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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 March 31, 2009
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
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Internal Revenue Service -- Employer Identification No. 23-2939222
150 North Washington Avenue, Scranton, Pennsylvania 18503-1848
(570) 346-7741
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant has submitted electronically and
posted on its corporate Web site, if any, every Interactive Date File required
to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section
232.405 of this chapter) during the preceding 12 months (or for such shorter
period that the registrant was required to submit and post such files).
Yes |_| No |_|
Indicate by check mark 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 |_| (Do not check if a smaller reporting company)
Smaller reporting company |_|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes |_| No |X|
The total number of shares of the registrant's Common Stock, $0.01 par value,
outstanding on April 30, 2009 was 3,276,079, which includes 1,128,079 shares
issued on April 1, 2009 in connection with the registrant's acquisition of Old
Forge Bank.
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PENSECO FINANCIAL SERVICES CORPORATION
PAGE
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PART I -- FINANCIAL INFORMATION
Item 1. Unaudited Financial Statements - Consolidated
Balance Sheets:
March 31, 2009............................................ 3
December 31, 2008......................................... 3
Statements of Income:
Three Months Ended March 31, 2009......................... 4
Three Months Ended March 31, 2008......................... 4
Statements of Cash Flows:
Three Months Ended March 31, 2009......................... 5
Three Months Ended March 31, 2008......................... 5
Notes to Unaudited Consolidated Financial Statements.......... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk...... 28
Item 4. Controls and Procedures......................................... 28
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings................................................. 29
Item 1A. Risk Factors........................................................ 29
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds....... 31
Item 3. Defaults Upon Senior Securities................................... 31
Item 4. Submission of Matters to a Vote of Security Holders............... 31
Item 5. Other Information................................................. 31
Item 6. Exhibits.......................................................... 31
Signatures ................................................................... 32
2
PART I. FINANCIAL INFORMATION, ITEM 1 -- FINANCIAL STATEMENTS
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
March 31, December 31,
2009 2008
------------- -------------
ASSETS
Cash and due from banks $ 9,186 $ 7,246
Interest bearing balances with banks 2,114 2,109
Federal funds sold - -
------------- -------------
Cash and Cash Equivalents 11,300 9,355
Investment securities:
Available-for-sale, at fair value 108,272 94,996
Held-to-maturity (fair value of $63,170
and $64,678, respectively) 60,580 62,484
------------- -------------
Total Investment Securities 168,852 157,480
Loans, net of unearned income 429,286 441,148
Less: Allowance for loan losses 6,050 5,275
------------- -------------
Loans, Net 423,236 435,873
Bank premises and equipment 10,647 10,391
Other real estate owned 474 -
Accrued interest receivable 3,344 3,518
Cash surrender value of life insurance 7,762 7,684
Other assets 22,678 4,666
------------- -------------
Total Assets $ 648,293 $ 628,967
============= =============
LIABILITIES
Deposits:
Non-interest bearing $ 72,621 $ 72,456
Interest bearing 362,466 352,269
------------- -------------
Total Deposits 435,087 424,725
Other borrowed funds:
Repurchase agreements 35,319 29,155
Short-term borrowings 28,468 24,204
Long-term borrowings 70,141 72,720
Accrued interest payable 1,042 1,118
Other liabilities 4,905 3,403
------------- -------------
Total Liabilities 574,962 555,325
------------- -------------
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 64,284 64,745
Accumulated other comprehensive income (1,793) (1,943)
------------- -------------
Total Stockholders' Equity 73,331 73,642
------------- -------------
Total Liabilities and Stockholders' Equity $ 648,293 $ 628,967
============= =============
(See accompanying Notes to Unaudited Consolidated Financial Statements)
3
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended Three Months Ended
March 31, 2009 March 31, 2008
------------------------ ------------------------
INTEREST INCOME
Interest and fees on loans $ 6,284 $ 6,661
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency obligations 878 905
States & political subdivisions 861 836
Other securities 14 74
Interest on Federal funds sold - -
Interest on balances with banks 3 11
------------- -------------
Total Interest Income 8,040 8,487
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INTEREST EXPENSE
Interest on time deposits of $100,000 or more 278 451
Interest on other deposits 943 1,533
Interest on other borrowed funds 821 926
------------- -------------
Total Interest Expense 2,042 2,910
------------- -------------
Net Interest Income 5,998 5,577
Provision for loan losses 996 235
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Net Interest Income After Provision for Loan Losses
5,002 5,342
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NON-INTEREST INCOME
Trust department income 310 365
Service charges on deposit accounts 339 263
Merchant transaction income 1,208 1,184
Brokerage income 117 181
Other fee income 287 298
Bank-owned life insurance income 79 78
Other operating income 70 36
VISA mandatory share redemption - 1,213
Realized gains (losses) on securities, net - -
------------- -------------
Total Non-Interest Income 2,410 3,618
------------- -------------
NON-INTEREST EXPENSES
Salaries and employee benefits 2,478 2,415
Expense of premises and fixed assets 791 768
Merchant transaction expenses 857 902
Merger related costs 1,335 -
Other operating expenses 1,663 973
------------- -------------
Total Non-Interest Expenses 7,124 5,058
------------- -------------
Income before income taxes 288 3,902
Applicable income taxes (153) 945
------------- -------------
Net Income 441 2,957
Other comprehensive income, net of taxes:
Unrealized securities gains (losses) 150 406
Unrealized gains on employee benefit plans - -
------------- -------------
Comprehensive Income $ 591 $ 3,363
============= =============
Earnings per Common Share
(Based on 2,148,000 shares outstanding) $ 0.21 $ 1.38
Cash Dividends Declared Per Common Share $ 0.42 $ 0.41
(See accompanying Notes to Unaudited Consolidated Financial Statements)
4
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
Three Months Ended Three Months Ended
March 31, 2009 March 31, 2008
---------------------- ---------------------
OPERATING ACTIVITIES
Net income $ 441 $ 2,957
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 217 214
Provision for loan losses 996 225
Deferred income tax (benefit) provision (381) 6
Amortization of securities, (net of accretion) 105 79
Gain on VISA mandatory share redemption - (1,213)
Net realized (gains) losses on securities - -
(Gain) loss on other real estate - -
Decrease (increase) in interest receivable 174 223
(Increase) decrease in cash surrender value of life insurance (78) (78)
(Increase) decrease in other assets (17,631) 400
(Decrease) increase in income taxes payable (274) 605
(Decrease) increase in interest payable (76) 52
Increase (decrease) in other liabilities 1,699 (1,208)
----------- ------------
Net cash (used) provided by operating activities (14,808) 2,262
----------- ------------
INVESTING ACTIVITIES
Purchase of investment securities available-for-sale (13,797) (27,214)
Proceeds from sales and maturities of investment securities
available-for-sale - 6,451
Purchase of investment securities to be held-to-maturity - -
Proceeds from repayments of investment securities available-for-sale 703 3,036
Proceeds from repayments of investment securities held-to-maturity 1,844 1,414
Net loans repaid (originated) 11,167 (4,336)
Proceeds from other real estate - -
Investment in premises and equipment (473) (91)
----------- ------------
Net cash (used) provided by investing activities (556) (20,740)
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FINANCING ACTIVITIES
Net increase (decrease) in demand and savings deposits 11,117 1,407
Net (payments) proceeds on time deposits (755) 3,374
Increase (decrease) in repurchase agreements 6,164 20,028
Net increase (decrease) in short-term borrowings 4,264 (12,998)
Increase in long-term borrowings 1,000 26,000
Repayments of long-term borrowings (3,579) (2,656)
Cash dividends paid (902) (881)
----------- ------------
Net cash provided (used) by financing activities 17,309 34,274
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Net increase (decrease) in cash and cash equivalents 1,945 15,796
Cash and cash equivalents at January 1 9,355 11,644
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Cash and cash equivalents at March 31 $ 11,300 $ 27,440
=========== ============
The Company paid interest and income taxes of $2,118 and $0 and $2,913 and $0,
for the three months ended March 31, 2009 and 2008, respectively.
