<Page>1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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 September 30, 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 checkmark 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 October 31, 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:
September 30, 2008...................................... 3
December 31, 2007....................................... 3
Statements of Income:
Three Months Ended September 30, 2008................... 4
Three Months Ended September 30, 2007................... 4
Nine Months Ended September 30, 2008.................... 5
Nine Months Ended September 30, 2007.................... 5
Statements of Cash Flows:
Nine Months Ended September 30, 2008.................... 6
Nine Months Ended September 30, 2007.................... 6
Notes to Unaudited Consolidated Financial Statements.... 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.............................. 15
Item 3. Quantitative and Qualitative Disclosures About Market
Risk.................................................. 29
Item 4. Controls and Procedures................................. 30
Part II -- OTHER INFORMATION
Item 1. Legal Proceedings....................................... 30
Item 1A. Risk Factors........................................... 30
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds............................................. 32
Item 3. Defaults Upon Senior Securities........................ 32
Item 4. Submission of Matters to a Vote of Security Holders.... 32
Item 5. Other Information...................................... 32
Item 6. Exhibits............................................... 32
Signatures......................................................... 33
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PART I. FINANCIAL INFORMATION, ITEM 1 -- FINANCIAL STATEMENTS
<Table>
<Caption>
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
September 30, December 30,
2008 2007
------------- ------------
ASSETS
Cash and due from banks $ 7,457 $ 10,677
Interest bearing balances with banks 19,325 967
Federal funds sold 5,000 -
------------- ------------
Cash and Cash Equivalents 31,782 11,644
Investment securities:
Available-for-sale, at fair value 91,029 77,328
Held-to-maturity (fair value of $64,427
and $69,491, respectively) 63,524 68,120
------------- ------------
Total Investment Securities 154,553 145,448
Loans, net of unearned income 432,980 404,639
Less: Allowance for loan losses 5,240 4,700
------------- ------------
Loans, Net 427,740 399,939
Bank premises and equipment 9,175 9,323
Other real estate owned - -
Accrued interest receivable 3,606 3,558
Cash surrender value of life insurance 7,605 7,368
Other assets 5,181 3,513
------------- ------------
Total Assets $639,642 $580,793
============= ============
LIABILITIES
Deposits:
Non-interest bearing $ 80,944 $ 73,926
Interest bearing 361,578 342,607
------------- ------------
Total Deposits 442,522 416,533
Other borrowed funds:
Repurchase agreements 45,857 20,492
Short-term borrowings 572 13,201
Long-term borrowings 75,275 55,966
Accrued interest payable 1,090 1,498
Other liabilities 2,412 3,388
------------- ------------
Total Liabilities 567,728 511,078
------------- ------------
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 64,160 59,697
Accumulated other comprehensive income (3,086) (822)
------------- ------------
Total Stockholders' Equity 71,914 69,715
------------- ------------
Total Liabilities and Stockholders' Equity $639,642 $580,793
============= ============
</Table>
(See accompanying Notes to Unaudited Consolidated Financial Statements)
<Page>4
<Table>
<Caption>
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended Three Months Ended
September 30, 2008 September 30, 2007
------------------ ------------------
INTEREST INCOME
Interest and fees on loans $ 6,543 $ 6,769
Interest and dividends on investments:
U.S. Treasury securities and U.S.
Agency obligations 1,047 896
States & political subdivisions 849 733
Other securities 68 84
Interest on Federal funds sold 31 129
Interest on balances with banks 28 121
------------------ ------------------
Total Interest Income 8,566 8,732
------------------ ------------------
INTEREST EXPENSE
Interest on time deposits of $100,000 or more 336 504
Interest on other deposits 1,385 1,858
Interest on other borrowed funds 1,017 840
------------------ ------------------
Total Interest Expense 2,738 3,202
------------------ ------------------
Net Interest Income 5,828 5,530
Provision for loan losses 167 308
------------------ ------------------
Net Interest Income After Provision
for Loan Losses 5,661 5,222
------------------ ------------------
NON-INTEREST INCOME
Trust department income 386 421
Service charges on deposit accounts 403 245
Merchant transaction income 1,583 1,482
Other fee income 483 414
Bank-owned life insurance income 78 80
Other operating income 30 23
VISA mandatory share redemption - -
Realized gains (losses) on securities, net 23 (2)
------------------ ------------------
Total Non-Interest Income 2,986 2,663
------------------ ------------------
NON-INTEREST EXPENSES
Salaries and employee benefits 2,481 2,108
Expense of premises and fixed assets 626 605
Merchant transaction expenses 1,182 1,149
Other operating expenses 1,537 1,238
------------------ ------------------
Total Non-Interest Expenses 5,826 5,100
------------------ ------------------
Income before income taxes 2,821 2,785
Applicable income taxes 579 604
------------------ ------------------
Net Income 2,242 2,181
Other comprehensive income, net of taxes:
Unrealized securities (losses) gains (1,817) 156
Unrealized gains on employee benefit plans - -
------------------ ------------------
Comprehensive Income $ 425 $ 2,337
================== ==================
Earnings per Common Share
(Based on 2,148,000 shares outstanding) $ 1.04 $ 1.01
Cash Dividends Declared Per Common Share $ 0.42 $ 0.37
</Table>
(See accompanying Notes to Unaudited Consolidated Financial Statements)
<Page>5
<Table>
<Caption>
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Nine Months Ended Nine Months Ended
September 30, 2008 September 30, 2007
------------------- -------------------
INTEREST INCOME
Interest and fees on loans $ 19,640 $ 19,621
Interest and dividends on investments:
U.S. Treasury securities and U.S.
