its core deposit base to fund operations.
Management has competitively priced its deposit products in checking, savings,
money market and time deposits to provide a stable source of funding.
As the economy shows strength and improves, there is migration of some deposits,
mainly to higher costing time deposits, as consumers become more prone to
increased yields. Historically, such changes in the Company's deposit base have
been minimal.
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 process of determining the adequacy of the
allowance is necessarily judgmental and subject to changes in external
conditions. The allowance for loan losses reflects management's judgment as to
the level considered appropriate to absorb such losses based upon a review of
many factors, including historical loss experience, adverse situations that may
affect the borrower's ability to repay (including the timing of future
payments), economic conditions and trends, loan portfolio volume and mix, loan
performance trends, the value and adequacy of collateral, and the Company's
internal credit review process. Accordingly, there can be no assurance that
existing levels of the allowance will ultimately prove adequate to cover actual
loan losses. The quarterly 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.
Based on this ongoing evaluation, management determines the provision necessary
to maintain an appropriate allowance.
For the three months ended March 31, 2008, the provision for loan losses
increased $139 to $235 from $96 in the three months ended March 31, 2007. Loans
charged off totaled $15 and recoveries were $5 for the three months ended March
31, 2008. In the same period of 2007, loans charged off totaled $96 and
recoveries were $0. At March 31, 2008 the allowance for loan losses was $4,925,
or 1.20% of gross loans.
<Page>19
OTHER INCOME
The following table sets forth information by category of other income for the
Company for three months ended March 31, 2008 and March 31, 2007, respectively:
<Table>
<Caption>
March 31, March 31,
Three Months Ended: 2008 2007
- ------------------------------------------------------------------------------
Trust department income $ 365 $ 372
Service charges on deposit accounts 263 251
Merchant transaction income 1,184 1,047
Other fee income 479 281
Bank-owned life insurance income 78 78
Other operating income 36 16
VISA mandatory share redemption 1,213 -
Realized gains (losses) on securities, net - 51
- ------------------------------------------------------------------------------
Total Other Income $ 3,618 $ 2,096
- ------------------------------------------------------------------------------
</Table>
Other income increased $1,522 to $3,618 for the three months ended March 31,
2008, compared with $2,096 for the similar period of 2007. Merchant transaction
income increased $137 or 13.1% due to higher transaction volume and new
business. Service charges on deposit accounts increased $12 or 4.8%, while other
fee income increased $198 from prior year levels. This increase was partly due
to increases in brokerage income of $160 and ATM transaction income of $23. The
Company realized a gain of $1,213 related to VISA Inc.'s Initial Public
Offering, which consisted of a mandatory partial share redemption discussed
above.
OTHER EXPENSES
The following table sets forth information by category of other expenses for the
Company for the three months ended March 31, 2008 and March 31, 2007,
respectively:
<Table>
<Caption>
March 31, March 31,
Three Months Ended: 2008 2007
- ------------------------------------------------------------------------------
Salaries and employee benefits $ 2,415 $ 2,375
Expense of premises and fixed assets 768 625
Merchant transaction expenses 902 824
Other operating expenses 973 1,408
- ------------------------------------------------------------------------------
Total Other Expenses $ 5,058 $ 5,232
- ------------------------------------------------------------------------------
</Table>
Total other expense decreased $174 or 3.3% to $5,058 for the first quarter ended
March 31, 2008 compared with $5,232 for the same period of 2007. Salaries and
employee benefits expense increased $40 or 1.7%. Expense of premises and
equipment increased $143 or 22.9% due to computer system upgrades and increased
occupancy expense. Merchant transaction expense increased by $78 or 9.5% due to
higher transaction volume. Other operating expenses decreased $435 or 30.9% due
to the reversal of the $497 VISA litigation accrual recorded by the Company in
the fourth quarter of 2007.
INCOME TAXES
Applicable income taxes increased $602 primarily due to the income on the VISA
initial public offering and overall higher income.
LOAN PORTFOLIO
Details regarding the Company's loan portfolio:
<Table>
<Caption>
March 31, March 31,
As of: 2008 2007
- ------------------------------------------------------------------------------
Real estate - construction and land development $ 22,545 $ 25,858
Real estate mortgages 326,017 318,437
Commercial 23,837 24,505
Credit card and related plans 3,113 3,324
Installment and other 27,611 26,542
Obligations of states & political subdivisions 5,852 5,973
- ------------------------------------------------------------------------------
Loans, net of unearned income 408,975 404,639
Less: Allowance for loan losses 4,925 4,700
- ------------------------------------------------------------------------------
Loans, net $404,050 $399,939
- ------------------------------------------------------------------------------
</Table>
<Page>20
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.