(See accompanying Notes to Unaudited Consolidated Financial Statements)
5
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE QUARTER ENDED MARCH 31, 2009
(UNAUDITED)
These Notes to Unaudited Consolidated Financial Statements reflect events
subsequent to December 31, 2008, 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, 2008,
which was filed with the Securities and Exchange Commission (SEC) on March 16,
2009.
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 or any other period.
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, 2008.
NOTE 3 -- USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
6
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 gains and losses, net of
tax, reported as a net amount in a separate component of stockholders' equity
until realized.
The amortization of premiums on mortgage-backed securities is done based on
management's estimate of the lives of the securities, adjusted, when necessary,
for advanced prepayments in excess of those estimates.
Realized gains and losses on the sale of securities available-for-sale are
determined using the specific identification method and are reported as a
separate component of other income in the Statements of Income. Unrealized gains
and losses are included as a separate item in computing comprehensive income.
The amortized cost and fair value of investment securities at March 31, 2009 and
December 31, 2008 are as follows:
AVAILABLE-FOR-SALE
Gross Gross
Amortized Unrealized Unrealized Fair
March 31, 2009 Cost Gains Losses Value
- -----------------------------------------------------------------------------------------------------
U.S. Agency securities $ 35,932 $ 745 $ 3 $ 36,674
Mortgage-backed securities 20,173 630 - 20,803
States & political subdivisions 44,763 643 1,405 44,001
- -----------------------------------------------------------------------------------------------------
Total Debt Securities 100,868 2,018 1,408 101,478
Equity securities 6,835 673 714 6,794
- -----------------------------------------------------------------------------------------------------
Total Available-for-Sale $ 107,703 $ 2,691 $ 2,122 $ 108,272
- -----------------------------------------------------------------------------------------------------
AVAILABLE-FOR-SALE
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2008 Cost Gains Losses Value
- -----------------------------------------------------------------------------------------------------
U.S. Agency securities $ 25,221 $ 919 $ - $ 26,140
Mortgage-backed securities 20,873 392 16 21,249
States & political subdivisions 41,726 514 1,460 40,780
- -----------------------------------------------------------------------------------------------------
Total Debt Securities 87,820 1,825 1,476 88,169
Equity securities 6,835 623 631 6,827
- -----------------------------------------------------------------------------------------------------
Total Available-for-Sale $ 94,655 $ 2,448 $ 2,107 $ 94,996
- -----------------------------------------------------------------------------------------------------
7
HELD-TO-MATURITY
Gross Gross
Amortized Unrealized Unrealized Fair
March 31, 2009 Cost Gains Losses Value
- -----------------------------------------------------------------------------------------------------
Mortgage-backed securities $ 31,352 $ 1,096 $ - $ 32,448
States & political subdivisions 29,228 1,508 14 30,722
- -----------------------------------------------------------------------------------------------------
Total Held-to-Maturity $ 60,580 $ 2,604 $ 14 $ 63,170
- -----------------------------------------------------------------------------------------------------
HELD-TO-MATURITY
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2008 Cost Gains Losses Value
- -----------------------------------------------------------------------------------------------------
Mortgage-backed securities $ 33,254 $ 661 $ 2 $ 33,913
States & political subdivisions 29,230 1,558 23 30,765
- -----------------------------------------------------------------------------------------------------
Total Held-to-Maturity $ 62,484 $ 2,219 $ 25 $ 64,678
- -----------------------------------------------------------------------------------------------------
Equity securities at March 31, 2009 and December 31, 2008 consisted primarily of
other financial institutions' stock and Federal Home Loan Bank of Pittsburgh
(FHLB) stock, which is a required investment in order for the Company to
participate in an available line of credit program. The FHLB stock is stated at
par value as it is restricted to purchases and sales with the FHLB. The FHLB
suspended its stock repurchase and dividend payments during December 2008. Based
on current financial information available, management does not believe the FHLB
stock value is impaired as of March 31, 2009.
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.
The amortized cost and fair value of debt securities at March 31, 2009 by
contractual maturity are shown below. Expected maturities may differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
March 31, 2009 Available-for-Sale Held-to-Maturity
- -----------------------------------------------------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
- -----------------------------------------------------------------------------------------------------
Due in one year or less:
U.S. Agency securities $ 9,136 $ 9,258 $ - $ -
After one year through five years:
U.S. Agency securities 26,796 27,416 - -
After five year through ten years:
States & political
subdivisions 936 1,006 5,488 5,745
After ten years:
States & political
subdivisions 43,827 42,995 23,740 24,977
- -----------------------------------------------------------------------------------------------------
Subtotal 80,695 80,675 29,228 30,722
Mortgage-backed securities 20,173 20,803 31,352 32,448
- -----------------------------------------------------------------------------------------------------
Total Debt Securities $100,868 $ 101,478 $ 60,580 $ 63,170
- -----------------------------------------------------------------------------------------------------
8
The gross fair value and unrealized losses of the Company's investments
aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, at March 31, 2009 and
December 31, 2008, are as follows:
Less than twelve months Twelve months or more Totals
----------------------------- ------------------------------ -----------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
March 31, 2009 Value Losses Value Losses Value Losses
- ---------------------------------- ------------ --- ------------ ------------- -- ------------- ------------- -- ------------
U.S. Agency securities $ 2,514 $ 3 $ - $ - $ 2,514 $ 3
States & political subdivisions 11,009 377 14,977 1,042 25,986 1,419
Equities 33 18 316 696 349 714
------------ --- ------------ ------------- -- ------------- ------------- -- ------------
Total $ 13,556 $ 398 $ 15,293 $ 1,738 $ 28,849 $ 2,136
============ === ============ ============= == ============= ============= == ============
Less than twelve months Twelve months or more Totals
------------------------------ ----------------------------- -----------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
December 31, 2008 Value Losses Value Losses Value Losses
- ---------------------------------- ------------- -- ------------- ------------ -- ------------- ------------- -- ------------
Mortgage-backed securities $ - $ - $ 5,351 $ 18 $ 5,351 $ 18
States & political subdivisions 21,569 1,247 1,409 236 22,978 1,483
Equities 37 15 395 616 432 631
------------- -- ------------- ------------ -- ------------- ------------- -- ------------
Total $ 21,606 $ 1,262 $ 7,155 $ 870 $ 28,761 $ 2,132
============= == ============= ============ == ============= ============= == ============
The table at March 31, 2009 includes twenty-eight (28) securities that have
unrealized losses for less than twelve months and thirty-four (34) securities
that have been in an unrealized loss position for twelve or more months. The
table at December 31, 2008 includes forty-two (42) securities that have
unrealized losses for less than twelve months and twenty (20) 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 and
intent to hold these investments until a recovery of amortized cost, which may
be maturity, the Company does not consider these investments to be
other-than-temporarily impaired at March 31, 2009.