Agency obligations 3,052 2,859
States & political subdivisions 2,521 2,178
Other securities 211 322
Interest on Federal funds sold 31 433
Interest on balances with banks 62 314
------------------- -------------------
Total Interest Income 25,517 25,727
------------------- -------------------
INTEREST EXPENSE
Interest on time deposits of $100,000
or more 1,142 1,540
Interest on other deposits 4,342 5,585
Interest on other borrowed funds 2,961 2,485
------------------- -------------------
Total Interest Expense 8,445 9,610
------------------- -------------------
Net Interest Income 17,072 16,117
Provision for loan losses 618 528
------------------- -------------------
Net Interest Income After Provision
for Loan Losses 16,454 15,589
------------------- -------------------
NON-INTEREST INCOME
Trust department income 1,133 1,160
Service charges on deposit accounts 1,062 756
Merchant transaction income 3,702 3,402
Other fee income 1,451 1,068
Bank-owned life insurance income 236 235
Other operating income 148 69
VISA mandatory share redemption 1,213 -
Realized gains (losses) on securities, net 23 49
------------------- -------------------
Total Non-Interest Income 8,968 6,739
------------------- -------------------
NON-INTEREST EXPENSES
Salaries and employee benefits 7,405 6,813
Expense of premises and fixed assets 2,061 1,955
Merchant transaction expenses 2,787 2,644
Other operating expenses 4,088 4,031
------------------- -------------------
Total Non-Interest Expenses 16,341 15,443
------------------- -------------------
Income before income taxes 9,081 6,885
Applicable income taxes 1,954 1,334
------------------- -------------------
Net Income 7,127 5,551
Other comprehensive income, net of taxes:
Unrealized securities (losses) gains (2,709) (44)
Unrealized gains on employee benefit
plans 445 -
------------------- -------------------
Comprehensive Income $ 4,863 $ 5,507
=================== ===================
Earnings per Common Share
(Based on 2,148,000 shares outstanding) $ 3.32 $ 2.58
Cash Dividends Declared Per Common Share $ 1.24 $ 1.11
</Table>
(See accompanying Notes to Unaudited Consolidated Financial Statements)
<Page>6
<Table>
<Caption>
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
Nine Months Ended Nine Months Ended
September 30, 2008 September 30, 2007
------------------ ------------------
OPERATING ACTIVITIES
Net income $ 7,127 $ 5,551
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 606 644
Provision for loan losses 618 528
Deferred income tax (benefit) provision (9) 117
Amortization of securities, (net of accretion) 223 281
Gain on VISA mandatory share redemption (1,213) -
Net realized (gains) losses on securities (23) (49)
(Gain) loss on other real estate (6) -
(Increase) decrease in interest receivable (48) -
(Increase) decrease in cash surrender value of life
insurance (237) (235)
(Increase) decrease in other assets (1,659) (375)
Increase (decrease) in income taxes payable 1,987 74
(Decrease) increase in interest payable (408) (86)
Increase (decrease) in other liabilities 633 (486)
------------------ ------------------
Net cash provided (used) by operating activities 7,591 5,964
------------------ ------------------
INVESTING ACTIVITIES
Purchase of investment securities available-for-sale (48,841) (12,496)
Proceeds from sales and maturities of investment
securities available-for-sale 24,544 21,838
Purchase of investment securities to be
held-to-maturity - -
Proceeds from repayments of investment securities
available-for-sale 6,494 9,665
Proceeds from repayments of investment securities
held-to-maturity 4,391 4,717
Net loans (originated) repaid (28,981) (26,317)
Proceeds from other real estate 28 76
Investment in premises and equipment (458) (662)
------------------ ------------------
Net cash (used) provided by investing activities (42,823) (3,179)
------------------ ------------------
FINANCING ACTIVITIES
Net increase (decrease) in demand and savings deposits 22,352 22,213
Net proceeds (payments) on time deposits 3,637 (12,581)
Increase (decrease) in federal funds purchased - -
Increase (decrease) in repurchase agreements 25,365 19,854
Net (decrease) increase in short-term borrowings (12,629) (4,861)
Increase in long-term borrowings 27,000 -
Repayments of long-term borrowings (7,691) (7,383)
Cash dividends paid (2,664) (2,384)
------------------ ------------------
Net cash provided (used) by financing activities 55,370 14,858
------------------ ------------------
Net increase (decrease) in cash and cash equivalents 20,138 17,643
Cash and cash equivalents at January 1 11,644 14,778
------------------ ------------------
Cash and cash equivalents at September 30 $ 31,782 $ 32,421
================== ==================
</Table>
The Company paid interest and income taxes of $8,853 and $2,080 and $9,696 and
$1,045, for the nine month periods ended September 30, 2008 and 2007,
respectively.
(See accompanying Notes to Unaudited Consolidated Financial Statements)
<Page>7
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE QUARTER ENDED SEPTEMBER 30, 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 and
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 (SEC) on March 17,
2008.
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.
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
<Page>8
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 September 30, 2008
and December 31, 2007 are as follows:
<Table>
<Caption>
AVAILABLE-FOR-SALE
Gross Gross
Amortized Unrealized Unrealized Fair
September 30, 2008 Cost Gains Losses Value
- -------------------------------------------------------------------------------
U.S. Agency securities $ 25,256 $ 91 $ 117 $ 25,230
Mortgage-backed securities 21,980 130 162 21,948
States & political subdivisions 40,400 195 3,053 37,542
- -------------------------------------------------------------------------------
Total Debt Securities 87,636 416 3,332 84,720
Equity securities 6,054 760 505 6,309
- -------------------------------------------------------------------------------
Total Available-for-Sale $ 93,690 $1,176 $ 3,837 $ 91,029
- -------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
AVAILABLE-FOR-SALE
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2007 Cost Gains Losses Value
- -------------------------------------------------------------------------------
U.S. Agency securities $ 14,929 $ 144 $ - $ 15,073
Mortgage-backed securities 15,402 161 - 15,563
States & political subdivisions 38,740 830 96 39,474
- -------------------------------------------------------------------------------
Total Debt Securities 69,071 1,135 96 70,110
Equity securities 6,812 921 515 7,218
- -------------------------------------------------------------------------------
Total Available-for-Sale $ 75,883 $ 2,056 $ 611 $ 77,328
- -------------------------------------------------------------------------------
</Table>
The Company does not hold any Federal National Mortgage Association (Fannie Mae)
or Federal Home Loan Mortgage Corporation (Freddie Mac) preferred or common
equity securities and does not hold any trust preferred securities.
<Page>9
<Table>
<Caption>
HELD-TO-MATURITY
Gross Gross
Amortized Unrealized Unrealized Fair
September 30, 2008 Cost Gains Losses Value
- -------------------------------------------------------------------------------
Mortgage-backed securities $ 34,291 $ 2 $ 240 $ 34,053
States & political subdivisions 29,233 1,169 28 30,374
- -------------------------------------------------------------------------------
Total Held-to-Maturity 63,524 1,171 268 64,427
- -------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
HELD-TO-MATURITY
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 September 30, 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>
September 30, 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 $ 5,000 $ 5,091 $ - $ -
After one year through five years:
U.S. Agency securities 20,256 20,139 - -
After five year through ten years:
States & political subdivisions 460 466 4,091 4,231
After ten years:
States & political subdivisions 39,940 37,076 25,142 26,143
- -----------------------------------------------------------------------------------------
Subtotal 65,656 62,772 29,233 30,374
Mortgage-backed securities 21,980 21,948 34,291 34,053
- -----------------------------------------------------------------------------------------
Total Debt Securities $87,636 $84,720 $63,524 $64,427
- -----------------------------------------------------------------------------------------
</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 September 30, 2008 and
December 31, 2007 are as follows:
<Table>
<Caption>
Less than twelve months Twelve months or more Totals
----------------------- --------------------- ----------------------
Fair Unrealized Fair Unrealized Fair Unrealized
September 30, 2008 Value Losses Value Losses Value Losses
- ------------------------------------- ----------------------- --------------------- ----------------------
U.S. Agency securities $20,139 $ 117 $ - $ - $20,139 $ 117
Mortgage-backed securities 45,365 402 - - 45,365 402
States & political subdivisions 29,303 2,976 700 105 30,003 3,081
Equities 43 8 561 497 604 505
----------------------- --------------------- ----------------------
Total $94,850 $3,503 $1,261 $ 602 $96,111 $ 4,105
======================= ===================== ======================
</Table>
<Page>10
<Table>
<Caption>
Less than twelve months Twelve months or more Totals
----------------------- --------------------- ----------------------
Fair Unrealized Fair Unrealized Fair Unrealized
September 30, 2008 Value Losses Value Losses Value Losses
- ------------------------------------- ----------------------- --------------------- ----------------------
Mortgage-backed securities $ - $ - $ - $ 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>
The table at September 30, 2008, includes sixty-nine (69) securities that have
unrealized losses for less than twelve months and thirteen (13) securities that
have been in an unrealized loss position for twelve or more months. The table at
December 31, 2008, includes twenty-five (25) securities that have unrealized
losses for less than twelve months and seven (7) securities that have been in an
unrealized loss position for twelve or more months. The Company has analyzed its
investment portfolio and determined that the market value fluctuation in these
securities is consistent with the broader market and not a cause for recognition
of a current loss.