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
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
The following table sets forth information regarding non-accrual loans and loans
past due 90 days or more and still accruing interest:
<Table>
<Caption>
March 31, December 31, March 31,
As of: 2008 2007 2007
- ---------------------------------------------------------------------------------------------
Non-accrual loans $ 301 $ 1,610 $ 3,011
Other real estate owned - - 73
- ---------------------------------------------------------------------------------------------
Total non-performing assets $ 301 $ 1,610 $3,084
- ---------------------------------------------------------------------------------------------
Loans past due 90 days or more and accruing:
Secured by real estate $ 186 $ 57 $ -
Guaranteed student loans 409 408 330
Credit card loans 2 2 9
Commercial 120 - -
Other loans to individuals for household,
family, and other personal expenditures - 12 -
- ---------------------------------------------------------------------------------------------
Total loans past due 90 days or more and accruing $ 717 $ 479 $ 339
- ---------------------------------------------------------------------------------------------
</Table>
Non-accrual loans decreased $2,710 to $301 at March 31, 2008 from $3,011 at
March 31, 2007. This decrease was due to two borrowing relationships being
resolved during the first quarter of 2008.
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 $301 and $3,011 at March 31, 2008 and March 31, 2007, respectively. If
interest on those loans had been accrued, such income would have been $33 and
$202 for the three months ended March 31, 2008 and March 31, 2007, respectively.
Interest income on those loans, which is recorded only when received, amounted
to $14 and $73 for March 31, 2008 and March 31, 2007, respectively. There are no
commitments to lend additional funds to individuals whose loans are in
non-accrual status.
<Page>21
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 March 31, 2008 there are no significant loans as to which management has
serious doubt about their collectibility. Subsequent to the closing of the first
quarter, on April 7, 2008, the Company was notified that The Education Resources
Institute, Inc. (TERI), a guarantor of a portion of our student loan portfolio,
had filed for Reorganization under Chapter 11 of the Bankruptcy Act. Currently,
the Company holds $8.6 million of TERI loans out of a total student loan
portfolio of $21.4 million. The Company does not anticipate that TERI's
bankruptcy filing will significantly impact the Company's financial statements.
These loans will now be placed on non-accrual status if they become more than 90
days past due. Currently there are $58 of such loans. At March 31, 2008 and
December 31, 2007, 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.
LOAN LOSS EXPERIENCE
The following tables present the Company's loan loss experience during the
periods indicated:
<Table>
<Caption>
March 31, March 31,
Three Months Ended: 2008 2007
- ----------------------------------------------------------------------
Balance at beginning of period $4,700 $4,200
Charge-offs:
Real estate mortgages - 84
Commercial and all others 5 -
Credit card and related plans 10 12
Installment loans - -
- ----------------------------------------------------------------------
Total charge-offs 15 96
- ----------------------------------------------------------------------
Recoveries:
Real estate mortgages - -
Commercial and all others 3 -
Credit card and related plans 2 -
Installment loans - -
- ----------------------------------------------------------------------
Total recoveries 5 -
- ----------------------------------------------------------------------
Net charge-offs (recoveries) 10 96
- ----------------------------------------------------------------------
Provision charged to operations 235 96
- ----------------------------------------------------------------------
Balance at End of Period $4,925 $4,200
- ----------------------------------------------------------------------
Ratio of net charge-offs (recoveries)
to average loans outstanding 0.002% 0.026%
- ----------------------------------------------------------------------
</Table>
The allowance for loan losses at March 31, 2008 was $4,925 or 1.20% of total
loans compared to $4,200 or 1.12% of total loans at March 31, 2007. Management
believes the loan loss reserve is adequate.
The allowance for loan losses is allocated as follows:
<Table>
<Caption>
March 31, December 31, March 31,
As of: 2008 2007 2007
- ------------------------------------------------------------------------------------------------
Amount % * Amount % * Amount % *
- ------------------------------------------------------------------------------------------------
Real estate mortgages $1,200 85% $1,200 85% $1,200 83%
Commercial and all others 3,125 7% 2,900 7% 2,500 9%
Credit card and related plans 300 1% 300 1% 250 1%
Personal installment loans 300 7% 300 7% 250 7%
- ------------------------------------------------------------------------------------------------
Total $4,925 100% $4,700 100% $4,200 100%
- ------------------------------------------------------------------------------------------------
</Table>
* Percent of loans in each category to total loans
<Page>22
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, 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 March
31, 2008 the Company had $179,725 of available borrowing capacity with the FHLB.
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.
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 March 31, 2008 the Bank has issued
standby letters of credit for the accounts of related parties in the amount of
$8,204.
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 common stock.
Management has no plans to offer additional common stock at this time.
The Company's total risk-based capital ratio was 20.11% at March 31, 2008. 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.
<Page>23
PART 1. FINANCIAL INFORMATION, ITEM 3 --
QUANTITATIVE AND QUALITATIVE 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.
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 its
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.