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 and intent to hold these investments until a
recovery of amortized cost, which may be maturity, the Company does not consider
these investments to be other-than-temporarily impaired at March 31, 2009.
9
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
and intent to hold these investments until a recovery of amortized cost, which
may be maturity, the Company does not consider these investments to be
other-than-temporarily impaired at March 31, 2009.
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 equity securities 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 cost, the Company does
not consider these investments to be other-than-temporarily impaired at March
31, 2009.
NOTE 5 -- LOAN PORTFOLIO
Details regarding the Company's loan portfolio on March 31, 2009 and December
31, 2008 are as follows:
MARCH 31, DECEMBER 31,
AS OF: 2009 2008
- -----------------------------------------------------------------------------------------
Real estate - construction and land development $ 23,736 $ 21,949
Real estate mortgages 349,029 355,528
Commercial 21,485 27,793
Credit card and related plans 3,168 3,272
Installment and other 27,519 28,135
Obligations of states & political subdivisions 4,349 4,471
- -----------------------------------------------------------------------------------------
Loans, net of unearned income 429,286 441,148
Less: Allowance for loan losses 6,050 5,275
- -----------------------------------------------------------------------------------------
Loans, net $ 423,236 $ 435,873
- -----------------------------------------------------------------------------------------
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 loan portfolio consists primarily of residential and commercial
mortgage loans secured by properties located in Northeastern Pennsylvania and
subject to 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.
10
NOTE 7 -- LONG-TERM DEBT
A summary of the Company's long-term debt at March 31, 2009 is as follows:
Monthly Installment Fixed Rate Maturity Date Balance
- ---------------------------------------------------------------------
Amortizing loans
$ 253 3.22% 03/15/10 $ 2,983
90 3.10% 02/28/13 3,981
430 3.74% 03/13/13 19,145
67 3.44% 03/02/15 4,303
13 3.48% 03/31/15 872
10 3.83% 04/02/18 923
186 4.69% 03/13/23 22,934
- ---------------------------------------------------------------------
Total amortizing 55,141
- ---------------------------------------------------------------------
Non-amortizing loans
2.62% 08/31/09 1,000
2.61% 03/01/10 1,000
1.71% 03/02/10 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 $ 70,141
- ---------------------------------------------------------------------
The loans are secured by a general collateral pledge of the Company.
The Company has agreed to maintain sufficient qualifying collateral to fully
secure the above borrowings.
Aggregate maturities of long-term debt at March 31, 2009 are as follows:
March 31, Principal
--------- ---------
2010 $ 13,550
2011 10,858
2012 10,160
2013 15,384
2014 2,450
Thereafter 17,739
-------------
$ 70,141
=============
NOTE 8 -- EMPLOYEE BENEFIT PLANS
The Company provides a defined benefit pension plan, currently under
curtailment, and a post-retirement benefit plan for eligible employees.
The components of the net periodic benefit cost are as follows:
Pension Benefits Other Benefits
---------------------------------------------------------
Three months ended March 31, 2009 2008 2009 2008
- --------------------------------------------------------------------------------------------------
Service cost $ - $ 101 $ 1 $ 1
Interest cost 175 204 5 5
Expected return on plan assets (205) (255) - -
Amortization of prior service cost - - 2 2
Amortization of net loss (gain) 49 35 - -
- --------------------------------------------------------------------------------------------------
Net periodic pension cost $ 19 $ 85 $ 8 $ 8
- --------------------------------------------------------------------------------------------------
Contributions
- -------------
The Company previously disclosed in its financial statements for the year ended
December 31, 2008 that it did not expect to contribute to its pension plan but
expected to contribute $18 to its post-retirement plan during 2009. Effective
June 22, 2008 the Company curtailed its defined benefit pension plan. The
11
actuarial calculations of required contributions for 2009 were revised to $468
and $32, respectively, as to its pension and post-retirement plans. As of April
15, 2009, $0 has been contributed to the pension plan for 2009 due to the use of
a portion of the Funding Standard Carryover Balance. Readers should refer to the
Company's Annual Report on Form 10-K for further details on the Company's
defined benefit pension plan. The actuarially computed information on the plan
curtailment, as to the pension obligation and funded status, was disclosed in
the Company's quarterly report on 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 began to sponsor a new 401(k) pension plan
for all eligible employees. The Company's 401(k) expense for the three months
ended March 31, 2009 was $38.
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 and the Bank's capital amounts and classifications are
also subject to qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the Capital Adequacy table on the following page) of Tier I and Total
Capital to risk-weighted assets and of Tier I Capital to average assets
(Leverage ratio). The table also presents the Company's actual capital amounts
and ratios. Management believes, as of March 31, 2009, that the Company and the
Bank meet all capital adequacy requirements to which they are subject.
As of March 31, 2009, the most recent notification from the Federal Deposit
Insurance Corporation (FDIC) categorized the Company as "well capitalized" under
the regulatory framework for prompt corrective action. To be categorized as
"well capitalized", the Company must maintain minimum Tier I Capital, Total
Capital and Leverage ratios as set forth in the Capital Adequacy table. There
are no conditions or events since that notification that management believes
have changed the Company's categorization by the FDIC.
The Company and Bank are also subject to minimum capital levels, which could
limit the payment of dividends, although the Company and Bank currently have
capital levels which are in excess of minimum capital level ratios required.
The Pennsylvania Banking Code restricts capital funds available for payment of
dividends to the retained earnings of the Bank. Accordingly, at March 31, 2009,
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.
12
Actual Regulatory Requirements
- --------------------------------------------------------------- ------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
------------------- ---------------------
As of March 31, 2009 Amount Ratio Amount Ratio Amount Ratio
- -----------------------------------------------------------------------------------------------------------------
Total Capital (to Risk Weighted Assets)
PFSC (Company) $ 80,303 19.09% > $ 33,648 > 8.0% > $ 42,060 > 10.0%
- - - -
PSB (Bank) $ 76,911 18.38% > $ 33,472 > 8.0% > $ 41,841 > 10.0%
- - - -
Tier 1 Capital (to Risk Weighted Assets)
PFSC (Company) $ 75,055 17.84% > $ 16,824 > 4.0% > $ 25,236 > 6.0%
- - - -
PSB (Bank) $ 71,671 17.13% > $ 16,736 > 4.0% > $ 25,105 > 6.0%
- - - -
Tier 1 Capital (to Average Assets)
PFSC (Company) $ 75,055 11.90% > * > * > $ 31,531 > 5.0%
- - - -
PSB (Bank) $ 71,671 11.43% > * > * > $ 31,351 > 5.0%
- - - -
PFSC - *3.0% ($18,919), 4.0% ($25,225) or 5.0% ($31,531) depending on the bank's
CAMELS Rating and other regulatory risk factors.
PSB - *3.0% ($18,811), 4.0% ($25,081) or 5.0% ($31,351) depending on the bank's
CAMELS Rating and other regulatory risk factors.