U.S. AGENCY SECURITIES
The unrealized losses on the Company's investments in U.S. Agency securities
were caused by interest rate fluctuations. The contractual terms of these
investments do not permit the issuer to settle the securities at a 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 September 30, 2008.
MORTGAGE-BACKED SECURITIES
The unrealized losses on the Company's investments 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 September 30, 2008.
STATES AND POLITICAL SUBDIVISIONS
The unrealized losses on the Company's investments in states and political
subdivisions were caused by interest rate fluctuations. The contractual terms of
these investments do not permit the issuer to settle the securities at a 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 September 30, 2008.
MARKETABLE EQUITY SECURITIES
The unrealized losses on the Company's investments 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. The Company has analyzed its equity portfolio and determined that the
market value fluctuation in these equities is consistent with the broader market
and not a cause for recognition of a current loss. 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 September
30, 2008.
<Page>11
NOTE 5 -- LOAN PORTFOLIO
Details regarding the Company's loan portfolio are as follows:
<Table>
<Caption>
September 30, December 31,
As of: 2008 2007
- ---------------------------------------------------------------------------------
Real estate - construction and land development $ 22,098 $ 25,858
Real estate mortgages 352,398 318,437
Commercial 24,014 24,505
Credit card and related plans 3,189 3,324
Installment and other 26,745 26,542
Obligations of states & political subdivisions 4,536 5,973
- ---------------------------------------------------------------------------------
Loans, net of unearned income 432,980 404,639
Less: Allowance for loan losses 5,240 4,700
- ---------------------------------------------------------------------------------
Loans, net $427,740 $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. The
Company's lending is primarily residential and commercial secured mortgage
loans, in Northeastern Pennsylvania, based upon conservative underwriting
standards.
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 September 30, 2008 is as follows:
<Table>
<Caption>
Monthly Installment Fixed Rate Maturity Date Balance
- --------------------------------------------------------------------------
Amortizing loans
$ 253 3.22% 03/15/10 $ 4,439
90 3.10% 02/28/13 4,456
430 3.74% 03/13/13 21,344
67 3.44% 03/02/15 4,628
13 3.48% 03/31/15 936
10 3.83% 04/02/18 965
186 4.69% 03/13/23 23,507
- --------------------------------------------------------------------------
Total amortizing 60,275
- --------------------------------------------------------------------------
Non-amortizing loans
2.61% 03/02/09 1,000
2.62% 08/31/09 1,000
2.61% 03/01/10 1,000
2.61% 08/30/10 1,000
2.88% 02/28/11 2,000
3.27% 02/29/12 2,000
3.49% 02/28/13 7,000
- --------------------------------------------------------------------------
Total non-amortizing 15,000
- --------------------------------------------------------------------------
Total long-term debt $75,275
- ---------------------------------------------------------------------------
</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.
<Page>12
Aggregate maturities of long-term debt at September 30, 2008 are as follows:
<Table>
<Caption>
September 30, Principal
------------- ---------
2009 $ 12,361
2010 11,214
2011 10,007
2012 10,315
2013 12,400
Thereafter 18,978
---------
$75,275
=========
</Table>
NOTE 8 -- EMPLOYEE BENEFIT PLANS
The Company provides a post-retirement benefit plan for eligible employees.
The components of the post-retirement benefit costs are as follows:
<Table>
<Caption>
Post-retirement Benefits
------------------------
Nine months ended September 30, 2008 2007
- --------------------------------------------------------------
Service cost $ 4 $ 3
Interest cost 14 12
Expected return on plan assets - -
Amortization of prior service cost 5 6
Amortization of net loss (gain) - -
- -------------------------------------------------------------
Net periodic pension cost $ 23 $ 21
- -------------------------------------------------------------
</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 post-retirement plan for 2008. The final actuarial calculation for
2008 was revised to $400 and $32, respectively. As of September 30, 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. However, effective June 22, 2008 the Company froze its defined
benefit pension plan.
The actuarially computed information on the plan curtailment, as to the pension
obligation and funded status, was disclosed in Form 10-Q for the six month
period ended June 30, 2008 as filed with the SEC on August 7, 2008.
Effective July 1, 2008, the Company sponsors a new 401(k) pension plan for all
eligible employees. The Company's 401(k) expense for the three months ended
September 30, 2008 was $60.
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 September 30, 2008, that the Company and
the Bank meet all capital adequacy requirements to which they are subject.
<Page>13
As of September 30, 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 following 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 September 30,
2008, the balances in the capital stock and surplus accounts totaling $10,840
are unavailable for dividends.
In addition, the Bank is subject to restrictions imposed by Federal law on
certain transactions with the Company's affiliates. These transactions include
extensions of credit, purchases of or investments in stock issued by the
affiliate, purchases of assets subject to certain exceptions, acceptance of
securities issued by an affiliate as collateral for loans, and the issuance of
guarantees, acceptances, and letters of credit on behalf of affiliates. These
restrictions prevent the Company's affiliates from borrowing from the Bank
unless the loans are secured by obligations of designated amounts. Further, the
aggregate of such transactions by the Bank with a single affiliate is limited in
amount to 10 percent of the Bank's Capital Stock and Surplus, and the aggregate
of such transactions with all affiliates is limited to 20 percent of the Bank's
Capital Stock and Surplus. The Federal Reserve System has interpreted "Capital
Stock and Surplus" to include undivided profits.