For a discussion of the Company's asset and liability management policies, as
well as the potential impact of interest rate changes upon the market value of
the Company's financial instruments, see Item 7A in the Company's Annual Report
on Form 10-K for the year ended December 31, 2007. Management, as part of its
regular practices, performs periodic reviews of the impact of interest rate
changes upon net interest income and market value of the Company's portfolio
equity. Based on, among other factors, such reviews, management believes that
there have been no material changes in the market risk of the Company's asset
and liability position since December 31, 2007.
PART 1. FINANCIAL INFORMATION, ITEM 4 --
CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including
our Chief Executive Officer and Controller, we conduction an evaluation of our
disclosure controls and procedures, as such term is defined under Rule 12a-15(e)
under the Securities Exchange Act of 1934. Based upon this evaluation, our Chief
Executive Officer and our Controller (our Principal Financial Officer) concluded
that our disclosure controls and procedures were effective as of the end of the
period covered by this quarterly report.
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.
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
<Page>24
inadequate due to changes in conditions, or that the degree of compliance with
the policies or procedures may deteriorate.
There have been no substantive changes in the internal control over financial
reporting during the quarter ended March 31, 2008.
PART II. OTHER INFORMATION
ITEM 1 -- LEGAL PROCEEDINGS
None.
ITEM 1A -- RISK FACTORS
In addition to the other information set forth in this report, you should
carefully consider the factors discussed below, which could materially affect
our business, financial condition or future results. The risks described below
are not the only risks that the Company faces. Additional risks and
uncertainties not currently known to us or that we currently deem to be
immaterial also may materially adversely affect our business, financial
condition and /or operating results.
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.
Also 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 also not
materially affected by seasonal changes.
MARKET RISK
CHANGES IN INTEREST RATES COULD AFFECT OUR INVESTMENT VALUES AND NET INTEREST
INCOME WHICH COULD HURT OUR PROFITS.
At March 31, 2008, the Company owned approximately $96.9 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
March 31, 2008, the Company's available for sale marketable securities portfolio
had a net unrealized gain, net of taxes, of $1.4 million. 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.
<Page>25
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 AFFECT 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.
COMPLIANCE RISK
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 services, 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 March 31, 2008, the Company employed 162 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.
<Page>26
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.
ITEM 2 -- UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3 -- DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5 -- OTHER INFORMATION
None.
ITEM 6 -- EXHIBITS
31 Rule 13a-14(a) / 15-d-4(a) Certifications
32 Section 1350 Certifications
<Page>27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PENSECO FINANCIAL SERVICES CORPORATION
By: /s/ Craig W. Best
---------------------------------
Craig W. Best
President and CEO
Dated: May 5, 2008
By: /s/ Patrick Scanlon
----------------------------------
Patrick Scanlon
Senior Vice President, Controller
Dated: May 5, 2008
<Page>28
EXHIBIT 31
CERTIFICATIONS
I, Craig W. Best, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Penseco Financial
Services Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b) Designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our
supervision, 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;
c) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of the
period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter (the registrant's fourth fiscal quarter in the case of an
annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors:
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control
over financial reporting.
April 30, 2008 /s/ Craig W. Best
------------------------------
Craig W. Best
President and CEO
<Page>29
CERTIFICATIONS
I, Patrick Scanlon, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Penseco Financial
Services Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b) Designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our
supervision, 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;
c) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of the
period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter (the registrant's fourth fiscal quarter in the case of an
annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors:
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control
over financial reporting.
April 30, 2008 /s/ PATRICK SCANLON
------------------------------
Patrick Scanlon
Senior Vice President, Controller
(Principal Financial Officer)
30
EXHIBIT 32
CERTIFICATIONS
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsection (a) and
(b) of Section 1350, Chapter 63 of Title 18, United States Code), the
undersigned officer of Penseco Financial Services Corporation (the "Company")
certifies to his knowledge that:
(1) The Quarterly Report on Form 10-Q of the Company for the quarter ended
March 31, 2008 (the "Form 10-Q") fully complies with the requirements
of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Form 10-Q fairly presents, in all
material respects, the financial conditions and results of operations
of the Company as for the dates and for the periods referred to in the
Form 10-Q.
/s/ Craig W. Best
-----------------------------
Craig W. Best
President and CEO
April 30, 2008
CERTIFICATIONS
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsection (a) and
(b) of Section 1350, Chapter 63 of Title 18, United States Code), the
undersigned officer of Penseco Financial Services Corporation (the "Company")
certifies to his knowledge that:
(1) The Quarterly Report on Form 10-Q of the Company for the quarter ended
March 31, 2008 (the "Form 10-Q") fully complies with the requirements
of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Form 10-Q fairly presents, in all
material respects, the financial conditions and results of operations
of the Company as for the dates and for the periods referred to in the
Form 10-Q.
/s/ PATRICK SCANLON
-----------------------------
Patrick Scanlon
Senior Vice President, Controller
(Principal Financial Officer)
April 30, 2008