Actual Regulatory Requirements
- --------------------------------------------------------------- ------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
------------------- ---------------------
As of December 31, 2008 Amount Ratio Amount Ratio Amount Ratio
- -----------------------------------------------------------------------------------------------------------------
Total Capital (to Risk Weighted Assets)
PFSC (Company) $ 80,630 19.81% > $ 32,570 > 8.0% > $ 40,712 > 10.0%
- - - -
PSB (Bank) $ 77,275 19.03% > $ 32,486 > 8.0% > $ 40,607 > 10.0%
- - - -
Tier 1 Capital (to Risk Weighted Assets)
PFSC (Company) $ 75,544 18.56% > $ 16,285 > 4.0% > $ 24,427 > 6.0%
- - - -
PSB (Bank) $ 72,197 17.78% > $ 16,243 > 4.0% > $ 24,364 > 6.0%
- - - -
Tier 1 Capital (to Average Assets)
PFSC (Company) $ 75,544 12.26% > * > * > $ 30,813 > 5.0%
- - - -
PSB (Bank) $ 72,197 11.73% > * > * > $ 30,765 > 5.0%
- - - -
PFSC - *3.0% ($18,488), 4.0% ($24,651) or 5.0% ($30,813) depending on the bank's
CAMELS Rating and other regulatory risk factors.
PSB - *3.0% ($18,459), 4.0% ($24,612) or 5.0% ($30,765) 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.
13
The following table presents the assets reported on the consolidated statements
of financial condition at their fair value as of March 31, 2009 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.
Level I Level II Level III Total
------------- -------------- -------------- -------------
Assets:
Securities available-for-sale $ 6,744 $ 101,478 50 108,272
There were no transfers in or out of the Level III classification and there were
no changes in the valuation of Level III assets during the first quarter of
2009.
NOTE 11 -- AGREEMENT AND PLAN OF MERGER
An Agreement and Plan of Merger (the Agreement) by and between the Company, the
Bank and Old Forge Bank, was entered into on December 5, 2008. The Agreement
provided for, among other things, the Company to acquire 100% of the outstanding
common shares of Old Forge Bank through a two-step merger transaction. The
Company consummated the acquisition of Old Forge Bank on April 1, 2009. Old
Forge Bank has been merged with and into the Bank. Following the merger, the
Bank will continue to operate as a banking subsidiary of the Company.
Shareholders of Old Forge Bank were entitled to receive the merger consideration
in either cash or shares of Company common stock, or any combination thereof,
subject to certain limitations and allocation procedures set forth in the
Agreement. The per share amount was calculated from the cash consideration and
the value of the stock consideration based on the Company's closing price, as
such term is defined in the Agreement.
Old Forge Bank was an independent $215 million community bank, operating from
three locations in Lackawanna and Luzerne Counties of Pennsylvania. As a result
of the acquisition, the Company is now an $870 million financial institution
serving Northeastern Pennsylvania from 12 locations. Management of the Company
believes that the combined entity is in a more favorable position to compete
with local and regional banks in the marketplace.
There was approximately $26.4 million of goodwill created in the acquisition,
largely based on the Company's evaluation of the business growth opportunities
inherent in the Old Forge Bank customer base of loans and deposits, as well as
operating synergies and economy of scale expected from the merger. None of the
goodwill is expected to be deductible for income tax purposes.
The following table summarizes the consideration paid for Old Forge Bank and the
identifiable assets acquired and liabilities assumed at acquisition date.
April 1, 2009
-------------
Consideration
- -------------
Cash $ 17,405
Common Stock issued - 1,128,079 shares
of the Company. 38,242
---------
Fair value of consideration transferred $ 55,647
=========
The fair value of the 1,128,079 common shares of the Company issued as part of
the consideration paid on the acquisition of Old Forge Bank stock was $38,242,
determined by use of the weighted average price of Company shares traded on
March 31, 2009 ($33.90 per share). The Company believes that the weighted
average price of the Company stock traded on March 31, 2009 is the best
indication of value since the Company's common stock is not a heavily traded
security.
Acquisition-related costs recorded in the income statements of the
acquirer and acquiree for the three months ended March 31, 2009
are as follows:
Penseco Financial Services Corporation $ 1,335
----------
Old Forge Bank 451
----------
14
Recognized amounts of identifiable assets acquired and liabilities
assumed on April 1, 2009 are:
Cash $ 4,944
Investments 32,095
Loans 159,949
Property and equipment 1,576
Core Deposit Intangible 2,027
All other assets 12,193
----------
Identifiable Assets $ 212,784
----------
Deposits 177,018
Borrowings 5,000
All other liabilities 1,515
----------
Identifiable Liabilities 183,533
----------
Identifiable net assets 29,251
Goodwill 26,396
Total consideration transferred $ 55,647
==========
PRO FORMA BALANCE SHEET
AS OF MARCH 31, 2009
Penseco
Financial
Services Old Forge
Corporation Bank Pro Forma
($ = 000's) 3/31/2009 3/31/2009 Elimination Marks/Costs Adjustments 3/31/2009
- ------------------------------- ----------------- ------------- ----------- ------------- ------------ --------------
ASSETS
Cash and Equivalents $ 11,300 $ 4,944 $ 16,244
Securities 168,852 32,095 200,947
Gross Loans 429,286 166,348 (6,399)(d) 589,235
Loan Loss Reserves (6,050) (725) 725(a) (6,050)
Goodwill - - 26,396(j) 26,396
Other Intangibles 69 138 (138)(b) 2,027(k) 2,096
Buildings and FFE 10,647 1,708 (132)(e) 12,223
Other Assets 34,189 10,174 2,017(f) (17,405)(i) 28,976
------------ -------------- -------------
TOTAL ASSETS $ 648,293 $ 214,682 870,068
============ ============== =============
LIABILITIES
Deposits $ 435,087 $ 176,089 929(g) 612,105
Borrowings 133,928 5,000 138,928
Other Liabilities 5,947 1,015 500(h) 7,462
------------ -------------- -------------
TOTAL LIABILITIES 574,962 182,104 758,495
EQUITY
Common Equity 73,331 32,578 (32,578)(c) 38,242(l) 111,573
------------ -------------- -------------
Total Equity 73,331 32,578 111,573
------------ --------------
TOTAL LIABILITIES & EQUITY $ 648,293 $ 214,682 $ 870,068
============ ============== =============
FOOTNOTES:
- --------------------------------------------------------------------------------
(a) Elimination of loan loss reserve
(b) Elimination of Old Forge's intangible assets
(c) Elimination of Old Forge's common equity
(d) Fair value adjustment for loans
(e) Buildings and FF&E fair value adjustment
(f) Deferred tax adjustments related to fair value adjustments
(g) Fair value adjustment for certificates of deposits
(h) Fair value adjustment for unrecorded contingent liability
(i) Escrowed purchase price related to cash component
(j) Goodwill created in the transaction
(k) Fair value adjustment for core deposit intangible
(l) Purchase price related to the equity interest transferred
15
PRO FORMA INCOME STATEMENT
FOR THE THREE MONTHS ENDED MARCH 31, 2009
Penseco
Financial
Services Old Forge
Corporation Bank Pro Forma
($ = 000's) 3/31/2009 3/31/2009 Adjustments 3/31/2009
- ---------------------------------------- ----------------- --------------- --------------- ------------------
INTEREST INCOME
Interest and fees on loans $ 6,284 $ 2,524 252 (a) $ 9,060
Interest and dividends on investments 1,753 377 (30) (b) 2,100
Interest on Federal funds sold - 1 1
Interest on balances with banks 3 - 3
- ---------------------------------------------------------------------------------------------------------------------------
Total Interest Income 8,040 2,902 222 11,164
- ---------------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Interest on deposits 1,221 897 (52) (c) 2,066
Interest on borrowed funds 821 9 830
- ---------------------------------------------------------------------------------------------------------------------------
Total Interest Expense 2,042 906 (52) 2,896
- ---------------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 5,998 1,996 274 8,268
Provision for loan losses 996 75 1,071
- ---------------------------------------------------------------------------------------------------------------------------
Net Interest Income After Provision
for Loan Losses 5,002 1,921 274 7,197
- ---------------------------------------------------------------------------------------------------------------------------
OTHER INCOME
Service charges on deposits 339 80 419
Other non-interest income 2,071 97 2,168