<Table>
<Caption>
Actual Regulatory Requirements
- ------------------------------------------- --------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
----------------------- -------------------
As of September 30, 2008 Amount Ratio Amount Ratio Amount Ratio
- --------------------------------------------------------------------------------------------------------
Total Capital (to Risk Weighted Assets)
PFSC (Company) $79,999 19.80% > $32,318 > 8.0% > $40,397 > 10.0%
- - - -
PSB (Bank) $76,623 19.03% > 32,210 > 8.0% > $40,262 > 10.0%
- - - -
Tier 1 Capital (to Risk Weighted Assets)
PFSC $74,952 18.55% > $16,159 > 4.0% > $24,238 > 6.0%
- - - -
PSB $71,588 17.78% > $16,105 > 4.0% > $24,157 > 6.0%
- - - -
Tier 1 Capital (to Average Assets)
PFSC $74,952 12.20% > $ * > * > $30,711 > 5.0%
- - - -
PSB $71,588 11.68% > $ * > * > $30,646 > 5.0%
- - - -
</Table>
PFSC - *3.0% ($18,427), 4.0% ($24,569) or 5.0% ($30,711) depending on the bank's
CAMELS Rating and other regulatory risk factors.
PSB - *3.0% ($18,388), 4.0% ($24,517) or 5.0% ($30,646) depending on the bank's
CAMELS Rating and other regulatory risk factors.
<Page>14
<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.
NOTE 10 -- FAIR VALUE MEASUREMENTS (SFAS NO. 157)
Effective January 1, 2008, the Company adopted SFAS No. 157, which, among other
things, requires enhanced disclosures about assets and liabilities carried at
fair value. SFAS No. 157 establishes a hierarchal disclosure framework
associated with the level of pricing observability utilized in measuring assets
and liabilities at fair value. The three broad levels defined by SFAS No. 157
hierarchy are as follows:
Level I: Quoted prices are available in active markets for identical assets or
liabilities as of the record date.
Level II: Pricing inputs are other than quoted prices in active markets, which
are either directly or indirectly observable as of the reported date.
The nature of these assets and liabilities include items for which
quoted prices are available but traded less frequently, and items
that are fair valued using other financial instruments, the
parameters of which can be directly observed.
Level III: Assets and liabilities that have little to no pricing observability
as of the reported date. These items do not have two-way markets and
are measured using management's best estimate of fair value, where
the inputs into the determination of fair value require significant
management judgment or estimation
The following table presents the assets reported on the consolidated statements
of financial condition at their fair value as of September 30, 2008 by level
within the fair value hierarchy. As required by SFAS No. 157, financial assets
and liabilities are classified in their entirety based on the lowest level of
input that is significant to the fair value measurement.
<Table>
<Caption>
September 30, 2008
---------------------------------------------
Level I Level II Level III Total
---------- ---------- --------- ----------
Assets:
Securities available-for-sale $6,259 $84,720 $ 50 $91,029
</Table>
<Page>15
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
September 30, 2008 and for the three and nine month periods ended September 30,
2008 and September 30, 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>16
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 holdings 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 of $1.2 million
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 September 30, 2008, the value of the Class A shares
was $61.39 per share. The value of unredeemed Class A equivalent shares owned by
the Company was $2.0 million as of September 30, 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.
<Table>
<Caption>
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.
Nine Months Ended
September 30,
2008 2007 Change
--------------- --------------- ---------------
Net interest income after provision
for loan losses $ 16,454 $ 15,589 $ 865
Non-interest income 8,968 6,739 2,229
Non-interest expense (16,341) (15,443) (898)
Income tax provision (1,954) (1,334) (620)
--------------- --------------- ---------------
Net income 7,127 5,551 1,576
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 $ 5,998 $ 5,551 $ 447
=============== =============== ===============
Return on Average Assets 1.30% 1.27%
Return on Average Equity 11.05% 10.86%
</Table>
Return on average equity (ROE) and return on average assets (ROA) for the nine
months ended September 30, 2008 was 13.14% (11.05% excluding the VISA IPO
impact) and 1.55% (1.30% excluding the VISA IPO impact), respectively. ROE was
10.86% and ROA was 1.27% for the same period last year.
<Page>17
EXECUTIVE SUMMARY
Penseco Financial Services Corporation reported an increase in net income of $61
or 2.8% for the three months ended September 30, 2008 to $2,242 or $1.04 per
share compared with $2,181 or $1.01 per share from the year ago period. The
increase in net income was primarily attributable to increased net interest
income of $298 or 5.4% and higher non-interest income offset by higher
non-interest expense. Interest on investments increased mainly due to purchases
of securities of states & political subdivisions and U.S. Agencies while total
interest expense declined mainly from lower deposit costs. The provision for
loan losses decreased $141 from the year ago period. The allowance for loan
losses at September 30, 2008 was 1.21% of total loans compared to 1.22% of total
loans at June 30, 2008 and 1.16% of total loans at September 30, 2007.
Non-interest income increased $323 or 12.1% to $2,986 for the three months ended
September 30, 2008, compared with $2,663 for the similar period of 2007. Total
non-interest expense increased $726 or 14.2% to $5,826 for the three months
ended September 30, 2008 compared with $5,100 for the same period of last year.
For the nine months ended September 30, 2008, net income increased $1,576 or
28.4%, to $7,127 or $3.32 per share compared with the year ago period of $5,551
or $2.58 per share. The increase in net income was primarily attributable to a
one time after tax increase in 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 the reversal of a litigation
liability accrual that had been recorded by the Company in the fourth quarter of
2007. Excluding the impact of the VISA transaction, net income increased $447 or
8.1% from the first nine months of 2007(1). Net interest income increased $955
or 5.9% to $17,072 for the nine months ended September 30, 2008 compared to
$16,117 for the same period of 2007. The increase resulted from higher interest
on investments of $425 or 7.9% due to purchases of securities of states &
political subdivisions and U.S. Agencies. Total interest expense declined mainly
due to lower deposit costs. Net interest income after provision for loan losses
increased $865 or 5.5%. Year to date the provision for loan losses increased $90
from the year ago period.
Non-interest income increased $2,229 or 33.1% to $8,968 for the nine months
ended September 30, 2008, compared with $6,739 for the same period in 2007 due
primarily to the gain on the VISA stock redemption of $1,213. Total non-interest
expense increased $898 or 5.8% to $16,341 for the nine months ended September
30, 2008 compared with $15,443 for the same period of 2007 primarily due to
increased salaries and employee benefits. Without the impact of the VISA
reversal, total non-interest expense would have increased $1,395 or 9.0%.
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 $439 or 8.4% to
$5,661 for the three months ended September 30, 2008 compared to $5,222 for the
three months ended September 30, 2007. The average yield on interest earning
assets decreased 62 basis points, largely from the Federal Reserve Bank lowering
its target for the federal funds rate 375 basis points from the fall of 2007
through the third quarter of 2008, offset by increases in the investment
securities portfolio.
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 September 30, 2008,
net interest margin decreased 14 basis points to 3.85% from 3.99% in the same
period of 2007.
- ---------------------------------
1 See pages 15 and 16 for a reconciliation of GAAP net income to net income
excluding the gain related to the VISA, Inc. initial public offering during
the nine months ended September 30, 2008.