Realized gains (losses) on securities - - -
- ---------------------------------------------------------------------------------------------------------------------------
Total Other Income 2,410 177 - 2,587
- ---------------------------------------------------------------------------------------------------------------------------
OTHER EXPENSES
Salaries and employee benefits 2,478 696 3,174
Expense of premises and equipment 791 146 937
Other non-interest expense 2,520 415 92 (d) 3,027
- ---------------------------------------------------------------------------------------------------------------------------
Total Other Expenses 5,789 1,257 92 7,138
- ---------------------------------------------------------------------------------------------------------------------------
Income before income taxes 1,623 841 182 2,646
Applicable income taxes 162 320 62 544
- ---------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 1,461 $ 521 120 $ 2,102
- ---------------------------------------------------------------------------------------------------------------------------
Earnings Per Common Share $ 0.68 $ 0.93 $ 0.64(e)
FOOTNOTES:
- --------------------------------------------------------------------------------
(a) Amortization of loan fair value adjustment
(b) Opportunity cost of cash paid to Old Forge shareholders at 0.70% rate
(c) Amortization of certificate of deposit fair value adjustment
(d) Amortization of core deposit intangible over a 10 year period using the
sum of the years digits method
(e) Pro Forma EPS based on Pro Forma shares outstanding of 3,276,079
(f) Excludes merger related costs of $1,335,000 and $451,000 and related tax
effect incurred by Penseco and Old Forge Bank, respectively
16
PRO FORMA INCOME STATEMENT
FOR THE TWELVE MONTHS ENDED DECEMBER 31, 2008
Penseco
Financial
Services Old Forge
Corporation Bank Pro Forma
($ = 000's) 12/31/2008 12/31/2008 Adjustments 12/31/2008
- ---------------------------------------- ----------------- --------------- --------------- ------------------
INTEREST INCOME
Interest and fees on loans $ 26,218 $ 10,184 $ 1,008 (a) $ 37,410
Interest and dividends on investments 7,583 1,779 (120)(b) 9,242
Interest on Federal funds sold 29 33 62
Interest on balances with banks 68 0 68
- ---------------------------------------------------------------------------------------------------------------------------
Total Interest Income 33,898 11,996 888 46,782
- ---------------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Interest on deposits 6,973 4,361 (208) (c) 11,126
Interest on borrowed funds 3,857 47 3,904
- ---------------------------------------------------------------------------------------------------------------------------
Total Interest Expense 10,830 4,408 (208) 15,030
- ---------------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 23,068 7,588 1,096 31,752
Provision for loan losses 861 300 1,161
- ---------------------------------------------------------------------------------------------------------------------------
Net Interest Income After Provision
for Loan Losses 22,207 7,288 1,096 30,591
- ---------------------------------------------------------------------------------------------------------------------------
OTHER INCOME
Service charges on deposits 1,477 486 1,963
Other non interest income 9,547 293 9,840
Realized gains (losses) on securities 12 20 32
- ---------------------------------------------------------------------------------------------------------------------------
Total Other Income 11,036 799 11,835
- ---------------------------------------------------------------------------------------------------------------------------
OTHER EXPENSES
Salaries and employee benefits 10,157 2,824 12,981
Expense of premises and equipment 2,703 543 3,246
Other non interest expense 9,312 1,635 368 (d) 11,315
- ---------------------------------------------------------------------------------------------------------------------------
Total Other Expenses 22,172 5,002 368 27,542
- ---------------------------------------------------------------------------------------------------------------------------
Income before income taxes 11,071 3,085 728 14,884
Applicable income taxes 2,458 565 248 3,271
- ---------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 8,613 $ 2,520 $ 480 $ 11,613
- ---------------------------------------------------------------------------------------------------------------------------
Earnings Per Common Share $ 4.01 $ 4.51 $ 3.55 (e)
FOOTNOTES:
- --------------------------------------------------------------------------------
(a) Amortization of loan fair value adjustment and effect in subsequent four
year period
(b) Opportunity cost of cash paid to Old Forge shareholders at 0.70% rate
(c) Amortization of certificate of deposit fair value adjustment
(d) Amortization of core deposit intangible over a 10 year period using the
sum of the years digits method
(e) Pro Forma EPS based on Pro Forma shares outstanding of 3,276,079
17
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 (the "Company") and its subsidiary, Penn Security Bank (the "Bank"),
and Trust Company, at March 31, 2009 and for the three month periods ended March
31, 2009 and March 31, 2008. All information is presented in thousands of
dollars, except as indicated. The Company consummated the acquisition of Old
Forge Bank on April 1, 2009. Therefore, the operating results for Old Forge Bank
for the three month period ended March 31, 2009 is not included herein.
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 Form 10-Q with respect to the three
months ended March 31, 2008 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. Also,
as to the three months ended March 31, 2009, these financial measures exclude
merger related costs related to the acquisition of Old Forge Bank on April 1,
2009. Financial measures which exclude the above-referenced items have not been
determined in accordance with generally accepted accounting principles ("GAAP")
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.
18
In March 2008, VISA, Inc. (VISA) completed its initial public offering. The Bank
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 0.6296 was established for the
conversion rate of Class B shares into Class A shares. If the funds in the
escrow account are insufficient to settle all the covered litigation, VISA may
sell additional Class A shares, use the proceeds to settle litigation, and
further reduce the conversion ratio. If funds remain in the escrow account after
all litigation is settled, the Class B conversion ratio will be increased to
reflect that surplus. As of March 31, 2009, the value of the Class A shares was
$55.60 per share. The value of unredeemed Class A equivalent shares owned by the
Company was $1.6 million as of March 31, 2009, 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 $497 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.
Merger costs related to the acquisition of Old Forge Bank consist of investment
banking costs, system conversion costs, valuation services, legal and accounting
fees and severance payments.
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.
Three Months Ended
March 31,
2009 2008 Change
--------------- ------------- --------------
Net interest income after provision for loan losses $ 5,002 $ 5,342 $ (340)
Non-interest income 2,410 3,618 (1,208)
Non-interest expense (7,124) (5,058) (2,066)
Income tax benefit (provision) 153 (945) 1,098
------------- -------------- ---------------
Net income 441 2,957 (2,516)
ADJUSTMENTS
- -----------
Non-interest income
Gain on mandatory redemption of VISA, Inc.
class B common stock - (1,213) 1,213
Non-interest expense
Merger related costs 1,335 - 1,335
Covered litigation provision - (497) 497
------------- -------------- ---------------
Total Adjustments pre-tax 1,335 (1,710) 3,045
Income tax provision (benefit) 315 (581) 896
------------- -------------- ---------------
After tax adjustments to GAAP 1,020 (1,129) 2,149
------------- -------------- ---------------
Adjusted net income $ 1,461 $ 1,828 $ (367)
============= ============== ===============
Return on Average Assets 0.93% 1.24%
Return on Average Equity 7.84% 10.37%
19
Return on average equity (ROE) and return on average assets (ROA) for the three
months ended March 31, 2009 was 2.37% (7.84% excluding the merger costs) and
..28% (.93% excluding the merger costs), respectively. ROE was 16.77% (10.37%
excluding the VISA IPO impact) and ROA was 2.00% (1.24% excluding the VISA IPO
impact) for the same period last year.
EXECUTIVE SUMMARY
Penseco Financial Services Corporation reported a decrease in net income of
$2,516 for the three months ended March 31, 2009 to $441 or $.21 per share
compared with $2,957 or $1.38 per share from the year ago period. The decrease
in net income was primarily attributed to $1,335 of merger related costs
associated with the acquisition of the Old Forge Bank, which was completed on
April 1, 2009, along with the first quarter 2008 one time positive impact of
$1,710 related to Visa International's Initial Public Offering. Net interest
income increased $421 or 7.5% largely due to reduced interest expense from lower
deposit costs. Core net income decreased $367 or 20.1% due to an increase in
FDIC insurance costs of $143 and a higher provision for potential loan losses of
$761. As of March 31, 2009 there are no significant loans as to which management
has serious doubt about their collectibility, however the Company felt it
prudent to increase its provision for loan losses as the general economy
continues to weaken. The allowance for loan losses at March 31, 2009 was 1.41%
of total loans compared to 1.20% of total loans at December 31, 2008 and 1.20%
of total loans at March 31, 2008.
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 before provision for loan losses increased $421 or 7.5% to
$5,998 for the three months ended March 31, 2009 compared to $5,577 for the
three months ended March 31, 2008. The average yield on interest earning assets
decreased 72 basis points, largely from the Federal Reserve Bank lowering its
target for the Federal funds rate to 25 basis points since the fall of 2007 from
5.75% to 0.25% in December 2008.
The net interest margin represents the Company's net yield on its average
interest earning assets and is calculated as net interest income divided by
average interest earning assets. In the three months ended March 31, 2009, net
interest margin decreased 29 basis points to 3.99% from 4.28% in the same period
of 2008.
Total average interest earning assets and average interest bearing funds
increased during the three months ended March 31, 2009 as compared to 2008.
Average interest earning assets increased $40.5 million or 7.2%, from $560.9
million in 2008 to $601.4 million in 2009 and average interest bearing funds
increased $34.3 million, or 7.7%, from $444.1 million to $478.4 million for the
same period, mainly due to increased loans during the 2009 period and increases
in money market accounts, time deposits, and repurchase agreements. Average
long-term borrowings increased a net of $8.0 million or 12.6% reflecting new
borrowings at the end of the first quarter of 2008. Average earning assets,
including Bank-Owned Life Insurance (BOLI), increased to 96.6% for the three
months ended March 31, 2009 from 96.2% for the year ago period.
Changes in the mix of both interest earning assets and funding sources also
impacted net interest income in the three months ended March 31, 2009 and 2008.
Average loans as a percentage of average interest earning assets decreased from
72.7% in 2008 to 72.6% in 2009. Average investments increased $10.6 million
remaining at 27.0% of interest earning assets. Interest bearing balances with
banks increased $.8 million to $2.3 million from $1.5 million. Average time
deposits increased $3.5 million to $110.9 million from $107.4 million, average
long-term borrowings increased $8.0 million, while repurchase agreements
increased $5.8 million or 24.5% to $29.5 million compared to $23.7 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 decreased 51 basis points from 5.92% for the
three months ended March 31, 2008 to 5.41% for the three months ended March 31,
2009. Average loan yields decreased 77 basis points, from 6.53% for the three
months ended March 31, 2008 to 5.76% for the three months ended March 31, 2009.
The average time deposit costs decreased 138 basis points from 4.21% for the
three months ended March 31, 2008 to 2.83% for the three months ended March 31,
2009. In addition, the average cost of money market accounts decreased 132 basis
points from 2.35% for the three months ended March 31, 2008 to 1.03% for the
three months ended March 31, 2009.
20
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY / INTEREST RATES
AND INTEREST DIFFERENTIAL
The table below presents average balances, interest income on a fully taxable
equivalent basis and interest expense, as well as average rates earned and paid
on the Company's major asset and liability items for the three months ended
March 31, 2009 and March 31, 2008.
- ----------------------------------------------------------------------------------------------------------------------
MARCH 31, 2009 MARCH 31, 2008
ASSETS AVERAGE REVENUE/ YIELD/ AVERAGE REVENUE/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
- ----------------------------------------------------------------------------------------------------------------------
Investment Securities
Available-for-sale:
U.S. Agency obligations $ 52,603 $ 497 3.78% $ 35,989 $ 471 5.23%
States & political subdivisions 41,124 474 6.99% 40,594 447 6.67%
Federal Home Loan Bank stock 5,568 - - 4,885 48 3.93%
Other 1,260 14 4.44% 2,736 26 3.80%
Held-to-maturity:
U.S. Agency obligations 32,537 381 4.68% 38,229 434 4.54%
States & political subdivisions 29,229 386 8.00% 29,239 389 8.06%
Loans, net of unearned income:
Real estate mortgages 274,297 3,972 5.79% 263,008 4,098 6.23%
Commercial real estate 101,798 1,440 5.66% 84,415 1,445 6.85%
Commercial 24,954 344 5.51% 23,706 444 7.49%
Consumer and other 35,714 528 5.91% 36,666 674 7.35%
Federal funds sold - - - - - -
Interest on balances with banks 2,300 3 0.52% 1,481 11 2.97%
- ----------------------------------------------------------------------------------------------------------------------
Total Interest Earning Assets/
Total Interest Income $ 601,384 $ 8,039 5.64% $ 560,948 $ 8,487 6.36%
- ----------------------------------------------------------------------------------------------------------------------
Cash and due from banks 8,066 9,900
Bank premises and equipment 10,519 9,257
Accrued interest receivable 3,300 3,335
Cash surrender value of life insurance 7,713 7,396
Other assets 4,962 4,770
Less: Allowance for loan losses 5,254 4,704
- ----------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 630,690 $ 590,902
- ----------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 52,007 $ 57 0.44% $ 52,436 $ 112 0.85%
Savings 74,963 74 0.39% 77,803 131 0.67%
Money markets 118,795 306 1.03% 103,638 610 2.35%
Time - Over $100 39,820 278 2.79% 40,131 451 4.50%
Time - Other 71,101 506 2.85% 67,220 680 4.05%
Repurchase agreements 29,544 108 1.46% 23,655 154 2.60%
Short-term borrowings 20,744 28 0.54% 15,835 140 3.54%
Long-term borrowings 71,423 685 3.84% 63,411 632 3.99%
- ----------------------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense $ 478,397 $ 2,042 1.71% $ 444,129 $ 2,910 2.62%
- ----------------------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 73,012 70,848
All other liabilities 4,708 5,413
Stockholders' equity 74,573 70,512
- ----------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 630,690 $ 590,902
- ----------------------------------------------------------------------------------------------------------------------
Interest Spread 3.93% 3.74%
- ----------------------------------------------------------------------------------------------------------------------
Net Interest Income $ 5,997 $ 5,577
- ----------------------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Net interest margin 3.99% 4.28%
Return on average assets 0.28% 2.00%
Return on average equity 2.37% 16.77%
Average equity to average assets 11.82% 11.93%
Dividend payout ratio 200.00% 29.71%
- ----------------------------------------------------------------------------------------------------------------------
22
INVESTMENTS
The Company's investment portfolio has primarily 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 increased $761 from $235 for the three months
ended March 31, 2008 to $996 for the three months ended March 31, 2009, mainly
due to the management's more conservative valuation of the loan portfolio for
loan losses in response to recent economic conditions. Loans charged off totaled
$222 and recoveries were $1 for the three months ended March 31, 2009. In the
same period of 2008, loans charged off totaled $15 and recoveries were $5. At
March 31, 2009 the allowance for loan losses was $6,050, or 1.41% of gross loans
compared to $4,925 or 1.20% of gross loans at March 31, 2008.