<Page>18
Total average interest earning assets and average interest bearing funds
increased in the three months ended September 30, 2008 as compared to 2007.
Average interest earning assets increased $50.4 million or 9.1%, from $554.7
million in 2007 to $605.1 million in 2008 and average interest bearing funds
increased $47.4 million, or 10.9%, from $435.5 million to $482.9 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 increased a net of $17.0 million or 28.5% reflecting new
borrowings during the first quarter of 2008. Average earning assets, including
Bank-Owned Life Insurance (BOLI), increased to 96.5% for the three months ended
September 30, 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 September 30, 2008 and
2007. Average loans as a percentage of average interest earning assets increased
from 70.4% in 2007 to 70.6% in 2008. Average investments increased $20.7 million
from 26.0% to 27.2% of interest earning assets. Average short-term investments,
federal funds sold and interest bearing balances with banks decreased $6.5
million to $13.3 million from $19.8 million. Average time deposits decreased
$3.4 million to $108.0 million from $111.4 million, average long-term borrowings
increased $17.0 million, while repurchase agreements increased $14.0 million or
50.7% to $41.6 million compared to $27.6 million for the year ago period.
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 3 basis points from 5.80% for the
three months ended September 30, 2007 to 5.83% for the three months ended
September 30, 2008. Average loan yields decreased 80 basis points, from 6.93%
for the three months ended September 30, 2007 to 6.13% for the three months
ended September 30, 2008.
The average time deposit costs decreased 79 basis points from 4.39% for the
three months ended September 30, 2007 to 3.60% for the three months ended
September 30, 2008, along with the average cost of money market accounts
decreasing 134 basis points from 3.17% for the three months ended September 30,
2007 to 1.83% for the three months ended September 30, 2008.
<Page>19
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
September 30, 2008 and September 30, 2007.
<Table>
<Caption>
- ------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2008 SEPTEMBER 30, 2007
ASSETS AVERAGE REVENUE/ YIELD/ AVERAGE REVENUE/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
- ------------------------------------------------------------------------------------------------------
Investment Securities
Available-for-sale:
U.S. Agency obligations $ 52,730 $ 634 4.81% $ 36,900 $ 426 4.62%
States & political subdivisions 40,688 457 6.81% 30,243 341 6.83%
Federal Home Loan Bank stock 4,771 41 3.44% 3,784 59 6.24%
Other 2,612 27 4.13% 3,089 25 3.24%
Held-to-maturity:
U.S. Agency obligations 34,820 413 4.74% 40,963 470 4.59%
States & political subdivisions 29,234 392 8.13% 29,245 392 8.12%
Loans, net of unearned income:
Real estate mortgages 274,047 4,130 6.03% 252,059 4,158 6.60%
Commercial real estate 94,135 1,456 6.19% 75,686 1,368 7.23%
Commercial 23,844 380 6.37% 22,992 489 8.51%
Consumer and other 34,861 577 6.62% 39,969 754 7.55%
Federal funds sold 6,685 31 1.85% 10,207 129 5.06%
Interest on balances with banks 6,627 28 1.69% 9,565 121 5.06%
- ------------------------------------------------------------------------------------------------------
Total Interest Earning Assets/
Total Interest Income 605,054 8,566 5.95% 554,702 8,732 6.57%
- ------------------------------------------------------------------------------------------------------
Cash and due from banks 10,137 10,648
Bank premises and equipment 9,154 9,646
Accrued interest receivable 3,455 3,430
Cash surrender value of life insurance 7,554 7,237
Other assets 4,559 4,228
Less: Allowance for loan losses 5,119 4,320
- ------------------------------------------------------------------------------------------------------
TOTAL ASSETS $634,794 $585,571
- ------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 56,199 $ 97 0.69% $ 57,406 $ 148 1.03%
Savings 76,338 92 0.48% 82,751 229 1.11%
Money markets 122,837 561 1.83% 96,410 763 3.17%
Time - Over $100 37,347 336 3.60% 40,913 504 4.93%
Time - Other 70,624 635 3.60% 70,512 718 4.07%
Federal funds purchased - - - - - -
Repurchase agreements 41,624 274 2.63% 27,609 231 3.35%
Short-term borrowings 1,333 8 2.40% 273 4 5.86%
Long-term borrowings 76,553 735 3.84% 59,633 605 4.06%
- ------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 482,855 $2,738 2.27% $435,507 $3,202 2.94%
- ------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 75,069 76,587
All other liabilities 3,616 4,363
Stockholders' equity 73,254 69,114
- ------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $634,794 $585,571
- ------------------------------------------------------------------------------------------------------
Interest Spread 3.68% 3.63%
- ------------------------------------------------------------------------------------------------------
Net Interest Income $ 5,828 $ 5,530
- ------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Net interest margin 3.85% 3.99%
Return on average assets 1.41% 1.49%
Return on average equity 12.24% 12.62%
Average equity to average assets 11.54% 11.80%
Dividend payout ratio 40.38% 36.63%
- -------------------------------------------------------------------------------------------------------
</Table>
<Page>20
Net interest income after provision for loan losses increased $865 or 5.5% to
$16,454 for the nine months ended September 30, 2008, compared to $15,589 for
the nine months ended September 30, 2007. The average yield on interest earning
assets decreased 38 basis points, largely from the Federal Reserve Bank lowering
its target for the federal funds rate 375 basis points from the fall of 2007
through the third quarter of 2008, offset by increases in the investment
securities portfolio.
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. For the nine months ended September 30, 2008,
net interest margin was 3.89% decreasing 1 basis point from 3.90% in the same
period of 2007.
Total average interest earning assets and average interest bearing funds
increased for the nine months ended September 30, 2008 as compared to the nine
months ended September 30, 2007. Average interest earning assets increased $33.4
million or 6.1%, from $551.0 million in 2007 to $584.4 million in 2008 and
average interest bearing funds increased $31.6 million, or 7.3%, from $433.4
million to $465.0 million for the same periods. As a percentage of average
assets, average earning assets, including BOLI, increased to 96.4% for the nine
months ended September 30, 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 nine months ended September 30, 2008 and
2007. Average loans as a percentage of average interest earning assets increased
from 69.0% in 2007 to 71.2% in 2008, due in part to the increase of new and
refinanced residential mortgages as well as an increase in commercial loans
secured by real estate. Average investments increased $10.2 million year over
year and increased as a percentage of average assets to 27.7% at September 30,
2008 from 27.5% at September 30, 2007. Average short-term investments, federal
funds sold and interest bearing balances with banks, decreased $12.7 million to
$6.6 million from $19.3 million and also decreased as a percentage of average
interest earning assets from 3.5% in 2007 to 1.1% in 2008. Average time deposits
decreased $12.2 million or 10.2% from 27.7% of interest bearing liabilities in
2007 to 23.2% in 2008. Average short-term borrowings increased $5.8 million;
average long-term borrowings increased $10.9 million, while repurchase
agreements increased $9.8 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 13 basis points from 5.70% for the
nine months ended September 30, 2007 to 5.83% for the nine months ended
September 30, 2008. Also, average loan yields decreased 58 basis points, from
6.88% for the nine months ended September 30, 2007 to 6.30% in the same period
of 2008.