22
NON-INTEREST INCOME
The following table sets forth information by category of non-interest income
for the Company for the three months ended March 31, 2009 and March 31, 2008,
respectively:
MARCH 31, MARCH 31,
THREE MONTHS ENDED: 2009 2008
- ------------------------------------------------------------------------------
Trust department income $ 310 $ 365
Service charges on deposit accounts 339 263
Merchant transaction income 1,208 1,184
Brokerage income 117 181
Other fee income 287 298
Bank-owned life insurance income 79 78
Other operating income 70 36
VISA mandatory share redemption - 1,213
Realized gains (losses) on securities, net - -
- ------------------------------------------------------------------------------
Total Non-Interest Income $ 2,410 $ 3,618
- ------------------------------------------------------------------------------
Total non-interest income decreased $1,208 or 33.4% to $2,410 for the three
months ended March 31, 2009, compared with $3,618 for the same period in 2008.
The lower non-interest income was attributed to a one time gain of $1,213
related to the VISA IPO during the first quarter of 2008. Trust department
income decreased $55 or 15.1% due to a decrease in the market value of trust
assets. Service charges on deposit accounts increased $76 or 28.9% primarily due
to the increased number of accounts and increased service charge activity.
Merchant transaction income increased $24 or 2.0% due to higher transaction
volume and new business. Brokerage fee income decreased $64 or 35.4% mostly due
to the decline in the overall market as the economy continues to slow.
NON-INTEREST EXPENSES
The following table sets forth information by category of non-interest expenses
for the Company for the three months ended March 31, 2009 and March 31, 2008,
respectively:
MARCH 31, MARCH 31,
THREE MONTHS ENDED: 2009 2008
- -----------------------------------------------------------------------------
Salaries and employee benefits $ 2,478 $ 2,415
Expense of premises and fixed assets 791 768
Merchant transaction expenses 857 902
Merger related costs 1,335 -
Other operating expenses 1,663 973
- -----------------------------------------------------------------------------
Total Non-Interest Expenses $ 7,124 $ 5,058
- -----------------------------------------------------------------------------
Total non-interest expenses increased $2,066 or 40.8% to $7,124 for the three
months ended March 31, 2009 compared with $5,058 for the same period of 2008.
Salaries and employee benefits expense increased $63 or 2.6% due to merit
increases in salaries and employee benefits. Merger related costs of $1,335
consist of computer and equipment upgrades totaling $606, investment banking,
valuation services, legal and accounting fees of $429 and severance payments of
$300. Other operating expenses increased $690 or 70.9% partly from a higher one
time FDIC assessment cost of $143. In March 2008, the Company reversed $497 of
legal and professional expense related to the VISA IPO thereby lowering other
operating expenses for three months ended March 31, 2008. Excluding both one
time charges, operating expense increased $50 or 3.4%.
INCOME TAXES
Applicable income taxes decreased to a benefit of $153 for the three months
ended March 31, 2009 from a provision of $945 for the same period of 2008, due
to additional expenses related to the merger with Old Forge Bank in 2009, a
higher provision for loan losses in 2009 and a one time gain on the VISA IPO
during the three months ended March 31, 2008.
23
LOAN PORTFOLIO
Details regarding the Company's loan portfolio on March 31, 2009 and December
31, 2008 are as follows:
MARCH 31, DECEMBER 31,
AS OF: 2009 2008
- --------------------------------------------------------------------------------
Real estate - construction and land development $ 23,736 $ 21,949
Real estate mortgages 349,029 355,528
Commercial 21,485 27,793
Credit card and related plans 3,168 3,272
Installment and other 27,519 28,135
Obligations of states & political subdivisions 4,349 4,471
- --------------------------------------------------------------------------------
Loans, net of unearned income 429,286 441,148
Less: Allowance for loan losses 6,050 5,275
- --------------------------------------------------------------------------------
Loans, net $ 423,236 $ 435,873
- --------------------------------------------------------------------------------
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 loan portfolio primarily consists of residential and commercial
mortgage loans, secured by properties located in Northeastern Pennsylvania and
subject to 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.
24
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:
MARCH 31, DECEMBER 31, MARCH 31,
AS OF: 2009 2008 2008
- ----------------------------------------------------------------------------------------
Non-accrual loans $ 882 $ 1,454 $ 301
Other real estate owned 474 - -
- ----------------------------------------------------------------------------------------
Total non-performing assets $ 1,356 $ 1,454 $ 301
- ----------------------------------------------------------------------------------------
Loans past due 90 days or more and accruing:
Secured by real estate $ 759 $ 810 $ 186
Guaranteed student loans 280 203 409
Credit card loans 18 17 2
Commercial - 119 120
Other loans to individuals for household,
family, and other personal expenditures - 4 -
- ----------------------------------------------------------------------------------------
Total loans past due 90 days or more and
accruing $ 1,057 $ 1,153 $ 717
- ----------------------------------------------------------------------------------------
Non-accrual loans increased $581 to $882 at March 31, 2009 from $301 at March
31, 2008. However, non-accrual loans have decreased $572 from $1,454 at December
31, 2008.
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 $882 at March 31, 2009, up from $301 at March 31, 2008. If interest on those
loans had been accrued, such income would have been $85 and $33 for the three
months ended March 31, 2009 and March 31, 2008, respectively. Interest income on
those loans, which is recorded only when received, amounted to $3 and $14 at
March 31, 2009 and March 31, 2008, 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 March 31, 2009 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 Federal Bankruptcy Act. Currently, the
Company holds $8.3 million of TERI loans out of a total student loan portfolio
of $20.0 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
March 31, 2009 there was $174,000 in such loans placed on non-accrual status.
At March 31, 2009 and December 31, 2008, 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.
25
LOAN LOSS EXPERIENCE
The following tables present the Company's loan loss experience during the
periods indicated:
MARCH 31, MARCH 31,
THREE MONTHS ENDED: 2009 2008
- --------------------------------------------------------------------------------
Balance at beginning of period $ 5,275 $ 4,700
Charge-offs:
Real estate mortgages 162 -
Commercial and all others - 5
Credit card and related plans 15 10
Installment loans 45 -
- --------------------------------------------------------------------------------
Total charge-offs 222 15
- --------------------------------------------------------------------------------
Recoveries:
Real estate mortgages - -
Commercial and all others - 3
Credit card and related plans 1 2
Installment loans - -
- --------------------------------------------------------------------------------
Total recoveries 1 5
- --------------------------------------------------------------------------------
Net charge-offs (recoveries) 221 10
- --------------------------------------------------------------------------------
Provision charged to operations 996 235
- --------------------------------------------------------------------------------
Balance at End of Period $ 6,050 $ 4,925
- --------------------------------------------------------------------------------
Ratio of net charge-offs (recoveries)
to average loans outstanding 0.050% 0.002%
- --------------------------------------------------------------------------------
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.
The allowance for loan losses at March 31, 2009 was $6,050 or 1.41% of total
loans compared to $4,925 or 1.20% of total loans at March 31, 2008. Management
believes the loan loss reserve is adequate.
The allowance for loan losses is allocated as follows:
AS OF: MARCH 31, 2009 DECEMBER 31, 2008 MARCH 31, 2008
- ------------------------------------------------------------------------------------------------------------
Amount % * Amount % * Amount % *
- ------------------------------------------------------------------------------------------------------------
Real estate mortgages $ 1,200 87% $ 1,200 86% $ 1,200 85%
Commercial and all others 4,000 5% 3,275 6% 3,125 7%
Credit card and related plans 325 1% 300 1% 300 1%
Personal installment loans 525 7% 500 7% 300 7%
- ------------------------------------------------------------------------------------------------------------
Total $ 6,050 100% $ 5,275 100% $ 4,925 100%
- ------------------------------------------------------------------------------------------------------------
* 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.
26
The Company remains in a highly liquid condition both in the short and long
term. Sources of liquidity include the Company's U.S. Agency bond portfolios,
additional deposits, earnings, overnight loans to and from other companies
(Federal Funds) and lines of credit at the Federal Reserve Bank and the Federal
Home Loan Bank (FHLB). The Company is not a party to any commitments, guarantees
or obligations that could materially affect its liquidity.
The Company offers collateralized repurchase agreements, which have a one day
maturity, as an alternative deposit option for its customers. The Company also
has long-term debt outstanding to the FHLB, which was used to purchase a Freddie
Mac pool of residential mortgages, as described earlier in this report. At March
31, 2009 the Company had $145,816 of available borrowing capacity with the FHLB
and a Borrower-In-Custody (BIC) line of credit of $14,500 with the Federal
Reserve Bank of Philadelphia.
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 March 31, 2009 the Bank has entered into contracts for the renovation of
various branches, in the aggregate amount of $1,909, approximately $132 of which
had been disbursed as of March 31, 2009.
RELATED PARTIES
The Company does not have any material transactions involving related persons or
entities, other than traditional banking transactions, which are made on the
same terms and conditions as those prevailing at the time for comparable
transactions with unrelated parties. At March 31, 2009, 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 shares of common
stock. Management has no plans to offer additional shares of common stock at
this time.
The Company's total risk-based capital ratio was 19.09% at March 31, 2009. The
Company's risk-based capital ratio is more than the 10.00% ratio that Federal
regulators use as the "well capitalized" threshold under the Federal prompt
corrective action regulations. 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% minimum threshold, which
determines whether a company is "adequately capitalized".
27
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, 2008. 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, 2008.
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 conducted an evaluation of our
disclosure controls and procedures, as such term is defined under Rule 13a-15(e)
under the Securities Exchange Act of 1934. Based upon this evaluation, our Chief
Executive Officer and our Controller (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.
28
There have been no substantive changes in the internal control over financial
reporting during the quarter ended March 31, 2009 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.
Also, the Company is not dependent upon a single customer, or a few customers,
the loss of one or more of which would have a material adverse effect on its
operations. The operations and earnings of the Corporation are also not
materially affected by seasonal changes.
MARKET RISK
CHANGES IN INTEREST RATES COULD AFFECT OUR INVESTMENT VALUES AND NET INTEREST
INCOME WHICH COULD HURT OUR PROFITS.
At March 31, 2009, the Company owned approximately $108.3 million of marketable
securities available for sale. These securities are carried at fair value on the
consolidated balance sheets. Unrealized gains or losses on these securities,
that is, the difference between the fair value and the amortized cost of these
securities, are reflected in stockholders' equity, net of deferred taxes. As of
March 31, 2009, the Company's available for sale marketable securities portfolio
had a net unrealized gain, net of taxes, of $.4 million. The fair value of the
Company's available for sale marketable securities is subject to interest rate
change, which would not affect recorded earnings, but would increase or decrease
comprehensive income and stockholders' equity.
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.
29
The Company continually monitors the relationship of its interest rate sensitive
assets and liabilities through its Asset/Liability Committee.
STRONG COMPETITION WITHIN OUR MARKET COULD HURT OUR PROFITS AND INHIBIT GROWTH.
The Bank operates in a competitive environment in which it must share its market
with many local independent banks as well as several banks which are affiliates
or branches of very large regional holding companies. The Bank encounters
competition from diversified financial institutions, ranging in size from small
banks to the nationwide banks operating in its region. The competition includes
commercial banks, savings and loan associations, credit unions, other lending
institutions and mortgage originators.
The principal competitive factors among the Company's competitors can be grouped
into two categories: pricing and services. In the Company's primary service
area, interest rates on deposits, especially time deposits, and interest rates
and fees charged to customers on loans are very competitive. From a service
perspective, the Bank competes in areas such as convenience of location, types
of services, service costs and banking hours. Our profitability depends on our
continued ability to compete successfully in our market area.
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 annual and quarterly reports of its operations with
the FRB.
As a financial holding company, the Company is permitted to engage in
banking-related activities as authorized by the FRB, directly or through
subsidiaries or by acquiring companies already established in such activities
subject to the FRB regulations relating to those activities.
Our banking subsidiary, Penn Security Bank and Trust Company, as a Pennsylvania
state-chartered financial institution, is subject to supervision, regulation and
examination by the Commonwealth of Pennsylvania Department of Banking and by the
Federal Deposit Insurance Corporation (the "FDIC"), which insures the Bank's
deposits to the maximum extent permitted by law.
Any change in such regulation and oversight, whether in the form of regulatory
policy, regulations, legislation or supervisory actions, may have a material
impact on our operations.
OPERATIONAL RISK
A CONTINUATION OF RECENT TURMOIL IN THE FINANCIAL MARKETS COULD HAVE AN ADVERSE
EFFECT ON THE FINANCIAL POSITION OR RESULTS OF OPERATIONS.
In recent periods, United States and global markets, as well as general economic
conditions, have been disrupted and volatile. Concerns regarding the financial
strength of financial institutions have led to distress in credit markets and
issues relating to liquidity among financial institutions. Some financial
institutions around the world have failed; others have been forced to seek
acquisition partners. The United States and other governments have taken steps
to try to stabilize the financial system, including investing in financial
institutions. The Company has not applied for and is not participating in any
government sponsored Capital Purchase Programs. Our company's financial
condition and results of operations could be adversely affected by (1) continued
disruption and volatility in financial markets, (2) continued capital and
liquidity concerns regarding financial institutions generally and our
counterparties specifically, including the Federal Home Loan Bank, (3)
limitations resulting from governmental action in an effort to stabilize or
provide additional regulation of the financial system, or (4) recessionary
conditions that are deeper or last longer than currently anticipated. Further,
there can be no assurance that action by federal and state legislatures, and
governmental agencies and regulators, including the enacted legislation
authorizing the U.S. government to invest in financial institutions, or changes
in tax policy, will help stabilize the U.S. financial system and any such
action, including changes to existing legislation or policy, could have an
adverse effect on the financial conditions or results of operations of the
Company.
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THE COMPANY NEEDS TO CONTINUALLY ATTRACT AND RETAIN QUALIFIED PERSONNEL FOR ITS
OPERATIONS.
High quality customer service, as well as efficient and profitable operations,
is dependent on the Company's ability to attract and retain qualified
individuals for key positions within the organization. The Company has
successfully recruited several individuals for management positions in recent
years. As of March 31, 2009, the Company employed 167 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
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PENSECO FINANCIAL SERVICES CORPORATION
By /s/ CRAIG W. BEST
------------------------------
Craig W. Best
President and CEO
Dated: May 6, 2009
By /s/ PATRICK SCANLON
------------------------------
Patrick Scanlon
Senior Vice President, Finance Division Head
(Principal Financial Officer)
Dated: May 6, 2009
32