The average time deposit costs decreased 49 basis points from 4.38% for the nine
months ended September 30, 2007 to 3.89% for the nine months ended September 30,
2008, along with the average cost of money market accounts decreasing 110 basis
points from 3.11% for the nine months ended September 30, 2007 to 2.01% for the
nine months ended September 30, 2008.
<Page>21
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 nine months ended
September 30, 2008 and September 30, 2007.
<Table>
<Caption>
- ------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2008 SEPTEMBER 30, 2007
ASSETS AVERAGE REVENUE/ YIELD/ AVERAGE REVENUE/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
- ------------------------------------------------------------------------------------------------------
Investment Securities
Available-for-sale:
U.S. Agency obligations $ 47,809 $ 1,774 4.95% $ 40,943 $ 1,404 4.57%
States & political subdivisions 40,799 1,353 6.70% 30,227 1,011 6.76%
Federal Home Loan Bank stock 4,796 135 3.75% 3,983 190 6.36%
Other 2,795 76 3.63% 4,661 132 3.78%
Held-to-maturity:
U.S. Agency obligations 36,454 1,278 4.67% 42,647 1,455 4.55%
States & political subdivisions 29,237 1,168 8.07% 29,247 1,167 8.06%
Loans, net of unearned income:
Real estate mortgages 267,788 12,265 6.11% 241,689 11,701 6.46%
Commercial real estate 88,392 4,265 6.43% 74,961 4,176 7.43%
Commercial 23,978 1,237 6.88% 23,237 1,476 8.47%
Consumer and other 35,812 1,873 6.97% 40,092 2,268 7.54%
Federal funds sold 2,228 31 1.86% 11,112 433 5.20%
Interest on balances with banks 4,337 62 1.91% 8,203 314 5.10%
- ------------------------------------------------------------------------------------------------------
Total Interest Earning Assets/
Total Interest Income 584,425 $25,517 6.12% 551,002 $25,727 6.50%
- ------------------------------------------------------------------------------------------------------
Cash and due from banks 10,078 10,446
Bank premises and equipment 9,183 9,675
Accrued interest receivable 3,363 3,311
Cash surrender value of life insurance 7,475 7,160
Other assets 4,667 4,099
Less: Allowance for loan losses 4,919 4,238
- ------------------------------------------------------------------------------------------------------
TOTAL ASSETS $614,272 $581,455
- ------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 54,349 $ 314 0.77% $ 55,419 $ 406 .98%
Savings 76,741 329 0.57% 81,376 683 1.12%
Money markets 112,516 1,696 2.01% 89,535 2,088 3.11%
Time - Over $100 38,042 1,142 4.00% 41,709 1,540 4.92%
Time - Other 69,872 2,003 3.82% 78,416 2,408 4.09%
Federal funds purchased - - - - - -
Repurchase agreements 34,256 681 2.65% 24,478 588 3.20%
Short-term borrowings 6,224 158 3.38% 396 15 5.05%
Long-term borrowings 73,003 2,122 3.88% 62,107 1,882 4.04%
- ------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 465,003 $ 8,445 2.42% 433,436 $ 9,610 2.96%
- ------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 72,213 75,164
All other liabilities 4,714 4,698
Stockholders' equity 72,342 68,157
- ------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $614,272 $581,455
- ------------------------------------------------------------------------------------------------------
Interest Spread 3.70% 3.54%
- ------------------------------------------------------------------------------------------------------
Net Interest Income $17,072 $16,117
- ------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Net interest margin 3.89% 3.90%
Return on average assets 1.55% 1.27%
Return on average equity 13.14% 10.86%
Average equity to average assets 11.78% 11.72%
Dividend payout ratio 37.35% 43.02%
- ------------------------------------------------------------------------------------------------------
</Table>
<Page>22
INVESTMENTS
The Company's investment portfolio has 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 general interest rates in the economy change, there is migration of some
deposits among investment options as customers seek 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.
The provision for loan losses decreased $141 from $308 for the three months
ended September 30, 2007 to $167 for the three months ended September 30, 2008.
Loans charged off totaled $82 and recoveries were $15 for the three months ended
September 30, 2008. In the same period of 2007, loans charged off totaled $28
and recoveries were $0. For the nine months ended September 30, 2008, the
<Page>23
provision for loan losses was $618, an increase of $90 from $528 in the first
nine months of 2007. Loans charged-off totaled $109 and recoveries were $31 for
the nine months ended September 30, 2008. In the same period of 2007 loans
charged off were $130, offset by recoveries of $2. At September 30, 2008 the
allowance for loan losses was $5,240, or 1.21% of gross loans compared to $4,600
or 1.16% of gross loans at September 30, 2007.
NON-INTEREST INCOME
The following table sets forth information by category of non-interest income
for the Company for the three months ended September 30, 2008 and September 30,
2007, respectively:
<Table>
<Caption>
September 30, September 30,
Three Months Ended: 2008 2007
- ---------------------------------------------------------------------------
Trust department income $ 386 $ 421
Service charges on deposit accounts 403 245
Merchant transaction income 1,583 1,482
Other fee income 483 414
Bank-owned life insurance income 78 80
Other operating income 30 23
VISA mandatory share redemption - -
Realized gains (losses) on securities, net 23 (2)
- ---------------------------------------------------------------------------
Total Non-Interest Income $ 2,986 $ 2,663
- ---------------------------------------------------------------------------
</Table>
Total non-interest income increased $323 or 12.1% to $2,986 for the three months
ended September 30, 2008, compared with $2,663 for the same period in 2007.
Trust department income decreased $35 or 8.3% due to the decrease in market
value of trust assets. Service charges on deposit accounts increased $158 or
64.5% primarily due to the increased number of accounts and increased service
charge activity. Merchant transaction income increased $101 or 6.8% due to
higher transaction volume and new business. Other fee income increased $69 or
16.7% from prior year levels mostly due to increases in brokerage income of $47.
Realized gains (losses) on securities increased $25 to $23 from ($2) for the
same period of 2007, due to the sale of equity securities and mortgage-backed
securities.
The following table sets forth information by category of non-interest income
for the Company for the nine months ended September 30, 2008 and September 30,
2007, respectively:
<Table>
<Caption>
September 30, September 30,
Nine Months Ended: 2008 2007
- ---------------------------------------------------------------------
Trust department income $ 1,133 $ 1,160
Service charges on deposit accounts 1,062 756
Merchant transaction income 3,702 3,402
Other fee income 1,451 1,068
Bank-owned life insurance income 236 235
Other operating income 148 69
VISA mandatory share redemption 1,213 -
Realized gains (losses) on
securities, net 23 49
- ---------------------------------------------------------------------
Total Non-Interest Income $ 8,968 $ 6,739
- ---------------------------------------------------------------------
</Table>
Total non-interest income increased $2,229 or 33.1% to $8,968 during the first
nine months of 2008 from $6,739 for the same period of 2007. Service charges on
deposit accounts increased $306 or 40.5% primarily due to the increased number
of accounts and increased service charge activity. Merchant transaction income
increased $300 or 8.8%, mainly due to higher transaction volume and new
business. Other fee income increased $383 or 35.9% mainly from increased
brokerage fee income of $326 compared to last year. Other operating income
increased $79 or 114.5% due to increased income on other real estate owned of
$49, along with an increase in general operating income. The Company realized a
gain of $1,213 related to VISA, Inc.'s Initial Public Offering, which consisted
of a mandatory partial share redemption, during the first quarter of 2008,
discussed earlier. Realized gains (losses) on securities decreased $26 or 53.1%
to $23 during the first nine months of 2008 from $49 for the same period of
2007.
<Page>24
NON-INTEREST EXPENSES
The following table sets forth information by category of non-interest expenses
for the Company for the three months ended September 30, 2008 and September 30,
2007, respectively:
<Table>
<Caption>
September 30, September 30,
Three Months Ended: 2008 2007
- ---------------------------------------------------------------------
Salaries and employee benefits $ 2,481 $ 2,108
Expense of premises and fixed assets 626 605
Merchant transaction expenses 1,182 1,149
Other operating expenses 1,537 1,238
- --------------------------------------------------------------------
Total Non-Interest Expenses $ 5,826 $ 5,100
- --------------------------------------------------------------------
</Table>
Total non-interest expenses increased $726 or 14.2% to $5,826 for the three
months ended September 30, 2008 compared with $5,100 for the same period of
2007. Salaries and employee benefits expense increased $373 or 17.7% aided by a
$210 rebate of health insurance premiums during the third quarter of 2007, along
with current quarter increases in salaries and commissions resulting from
additional employee hires and increased wealth management revenue. Other
operating expenses increased $299 or 24.2% aided by a $139 rebate of computer
processing fees during the third quarter of 2007, along with current quarter
increases in professional services of $124, brokered money market administrative
fees of $25 and stationery and supplies of $25.
The following table sets forth information by category of non-interest expenses
for the Company for the nine months ended September 30, 2008 and September 30,
2007, respectively:
<Table>
<Caption>
September 30, September 30,
Nine Months Ended: 2008 2007
- ---------------------------------------------------------------------
Salaries and employee benefits $ 7,405 $ 6,813
Expense of premises and fixed assets 2,061 1,955
Merchant transaction expenses 2,787 2,644
Other operating expenses 4,088 4,031
- ---------------------------------------------------------------------
Total Non-Interest Expenses $16,341 $15,443
- ---------------------------------------------------------------------
</Table>
Total non-interest expenses increased $898 or 5.8% to $16,341 during the nine
months of 2008 compared with $15,443 for the same period of 2007. Salaries and
employee benefits expense increased $592 or 8.7% mainly due to increased
salaries resulting from additional employee hires, along with increased
commissions of $246 related to our wealth management division. Premises and
fixed assets expense increased $106 or 5.4% due to computer system upgrades and
increased occupancy expense. Merchant transaction expenses increased $143 or
5.4% due to higher transaction volume. Other operating expenses increased $57 or
1.4% due to increases in professional services of $285, contributions of $91,
stationery and supplies of $51 and general operating expenses, offset by the
reversal in the first quarter of 2008 of the $497 VISA litigation accrual
recorded by the Company in the fourth quarter of 2007. Without the impact of the
VISA reversal, total non-interest expenses would have increased $1,395 or
9.0%(2).
INCOME TAXES
Applicable income taxes decreased $25 or 4.1% to $579 for the three months ended
September 30, 2008 from $604 for the same period of 2007 due to more tax-free
income included in overall operating income. Also, applicable income taxes
increased $620 or 46.5% during the first nine months of 2008 primarily due to
the income on the VISA initial public offering and overall higher income.
- -----------------------------
2 See pages 15 and 16 for a reconciliation of GAAP net income to net income
excluding the gain related to the VISA, Inc. initial public offering during
the nine months ended September 30, 2008.
<Page>25
LOAN PORTFOLIO
Details regarding the Company's loan portfolio are as follows:
<Table>
<Caption>
September 30, December 31,
As of: 2008 2007
- -------------------------------------------------------------------------------------
Real estate - construction and land development $ 22,098 $ 25,858
Real estate mortgages 352,398 318,437
Commercial 24,014 24,505
Credit card and related plans 3,189 3,324
Installment and other 26,745 26,542
Obligations of states & political subdivisions 4,536 5,973
- -------------------------------------------------------------------------------------
Loans, net of unearned income 432,980 404,639
Less: Allowance for loan losses 5,240 4,700
- -------------------------------------------------------------------------------------
Loans, net $427,740 $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. The
Company's lending is primarily residential and commercial secured mortgage
loans, in Northeastern Pennsylvania, based upon conservative underwriting
standards.
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. Due to the
consistent application of conservative underwriting standards, the Company's
loan quality has remained strong during the current general economic downturn.
The Company has not engaged in any sub-prime credit lending and is therefore,
not subject to the credit risks associated with such loans.
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.
<Page>26
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>
September 30, December 31, September 30,
As of: 2008 2007 2007
- ---------------------------------------------------------------------------------------------
Non-accrual loans $ 1,352 $ 1,610 $ 406
Other real estate owned - - -
- ---------------------------------------------------------------------------------------------
Total non-performing assets $ 1,352 $ 1,610 $ 406
- ---------------------------------------------------------------------------------------------
Loans past due 90 days or more and accruing:
Secured by real estate $ 924 $ 57 $ 285
Guaranteed student loans 200 408 461
Credit card loans 29 2 17
Commercial - - -
Other loans to individuals for
household, family, and other personal
expenditures - 12 2
- ---------------------------------------------------------------------------------------------
Total loans past due 90 days or
more and accruing $ 1,153 $ 479 $ 765
- ---------------------------------------------------------------------------------------------
</Table>
Non-accrual loans increased $946 to $1,352 at September 30, 2008 from $406 at
September 30, 2007. However, non-accrual loans have decreased $258 from $1,610
at December 31, 2007.
Loans are generally placed on a non-accrual status when principal or interest
is past due 90 days and 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 future principal and
interest is probable.
Loans on which the accrual of interest has been discontinued or reduced amounted
to $1,352 at September 30, 2008, up from $406 at September 30, 2007. If interest
on those loans had been accrued, such income would have been $186 and $253 for
the nine months ended September 30, 2008 and September 30, 2007, respectively.
Interest income on those loans, which is recorded only when received, amounted
to $16 and $143 at September 30, 2008 and September 30, 2007, respectively.
There were no commitments to lend additional funds to individuals whose loans
are in non-accrual status.
Management's 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 September 30, 2008 there are no significant loans as to which management
has serious doubt about their collectibility. During the second quarter of 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 $8.4 million of TERI loans out of a total student loan portfolio of $20.7
million. The Company does not anticipate that TERI's bankruptcy filing will
significantly impact the Company's financial statements. These loans are placed
on non-accrual status when they become more than 90 days past due. At September
30, 2008 there was $128,000 in such loans placed on non-accrual status,
essentially unchanged from June 30, 2008.
At September 30, 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.
<Page>27
LOAN LOSS EXPERIENCE
The following tables present the Company's loan loss experience during the
periods indicated:
<Table>
<Caption>
September 30, September 30,
Three Months Ended: 2008 2007
- ---------------------------------------------------------------------
Balance at beginning of period $ 5,140 $ 4,320
Charge-offs:
Real estate mortgages - -
Commercial and all others - 10
Credit card and related plans 2 18
Installment loans 80 -
- ---------------------------------------------------------------------
Total charge-offs 82 28
- ---------------------------------------------------------------------
Recoveries:
Real estate mortgages - -
Commercial and all others 1 -
Credit card and related plans 14 -
Installment loans - -
- ---------------------------------------------------------------------
Total recoveries 15 -
- ---------------------------------------------------------------------
Net charge-offs (recoveries) 67 28
- ---------------------------------------------------------------------
Provision charged to operations 167 308
- ---------------------------------------------------------------------
Balance at End of Period $5,240 $4,600
- ---------------------------------------------------------------------
Ratio of net charge-offs (recoveries)
to average loans outstanding 0.016% 0.007%
- ---------------------------------------------------------------------
</Table>
<Table>
<Caption>
September 30, September 30,
Nine Months Ended: 2008 2007
- ---------------------------------------------------------------------
Balance at beginning of period $ 4,700 $ 4,200
Charge-offs:
Real estate mortgages - 84
Commercial and all others - 10
Credit card and related plans 16 34
Installment loans 93 2
- ---------------------------------------------------------------------
Total charge-offs 109 130
- ---------------------------------------------------------------------
Recoveries:
Real estate mortgages - -
Commercial and all others 14 -
Credit card and related plans 17 1
Installment loans - 1
- ---------------------------------------------------------------------
Total recoveries 31 2
- ---------------------------------------------------------------------
Net charge-offs (recoveries) 78 128
- ---------------------------------------------------------------------
Provision charged to operations 618 528
- ---------------------------------------------------------------------
Balance at End of Period $ 5,240 $ 4,600
- ---------------------------------------------------------------------
Ratio of net charge-offs (recoveries)
to average loans outstanding 0.019% 0.034%
- ---------------------------------------------------------------------
</Table>
The allowance for loan losses at September 30, 2008 was $5,240 or 1.21% of total
loans compared to $4,600 or 1.16% of total loans at September 30, 2007.
Management believes the loan loss reserve is adequate.
<Page>28
The allowance for loan losses is allocated as follows:
<Table>
<Caption>
September 30, December 31, September 30,
As of: 2008 2007 2007
- ----------------------------------------------------------------------------------------
Amount % * Amount % * Amount % *
- ----------------------------------------------------------------------------------------
Real estate mortgages $1,200 86% $1,200 85% $1,300 84%
Commercial and all others 3,440 6% 2,900 7% 2,780 7%
Credit card and related plans 300 1% 300 1% 250 1%
Personal installment loans 300 7% 300 7% 270 8%
- ----------------------------------------------------------------------------------------
Total $5,240 100% $4,700 100% $4,600 100%
- ----------------------------------------------------------------------------------------
</Table>
* Percent of loans in each category to total loans
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
September 30, 2008 the Company had $202,978 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.
At September 30, 2008 the Bank has entered into contracts for the renovation of
various branches, in the amount of $3,216, approximately $748 of which had been
disbursed as of October 17, 2008.
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
<Page>29
same terms and conditions as those prevailing at the time for comparable
transactions with unrelated parties. At September 30, 2008 the Bank has issued
standby letters of credit for the accounts of related parties in the amount of
$7,990.
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 19.80% at September 30, 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.
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.
<Page>30
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
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 September 30, 2008 that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
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.
<Page>31
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 September 30, 2008, the Company owned approximately $91.0 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 September 30, 2008, the Company's available for sale marketable
securities portfolio had a net unrealized loss, net of taxes, of $1.8 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.
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.
<Page>32
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 September 30, 2008, the Company employed 173 full-time equivalent
employees. The employees of the Company are not represented by any collective
bargaining group. Management of the Company considers relations with its
employees to be good.
OUR OPERATIONS COULD BE AFFECTED IF WE DO NOT HAVE ACCESS TO MODERN AND RELIABLE
TECHNOLOGY.
The Company operates in a highly-automated environment, wherein almost all
transactions are processed by computer software to produce results. To remain
competitive, the Company must continually evaluate the adequacy of its data
processing capabilities and make revisions as needed.
The Company regularly tests its ability to restore data capabilities in the
event of a natural disaster, sustained power failure or other inability to
utilize its primary systems.
LIQUIDITY RISK
INCREASED NEEDS FOR DISBURSEMENT OF FUNDS ON LOANS AND DEPOSITS CAN AFFECT OUR
LIQUIDITY.
The objective of liquidity management is to maintain a balance between sources
and uses of funds in such a way that the cash requirements of customers for
loans and deposit withdrawals are met in the most economical manner. Management
monitors its liquidity position continuously in relation to trends of loans and
deposits for short-term as well as long-term requirements. Liquid assets are
monitored on a daily basis to assure maximum utilization. Management also
manages its liquidity requirements by maintaining an adequate level of readily
marketable assets and access to short-term funding sources. Management does not
foresee any adverse trends in liquidity.
OUR FUTURE PENSION PLAN COSTS AND CONTRIBUTIONS COULD BE UNFAVORABLY IMPACTED BY
THE FACTORS THAT ARE USED IN THE ACTUARIAL CALCULATIONS.
Our costs for the 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>33
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: November 6, 2008
By /s/ PATRICK SCANLON
------------------------------
Patrick Scanlon
Senior Vice President, Controller
(Principal Financial Officer)
Dated: November 6, 2008
<Page>34
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.
October 31, 2008 /s/ CRAIG W. BEST
------------------------------
Craig W. Best
President and CEO
<Page>35
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.
October 31, 2008 /s/ PATRICK SCANLON
------------------------------
Patrick Scanlon
Senior Vice President, Controller
(Principal Financial Officer)
<Page>36
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
September 30, 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
October 31, 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
September 30, 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)
October 31, 2008